Usman W. Chohan (楚浩云) is an MBA candidate at Desautels with a Concentration in Strategy and Leadership. He is currently on an MBA exchange in Beijing, at a joint program between Tsinghua School of Economics (SEM) and MIT. The following piece is based on his work on financial innovation in China, in collaboration with Professor Alexander White of the Tsinghua University School of Economics and Management.
In the art of financial innovation, one of the most preponderant drivers is predicated on unlocking value in segments overlooked by incumbent players in the financial arena – a philosophy of “banking for the unbanked”. Companies that can address the unmet needs of under-explored financial segments will reap extraordinary rewards for their creative initiatives.
In the financial landscape of China, an important under-banked segment is comprised of internet-savvy individual investors with meagre per head (but collectively substantial) savings. An ideal product for reaching out to this market of largely young and aspirational netizens, with its users actively exploring e-platforms and wielding growing disposable income, would be such that it tapped into their eagerness to grow their pool of wealth while minimizing transaction costs and leveraging the micro-scale of their individual account sizes. Alibaba group, China’s largest e-commerce player, introduced just such a financial vehicle, Yuebao 余额宝, and reaped fructiferous returns in the process.
Yuebao, signifying “Leftover Treasure” in Mandarin, is essentially an investment management experience transposed onto an electronic commerce platform. Users can divert the unused “leftover” balance deposited in their Alibaba e-commerce accounts for investing in short term fixed-income instruments through their mobile devices. The platform is linked to various other services offered by Alibaba such as the shopping website Taobao, and the amount held in the Yuebao investment account is also transferable back-and-forth between the Alibaba sites at any time.
Yuebao was launched by Alibaba in June, 2013 through its PayPal-like subsidiary Alipay, which itself is the largest 3rd-party platform in China. Alipay partnered with the Tianhong Fund of China to launch this product to the general public, and saw a meteoric rise in its user base: in the six months following its launch, it garnered 49 million users and over 250 billion yuan ($41.5 billion CAD). At most recent count, this has grown to more than 81 million customers – which is 18 million more than the aggregation of retail investors on the Shanghai and Shenzhen stock exchanges, and half a trillion yuan ($90 billion CAD) of deposits from investors. This amount would be comparable to that overseen by the seventh largest fund house in the world, Fidelity Investments, and nearly equal to one-fifth of new household and corporate deposits in China for the period since Yuebao’s inception.
The most important factor behind the success of the Yuebao product, as well as its most admirable quality, is its financial inclusion. Through its extremely low threshold of just one yuan (16 cents in CAD), ordinary small-scale investors are allowed to effectively participate in a large investment vehicle. By comparison, most wealth management products offered by Chinese banks require a minimum investment of 50,000 yuan ($8,000 CAD). The participatory nature of the product makes it a very promising instrument for greater financial inclusion of the middle-class young adult population in China, which in itself is an important part of realizing the Chinese government’s goal of transforming its economy from an investment-driven equation to a consumption-driven equation. Additionally, Yuebao allows clients to withdraw their money at any time, providing a mobility of capital that is extremely beneficial to liquidity needs of individual investors.
The second most important factor behind Yuebao’s success is the minimization of transaction costs. The e-commerce platform used by Alipay minimizes the cost of each operation through the application of online infrastructure to facilitate investment transactions. Existing banks ignored this segment largely because the cost of reaching out to these users was extortionate, and the size of each user’s individual wallet was prohibitively small. However, it is through pooling the assets of all these individuals under negligible transaction costs per head that Yuebao has generated an economically efficient scale. Additionally, by having the pre-existing e-commerce user base and infrastructure already installed, Yuebao has really unlocked synergies through the use of existing e-commerce tools in an innovative context of wealth management. Further synergies may be realized as Alibaba applies the data it has on the buying patterns of its consumers to their investing patterns.
A third critical factor is indeed the superior returns that Yuebao has generated since its inception. Yuebao focuses on fixed income type instruments such as money market funds and treasury bonds, and its products offer a higher yield than do most other products available in the same asset classes in the market. As an example, Yuebao offers a 6.114% annualized return, whilst the big four Chinese commercial banks only offers 3.25% yield for a one-year term deposit. It is evident, therefore, that many investment products in China are seen to provide meagre spread above the rate of inflation (roughly 2.5% annualized), therein reducing the real returns to investments. In sheer yield-spread terms, therefore, Yuebao offers an attractive investment product.
