On Nov 29th, People's Bank of China (PBoC) issued a circular concerning third-party payment companies, which is set to impact the profitability of Chinese payment companies including Alipay and WeChat.

According to the circular, payment companies which are already connected to Wang'lian, a third party clearing house, should cancel their customer prepayment accounts at their respective cash management bank.

In other words, third party payment companies are required to deposit 100% of their customers' prepayment deposit to PBoC, which has to be completed by the end of January 14, 2019.

The raison d'être behind the circular is a logical extension of previous measures to increase the amount of cash deposited straight to the PBoC, ultimately with the aim of eliminating the misuse of deposits by third-party players.

To set the directive in context, e-commerce customers make payment of their orders before they receive goods purchased. The prepayment money is funnelled into third-party payment companies' bank accounts. The cash is ring-fenced and monitored by PBoC, which is also be able to access the data of each payment or transfer.

As third-party payment companies accumulate large amounts of cash, interest from bank deposits and also cash loans lent out to retail customers become a major source of revenue for them. This robust business model of the payment companies has posed a threat to commercial banks.

PBoC data show that account balances of third-party payment companies at PBoC totalled 995.7 billion yuan ($145 billion) as of end of October. It is estimated that the total balance could reach 1.3 trillion yuan.

In a bid to crack down on embezzlement and misuse of the deposit, PBoC started to insist that third-party payment companies put 20% of prepayment deposits at PBoC in January 2017. This proportion was raised to 50% in April 2018, which has now been increased further still, to 100%.

The latest circular also requires the cash management banks or settlement banks to blow the whistle whenever suspicious transactions are detected.

Since June 2018, a centralized clearing procedure has been put in place, when a third party clearing house, Wang'lian, started to act as the sole intermediary clearing entity to handle all transactions between payments companies and banks. In the past, each payment company connected directly to the banks and each transaction was cleared without the presence of any other player.