Introduction
As a system, Internet finance (IF) has originated in the West, but China has become the place where it is currently the most powerful and developed in the world. Internet-based companies in this country were the first to realize the potential of the new model. Nowadays, corporations like Alibaba and Tencent are leading the market after introducing financial products in addition to their primary businesses. Their IF platforms draw millions of users and generate capitals that start to create the real competition to the traditional sector. However, the industry is still developing, and there are issues that require the unique approach to their solution to prevent this important part of the Chinese economy from a potential default.
This research is significant since it analyzes the latest trends in the industry of Internet finance. The literature background is important for understanding the origins of the concept, as well as comparing it to processes that had happened in other countries before IF has come to China. However, the nature of this model is built around the high speed of changes that is a feature of all online-based businesses. Thus, what used to be significant several years ago does not characterize the current state of the industry.
The research starts with the background of Internet finance as a concept, providing its definition from the literature. The features of IF are given, followed by its comparison to the traditional sector. Theories are combined with practical results shown by the industry in the description of IF development. The values of Internet finance are presented, as well as the issues facing the sector and the solutions that might work to tackle them. The method of empirical analysis has been used in this research, and the latest news reports and statistical data have been provided to support the conclusions.
Defining Internet Finance
The definition of the concept of Internet finance varies depending on the spectrum of its application. In general, it forms around financing and investing as two core activities that are performed in a mixed-operation manner with the use of technological platforms. In many countries, alternative finance is used as an umbrella term for the concept, covering various models of operations between companies and individuals.
In China, Internet finance is defined as a model, where traditional institutions and online companies use the Internet and IT as a communication tool to “realize accommodation of funds, payment, investment, and information intermediary services” (Ye and Ma 241). However, the background behind operations of these two types of organizations is quite different, which often puts them as competitors rather than partners.
The idea of Internet finance has come to China from the Western market. In the late 1990’s, the process of digital finance development gave a start to several companies that shaped the operations model (Guo et al. 4). PayPal has become one of the first solutions for Internet payment, while the British Zopa.com and the American Lending Club allowed peer-to-peer funds exchange activities. Other types of financial interactions also took their start in the United States or Europe.
The Chinese term for the concept was created in 2012 by Ping Xie, who used to be Vice President at the China Investment Corporation (Guo et al. 4). He claimed that modern technologies that use the Internet as their operations base, including social networks, search engines, and cloud storage services, will become the driving force for changes in the financial sector.
Nowadays, China is the leader in Internet finance as its largest corporations use their online platforms to develop this sphere. Researchers admit that this country has achieved tremendous growth in this field over the last decade, having hundreds of millions of its citizens using e-payment services in their everyday life (Loubere 9). Operations include transactions for buying products, lending money from individuals or online banks, and funds investments.
There are several factors in the Chinese traditional financial segment that have made IF so successful. They are mostly associated with the nature of work organization in brick-and-mortar institutions, as well as the national specifics of economic regulation. Firstly, operations in banks require much paperwork to be done that supports each activity, which is rather time-consuming. Moreover, documents utilize physical resources such as paper and stationery and take up space for storage purposes creating additional costs. Secondly, customer incomes from investments in traditional banks are relatively low, which is a direct effect of the Chinese economic system.
The government controls interest rates, making them seemingly lower than those offered in other countries where the market plays the primary role in determining revenue offers. Finally, the option of loaning funds from a bank is practically impossible for the large portion of the population in China. The rules that are created to minimize risks for traditional financial institutions do not allow most low-income customers and small business operators to receive money due to the failure to meet high profile standards.
Several years ago, the described factors were supported by the changes in the online market segment. At some point in their history, large Internet-based companies realized that advertisement could not be a stable source of income for the years to come. At the same time, their audience started to multiply rapidly, which was caused by the socio-economic processes in China. The past several decades were marked by the tremendous technology development combined with the creation of new online services. Smartphones became an essential item for most people, becoming a common device even in rural areas.
The Chinese nation started to explore different social networks and online commercial sites, and the information that users shared in the process was collected as the big data. Internet companies soon realized the potential of that technological development and the shift between peer-to-peer interactions. As a result, they offered a model of Internet finance that could satisfy the needs of many people in saving, investing, or borrowing money in a much easier way.
Nowadays, organizations that have started as online companies are now the leaders of Internet finance in China. Yu’e Bao, for example, has become one of the largest investment funds in the world that managed approximately $165 billion in 2017 (Loubere 10). It was created in 2013 by Alibaba Group Holding Ltd. – the largest e-commerce site in China and one of the most popular trade platforms in the world. Yu’e Bao was offered to users of Alipay, the holding’s payment system, as an investment tool. In just several months after its launch, the platform attracted millions of investors that enjoyed more benefits than a traditional institution could offer them.
