The money is being siphoned out of China's state-controlled banks, which pay 0.35 percent annual interest on checking accounts, one-seventeenth of the 6 percent Ning earned by investing in a mutual fund paying market-based rates. Had she kept her money in a one-year time deposit, she would have made China's benchmark rate of 3 percent, slightly more than last year's lower-than-expected inflation rate of 2.6 percent.

With no minimum deposit or time frame required, the new technology brings interest-chasing to China's masses and challenges an industry facing increased competition from deposits and loans offered through an estimated $6 trillion shadow-banking system and a pledge by the banking regulator to allow private lenders to start operating this year for the first time. The government has said it wants to allow greater market forces to take hold in the economy.

"It's disruptive to traditional ways" of raising deposits, said Zhang Zhiming, head of China research at HSBC Holdings Plc in Hong Kong. "Traditional banks will be challenged. That's not necessarily bad news."

Drawing Cash

Banks have started offering wealth-management products, defined by the government as shadow banking, to keep money from flowing out the door. Most carry restrictions: a 50,000 yuan minimum, a one-month time period, and business-hours-only service. Unrestricted Internet-based investing, in which savers can move as little as 1 yuan at any hour of the day for any length of time, is China's next evolution.

Yu'E Bao's cash is invested in a money-market fund run by Tian Hong Asset Management Co., in which Hangzhou-based Alibaba, the nation's largest e-commerce company, owns a majority stake. The money goes into negotiable bank deposits as well as government and corporate bonds on the interbank market.

Volatile yields there climbed as high as 10.8 percent in late June and hit 8.8 percent last month as Chinese banks hoarded funds to meet quarter-end regulatory requirements, according to data compiled by Bloomberg. As a result, Yu'E Bao's return has varied between 4.3 percent at its June 17 debut and a high of 6.8 percent on Jan. 2.

Investors in money-market funds, like those who have bank savings accounts with fixed returns, rely on implicit government support to protect their principal. They shoulder the risk of fluctuating returns, which can drop to negligible levels.

China is the world's biggest mobile-banking market, with 60 percent of bank customers completing some transactions with a smartphone or tablet, compared with 45 percent in the U.S., according to a December survey by consulting firm Bain & Co.

The government is encouraging innovation in Internet financing and sees it supplementing the traditional financial system, Liu Shiyu, a deputy governor of China's central bank, said last month.

"Alibaba and genuine Internet banks are a force to be reckoned with in future years," said Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd. "If e-commerce-based banking services are able to develop sizable cash flows and transaction volumes over the next few years, then the commercial banks are going to have to take actions to counter the new competition."

Few Options

China's savings rate of more than 50 percent of gross domestic product was the highest among major economies as of 2012, exceeding 31 percent in India and 13 percent in the U.S., according to the International Monetary Fund. Even so, Chinese have few legitimate investment options for their deposits.

"Undoubtedly, a group of new entities like Alibaba have marched ahead of traditional institutions like us, but we won't just sit back," Zhang Jianguo, president of China Construction Bank Corp., the nation's second-largest lender, told investors in August. Construction Bank, based in Beijing, began an e-commerce platform in November 2012 that allows users to buy products including digital gadgets, cosmetics, books and food in addition to financial services.

China Minsheng Banking Corp. plans to tie up with its own fund-management unit and China Universal Asset Management Co. to offer electronic cards that allow holders to receive a 5 percent expected rate of return on savings, Xinhua News Agency reported in November. The product has no minimum requirement and can be redeemed anytime with same-day settlement on the transaction. Bank of China Ltd., the fourth-largest lender, is exploring similar products, according to Caixin magazine.

As Internet financial products gather momentum, China's state-controlled banks are losing share of the nation's 44.8 trillion yuan in household deposits, which for decades have helped keep their profits high as rates fixed by the government created a 3 percent spread between what they collect on loans and what they pay on one-year time deposits.

Household savings fell by 897 billion yuan in October, 35 percent more than the drop a year earlier, as investors shifted out of savings and checking accounts into investment products, central bank data show.

"Given time, such a combination of the Internet technology business model and financing products could meaningfully change the entire industry's landscape and the rules of the game," Victor Wang, a Hong Kong-based analyst at Credit Suisse Group AG, wrote in a Nov. 18 note to investors. "Banks do not have many choices but have to proactively participate in the trend."

Money-market funds in China could exceed 2 trillion yuan by 2014 if they draw 10 percent of household demand deposits, Wang estimated this month. By 2020, they could reach 5 trillion yuan, or about 10 percent of the nation's economy, he said.

Ning, a frequent user of Alibaba's online retailer Taobao Marketplace, where she buys and sells clothes and makeup while studying finance at Hong Kong Baptist University, transfers her funds from an account at Industrial & Commercial Bank of China Ltd. (ICBC) to one operated by Alipay.com Co. and then to Yu'E Bao.

"Yu'E Bao is very convenient in that you can get back your money anytime, whereas other investment products provided by banks only allow you to get back your money on workdays, and the process is a lot more complicated," said Ning.

Executives at Beijing-based ICBC, the nation's largest bank, and other lenders including China Citic Bank Corp., have dismissed competitors.

"I don't think it's a realistic or viable model for e-commerce entrepreneurs to start banking just because they are motivated by our profits," Zhu Xiaohuang, president of Citic Bank, said at a conference in Beijing in November.

Revamping Banking

Billionaire Jack Ma, Alibaba's executive chairman, has called for a revamp of China's financial sector, saying it needs an outsider to "stir things up," according to a transcript compiled by the official People's Daily. His financial arm, Small & Micro Financial Services Group, contains two loan companies as well as Alipay, which had more than 800 million registered accounts as of July.

