Whilst summer is almost upon us, unfortunately it seems that the Chinese internet finance industry is still stuck in winter. In the most recent article published by Sheng Songcheng, head of statistics at the People’s Bank of China, it said that bank deposits from money-market funds, for example Yu’e Bao, should be subject to reserve requirements just as traditional bank deposits. Such reserve requirements should be applied indirectly – only on those amounts held by banks on behalf of these investment companies.

Yu’e Bao, the investment product offered by China’s e-commerce giant Alibaba, has accumulated at least 500 billion yuan ($81 billion) in deposits as at the second week of March 2014. Similar financial products provided by its rivals Tencent and Baidu are also hugely popular in China, as more and more people demand alternative financial products in their search for higher yields. Internet financing China

According to the article, the annualized return of Yu’e Bao would be reduced by one percentage point if there were a 20% reserve requirement on the portion of its money placed as deposits with banks. Currently, most of the internet financial products offer a return of about 5% – 6% to investors, still well above the maximum 3.3% that banks can offer on a one-year fixed deposit.

China has always been known as the home to some of World’s largest banks and most stringent financial regulations, which never makes life easy for disruptive innovators in the financial industry. As these private Chinese online financial firms enjoy their blooming, executives of China’s largest banks have been calling for more regulation to curb the rapid expansion of Internet financing. They hope such regulations will help stop the decline of their banking deposit volumes which have been adversely affected by the emergence of online financial services. They claim that the lack of oversight and risks related to account security, yield volatility and liquidity management threaten China’s financial stability. Such a position is also well echoed in the China Financial Stability Report 2014 (“the report”), issued by People’s Bank of China (“PBOC”) on April 29th.

Among other things, the report points out that China’s internet financing is still in the initial and observation period, which requires further balance of the relationship between innovation, consumer protection and risk prevention. The report introduces five regulation principles of the internet finance industry in China, officially setting the tone of the role of internet finance as a substitution of the real economy, and it should in no way affect the stability and liquidity of the settlement capacity of banks. The principles also require the internet financing industry to establish proper industrial guidelines and information disclosure mechanisms to safeguard the legitimate rights and interests of consumers and ensure fair competition.

On the positive side, the report does acknowledge the benefit of a well-regulated internet finance industry, and that internet companies could still play a role in making China’s creaky financial system more competitive. This will improve the flow of lending to small businesses and encourage greater competition from stodgy state-run banks. At the same time, the report warns that the potential financial and economic risks associated with internet finance. The report specifically mentioned peer-to-peer (“P2P”) lending and crowd funding, stated that P2P lending and crowd funding should remain as financial platforms and stay away from illegal funding, illegal securitization and illegal depositing.

The report discussed in length about how moderate regulation should be timely casted on internet finance to ensure the healthy development and incentive for innovation. The report gives heavy emphasis on the self-regulation of internet finance firms to create an efficient substitution in areas where major Chinese banks fail to provide an efficient service, for example: small to micro amounts and high speed transfers.

Although PBOC was less blunt in taking its position than the industry expected, the message is fairly clear. These overarching principles leave some room for the regulators to further promulgate laws and industrial practices, as they deem necessary. Further news was that the regulators have also been looking to establish an industrial association in June this year to supervise the internet financial industry. Relevant proposals have already been approved by the State Council.