Can A Single Spark Start a Prairie Fire?
Will Internet Revolutionize the World of Finance? How Internet Finance is reshaping Chinaand the world?
Dr. Ben Shenglin 贲圣林 教授
Professor of Banking and Finance
Keynote Speech at the Asia Business Conference,Wharton School, University of Pennsylvania
One of the most popular search phrases in Baidu – China’s Google equivalent is Internet finance, so popular that when you type the Chinese word of internet, the system would prompt the Internet Finance as the most searched word for you to choose, with over 18 million leads!
So what is internet finance? In terms of functions and scope, Internet finance mainly conducts (1) online payment services, (2) lending, such as microcredit, supply chain financing, peer-to-peer lending, and crowd-funding, (3) sales of investment and risk management products such as money market funds and insurance, and (4) assessment and scoring of credit risks across businesses and individuals.
Though internet-based financial services such as peer-to-peer lending, online payment, crowd-funding and internet banking all started in the west especially here in the US, China was a quick learner, having replicated and in most cases adapted and expanded them to Chinese market. Now China is leading some of the trends and innovations in the field of “Internet finance”, a term coined in 2012 by Dr. XIE Ping who was a senior official at the Chinese central bank. The term itself is probably one of the very few original thoughts that so far China has contributed to the world of finance and banking. Two broad trends are driving the growth in Internet finance in China. First, e-commerce and other Internet companies have been branching into the financial sector. Second, traditional financial service providers have been migrating to the Internet (e.g., online banking, online broking).
Why is internet finance getting so much attention? Like what has happened in the rest of the world, internet has changed a lot of things in my home country since the nation was connected to it in 1994. While its impact has been across the board, from e-commerce to tourism, from news and media to restaurant booking, from medical services to online language courses, its impact on finance appears to be most profound and have gained most attention.
To understand this, we must first understand the industry dynamics there: financial service sector in China is a relatively regulated and to some extent “protected” sector thanks to the high entry barriers and interest rate regulations. These largely explain why the Chinese banks are “notoriously profitable”: the listed Chinese banks made more profit than the total of all listed-companies in ALL other sectors. That of course has not made the bankers very popular in China! When I left banking for academia last year, many of my friends “comforted” me that my loss of income was more than compensated by the gain of respect I have earned as a professor!
Because of the particular industry dynamics and landscape, China has been suffering what the late Stanford professor Ronald McKinnon called financial repression: the lack or inadequacy of financial services to effectively meet the needs of the society, across all segments: corporate, small businesses as well as households and individuals. Evidences of financial repression are abundant, with too many people and companies in China who are either not satisfied with the financial services they have been receiving or they are not served at all. Chinese banks have been complacent with the relatively easy money they have been able to make by serving the premium client segments: with what bankers call “plain vanilla” products, they have been able to make good margins so far thanks to the inadequate competition, regulated interest rates, and other institutional deficiencies. In other words, they have been reaping the so-called structural and institutional dividends.
Financial repression is particularly severe in the micro-finance sphere: the small businesses and lower income households in urban and the vast rural areas, as the mainstream financial services providers have largely ignored these sections. Though they have recently shown some willingness to change (or forced by regulators to change), their ability to re-tool their institutions to serve these masses has proven inadequate.
In China, there is a famous quote of Chainman Mao: Whereas there is oppression, there shall be rebellion. (哪里有压迫，哪里就有反抗。)Here come the Chinese internet companies, who have experienced phenomenal growth and some have become global leaders already, such as Alibaba and Tencent. They saw the financial repression as opportunities and started entering the field. Alibaba was the first one. It set up Alipay in 2005 to focus on payment services online, which Chinese banks ignored as it was not making money. Today Alipay has about 200 million registered mobile users and processes 45 million mobile payments a day. Last year during the “Double 11” Singles Day, it processed 197 million “mobile payments” on a single day, 336% increase from previous year, making it the world’s largest mobile payment service provider.
In 2012, seeing the paltry interest rates banks were paying on the deposits especially the small amounts, Alibaba partnered with a fund management company and emulated what PayPal used to do in the USA in 1998 by selling simple money market funds which pays at a much higher rate than the bank deposit rate. Within a year, Alibaba were able to attract over 500 billion RMB assets under management, serving over 150 million accounts, the previously little-known fund management company they partnered with became the largest fund manager in China.
What is so special about this money market fund sold by Alipay? You can start with 1 dollar, but can enjoy the SAME attractive rates and services as other accounts. Compared to PayPal’s eventual exit from this field, Ali’s success in this field is partly due to the particular institutional landscape in the Chinese financial system.
With all these developments, today Alibaba’s financial services arm, neatly called Ants Finance Holdings to reflect its focus on micro-finance, has established a financial service empire encompassing small loans, fund management, payment services, credit checking, and banking.
Tencent is another internet giant that has entered into the financial services. Leveraging its powerful WeChat platform, it now has established the first truly “internet bank” – WeBank in Shenzhen with no branch network.
What Alibaba, Tencent and other internet giants have been trying to do is to provide the largely-ignored mass market or the “fat tail” client segments with the same kind of services as the higher end clients – essentially establishing a level-playing financial field for the less-privileged in the society. They have won a lot of public applause and official support.
