Banks, online funds battle for larger share of savings

Internet finance firms are gaining ground on banks, but the online fund products face some new barriers and challenges

The battle between China's long-established banks and emerging Internet finance organizations for the nation's massive personal savings is getting uglier.

Traditional financial institutions are clearly losing some ground to online upstarts. Bank deposits dropped 940 billion yuan ($154 billion) in January.

Some of that money was probably withdrawn for Lunar New Year holiday spending, but some of it evidently flowed into Internet-based money market funds, which expanded by 206 billion yuan during the month.

But it's still too early for the virtual financial world to declare a real victory. Recent actions by regulators may spell trouble for the newcomers.

According to the financial publication Caixin, during a recent meeting with the managers of China's largest money market funds, an official of the China Securities Regulatory Commission said the agency may raise the level of required capital reserves for fund companies to ensure they can repay depositors.

Under current regulations, fund managers must set aside at least 10 percent of their monthly revenues from fund management to meet possible redemptions.

Commercial banks must hold about 20 percent of their deposits in reserves, according to the China Banking Regulatory Commission.

Money market funds are open-ended mutual funds that usually invest in short-term debt securities. They're widely regarded as being as safe as bank deposits, only with a higher yield.

The scale of China's money market funds exploded beginning in June 2013, with burgeoning Internet finance and a variety of online wealth management products introduced by Internet giants such as Alibaba Group Holding Ltd and Tencent Holdings Ltd.

Offering rates of return as high as 7 percent, with easy access through mobile Internet devices, money market funds grew at a daily average of 6.6 billion yuan over the past 12 months.

As of Jan 30, money market funds accounted for 30 percent of the total value of fund assets in China, up from 18 percent only eight months earlier, according to the Asset Management Association of China.

The boom was driven by the launch of Yu'E Bao, China's first online wealth management product, which was offered by Alipay (a division of Alibaba).

On Jan 15, Tian Hong Asset Management Co, which operates Yu'E Bao, became China's largest fund company by assets and the world's 14th-largest money market fund, with an estimated scale of 250 billion yuan.

But according to Tian Hong's fourth-quarter report, more than 90 percent of its fund assets were in the form of agreement deposits with banks, also known as negotiated deposits.

Less than 7 percent of the fund's assets went into fixed-income securities - the usual choice for money market funds in other countries.

The massive assets available to the online fund allowed it to negotiate preferential interest rates for its deposits with banks, many of which sought alternatives to raising liquidity in the interbank market last year when interest rates there surged.

But analysts have warned that portfolios structured in this way ultimately render money market funds vulnerable to fluctuations in the interbank market.

The average interest rate for agreement deposits has fallen below 5 percent from a peak of 9 percent before the Lunar New Year, which began on Jan 31, and it's still declining.

That means the online funds have seen their returns from these deposits decline, and they're offering lower rates for WMPs. The return rate for various online wealth management products has declined from more than 7 percent earlier this year to about 6 percent now.

Zeng Linghua, chief researcher with howbuy, an investment consultancy website, said the return rate of money market funds is set to fall even further to 4 percent in March.

"Money market funds require high liquidity, but agreement deposits are mostly based on fixed contracts, so there are cases of mismatch. Sometimes the fund company has to make advance payments on its own," said Xu Gao, chief economist with Everbright Securities Co.

There are other problems, too. Some funds have at times withdrawn their deposits from banks in advance of the agreed maturity. Regulators may halt that practice, which will pose a further challenge to the liquidity of fund companies.

Although the majority of the money deposited with the online funds is still circulating within the broader banking system, Xu expressed concern that the online "spoilers" could further raise financing costs.

"The capital cost for banks will inevitably rise, which may be passed on to the real economy," he said. "But a declining interbank capital market may not be adequate to support such high yields, so default risk does exist."

Niu Wenxin, a commentator with China Central Television, has been among the most vocal critics of online funds, calling Yu'E Bao a "leech" on the banking system.

"By establishing expectations of high yields, (the funds) merely cause higher borrowing rates and tighter liquidity in the money market," Niu wrote on his blog. "To protect the county's macroeconomic interests, the authorities should ban Yu'E Bao."

However, Niu's call for ban encountered strong resistance both online and offline.

In respond to Niu's claim that Yu'E Bao's fees actually add up to 2 percentage points more than its stated charges, the fund said its management fee is only 0.63 percentage point.

For their part, customers said they'd still put their spare cash to Yu'E Bao rather than bank deposits, despite the recent decline in return rates, because it's still a better deal than the annual fixed deposit rate of 3.5 percent.

Lin Caiyi, chief economist with Guotai Junan Securities Co Ltd, said the popularity of Yu'E Bao reflects more than just its higher return. It's also a function of easy access and convenience in shopping and payments.

"It is the choice of the market, and it is the most efficient."

The current scale of money market funds, at nearly 1 trillion yuan, is a mere 2 percent of the 48 trillion yuan in total personal savings, though experts said the industry is still in its infancy.

Yi Qiang, managing director of the Shanghai-based Tebon Fund Management Co Ltd, said the development of China's money market funds in recent months was similar to that of funds in the United States in the 1970s.

"There was explosive growth during the reform process, with a move from regulated interest rates toward liberalized interest rates," he said.

Banks in the US also sought to block the development of money market funds.

The trouble in the US was, these funds drove up capital costs, and banks that were subject to regulated interest rates ultimately failed.

Yi said that the scale of US money market funds didn't shrink until interest rates were fully deregulated in the 1980s.

"In my view, there will be another five to 10 years of rapid development for money market funds in China, and during the process, some small banks that aren't able to control their capital costs will inevitably close down, just like what we saw in the US in the 1980s," he said.

But Xu said with more money market fund companies joining the party, and tougher regulations in the pipeline, the funds themselves will also face more competition.

The "operating abilities of money market funds will be tested, because short-term financing tools offered by banks will be more of a choice in their investment portfolio.

"In the meantime, due to the similar return rates they offer, brand recognition will also be a key factor in the competitiveness of the fund companies," he said.

"Eventually, it will be an oligopoly market, with only major players," Xu said.