Currently, there are several Internet companies in China that offer similar P2P financial products, including Tencent (the owner of WeChat), Weibo, and Baidu. These companies acknowledged some time ago that online advertising was reaching its limits as a source of profit. The solution was to change the model and shift the focus from businesses to users. Online corporations were quick to realize the potential of the Chinese audience they managed, which remains largest in the world. Traditional institutions also joined the trend and are now working towards creating services that would promote their products via the Internet. These changes have created various business models that are exercised as a part of IF strategies by the leading Chinese companies in this industry.
Characteristics of Internet Finance
Most IF companies in the world have similar features between them. China is not an exception, with the central element of the sector being tightly connected to the functioning model of each platform. The characteristics that are essential to Internet finance are associated with information management strategies, mobile payment, capital flows, and business models. While the Internet finance system may seem uniform, e-commerce companies differ according to these factors.
The method of collecting and managing information is the first characteristic that is essential to IF. For instance, user activities on the Internet may be one of the data sources. Companies may collect and store personal information of people when they make purchases in online stores, book tours, spend time in social networks, and browse the Internet. Some of the facts that can be determined are users’ interests, material status, family and social interactions, and other distinguishing characteristics. Modern technologies allow treating this information as big data, making it possible to determine a buyer portrait of an individual in a short period. The more people spend time online engaging in the listed activities, the more accurately their needs can be assumed by businesses.
The system of information management exercised by IF also works as a method for risk reduction. Having a detailed customer portrait is helpful in predicting, for example, whether someone would be able to return a loan. This proves to be especially beneficial for investors who need to analyze the potential for revenues beforehand. Of course, Internet finance companies cannot guarantee the hundred percent of risk-free investment activities.
However, the accuracy in measuring the level of trustworthy for each user is rather high. Moreover, companies save money on performing customer checks before each operation that is a common practice in traditional banking. All data is already collected and analyzed by a specially designed software. Lately, the trend for Internet privacy has developed, and many websites are now warning visitors about using cookie files for better performance. While the Chinese segment of the Internet has not yet been covered by this norm, new regulations may soon appear for the local online-based companies on how they should treat customer information they receive through their platforms.
The second characteristic of Internet finance is the mobile payment system. It is based on making money transactions with the help of a smartphone, computer, or another electronic device with similar functions. A mobile wallet is an example of this system that was introduced over a decade ago. Its operation principle is based on electronic accounts linked to a credit card information. Users register their profile on the platform’s website or application and input their card number and other required data.
A service sends a verifying message with a PIN code to users’ mobile phones. This step is usually repeated each time users make a transaction to ensure security payments. PayPal was one of the first companies that introduced the model of mobile payment. In China, Ant Financial, a governing company for Alipay, is the largest service that runs on the described principle.
Mobile wallets facilitate payment processes and stimulate buyer behavior. The latter is the result of the fact that customers do not have to enter their card information every time they shop online. Of course, there are other models that fall under the concept of mobile payment. For example, many online stores still offer their customers to enter credit card details directly every time they make a purchase. This operation often transfers buyers further to the bank’s webpage to complete the transaction. Another option is carrier billing when online sites access users’ mobile accounts to collect payment for their products or services. The method is rather popular as it does not require any formal institutions like banks as intermediate members of the process.
The third characteristic of Internet finance is the variety of models of how capital flows between suppliers and borrowers. Peer-to-peer lending is one of the services among IF platforms, which is especially popular in China. Potential investors may access profiles of people who seek to take a loan. Informational details described previously in this section allow choosing a money recipient among many others. Crowdfunding, which is another system of resource allocation in IF sector, works similarly.
People may familiarize themselves with different projects that require financing and choose the one that they find most appealing. Both models are perfect ways of receiving funds for people or small businesses that cannot get a loan from a traditional bank due to low income and other factors influencing their credit rating. Internet finance releases this constraint allowing investors to choose a destination for their funds more liberally. The direct result of this politics is the large audience of IF platforms, especially in P2P systems.
Finally, Internet finance is characterized by different business models that make its functioning possible. One of them is based on financial platforms that have developed from existing e-commerce business. There are several such companies in China that currently make up the leading power of the country’s IF industry. Alibaba and Tencent, mentioned above, are the examples of organizations that utilize this model.
There is a working business behind each of this organization that works as a support for their third-party investment platforms. The companies’ success is explained by a tremendous amount of information regarding their customers, which has become a base for the development of investment tools that answer users’ needs. Besides, there was no need to spend much money on constructing additional technologies for launching IF platforms since the base had already been set up for running the initial services, the online shop and the messenger respectively.
