Since the cancellation of the Ant financial IPO in early November, the press has been presenting Jack Ma as a modern-day Icarus; a man who chose to fly too close to the Sun and whose wings the gods melted. At first sight it might appear that the Chinese Communist Party is trying to curb the power of tech billionaires, but we believe that the government’s actions are not only aligned with consumers but are aiming to succeed where the West so far has failed with Open Banking projects. If it succeeds, the expansion of credit can drive more inclusive consumption and economic growth.
Divergence of Ant’s and consumer interest
We believe that the Chinese government accepted the rapid growth of Ant while it drove reform that helped consumers. Before Ant launched in 2013 Yu’e Bao, its online saving product, consumers had little choice as the “Big Four” state-owned banks controlled 70% of the market. A popular joke about ICBC, one the Big Four, mocked its initials in Chinese as standing for, “ai cun bu cun”, translating loosely as “who cares if you save with us or not, whatever”.[1]
Banks at the time paid low interest rates, sometime below inflation. Ant was paying interest rates that were 2 percentage points above those paid by the SOEs and also allowing customers to make withdrawals at any time with no penalty. The Chinese government, although it had a vested interest in the SOEs, it recognised the need for more effective and efficient capital allocation, so did not intervene as Ant took almost $100bn in funds in the first 10 months after Yu’e Bao’s launch.
in provision of credit, the interests of consumers and Ant Group are no longer perfectly aligned
But when it comes to provision of credit, the interests of consumers and Ant Group are no longer perfectly aligned because of asymmetric information. Institutions will charge higher interest in the absence of information about someone’s credit worthiness. If only one institution, Ant Group for example, has the information, it has no incentive to price the risk correctly. It only has to charge marginally less that its competitors, keeping the difference.
Control of transaction data is at the heart of the battle
We believe that this is a battle between the PBOC, China’s central bank, and Ant Group, for control of transaction data, but with an outcome where a fintech like Ant can remain to play a major role in the banking system.
Data on a consumer’s transactions, when combined with other behavioural data, can provide all sorts of companies with valuable predictive indicators. It’s especially valuable in financial services where it helps to predict creditworthiness, and so gives commercial advantage to the controller of the data.
Lenders or agencies with access to granular consumer data can assess and price credit risk more accurately, and therefore can allocate capital more efficiently. This means for certain consumer and small business borrowers, the cost of debt can be lower. At the level of the economy, in theory, this should eradicate both moral hazard and adverse selection, reducing the systemic risk that Ant Group may well be contributing to.
information asymmetry that creates bottlenecks and rent seeking in consumer and SME credit markets
Access to the data should overcome the information asymmetry that creates bottlenecks and rent seeking in consumer and SME credit markets. In turn, this focuses the firepower of debt towards productive activity. By reducing the level of non-performing loans, more capital is recycled, pumped back into economic growth as credit expansion, feeding consumption. While companies like Ant Group may have to suffer lower margins, the overall credit market should expand to benefit them, and likewise the economy, potentially benefiting Ant’s parent, Alibaba.
Could China succeed where the Developed World has failed?
In the developed world, initiatives like Open Banking seek to wrest control of data from banks, passing control back to individual consumers. We see this as aligned with western values of individual determination, or as in the EU’s General Data Protection Regulation (GDPR), an answer to the question “to whom does that data belong?” Open Banking sets a common standard for financial institutions to pass data to each other, but always with the consent of the individual to whom the data “belongs.”
China can succeed where Open Banking has so far failed in the West?
But uptake in the West is slow, arguably too slow to be effective as we are waiting for collective action. The incumbent banks have an interest in slowing it down. This contrasts with China which can implement it quickly and effectively if the PBOC approach establishes a “People’s Credit Reference Agency”. That would still allow companies than can more intelligently process the data to gain an edge in credit scoring and therefore profitability in the lending market.
In our view, China is more likely to succeed because it doesn’t face the reluctance that we see from banks in the West which are unwilling to cede control of data for fear of hitting market share and margins. China has leapfrogged ahead in fintech such that Ant Group has control of enormous amounts of consumer data, and is already sucking margins away from the banks.
China has leapfrogged ahead in fintech such that Ant Group has control of enormous amounts of consumer data, and is already sucking margins away from the banks.
The knowledge that Ant Group has on the creditworthiness of consumers has the potential to drive fairly-priced credit and further boost economic development. However, there is a risk that Ant Group is creating systemic risk by underwriting only an average of 2% of the value of loans that it facilitates, effectively acting as a middleman, yet taking half the interest on each loan as per disclosures before its planned IPO.
As opposed to vindictive action by the Chinese government, against the man who flew too close to the Sun, we see the intervention as an attempt to create a more competitive financial services sector, enabling small businesses and consumers to flourish. Although margins would come down, the strongest players will benefit by taking their fair share of a bigger pie. Although the market has priced in an Icarus fall for Ant Group, we could well see a rise of the Phoenix from the ashes.
[1] Duncan Clark (2016) The House That Jack Ma Built, Harper Collins
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Trinetra Investment Management LLP and are subject to revision over time. Trinetra is authorised and regulated by the Financial Conduct Authority in the United Kingdom.