The Ant and the Grasshopper
In the original fable, the ant worked hard all summer and saved up for winter. It laughed in the face of the grasshopper who had idled away the summer and came begging for food in the winter. In Somerset Maugham’s version though, the hard working lawyer of an Ant had a good for nothing brother who scrounged and lazed through life until he married a rich widow and soon thereafter inherited a fortune.
In the modern version of the fable though the winners and losers and the happy ending is far from clear. Ant Financial is in the news for having its USD 37 Billion cancelled by regulators after the issue had been subscribed. Is it being punished for jack Ma’s stringent criticism of regulators (“pawnshop mentality”) a week before the IPO ? Surely the world’s top merchant bankers did not just drift into a behemoth of an IPO without the regulator’s blessings ? So what gives !
The story of Ant finance began in 2003 when online market places were still new – at least in asia. Why transact online ? what is the assurance that goods would eb delivered and meet standards once the payment is made ? Jack Ma’s online platform Taobao tried to solve the problem with a product, now famous as Alipay. In essence buyers paid money to the market place who would only release the payment if the goods were satisfactory. A sort of escrow account. [ in India market places must have a “Nodal account” form which payment is released only after goods are received in good condition] as per RBI regulations.]. To provide this account, Alipay tied up with China Commercial Bank and acted as the front end. In time Alipay became a wallet. It offered interest on deposits and deployment options – today it has over 150 Billion of AUM in the Ant Finance Money Market Fund. With 700 Million active users, it started selling insurance. The Huabei Virtual credit card. Jiebei unsecured loans to SME and traders. Credit scores for borrowers. In short a very full service bank. Profits for the six months ended June 2020 were estimated at USd 3 Billion on revenue of USD 10 Billion. Clearly this is not a start up story. The IPO would have valued the company at about USD 316 Billion. More than any Chinese bank. In fact more than JP Morgan Chase – the top US bank.
It would seem that this was simply a case of regulatory spite from the Chinese Communist Party. Some interesting snippets though hint at a different view. First Ant provides a lot of loans in fact its retail loans originated exceed that of any other Chinese bank. But most of the funding and the loan (88%) sit on books of the Chinese banks. A further 10% was securitised. Ant’s own capital employed is only 2% of the originated loans. Fees for arranging loans contributed 39% of the total revenue. At a 2.5% per go, this could be a very sweet business… facilitate a payment… provide a short term loan through the virtual credit card and arrange a longer term finance from a bank. So whats wrong with that ? As the Great Recession of 2008 showed Skin in the Game is big deal. So the Regulator now wants online lenders to put up “thirty percent of the Joint loans”- with Joint loans yet to be defined.
Typically Ant does not charge interest for Credit card use if there is money in the wallet. For most banks though it would not work this way – statutory liquidity ratio and cash reserves would make it make it uneconomical. Score one more for what may be a regulatory arbitrage.
Ant seems to have set up its loan and card limits in a way where if the client has not paid his loan on due date, the credit card is debited. This may seem like a prudent practice. However t can potentially mask the buyers payment track record for a time. A customer who has not made his loan repayment would still be sound. This would not matter if both exposures are from the same Lender – Ant. But 98% of the loans are not on Ant’s books. Payment track records on those may be subject to “evergreening” – one of the dreaded words in the RBI lexicon where accounts never go bad but never repay…
Another aspect of the regulatory quagmire is the basic issue of a license. If it takes deposits by way of a wallet and makes loans, Is it not a bank ? Should it not be subject to licensing. In China each branch has its own capital adequacy and the centralised HO is not obliged to stand in and repay a letter of credit if say the Xinjiang branch of a leading bank defaulted. Conversely each province issues a license. Would Ant need a cross provincial license ?
Ant is a solid business. Its brought new clients to financial services and filled a huge need. It’s a poster boy for innovation and making good. But with so many questions waiting to be answered its valuation story is very unclear.
Would it have been different in India ? Amongst international regulators, the RBI scores high in terms of foresight and thoroughness of rules. It avoided the excesses of securitsation which played out in 2008 in the US and European markets by forcing NBFC and banks to amortise securitised revenue over the life a good two years before any crisis appeared on its horizon. It defined true sale and tightened capital adequacy. In the area of online marketplaces, the RBI has well defined rules for nodal accounts as well as a licensing regime for “Payment Banks”. India is the leader in Unified Payments ( BHIM/ Google Pay/ Phone Pe through UPI) for players of any size with its own indigenous solutions through the National Payment Corporation – something that most advanced markets like the US do not have. Like Ant India has numerous NBFC and banks who offer loans to online shoppers, but the rules on securitisation and co-lending do not make it easy to sell these onward. This forces originators to be careful and put up capital.
India’s real challenges though are yet to come – no player of size and scale like Ant has appeared yet. But the confluence of Mutual Funds for availing liabilities, selling insurance and online lending through a finance company is now well entrenched. With Open Credit Enhancement Network set to debut and do a pure distribution of loans role, Regulators in India may find they have not yet been put to the test.