• Chinese savers are no longer limited to stocks or property to beat suppressed deposit rates. Innovations in fintech and the financial system have produced a swath of higher return investment products.
  • Bank deposits remain the most popular pick, but for younger or lower income consumers Yu’E Bao is the second most popular choice for liquid asset allocation. Older or higher income consumers prefer wealth management products (WMPs).
  • A more stringent financial regulatory regime may lower the returns offered by these products but they will remain more attractive than those offered by banks.

A combination of financial system and fintech innovation is shaking up China’s banking system and providing consumers with a growing number of higher return alternatives to traditional deposit facilities. These are becoming mainstream choices, according to an FTCR survey, but are a growing concern for regulators, who see their untrammelled growth as risky.

Our survey of 1,000 urban consumers found that Yu’E Bao, the Rmb1.6tn ($241bn) money market fund established by Alibaba, and investment products sold on platforms such as Lufax are likely to see the biggest inflows in the coming six months (see chart). Growing consumer appetite is being met by tougher regulation, although the authorities wish to contain the risks associated with these products even as they encourage their development.

Barring a significant market failure that challenges the moral hazard underpinning these investments, we believe such alternative choices are here to stay.

A changed landscape

The old canard that Chinese retail investment options are limited to property or the stock market no longer applies. Investment choices have grown, with many offering returns well above those provided by the state-dominated banking system (see chart).

The banks still receive a large chunk of Chinese savings. Urban consumers said they had an average 38.8 per cent of their liquid assets in demand or time deposits (see chart). But they also allocated an average 10.7 per cent to Yu’E Bao, while another 5.9 per cent was kept with WeChat Pay, the financial adjunct of Tencent’s popular social messaging platform.

Such products are more popular with younger consumers and lower income households because their barriers to entry are lower than WMPs or stocks, assets favoured by our highest income survey group. A tap of a smartphone screen allows account holders to invest just Rmb1 in Yu’E Bao, while WMPs commonly have minimum investment thresholds of Rmb50,000.

Established in 2013, Yu’E Bao has become the world’s biggest money market fund by pooling the idle cash sitting in the ecommerce accounts of Alibaba customers. Other internet companies have followed and set up money market funds or wealth products for their customers.

Survey respondents said Yu’E Bao’s key benefit is the ease with which money can be deposited and withdrawn; 51.9 per cent cited liquidity as their main consideration, compared with 17.5 per cent of those putting their funds in a savings account (see chart).

Investing in the deregulated interest rate regime of China’s interbank market means Yu’E Bao can offer nearly 4 per cent interest, compared with a demand deposit rate of 0.35 per cent offered by more closely regulated banks (according to financial portal Rong360, one-year time deposit rates averaged 2.28 per cent in the third quarter). Despite the higher rates, short record and lighter regulatory treatment, our survey found consumers consider Yu’E Bao as safe as a bank. In response to the fintech challenge, banks are offering WMPs with higher investment thresholds but at competitive rates and with fewer withdrawal restrictions than time deposits have.

For older and higher net worth depositors, WMPs are considered the main alternative to bank deposits. These are generally short-term, offer a fixed return and invest in a range of products — including other WMPs. They have become popular on platforms such as Lufax, which began as an online peer-to-peer lender but has morphed into a financial products supermarket. WMPs are also distributed via internet platforms such as those run by Alibaba and WeChat.

Among our highest income group, 58.3 per cent said they intended to boost their allocations to WMPs (these respondents, predictably, had a higher appetite for risk — 45.2 per cent said they planned to increase their allocation in stocks versus the average 35 per cent). But Yu’E Bao’s low barriers to entry are compelling for younger savers. Among 18-24-year-olds, 53.9 per cent said they intended to increase their exposure to the fund in the next six months versus the 44.2 per cent who said they will boost their cash in demand deposits.

Regime change

After the government spent years inching towards deregulating the deposit rates that banks offer their customers, those customers have instead found the freedom of liberalised interest rates in the interbank market, the heart of the Chinese financial system.

For regulators, this arrangement has kept the credit flowing while helping ringfence bank risk, but it has brought many problems, including consumer ignorance about the products they are buying. Lax oversight coupled with an implicit belief that the government will make good on investor losses has allowed lending and borrowing activities to thrive in the interbank market, and allowed risks to build. WMPs, as well as the kinds of deposit instruments invested in by Yu’E Bao, have helped support increasingly complex borrowing arrangements in the interbank market, fuelling housing bubbles and allowing rickety state enterprises to stagger on.

Fintech, money market funds and the interbank market in which they operate are becoming subject to tighter regulation. Tianhong Asset Management, which runs the Yu’E Bao fund with Alipay, has reportedly said returns will gradually fall, driving out wealthy investors. The fund has been lowering the ceiling on the total amount that investors can deposit, although the Rmb100,000 cap means it will remain attractive for the young and for lower income households.

The authorities — egged on by a state bank lobby trying to reverse the slowing growth of deposits — want returns to come down. The government may attempt to lower them by administrative fiat but is taking a gentle tack for now. Fintech is a shining example of the kind of Chinese innovation that President Xi Jinping wants to nurture. Besides, Yu’E Bao is too big to fail.

This means providers of alternatives to bank deposit facilities will continue to maintain a spread over bank deposit rates and, so long as credit demand exists, the Chinese financial system will be able to find the funding if the price is right.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.