Other popular business models of Internet finance in China include P2P lending systems, crowdfunding, and partnerships between e-commerce platforms and traditional investment institutions. The former two types do not have any real source like products or services as support for operations. At the same time, this sector enjoys a high level of freedom regarding customer activities and investment choice options. There are fewer constraints to operation limits than it is in other forms of IF or traditional financing. Partnerships, on the other hand, offer more guarantees to their customers as they are supported by conventional institutions with real funds behind them. Finally, other models may be applied depending on the business category, whether it is built around payments, investments, fund markets, lending, or insurance.
Internet Finance versus Traditional Finance
To achieve a better understanding of the processes happening in the IF sphere, it is necessary to compare it to traditional finance mechanisms. It appears that both systems have many common elements, while the main differences are based on funds background and the principles of customer support. Internet finance currently has a visible effect on the traditional sector, and the latter must seek ways to adjust to the changing environment. The section discusses the strengths and weaknesses of these two systems and offers solutions that can benefit each of them.
Advantages and Disadvantages of Traditional Finance
The primary advantage of traditional financial institutions is their high security level. Firstly, many of them have a diversified system of physical locations where funds and other valuables are stored. Secondly, customers always receive a hard copy of documents proving their operations, including deposit and loan agreements, receipts, and other papers. Thirdly, organizations like banks are not subject to hacker attacks and information theft as much as online platforms are. Another advantage of traditional finance is that it usually allows customers to receive face-to-face support from its specialists and clarify any points arising in negotiation processes.
This might be helpful for people that lack knowledge about different financial products and find it difficult to make the right choice. Finally, the Chinese traditional sector also has a competitive advantage explained by its control and support from the government. At the same time, this feature also has a negative side, as the spending and credit demand of the population is not fulfilled, making finance institutions the only winners (Xie et al. 9). The country, for instance, regulates interest rates and keeps them lower than the ones developed by the market, which allows organizations like banks to receive a near-guaranteed profit.
However, the physical and complex nature of traditional finance institutions also causes several disadvantages that become more evident nowadays. Firstly, it is the inability to restructure and offer significant innovations in a short period. It takes a lot of time for these institutions to reorganize, re-educate employees, and build new infrastructure, not talking about receiving approval from regulating agencies. The second disadvantage is specific for the Chinese region, as most local organizations do not provide any options to invest money except creating a saving account or directing funds to the real estate sphere. The conservative nature of traditional finance in China does not allow to predict rapid changes regarding this issue.
Advantages and Disadvantages of Internet Finance
Most of the advantages of Internet finance are based on its flexible character. Customers do not have to plan their schedule to access an institution within its working hours, and there are no lines of people waiting for their turn to be served. Online platforms are available at any time and place wherever there is a stable Internet connection. Another advantage is the variety of financial operations available on IF services.
Users can shop online, invest money, take loans, and engage in other activities at the same time. There is no need to wait for the audience in different departments responsible for providing these services as it is organized in traditional institutions. The variety of investment products allows people to be more flexible in choosing their way of receiving profit. Finally, Internet finance does not require developed brick-and-mortar infrastructure. Most of its front-end operations that are associated with customer service are run on users’ electronic devices like smartphones or PCs.
The Internet-based character of IF is the source of its primary disadvantages. For instance, its platforms are subject to the risk of hacker attacks. Besides, there are numerous cases of fraud when customers’ personal information and money are stolen. People may be unaware that someone else has access to their accounts registered on IF sites. Another disadvantage, which is especially true for China, is the lack of developed regulations that would control activities in this industry.
Of course, the sector is subject to the national law, and there are general guidelines for major groups of operations. However, there is not much transparency in IF, especially in the P2P lending sphere. This factor prevents regulators from evaluating risks associated with capital management. For instance, some IF companies spend funds from their pocket to ensure that customers receive high returns from their investments. While the practice helps to retain users and enlarge the audience, this is a high-risk practice in the long run.
Differences Between Internet and Traditional Finance
While Internet and traditional finance are designed similarly regarding their algorithms of receiving profit, there are three differences that set apart these two systems. They include the revenue rates, the limits for inputs and withdrawals, and the socio-economic profile of customers as the result of the former two elements. The choice between the two systems is dictated largely by the size of investments and the accessibility of services.
Firstly, Internet finance companies offer revenues that are higher than those available in traditional organizations. For example, in 2017 Alibaba’s Yu’e Bao provided approximately 4% as an interest rate for investments, while the government’s official banks mostly gave 0,35% (Loubere 10). There is also more flexibility among online investment accounts as they are subject to withdrawal upon demand without revenue loss. Customers may even choose to spend only a part of their funds as payment for products or services.
