China's internet finance companies are driving the country's banks to innovate and upgrade their digital offerings. The process should create new financial services that better fit a consumption-led economic growth model. S&P Global Ratings believes most banks will adjust to the digital disruption, although their market share in consumer-related finance will become less dominant. They will have a smaller slice of a bigger pie.
Financial technology is large and fast-growing in China. Since the launch of Alipay in 2012 and WeChat Pay in 2014, mobile-phone payments have soared to RMB320.4 trillion (US$46 trillion) from less than Chinese renminbi (RMB) 50 trillion. On the online bank front, WeBank's asset reached RMB81 billion by the end of 2017. Although still tiny compared with the Chinese banking system's assets of RMB252 trillion assets and loan balance RMB120 trillion, this represented growth of 7.5x in the first two years of operations. And WeBank's loan growth tripled last year, to RMB47 billion (US$6.9 billion).
In our view, the business model and credit impact is greater for smaller banks. Some may lack the resources to make necessary technology upgrades. As a result, they may cede underwriting control on consumer loans to tech giants using big data and behavior models. Increasingly we are seeing banks collaborate with internet finance companies on consumer loans, but these assets are under-tested through a cycle—i.e., against increasing unemployment rates and declining disposable income. While internet finance companies see smaller banks as funding partners, they have less incentive to collaborate on new products and services.
China's financial regulators have given the fintech industry space to grow, while retroactively punishing excesses, particularly if fintech is used as a guise for regulatory arbitrage. This approach has worked in certain situations while faced significant challenges in others. Peer-to-peer (P2P) lending is an example of the latter.
Payment Services: A Disruption With An Upside
We view disruption in China's payment services as a model for other transformations that could follow. Chinese nonbank digital payment providers, led by Alipay and WeChat Pay are in many ways outcompeting banks on payment services. On the other hand, these companies are helping to grow new markets for all lenders.
By transaction volume, digital payments conducted through nonbank providers overtook those transacted by banks in 2016. By the end of 2017, nonbank digital were almost double those of banks (see chart 1). In terms of value, banks still beat the rankings (see chart 2).
Chart 1
Chart 2
Technology is clearly changing consumer payment behavior in China. Payments are made easy for both buyers and sellers, with a simple cell-phone scan of a vendor's "QR" code. Thus they're accepted everywhere, from online retailers to grocery stories to flea markets. Businesses can maximize customer relationships by, for example, offering discounts if the customer adds the vendor as a social media contact. Often these payment platforms are just another function under the main online retail/social media app, maximizing clicks per day and in turn customer loyalty. Since Alipay Mobile and WeChat Pay were launched, China's bank card penetration rate has plateaued (see chart 3).
Chart 3
However, a look at the trend in settlement fees shows that growth in online payments has come at some cost to banks, as indicated by declining settlement fees as share of total fee income (chart 4). We believe the falling growth in payment and settlement fee income will likely stabilize. This is because the nonbank digital payment service providers have already saturated the small ticket transactions, further explosive growth in this area is unlikely, and businesses and the general public continue to trust banks with large transaction settlement.
Chart 4
In our view, banks are adjusting to changing payment behavior. While the amount of nonbank third-party payments grew by 480% from 2014 to 2017, banks' own mobile payments rose by 798% during the same period (see chart 5). Chasing such growth often involves collaboration with the disrupters. On platforms such as WeChat Pay or Alipay, banks cards are linked to enable consumers to make digital purchases. However, because these nonbank digital payment platforms act as the intermediary, banks receive significantly lower fee rates from these transactions.
Chart 5
Consumer Loans, The New Battleground
"Big data" and hyperconnectedness will continue to expand China's banking frontier. Individuals and small businesses with limited credit histories, for example, will increasingly be able to access banking services at their fingertips. If these new transactional relationships are not managed well, however, digital loans could increase credit risks in China.
Lending is a natural extension of payment and transactional services. Alibaba Group Holding Ltd. and Tencent Holdings Ltd., China's two largest internet companies, both secured internet micro-credit licenses soon after they started their payment businesses. Moreover, Alibaba launched the digital MyBank in 2015, the same year Tencent-backed WeBank also started operating. In 2017, the two digital banks underwrote RMB1.3 trillion in loans collectively.
These developments raise a number of questions.
Are the lending arms of Chinese tech giants a threat to traditional bank loan business?
Banking operations: Yes, but a number of factors limit the disruption. First, accounts at the branchless digital banks have regulatory limitations on transaction volume and cash deposit-taking, which limits their retail deposit base, so their average cost of funding is typically higher. Second, these companies target smaller-ticket loans, e.g., a retail loan could be a few hundred renminbi whereas a bank consumer loan is typically in the thousands. These small-ticket loans typically repay much faster. Third, retail and small and midsized enterprise (SME) loans still make up less than one-third of commercial banks' book, contributing around 24.7% of total bank loans as of end-2016. At least for now, we estimate only a small portion of this is in direct competition with the clientele focused by the banking arm of the Chinese tech giants.
