S20: Shadow Banks

How many times have I lost my way How many times have my dreams been shattered Now I no longer feel lost I want my life to be set free

I want a life that blooms Like flying in the vast sky Like traversing the boundless wilderness Possessing the strength to break free from everything

• How did Jack Ma build Alibaba?
• What went wrong for Ant Financials? What can its aborted IPO tell us about the relationship between the party and the capitalists?
• Anti-trust and financial risks: How did the CCP regulate China’s financial market?

• 1964: Born in Hangzhou; parents were cultural/artistic workers who bought a radio for him to learn English
• 1984: Poor at math and struggled with the college entrance exam (Gaokao): passed only on the third try with a score that got him into Hangzhou Normal University, Foreign Languages department
• 1988: Worked an English teacher at Hangzhou Electronic Industry School

• 1994 Haibo Translation Agency
• 1995: China Yellow Pages website (an online “phone book” for companies)
• Within a few years this venture earned him significant profit (~5 million) and launched his Internet career.

• How did it work?
• What made it so successful?

• What’s Alipay’s business model?
• How does it disrupt China’s banking model?

• In a command economy, banks were essentially branches of a single government “monobank” that held almost all financial assets.
• Household savings were extremely low due to strict income control and few private businesses.
• Transactions often bypassed money, especially in rural collectives.
• The financial system was shallow, providing trade credit and payment services, but no long-term investment lending.

• The People’s Bank of China (PBC) was transformed into a central bank.
• Four large state-run commercial banks were established.
• New laws in 1994-1995 created a legal structure for banks.
• Three “policy banks” were set up for government-directed lending.
• The China Bank Regulatory Commission (CBRC) was created in 2003.

Huge, dominant deposit-taking institutions with nationwide branches:

• The Industrial and Commercial Bank of China (ICBC) is the world’s largest bank by assets.
• The Construction Bank (CCB) evolved from the project financing parts of the old monobank.
• The Bank of China (BOC) originated from foreign trade and exchange departments of the old monobank.
• The Agriculture Bank of China (ABC)

• Three Chinese policy banks – the China Development Bank (CDB), the Agricultural Development Bank, and the China Export-Import Bank – are directly controlled and 100% owned by the government.
• The China Development Bank (CDB) is the largest and most important of these banks.
• CDB’s core mission is to provide long-term financing for large infrastructure projects and priority industries: Three Gorges Dam, affordable housing, Belt and Road Initiative.

• Banks lent to unviable clients due to soft budget constraints, creating many “zombie firms” and a large buildup of nonperforming loans (NPLs).
• The 1997-1998 Asian financial crisis highlighted the risks of using banks to support state-owned firms.

• Savers receive very low or negative returns and have few choices.
• Banks and governments benefit from cheap funds, directing credit to favored borrowers (SOEs).
• Households are restricted from buying financial assets other than bank deposits.

Deep (high savings)

• Households saved, deposited money in banks, which then lent to businesses.
• The ratio of broad money (M2) to GDP increased significantly.
• By 2016, China’s banking system was the largest globally and surpassed that of the entire Eurozone.

Narrow

• Banks provided most corporate funding (80%), with bonds and stocks playing a smaller role.
• The system began changing gradually after 2009, but remains bank-dominated because most banks are state-owned.

• Japan and Korea also used financially repressed systems during their high-growth periods.
• At minimum, China protected savers by maintaining a stable economy and adding interest to deposits during high inflation (until 1997).
• This kept savings value intact, unlike in many transitional economies where inflation destroyed savings, such as Russia.
• China funded State-Owned Enterprises (SOEs) by having its banks absorb costs, but it also left banks bankrupt and needing rescue by late 1990s.

• Interest rate spreads – the difference between interest rates on loans and those on deposit rates – were increased (above 3%) from 1999-2012 to help banks become profitable.
• Nominal deposit rates stayed low (2%-4% after 1999), so real interest rates depended on inflation.
• From 2003-2013, average real interest rates were negative, reducing household purchasing power.
• This policy effectively transferred wealth from households to the banking system.

• Banks profited from wide interest-rate spreads, but households were not motivated to deposit savings in the bank: savings deposits grew slowly 2003 and 2012.
• Interest rates were capped by regulators; lending was restricted to 75% of deposits.
• Ambitious institutions such as Alipay matched savers and borrowers at higher rates for greater profit.

• Bank credit was the main financing method until 2009.
• After 2009, banks offered “wealth-management products” (WMPs) with higher rates.
• WMP funds were invested in bonds, money markets, nonstandardized debt, bank deposits, and equity-like instruments: off-balance-sheet products bundling various, often risky, financial assets.

• Banks could get funds and make new investments off their balance sheets.
• Consumers could participate in nonbank financing through wealth-management products (WMPs) and earn higher rates.
• Businesses gained new funding to businesses.
• Policy-makers: WMPs and shadow banking contribute to the diversification and restructuring of the economy.

• Financial are highest during periods of liberalization and systemic change.
• China’s total debt has rapidly increased: Leverage increases both investment returns and financial risk.
• WMPs are not deposits, and the risks are not explained to savers, who may take on more risk expecting government bailouts.
• Debts are frequently rolled over (“evergreened”) instead of being restructured.
• Within the banking system, budget constraints – the target of bank restructuring in the early 2000s – became softer since the 2008 Financial Crisis.

• P2P lending is an online platform that connects borrowers and lenders.
• The industry grew rapidly due to financial constraints faced by small businesses and consumers and lax regulation.
• Direct model: Platform acted purely as intermediary by providing credit information about borrowers and connecting them to lenders.
• Self-guarantee model: Guaranteed borrower repayment to investors, sometimes through third party.

• Some platforms acted like banks, sometimes lending to risky borrowers or governments.
• At times, this was intentional, as borrowers consisted of local governments that could not otherwise fund infrastructure projects.
• Riskier models, like platforms guaranteeing repayments, caused failures.
• Strict regulations imposed in 2018-2019 led to the P2P industry’s near elimination.

• Shadow banks function like regular banks but with less regulatory oversight.
• They facilitate financial intermediation, turning short-term funds into long-term loans and managing risk.
• The shadow banking sector is diverse and hard to define precisely.
• Large state-owned banks can also engage in shadow banking activities, often off their official balance sheets.

• Oct 24, 2020: Jack Ma’s critical speech at the Shanghai Bund Financial Summit preceded regulatory action
• Nov: Within days Ant Group’s IPO was halted and regulatory scrutiny intensified.
• Ma retreated from Alibaba business and left China

• Does Jack Ma have a point?
• How might the party respond?
• What caused the ultimate conflict?

• 2020–2024: Jack Ma retreats from public life
• June 2021: Regulatory crackdowns on platform companies continued; Didi’s U.S. listing dropped
• Jan 7, 2023: Ant Group announced an equity adjustment that effectively removed Jack Ma’s actual control.

• Was Alipay too big to fail?
• How should Alipay and other fintech companies be regulated?
• Should the crackdown be understood as anti-trust?

• 2012: Pre‑IPO equity transactions added major strategic shareholders with CCP connections (e.g., Boyu Capital, CITIC Capital, China Development Bank Financial, New Horizon Capital, Beijing Zhaode Investment).
• Xiao Jianhua – associated with CCP’s red princelings and currently detained for bribery and corruption – secured over $1 billion in lucrative shares in Mr. Ma’s businesses through his company Tomorrow Group.
• Jack Ma denies any knowledge of the transactions.

• What should Alibaba do next?
• How should the CCP manage its relationship with private entrepreneurs?
• What would be the next chapter for Alibaba, for Jack Ma, and for China?