Secondly, IF provides more freedom in choosing the amounts of input and withdrawal than traditional finance institutions have to offer. Yu’e Bao, for instance, does not limit the amount its customers can invest. However, the situation with the maximum investment size is changing, as Chinese regulators wish to ensure better control over the field which was growing rapidly. Thus, in 2017 Yu’e Bao had to limit the amount of money its customer could put daily on their account, making it around $3000 (Cadell). It is possible that input and withdrawal limits may soon match in both systems as the Chinese government wishes to better regulate the huge Internet finance market.
Finally, the audience of IF services in China is much more extensive than it is in the traditional sector. The possibility to invest as little money as possible and to withdraw it upon demand attracts people with low income and small-sized businesses. It is reported that Yu’e Bao has more than 70% of private accounts with a balance less than $145 (Guo). Moreover, Internet finance wins in most rural areas where there is no brick-and-mortar infrastructure for traditional banking and investment. The Chinese nation becomes more tech-savvy, and there are smartphones and computers in most households. IF services have become especially popular among the younger generation, many of whom are under 30. Traditional finance, on the contrary, is the place for mature customers that have a secure material base and funds to invest.
The Impact of IF on Traditional Finance
The development of Internet finance has a significant effect on the traditional sector, pushing it towards changes. Funds, which could be invested in government-controlled physical institutions, flow to IF services. Considering the number of people disregarded by organizations like banks due to their low income, the amount of money going past the traditional sector is great. The situation encourages the Chinese government to develop new regulations that would provide more control over IF and restrain its rapid capital growth. In other words, officials wish to limit online financial services regarding some of their competitive advantages.
At the same time, the Chinese government realizes that IF sector is a source of growing national wealth. Besides, online platforms are sometimes the only tools that citizens may use for financial purposes. Most traditional institutions have already noticed the benefits of Internet services and are currently developing their applications with similar features. For instance, many banks are now offering customers online tools for performing various operations, including transactions between accounts and credit cards, billing, paying for services, and others. Another important effect of IF is that the traditional finance sector is slowly adapting to meet the standards developed by the market economy.
Thus, the terms of determining an interest rate become more liberal, dictated by the need to match the official profit offerings to the ones existing on the IF services. Banks are now able to trade negotiable deposit certificates while setting market prices. There are also different wealth management products appearing in traditional finance organizations. However, the biggest issue for this sphere remains as there have been no significant movements to include low-income customers and businesses to their system of service.
Solutions for Traditional Finance
There are several strategies that traditional finance organizations must take to gain competitive advantage. In general, there are two main paths, one of which is to keep developing online services and another is to design products that would be attractive to customers with limited income and small businesses. Besides, help from the government is also required, as official organizations such as banks and investment funds are not autonomous enough to introduce significant reforms regarding their products, interest rates, safety regulations, and other features.
Reviewing the basics of customer service is essential if traditional finance institutions want to stay profitable. Of course, there must be a careful analysis of which products can be introduced to the larger audience. For instance, there is no need to lower the requirements for credit profiles of people who wish to receive a loan. In a situation when China is experiencing the lack of economic stability due to the recent trade negotiations with the U.S., lending money to customers who will be unable to return it is not a reasonable step. Crediting low-income individuals should stay in the P2P loan sector, which is also subject to changes due to a series of failures among noncomplying platforms.
The focus of traditional finance organizations must shift towards creating more options for investments. As it has been mentioned above, Chinese institutions mainly offer deposit accounts as a source of income for regular customers, while real estate is the second option. The solution is to stop the practice of neglecting people that wish to invest small amounts of money. Offering an unlimited input product may fill traditional institutions with funds that currently flow to IF. Besides, accounts must become more flexible, letting their owners withdraw money partially without losing revenues.
On the overall, it must be mentioned that traditional finance is moving towards providing its services both in physical institutions and online. Besides, features such as the interest rate control are becoming more liberal and dictated by the market because of IF. As the nation becomes more experienced in using various technology, organizations such as banks, insurance companies, and investment funds are trying to develop products for different platforms that would attract customers and cut costs on operations within physical offices.
The Development Status of Internet Finance in China
The IF sector in China is rapidly changing as new records are reached every year. As technologies become more widespread, people and businesses become a part of the online financial market. However, not all IF products are similarly successful, and the government must interfere to bring more order to the industry. For instance, mobile payments are experiencing tremendous growth while P2P lending has one platform being closed after another. This section aims to analyze the development status of several IF products in China based on the results they have shown in recent years. Moreover, there is a note on the development status of cryptocurrency as the latest world trend that is lately not supported by the nation’s government.
Mobile Payments
The market for online payments has been successful from the start and is growing massively each year. At the beginning of 2018, Alipay and WeChat Pay, owned by Alibaba and Tencent correspondingly, were named the most preferred methods of payment by rich citizens of China (M. Zhang). This fact is an example of the mind shift that has happened in the country’s society, as two years ago credit cards were leaders of the people’s choice. It is an evidence that China as the world’s largest economy is moving towards creating an economy based on Internet finance operations.
