China Telecom Joins Banking Rush

| About: China Telecom (CHA)

Wireless carrier China Telecom (HKEx: 728; NYSE: CHA) was in the headlines last week with its launch of a financial product similar to savings accounts, becoming the latest in a long string of companies to enter an area dominated for decades by state-run banks. At the same time, separate reports said the central bank was nearing a plan to introduce its first major regulation of these new products, in another widely expected move.

This sudden explosion of savings products from non-banks is injecting a much-needed shot of competition into the sector, giving consumers a choice to the stodgy state-run banks that have been their only choice for years. But while the risk from traditional savings accounts is quite low due to banks' close government ties, the same isn't true for these newer entrants, many of which are privately owned.

To better protect consumers and ensure orderly development of the sector, the central bank should quickly roll out its first measures to regulate this growing group to boost confidence among consumers and the broader financial industry. It should quickly follow those initial steps with a more comprehensive regulatory plan that will ensure market stability, and also create a level playing field for these new players to compete with traditional banks.

China's new gold rush into financial services began last summer when e-commerce giant Alibaba rolled out Yu'ebao, a product that allows users of the company's Alipay electronic payments service to put idle funds from their accounts into interest-yielding money market funds. Consumers quickly realized that Yu'ebao offered return rates that were far higher than traditional bank accounts, and began moving billions of yuan into the service to get those better yields.

That rush catapulted Yu'ebao into China's largest fund in just a matter of months, becoming the first in Chinese history to pass the 100 billion yuan ($16 billion) mark by November last year with nearly 30 million customers. Others quickly followed Alibaba's lead, including Internet giants Baidu (Nasdaq: BIDU) and Tencent (OTCPK:TCEHY, HKEx: 700). Since none of those big companies are officially licensed for financial services, all have teamed up with banks and fund management companies to offer their products.

Last week China Telecom became the latest company to jump on the bandwagon with the launch of its own similar product called Tianyi Bao (English article). The move marked a slight shift from previous patterns, since China Telecom is a major state-run company unlike most of the earlier players that were private. China Telecom chose Minsheng Bank (HKEx: 1988; Shanghai: 600016) as its financial partner, also differing from most previous tie-ups where the financial partner was a fund management company.

But the bottom line was the same for consumers. The new Tianyi Bao product promised attractive returns in the 4-7 percent range, well above the state-set interest rates that banks can offer that are usually closer to 3 percent.

Traditional banks have complained loudly that they are subject to much tougher restrictions than new products like Yu'ebao, and last week the central bank finally looked ready to answer their protests by rolling out its first major regulation of the new sector. Media reports cited unnamed sources saying the new regulation would require Yu'ebao and others to set aside a certain amount of their deposits as reserves, the same way that banks currently have reserve requirement ratios of around 20 percent (previous post).

Such reserves are the norm throughout the global banking industry, providing a cushion for banks during personal troubles or market downturns that might see many depositors try to withdraw their funds at the same time. Such a requirement will inevitably drag down the return rates that Yu'ebao and other newcomers can offer, since they won't be able to put the required reserves into high-yielding money-market funds.

The central bank should follow this initial move with other similar regulation to ensure the safety of consumer deposits. Most notably, it should create an insurance mechanism to protect consumers from losing all their money in the most extreme cases of a company failure.

The big banks all have implicit insurance due to their government ownership, which would most likely see Beijing rescue depositors in any extreme situation. But the new companies are mostly private and have no such implicit guarantee of assistance from the state or even their wealthy backers like Alibaba and Tencent in times of distress. The central bank can provide better assurance through improved regulation, ensuring the healthy development of this new field of aggressive private players.

Bottom line: The central bank should move quickly to roll out a comprehensive set of regulations to govern Alibaba's Yu'ebao and other similar services to ensure orderly development of the sector.

Disclosure: No positions