Innovation in financial technology (fintech) has made life easier, but how about potential risks? China's banking and financial authorities' regulatory talks with Ant Group, the fintech affiliate of e-commerce giant Alibaba, at the end of last year were evidence of the government's concern.

The meeting was attended by officials from the People's Bank of China (PBC), the China Banking and Insurance Regulatory Commission (CBIRC), the China Securities Regulatory Commission and the State Administration of Foreign Exchange.

In a press release, PBC Deputy Governor Pan Gongsheng said the regulatory talks with Ant Group were mainly aimed at urging the firm to fulfill financial regulatory requirements and the requirements for fair competition and protection of consumers' legitimate rights and interests.

"Fintech and Internet platform enterprises are fresh business forms that innovate and evolve rapidly, taking on many new features," Pan said. "Financial regulators will continue to strengthen international exchanges and cooperation in supervision, while promoting fintech innovation as well as the healthy development of the financial system."

An announcement from Ant Group said that it accepted the requirements and would establish a special working group to deal with rectification and follow guidance from the regulators during the entire process.

In early November 2020, the Shanghai and Hong Kong stock exchanges suspended Ant Group's planned initial public offering.

Also, the Zhejiang Office of the CBIRC issued a notice in late December 2020, requiring all types of banking institutions within its jurisdiction to stop accepting deposits through third-party Internet platforms or through cooperation with other third-party intermediaries, and to remove existing such deposit products.

A few days before the notice was issued, Ant Group, which is headquartered in Hangzhou, Zhejiang Province, announced that it had removed all its online deposit products. This move was then followed by a dozen other online financial platforms affiliated to leading Internet firms such as Tencent, JD.com and Baidu.

Potential risks

The online deposit products were ordered to be removed because the financial supervisory authorities noticed the potential risks of such products.

Small and medium-sized banks broke the limit of traditional channels in absorbing online deposits, and they were becoming national banks from the perspective of funding sources, which is a deviation from their market position of being based in their local markets and serving micro, small and medium-sized enterprises, said Sun Tianqi, head of the PBC's Financial Stability Bureau, at a seminar on the supervision of digital finance held in Hangzhou on November 7, 2020.

Sun said sellers of online deposit products deliberately highlighted the government's protection of deposits and implied that online deposits have "zero risk" and "high yield."

Dong Ximiao, chief researcher with Merchants Union Consumer Finance Co. Ltd., said that on the business chain of online deposits, the Internet platforms provided an interface for information display and purchase, while deposit products and services were provided by banks.

"In this pattern, it needs to be confirmed by the financial supervisory authorities whether Internet platforms are suspected of illegally handling savings business. Internet platforms are not savings institutions regulated by law, and they cannot handle savings business," Dong said when interviewed by Economic Information Daily.

Wang Yifeng, chief analyst of finance with Everbright Securities Co. Ltd., said small and medium-sized banks were highly dependent on Internet platforms in attracting online deposits. Conventional liquidity management indicators are not able to fully assess the instability of online deposits, making it more difficult for small and medium-sized banks to manage their potential liquidity risks.

In the meantime, the high costs of online deposits are likely to increase the potential risks. Small and medium-sized banks don't have enough capability in investment, so they have to invest the deposits they attracted through Internet platforms in high-risk assets, which may result in accumulation of credit risks, Wang told Economic Information Daily.

Blind spots of supervision

There are hidden risks behind online financial business through cooperation between banks and Internet platforms.

Guo Feng, an associate professor with the School of Public Economics and Administration of the Shanghai University of Finance and Economics, said in the online deposit business, financial institutions with a strong position may shift their risks to Internet platforms via contracts or other ways. Internet platforms are not financial institutions, but they actually assume financial functions. However, they are not subject to supervisory requirements such as the capital adequacy ratio and liquidity that financial institutions must abide by.

According to him, in the cooperation between large Internet platforms and small or medium-sized financial institutions such as local banks, the latter have to take most of the risks and costs because they have weak bargaining power and inadequate risk control measures against Internet platforms.

In addition, the cooperation between local banks and Internet platforms imposes new challenges to financial supervisory authorities that are used to the supervision of financial institutions in their respective localities, Guo said in an interview with news website ThePaper.cn.

"Small and medium-sized banks are unable to conduct effective risk control but have to bear all the debts in the online deposit business," Chen Wen, head of the Digital Economy Research Center of Southwestern University of Finance and Economics, told ThePaper.cn.

He said this will lead to a serious moral hazard. It will be possible for small and medium-sized banks to frantically rely on Internet platforms to attract deposits and grant loans, expanding their asset scales rapidly as long as they are willing to do so, but the one ultimately assuming all the risks may be the central bank.

Therefore talking about future supervisory policies on fintech companies, Pan said in the PBC press release that all financial activities must be brought under regulatory coverage in accordance with laws and regulations, financial services must be conducted on a license basis, and zero tolerance will be adopted for illegal or irregular conduct.

Guo thought more supervisory measures are likely to be formulated in the future to regulate the cooperation between traditional financial institutions and fintech platforms and make the risks and responsibilities more reasonably shared by the two parties.

"However, I think the supervisory departments also need to consider how to better divide the responsibilities of central and local supervisory authorities, and how to make the traditional supervisory model better adapt to the demand in the Internet era, rather than simply requiring the Internet-based business to adapt to the traditional supervisory model," Guo said. 

(Print Edition Title: Fintech Supervision)  

Copyedited by Madhusudan Chaubey

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