UnionPay is now the largest card scheme, but the Chinese banking system still has a long way to go
[Personal views only. Not associated with my employer’s standpoint.]
Worldwide card payment transactions reached US$21.6 trillion in 2015, according to Retail Banking Research’s Global Cards Data and Forecasts published in July 2016. China UnionPay accounts for 37% of the market share, making it the largest card scheme in the world, above Visa with 32% and MasterCard with 20%. Also, Alipay transaction volume reached around US$2 trillion in transaction volume in 2015, according to iResearch. Combining UnionPay and Alipay, we are talking about US$10 trillion in transaction volume from the most popular Chinese payment methods.
Despite their sizes, UnionPay and Alipay are still largely domestic networks, because the Chinese banking and financial system is far from opening up. One of the reasons why the Chinese financial system is still a closed one is the lack of structural depth. To understand this, we need to look back into the history of the Chinese banks. Unlike in many other capitalist countries, the Chinese banks were created by the central government to provide funding for state owned enterprises (SOEs), back when China was kick-starting the industrialization process. For this purpose, lending interest rates need to be kept artificially low, and almost no one other than these designated SOEs have the rights to receive these loans.
As a result, the banks are complacent with serving SOEs and are not looking to expand their business to fund small and medium size private companies (SMEs), and the SOEs are complacent with using cheap loan as primary source of funding, and are not looking to diversify into debt or equity financing. And consequentially, debt and equity markets are too underdeveloped to absorb volatility, most SMEs have limited access to the capital market, and most consumers are neglected by the credit system.
In addition, more than half of the Chinese population are farmers living in rural area, low-income, far from banking coverage, poorly educated, but are producing the goods that we cannot live without. In fact, only 300 million out of the 1.3 billion Chinese population are banked, and less than 200 million have credit and lending history.
Spotting the opportunity with this 1-billion-population market, many fintech startups emerged in the past years focusing on person-to-person (P2P) lending, copying the business model of Lending Club. The space later became so heated that there were way too many P2P companies — about 5000 were created within just a few years. Even worse, almost half of them are actually just Ponzi schemes. Many of their founders have disappeared with the deposited capital, leaving many investors bankrupt.
On the other hand, credit rating is a promising fintech sector in China. However, the regulators have been very hesitant in giving out licenses for private companies and startups to enter the market. They are faced with a dilemma: although it is clearly beneficial to the economy to carry out credit rating on the 1 billion unbanked population, the banks, however, who form the strongest lobbying group and the regulatory institution, are not likely to benefit from this because the 1 billion unbanked population are too expensive to cover for traditional banking business anyways.
This is very similar to another dilemma that the regulators are faced with in the 3rd-party payment industry: wallets such as Alipay and Wechat Payment have grown so fast and made people’s lives so much easier, but they are bypassing the banking system, leaving the banks out of the huge ecommerce market. As a result, the People’s Bank of China have announced new restrictions on the transactions via 3rd-party solutions similar to Alipay, a policy heavily criticized by the progressive tech community and consumers.
Even so, there is still tremendous momentum in the credit rating space. Large companies such as Alibaba, Tencent and PingAn are entering the market, utilizing their access to big data from ecommerce transactions, social fingerprints, mobile communications, insurance history, even GPS records. More importantly, we are seeing smaller startups in this field, with their own proprietary machine learning algorithms, AI engines and access to big data, trying to make a better credit rating system.
Thanks to the improving credit system, there also emerged a new generation of startups that provide lending, such as Shenma JR, which focuses on farmers and rural development, and Swipal, which focuses on students and young professionals who face formidable costs of living in major city but strive to be more productive.
A lesson learned from the most recent 40 years of Chinese history is that even small innovations on the local level can quickly generate huge momentum and make revolutional impact. I’m hopeful that these entrepreneurs with solutions for the majority yet neglected people — the low income, the unbanked — are the future for a better financial system in China.