Want to See Technology Taking Over Finance? Look at China

By Gillian Wong and Juro Osawa BEIJING—China is moving to rein in its fast-growing and innovative online finance sector, which offers a glimpse of how the rest of the world may someday handle money but has seen a number of high-profile abuses. ​​Chinese Internet companies have transformed the average smartphone into a platform for cashless transactions, bank transfers, loans and investments far beyond what is common in the U.S. With many skipping credit cards entirely, Chinese people buy money-market funds, split a restaurant check and pay for services ranging from taxis to takeout food all within the same phone app.Last year, nearly a quarter of China’s population—a number bigger than the total U.S. population—made payments online. Data provider Euromonitor International estimates that China’s mobile payments this year will total $213 billion, compared with $163.5 billion for the U.S. The biggest payment service, an affiliate of e-commerce giant Alibaba Group Holding Ltd. called Alipay, has 400 million users. “These numbers are phenomenal when compared to other payment providers that operate globally,” said Ng Zhi Ying of Forrester Research Inc. Internet companies are pushing to allow users to open online-only bank accounts on their smartphones, with their identities confirmed via selfies. Meanwhile, China’s peer-to-peer, or P2P, lenders, which connect investors with borrowers through online networks, are set to make $33.2 billion in loans this year, 43% more than in the U.S., and could see issuance triple over the next two years, according to Morgan Stanley projections.Now, Chinese regulators have moved to lay down some ground rules. On Monday, they issued guidelines limiting what payment platforms can do and proposed draft interim rules on the P2P lending industry, where explosive growth has been tainted by cases of alleged fraud.“The opportunities and the risks of Internet finance are proportional, which means they are both immense,” said Joe Ngai, director and managing partner of McKinsey & Co.’s Hong Kong office.Regulators have also resisted approving technology, such as facial recognition, for opening full-service online bank accounts without the need for physical outlets or ATMs. The People’s Bank of China’s said Friday that China doesn’t have basic standards for biometric technology and no national or industrial standards for its use in the financial sector. “Therefore, the conditions are not yet mature for using biometric technology as the primary means of verifying the identities of depositors,” the central bank said.“In China, you see a lot of stuff happening for the first time over the mobile and Internet platforms,” said Tim Pagett, financial-services industry leader at Deloitte China, adding that Chinese consumers may soon buy cars and insurance via their phones. In terms of how widely Internet finance is used, he said, “China is far ahead of the rest of the world.” Internet finance is touching parts of China’s economy—everybody from students to farmers to truck drivers—long denied credit in China’s state-run banking system. In the port city of Tianjin, long-haul trucker Shi Junze fell on tough times two years ago when transportation fees dropped and clients delayed payments. “We were at a point where we basically could no longer maintain our trucks,” Mr. Shi said. “And banks wouldn’t give loans to ordinary people like us.”Fincera Inc., an online truck-financing service supported by a P2P lending platform, gave him 30,000 yuan ($4,600) in monthly credit for repairs, maintenance and gasoline. “Slowly, we were able to make our payments and finally got through that difficult time,” he said. With that extra income, Mr. Shi’s family started a small business this year selling trucks.Internet finance in China has skyrocketed largely because traditional banks haven’t provided many individuals with access to investment vehicles and other ways to increase their money. Banks have stuck to lending primarily to state-owned enterprises because they have implicit or explicit government backing for debt repayment, which makes them seem more secure. China’s banks have vowed to compete. Until now, regulators have stayed on the sidelines, aware that these offerings can help promote the government’s goals of boosting domestic consumption and entrepreneurship. China is “a big gray area,” said Fan Bao, chairman and chief executive officer at the boutique investment bank China Renaissance, which has done deals involving Internet finance companies. “You can be very creative, do whatever you want.”Chinese Internet giants including Tencent Holdings Ltd. and Alibaba affiliate Ant Financial Services Group are taking the next step by opening Internet-only banks.“Traditional banks are only for savings,” said Hu Yu, a 24-year-old entrepreneur in the city of Hangzhou. Mr. Hu said he used an online bank backed by Tencent to invest 40,000 yuan in a money-market fund offering an 8% annual interest rate, a much higher rate than bank deposits.The Internet giants have proposed allowing prospective customers to open new accounts through facial-recognition software using their smartphone cameras. Such technology would allow users to open regular bank accounts remotely and for the banks to receive deposits.While bank regulators haven’t approved it, industry players say discussions with the companies continue.“I can understand that regulators are very cautious,” said Jason Lu, who is in charge of fraud risk management at Ant Financial Services Group. “This is a very, very important milestone, we are pushing technology into financial services, which is the most heavily secure, sensitive area.”In P2P lending, dozens of platforms shut every month, with operators running away with funds put in by investors. In September, authorities in Guangdong province solved a P2P fraud case in which more than 90 people in Guangdong, Shanghai and nine other provinces and cities had been cheated of more than 10 million yuan. Officials said three suspects were arrested.This month, Beijing police said they were investigating Chinese P2P lender Ezubo and associated companies for alleged illegal operations, without giving details. Ezubo’s site has been taken down, and its executives couldn’t be reached for comment. As of Dec. 8 it had 74.568 billion yuan in loan volume and 909,500 total investors, according to Chinese P2P industry tracking firm Wangdaizhijia. In online payments, the central bank’s new rules require companies to take more steps to verify the identities of their users and limit the amount of funds that can be transferred between accounts.When first proposed, the rules triggered criticism that many of the requirements would take away the convenience that payment platforms have created to address the shortcomings of traditional banks.The proposed interim rules on such services released Monday for public comment state that P2P platforms must entrust their users’ funds to the custody of brick-and-mortar banks—a move aimed at protecting investors. But industry players and experts say most banks aren’t ready to serve Internet-based lending, which has mostly worked through online payment platforms.“Under such circumstances, the requirement that all funds should be held in custody by the banks is nearly impossible for most of the industry,” said Paul Shi, chief executive officer of Wangdaizhijia, the data provider. “The government should provide a clear path to get there and sufficient time to ensure the industry makes a stable transition.”The majority of Chinese P2P loan companies would struggle to survive under the stricter rules, said Kevin Guo, founder and co-chief executive of Dianrong.com, one of China’s biggest online P2P lending platforms. Shanghai-based Dianrong, which already works with banks, expects to benefit as tighter regulation weeds out some competitors, he said.Some industry observers see the regulatory push as giving traditional banks time to catch up.Fincera, the truck-financing platform, said it is in discussions with a Chinese bank to position itself for the new restrictions, but the process is onerous. Spencer Li, Fincera’s vice president of product, said there were few banks that had products that could serve the needs of P2P platforms.“Whatever products the banks have now, they don’t have the best user experience,” Mr. Li said. “After all, banks are not Internet platforms. They don’t make the best Internet product.” Write to Gillian Wong at gillian.wong@wsj.com and Juro Osawa at juro.osawa@wsj.com

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