- Alibaba is more than just an e-commerce company.
- Its move into banking without central government intervention ensures faster liberalization in China.
- The banking customers win in the long run.
As many people now know, or are starting to realize, Alibaba is indeed China's answer to ebay (NASDAQ:EBAY) and Amazon (NASDAQ:AMZN). Alibaba has become so large inside China, it actually outsells ebay and Amazon combined, based on gross trading volume. If you weren't aware of that fact, then you will probably be surprised to hear that this China-born innovator also holds around 50 percent of China's mobile and online payments market (the payment device Alibaba uses is named Alipay). Alipay syncs directly with its B2C and C2C commerce sites, Taobao and Tmall, for a one-stop shop of online shopping and convenience. While this is all quite impressive, what has been occurring in the last nine months under the Alibaba umbrella is even more impressive, setting precedent in China's market and guaranteeing to shake things up in the future.
Alibaba enters the highly regulated banking market
In June 2013, Alibaba made the decision to enter China's highly regulated State-owned banking industry. The first question western investors should ask is: How can this be possible, isn't China's government a communist state that controls loans, interest rates, and above all its banking system?
Well, yes, technically the Chinese government could come out tomorrow and make life extremely difficult for the privately held conglomerate to operate amongst its monopoly-protected big 5 banks. However, in an even more impressive move, the central government has decided to do the opposite. Instead of intervening, China's central government is allowing Alibaba to enter the (online) banking world, here's why:
According to China's 12th Five Year Plan (2011-2015), the central government has openly supported high-technology ventures for business activity that will help create jobs inside China, help transform China's GDP to a more consumer-driven model, and allow China to be more globally competitive by tapping its own 'home-grown' business developers. Thus, on the one hand you have organically home-grown competitors that are encouraged and supported by the government to help transform China, and on the other hand, you have China's State-owned banks, operating with monopoly rights inside China for years. Something will have to give.
How have China State-owned banks benefited in the past?
The Chinese big five State-owned banks are giants. By market capitalization, they are some of the largest banking institutions in the world (ICBC, Bank of China, etc). Throughout the years, they have stayed tremendously profitable by enjoying a rather sizable fixed net interest income spread on loans (interest income received) versus deposits (interest expense paid) to the customer. This income spread, particularly the interest expense, is set by the People's Bank of China, which has allowed these banks to lend at market rates, but to thoroughly control and cap their depositor interest rates paid to customers.
For years, banks have been able to earn trillions of Yuan in cheap financing from Chinese citizens (some of the most diligent savers in the world), by paying them around 0.35 percent on their deposits, while taking advantage of sizable loan rates and inter-bank spreads.
What is Alibaba's Yuebao?
Alibaba's Yuebao is an online mutual fund that sprang onto the scene about nine months ago. It was at this time that China's overnight market interest rates became extremely volatile, while liquidity disappeared from the financial markets. This condition was a response from the central government proclaiming to the market that China's shadow banking industry (which are mostly just third-party lenders providing alternative loans to fund urbanization or private business loans) will be more strictly scrutinized.
To make a long story short, overnight interbank offer rates in China spiked to over 25 percent, from around the usual 5-7 percent range last year, and businesses found it much more difficult to get loans to fund everyday business expenses. It was at this time that Alibaba launched Yuebao (which acts as an 'online mutual fund' by storing customer funds electronically and paying a rather significant return). What makes Yuebao truly unique is that in addition to paying interest to customers, Yuebao acts as a convenient intermediary that directly connects its depositors to Alipay and Alibaba's B2C and C2C platforms, without any deposit restrictions, for a one-stop banking and shopping experience unlike anything seen in China.
How does Yuebao offer above market returns, and why doesn't the US do this?
On the first day of its capital-raising existence, Yuebao collected 50 million Yuan in deposits from customers/depositors, in its first month: 500 million Yuan. After nine months, Yuebao currently holds a staggering 500 billion Yuan (or 90 billion USD) in customer deposits. The growth rate of this equation approximates to about 3 million Yuan collected every single minute! Due to excessive consumer demand for the Yuebao financial product, Yuebao not only has attracted more investors than the entire Shanghai Stock Exchange and Shenzhen Stock exchange combined, but it also has significant bargaining power with local banks. This is how they are able to earn significant spreads on deposits. If the overnight rate is 5 percent, they are able to bargain for a 200 to 300 basis point spread for funding cash-strapped local banks. It should be noted that this is the same money depositors yanked from the banks, and is now being lent right back to them at a higher rate!
Because of their negotiating power, in Yuebao's first 9 months of existence it has been rewarding investors between 5 and 7 percent, which is considerably higher than the 0.35 percent the big 5 State banks have been notoriously paying for years. In addition, there is no restriction on these deposits, there is no time horizon or lock-up period, and there is complete freedom to add or withdraw funds. Yuebao will even show you the daily interest you have made on your deposit, on any given day.
The US market is unable to do this (PayPal previously tried) because the US is an open, mature, and transparent market, unlike China. If there are any arbitrage opportunities in the US, competition will swiftly move in and rates will converge. In the case with China, it is still a State-run, highly regulated, and inefficient country/system; however, central government leaders are becoming more and more open to the ideas of a private capital intensive, competitive market.
What will happen in the future?
Currently, Yuebao has succeeded in both raising the interest rate for customers and creating a market opportunity for itself to capture arbitrage interest rates. This type of success has already attracted Alibaba's direct competitors to the online fund platform, and Alibaba's competition has already begun to raise money from investors. Tencent, (OTCPK:TCEHY) the creator of the popular person-to-person communication device WeChat and QQ, has already started to introduce their own savings platforms. While China's biggest search engine, Baidu, (NASDAQ:BIDU) has also raised the sufficient funds to commence its online fund that intends to compete with Alibaba.
Will they be as successful as Yuebao?
That remains to be seen. Both competitor platforms are not nearly the size of Alibaba's Yuebao platform (in terms of total deposits), thus they may not have the bargaining power with banks, nor do they maintain a streamlined source and use of funds, like Alibaba's Taobao or Tmall in the B2C and C2C arenas. But what they will do is force even greater competition with the banks, and with online banking competition, which would create an environment where market participants are drawn to the higher rates payable on any given day or month, which is a win for capital markets and fair competition in China.
This competitive market that may take shape, also depends on China's big five banks' willingness to not compete (i.e. keep rates on consumer deposits low). As long as State-owned banks keep their deposit rates low, they are effectively allowing these new online platforms to exist and compete for deposits. In addition, if China's capital markets become more liquid in the future, the interbank lending rate should come down, which would put pressure on these online money market funds' ability to provide high return to its depositors.
Thus, it is my belief that Alibaba will continue to grow its online banking platform, but in the long-term the true winner will not be Yuebao, or Baidu or any large monopoly bank. The true winner will be the consumers and depositors, who for years were offered next to nothing for their banking deposits. In an age of competition amongst banks and online players, the consumer/depositor will benefit from increased competition and transparency, as well as further banking reform. This type of reform has been lacking in China since China's reform period in the late 1970s. The government is showing signs that it is not only going to allow competition, but it is going to support and encourage it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Business relationship disclosure: The article has been written by ActiveVest’s, Co-Founder and Chief Investment Officer. ActiveVest is not receiving compensation for it (other than from Seeking Alpha). ActiveVest has no business relationship with any company whose stock is mentioned in this article.