12 Mar 2014
Imagine that you belong to a Chinese middle class family and is the mother of only child whose father is employed in a factory in some Chinese province. You have a sewing machine and therefore some neighbourhood business and you also own a smart phone. You have an account in a Chinese bank that returns you meagre interests. Then you hear of Alibaba and its Alipay providing you with Yu’e Bao, a financial product.
You have an account in Alipay—a Paypal like system-- and once you transfer the titbits of money you have with you from the State-owned bank’s account to Yu’e Bao, you start receiving 17 times interest compared to traditional savings opportunity! Besides, you can withdraw the money anytime you want from Yu’e Bao! At approximately 6% of annualised interest rates, your life changes all of a sudden. You can save more and shop more using the Alipay system from Alibaba’s e-commerce sites, if that be your choice.
Thus, suddenly you are in a wonderland!
Alibaba—world’s largest online Bazaar does more business in the e-commerce sector than Amazon and Ebay combined. It has Alipay service which in turn launched Yu’e Bao in June 2013.The fund takes deposits from laymen and businesses and funnels them to interbank market.
“Up to 90 percent of Yu’e Bao funds are invested in interbank deposits at 29 large banks, including the big state-owned ones,” notes IB Times in an article.
Given the size of deposits—Yu’e Bao raised $90 billion in 8 months—it can negotiate for better interest rates from banks unlike other customers.
However, behind the success of Yu’ e Bao lays some penchant realities in the Chinese banking sector.
The Chinese banks are primarily state-owned enterprises. Like any other banks, they take deposits from people and dishes out loan to the needy enterprises and individuals. But the banks are also tightly regulated in that the interest rates on deposits and loans are determined not by market forces, but by People’s Bank of China (PBoC), the Chinese equivalent of India’s Reserve Bank.
For decades, the state-owned banks were provided with a huge spread between interests on loans and deposits helping them to rake in gigantic amount in profits. The layman in China having no other avenues to save his precious money always resorted to deposit options provided by banks.
This meant they received just 0.35% interest in savings account and to secure a loan, had always had to attend to sky-high interest rates. Meanwhile the state-owned banks in China channelled this easy money from deposits—it stands somewhere around $12 trillion—to various state-owned enterprises and other industries.
Communist rate of growth
In a bid to keep the Communist growth rate of 8% for GDP, reckless lending measures ensued in China. In addition to legitimate lending, banks also opted for shadow lending as well. This phenomenon resulted in an excessive infrastructure boom. Buildings were built which were never occupied; malls were built where there were no footfalls.
All these resulted in a commodity consumption boom and along with trillions of Yuan in stimulus measures in the wake of Great Recession, assumed a ghastly dimension in terms of credit situation in China. Consequently, the past year in June saw a freezing of interbank lending in China.
The same month also witnessed the launching of Yu’e Bao!
In short, Yu’e Bao was derived from the financial arsenal of China to keep in check the liquidity crunch in the interbank lending using people’s money. By shooting this dart, China valiantly deployed the interbank credit freezing and resultant financial crisis risks on to broader shoulders of Chinese public.
With surplus money in the interbank lending system courtesy of Yu’e Bao, China is in a position to manage credit risks better, one may think. Hold your breath.
News reports today said of a Chinese solar company defaulting on onshore corporate bonds; the bond market is regulated by PBoC since 1997. Unlike the presumed bailout it carried out in case of a trust company, this time around, nobody came to the rescue of Chaori Solar Energy Science and Technology Company. Obviously, Chinese banks are exposed to this credit default risk.
If more of such news follow, and banks grow more cautious in lending to each other, it would help Yu’e Bao to demand excessive interest rates by any standards which could be passed on to customers. The growth momentum of GDP fixed at 7.5% by Xi Jinping means China will have to continue moving on its growth trajectory. This would put pressure on banks to lend voraciously. But waves of default may make lending by Yu’e Bao run to dead end.
While the users of Yu’e Bao can withdraw money in a swish using their smart phones, Yu’e Bao may not be in a position to take out money with such speed as the same would be locked-in within the system. This means, the promoters of Alibaba may have to face the heat; it would possibly face severe financial crisis and in case of a Yu’e Bao default reckless public fury.
Given that Yu’e Bao can continue to grow for the time being, this risk may not emerge until the bubble pops. Chinese e-commerce companies like Baidu and WeChat are also on the move to aggressively promote products like Yu’ e Bao. When they assume a sizeable chunk of the economy the popping of the bubble can contribute to a nightmarish scenario: trigger a financial meltdown, spur an economic failure and spark a political crisis of lethal dimensions.
Perhaps, in a bid to avoid that mishap China is mulling the introduction of private banks on a trial basis which would address the credit requirements of individuals and SMEs. The authorities are also contemplating further de-regulation of the banking sector.
The sooner, better! (rakesh.neelakandan@gmail.com)
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