What about the banks? At the recently closed annual congress session in China, a Chinese bank CEO who is also a congress delegate, was lamenting to the Premier that banks in China have become a “weaker and under-privileged sector”, which drew a lot of laughter in the room but scorns from the general public. However the Chinese bank CEO may be right.
Because of the competition from internet finance companies including online fund product sales, suddenly the banks feel threatened: they can no longer take for granted the dormant accounts and passive balances, these accounts are suddenly activated by customers and balances are becoming flighty, flying to the world of internet finance. To add insult to the injury, most of these money have been placed back into banks as deposits, but at a much higher cost given the strong(er) bargaining power these internet giants enjoy vis-à-vis banks.
Internet finance is making traditional banking, insurance and securities brokerages increasingly outdated. Bill Gates is purported to have said that the world may need banking, but not necessarily need banks，I got to know his famous saying of "last dinosaurs standing” about commercial banking in 1994 when I first started my banking career, but it almost took my entire banking career to see his vision becoming a reality. Similarly, when Jack Ma of Alibaba was quoted famously as saying that “if the Chinese banks do not change, we will force them to change”. People in China did not believe this, but we all know that his envisaged future is already here with us today, sooner than many of us have expected.
What challenges do internet finance companies face? Internet companies are not short of entrepreneurial spirit and risk-taking culture, what they need is the credit and risk management capabilities. Internet finance companies also face the monopoly of central banking and unclear regulatory prospects. In terms of size, despite their rapid growth, internet finance companies are small compared to industry incumbents. For example CreditEase(宜信) looks tiny compared to ICBC, similarly in the United States, Lending Club is small as compared with Wells Fargo.
What is the future of internet finance? While they face various challenges, some of which are very daunting, internet finance will become a stronger new force in the rapidly changing financial service industry. As a new comer, it is challenging the industry incumbents to be more efficient and responsive to the real financial needs of their customers, not just the largest and best ones, but the whole segments. The day that every one is created equal from financial services perspective is closer than ever, thanks to internet finance.
In terms of opportunities, developing countries probably have the best growth potential for internet finance given less competition from industry incumbents, more untapped demand, and the efficiency of internet finance. For the similar reasons, in each developing country, opportunities are likely to be more abundant in the micro-space, in rural areas. With emerging markets under their belts, they can replicate their successes to the developed markets and potentially will leapfrog the current global financial giants who have been struggling to respond to the financial services needs in the internet age.
Lessons from the history
Many of you might think I am being too optimistic here. But the history I know offers good references for my optimism.
Chinese communist party: The Road from Yan’an to Beijing
Many of you here have not heard of the small Chinese city called “Yan’an”. It is in northwestern China, about 200 miles from Xi’an, the ancient Chinese city famous for terra cotta. In 1935, Chinese communist-led troops were forced to retreat and settle down in this remote region, with only the dreams, passions and little else. The American journalist Edgar Snow was attracted to visit there and wrote the famous book “Red Star over China”(红星照耀中国). Because Yan’an was so rural with mountains around it, the Kuomingtang troops stopped short of getting to this isolated region and stayed in more comfortable big cities like Xi’an. Chairman Mao saw this opportunity and formulated the famous strategy of “encircling the cities with the rural China”(农村包围城市战略): by taking control of vast rural China first, then take the cities when they are all surrounded by the rural areas which are already under control. The strategy proved perfect, it took them less than 14 years to transform themselves from a group of rebels into the governing party of the country in 1949.
Huawei: from emerging market to global leadership
Huawei appears to have emulated what Chairman Mao did, probably because its founder Mr. REN Zhengfei was a retired military officer. Huawei first focused on the toughest and least developed markets in the world that Nokia and other industry leaders had largely ignored. After Huawei conquered those less developed markets, they successfully penetrated into the developed markets, with USA as a major exception for the reason we all know. Nevertheless, Huawei is now a global leader, even without US market!
Alipay and Apple: similar paths to success?
Alipay has experienced similar successes by focusing first on the “peripheral” finance areas such as low value online payment and microfinance! To a certain extent, Apple took a similar strategy. It did not start by competing against IBM in the corporate sector. Steve Jobs not only saw the opportunities in the largely ignored PC market, more importantly he made it affordable to the “mass” market.
Are there anything common behind the successes of Chinese communist party, Huawei and to a certain extent Alibaba and Apple? They did not take on formidable incumbents head-on, instead they focused on the areas ignored by their competitors: rural China, less developed countries, lower end and un(der)-tapped customer segments. This has been the strategy and roadmap that Chinese communist party, Huawei, Alibaba, Apple took, and they all succeeded. They were all tiny and weak at the beginning, but as the strategist Mao said, “A single spark can start a prairie fire” (星星之火可以燎原). I am hopeful that the spark of internet finance will start a praire fire in the world of finance!
Finally and more importantly, the future success of internet finance will have broader impact beyond finance or economic sphere. From a social perspective, internet finance has bestowed the underprivileged classes the equal right, for the first time, as a customer of financial services. This will have profound implications as the masses, equipped with the financial means and lower barriers to entrepreneurship, will be fully participating in, if not at the forefront of, the global waves of innovation and entrepreneurship. What will then happen to the current power structure, social hierarchy and global governance system? Change! A lot of changes!
Let us encourage and embrace the changes, for we do not have other choices.