Asia Financial Industry Blog

An interesting graphic from IDC and WSJ looks at the declining growth rate in smartphone sales in China. China's smartphone market is maturing.

Money funds in China have been around for a long time with the first launched just over a decade ago in 2003. For the most part, these funds existed in relative harmony with the banking industry and occupied a small niche in the investment market. However, the emergence of Yuebao in 2013 started to change that. Money funds have now grown significantly in prominence and present an increasing threat to traditional banking services.

The Basics

If you haven’t been following Chinese online finance innovation industry, here’s a quick brief: leveraging mainly underlying high-yield interbank deposits as assets, China’s main internet giants including Tencent, Alibaba and Baidu have launched online finance products where users can quickly and easily move money out of their banks accounts onto these platforms. Tencent uses their nearly ubiquitous Wechat app as the main user interface which Alibaba uses their Alipay platform to distribute the products; the underlying funds are managed by an external asset manager.

The typical returns of Chinese online finance innovations are between 5-8% and greatly eclipse traditional bank deposits, which yield less than 1%. With this kind of return, it’s not surprising that consumers are moving assets over to the platforms at an astonishing rate with some funds accumulating over 400 billion RMB (~US$66B) in AUM in less than a year making the asset managers some of the largest in China.

At the same time, taxi booking apps are growing incredibly rapidly in in China’s eastern coastal cities – some with the support of the internet giants as well. Over US$40 million of investment has gone into the taxi booking apps over the past two years and it’s not uncommon to ride in a taxi where the driver will have 3-4 phones all running the apps on his/her dashboard.

Bring it together

A key part of the internet giants’ strategy has been to bring everything together in one platform. Tencent, already with a significant user base through it’s ‘whatsapp on steroids’ Wechat app allows you to invest in their online finance product called Licaitong and they have integrated a taxi booking app called Didi Taxi where you can ‘tip’ taxi drivers a pre-selected extra amount to come and pick you up.

Money for nothing and your taxi for free

So, all of the above is well and good. Where it gets interesting is the level of competition in the marketplace and what companies are doing to gain marketshare. A Chinese friend related her experience:

She initially called a taxi via Didi taxi. Didi is running a promotion where you can get 12 RMB (~US$2) back on your taxi ride when you use the app. Base fare in a taxi is 14 RMB (~US$2.33), so she paid 2 RMB (~US$0.33) for the taxi ride. But wait, there’s more…

The taxi driver then asked if she could pay using Alipay and she said yes. Why? Because Alipay is running a promotion where she could get 13 RMB (~US$2.15) back and the taxi driver then likely also received some reward. The taxi driver then gave her the 14 RMB in cash and she sent him 14 RMB via Alipay.

So let’s do the math:

 

Rider

Taxi Driver

Internet Giant

 

Change

Balance

Change

Balance

Change

Balance

Initial Ride

-14 RMB

-14 RMB

+14 RMB

+14 RMB

0

0

Bonus for using Didi

+12 RMB

-2 RMB

0 RMB

+14 RMB

-12 RMB

-12 RMB

Driver pays rider cash

+14 RMB

+12 RMB

-14 RMB

0 RMB

0 RMB

-12 RMB

Rider pays driver w Alipay

-14 RMB

-2 RMB

+14 RMB

+14 RMB

0 RMB

-12 RMB

Bonus for Using Alipay

+13 RMB

+11 RMB

??

??

-13 RMB

-25 RMB

Net

 

11 RMB

 

14+ RMB

 

-25 RMB

So basically, my friend was paid to ride the taxi. She can then take that 11 RMB and instantly put it on her online finance account where she’ll earn about 6% and the internet giants are out a combined 25 RMB.

Of course in the internet space, we’ve seen plenty of companies providing products or services for free or nearly for free, but the scope with which this is happening in China is amazing. And it’s happening more and more.

Take your lessons to go

Time is compressed here. Group buying developed over years in the US and took another couple to fade away. In China, it was started and finished in less than 3 years. Will taxi booking and online finance be similar?

Although both products are essentially in the middle of a ‘perfect storm’ of a huge potential user base, very tight liquidity (giving high overnight lending / fixed deposit rates) and tremendous mobile and internet penetration and momentum, the winds are shifting in terms of innovation and it has put fear into the financial industry.