Executives at Alibaba have talked about an initial public listing in Hong Kong or New York this year. The company is about 24 percent owned by Sunnyvale, California-based Yahoo! Inc.

Behind Yu'E Bao is the money-market fund run by Tianjin-based Tian Hong Asset Management, which until June had steady losses and ranked 45th by assets under management among 77 peers in China, according to data compiled by Galaxy Securities Co. After Alipay chose Tian Hong to oversee Yu'E Bao's money, investors poured in more than 185 billion yuan as of Dec. 31, Galaxy data show.

Tian Hong surged to No. 2 by the end of the year as its Tianhong Enhanced Income Treasure Money Market Fund, in which Yu'E Bao is invested, became China's largest mutual fund. Alibaba in October agreed to pay 1.18 billion yuan for a 51 percent stake in Tian Hong to cement the partnership.

Yu'E Bao has the potential to reach 300 billion yuan, a 60 percent increase from its current level, before it faces difficulties managing liquidity and fending off competitors, according to Dai Zhifeng, a Shenzhen-based analyst at Haitong Securities Co. Eighteen asset-management companies offering funds similar to Yu'E Bao's are using Alibaba's Taobao Marketplace to sell investment products, lacking only direct access to Alipay account holders.

Other Internet firms are following suit. Search-engine company Baidu in October began offering "Baifa," a money-market fund managed by China Asset Management Co. The product attracted more than 1 billion yuan of investment from at least 120,000 customers on its debut, according to Kaiser Kuo, a Beijing-based spokesman for Baidu.

Exploring Competition

Tencent Holdings Ltd., Asia's largest Internet company by market value, gives users of its WeChat instant-message and social-network service access to accounts set up by fund-management firms and will direct customers to the funds' products. The firm is "exploring ways to cooperate with different financial institutions to drive online innovations in financial services," Jerry Huang, a director of investor relations for Shenzhen-based Tencent, said in an e-mail.

The Tian Hong fund in which Yu'E Bao users are invested held 84.5 percent of its assets in bank deposits as of Sept. 30, with the rest in bonds, asset-backed securities, and reverse repurchase agreements, according to its quarterly report.

The fund can wring a better yield from banks on such deposits than individuals, as only financial institutions can negotiate rates on large-sum savings. Normally those would be based on the Shanghai interbank offered rate plus a premium and change along with liquidity conditions on the interbank market.

The Tian Hong fund has reaped 1.8 billion yuan in gains for Yu'E Bao investors since its inception, or an annualized return of 4.9 percent, according to the company. That's 14 times the rate banks pay on checking accounts.

Tian Hong pays Alibaba a payment-technology fee and a platform-marketing fee for investor referrals, Teresa Li, a Hong Kong-based spokeswoman for Alibaba, wrote in an e-mail.

In the U.S., EBay Inc.'s online payment service PayPal started a similar product in 1999, allowing users to invest residual money in PayPal accounts in a money-market fund. The fund closed in July 2011 because "the financial advantages of maintaining a PayPal Money Market Fund account have diminished for our customers" amid low interest rates, according to a company statement. The yield fell to less than 0.05 percent after the 2008 financial crisis from about 5 percent in 1999, according to a Barclays Plc note.

Strategic Importance

Chinese banks need to attach "strategic importance" to Internet financing, Gu Shu, a vice president of ICBC said at a Nov. 25 conference. Customers using ICBC's website or mobile-phone application can purchase its mutual funds, wealth- management products, insurance policies, gold, currencies and other services.

ICBC, the world's most-profitable lender, has more than 100 million mobile-banking users, and transactions via its electronic-banking network accounted for 79 percent of the total, equivalent to 30,000 bricks-and-mortar branches, Gu said.

Combined net income at ICBC and the other 15 publicly traded mainland banks rose 13.6 percent in the first six months of 2013 from a year earlier, to $101 billion, data compiled by Bloomberg show. The earnings accounted for more than half of the total net income of China's more than 2,400 listed companies. It also exceeds the $82.5 billion earned by 7,000 U.S. banks, Federal Deposit Insurance Corp. data show.

The central bank is doing away with interest-rate controls, a process that began with the July move to eliminate a floor on borrowing costs. Liberalization of deposit rates, which Moody's Investors Service expects in the next 12 to 18 months, may also change the dynamic in the $24 trillion banking industry.

President Xi Jinping is pushing changes that may be the most sweeping since Deng Xiaoping's liberalization in 1978. The goal is to loosen government controls in everything from energy pricing to banking and let market forces have more influence. Consumer spending is to become a driver of the economy, which at projected 7.6 percent growth last year was headed for the slowest increase since 1999.

China's banking regulator said last week it will allow a batch of three to five banks, completely funded by private investment, to operate this year under a trial as part of the country's financial reform. That could help companies like Alibaba further erode what former Premier Wen Jiabao called the "monopoly" of big lenders.

While that may be good news for investors such as Ning, others aren't so sure.

Wang Lin, a 50-year-old English teacher in Chengdu, said her Yu'E Bao experiment lasted only a few weeks before she took out the 2,000 yuan she invested. She earned 8 yuan in interest.

"At first I thought it was similar to a bank deposit," said Wang, who considers mobile phones unsafe and prefers not to link any of her bank accounts to the gadget. "But later I found out it actually was a fund product, and it was risky. If I have money, I would still prefer to put it into property. That is the only thing that has provided a stable return."

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