China's online finance companies, including Alibaba and Tencent, are competing fiercely with China's traditional banks, which are adapting to the new marketplace.
The online firms have lent out substantial sums that they raised from Hong Kong and New York stock markets. But the traditional banks are competing for customers by shifting 80 percent of their retail business to their own online platforms.
Internet companies lent more than $150 billion to customers in 2015, which is an extremely small amount compared to the much larger lending by commercial banks last year.
"The traditional banks are not dinosaurs waiting to be killed," said Oliver Rui, professor of finance and accounting at the China Europe International Business School. "Less than one percent of China's retail banking was conducted by the Internet-based 'fintech' companies in 2015. Commercial banks have done a good job of adapting to the new technologies."
The Chinese government has been encouraging the growth of the online finance industry in a variety of ways, resulting in mushrooming growth in the number of companies that have no background in financial business.
Lower costs, diversify
The government's goal has been to push commercial banks to carry out market-oriented reforms, bring down their high costs of transactions, and diversify the product mix available to the customer. Transaction costs on mobile banking are as little as 8 cents per transaction, against $4 for branch operations in banks, according to Guotai Junan Securities, which says it is 17 cents for online banking and 85 cents for use of an ATM in banks.
"Regulatory controls on banks are very severe. The government has been comparatively lenient with the Internet finance companies," Rui said.
The growth of these so-called fintech companies has pushed traditional banks to shed their complacent cloak and begin infusing technology in their financial business.
That said, the peer-to-peer (P2P) businesses, which are online services that match lenders directly with borrowers, have seen startling amounts of fraud, causing serious losses to millions of Chinese investors who put money in these ventures. About one fourth of the 4,000 P2P companies in China have closed due to fraud, and another 1,500 have been put on a 'watch list' due to their suspicious transactions, Rui said.
Despite recurring fraud, the P2P business has continued to grow. There was a 205 percent growth between 2014 and 2016, when it stood at half a billion dollars, according to CEIBS data. Crowdfunding, which is another form of fintech business, saw growth of 429 percent in one year between 2014 and 2015.
Other forms of Internet-based fintech companies, including those that offer loans for shopping, have seen extremely large growth, although they have not been able to match traditional banks in terms of business size.
"Companies selling financial products through using online and mobile platforms have recorded phenomenal growth in recent years. Mutual fund sales through these platforms have nearly doubled in 2015," said Yunying Liu, analyst with Z-Ben Advisors, a Shanghai-based financial consultant.
Bigger role ahead
"But we see the future scenario changing. Online and mobile distribution will play a much bigger role in the retail market, while banks will focus more on institutional investors and high net worth individuals," she said.
An important reason why online finance platforms have grown quickly is that small and medium enterprises find it very difficult to get loans from traditional banks that have rigid sets of rules and requirements. A study shows that only 11.9 percent of small and medium enterprises have received loans from traditional banks. They had depended heavily on underground banks before the advent of online finance.