Both banks and securities firms are feeling the pinch from internet finance. Banks are facing eroding deposits in the face of gradually liberalizing interest rates, while brokers and asset managers are seeing their customers move to relatively high-return products that carry very few fees.

Although the same ‘perfect storm’ may not be happening in the west, paying attention to how things are developing in China is important as more Walmarts and Tescos move into the banking space. Not that banks were ever really known for innovation, but here in China, it's clear that the innovation is certainly not - which is putting them in an increasingly tight position.

The latest figures from the China Banking Regulatory Commission (CBRC) shows that China commercial banks’ deposit net interest margin has been increasing from 2.57% in 2013Q1 to 2.68% in 2013Q4, despite of the pressure from the interest rate liberalization.

February 2014, represented another month of decreasing commission fees in China's capital markets as the entrance of China's technology giants in internet finance starts to affect not just banks, who are losing deposits, but securities brokers whose fees are being squeezed. 

According to the latest figures from the China Banking Regulatory Commission (CBRC), both commercial banks' balance of Chinese bad loans and the ratio of bad loans increased throughout 2013.

The continuing increase of bad loans is an indication of the challenges in China's economy currently. With an economic transition happening and increased lending on bad loans, this is not likely to decrease in 2014 which will pose even more of a challenge for banks as they face increased interest rate liberialization and other financial industry reform. 

China's Bad Loans

According to the latest figures from the China Banking Regulatory Commission (CBRC), Chinese commercial banks’ accumulated net profits reached 1.4 Triliion RMB in 2013, up 179.4 Billion RMB from 2012. However, the growth rate of net profits has been decreasing in recent years. In 2011, profits grew 36.33%, then dropped dramatically to 18.96% in 2012, and again in 2013 to 14.48%.

Research shows that the decreasing trend of Chinese commercial banks’ profitability growth rate seems to be in line with China’ declining GDP growth rate, shown in the chart below. It reflects that with the acceleration of interest rate reform and the influence from internet finance, China’s commercial banks profit margin faces continuing pressure.

Chinese Bank Profitability struggles

Yu’ebao had already made Tianhong Asset Management the largest one in the public fund industry in China in early 2014. However, the scale of Yu’ebao has continued to grow with the latest figures showing the AUM of Yu’ebao reaching RMB400bn on Feb 14, 2014, a leap of 60% compared to only one month ago. The speed of capital inflow is still accelerating in 2014. We may witness Yu'ebao becoming the largest money market fund in the world soon. 

The fast expansion of Yu'ebao crosses 400B under managementYue bao AUM data of Chinese money market funds, especially the ones leveraging Internet Finance, reflects the large wealth management demand potential of Chinese market and new innovative finance forms that will appear in the Chinese market in 2014.  

After what seems like forever, on February 18th, the regulators gave us a milestone reform for cross-border trade.

Not satisfied with just taking deposits from banks, online finance platforms are facing more competition from each other.

 

Over the past weekend, Alipay announced that it processed about US$150 billion in mobile payments in 2013 which is potentially more than PayPal and Square combined. PayPal cleared US$27 billion in 2013 and Square's number is not public, but likely far less than even PayPal's. 

Mobile Payment Transaction Value

That's a huge number and makes Alipay the largest mobile payments platform in the world. It wasn't really a question of if it would happen, but when. With over 300 million users and 100 million mobile users, Alipay's mobile payment growth has tremendous market scale which is part of the reason for the success of their Yu'ebao investment product that just seems to keep growing and growing... 

According to data from the China Securities Depository and Clearing Corporation Limited (CSDC), there were 261 new Qualified Foreign Institutional Investor (QFII) accounts opened in 2013 which represents about 43% of the total QFII account number from 2003 to 2013. Compared to 2012 figure. Number of QFII accounts rises by 129%.

So why are foreign investment institutions so interested in opening up accounts to trade the Chinese market when returns are so low? One reason is that the mainland regulators have been pushing towards more open markets and lowering the QFII requirements with the intent of introducing foreign capital to provide better liquidity in an anemic a-share mainland market. In addition to new accounts, more than $49.7 billion in QFII investment quota was approved in 2013.

