Fraser Howie and co-author Carl Walter wrote Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, a seminal book on the creation of China’s state-owned banking behemoths. Howie thinks the country’s fintech upstarts like Ant Financial, for all of their newfound clout, are still beholden to the brittle foundation of their old-economy predecessors.
Howie was an equity derivatives trader at Morgan Stanley in Hong Kong, and moved to China in 1998 to work for China International Capital Corporation. His book describes state-owned banks that look like capitalist institutions on the outside, but are tools of the Communist Party’s power. Their lending practices are guided more by the Party’s political aims than by commercial ones, and the institutions have required periodic bailouts to remain solvent.
The country’s mega banks have historically fueled state-owned enterprises, but provided little sustenance to smaller private businesses. In absence of other options, risky shadow banking, as well as financing from the likes of Alibaba affiliate Ant Financial, has sprung up outside the formal Party-controlled banking system.
Howie says some aspects of China’s financial system have evolved beyond recognition in recent years. The country’s stock, bond, and interbank-lending markets have developed substantially, and physical cash seems nearly obsolete in many aspects of daily life. Other things remain the same, he says, like Communist Party control.
Howie is now an independent analyst based in Singapore. Quartz spoke with him about how China’s financial system has evolved since his book was first published in 2011, and how Ant Financial and Tencent fit into that system. The conversation was edited and condensed for clarity.
Quartz: One of the things I took from your book is that China’s banking system isn’t what it appears. Has that changed in the years since it was published?
There are some big changes in the financial system, and there’s a lot of things that I think are very similar. What I think is similar is the outsize role of the state and Party in allocating resources. The market is not the deciding factor by any means. The role of the state, and that could be license approval, guiding resources, guiding banks, guiding lending, is still very significant. The unwillingness to recognize loss, and the broad sense of kicking the can down the road, remains very prevalent. Having said that, I look at Europe or America, and I’m thinking we’ve only done the same thing ourselves. From that perspective, the Chinese have no monopoly on refusing to confront losses.
There are certain things that work extremely well in China. You have a stock market that is trading $150 billion today, and millions of transactions. You simply do not trade that amount of activity without things working. So there are certain things that work extremely well.
What’s become extremely clear, the Alibaba, Alipay, internet-related payments, that has gone extremely smoothly. It still can be extremely clunky moving money between banks, between institutions, and things like that. That can be problematic. The fintech thing has changed.
Moving money out of the country is extremely clunky. Moving money into foreign currencies can be still very difficult. Paying for your coffee with your WeChat wallet, super easy.
Consumption is easy.
Yeah. So that all works. But at the same time, here’s something. It’s really cool if you’re a Chinese, with a mainland ID, with a domestic bank account, and you’re fully integrated into the system. You go into many bars and restaurants in Beijing, and try and pay a bar bill, even an expensive bar bill, with an international credit card, and you’ll find it may be impossible to do so.
So what you’ve seen is, while there’s been a tremendous efficiency for Chinese-to-Chinese business, and intra-Chinese domestic business, where it very much lags, and therefore you could say in some ways has gone relatively backwards, is China’s openness and ability to actually engage with the world.
Rules are being written purely with a domestic audience in mind. Financially, there are obviously currency and capital controls, and there is the Great Firewall. There simply is no concept of writing something which isn’t for domestic consumption.
At many levels you’re seeing this “us and them,” which is very common in China.
My reading of your book is that China’s state-owned banks mainly lent to state-owned companies, and regular, smaller businesses were left out. Does Ant Financial deserve credit for reaching the smaller enterprises ignored by the big banks?
Absolutely, yes. They do deserve credit. I think their numbers are still relatively low, but without question, Ant Financial does get credit.
But also, I will give full credit as well to the shadow banking industry for doing the same thing effectively. The shadow banking industry has been rightly condemned, or there are worries about the quality of documentation and where the risks are and the transparency and all those sorts of real, genuine issues. They too largely sprung up because there was a need that was to be met by the million or so small businesses in China, which were basically completely outside the banking system. So yes, they definitely deserve credit for trying to democratize finance in that way, where the state banks were unable to do so, or were slow to do so.
In a world of fixed-deposit rates, of restricted lending to only the state-owned enterprises, both of those are developments that allow depositors to get a better return on their deposits, and also clearly got money to a lot of companies that would not have got money otherwise.
Can China now develop that and bring those things into fold, as it were, and better regulate them and make them more standardized, and more reliable and trustworthy? Certainly in the shadow banking sector there was a lot of dubious things going on, or poorly undocumented stuff going on.
If the state-owned banks are levers that the Party can pull to carry out its objectives, does the rise of Tencent and Ant Financial weaken the government in some way?
