Author: Yang Ji

fintech fintech asia innovation regulation

Seeking balance between fintech innovation and regulation in China

The rapid development of fintech in China has prompted regulatory authorities to consider the potential risks it poses on the overall financial system.

Ant Group’s initial public offering (IPO), set to become the largest in history, was suspended by regulators last minute. According to the Shanghai Stock Exchange, ‘major issues regarding changes in the fintech regulatory environment might cause the company not to meet the listing conditions or disclosure requirements’. A new balance between fintech innovation and regulation needs to be reached before the IPO goes ahead.

The changes in the fintech regulatory environment refer to a new rule proposed by the China Banking and Insurance Regulatory Commission. Internet platforms must now fund at least 30 per cent of any loan in their co-lending partnerships. Ant’s funding has been lower than that — its current role in co-lending is mainly as a technology and information provider, with partner banks providing most of the funding.

The new rule means that Ant needs to set aside more money for the loan originations when it participates as an internet financial platform. The market may need to reconsider Ant’s ‘Tech’ component relative to its ‘Fin’ and re-evaluate the company’s market value as a technology-intensive company, as the capital adequacy ratio requirement could shift Ant from a technology-intensive company toward a capital-intensive bank.

Ant operates Alipay, the world’s largest mobile payment platform, offering customers various financial services including payment, wealth management, borrowing and insurance. Ant charges fees from partners, including banks, mutual funds, insurers and other financial institutions, for access to a wide customer base through its platform and technology services.

According to the IPO document, Ant’s revenue can be categorised into three business segments: innovative business, digital payments and fintech platform. These contribute 0.8, 35.9 and 63.4 per cent to total revenue, respectively. Within the fintech platform segment, there are three main subdivisions, CreditTech, InvestmentTech and InsureTech, which contribute 62.2, 24.5 and 13.3 per cent of the total fintech platform revenue, respectively.

As an important driver contributing 39 per cent of total revenue, CreditTech includes short-term consumer credit and small business lending services. While it is an important aspect of inclusive finance that the Chinese government greatly encourages, small business lending only makes up a small share of CreditTech services. Short-term consumer credit accounts for 80 per cent of the 2.1 trillion RMB (US$321 billion) loan balance facilitated by Ant’s platform as of 30 June 2020.

There are several concerns about consumer credit. First, Ant’s short-consumer credits have been criticised as high-interest debt. When compared with banks, it appears that some banking credits are also priced at similar or higher levels. But their borrower bases are drastically different as Ant often serves borrowers who are excluded from the traditional banking system. The real problem is not how high the interest rate is, but how well the consumers understand the real cost of consumer debt, especially for those with relatively low level of financial literacy. For example, for a three-month-installment loan charging 2.5 per cent principal as financing cost, some underbanked consumers may have difficulty correctly calculating the true annualised interest rate, which is around 15 per cent, underestimate real costs of installment, and overspend.

Second, consumer credit can raise overall leverage in the household sector — a leading indicator of financial crises. But since the majority of household leverage in China is in the form of home mortgages, the rising household leverage should not be solely attributed to short-term consumer credit, which was shrinking by a year-over-year rate of negative 11 per cent in the third quarter of 2020. A more relevant question is how to strike a balance between promoting financial service inclusion and restricting excessive household debt accumulation.

Third, Ant’s business model to facilitate consumer credit has long been criticised. Ant previously packaged consumer loans into securities to sell to institutional investors to fund the rapid expansion of its loan books. Regulators quickly capped the use of asset-backed securities (ABS) in consumer loan funding, resulting in a shift away from ABS to the co-lending model after 2017. Ant now primarily acts as an agent or partner for banks, with banking institutions directly lending around 88 per cent of Ant’s outstanding loans.

The co-lending models are subject to systematic risk. Similar to the moral hazard concern in syndicated loans, Ant enjoys information advantages, retains a small share of the loans, bears a small share of credit risk and may exert less monitoring effort. If regulators required Ant to provide a larger share of its own funds, Ant might be prodded into further improving loan performance. Meanwhile, the partner banks’ motivation to control risks would be undermined, contrary to the intention of the new co-lending rule.

The halting of Ant’s IPO offers a chance to reconsider the balance between fintech innovation and regulation. As fintech companies develop new products, regulators should enforce disclosure standards and ensure the price comparability between different financial service providers. As financial services become more inclusive, it’s important to also promote inclusive financial education along the way, so that consumers can make informed financial decisions. As data increasingly becomes an important factor of production, how to best utilise and govern the value of data should be incorporated into the current co-lending regulatory discussion on both fund-raising and risk-sharing.

Source: East Asia Forum

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