The popularity of mobile payments is explained by their convenience. In many cases, the process is done in few steps as a customer chooses a product, scans its QR-code, and scans his or her thumbprint to pay. The latter feature also makes transactions more secure since fingerprints are more personalized than, for instance, credit card PIN codes. As more customers are choosing mobile payments, vendors must adjust to the demand for a new system. In the past, the method was available in large shopping malls and expensive restaurants. Nowadays, it has developed so much that is even accepted on fresh produce markets and street food corners. Transportation industry also implements innovations like a possibility to pay for tickets with Alipay.
The development of mobile payment in China is best described by the figures it has shown. At the end of 2017, the sector went over 29,5 trillion yuan (M. Zhang). More than 90 percent of this market is currently dominated by Alipay and WeChat Pay. The former remains the leader, with a 54 percent share of the segment estimated in 2017. Nowadays, both companies aim to conquer foreign markets and create options for cross-platform transactions. For instance, this autumn Hong Kong has become a place where its citizens who use e-payment platforms may transfer funds between Alipay and WeChat (Yiu). Finally, companies’ management is planning to further develop their services to make them available on other devices like smart watches.
P2P Lending
Unlike the mobile payment segment of IF in China, P2P lending is experiencing changes that seem to change the industry in the nearest future. The system has existed for more than ten years now, and many people across the country have found it very convenient. The general idea behind P2P lending is that investors are linked to borrowers directly. While traditional institutions like banks work as intermediaries that guarantee deposit returns even if loans are not paid back, these online platforms do not have this type of support.
This factor appeared to be the primary cause of the current crisis in the sector. In 2013, P2P lending started to grow rapidly, as China experienced the boom in IF services. Until recent times, investors were attracted by the opportunity to receive high revenues from using the model. Two years ago, the government developed a series of regulatory steps aiming to better control the sector, as numerous platforms had failed to meet their obligations (Chorzempa). Although the new rules had to force noncompliant companies to leave the market, the Chinese P2P lending industry only grew in the past two years by 43 percent (Chorzempa). People did not want to lose such a convenient finance tool.
However, in July 2018 serious changes occurred, pulling the sector into a crisis. The number of investors dropped by almost 20%, and the sum of outstanding loans went down by 0.3 trillion RMB (Chorzempa). The situation was likely to be caused by the regulators’ official warning declaring that returns higher than 10 percent were a signal of a potential money loss. Investors understood the message as a sign that the government would not support them in situations with unreturned loans.
Over the past few months, 268 platforms have experienced serious issues or terminated their operations (Chozempa). Nevertheless, the recent changes in the industry are unlikely to cause the decline for the whole P2P lending sphere. On the contrary, it is expected that the new regulatory actions will allow making the industry safer, as only compliant companies will stay on the market.
Cryptocurrency
The current situation with cryptocurrency in China is rather twofold. As soon as the potential of the bitcoin was realized in the world, many companies and individuals began to seek ways to invest in it. The process of acquiring this currency is known as mining, and it takes much time and resources, while the outcomes are mainly unpredictable. Special software is required for it and needs to be run on numerous computer chips. The entire process consumes a great amount of energy, as electricity and cooling systems are essential for it. Moreover, the stable, permanent Internet connection is also compulsory for operations to happen.
China has become the perfect place for mining bitcoins as its territory is huge, combined with cheap workforce and energy resources. The situation has raised concerns among officials and scientists who now aim to determine the viability of cryptocurrencies. Research suggests that they are “too unstable, consume too much electricity, and are subject to too much manipulation and fraud” (“Bitcoin is an ‘Environmental Disaster’”). This, as well as other issues, have led the Chinese government to ban the initial coin offerings last year, regarding them as illegal. The step aimed to create more control in the situation when people were becoming more interested in cryptocurrencies.
Nevertheless, the recent official initiatives show the country’s interest in this sphere of Internet finance. The Digital Currency Research Institute, a division of PBOC, is currently hiring specialists that will work on developing a national cryptocurrency (Huang). The primary idea is to make the new digital money cheaper and easier to obtain. On the overall, cryptocurrency in China has great potential once its legal status is cleared and bureaucratic processes are settled.
The Value of Developing Internet Finance
The benefits of developing Internet finance in China relate to many aspects of the socio-economic state. Some of them include empowering the low-income population, increasing the country’s rating among investors, and improving the environmental situation by reducing resource usage on infrastructure and operations. All three outcomes serve as factors that increase the country’s overall well-being.
Internet Finance for Low-Income Individuals and Small Business
Increasing wealth among the low-income groups of the Chinese population is probably the most obvious value of developing IF. Despite the issues associated with the P2P sector and the overall drawbacks of microfinancing as its background idea, online sources that provide loans to uncredited individuals can tackle poverty and gain profit at the same time. IF has been recognized as a tool for achieving financial inclusion.
