Beijing's Grip on Internet Finance Is Tightening

The days of laissez-faire are numbered for financial technology companies in China. For more than a decade, entrepreneurs like Alibaba and Tencent have had freedom to innovate and run vast networks of new internet-enabled business models, taking advantage of a regulation-free environment or circumventing regulations that existed. But in the last few months, China’s government has begun reasserting control, with potentially far-reaching consequences. If Beijing goes too far, it could slow innovation, erode already weak privacy protections, and face slower growth from a less efficient financial system.

At stake is the future viability of highly successful finance operations built on user bases and technical capabilities created by Alibaba, Tencent, and other companies. In the Alipay (Alibaba) and WeChat (Tencent) applications, a swipe of the thumb can not only execute a purchase but also make an investment, apply for a loan, make payments, call a taxi, or send messages to friends. In their wake, other firms serving as online peer-to-peer lenders and microloan companies sprouted to make loans worth trillions of renminbi, with virtually no regulation.

Government officials, from Premier Li Keqiang to regulators at the central bank, have consistently praised the potential of the internet and new technologies like big data to drive future growth, but at the same time the government is also moving to harness the potential of data and technology for social control and power. Leaders from President Xi Jinping down are warning against excessive lending and emphasizing financial security to control financial risk, while proposing measures to wean China’s economy off its addiction to credit. Recent regulatory measures affect electronic payments, credit scoring, securitization, and cryptocurrencies/initial coin offerings or ICOs (fundraising for new networks/companies by issuing digital tokens instead of equity or loans). Together, these measures call for tougher supervision throughout the financial sector with increased government access to, and control of, private firms’ data.

For example, in August 2017, the People’s Bank of China (PBoC) moved to centralize payments and associated data that previously ran as proprietary networks of third party payment operators. Payment systems like Alipay and Tenpay/WeChat Pay could run as a closed loop: An individual puts money from a bank account into her or his internet-based account and then transfers funds freely within that network without a bank being able to see any of these transactions. Since Alipay’s emergence in 2004, these systems had operated with great autonomy until a licensing regime became final seven years later, in 2011. As these systems grew to process RMB100 trillion of payments in 2016 (link in CN), growing at 100 percent per year, the government became increasingly concerned about their stability and the threat they posed to traditional payment providers, incumbent banks, and China Unionpay. More regulation became inevitable. PBoC’s August measure allows it greater access to information about these transactions, by forcing the internet giants to share valuable data. Sources have suggested to me that banks also have been able to access data on transactions from this measure, but I have not been able to confirm which data and how the access works. Starting this month, another PBoC measure (link in CN) forces online payment providers to place much higher shares of customer funds in special accounts that do not pay interest, thus hitting their profitability. Over US$600 million in annual interest income from these reserves will reportedly disappear under the latest requirements.

In addition, PBoC appears to be withdrawing its plan to allow eight private firms, including systems under Alibaba affiliate Ant Financial, Tencent, and Ping An, to create their own credit scores. The original 2015 plan to approve qualifying systems in six months remains in limbo two years later. In parallel, the National Association of Internet Finance, created by PBoC and headed by one of its former vice governors, has applied for a license for its own credit scoring system called XinLian (roughly translated as “credit link”). Major players like Ant Financial and Tencent appear to support the system publicly, because they have signed on as shareholders. However, these businesses will in effect be forced to turn over valuable credit and possibly other data to XinLian. They are resisting turning over such data, but the regulators appear to be winning. These moves show a clear shift towards centralized, heavier regulation of credit data and payments.

The main channel through which Ant and Tencent fund their loans has been obliterated, a case of collateral damage from measures released on December 1, 2017, to crack down on the mostly unrelated phenomenon of high-interest, short-term loans called “cash loans.” One of the provisions of the regulations (section 2, subpart 3), which the English-language press has mostly missed, requires online microlending companies like those owned by Ant and Tencent to now count loans they sell to others, including securitizations, against meager limits on outside fundraising originally intended to keep these firms and their loans small. Large fintech firms have issued trillions of renminbi in loans thanks to these methods, which may have escaped scrutiny if unscrupulous cash lenders had not also begun to employ them. It is striking that regulators were willing and able to take such a drastic measure to eliminate a well-established funding channel for China’s most powerful companies, with no replacement in sight.

Finally, as described in an earlier blog post, the all-out ban on ICOs in China suggests that regulators are willing to move much more quickly and boldly to assert coordinated control over new forms of finance. ICOs would have been a sort of “hot potato” that no regulator wanted to touch, to avoid being seen as responsible for the inevitable blowup.

All these decisive regulatory actions show a change in the government’s thinking that has profound implications for the future of Chinese finance. Some of its policy reversals stem from collapse of the multibillion dollar Ponzi scheme Ezubao in December 2015 and the protests it sparked. The downsides and risks of so-called financial innovation could no longer be overlooked, and “internet finance” became a “bad word” in the eyes of regulators and defrauded investors. Though tiny as a share of China’s enormous financial sector, regulators saw the new activities and companies as posing serious risks to both financial and social stability. But they clearly have other motives. The data these firms generate have political ramifications, beyond creating opportunities in the financial sector. The Communist Party is always looking for ways to expand its influence and thus wants real-time access to these data.

I expect that Beijing will continue to tighten regulations in China’s financial technology sector, not just to guard against financial risk and respond to legitimate monopoly concerns but also to give China’s slow-moving banks a chance to catch up with their newer, nimbler virtual competitors. This tightening might reduce certain types of fraudulent or risky activity, but it might also repress the financial sector again. Jack Ma recently commented: “I don’t see anything that’s bad for us yet honestly.” If the pendulum swings too far toward greater government control and regulation, however, laudable progress in making credit available to more consumers and increasing competition for inefficient banks may fade away.