Yu'e Bao and Consumer Loans Shrank by 754.5 Billion Yuan in a Year. Regulators Have Ended Alipay's Banking Dream

As policy tightens, Alipay is being capped on every front.

"A company like Ant Group is supervised every day and has to write 700 inspection reports a year…" Jack Ma said at a Zhejiang Chamber of Commerce gathering late last month. He called it a good thing, because the state was giving Ant Group a physical.

The physical did not come cheap.

As of December 31, 2018, assets under management at Tianhong Asset Management, the fund company behind Yu'e Bao, had fallen to 1.34 trillion yuan. At the end of the first quarter of 2018, Yu'e Bao alone still held 1.99 trillion.

Savings are where a commercial bank's business begins: the relationship between a bank and its customers starts when money goes in. If you think of Alipay as a bank, Yu'e Bao is its savings account.

In less than a year, Yu'e Bao's own savings pool shrank by 648.1 billion yuan — its first annual decline since it launched in 2013. That does not mean people stopped using Yu'e Bao, or stopped buying money market funds. Both numbers are still rising. But the money flowing into Yu'e Bao no longer goes into Ant Group's own fund.

Beginning in March 2017, when the China Securities Regulatory Commission issued its rules on money market funds, Yu'e Bao cut its holding and purchase limits five times in a little over a year, from 1 million yuan down to 100,000. In the end it became a wealth-management product you had to be at your phone on the hour to buy.

By May 2018, Ant Group had opened Yu'e Bao to other fund companies. Their products had no purchase caps and paid rates in line with Ant's own Tianhong fund, so the money went to them.

Yu'e Bao's Adjustments

2017.5.27

Tianhong cut the per-person holding limit in Yu'e Bao from 1 million yuan to 250,000.

2017.8.14

The maximum an individual could hold in Yu'e Bao was cut to 100,000 yuan.

2017.12.8

Purchases were capped at 20,000 yuan per calendar day.

2018.2.8

A cap was set on Yu'e Bao's total daily purchases.

2018.5

Other money market funds were plugged in, with no purchase caps.

Savings are a bank's foundation, but lending is where the profit is. Alipay's profit comes from lending through Huabei and Jiebei. At almost the same moment the securities regulator was reining in Yu'e Bao, the People's Bank of China was choking off the money behind Alipay's loans.

Whether a consumer buys something with Huabei or a small business borrows through Jiebei, Alipay has to put up the cash first. In 2017, Huabei and Jiebei raised more than 278.8 billion yuan through ABS — asset-backed securities — up 334% from the year before.

After the People's Bank of China turned its attention to the cash-loan market, Alipay suspended Jiebei's ABS financing for three months in early 2018. Over the full year, Jiebei's issuance fell by 66.91 billion yuan and Huabei's by 39.5 billion.

Alipay's savings and its lending were now both under control. Next to that, the central bank's demand at the end of 2018 that every payment institution hand over a trillion yuan of customer reserve funds was, if anything, not the most important thing that happened.

And it was only the beginning. In June 2018, the central bank named Ant Group one of five companies to serve as pilots for new rules on financial holding companies. Then, in the China Financial Stability Report 2018 released at the end of the year, it singled out, for the first time, the risks hidden in internet companies pushing into finance.

Alipay's official answer to all this is that it "does not dodge regulation." Ant Group chairman Eric Jing told The Beijing News that the credit for how far Ant Group has come belongs to the regulators: "Without correct and effective guidance from the regulators, none of it would have been possible."

The sharpest turn is Jack Ma's. In 2008 he said, "If the banks don't change, we'll change the banks." In 2018 he said, "Although Alipay has shaken up finance these past few years, we never meant to overturn financial institutions."

Yu'e Bao doesn't make much money, but it's the main reason hundreds of millions of people put Alipay on their phones

Yu'e Bao launched in the summer of 2013. Users could take money out or spend it at any moment, and still earn a daily return far above what a bank paid on a demand deposit.

A few bank wealth-management products could match Yu'e Bao's yield at the time (7%), but they generally required 50,000 yuan to start, could not be cashed out on demand, and often carried real risk — and bank apps back then were barely usable. Yu'e Bao pulled a sizable share of bank depositors away.

Within six months it had taken in more than 500 billion yuan. Central bank figures for January 2014 show that renminbi deposits fell by 940.2 billion yuan that month.

The money in Yu'e Bao still ended up at the banks, but in a way the banks disliked. Yu'e Bao collected it from scattered individual users, then pooled it to buy bank certificates of deposit — in effect one enormous fixed-term deposit. The same money a bank could have had for a 0.35% demand-deposit rate now cost it more than ten times that much once it passed through Yu'e Bao.

