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China’s Small Banks Suffer from Platform Deposit Crackdown

Jan 30, 2021
  • Sara Hsu

    Visiting Scholar at Fudan University

China’s small banks are under pressure as the fintech sector is experiencing increasing regulation. Regulations cracking down on deposit-taking in the sale of banks’ financial products through third-party platforms will soon result in a contraction of small banks’ loan bases. As larger banks shift from platform deposit-taking to other sources of funds, this regulation will likely compound an already-squeezed small banking sector.

China’s fintech sector is undergoing extensive scrutiny at present, from the sudden imposition of regulations on Ant Financial to the implementation of risk ratings on consumer finance companies. While small banks, which struggle to obtain deposits from their local customer base, had hoped to benefit from the fintech boom, they are facing increasing regulation. Banks overall have been found responsible for subverting financial regulations in order to grow their funding base.

On January 15, the China Banking and Insurance Regulatory Commission banned commercial banks from selling deposit products via third-party internet platforms. The regulatory body stated that China’s fintech sector has brought with it hidden risks regarding information disclosure and product management. Online third-party deposit sales have resulted in the potential for financial contagion.

Small banks in particular found that, by selling financial products through third-party platforms, they could break through geographical restrictions in order to obtain deposits from the entire country rather than from their own location. Products sold online included personal time deposits, with a focus on three and five-year maturities. Interest rates on these products were close to the upper limit of banks’ self-regulatory pricing mechanism, which is tied to the benchmark interest rate. Most products required an initial deposit of only 50 RMB and could be withdrawn at any time. 

The products were also attractive to customers. This is because, due to regulations, bank wealth management product yields have declined, and such products have become known for being excessively risky. Internet platforms have striven to clearly mark deposit products as fully covered by deposit insurance up to 100% compensation. As a result, customers increasingly flocked to these products. 

For small banks, these third-party deposit sales accounted for more than half of their deposit base. However, they do not function in the same way as direct deposit sales. Customer service is poor, since the third-party mechanism restricts customers from inquiring about their accounts, and the transactions take place only on the platform. What is more, the platforms selling the banks’ deposits do not have financial licenses, and remain outside of regulators’ supervision. Therefore, the banks have been found to fall short on consumer protection. 

To make matters worse, banks may subvert interest rate self-regulation by increasing deposit interest rates, disguised by shortening the interest payment cycle or issuing cash rewards. They do this in order to obtain deposits in a highly competitive environment. Small banks often do not have the capacity to control risks for such nationally-based, large-scale deposits, especially while offering higher interest rates. 

Small banks’ use of national funds creates the potential for risk contagion. Risks from one region can spill over into another as funds dry up or become volatile. Small banks create additional risks by matching high-yield assets with high-risk projects. All of this together results in problems with liquidity matching, liquid asset adequacy, and core debt ratios. 

While larger banks have also used online platforms to sell depository products, small banks will suffer disproportionately as yet another funding channel is cut off. At the end of last year, the cost of one-year interbank debt rose to the widest gap against the central bank’s rate on medium-term loans since July 2018. This funding source is considered critical for small and medium-sized lenders in maintaining liquidity. Concerns that small lenders could soon collapse have also led to bank runs, in the fear that other small banks would follow in the steps of Baoshang Bank, whose collapse was stemmed by a bailout, but not without causing a short-term funding crisis. 

Structural problems in China’s banking system, in which the largest commercial banks are favored over smaller banks for deposits and national activity, coupled with slowing economic activity in recent years, have created this challenging atmosphere for small banks. The Big Four banks have extensive market power, most of the nation’s deposits, and assist in carrying out government policies. 

In addition, small banks often have negotiable certificates of deposit with lower ratings, which translates into higher yields. Smaller banks are also not viewed as “too big to fail,” which means that depositors often lack confidence that small banks will survive difficult circumstances. Finally, small banks have frequently lent to local governments, which found themselves unable to meet loan repayment deadlines. The new regulation on third-party deposit sales will squeeze small banks even further as they struggle to obtain deposits. 

Ant Alipay, Tencent Licaitong, JD Finance, and Duxiaoman Finance were among the platforms selling deposit products, and they have since removed them. It is expected that platforms will simply shift to selling more of their other products categories.

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