Chinese-based digital wallets are going to have start acting like banks rather than apps. A regulatory action by China’s central bank shows how blurred the line between banks and digital wallets has become.
The People’s Bank of China (PBOC) has ordered Ant Financial’s Alipay and Tencent Holdings’ (HKG: 0700) WeChat Pay to hold all customer funds in reserve, The Financial Times reported. That indicates the PBOC considers those institutions as banks rather than technology companies.
It also raises a very frightening possibility, that the PBOC discovered one of those companies did not have the money to cover its payments. If true that might trigger a financial crisis as bad as the Great Meltdown of 2008.
Financial crises usually begin with liquidity crises in which institutions run out of money. The PBOC apparently believes Tencent and/or Ant might run out of money triggering a liquidity crisis.
Will Digital Wallets Trigger a Financial Crisis?
Such a crisis would be catastrophic because Alipay and WeChat Pay reportedly processed $16 trillion worth of payments last year.
To make matters worse, WeChat Pay alone had 600 million users in August 2017, Statista calculated. Furthermore, Alipay had 400 million users. Therefore one billion people might be affected by a collapse of those organizations.
Disturbingly, the PBOC also ordered Ant and Tencent to stop investing customer funds outside of digital wallets. That sounds frighteningly like the behavior that triggered the Great Meltdown.
The Meltdown was triggered by the investment of funds from investment and commercial banks in questionable assets. The Ant and Tencent mess would be different from 2008 because the money involved belongs to ordinary people. Back in 2008, most of the funds were lost to investment banks.
Are Digital Bank Runs Possible?
Most of the WeChat and Alipay funds come from ordinary consumers and mom and pop merchants.
A particularly catastrophic crisis would be a digital bank run. A bank run occurs when people suddenly yank their money out of accounts. The bank collapses because it lacks the cash to cover all the withdrawals.
A digital bank run would be worse, because there might be no way to stop people withdrawing funds. In contrast to a digital wallet, a brick and mortar bank can simply lock its doors.
One has to wonder if the PBOC just prevented a digital bank run in China. In light of that Americans should wonder how safe our digital wallets are.
Could a Digital Bank Run Happen in America?
How safe are PayPal (NASDAQ: PYPL), Venmo, Square (NYSE: SQ), Apple Pay, Google Pay, Walmart Pay, etc.? Do those companies have the funds to cover a sudden loss of liquidity in their digital wallets?
Apple Pay and Google Pay try to get around that by accessing bank accounts with Federal Deposit Insurance Corporation (FDIC) coverage. What about PayPal and its Venmo peer-to-peer (P2P) solution?
The Federal Trade Commission (FTC) alleged that some customers’ funds were not available through Venmo in February. In essence, the FTC charged that Venmo lacked liquidity.
Could Digital Wallets Trigger a Financial Crisis?
This is a concern because there were 237 million PayPal digital wallets in existence in 1st Quarter 2018 according to Statista.
What would happen if just one third of the holders of those wallets tried to yank funds from those accounts? The probable result would be panic and a sudden collapse of PayPal itself.
Beyond that there are the next-generation digital wallets such as cryptocurrency products coming our way. How safe are those products, and who is watching the show?
Not to mention other tech companies like Facebook (NASDAQ: FB) which is getting into finance with WhatsApp Pay. Something to remember is that Facebook has no real experience or expertise in finance. Yet it might be acting as a bank for tens of millions of people all over the world.
Perhaps it was time the Federal Reserve; and agencies like the FDIC, started the kind of aggressive regulation the PBOC is engaging in. If they do not we are probably setting ourselves up for economic disaster.
Historically, depressions and downturns have often been caused by financial institution collapses. The depression of 1837 was triggered by the collapse of the Bank of the United States, while the 2008 catastrophe began with the collapse of Lehman Brothers.
The Federal Reserve needs to Crack down on Digital Wallets
Hopefully, it will not take the collapse of something like Ant Financial or PayPal to get Uncle Sam and the Federal Reserve to take action.
Lax financial regulation partially caused the catastrophe of 2008. As a consequence of another round of regulatory dereliction of duty – history might repeat itself on your smartphone.
America’s financial regulators need to learn from the PBOC and become more aggressive. Allowing Big Tech to run roughshod over finance will lead to a repeat of 2008. Perhaps the Fed, the PBOC, and some of the other central banks should team up and crack down on the wallets together.
What if Ant Financial Collapsed?
Ant Financial in particular deserves a close look because it is supposedly the world’s most valuable unicorn or pre-initial public offering (IPO) company. Ant is now the world’s largest fintech firm capable of raising $14 billion in a single day.
Ant is now so large that its collapse would trigger a global financial crisis. Disturbingly, Tencent Holdings is even larger, and neither company is regulated like a bank.
It is something we should think about because Alipay is becoming very powerful. For example, Singapore’s Straights Tourism Board (STB) and Ant Financial are teaming up to attract more Chinese to the city state.
The belief is that catering to Alipay users is the way to attract China’s middle class. Hopefully it will not attract bank runs and financial panics to Singapore as well.