The disruptive nature of this e-commerce/investment management fusion in Yuebao has jostled the other large e-commerce companies in China. Tencent and JD.com, under the names Licaitong and Xiaojinku respectively, have subsequently introduced their own investment products similar to Yuebao. In fact, Tencent purchased a 15% stake in JD.com in early March, 2014. In spite of this competition, first-mover advantages have accrued to Yuebao, and it has leveraged the user base of its other major products such as TaoBao towards establishing a firm and dominant market position for Yuebao.
Another unprepared set of players struck by Yuebao have been the traditional banks, who have since then admitted to feeling the pressure to develop similar tools to Yuebao. In fact, since Yuebao's inception, seven banks have attempted some variant of Yuebao's model. However, Yuebao should not be seen as a direct competitor to banks; and the main reason for this is that the financial instruments that Yuebao offers must in the end invest their inflows into the instruments offered by traditional banks. Therefore, Yuebao is part of the value chain of investing in a bank’s spectrum of investment vehicles via its funds; and is in reality not a genuine competitor to traditional banks.
Nonetheless, there is an adversarial element to the Yuebao-Traditional Bank relationship. From a financing perspective, products such as Yuebao are forcing up the cost of capital for banks. According to China's largest investment bank, China International Capital Corp, the net interest margins could gradually but substantially be reduced from the 2.7% they had in 2013. This is perhaps why there have been some acrimonious reactions to Yuebao’s success: a commentator from the state broadcaster CCTV first branded Yuebao as a “blood-sucking vampire” à la Goldman Sachs minus the "squid" moniker; and then as "an unofficial second central bank”. Some have even called for Yuebao to be debarred, but central bank governor Zhou Xiaochuan has told reporters that Yuebao will not be banned. Moreover, the most encouraging comments have come from the President and the Vice President of the PRC. In response to a journalist's question, President Xi Jinping has said that Yuebao should not be cancelled, but adequately regulated, because attacking financial innovation is an incorrect approach. The Vice-President Li Yuanchao has similarly expressed support for such financial innovation, and encouraged other financial companies to come up with similar products.
The prospects for growth in Yuebao’s market are immense. One way to presume the growth potential of the market is to realize that the 500 billion yuan drawn in by Yuebao to-date is less than 1% out of the Chinese banking sector’s total deposit base of about 74.2 trillion yuan. The total assets of Chinese banks are about 151 trillion yuan. Many observers feel that this small percentage could expand over the coming years, and according to China International Capital Corp, money market funds like Yuebao’s could manage amounts nearer to 8% (from its currently meagre <1%) of overall bank deposits in three years’ time. This sort of manifold growth in such a short timespan would make Yuebao one of the most successful financial innovations in recent memory.
However, it should be kept in mind that such a product does not exist in the United States and Canada largely because these countries have free-market interest rate regimes. In China, deposit and lending rates are meticulously regulated in China, which is why banks can earn a lucrative and entirely fixed return from the deep reservoir of capital held by the country. However, very recent comments from the governor of the Chinese central bank indicate that their interest rate regime may be liberalized “within the next two years”, which would allow the Chinese deposit-rate system to begin to resemble North American market-based arrangements, therein nullifying the financial arbitrage opportunity Yuebao is largely premised upon.
Another concern is in the regulatory framework in China for the purchasing of money market funds by Yuebao. Technically, this falls into a regulatory grey area, which the authorities have decided not to actively pursue. However, if the growth in the Yuebao system continues to rise meteorically and indefinitely, the regulatory framework may divert focus and scrutiny towards the issue.
Nonetheless, the trailblazing inventiveness of Alipay’s Yuebao has helped to unlock value in a financial segment that was overlooked by incumbent financial players. As a result of its forays into the wallets of young netizens, Yuebao has been able to draw upon more than 80 million users with billions in assets. The inclusive and participatory nature of its product, coupled with superior returns and low transaction costs, demonstrates the sort of financial ingenuity that broadens financial inclusion and maximizes the value of “leftover treasure”. The leftover treasure of Yuebao is a remarkable example of the creativity that furthers the noble goal of greater financial inclusion as much as it demonstrates excellence in the art of financial innovation.