Are Tencent, Alibaba Innovators or a New Cog in the Chinese Regime?

Ever since Alibaba and Tencent secured commercial banking licenses from the China Banking Regulatory Commission (CBRC) in September and July 2014, respectively, the Internet big boys’ onslaught into the financial industry arena has been nothing short of spectacular. And with both companies going a step further in gaining clearance from the CBRC to establish their consumer credit rating operations in January 2015, their presence may prove revolutionary. Already some in the Chinese capital markets prophesize the eventual obsolescence of traditional financial intermediaries there.

Indeed, Internet financing in China has been touted by some of its hardcore supporters to be the panacea towards establishing a more convenient payment mechanism, and one that has the least informational asymmetry. With the rise of Internet financing, these supporters say traditional intermediaries such as a bank, security house, and financial exchange will gradually lose their relevance, leading to a great reduction in the cost of capital for every stakeholder within the ecosystem. (View the investor protection issues CFA Institute has raised in connection with crowdfunding.)

Beneath all these seemingly grand Internet financing capital market benefits, however, lurks a slow, strong, agenda-driven undercurrent — the Chinese government.

A school of thought has attributed Alibaba’s and Tencent’s success to loopholes within the legal framework. By the time regulators caught up to them, their financial business operations had surpassed the point at which they could be contained. This “too-big-to-fail” argument might sound plausible on the surface, but to those with a better understanding of the Chinese legal, cultural, and political systems, where nothing happens by chance, it barely holds water.

First, when it comes to legal enforcement in China, the interests of the country and political party override everything. Regardless of whether the regulatory framework is robust enough to deal with such innovative evolution as described here, the Chinese government still possesses the power to veto anything it deems unfavorable. Such a situation might be unthinkable in the West, but it is common stuff in this part of the world.

Second, most of the banks with sizable balance sheets in China are state-owned. That includes the Bank of China (BOC), the Agricultural Bank of China (ABC), and the Industrial and Commercial Bank of China (ICBC). Together, these banks make up the supporting pillars for the Shanghai and Shenzhen Stock Exchanges, and to a certain extent the Hong Kong Stock Exchange. As such, without the inherent blessing from the Central Politburo, it is next to impossible for both Alibaba and Tencent to throw their punches directly at these state-owned money-spinners.

Third, Alibaba and Tencent are Chinese-owned enterprises. One of the best ways to tackle the inefficiency and complacency within state-owned banks is to create external competition. However, national interest still takes top priority. To strike a balance between safeguarding national interests and injecting competition into the finance industry, grooming home-grown enterprises like Alibaba and Tencent is the preferred solution.

Need more convincing? Think about this. The Chinese government did not question Alibaba’s or Tencent’s entrance into the consumer credit market? In fact, both the CBRC and Xinhua news agency (China’s official voice of the Central Politburo) were effectively silent when all these activities were going on in the background. Also, Alibaba’s and Tencent’s maiden encroachments into the banking sector occurred during a series of banking reforms specifically directed to tackle the complacency and inefficiency within state-owned banks.

Internet financing is something truly unique to China and has no context in other parts of the world. Witnessing its evolutionary development within the Chinese capital markets is exciting, and continued analysis of it in the next five years will be insightful.

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Image credit: iStockphoto.com/Pogonici