Internet finance debate heated amid regulation proposals

Online deposit products provided by Chinese technology firms have not only gotten on the nerves of big commercial banks, but drawn attention from the country's top legislators and political advisors.[Special coverage]

According to media reports, Wang Jingwu, a banker from Guangzhou and deputy to the National People's Congress (NPC), and Xie Wei, vice manager of a fund company who is in Beijing for the National Committee of the Chinese People's Political Consultative Conference (CPPCC), have brought their own proposal on how to regulate Internet finance.

The annual sessions of the NPC and CPPCC are set for some intense debate on Internet finance. It will be the latest episode in a Chinese drama in which the lead role is played by Yu'E Bao (Left-over Treasure), a star online deposit service launched by Internet giant Alibaba's online payment arm Alipay in June 2013.

Allowing Alipay users to channel spare money to money market funds with high returns and almost zero threshold, Yu'E Bao became an instant hit. The service has so far attracted 81 million users, with aggregate deposits estimated at around 500 billion yuan (81 billion U.S. dollars).

Many netizens and entrepreneurs have supported it, hailing it as a good innovation, a relief for individual savers and micro businesses and a whip on China's interest rate reform. Financial experts, on the other hand, have cautioned against risks.

"The biggest problem for the development of Internet finance is default risks that might inflate within a short period of time," said Li Daokui, an economist and member of the National Committee of the CPPCC, the top political advisory body.

Li explained that "a moderate amount" of regulation is needed to prevent risks such as collective withdrawals, that are easily fulfilled on an online world.

"But whether it should be regulated in the same way as offline products needs further study," he said.

UP IN THE AIR

Although the central bank scrapped the floor of lending rates in July 2013, its reins on deposit rates have not been relaxed. Banks short of cash may resort to the interbank market, which involves borrowing from other banks and financial institutions, often with much higher rates.

The latest quarterly report by Tianhong Asset Management, a money market fund company in close partnership with Alipay, showed 92 percent of Tianhong's assets are invested in the banks.

Yu'E Bao could make a profit between the high lending rates enjoyed by a fund company on the money market, and the deposit rate it offers for ordinary savers using Yu'E Bao. This has prompted calls to put restraints, such as reserve requirements, on the funds Yu'E Bao has pooled.

China's securities regulator said on Friday that it is working on a set of rules to guard against risks in funds raised online, but the central bank and other regulators have been reserved about any precise moves they would take.

Yi Gang, vice governor of the central bank, said Tuesday that the central bank is "supportive" of innovative financial products like Yu'E Bao, but "appropriate measures" will be taken to prevent possible risks arising from the sector.

Yi said the central bank will closely watch market changes to prevent possible risks, while warning investors to be more cautious in their choices.

Kuang Xianming, head of the economic research center at Hainan's China Institute for Reform and Development, said it is unlikely to unveil regulations targeted only at Internet finance at this moment.

"The development of Internet finance is at an early stage. Innovation may be inhibited if targeted regulations come too fast," said Kuang.

But he noted that uncertainties at the regulators' level could also be a drawback for the burgeoning business.

Internet finance may pose a new challenge to China's financial regulators, which carry out their work largely in fragmented sub-sectors like banking, insurance and securities.

A unified, effective system of regulation is needed for serving both Internet finance, and the traditional financial sectors, said Kuang.

Mei Xingbao, a political advisor and former president of the state-owned China Orient Asset Management Corporation, said a key task for regulators is to direct funds raised by Internet companies into the real economy.

One solution is to match the funds with specific projects, like those in environmental protection and new energy, but policy support might be necessary in this regard, Mei said.

INNOVATION WITH COSTS

The dilemma of Internet finance also stems from its role as a challenger to traditional banking.

Commercial banks have certainly felt the pressure. The state-backed "Big Four" launched a host of quasi-Yu'E Bao products, trying hard to retain prospective depositors.

"Being zero-cost and convenient, Internet finance adapts to and satisfies social demand, and fills a gap that the traditional banks do not care to look at," Kuang said, calling it "an example of innovation shaped by market forces."

Mei agreed that Internet finance will help spur China's interest rate reform and drive banks out of their comfort zone, but added that an overthrow is unlikely as large enterprises and institutions are still a major source of income for banks.

The debate centered around Internet finance and innovative power has also caught the attention of China's leading entrepreneurs.

"Internet finance is not just about what it is, but what it represents" said Li Shufu, chairman of Chinese carmaker Zhejiang Geely Holding Group. "What we care about is whether it's fair, open, transparent. Who can do it and who cannot? Is it decided by the market or the very few?"

Robin Li, the chief executive officer of Baidu, another Internet giant, noted that "innovation always comes at a cost" when asked to comment on the Internet finance controversy.

Given the risks brought along with innovation, it is fully justified for the government to strengthen regulation, according to Li.

The shocks imposed on some industries by the Internet may catalyze landmark changes, he said.