China is close to releasing a national digital currency. How would such a currency run by a central bank work? China is where paper money was first invented a thousand years ago, and it might be where paper as a proxy for value also fades from the world stage.
China’s financial sector used to be famous for its poor service and imperviousness to innovation. Even today, when customers go to make a transaction at one of the country’s big state-run banks, they often take a bag of snacks with them—they know they’re in for a long wait. But things are changing fast in the Middle Kingdom. A new generation of digital finance firms is taking the country—and the global markets—by storm in everything from digital payments and micro-lending to insurance and wealth management. How will China’s lumbering state-run banks react? Will tightening regulation nip this revolution in the bud?
One day in October, 2015, a group of disgruntled investors gathered in Beijing to lodge a complaint: they had bought so-called wealth management products from a state-owned guarantor backed company that managed nearly $8 billion in assets, and which had collapsed later. Such defaults have been uncommon in China’s wealth management product space, but the now-gargantuan industry may pose a large risk to China’s financial system. Many risky aspects of the wealth management products industry make people worry about the possibility of a chain reaction similar to the 2008 financial crisis, when the US mortgage market buckled under similar strains.
Central banking is not enough. While monetary policy did much to recover from the global financial crisis, its instruments have been largely exhausted and rendered ineffective. Low interest rates and quantitative easing may have kept the engine spinning, but are not pillars of sustainable economic policy. In China, there might still be scope for more monetary easing, but Mohamed El-Erian, chief economic advisor at financial services group Allianz and formerly at the helm of investment firm PIMCO, warns that, ‘‘China needs to avoid the trap that the advanced countries have fallen into, namely that of excessive prolonged reliance on central banks.’’
The upsurge in mobile transaction services used through smartphones is at the heart of a sudden expansion of the online financial services industry in China. This is a diverse and dynamic marketplace with investment, small-lending companies, peer to peer (P2P) lending, and most recently the emergence of the first batch of online-only banks: MYbank, 30% owned by Ant Financial (founded by Alibaba), and WeBank, which is 30% owned by Tencent. These new services provide a much-needed expansion of financial access for Chinese consumers and small and medium-sized enterprises (SMEs), that have long been underserved by the state-dominated banking system. What lies ahead for China’s online banks?
Ten years from now, business historians will offer a number of reasons financial services had changed so radically since 2016, from general advances in technology to the regulatory reaction to the crash of 2008. But one factor appears likely to stand out above all the others: the blockchain, a distributed database that serves as the backend of the virtual currency Bitcoin. Today, financial services are investing billions in blockchain technology. Many believe it will lead to a radical simplification of banking and payment systems everywhere—a world where money and other assets take nanoseconds to transfer, cannot be lost or stolen, and require no intermediaries to process.
Investment banking has always been a highly cyclical business, growing when the markets grow, shrinking when they shrink. But a combination of regulation, technology and investment suggests that, as stockbrokers have traditionally whispered in boom times, this time it’s different. The go-go era of investment banking that began in the mid-1980s and thrived up to the financial crisis appears to be on its way out, as the biggest banks shrink in response to regulation and smaller, more focused firms, funds and start-ups take a larger share of the market. It’s becoming a mature industry. So what is set to change on Wall Street then?
Bad loans were at the core of the 2008 financial crisis, so it makes sense that lending may be the banking function that changes the most over the next 10 years, particularly as peer-to-peer lending platforms claim that they can make smarter loans faster and more cheaply than conventional banks. So will banks get ‘ubered’ by these peer-to-peer lending start-ups? A match that pits old and anxious institutions with high capital withholding requirements against young, tech-savvy, and lightly regulated start-ups might sound like a foregone conclusion, but some analysts say the outcome is not as certain as it appears. So what does the future hold?
For consumers in mature markets, the financial technology boom doesn’t seem very exciting. What they’ve seen so far is technology that shaves a few minutes off an efficient process, such as being able to deposit a check by taking a picture of it instead of going to the ATM. But for parts of the world where people still buy and sell things with banknotes, the FinTech boom is likely to be a major event with important economic consequences.
From the crash of 1929 to around 1981, banking was generally considered a fairly dreary business. And between now and 2025, banking seems likely to undergo a digitally driven transformation that will change how we save, spend, borrow and invest. Even as regulators do their best to try to make banking a boring business again, and politicians still vow to rein in the “banksters”, a number of well-financed start-ups look poised to reinvent almost every aspect of finance—and could even make banking sexy once more. First we look at how regulators’ push and FinTech’s pull may be setting the stage for some dramatic changes.