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Zhaofeng Xue: Management Philosophy of Internet Finance



The rise of Yu'E Bao triggered widespread interest in Internet finance. This interest led to discussion of different ideas, technologies, and ultimately, benefit that goes to different parties. Today, the technology that supports Internet finance has become mature; products like Yu Ebao have entered market; consumers have enjoyed benefit from these products and services; even banks have become aware of the value of this sector. As a result, revolution led by development of Internet in financial market is inevitable. However, government should identify the strength and weakness of Internet finance and be aware of the risk associated with this rising sector. It is important for government to push for regulatory policies that have specific aims, while leaving enough room for new entrants to grow with freedom.

Risk of Internet Finance

There are five types of risk associated with Internet finance. The first type is financial fraud, such as embezzlement of users’ deposit by financial service providers. Embezzlers set up a Ponzi scheme to lure investors with high return rate and raise fund. The embezzlement is sometimes followed by disappearance of the embezzlers with users’ saving. Theoretically, the distinction between Ponzi scheme and legitimate deposit and loan service is clear – the return in legitimate deposit and loan service is based on value-creating service and actual profit; the return in Ponzi scheme comes from additional deposit of other users. However, in real life, it is often difficult to correctly make this distinction. In fact, one of the reasons for private financing to suffer from numerous regulations is the difficulty in identifying a series of financial fraud characterized by Ponzi scheme.

Yu Ebao provided by Alipay is an example of good Internet financial service. Yu Ebao is a financial product that negotiates to gain high interest rate on deposit from banks through Tian Hong Asset Management Co., Ltd. I don’t think Yu Ebao guarantees rate of return to its investors nor does it provide any type of bonus. Its accounts and fund has always remained under surveillance of associated banks and regulatory departments. Because of these practices, Yu Ebao provides us with an industry standard for Internet financial service that would keep the risk of fraud under control.

In addition to Yu Ebao, petty loan service provided by Ali Financial Service is another service that is worth of support. Based on the Big Data collected from its platform, Ali’s petty loan service excels in analyzing performance of E-commerce business owners and achieves profit by overcoming problems caused by information asymmetry. In comparison, many other Internet financial service providers simply amass large amount of fund using communication advantage of Internet. The way that these organizations operate makes no important contribution to overcome challenges caused by information asymmetry between loan providers and receivers. Regulatory organizations should be aware of these organizations because they are unlikely to achieve sustainable development.

The second type of risk is about technology, which includes information safety, operating procedure, financial crime, liquidity support, and other aspects. In order to reduce this type of risk, associated regulatory departments need to promptly update industrial safety standards and strictly and fairly ensure abidance of Internet financial companies.

Since telephone was first introduced in business in 1878, criminal activities through telephony has never stopped. However, these crimes have never become a reason for us to stop using telephone. For the same reason, although many safety issues, privacy concerns, and criminal activities come along with Internet, development of Internet should not be suppressed. When a problem is identified, people always come up with solutions. For example, opening of online account has always faced the challenge of identity authentication. However, using boarding record of airline companies can partially solve the problem. In general, specific and detailed regulatory goals help to increase options of solution.

The third type of risk is investment risk. Internet financial products are exposed to risk associated with business and political activities. Furthermore, under status quo, the huge amount of fund raised from fragmental capital leads to reduced return of capital. Under this type of risk, the essential strategy is to adopt sufficient information exposure and communication.

It is important to notice that the return of capital is actually reducing as capital accumulation increases. This realization contradicts to Yu Ebao’s claim that “it will increase the cost of finance for companies.” Today, the low interest loan provided by every major bank is mostly received by large corporations, state-owned companies, and state-subsidized programs. The actual cost of finance in private, small and middle companies is much higher than the claimed interest rate of major banks. As services like Yu Ebao grow large, more and more capital will flow to smaller, private companies. As a result, the actual cost of finance will decrease instead of increasing.

The fourth type of risk is associated with the amount of currency in circulation. Internet financial services cause rapid changes in the state of currency circulation. These changes lead to risk of error in regulation of the amount of currency in circulation by the Central Bank.