The potential second reason is that foreign investors see potential opportunities in the mainland market either with current relatively low valuations or in the anticipation of future market growth if the market does pick up. 

 

New QFII account growth

As Chinese New Year wraps up and people (very!) gradually come back to work in mainland China, we wanted to take a step back and look at where we are with Bitcoin in China for the year of the horse.

Thank you to everyone who attended the Top-10 China Financial Technology trends webinar just over a week ago.

The sheer size of China's population and geography means that you get some pretty amazing statistics out of it. Couple that with increasing internet and mobile penetration and you have some pretty sizable numbers.

For decades, China has been known as the imitator and not the innovator. The argument goes that the West came up with social networking, mobile payments, group-buying, etc. and China imitated it, sometimes better, sometimes worse. C2C – copy to China. R&D – rob and duplicate. There are numerous terms to describe it. 

The Shanghai Stock Exchange has been in the doldrums for the past couple of years and was the worst performing Asian exchange of 2013.

2013 will remembered as an incredibly dynamic year for China’s financial services industry. From the increasing number of hedge funds in the market to the emergence and regulation of Bitcoin, industry observers, investors, participants and regulators have had their work cut out for them keeping up with the market.

Over the past week, Robocoin Technologies announced they were expanding their Bitcoin ATM offering into Asia with planned ATM installs in Taiwan and Hong Kong.

On November 27, 2013, the Ali-cloud division of Alibaba group announced the launch of Ali Financial Cloud services.

Background

Ali financial cloud services has been developed to provide secure and stable IT resources and internet operation services for financial institutions including banks, funds, insurance companies and securities companies. The service is based on cloud computing, with the cooperation from many well-known financial product solution providers and Alipay’s standard connection portal and a completely sandboxed environment.

At current stage, China's approximately 2,000 small and medium banks are the focus of Ali Financial Cloud as these banks typically do not have enough capital and technology experience to develop their own robust IT structure, so outsourcing is thought to be a low cost and efficient way for these banks to process large amount of data and information.  

The claimed benefits Ali Financial Cloud include:

  1. Enable Small and medium banks to have their own online banking system and mobile banking systems and expand e-commerce and online banking services in the rural areas.  
  2. Provide stable and strong business processing capabilities for small and medium banks during high demand periods
  3. Enable small and medium banks with smaller technology footprints to develop innovative products and solutions that would typically only be available to larger banks
  4. Reduce IT support requirements

One example provided by Ali cloud website shows the processing capabilities of Ali cloud. About 300 million transactions of Yu’ebao could be cleared within 140 minutes, or about 35,000 transactions per second. Some financial firms are already using the Ali fianancial cloud including asset management companies, rural banks, regional banks and insurance companies.  

Historical Context

Cloud computing in China's financial services industry, similar to other global markets, has been slow to take off. Players like IBM have in the past setup comprehensive cloud computing research centers to attempt to move the market, but none have been incredibly successful in gaining a foothold. 

2014 might be the year when we see this change. Cloud technology and security has become increasingly sophisticated and with an increasing profit squeeze due to liberalising interest rates, banks will be looking for ways to increase revenue, reduce cost, and more importantly, stay innovative.

2014 - Year of the Cloud

Certainly Cloud will be a key industry topic as we move into 2014 with major players besides Alibaba including IBM, 21Vianet and Tencent all vying for a part of the increasing cloud computing pie.

It will also be interesting to see the level of innovation that happens in the space. Alibaba has rapidly moved beyond just an IT / e-commerce company to provide a variety of products and services beyond just technology. Its Yu-ebao product is forcing banks to re-think their retail investment products and how they price and distribute them – it has completely changed the industry.

With China's cloud services in the financial indusry being a key topic of discussion in 2014, could we see Alibaba do the same thing it has with 3rd Party Payment Platforms?

The China Securities Regulatory Committee (CSRC) announced in December that the currently non-active A-share IPO market would reopen at the end of January, 2014.

It sounds trite if you’ve read my other posts on Bitcoin in China, but ‘wow! What a week it has been for Bitcoin in China’. With the PBOC effectively cutting off (legal) funding of accounts on exchange platforms, is there a future for the currency in China?

