Chapter 8
Internet Finance

On January 4, 2015, the internet firm Tencent launched China's first internet-based bank “WeBank”. One of the five privately funded banks approved by China's central bank, PBOC, WeBank in Chinese suggests a bank for “micro and many”, reflecting its focus on ordinary individuals and small businesses and its linkage to the internet and social network. The ceremony was officiated by Premier Li Keqiang, and he pressed the “enter” button on a computer to send out the first loan of RMB35,000 ($5,400) by WeBank to a truck driver.

This first internet loan represented three important innovational aspects.

First, by providing microloans to the public, internet banks like WeBank addressed demands from individuals that were not adequately addressed by the existing financial system, with its focus on large companies.

Second, the internet bank conducted all operations online, so that the borrower did not need to go to an offline outlet to obtain the loan. WeBank first used Tencent's own version of facial recognition technology to verify the borrower's identity from a remote terminal; all of the loan processing was completed online.

Third, the creditworthiness of the borrower, the truck driver, was analyzed by utilizing big data technology, which effectively reduced the information asymmetry between the bank lender and the borrower. The driver was a member of a Tencent-invested logistics platform called Huo-che-bang (Truck Club), which links truck services with logistics companies. Based on the driver's driving history on the mobile app and his online profiles on other e-platforms, WeBank's financial model gave the driver a high credit rating and granted a loan carrying a 7.5% interest rate, without requiring collateral or a guarantee. In financial terms, WeBank's superior data sources and processing capability enable this internet bank to provide better priced credit to consumers. (Without sufficient information on the borrower, the interest on the loan would likely have been set higher by the bank.)

As summarized by Premier Li at the ceremony, “one small step for WeBank is a giant leap for financial reform”. This statement was no exaggeration as online purchases were only made possible in China a decade ago by an escrow-like service designed by Alipay, the online payment system affiliated with Alibaba. e-Commerce in China started with a cash-on-delivery model, but Alipay and other internet payment platforms managed to build trust between consumers and vendors by serving as a sort of escrow service: when a consumer made a payment through Alipay, Alipay notified the merchant to ship the order, and Alipay released the funds to the merchant only when the consumer received the product. This innovative set-up led to a boom in online transactions in China.

Today a large part of the Chinese population has skipped credit cards entirely in favor of digital payments, just as people in many parts of China are skipping landline phones to buy a smartphone to access the internet for the first time. In addition, Chinese consumers are comfortable with using the internet to manage their savings and investments. As internet companies transform smartphones into a platform for financial transactions, China is way ahead of the rest of the world in terms of how widely internet finance is adopted.

The rising integration of internet and finance is closely linked to two imperfections in the financial system – and potential solutions stemming from the internet. One is the lack of investment choices for individual savers and investors. China's financial services sector is immature compared with developed markets, and it lacks the variety of products and services found in the US market. The two major investment channels – public stock and real estate markets – require large investments and a high risk tolerance. Meanwhile the deposit interest rates at banks are tightly regulated and currently set at low levels.

The other imperfection is the difficult access to credit by small and new businesses, because banks concentrate on the bigger and established companies because of their perceived lower credit risk. In response, internet firms have set up online investment platforms for individuals to educate themselves on capital markets and invest in financial products. New lending and equity financing models are also initiated for under-served individuals and SMEs (small and medium-sized enterprises), such as peer-to-peer (P2P) lending, equity-based crowdfunding and microloans based on big data.

In a short period of time, internet finance has fostered a more inclusive financial system where loans and equity financing are more widely available to consumers, start-ups, SMEs and whoever can put them to productive use. New players, many of which are private, internet-based and light on assets, have entered China's mostly state-controlled financial industry and offered innovative products and services. (See Table 8.1 for selected providers of internet finance to be discussed in this chapter.)

Table 8.1 Examples of internet finance in China

However, due to the lack of a market entrance threshold or business operation standards, many of these new offerings have evolved from regulatory “gray zones” and have grown rapidly “in the wilderness”. For example, in the first half of 2015, there were more than 400 new cases of P2P lending platforms running into operational difficulties, according to data from P2P portal .

On July 15, 2015, China's central bank, PBOC, teamed up with other related regulators and jointly issued the long-awaited policy framework on internet finance in China, the Guidelines on Promoting the Healthy Development of Internet Finance (referred to as “the Guideline” in this chapter). The Guideline defined internet finance as “traditional financial institutions and internet companies using internet technology for payments, internet lending, public equity financing, internet fund markets, internet insurance, internet trust, and consumer finance”. For the first time, government regulation defined the term “internet finance”, and the new financing businesses such as P2P lending and crowdfunding were recognized and addressed.

Reflecting the exceptional complexity of internet finance – which covers numerous financial services under different regulators – a total of 10 government ministries and commissions jointly issued the Guideline. On the financial industry regulators’ side, there were the central bank (POBC), the Ministry of Finance, the State Council Legislative Affairs Office and three regulatory commissions for the stock market, banking market and insurance market (CSRC, CBRC and CIRC, respectively). The internet industry was represented by the Ministry of Industry and Information Technology, the State Administration for Industry and Commerce and the State Internet Information Office. In view of fraud and other crimes in this field, the Ministry of Public Security also joined the taskforce.

In terms of the regulatory responsibilities defined by the Guideline, the central bank would monitor online payments, the securities regulator CSRC would supervise crowdfunding and online sales of stocks and stock funds, and the banking regulator CBRC would oversee online lending platforms such as P2P lending. Based on this joint policy framework, the regulators would develop specific rules in their respective jurisdictions. As the topic of mobile payment has already been covered in the chapters on e-commerce and O2O markets, the following sections will focus on the new financing models (equity crowdfunding and P2P lending), the new internet distribution channels for asset management products and their related regulatory challenges.