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Understanding Yu'e Bao: the Implications of Internet Finance

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Understanding Yu’E Bao: the implications of Internet Finance development in China BY XIAO YAYUE STUDENT NO.14252961 A PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF BACHELOR OF SOCIAL SCIENCE (HONOURS) DEGREEN IN CHINA STUDIES ECONOMICS CONCENTRATION HONG KONG BAPTIST UNIVERSITY APRIL 2018 HONG KONG BAPTIST UNIVERSITY April 2018 We hereby recommend that the Project by Ms. Xiao Yayue entitled “Understanding Yu’E Bao: the implications of Internet Finance development in China” be accepted in partial fulfilment of the requirements for the Bachelor of Social Sciences (Honours) Degree in China Studies in Economics. _________________ _________________ Dr. Luk Sheung Kan Dr. Project Supervisor Second Examiner 2 Acknowledgements First and foremost, I would like to take this opportunity to express my deepest gratitude to my supervisor Dr. Luk Sheung Kan, Paul for overseeing my progress and advising me at every step through the entire project. It has been an honour and pleasure working with him. Moreover, thanks are also due to all the professors and lecturers in HKBU Department of Economics for their constant guidance throughout the entire course of my undergraduate study in Hong Kong. Their dedication and hard work make my college years an unforgettable and valuable experience in my life. Finally, I would like to thank my parents for their love and care. I am grateful for their unconditional full support, financially and spiritually. _______________ Student’s signature: China Studies Degree Course (Economics Concentration) Hong Kong Baptist University Date: _________________ 3 Contents Abstract ...................................................................................................................................... 5 1. Introduction and Background .................................................................................... 7 1.1. What is Internet Finance: Review on its development in China .....................10 1.2. What is Yu’E Bao: Review on money market fund ...............................................13 1.3. Historical data and policy change .............................................................................14 2. Literature Review ........................................................................................................ 20 2.1. Determinants of interest rate of Yu’E Bao ..............................................................20 2.2. Underlying risks of Yu’E Bao .......................................................................................22 2.3. Money market fund, traditional banking sector and interest rate liberalisation ...................................................................................................................................25 3. Data.................................................................................................................................. 28 4. Methodology and Empirical Results ...................................................................... 29 4.1. “Mean-Variance”, Capital Asset Pricing Model (CAPM) and Sharpe ratio ..29 4.1.1. Proxy selections and definitions of relevant terms ...............................................34 4.1.2. Empirical results and analysis ......................................................................................40 4.2. Third and fourth moment: shape of the distribution .........................................43 5. Economic Interpretations and Further Analysis ............................................... 46 6. Limitations..................................................................................................................... 54 7. Conclusions and Suggestions ................................................................................... 56 8. Appendix ......................................................................................................................... 58 9. References ...................................................................................................................... 62 4 Abstract This paper is based on a case study of Yu’E Bao, a popular Internet Finance investment product in China. We start with an introduction of China’s Internet Finance development situation and four major forms of Internet Finance. Following this we provided a detailed description on Yu’E Bao’s model, including its historical performance, interest rates determinants, underlying risks, and its impacts on the banking sector. Then, we move on to two research questions: 1) Has Yu’E Bao actually outperformed other investment alternatives? If not, what are the major factors contributing to its popularity? 2) Assuming Yu’E Bao is a representative of money market funds and China’s Internet Finance product, what economic implications can we draw from this development, especially regarding the Chinese financial system? Based on Capital Asset Pricing Model (CAPM) and Sharpe ratios, we analysed daily data on stock market performance and similar investment products, from 2013 to 2018. We further divided the sample time period into shorter time frames to better see the changes occurring overtime. Our research findings to the first question are as follows: 1) compared to the stock market, Yu’E Bao and other money market funds have a higher risk-adjusted return. The advantage of less volatility in return is more obvious during stock crash time; 2) compared to other money market funds, the Sharpe ratio of Yu’E Bao is consistently higher than the average of money funds in different time frames, providing a high and also stable risk-adjusted return; 3) high households’ saving ratio, relatively poor performance of investment alternatives, and use of Internet and technology together contribute to the popularity of money market funds in China. 5 Regarding the impacts of money market funds and Internet Finance on the Chinese financial system, our analytical results are the following: 1) On one hand, the sheer size of assets managed by money market funds will take away some portion of bank deposits and thereby affect banks’ lending ability; 2) On the other hand, the large amount of assets invested in cash equivalents extend the lending ability of banks through negotiable deposits; 3) recent policy changes show that the development of money market funds is still under control of the Chinese government and therefore, will not cause fundamental change to China’s traditional banking sectors; 4) In general, Internet Finance development has brought fiercer competition to the traditional banking sector and accelerated the process of interest rate marketization. Key Words: Yu’E Bao; Money Market Fund; Internet Finance; Sharpe Ratio; China 6 1. Introduction and Background Yu’E Bao, an investment product based on the third-party payment platform Alipay and managed by Tianhong Asset Management Co., has gained increasing popularity since it first appeared on the market in May 2013. At the end of 2017, Yu’E Bao has reported 1.58 trillion yuan (US$ 251.2 billion)1 in asset value under management, surpassing JPMorgan’s US government money market fund to become the largest money market fund in the world. Yu’E Bao is also considered one of the most typical products of Chinese Internet Finance (Jingu, 2014). Even so, the concerns over the security and further development of the poduct exist. Fitch, one of the world’s big three crediting rating agencies, consider Yu’E Bao much riskier than JP Morgan’s US government money market fund. Their evaluation criteria include credit quality, liquidity and market concentration.2 China’s implicit state- guaranteed financial system3 and special economic environment also contribute to other concerns about multiple regulators and regulatory arbitrage (Chan, 2017).4 The sheer size of Yu’E Bao’s asset under management and its broad investor base mandates these risks merit our attention. This paper addresses two major questions: (1) Has Yu’E Bao actually outperformed the market and other alternative investment? If not, what major factors have inspired its popularity among Chinese investors? (2) 1 Data source: Tianhong Asset Management Co. (2017, Dec 31). Tianhong Yu’E Bao Money Market Fund Q4 2017 Report 2 Fitch Ratings Inc. (2017, Dec 13). Comparing the World’s Two Largest Money Funds (More Risk for World's Biggest, China's Yu'E Bao, than JPM USG MMF) Retrieved from https://www.fitchratings.com/site/re/906997 3 Implicit state guarantee means that government will bail out a firm when the firm face default risk through the implementation of public policies. 4 See Chan, H. (2017, May 10). Yu’E Bao: A Double-Edged Sword for Financial Innovation. Retrieved from https://ippreview.com/index.php/Blog/single/id/434.html 7 Assuming Yu’E Bao is a representative of money market fund and China’s Internet Finance development, what economic implications can we draw from this development? What changes this development may put on Chinese financial system? Year 2013, which is often referred to as “the year of Internet Finance in China”, is widely considered a new era for Internet Finance development (Jingu, 2014). Most research into Internet Finance has taken the form of qualitative analysis of the industry’s emerging business models, underlying risks and governance and regulatory problems. Pricing problems on P2P lending platforms has also been the subject of several quantitative studies centred on Internet Finance centred. Though some studies have been previously conducted, this paper still contains a number of relevant contributions.
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