Shanghai Stock Exchange and China Securities Index co.ltd announced that the new TMT (Technology, Media and Telecom) industry index and national defense indices would be released on December 25th, 2013.

Kapronasia began researching Bitcoin in China in August 2013. Our Bitcoin in China report released on September 18th mentioned that in the future there would be two factors that really influence the fate of Bitcoin in China: the Chinese government’s attitude towards Bitcoin and Bitcoin’s acceptance as a method of payment, at least initially, by merchants.

After 18 years of economic development, China’s Tier 2 Banks, mainly city commercial banks, are growing to fill a gap in-between state-owned banks, and rural commercial banks. As part of their growth, many city commercial banks are attempting to expand their branches in other regions, however, the Chinese Banking Regulatory Committee (CBRC) regulations are, in certain cases, holding them back.

The recent tight regulation regarding supra-regional city commercial banks is largely the result of increasing internal fraud cases in city commercial banks such as Qilu Bank and Hankou Bank. The good news is that the CBRC is not prohibiting city commercial banks from expanding supra-regionally. Instead, the approval process is just longer and the standard of regulatory evaluation indicators such as asset scale, capital adequacy ratio, profit margin, and non-performing loan ratios are higher than before. In this case, if city commercial banks attempt to expand outlets in other regions, they need to enhance their internal control and risk management abilities above the required standard.

Because the asset scale and business model vary based on the local economies in each city, the evaluation regulation will be different. If the investment in other regions is excessive, the CBRC will require a higher capital adequacy ratio; if the risk management does not match the fast growing asset scale, the CBRC will restrict the expansion of these city commercial banks. Thus, regulators support supra-regional expansion if the tier 2 banks meet the entire set of regulatory requirements.

China’s tier two banks are some of the more dynamic banks in China in terms of business models and innovation – they have had to be in order to compete with their larger counterparts that typically have much larger deposit bases and distribution networks.

The tier-2 banks are still focused on expanding their asset base and while supra-regional expansion will help them accomplish this, it is not the ultimate goal of the banks, at least not in the near future. The regulations do serve a valuable purpose to ensure that banks’ expansion is based on quality assets and business practices.  

 

 

December 16 2013

China 2013 in (brief) Review

Written by

2013 will remembered as an incredibly dynamic year for China’s financial services industry. From the increasing number of hedge funds in the market to the emergence and regulation of Bitcoin, industry observers, investors, participants and regulators have had their work cut out for them keeping up with the market.

The year started out with the prospects of a new government taking a new stance on reforming what had been a highly regulated financial services industry; we weren’t disappointed. Regulators unveiled a reform agenda both at the fall plenary session and throughout the year that has, and will have, a significant impact on interest rate reform, capital market investment in and out of China and the financial industry as a whole. Although some of the measures are still somewhat vague, some of the implementations, including the removal of the floor on lending rates, have already have a significant impact on banking profitability – it will be a new market in 2014.

China's finance in 2013 also brought an increased focus on development zones and centers. Opened to much fanfare, but little detail, the Shanghai Pilot Free Trade Zone (FTZ) was formally established in late September. Although it is still early days, if news reports and indications from the regulators are to be believed, the FTZ promises to be a new test-bed of reform for ‘value-add’ services similar to what Shenzhen was to the manufacturing / production industry in the late 70s and early 80s; arguably, one of the most important developments in China’s economic history. Smaller initiatives such as the Hongkou Hedge Fund Center in Shanghai sought to make it easier for hedge funds to enter the market and trade on China’s expanding base of capital markets products.

And last but certainly not least, we would be remiss if we didn't touch on Bitcoin. Chinese investors and tech enthusiasts were truly ‘chomping at the bit’ in 2013 as Bitcoin went from a little known US$13 cryptocurrency, to a US$1,000 potential economic destabilizer. China topped the world in Bitcoin wallets in May 2013 and then surpassed that again in November with over 150,000 wallet downloads. With the world’s biggest Bitcoin exchange and increasing popularity, China had little choice but to weigh in on the matter and in early December the People’s Bank of China annouced that Bitcoin was not a currency, banks could not deal in it, yet it could continue to be used in China. The price of Bitcoin fell, only to rise almost immediately afterward.