They have not lost control in the sense that [Alibaba founder] Jack Ma, first of all he’s a Party member, and he has openly said that he would happily hand over Alibaba if it was in the interest of the country. So the state’s ability, or the Party’s ability, to exercise influence in private businesses is as great now as, in some ways, it has ever been. Nobody should be naïve about the reach of Xi Jinping’s Party into private businesses, and its feeling that it can exercise its influence however it sees fit. So that still remains.
It has complicated things because the system has now become much, much more complex. It used to be when you go back 20 years ago, or 15 years ago, you had basically five banks doing 70% of the lending, 85% of that to state-owned companies, and loans basically were determined by a loan-to-deposit ratio set by the central bank. What could have been easier?
You now have a far more complicated financial system of institutional actors, private-sector actors, complexity of products, whether it be through shadow banking or even banker’s acceptances and commercial paper and a broader range of financial instruments. So complexity in the system has definitely increased. You could argue that’s also losing control.
Having said that, the fact that so much of this is now going into digital format, and all-encompassing AI intelligence or something, it’s all going into the big central databases, you could also argue that there’s a case that it may become more transparent in the end.
So yes, it’s a far more complicated picture, which implies loss of control, but the more things become digital, maybe you have far greater control. Because literally with the flip of a switch you can turn people on or off.
I certainly don’t see these companies posing a threat to the Party, let’s put it that way.
So where do Ant Financial and Tencent fit in the Party system?
Jack Ma and [Tencent founder] Pony Ma, the two of them know which side their bread is buttered on. If the Party wants their data, they’re going to hand it over to them. Their companies have become so intrinsic and so important to the running of the economy in China now that they are effectively beholden to the state. They may not be state owned, but they are beholden to the state because the state simply can’t operate without these companies.
If you were to close either of them down, it would cause tremendous dysfunction within the economy and people’s livelihoods. So, therefore, the companies are certainly not independent from the state.
That makes me think of Ant’s money market fund, Yu’e Bao, which is so big it has become a systemic risk for China. Is it also a sign of imbalance, reflecting a lack options for Chinese savers? Because of capital controls, Chinese investors can’t easily invest in international stocks and bonds, for example.
What it tells me is, why on Earth are there so few opportunities, that the best thing you can do with your money is put it in a money market fund? There is just a tremendous amount of money that’s been printed in China, a tremendous amount of liquidity that’s out there. So it is a sign of imbalance.
You know, China loves big numbers. Someone has got to have the biggest fund. And the fact that it’s China’s is reflective of a tremendous amount of liquidity that’s been pumped into the Chinese economy… and can literally find no better use than to sit in cash and short-term products.
Do you think Ant Financial and WeChat Pay are tech companies or financial companies?
They’re a bit of both. Deliveroo isn’t a pizza company, and yet you order a pizza through it. And I think in the same way, they’re not financial companies in the sense that they’re still not running market-related risk. Interest rates change, they don’t change. Yield curve changes, they don’t change. What they have done is used a technology platform to gather financial assets.
In that sense, even their financial bit is actually very, very similar to what all other financial companies are doing. The difference is their tech side. They simply had a different reach, because they were reaching people through a tech platform, rather than actually doing anything particularly unique in finance, as it were.
If you think of what financial companies do, they are exposed to capital-market risk, they are exposed to credit risk, things like that. These companies generally are not. Now they have started to move into credit risk, to some extent, by making loans to small- and medium-size enterprises through their platforms. So that’s going on there. They’re generally not deposit-taking institutions. You know you can leave money in your Alipay account or your WeChat wallet. But many of these accounts are linked to bank accounts anyway. They’re not necessarily deposit-taking institutions in the traditional sense.
So you have this shiny, new internet thing on top—Alipay and WeChat Pay—but they’re sitting on this bedrock of not-so-functional, not-so-modern, state-owned infrastructure.
They’re not a bitcoin, as it were. There’ve not somehow created a different or an independent financial system. Ultimately, they’re still sitting on bank deposits, lending money, stuck in that state system. And I’m not sure why anyone should think otherwise. All they’ve done is find a different way to collate money.
You come back to Yu’e Bao, half of the money is in time deposits. OK. So, let’s think back to your question. Is it a finance company or a tech company? So basically, all they’ve done is, online, they’ve hoovered up all these deposits. And what have they done? They’ve turned around and put them in a state-owned bank.
So again, you think, this is really high tech! This is super sexy, we’re changing the world, we’re the disrupter. And so what you did was you sent somebody to the local branch and deposited a lot of money. Well, that doesn’t look really high tech to me.
You’re still dependent on what is very much the traditional financial institutions to put money in deposits. They’ve gone from new economy to old economy very, very quickly.
What else should readers keep in mind when it comes to China’s financial system?
Always be cautious, because what appears on the surface in China is almost certainly not the substance.