In 2014, ICBC and Agricultural Bank of China cut the amount that could be transferred into Yu'e Bao, and three other large commercial banks refused to pay Yu'e Bao's negotiated deposit rates. That was the banks fighting back. But as Yu'e Bao kept growing, they had no choice but to go from hostility to cooperation.

With nearly 2 trillion yuan in hand, Yu'e Bao was the largest money market fund in the world, and it gave Alipay far more leverage: banks need deposits, and Yu'e Bao's large, high-interest certificates of deposit are deposits. China has more than 300 banks big and small, but one company, Alipay, decided where trillions of yuan would sit.

And Yu'e Bao could only be bought inside the Alipay app. Nearly 500 million people installed Alipay because of it, then used it more and more often to scan a code to pay, settle utility bills, ride the bus. All of that was what bank apps wanted to do and could not do well.

So what the banks handed over was not just the interest spread but their relationship with the customer. Yu'e Bao became a big reason hundreds of millions of Chinese internet users put Alipay on their phones. At the end of 2017 it had 474 million users, more than 99.94% of them individual investors.

All of it became the base on which Alipay later built its other financial services.

With users and data in hand, Alipay made 8 billion yuan a year lending through Jiebei and Huabei

Beyond getting hundreds of millions of people to install Alipay, Yu'e Bao bought something else: trust — enough trust that people were willing to keep their money in it.

To make sure users did not lose that trust over a risky investment, Alipay has stayed out of stocks, P2P wealth management and other high-risk, high-fee businesses, even though it has taken a stake in China's largest brokerage-trading software provider and Alibaba holds a stake in a securities firm.

Alibaba and Alipay also hold an enormous amount of data on small merchants and individual consumers. As of September 2018, at least 700 million people in China had used Alipay at least once in the past year, and 576 million had bought something on Taobao. Since almost every Taobao transaction runs through Alipay, the Taobao figure alone puts the online spending records of 576 million people in Alipay's hands, conservatively.

Outside e-commerce, the everyday data is there too: water and electricity bills, offline code scans, taxi rides. And the perks Sesame Credit hands out have made users volunteer their social security, vehicle and education records as well.

All that private information tells Alipay exactly who to lend to, and how much.

In 2015 Alipay began lending on it — to individual consumers through Huabei, to small merchants through Jiebei. Huabei is essentially Alipay's credit card: pay now, repay later, and pay a fee to split the bill into installments if you can't clear it. Jiebei is closer to a bank's micro-loan business, with a lower bar to entry and credit lines from 1,000 to 300,000 yuan.

Alipay can judge an individual borrower's risk more accurately than a traditional bank, and so lend to more people.

Wang Tao, who runs China Merchants Bank's inclusive finance service center, told Securities Times last September that a bank's average cost of lending to small and micro enterprises is around 2%, and that a single small loan can eat up a great deal of a loan officer's time. Even then, because banks lack enough credit data and borrowers' financial disclosures are not transparent enough, the bad-loan ratio stays around 1.5% after all that money and manpower. At China CITIC Bank, the small and micro enterprise bad-loan ratio hit 2.69% in 2017.

Lending takes money, and Huabei and Jiebei get theirs from ABS. By Alipay's own account, the bad-loan ratio on both has held near 1% since they launched in 2015.

The mechanism: when someone buys something in installments with Huabei, they owe Alipay a debt and repay principal and interest every month. Alipay bundles those debts into ABS and sells them to investors, who collect interest monthly — much like buying a wealth-management product yourself.

There is a spread in between. Users pay Alipay an annualized 14–15%; the ABS Alipay sells pays 6–7%. Subtract 1% for bad debt and Alipay keeps 6–8%.

Once the ABS is sold, Alipay gets its principal back at once and can lend it out again.

Yu'e Bao has no room for a spread and cannot reinvest the money, so it earns little. The lending business Alipay built on top of it earns a great deal. Prospectuses for Ant Huabei and Jiebei ABS issues show that in 2017 Huabei had revenue of 2.989 billion yuan and net profit of 2.039 billion; Jiebei had revenue of 9.262 billion yuan and net profit of about 5.992 billion. Their net margins were 68% and 62%.

As policy tightens, Alipay is being capped on every front

Running at extreme efficiency, Taobao and Alipay grew over a little more than a decade into something no bank could ignore. When Yu'e Bao's assets approached 2 trillion yuan, Bank of Communications' personal demand deposits were a third of that.

