China signals move to regulate Internet finance

China will not ban web-based financial products like Yu'E Bao, but will strengthen regulation to guide the healthy growth of Internet finance, China's central bank officials said Tuesday.[Special coverage]

With this reassurance, made four times in one day on different occasions by three top central bankers, the dust seemed to have settled following months-long debate about the fate of popular Internet financial products.

The emergence of Yu'E Bao and its peers has brought joy for millions but also unnerved many. Whether authorities should step in to regulate the burgeoning Internet finance has been a widely watched topic as China's lawmakers and political advisors gather this week in Beijing to discuss the country's social and economic policies.

DAVID VS.GOLIATH

Internet financial products like money market fund Yu'E Bao, created by e-commerce giant Alibaba, have been instant hits among the Chinese public.

Chinese people have pulled money from traditional banks, which offer a maximum 3.3 percent interest rate for one-year deposits, and moved it to web-based money market funds like Yu'E Bao, which offers a seven-day annualized yield of nearly 6 percent.

The better interest rate enabled Yu'E Bao to attract 81 million users with aggregate deposits estimated at around 500 billion yuan (81 billion U.S. dollars) in just eight months.

Big banks are not happy. At a time when China's liquidity is generally tight, such a big migration of money has eaten up much of their profits.

Yu'E Bao and its peers have quickly been labeled "blood suckers" by commentators, while the public has seen the banks and their low rates as miserly.

Rounds of tit-for-tat between the two sides showed no signs of abating until the authorities weighed in on Tuesday.

China will not ban Internet finance, but will improve regulations in the area, said Zhou Xiaochuan, governor of the central bank.

"China encourages technological applications in the financial sphere," he said.

"Improvements must be made in existing policies, supervision and regulation as they cannot cope with new things such as Internet finance and guide its healthy development," said Zhou.

Internet finance encourages innovation and development, and what it needs is improved and coordinated supervision, said Pan Gongsheng, a vice governor of the central bank.

Despite being supportive of innovative financial products like Yu'E Bao, the central bank will take "appropriate measures" to prevent possible risks arising from the sector, said Yi Gang, another vice governor of the central bank.

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

It seems that David has gotten the better of Goliath again, at least for now.

PROFITS VS. RISKS

Financial innovations like Yu'E Bao are nimble and attractive, but economic pundits have warned that they are not risk-free and should be regulated to avoid any adverse effect on the general economy.

China International Capital Corporation, China's largest investment bank, said in its latest research note that Yu'E Bao has placed 92 percent of its assets in interbank deposits and used the different terms of maturity between investors to reap high interests.

However, such Web-based money funds may face huge risks, warned Lyu Suiqi, deputy dean of the finance department at Peking University.

"As the assets of Internet finance products like Yu'e Bao increase, so will their liquidity management pressure," Lyu said, adding that such money funds rely too much on interbank deposits for high interest.

Their ability to bargain with traditional banks will weaken as market liquidity improves and more competitors enter the race, he said.

Millions of investors woke up on Tuesday to find the seven-day annualized interest of Yu'e Bao eased to 5.93 percent, the lowest level since December.

"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 Chinese People's Political Consultative Congress, the top political advisory body.

That said, there is no reason to throw the golden baby out with the bath water if a little amount of regulation will nurture financial innovations for maximum benefit to the Chinese economy.

Not only do these new products offer a sign of hope for individual savers, but they have assisted micro businesses and spurred China's interest rate reform.

"The public is more concerned about what real changes Yu'e Bao could bring to the financial monopoly," said Xu Xuelan, secretary-general of the Chinese Institute of Electronics. "We are expecting much more reform resolve and action in this regard."