According to the official documents, digital finance “has successfully improved access to finance by the poor, the elderly, the young, women, farmers, SMEs, and other under-served groups” (Loubere 11). In turn, empowering these categories of people serves as an engine of developing the rural areas of China. This is especially important as the country’s territory is large, and it is not always possible to build the physical infrastructure for traditional finance institutions.
Small and medium-sized business is the core of any healthy economy. It is a source of money for a country’s budget and an important wealth factor for many households as a provider of job placements. However, it is often challenging for small-sized companies to receive funding from traditional financial institutions as the latter requires a long list of guarantees that a loan will be returned.
IF services like P2P lending and crowdfunding solve this issue, working as major factors for the national economic growth. Besides, online platforms that incorporate big data may appear to be more suitable for small business operators. For instance, a service may analyze customer’s transactions and calculate a credit rating more precisely than it could be done by a specialist in a bank. Similar applications may even offer advice on payment amounts that would be best for a particular customer or business.
While loans are significant to the described part of the Chinese population, developing Internet finance may also benefit those people by providing options to invest their incomes in various platforms. Since traditional banks and funds do not accept small sums of money for this purpose, IF may become the only option for them to grow wealth. Besides, the international dimension of this industry allows choosing between domestic and foreign services. The feature becomes especially useful when the local economy is experiencing crisis, and diversification of investments raises the level of security.
Investor Interest
The second benefit of developing Internet finance is that it makes the country look attractive to investors. Despite the current tensions between China and the USA often referred to as a trade war, rich individuals show growing confidence in the country’s economy. Thus, the polls show that 46 percent identify themselves as being very confident about it, while the number used to be just 28 percent in the last year (M. Zhang). Moreover, about 72 percent of interviewees declared they believed China to be ahead of the U.S. economy in ten years, while the previous result was seven percent lower (M. Zhang). The positive attitude allows China to receive investments for its companies, creating a healthy economy.
Another factor that makes Internet finance so attractive for investors is its potential to facilitate different operations and make them cheaper. For instance, the Hong Kong Monetary Authority has recently introduced the Fast Payment System that offers services that are unique in the world (Yiu). The most significant feature of the platform is that it allows making transactions between its operators, which include twenty-one traditional banks and ten mobile payment companies.
Previously, it usually took several days for the money to be sent from one account to another if they belonged to different banks. Moreover, there was a fee for each of such operations. The new product introduced by HKMA may become the perfect tool for investors as it allows to close deals in real time round the clock, independent from weekends and holidays.
Finally, the growing market of Internet finance allows investors to go international. IF gives an opportunity to become a part of foreign projects without the necessity to travel to other countries and collect different documents for banks. Chinese citizens may invest in the international business through IF platforms and receive profit, a part of which would flow to the national budget in the form of taxes, which is beneficial for the domestic economy.
Benefits for the Environment
The value of Internet finance may also be estimated by its impact on the environment. There are many benefits that occur once traditional companies do not have to build and operate brick-and-mortar facilities like banks. Firstly, money is saved when there is no need to construct and maintain a building. Secondly, there is no documentation that typically supports financial operations, which means that there are fewer natural resources spent on paper.
The lack of necessity to pay with real money also reduces the use of paper and metals. Moreover, with services like mobile payment, there are no receipts that are normally issued with each transaction. Since all information is kept digitally, it allows saving more trees. The less obvious impact on the environment of the IF is the reduction of emissions from transportation. Since there is no staff who typically goes to work by car or public transport, the amount of CO2 and other air contaminants associated with it drops significantly. Finally, physical facilities need resources like water and electricity to perform various activities. Moving operations to the Internet helps to eliminate these inputs.
However, a note must be made on the adverse effect of IF on the environment in the case with cryptocurrency mining. The process may consume as much electricity as small European countries and will eventually overwhelm all electronic devices and hardware (“Bitcoin is an ‘Environmental Disaster’”). Currently, China uses diverse resources for generating electricity, including the power of wind, water, atomic reactions, and others.
Coal combustion is one of the most popular choices, as the country possesses a great amount of this material. However, the method has a drawback as the air becomes contaminated with different gas and small particle emissions. The situation with pollution in China is currently very serious, and the government is seeking ways to improve it. There is a possibility that the country will spend too much budget funds to deal with effects of cryptocurrency mining, which will eventually harm the economy. Thus, the balance must be found between gaining advantage from this sector of IF and resolving the environmental issue.