Will the sequel to 2013 in 2014 be as exciting? Will Xi Jinping continue to push reforms? Can the PBOC accept Bitcoins as a legitimate currency? Whatever happens, 2014 will be another dynamic year for Chinese markets and we’ll be here every step of the way to help you understand what’s happening in China’s financial services industry. 

As fixed interest rates in China start to loosen up, banks' bottom lines are starting to feel the pressure. According to the latest figures from China major banks’ annual reports, the net profits of China Mingsheng Banking Corp.(Minsheng), Industrial & Commercial Bank of China Ltd.,(ICBC), Bank of China Ltd. (BOC) and Agricultural Bank of China (ABC) in the third quarter 2013 shrank on a YOY base. 

As shown in the graph below, the net profits growth rate of Minsheng, a relatively smaller bank, dropped dramatically almost 25% comparing with the same period last year, likely due to its relatively large interbank business, which was heavily affected by high interest rates in the middle of June. The high interest rates in China also had a big impact on ICBC. The banks' profitability growth rate dropped to around 7.5%.

Chinese Bank Profitability - Q3 2013

 

With a wide range of channel choices for retail customers, banks need to be aware of the usage and preferences for each channel which can vary for multiple reasons including the purpose of the transaction, complexity and where the person is from.

On the digital channel, customers usually require a fast and convenient service such as simple transaction or checking an account balance, but for branch service, customers, especially affluent customers require tailored personal interactions such as loan servicing, investment advice, and other complex transactions.

In self-service channels, Asian customers not only need a convenient and easy channel, but also a personalized interactive service to increase their loyalty to the bank as competition is rising and switching costs are lowering, especially in the wealth management space.

These wealthier customers produce higher value for banks, and usually they have a wide range of choices on banking services. In Asia, affluent customers show greater loyalty to their banks, while in most European countries and the U.S., affluent customers have relatively lower loyalty to their banks. Thus, maintaining affluent customers is important for banks to generate higher revenues.

Citi, one of the major players in Asia's wealth management space offers tailored services in Singapore. Their Citigold service provides a dedicated center for nonresident Indians. The personalized interaction improved the loyalty from their affluent customers because Citigold satisfied nonresident Indians’ special requirement on banking services.

However, China is showing a significant gap between affluent and mass-market customers on loyalty because the affluent customers receive much better service from their bank than mass-market customers do.

Banks should not only rely on channel innovation but also focus on improving service on the existing channels. Maintaining the existing affluent customers with tailored service is crucial to the bank since the affluent customers will continually show a high loyalty to their banks in Asia, but enhancing a required service or product for mass-market customers through different bank channels will also increase the overall customer loyalty.  

Customer Channel Preferences in Asia

Hongkou is a geographic district in Shanghai, on the west side of the Huangpu River, north of the center of Shanghai and close to Pudong District. The Hongkou Hedge Fund Park was officially established on Oct. 18, 2013, as the first test-bed specifically for developing local hedge fund industry and introducing foreign hedge funds in China. Through market reforms and special incentives, the Hongkou government hopes to make the Hedge Fund Park a key part of Shanghai, and indeed China’s, hedge fund industry.

yuebaoThe latest figures from Tianhong Asset Management show that the AUM (asset under management) of Yu’ebao deposits, the currency market fund which is co-launched by Alibaba and Tianhong on 13 June, 2013, has rocketed from June 13th to November 14th, 2013, from 0 to CNY100B. Now Yu’ebao is the largest fund in China leveraging it's enormous Taobao, T-mall and Alipay customer base.

The success story of Yu’ebao has not only encouraged the Chinese IT giants and online payment providers to enter the asset management market, but also is a worry to the traditional asset management firms. Currently, most public funds in China sell their products on their own websites or choose to cooperate with the online platforms to sell their products. Asset managers do recognise the benefit of selling funds online including low cost and convenience, but struggle as they simply just do not have the customer base of Alibaba/Alipay.

Date   13 June 30 June  9 Sept  14 Nov
AUM (CNYB)  6.6  55.65  100

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