2023 New Value Report

China’s Favorite Banks are Internet Companies

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Chinese Banking

Known as the Amazon.com of the Middle Kingdom, Alibaba is now the country’s largest money market fund, with $40 billion worth of customer deposits, according to  a report by The New York Times. In China, Internet startups are the new banks.

Call it innovation borne of necessity. Unhampered by a heavy-handed central authority, the e-commerce behemoth’s banking subsidiary Alipay can provide competitive rates—as much as 7 percent—more than double the fixed variety offered by the state-controlled banking sector. Other tech-centric firms, like Baidu and Tencent, have rushed to join the races.

With veritable megacorps providing preferable options—Alibaba’s pre-IPO market capitalization is already around $150 billion based on actual earnings—the liberalization genie of interest rates is officially out of the bottle.

China’s 1.3 billion savers are predictably rejoicing, having had few choices beyond bubbling real estate and a piping hot stock market, both fraught with uncertainty. While government-sponsored savings accounts offer more security than the proverbial mattress, such peace of mind comes at a cost as rates of around 3 percent often lag inflation.

The rise of “web banks,” as the Times dubs them, plays precisely into the hands of the country’s one-party leadership, as the second largest country by GDP enters its next chapter of economic development—one driven by domestic demand rather than cheap exports, a successful strategy that has brought hundreds of millions out of poverty but is now paying diminishing returns.

Loosening control of interest rates is another step toward the continued evolution of a freer Chinese market. Geopolitically, a more decentralized and open Renminbi will act as a key competitor against the U.S. dollar in coming years.

And who else to lead the revolution than the man the Chinese compare most frequently to Steve Jobs? As founder and current Executive Chairman of Alibaba, Jack Ma is the country’s first rock star entrepreneur, one The Financial Times named its 2013 person of the year.

As the NYTimes reports:

Jack Ma, Alibaba’s flamboyant and sharp-tongued chairman, insists China’s financial regulations are suffocating smaller investors and average consumers. He has vowed to shake up the country’s banking and financial services sector. “The financial industry needs spoilers to make a revolution,” he said during a speech last June.

The big losers, presumably, will be the banks, which, unable to compete with market products and struggling from the consequences of post-crash stimulus projects, have been dipping their hands into the unregulated shadow economy in order to keep the machine in motion.

“China and Southeast Asia e-commerce growth is a very big investing theme right now,” said Phil Rapoport, director of markets and trading at Ripple Labs. “People are forecasting 100 million new internet users coming online in the region each year for the next few years.”

“That’s basically like an entire USA of new users every 2-3 years, creating tremendous revenue growth,” he added pointing to a chart by the Economist:

Chart: The Economist

Incidentally, the leading Internet companies in China could one day become the biggest banks.

And although the two countries are in different stages of their respective economic narratives, the situation has palpable similarities with the U.S., where too-big-to-fail banks appear more concerned with trading operations than traditional banking services, which are becoming an increasingly prominent portion of their revenue pie, as monetary policies implemented by the Federal Reserve in response to the Great Recession kept interest rates at historic lows.

Walmart—making its own push into e-commerce (given the success of the American version of Amazon)—already offers checking accounts. Punkish CEO John Legere wants to crash the party, too, having announced T-Mobile’s app-supported service, Mobile Money, targeting the underbanked.

“Retailers and carriers are good examples of players that are leveraging their unique relationships with consumers to offer financial products,” said Danny Aranda, director of business development at Ripple Labs. “Number and distribution of physical locations, brand name, and even basic convenience are positioning these entrants to expand and complement their current offerings with products that often target underbanked consumers that are beginning to enter the financial mainstream.”

Traditional tech powerhouses also are willing participants. Google has its Wallet and a venture fund with hands in a slew of fintech cookie jars, Apple is said to be working on its own payments app, and Ebay has big plans for Paypal—not to mention relatively recent entrants like Square and Venmo, eager to make an impression. [Google Ventures is an investor in Ripple Labs.]

Then, of course, there’s Bitcoin. Unable to be ignored, Satoshi Nakamoto’s creation provides the likes of Silicon Valley a backdoor to finally infiltrate an incumbent financial sector, long fortified by an unbreachable wall of rules and regulations that made bootstrapping into Wall Street all but impossible.

The open source, peer-to-peer currency is a natural fit for e-commerce, with Overstock.com entering the fray in recent months. The online retailer with over $1 billion in annual sales is powered by Coinbase, the current darling of Bitcoin startups already serves over one million wallets.

A similar marriage is manifesting in the East, where the digital gold rush was first sparked by Baidu’s announcement last fall that the search giant would accept BTC as payment. Though the company—always accompanied with unavoidable comparisons to Google—eventually reversed its decision, choosing to toe the party line after a government crackdown, the Chinese crypto-love affair is remarkably still in full force.

Ultimately, as these forces inevitably converge, interest and competition from outside players and technologists will further push the financial sector as a whole into the digital age—a new world that benefits from a more networked and accessible economy. Comparisons to the birth of the Internet and the dawn of email seem apt.

Where friction is reduced and middlemen are cut out, costs invariably go down. When a sizable portion of the global population historically cut out from the system can finally participate, everyone stands to gain. For the average consumer, a more efficiently integrated system can only mean better options and smarter solutions.

But just as in the People’s Republic—Alipay’s $40 billion in assets under management is a pittance compared to the broader $9 trillion market—this potentially seismic shift in how individuals, companies, and entire nations view the metamorphosis of money and finance is still at nascent stages.

Between “the next big thing” and “too good to be true” is persistently a fine line. There’s plenty of good reasons why the financial institutions that have survived the longest are notoriously conservative. Offering superior rates isn’t particularly helpful if they aren’t paid in full. The onus will be on this unprecedented generation of techies-cum-bankers to finance and secure their latest business model and deliver on their lofty promises.

The recent and ongoing fiasco with now bankrupt MtGox then, is an unpleasant reminder of the embedded risk of investing in the future and innovation’s proclivities for the Wild West where regulators are perpetually playing catchup. Growing pains, though necessary and inescapable, are exactly that—painful.

“It’s on the one hand a setback, on the other hand it will cause further improvements in this industry and some more regulatory involvement,” Superintendent Benjamin Lawsky, the man leading the regulatory charge in New York, told Reuters.

In all likelihood, plenty more can go wrong before someone starts to get it right. What’s clear, however, is that an undercurrent of change is bubbling beneath the financial sea, fueled by the technologies that connect us and the companies that create them.

Photo: David Dennis

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