Issues
Internet finance may become a source of more problems than it can be assumed initially. Several of them have already been mentioned in other parts of this paper. Some of the most significant issues associated with the industry include safety breaches, a risk of default, and the lack of financial inclusion for certain social groups of people. While a part of these factors can be eliminated by changing the regulations for the industry, others will remain a threat due to the nature of IF itself.
Safety Issues
Ensuring that every operation done through IF services is safe is a task more challenging than it is for traditional finance institutions. While places like banks usually include only two parties of the process, being a customer and a service manager, online activities always have technology as an intermediary tool. Electronic devices may become a gate through which customer’s confidential information is stolen. Specialists are currently working on developing new methods of data protection, yet they are far from being advanced.
Even the most advanced online platforms cannot be hundred percent protected from hacker attacks. Usually, when this happens, account information of hundreds of service users is stolen. It typically includes logins and passwords that hackers may use to access electronic wallets and transfer funds from them. Of course, IF services let their customers know about safety breach episodes once they occur.
However, the message may be late or left unnoticed by users, not mentioning the inconvenience of having to change the login information. Another scenario of hackers accessing accounts of IF service customers happens when the latter are transferred to websites mimicking original ones. While this may not be a problem for experienced Internet users, who may spot the difference, many people may enter their information to the false platform, thus providing it to others.
Another important issue associated with IF platform safety is the possibility of customer information being used by third parties. Some services give a warning that they are sending some of this data to other companies to improve user experience or to comply with existing regulations. However, there are numerous cases when customers’ profile and activity information was sold to other organizations. Besides, platform developers do not always mention if there is a possibility that some business or government is collecting personal data from IF services for their purposes. It is difficult to predict the adverse effects for people who have gone through this experience, but the practice itself raises questions about the ethics violation and the national security threats appearing as a result.
The Risk of Default
Although the Chinese government is developing rules that would help to better control the Internet finance sector, the industry is still poorly regulated. Many online companies are engaged in high-risk practices, including investment and P2P lending services. The latter provides an especially big threat as there is no intermediary player that would guarantee investment returns. Numerous platforms go offline, leaving people without funds that they expected to grow.
Some of the least fortunate users find themselves in a situation when they lose everything they have been saving for years. Restrictive actions taken by the government a couple of years ago, which aim to prevent such outcomes, do not have much effect as local administrating offices are often bound with P2P services for covering some of the necessary costs (Chorzempa). As a result, the lack of centralized control over the situation makes it possible for non-compliant platforms to exist until they disappear with customers’ money.
While P2P lending does not look like a hundred percent safe investment option from the start, IF funds can also have a high level of risk without flaunting it. Many platforms promise high returns in the attempt to draw more customers to their services. However, the real profit of those companies hardly covers the interest they have to repay to investors. One of the reasons for this situation is a poor choice of asset management.
For instance, the Alibaba-owned Yu’e Bao sets its funds as time deposits in Chinese banks that only have the A+ credit rating, unlike its American competitor, which invests in the country’s government debt (Lee). As a result, Chinese IF services are forced to pay most of their income to investors, making the whole business model non-profitable in the long run and putting the entire sector under the threat of a default.
The Lack of Financial Inclusion
Although Internet finance is a powerful tool for giving all social groups of people various opportunities to manage their funds, it may also become a source of inconvenience for others. One of the biggest problems is associated with the development of mobile payment systems. As numerous large businesses and individual vendors switch to the new method, some stores become entirely cashless.
People who are used to paying with physical money are now experiencing problems whenever they encounter a place that does not accept it. The situation that happened last month is a bright example of this trend. A man offered cash for products in one of the supermarkets in northern China but was told that this payment method was not accepted (P. Zhang). The argument has started a discussion about whether the new economy is leaving some people behind.
The issue is especially serious as many social groups do not seem to have a choice in this situation. For instance, not every household can afford to buy smartphones and pay for Internet that is required for application functioning. Moreover, parents often do not give their children expensive devices that support external services. This means that a child may appear in a situation when he or she would not be able to buy food or other important products when needed. Finally, seniors often find it challenging to learn how to use modern technology, not talking about difficulties like the inability to read small text from a display.
The new trend threatens to make all these groups of citizens excluded from the modern commerce system. Besides, it creates a situation when the nation becomes more dependent on technology and divides people by their ability to spend money on expensive devices.
Solutions
There are several strategies for tackling the issues associated with Internet finance. One of them includes actions from the government that would allow to better control this industry and prevent it from major failures. Another is based on merging the most successful practices of both IF and traditional finance for developing a service that would benefit both customers and company owners. The process of developing working solutions must consider the pace at which the industry grows so that new rules could apply to the rapidly changing services.
