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Mingchun SUN Senior Partner & Chief Economist China Broad Capital Ltd. January 6, 2014

Shadow Banking and Internet Finance in China. Mingchun SUN Senior Partner & Chief Economist China Broad Capital Ltd. January 6, 2014. China’s financing system. Social financing aggregate (SFA). Bank acceptance bills. Corporate bonds. Equity financing. Entrusted loans. Trust loans.

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Mingchun SUN Senior Partner & Chief Economist China Broad Capital Ltd. January 6, 2014

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  1. Shadow Banking and Internet Finance in China Mingchun SUN Senior Partner & Chief Economist China Broad Capital Ltd. January 6, 2014

  2. China’s financing system Social financing aggregate (SFA) Bank acceptance bills Corporate bonds Equity financing Entrusted loans Trust loans Others Bank loans Shadow banking system (SBS)

  3. Social financing aggregate (SFA) The distribution of SFA (total: RMB98trn, as of September 2013) Newly increased bank loans & its share in SFA Source: PBOC, CEIC, and China Broad Capital Ltd.

  4. The shadow banking system (SBS) The size of the shadow banking system (total: RMB24trn; as of September 2013) The ratio of the SBS to GDP (3Q2013 vs. 4Q2010) Source: PBOC, CEIC, China Leasing Alliance, Ministry of Commerce, and China Broad Capital Ltd.

  5. The recent surge in SBS was a combined result of over-investment… Annual fixed-asset investment vs. newly increased bank loans Cumulative financing amount by category (2002 -- 3Q2013) Source: PBOC, WIND, CEIC,and China Broad Capital Ltd.

  6. … and excessive regulation • Local governments were not allowed to issue municipal bonds • Property developers were not allowed to do equity financing or issue bonds in domestic markets after 2010 • Banks were restricted by loan quotas, loan-to-deposit ratio ceiling, guidelines on allocation of loans to particular sectors (e.g. property), and other regulations • Corporate bond issuance needed approval by NDRC or CSRC, forcing PBOC to open a leeway in the inter-bank bond market • A sudden prohibition of banks from rolling over loans to local government financing vehicles (LGFVs) in 2011 forced LGFVs and banks to turn to trust loans Changes in the components of SFA (3Q2013 vs. 4Q2008) Source: PBOC, CEIC, and China Broad Capital Ltd.

  7. Borrowing costs are very high in SBS Expected yields of trust products by types of underlying projects (as of October 2013) Average lending rates (as of September 2012) Source: WIND and China Broad Capital Ltd.

  8. China’s SBS will likely grow rapidly Annual fixed-asset investment vs. newly increased bank loans Source: WINDand China Broad Capital Ltd.

  9. How high is the risk? Its contribution Without SBS, China’s economy would have encountered a major crisis during 2011-13 Major risks Credit risk Liquidity risk: maturity mismatch Some turbulences seem inevitable Some defaults will likely occur in 2014 But a systemic implosion is unlikely within 2-3 years The real challenge may be in 2016-2018

  10. Potential solutions Slowing investment growth to a more sustainable level Reduce incentives for local governments to over-invest Reduce investments in sectors with over-capacity Broadening and deepening the financial markets in China Accelerate the development of the bond/credit markets Promote equity financing, including the restart of IPO, the issuance of preferred shares, launching more regional exchanges for SME shares, encouraging private equity and venture capital activities, etc. Further liberalization of the formal banking sector Lower the entry barriers for private capital to set up banks Reduce excessive regulation on banks’ routine operation

  11. Internet finance in China Internet finance in China Wealth Management Payment Lending or Fund-raising Insurance Credit Data Collection Stock Trading Banks Brokers P2P Insurance companies Brokers Banks Mutual funds Brokers Internet companies (NCF online) Micro lending (Ali-loan) Internet companies (Alipay, WeChat Payment) Internet companies (inins.com,Zhongan.com) Insurance companies (Pingan’s Lufax.com) Credit search (Rong360) Telecom operators (China Mobile) Internet companies (YuEBao, Eastmoney.com) Crowd-funding (Zhong-chou)

  12. It is growing rapidly Chinese internet population Amount of 3rd-party payment via internet Source: China Internet Information Center, WIND and China Broad Capital Ltd.

  13. Going mobile is the trend Chinese population using mobile internet 3rd-party payment using mobile phones Source: China Internet Information Center, WIND and China Broad Capital Ltd.

  14. P2P lending is becoming “hot” Monthly P2P transaction value: Shenzhen Index Average interest rate of P2P loans: Shenzhen Index Source: Shenzhen E-commerce Association, WIND and China Broad Capital Ltd.

  15. This is likely just the beginning Alipay 1-day transaction value on Nov. 11th Online Shopping Festival E-commerce transaction value Source: China E-commerce Research Center, WIND and China Broad Capital Ltd.

  16. The demand for online WMP is high Interest rates/expected yields for household deposits/WMP Household bank deposit amount Note: WMP stands for wealth management products. Source: WIND and China Broad Capital Ltd.

  17. The competition is fierce Internet companies are entering the financial arena aggressively Those with established online business and large installed customer base: Internet portals, social media, search engines, B2B or B2C platforms New entrants starting from scratch Financial institutions are fighting back Banks, insurance companies, brokers, and asset management companies are forced to reshape their internet business strategy Some are even spinning off their online functions and set up separate companies specializing in internet finance business Some are entering non-financial businesses and trying to expand their existing online business into B2B or B2C platforms

  18. But cooperation is also a trend Internet companies form joint ventures with financial institutions Alibaba, Tencent, Ctrip and Ping An Insurance launched a joint venture Zhongan.com, which offers insurance policies online, in October 2013 Internet companies acquire controlling stakes of financial institutions Alibaba acquired 51% shares of Tianhong Fund in October 2013 Internet companies and financial institutions form strategic partnership Minsheng Bank and Alibaba signed a contract in December 2013 to cooperate in eight business areas including credit card, WMP, and IT Sinolink Securities signed contracts with Tencent in November 2013 to promote its online brokerage and WMP via Tencent’s platforms Financial institutions leverage internet companies as a channel China AMC and Harvest AMC are selling MMF via Baidu’s Baifubao.com

  19. Many issues need to be addressed What are the essential differences between internet finance and traditional finance? Will internet companies be able to stay long in the financial arena? Will traditional financial institutions succeed in transforming themselves into the internet model? Will the boundaries of financial institutions change in the future, due to the fierce competition from internet companies? How high are the risks hidden in the rapid growth of internet finance? How should financial regulators react to the rapid expansion of internet finance in China?

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