2017 was the fastest year for Jiebei and Huabei; Alipay's profit in a single quarter could top 5 billion yuan.

That a business like Alipay — or Ant Group — was born in Hangzhou rather than Silicon Valley owes most of all to how loose regulation was in the early years. Lending out more than 100 billion yuan on registered capital of 3.8 billion, as Jiebei did, is something a bank could never do. And for exactly that reason, Alipay has been suspected of running a shadow bank.

"By the Financial Stability Board's definition of shadow banking, the shadow-banking activities they carry out involve maturity transformation, excessive leverage, and capital requirements different from those on traditional banks," Zhou Xiaochuan, then governor of the central bank, said in 2016.

Because finance is what it is, its regulation and compliance rules are usually among the strictest of any industry in an open market. Japan's Mizuho Financial Group, the Bank for International Settlements and other institutions, along with some scholars, argue that from the standpoint of protecting users and keeping the financial system stable, internet finance platforms including Alipay are either under-regulated or governed by an incomplete system.

In a discussion of the new financial risks technology creates, Mizuho said developed countries generally treat fintech as an extension of traditional financial business and fold it into the existing regulatory system. Take P2P lending: according to central bank researcher Deng Shuren, the United States and Britain regulate it fairly loosely, concentrating on information disclosure, risk warnings and consumer protection, while Germany and France are stricter, requiring P2P platforms to hold a banking license and be supervised under banking rules.

Besides the loose early regulation of internet finance, there was a particular historical reason: Alipay and the modernization of China's banks began at roughly the same moment, so it never had to take on a financial system as fully built out as those in the United States or Japan.

Each of China's four large state-owned banks can trace its history back decades or a century, but in the early 2000s, when Alipay was born, their bad-loan ratios generally ran above 20%. Only after state asset-management companies took over the big four's bad assets and foreign banks were brought in to drive reform did China's banking industry get back on track.

Then there is China UnionPay, which long monopolized domestic payment clearing. It was founded in 2002, one year before Taobao and two before Alipay. For a long stretch, Alipay went around UnionPay entirely and settled straight with the banks.

Now, as policy tightens, Alipay is being capped on every front. The China Financial Stability Report 2018, published by the People's Bank of China a little over two months ago, flagged the regulatory risk that financial holding companies like Alipay are "too big to fail."

The across-the-board tightening on Alipay began earlier, in 2017. Yu'e Bao went through five rounds of cuts in under a year.

Beyond Yu'e Bao, as the central bank tightened its grip on the customer money parked at third-party payment institutions, every payment company was ordered to move those funds — which had been earning 2.5% a year — into accounts designated by the central bank before January 2019, in batches and by fixed proportions, with no interest paid on them any more.

Central bank figures show payment institutions transferred more than 100 billion yuan of reserve funds in January 2018, and 1.24 trillion by November. The whole pool is estimated at 1.3 to 1.4 trillion yuan. Working from market share and transaction volume, Zhongtai Securities analyst Dai Zhifeng calculated that Alipay would lose close to 5 billion yuan of interest income a year.

Jiebei, whose lending spread is three or four times a bank's, also drew questions from the central bank over its "leverage ratio." Alipay put another 8.2 billion yuan of capital into Jiebei at the end of 2017, and the central bank still summoned Alipay staff in early 2018 to screen for high financial risk. Nobody knows what was said in that meeting, only what followed: Alipay shut off Huabei and Jiebei for some users and suspended Jiebei's ABS issuance for three months.

Alibaba's financial filings show Ant Group began posting net losses in 2018, 1.9 billion yuan in the first quarter.

From big profits to big losses in one year. With the business suddenly smaller and compliance costs certain to rise, whether Ant Group can still hold up a US$150 billion valuation is a large question mark.

Besides plugging other fund companies into Yu'e Bao, Ant Group went to the banks to fill the lending gap left by shrinking ABS issuance. Bank money took the place of cheap ABS financing, and Ant Group's role shifted from a bank earning a spread directly to a financial adviser charging technology fees and supplying channels to loan capital.

In a 2016 conversation, IMF Managing Director Christine Lagarde also asked Zhou Xiaochuan, then governor of the People's Bank of China, what he thought about financial regulation.

Her last question was whether the central bank wanted to tighten its regulation of Alibaba.

"These companies really are engaged in some shadow-banking activity. We will study these questions and create a level playing field," Zhou said, adding that the central bank encouraged internet companies to grow, but that they had to follow the existing rules when they did financial business.

All of this is still going on.

Data compiled by Gong Fangyi and Xie Jinping; graphics by Feng Xiuxia

Cover image/Unsplash (1, 2)