New Regulations
While traditional finance organizations in China are well under the control of the government, their Internet analogs are yet to be re-designed to follow the local rules. Since the sector is constantly developing, it is difficult to adjust new products to existing models of regulation in a short time, as preliminary research and assessment must be carried out. However, there are three scenarios that may be potentially useful when solving the issue. They include implementing similar regulations to corresponding services of both systems, partnering with traditional institutions for creating shared programs of support and control, and using foreign experience on the domestic market when applicable.
Since both Internet and traditional finance have a range of similar services, it may be reasonable to introduce the same regulation models for them. A good example of such step is the initiative of the Chinese government to limit the inputs to online investment platforms like it usually is in official banks. Firstly, the measure helps to control the size of capitals managed by Internet-based finance services. Besides, there is a long-run benefit since people will lose less money in a case of potential service failure. Secondly, the step helps to reorganize the flows of investments, directing them to the government-controlled traditional structures.
Another solution that can increase the safety level of crediting operations is to create a universal base of customers between banks and IF services. One of such initiatives is currently starting to act, as information on people who have failed to return loans on P2P platforms is now collected and transferred to the national credit databases (Yujian and Jiefei). The reason for implementing this step is rooted in troubles that Chinese peer-to-peer lending system has recently faced. There are not many guarantees offered to investors that their funds will be returned on time and bring profit. Sharing information about non-compliant borrowers will help them to make safer choices regarding where to address their money.
Finally, foreign experience in this industry may become helpful when drafting domestic rules. The provided example of issues faced by the Chinese P2P lending sector is not unique, as similar processes have taken place in the Western finance market. Local authorities could have analyzed them for developing preventive measures that could hold back the crisis in this sphere. At the same time, lending platforms in China continue to grow despite the run of investors, which proves that this market is unique, and solutions developed for similar platforms overseas may not always apply to the situation.
Partnership Between Internet and Traditional Finance
Nowadays, many resources are used by rival corporations in the challenging task to gain competitive advantage. However, both finance systems may become winners by uniting their forces to develop solutions that would benefit each of them. One of such activities is sharing experience regarding operations, making a special focus on their technological side. It is a fact, for instance, that traditional banks are conservative and slow to respond to changes.
However, even these institutions are trying to follow the trend by introducing their Internet-based applications as extensions to offline services. IF companies may step forward to share their experience and technical knowledge to facilitate this process.
At the same time, traditional institutions may offer them guidance on topics like capital management and protection of secure customer information. The former is especially important as many modern IF corporations in China have evolved from businesses that had little in common with the finance industry. Managers of investment funds like Yu’e Bao lack experience in this sphere, which may become the background for default and platform failure. The second topic, the safety of information, can also become a place for partnership between online services and banks, as the latter have a long history of experience in this sphere.
Finally, there is an issue of financial inclusivity, which both systems face nowadays. The solution is to make the products and services as diverse as possible, with no social group left behind. This is a question that must be discussed on many levels, including the government, traditional institutions, ad IF organizations. Online-based companies become responsible for designing solutions that would be suitable for all citizens, independent of their income level and technological supply. The task of the government is to keep China a place where every existing financial operation is available simultaneously.
Conclusion
The development of Internet finance in China is occurring at a very fast speed, as the industry is showing tremendous growth each year. The modern sector takes its roots in the products of the country’s online business giants – Alibaba, Tencent, and others. They have become the first to realize the potential of the Internet for the finance sphere and created successful ways of monetizing their large customer base. Currently, Chinese IF offers a wide range of products that answer the needs of different social groups. They include investment funds, peer-to-peer lending, crowdfunding, insurance, mobile payment systems, and other services. The growing popularity of online-based platforms creates a real challenge for traditional institutions that are slow in responding to changes.
However, there are several drawbacks of Internet finance in China. Some of the most significant issues include potential default due to the lack of capital management experience and poor financial decisions, hacker attacks and personal information theft, as well as exclusion of some social groups from the system. The recent crisis in the P2P lending sector caused by numerous non-compliant platforms going offline and leaving investors without money has raised the question of how the industry must be further controlled to prevent this scenario. The Chinese government continues to tighten regulations and tries to adjust IF to the existing economic model.
Nevertheless, the future of Internet finance in China looks positive. Despite the recent negative trends, the lending sphere seems to continue its existence as many people, qualified as uncredited due to low income, are seeking ways to receive loans. Even the situation with the government setting a ban on some operations with cryptocurrencies does not work as a signal of the country turning away from the industry. On the contrary, news reports provide evidence that China realizes the potential of things like the bitcoin and works towards developing its currency of this type to become more independent from the foreign market.
At the same time, the development of Internet finance pushes China towards liberating its market. While the government still controls elements such as interest rates in banks, it must provide more freedom to traditional institutions for them to stay competitive. As a result, IF is slowly changing the country, directing it towards the market economy. The system may eventually become the tool for transforming China into the leading state with the most developed financial market considering the size of its customer base.
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