The risk of currency circulation will undeniably come along with Internet financial activities more or less. However, the very same type of risk will also come along with any financial organization, financial product, and even economic activity. It is the responsibility of the Central Bank to consistently improve its technique of controlling the amount of currency in circulation based on changes in market and improvement of technology. Therefore, it is the Central Bank that needs to keep up with market and technological development instead of the other way around. In other words, it is the responsibility of the Central Bank instead of companies who engage in Internet finance to take on this type of risk.

Recently, Mr. Renjie Li, president of Industrial Bank, said that all the major banks are now connected with Alipay, which has replaced the Central Bank to some extent. This view is contradicted to common sense. The division of functions between the Central Bank and the other major banks is clear. Since all the major banks cannot possibly replace the Central Bank, how can a financial organization that is merely connected to the major banks replace the Central Bank? I agree with Mr. Greenspan, the former president of the Federal Reserve, who said that “The People’s Bank of China (Weibo) is the Central Bank of China (Weibo). No other organization can replace it now or in the future. It is very inaccurate to say that Yu Ebao is the second Central Bank.”

The fifth type of risk is associated with redistribution of interest. For a very long time, China regulated deposit rate in banking business. The interest spread of deposit and loan has become a monopolized rent that is enjoyed solely by programs between banks and state-owned firms, large corporations, and state-subsidized projects. Through Tian Hong Asset Management Co., Yu Ebao is able to negotiate for relatively high deposit rate and return part of this benefit to users. In essence, Yu Ebao pursues vested interest; in the meanwhile, it returns part of this interest to the public depositors.

Although their interest is being targeted, the major banks are not panicking because they know that their market dominance is protected by the government. These banks publicly formed alliance and refused to negotiate on deposit rate with foundations from different money markets. Their goal is to prevent the monopolized rent that they have always received from going into the hands of the public. This is the core of interest conflict in the discussion of Internet Finance.

There are many reasons for a monopoly to take place, such as natural barrier, innovation in product, and protection of government. Out of all the reasons, only the last one should be eliminated. The most improper competition occurs when monopolists, who are under government protection, come together to repel competition.

We should come to the realization that technological advancement is a weapon that will destroy monopolized markets. Even if the current development of Internet Finance in private companies will be slowed down by political means, Internet Finance will nevertheless grow and prosper inside the major banks. Regulatory organizations should realize the risk associated with redistribution of interest, comprehend the big picture, play the role of a regulator instead of a practitioner, and open up fair competition between the major banks and civilian Internet financial organizations.

Reasonable Regulation

Reasonable regulation is based on understanding of risk and characteristics of Internet financial products. Traditional economic products are certified goods produced by certified producers, in certified locations, using certified production factors, and through certified production procedure. The regulation of traditional economic activities usually focused on identity authentication of producer, standardization of production location, restriction on range of product, and quality control of product.

The regulation of Internet products is different. It is difficult to determine characteristic and boundary of producer, production location, production factors, production procedure, goods, and service before the business actually takes place: an instant messaging software can transform into a social platform, which can then transform into a trading platform and further into a deposit and investment platform. Consumers on the platform both consume and provide information. In the Era of Internet, it is difficult to define the scope, partner, product, and target consumers of a business.

Under the technological and market situation, regulators should forgo traditional standards including identity authentication of business owner, scope of business, and the definition of certified goods. Furthermore, regulators should ignore the pedantic discussion of “whether Internet Finance is real innovation.” Instead, regulators should follow the regulatory philosophies of “bottom-line monitoring” and “gardener management.” In other words, regulators should identify potential risks. In the meanwhile, they should open up the market to the highest extent, support data sharing, allow expansion of business, encourage evolution of product, and let civilian Internet companies to compete against traditional financial organizations on equal grounds. This is the way to build a healthy business culture for E-commerce.


The author is an economist and co-director of Institute for Law and Economics at Peking University.

Source: Caijing Magazine