Online finance gaining share but facing challenges

The dramatic push into Internet finance this year has opened up a revolutionary means of financing other than resorting to the capital market or conventional banks. It heralds an era in which all market competitors can borrow and lend directly on the Internet with few information barriers.

Booming Internet finance is closely associated with the development of so-called big data, which incorporates all sorts of information on a platform accessible to many people. The chance of a company defaulting on its loans can be more easily calculated by looking at the data of its past performance instead of just at its balance sheet.

In spite of all the advantages in terms of convenience, high returns and easy access, Internet finance is full of uncertainties just like anything else that is new. The safety of the data, fierce competition and risks could dampen the profitability of Internet finance.

The year 2013 has been called the first year of the Internet finance era. This innovative form of finance actually entered China seven or eight years ago, but last year witnessed an exponential growth of various forms of Internet finance, including online credit, big data, IÏnternet financial portals and third-party payments.

There are three main categories of Internet financial products.

First is payment and settlement services, most of which used to be carried out by banks. Now bills such as water, electricity and gas can be paid through third-party payment platforms.

Second is financing services, such as taking out loans through e-commerce platforms. Customers can seek capital on the Internet independent of bank loans. Many peer-to-peer platforms fall into this category.

The third category is the sale of financial products on the Internet, such as Yu'ebao, Bitcoin, a peer-to-peer payment network and digital currency, and ZhongAn Online P&C Insurance Co Ltd that sells insurance targeting e-commerce vendors.

The overall scale of Internet finance is still small. For instance, third-party payment accounts for only 1 percent of total finance. Major settlements still takes place among conventional banks.

Alibaba Group's Yu'ebao has become a highly successful example of Internet finance. Since its launch in June, it has attracted more than 30 million users with 100 billion yuan ($16.5 billion) of deposits by mid-November. Yu'ebao distinguishes itself with a stable and high return as well as convenience. In 2012, time deposits of 100,000 yuan could generate 3,250 yuan in annual interest. The same amount in Yu'ebao could yield an extra 750 yuan in interest. The money in the account could be used for online-shopping, transfers, credit card repayment, paying phone bills and other tasks.

Other Internet giants, such as Tencent Inc and Baidu Inc, have launched their own versions of monetary fund wealth management products. Major e-commerce operators such as Beijing Jingdong Technology Co Ltd and Suning Commerce Group Co Ltd are also trying their luck with Internet finance.

However, the competition that it poses to traditional banks is yet to be fully understood.

"If metal currency substituting for shell currency was the first financial revolution, followed by bank notes substituting for metal currency, Internet finance is the third revolution in finance," said Zhang Guoqing, vice-president of Zhongguancun Innovation Institute.

The first revolution made it possible to lend and borrow at a specific level of interest. The second revolution enriched financial products, introducing funds, securities, equity rights and other products. The third revolution that is taking place now is breaking the profitability of information asymmetry, expanding the means of knowing who has money and who needs it, said Zhang.

Opportunities in risks

The enthusiasm for Internet finance is partly caused by the underdevelopment of China's financial market. Interest rates are not completely opened up and the investment channels are limited. Therefore, investors find the high returns of Internet financial products appealing.

However, most investors are only seeing profits rather than risks, taking it for granted that the government will clear up any mess should any risks hit the industry. Therefore, Francis Chen of Bloomberg Research Information believes the government will tighten its control over Internet finance in the future.

"Internet finance will face more stringent and detailed supervision than conventional banks, putting pressure on profitability," said Chen. "Once the restriction on interest rates has been completely lifted, the interest arbitrage that Internet financial products now enjoy will soon disappear."

Zeng Gang, director of the banking research center of Institute of Finance and Banking at the Chinese Academy of Social Sciences, summarized three points for the future of Internet finance.

Internet financial service providers must enhance their investment management capabilities. The expanding financial products on the Internet require stable returns to customers. Yu'ebao and other Internet-based money market funds are making very simple investments, which cannot offer high returns in the long term.

"Internet finance has been advocating its advantages of lowering credit risks through streamlined data management. However, mathematical analysis cannot be so accurate as to fend off any kind of risk," said Zheng, "The United States for instance, with its strong ability in Internet data processing, did not avoid the sub-prime crisis."

The risks in finance have become so diversified that they are no longer the only or most serious kind. Having enough money does not only mean higher responsibility in risk prevention but also exploration of the means to deal with financial fluctuations in the future, said Zeng.