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Home / Issues / Volume 8, Number 1 / Regulation of Digital Financial Services in China: Last Mover Advantage?
VOLUME 8, NUMBER 1
Regulation of Digital Financial Services in China: Last Mover Advantage?
By ZHOU Weihuan, Douglas W. Arner, and Ross P. Buckley | Article | 8 Tsinghua China L. Rev. 25 (2015) | Download Full Article PDF

Abstract

Since 1979, China has made tremendous progress in its transformation to a socialist market economy. As part of this process, China’s financial system has evolved to one characterised by a high degree of marketization. At the same time, China today faces new challenges to growth and development, particularly from the necessity of restructuring its economy to focus increasingly on innovation and away from government led investment and low-wage labour. In the context of digital financial services, China has been a late mover but this has changed dramatically in the past five years, to the point today where China is one of the major centres for digital financial services and financial technology (“Fintech”). Looking forward, China needs to provide an appropriate regulatory basis for the future development of digital financial services and Fintech, balancing growth and innovation with financial stability. China today is exhibiting signs of a last mover advantage in this respect that may see it leaping regulatory developments elsewhere.


I. Introduction

The rise of digital financial services (DFS) over the past three decades is an important global phenomenon. Today, financial services is probably the most digitized industry, as well as the most globalized, in addition to being for at least the past two decades the single largest component of global technology spending.

In China, DFS developed much later than elsewhere, with major development only beginning in the late 1990s as the financial services sector modernized and developed in the context of the overall process of economic liberalization. Likewise, more recent developments in digital finance (such as internet payment services and peer-to-peer (P2P) lending) began to emerge only in the middle of the last decade. Innovations in DFS in China beyond internet banking and electronic payments are even more recent phenomenon, dating only from the beginning of this decade. Nevertheless, in many ways, China is experiencing a “last mover” advantage in the context of DFS and now appears to be developing more rapidly than most other jurisdictions.

Many factors have contributed to this rapid development, including technological innovation, rapidly increasing use of digital devices and changing consumer behaviour, explosive growth of DFS providers, and the policy objective of the Chinese government to enhance financial inclusion via digital finance to support growth and encourage greater innovation. The significance of digital finance to the achievement of full financial inclusion has been firmly endorsed by the Chinese government. The expansion of financial inclusion for underserved segments, ranging from rural areas to the urban poor to (perhaps most importantly) non-state small and medium sized enterprises (SMEs), has been one of the key elements of China’s financial sector reforms which in turn have been an integral element of China’s overall economic reform and innovation strategies.

As well as promoting the development of digital finance, the Chinese government is now dedicated to establishing a regulatory framework to oversee and supervise DFS so as to ensure its healthy growth. The approach seeks to balance the needs for innovation and growth in the economy, particularly in relation to non-state firms and SMEs, with the requirements of financial stability. However, the regulatory efforts of the Chinese government have yet to lead to the establishment of a comprehensive framework, such that DFS remain under-regulated, and in some areas, unregulated in China. In particular, the rapid development of non-traditional forms of DFS such as non-bank electronic payments and P2P lending have often occurred prior to the establishment of a supporting regulatory framework, often to take advantage of gaps in existing legal and regulatory systems. With the release of a new policy framework in July 2015, the Chinese government is seeking to implement a strategically designed framework to balance the sometimes competing objectives of innovation, growth and financial stability.

This paper is organized as follows: Section II provides an overview of China’s financial sector reforms since 1978, including the early development and evolution of DFS. It highlights the lack of financial inclusion in China, a significant and longstanding issue that has attracted considerable government effort in the past decade. Despite these efforts, financial services for underserved sectors continues to be a major issue and a roadblock to future growth and innovation. Section III analyses the evolution of DFS over the past decade setting out various forms of digital finance provided by major internet and e-commerce companies, other non-financial institutions and banks. The section shows that the number and scale of digital finance providers has grown phenomenally since 2013, paralleling the increase in the acceptance of DFS by consumers in China.

China’s regulatory framework for DFS can be divided into two periods: the initial period before 2015 and the development period since 2015. The initial period witnessed the promulgation of several rules by China’s banking regulators on certain types of digital finance such as internet payment and third-party payment services. While these rules contributed to the development of a regulatory framework on DFS, they are inadequate in many respects such as a lack of detailed and comprehensive provisions for the protection of consumers. Moreover, regulations of many other forms of digital finance will need to be developed. Since early 2015, there has been growing recognition, from both official and unofficial sources, that China needs to accelerate the development of DFS regulation with an aim to establish a preliminary regulatory framework by the end of 2015. On 18 July 2015, ten central government ministries and commissions jointly issued a ‘Guideline on the Promotion of the Health Development of Internet Finance’ (2015 DFS Guideline). The Guideline clarified a number of important issues and addressed various types of DFS. Further, the Guideline mandates the relevant authorities to develop detailed rules on the areas of digital finance for which they are responsible. The issuance of the Guideline, therefore, reflects a great effort and achievement of the Chinese government. Sections IV and V thus offer a comprehensive study and analysis of China’s regulation of DFS by discussing, respectively, China’s DFS regulations before 2015 (section IV) and the 2015 DFS Guideline (section V). These sections show that digital finance is considered by the Chinese government as being essential to achieve full financial inclusion, and that regulatory efforts have been made to ensure the healthy development of DFS. Section VI concludes, arguing that China is now on the verge of moving from last mover to first mover in respect of both DFS and its regulation.
 
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