Chinese regulators explain the recent internet finance ban

There are more than 4,500 local banks in China, and tens of thousands of internet platforms – from big to small. 

Local banks unlike national banks in China are approved at the provincial level, and were set up to serve the needs of locals of that province. In recent years, with the rise of internet platforms, many of these local banks have partnered up with national internet platforms to reach out to more people.

Perhaps linked to the recent ban on internet platforms offering bank deposit products, Sun Tianqi, Director-General of Financial Stability Bureau of People’s Bank of China (pictured top), explained in a recent speech on that local banks offering high interest rates to attract deposits nationally through Internet platforms have increased systemic risks in multiple ways, and the regulators were taking steps. 

He split his speech into 3 parts – (1) Overview of deposit business on the internet platform; (2) Issues that need attention on deposits on internet platforms and (3) Improving the regulatory system and regulating the deposit business on the internet platform. 

Below are some highlights of the speech split into the respective parts: 

Overview of deposit business on the internet platform

There have been 4 major developments that the authorities have observed with regards to local banks partnering with internet platforms in recent years: 

1. Banks leverage extensively on internet platforms to offer online deposit products – and getting access to customers outside of their geographical boundaries. 
2. Requirements to open a bank account through the internet platforms have been massively simplified. For example, to open account with Bank A, a customer will just need to link up his bank account from Bank B onto the internet platform, upload his IC, and complete a facial recognition scan. It is surprisingly simple, and the entire process can be completed in a few minutes. 
3. Main products offered by banks on these internet platforms are generally personal fixed time deposits with fierce competitive rates.  There are instances with 3 and 5 years fixed deposit offering interest rates of 4.125% and 4.875% respectively- hitting the national recommended upper benchmark.
4. Barrier to entry (to open a bank account) on internet platforms is very low- a scan showed that almost half of all bank deposit products offered online had a minimum deposit requirement of RMB50, and customers could make early withdrawals whenever they liked. 

All in all, Internet banking deposits are structured to be very interest rate sensitive with flexible withdrawal options. Adding on the fact that deposits are taken from around the country, there is very little loyalty or stickiness to any one bank. 

Issues that need attention on deposits on internet platforms

There are 8 issues which the development of deposit business on the internet platform is causing concerns for regulators:

1. The services provided by the internet platforms (e.g. advertising about a bank’s products, opening a bank account, taking deposits, allowing for withdrawal of deposits) are akin to that of a bank branch services. However, internet platforms do not have the financial licences to conduct these activities and are outside of financial supervision – in essence, conducting illegal activities; 
2. Due to the intense competition, many banks are taking creative ways to increase deposit interest rates for products sold on the internet platforms. Banks may make interest payment in stages, shortening the interest payment cycle, or issuing interest rate coupons and cash rewards. For example, a bank’s 5 year time deposit product will have an interest payment cycle every 3 months, and the interest rate can be as high as 4.1%, whilst the 3 month time deposit benchmark interest rate is only 1.1%. These tactics directly exceed the national recommended upper benchmark;
3. When local banks expand their deposit business to the whole country, they are in essence a national bank by proxy of their funding source. However, this deviates from their original purpose of serving small, medium, and micro-enterprises in their region. In addition, the scale of deposits absorbed may exceed their own banks’ risk management capabilities. 
4. Some banks may use these internet platforms to take on unstable sources of funds to maintain high risk lending operations. This can exacerbate their own risks, their customers’ risks, and could create a serious systemic problem for the country; 
5. Banks that offer competitively high interest rates will need to find assets to back these rates. At the same time, they will also need to pay for the internet platform customer acquisition costs. These two funding costs will inevitably push the bank to pursue higher-yield (i.e. higher risks) assets leading to increased asset-side risks. In the long run, asset quality of banks that are highly dependent on Internet platform deposits will be a concern;
6. Customers could easily switch to a competitor bank offering higher interest rate anytime, and this can create new liquidity challenges for banks as they will find it difficult to estimate their liquidity status, and assess mitigation measures to prevent a run on the bank;
7. Small and medium size banks do not have the capabilities to support the sufficient authentication and due diligence of depositors, or continuous business monitoring of transactions (of funds coming in and out). This increases compliance risks, and could be a violation of national money laundering regulations;
8. Without the full authorization of the customer, some Internet platforms actually contacted the customer’s personal identity authentication information and financial information, and the relevant information may be shared by the platform and the bank. These are instances of infringement of the rights and interests of financial consumers in terms of personal information protection.

Improving the regulatory system and regulating the deposit business on the internet platforms

The below recommendations were made to address this issue :

1. Regulate standards for local banks including business access thresholds, scale limits based on bank regulatory ratings, operating conditions, capital and risk management capabilities, etc must be standardised. Regulators will also need to assess how to implement regional online operations restrictions in the digital environment for local banks.
2. Research and promulgate relevant laws and regulations for high-risk banks’ deposit taking behaviour. China can study and explore these type of regulations in other countries, for example the U.S. Federal Deposit Insurance Law, and promulgate it in China. 
3. Improve the prudential supervision indicators, increase the monitoring of dependence and concentration of internet platform deposit. And since 80% of bank runs in 2020 came from online banking, regulators would need to assess the ways to manage online and offline bank runs. 
4. Strictly regulate financial activities online and through digital apps. Internet platforms that engage in financial activities must have the licence to operate, and clarity on which activities they are allowed to do.Relevant guidelines have been issued on application, technical requirements, risk prevention and control and information security to strengthen the technical aspect of conducting deposits online. Strict supervision will be enforced.
5. Improve the deposit insurance payment rules to prevent financial institutions from abusing deposit insurance statutory payment standards and engaging in capital price competition.
6. Currently, most internet platforms display deposit products ranked by the interest rates – intensify inter-bank bidding and disrupt market interest rate mechanisms. Going forth, internet platforms are banned from encouraging comparison or bidding of deposit insurance products.

Ultimate aim of these new regulations are to balance the relationship between Internet financial supervision and financial technology innovation, tolerate reasonable innovation, lower market entry barriers, promote full and effective market competition, and provide more convenient, high-quality, and safe financial services.

What happens next? 

While this was aimed at all FinTech platforms, big players like Alipay, JD Finance and Lufax took down their internet deposit product offerings within 24 hours after the announcement. 

Other forms of FinTech with the potential for scale, such as insurance and wealth management, among others, might see greater scrutiny and attract more stringent rules from Chinese authorities in the years to come. The full impact of this wave of regulatory moves will take time to settle, and will keep the Ant leadership busy for a while. Ant’s other business plans, including international expansion, will probably be put on the back burner.

It will be interesting to see how this pans out for China, and there will definitely be learning as SEA as we move along.