China’s technology companies had been muscling their way into the traditional business of banking and finance, using the convenience and ubiquity of the smartphone-enabled mobile internet to provide everything from online cashless retail payments, to peer-to-peer lending, to asset management.
These operations could weaken the internet companies’ credit quality, especially if their finances are consolidated on the technology companies’ accounts, Moody’s Investors Service said.
That’s because most internet companies don’t generate enough profits from operating these businesses, and they lack a track record of holding borrowers accountable for timely payments on their loans, Moody’s said.
“Loans to consumers and merchants, and distribution of wealth management products, two of the primary services that finance operations provide, can lead to contingent liabilities and potential capital calls for internet companies,” said Lina Choi, a Moody’s vice president and senior credit officer. “These risks will persist even after the finance operations are de-consolidated, although further removed from the core business. The loans and wealth management services will still be offered with the internet companies’ brand names, and the strategic relationship between the core and finance operations remains.”
The warnings came amid the aggressive pace at which Chinese internet companies are disintermediating the traditional brick-and-mortar businesses. In the past year, half a dozen of China’s biggest technology companies have been awarded new banking licenses.
While these licenses give the technology companies to bring innovation to bear on finance, creating the newfangled field of financial technology, or fintech, there’s also a more practical synergy. Moody’s sees synergy between online retailers and their online financing business, which draw more customers to their core business.
“By providing loans to consumers and merchants that transact on their platforms, Alibaba, JD.com and VIPshop can drive higher transaction volumes, revenue and cash flow,” Choi said. “The data these companies gather on consumers and merchants also help their finance operations decide to whom and how much to lend.”
Although Baidu’s finance operation doesn’t directly help its core business of operating China’s dominant internet search engine, the company has a large cash buffer against potential capital calls, Choi added.
Despite the credit quality concerns on Chinese internet companies, their quick development of finance has “ resulted in China leapfrogging from a world where consumers largely relied on cash, to cashless or even cardless transactions, paying, borrowing and investing, all through their smartphones,” Goldman Sachs said in a report. “We expect the changes to continue over the next five to 10 years, with new entrants emerging and new profit pools being created, “ said Goldman’s analysts led by Mancy Sun. “We see under penetrated markets for underserved consumers in three core businesses of traditional financial services: payment, lending and investing.”
Goldman Sachs also said “the core of a lending business is to price the credit and liquidity risks” amid aggressive growth.
“Alibaba’s risk exposure is lower, because its finance operation is an associate company not consolidated on its balance sheet and other shareholders help shoulder the risks,” Moody’s Choi said. Alibaba is owner of the South China Morning Post.
The investing bank estimates the consumer lending opportunity will be driven by consumption growth that’s still tricking at a break-neck pace, as well as 360 million rural workers, 170 million migrant workers, 37 million college students and some of the 70 million blue collar workers — all of whom are inadequately served by existing banking infrastructure.
“We forecast total balance outstanding of consumer credit to grow from US$841 billion in 2016 to
US$1.9 trillion in 2020, among which internet lending to increase from US$100 billion to US$480 billion,” said Goldman Sachs. “China’s consumer credit is significantly underpenetrated at 7 per cent of gross domestic products, compared with 20 per cent in the US.”
Goldman Sachs estimates that the total payment volume of consumption-related third-party payment will reach US$4.6 trillion 2020 from US$1.9 trillion in 2016. “We highlight the importance of payment services to gain customer account relationships as well as transaction data, which in turn offer payment companies opportunities to tap into consumer lending and investing,” said Sun.
With the quick development of internet finance, China authority shifts from its initial free hand to tighten regulation with the rapid growth coming fraud and dangerous funding models, especially in the internet lending space.
“The tightening trend of the regulatory environment will increase regulatory costs, although overall the regulatory environment is still supportive,” said Sun. “As risks events started to occur, Chinese regulators started to put more emphasis on market order, healthy development, and risk management and these measure are not targeted to suppress innovation but this would add speed bumps and induce significant business models changes for some players. “