Why Yu’E’Bao won’t Threaten China’s Financial System

Although Yu’E’Bao’s future remains unclear, with greater management and oversight, it will not result in a national financial crisis.

On March 17, the Chinese central bank announced a series of rules to strengthen regulation on Yu’E’Bao, in order to prevent it from becoming a real threat to China’s financial system.

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A user’s account webpage displays his Yu’E Bao account profit. Credit: CNS

Yu’E’Bao, which means “leftover treasure,” is an online financial product presented by Chinese e-commerce giant Alibaba Group Holding Ltd. in June 2013. Individuals and corporates can put money into Yu’E’Bao without a minimum amount or holding duration.

Collected money is then invested to a money fund called Tianhong Asset Management. With predicted annual yield of 6%, Yu’E’Bao has been popular among the public.

Until now, Yu’E’Bao has gathered more than CNY $500 billion (about $83 billion). Obviously, the advent of Yu’E’Bao is like an earthquake in the Chinese financial system. Many stakeholders such as bankers are hostile to this innovated Internet financial product, afraid of unknown threats it may bring.

Traditional banking is the first to be affected. Relying on five advantages –flexibility, low-barrier, high yield, convenient services, and high reputation and guarantee– Yu’E’Bao has attracted many customers to transfer their deposits from banks to Yu’E’Bao.

The more customers banks lose, the less profits they will make. As China International Capital Corporation Ltd. says, the migration of deposits will bring down banks’ net interest margins by as much as 0.15 percent (In 2013, Chinese banks’ average net interest margins is 2.68 percent).

Besides decreasing banking revenue, Yu’E’Bao itself has a crucial problem of liquidity risk, too. To put it simply, liquidity risk means a given security or asset cannot be traded quickly enough in the market to prevent a loss.

To avoid this, banks are required to keep a portion of their deposits in reserve at the central bank. However, for Yu’E’Bao and Tianhong Asset Management, there is no such guarantee money for deposits. Moreover, Tianhong Money Funds’ promise of T+0[1], or when a security is purchased payment and the securities certificate must change hands in the same day after the trade is executed, requires an extremely high ability of liquidity position arrangement.

Under some condition, when a large amount of funds are withdrawn in a short time, Tianhong will face a huge liquidity risk and may be squeezed or even close down. What’s worse, since liquidity risk disseminates rapidly, it will soon spread to the entire financial system.

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That’s how a financial crisis generates. Look back at the 2008 financial crisis and Barings Bank in 1995, and you will realize how serious this could be.

However, as terrifying as it seems, Yu’E’Bao may not cause too much trouble to the Chinese financial system as long as it is properly regulated.

In the eyes of many bankers, Yu’E’Bao is a “cheese mover” and will beat traditional banks in the near future. Nevertheless, according to the 2013 Q3 data, the total amount of deposits in Chinese financial institutions is 100 trillion. In contrast, money funds, with the support of Yu’E’Bao and other similar online financial products, have only collected over 1 trillion funds. With a proportion of 0.5 percent, Yu’E’Bao is far less from being a danger to traditional banks in China.

Won’t there be more and more customers joining in Yu’E’Bao and enlarging the proportion? Probably not. The primary temptation of Yu’E’Bao is its guarantee of high yield rate of 6 percent (compare to banks current deposit interest rate at 0.35 percent).

However, as observed, prior to March 1, Yu’E’Bao’s 7-day annualized return held above 6 percent. It dipped below 6 percent the next day, and had slipped down to 5.54 percent on March 18. As the yield rate keeps decreasing, enthusiasm for Yu’E’Bao will gradually cool down.

Will this reducing yields cause a large-scale divestment then?Not really. Although customers would be disappointed by a declining yield, as long as Yu’E’Bao offers a higher return rate than banks, people will not drawback their money (and don’t forget all the convenience Yu’E’Bao provides).

Actually, serious divestment will not happen unless there comes a new financial product, with a much higher yield rate meanwhile maintain security and liquidity risk at a minimum level. However, given current condition of the Chinese financial market, such products don’t exist.

In conclusion, although Yu’E’Bao’s future remains unclear, with greater management and oversight, it will not result in a national financial crisis. For investors, they need to be careful and informed when purchasing financial products, and remember not to put all their eggs in one basket.

Yan Cong is a Master’s student in New York University’s Political Science Department.