Microcredit operations: On the other hand, the Chinese tech giants have a clear advantage in distribution and approval speed for small ticket loans, access to better behavioral and consumption data. They are quick to respond to changing market dynamics. Internet microcredit is comparatively less regulated than banks, having to answer only to the local China Banking and Insurance Regulatory Commission (CBIRC)
We see increased collaboration as a sign that the fintech threat can also be an opportunity, with synergies derived from fintech distribution strengths and banks' cheaper cost of funding. The bargaining power varies considerably, with banks coming on top when collaborating with small internet microcredit companies, and quite the opposite when it comes to the tech giants. As an example of the latter, the partnering banks underwrite most of a loan (up to 90%). The large tech firms would charge a distribution fee of around 30% of total interest to be received. In some instances, insurance companies and guarantee companies are also looped in, providing a buffer to potential credit losses. For the moment, the appeal is significant, particularly for smaller banks with a high deposit base but limited retail-distribution ability. In these instances, small banks might be exposing themselves to a high level of credit risk for rather modest return.
What are the risks to banks of increased collaboration with fintech firms?
We see two risks: (1) overreliance on third-party distribution and not "owning" the customer relationship, overshadowing retail outreach capabilities; and (2) under-tested credit performance with a relatively short proven record that not yet gone through a cycle. For now, the credit risk appears manageable. While banks do not disclose credit metrics per business line, WeBank and MyBank disclosed their nonperforming (NPL) ratios at 0.64% and 1.23% as of end-2017, respectively. This is below the banking sector average of 1.5% for similar unsecured consumer loans. Note, these two entities did not disclose past-due loan and charge-off information.
Are internet micro-loans replacing credit cards?
To some extent. For example Huabei, the online credit-card service of Alibaba arm Ant Financial, is now the second largest player in credit-card-related services by number of users (see chart 6). Huabei says that 60% of its users don't have a bank credit card. While a card's average credit line is about RMB20,000, Huabei's is well below RMB10,000. Nearly a third of credit card users are aged 25-30, while about 50% of Huabei users are 20-28. Based on experiences in developed markets, younger cardholders typically exhibit higher risks in terms of delinquency. The average age of bank credit card clients are typically older; however, with increased digital investment and online distribution the clientele overlap is quickly increasing. Credit card lending has taken a more significant share of the bank loan book, reaching 5.4% of commercial bank loans in 2012 from 2.7% in 2017.
Chart 6
Do the lending arms of Chinese tech giants companies have an information advantage?
In some areas, yes. Access to transactional, behavioral, and personal data has aided the rapid growth of digital financial services in China. The People's Bank of China's (PBOC) credit reference system is a key source of such data, with 412 million individual records as of September 2016. Tech giants gets additional data from their platforms: Tencent through social media, Ant Financial and JD Finance from online transactions.
Banks also have their own data advantages, however, such as traditional transaction records, and payroll information. They can swap information among each other, and partner with local tax offices and other government agencies to get useful data. In addition, banks also typically lend when there is a particular loan purpose, whereas the lending arms of Chinese tech giants are typically more liberal about loan purposes so long as the customer passes its credit scorecard; they also mitigate risk by limiting loan size and requiring fast repayment. We note that while these fintech tools are efficient, they are untested through a credit cycle.
Without The Right Regulatory Balance, Fintech Could Undermine Financial Stability
We view regulation as a key variable in the state of play. We believe Chinese regulators will remain open to tech-enabled banking. Digital innovation in this arena is consistent with financial inclusion for the general population, and the transition to a consumption-led economic growth model.
Both the PBOC and the CBRIC have thus far shown regulatory tolerance toward fintech companies. They have employed a "trim the edges" approach which fosters the unencumbered development of fintech companies but curbing financially destabilizing activities as they arise. We believe this balancing act between innovation and financial stability will continue. However, policymakers may find it increasingly difficult to maintain this delicate balance, given the rapid development in both the tech industry and Chinese financial system. Failure to identify and react to raising risks promptly and properly could trigger a domino effect in the country's banking system.
In a typical reactive regulatory approach, rules are only set out after the risk becomes clear. For example, payment companies were allowed to keep customers' excess balances to invest and earn interest income. New rules were issued this year, seven years after the inception of payment licenses, requiring these excess balances to be fully kept with the PBOC by Jan. 14, 2019 (see table 2).
Another example of retrospective regulatory supervision can be seen in the case of Tianhong Yu'ebao, the money market fund Ant Financial initiated. It took only four years for the fund to become the world's largest money market fund. With a net value of RMB1.5 trillion (US$218 billion), Tianhong Yu'ebao has surpassed the total-deposit amount of many city commercial banks and even some joint-stock commercial banks in China. However, it took a few iterations of new rules to fine-tune and balance the interests of investors, funds, and other stakeholders in regards to fund redemptions.
While the retrospective regulation approach did not cause any financial or social stability issues, P2P lending tells a different story. The below chart (see chart 8) show a prolonged "sit and watch" period, during which the number of problematic P2P platforms increased. Cases of fraud, money laundering, fund pooling, and aggressive debt-collection methods came to the fore before regulations were introduced that have addressed such problems. These regulations have brought more order to this sector, and at the same time significantly impeded growth.
Chart 7
Regulatory decrees and dates: (1) Implementation Plan for the Special Rectification of Risks Concerning Online P2P Lending, April 3, 2016; (2) Interim Measures for the Administration of Business Activities of Online Lending Information Intermediary Institutions, Aug. 17, 2016; (3) the Guidelines For the Registration and Licensing of Online Lending Information Intermediary Institutions, Oct. 28, 2016; (4) Guidelines for Online Lending Fund Depository Business, Feb. 22, 2017; (5), Guidelines for the Disclosure of Information on the Business Activities of Online Lending Information Intermediary Institutions, Aug. 23, 2017; (6) Notice on Immediately Stopping The Set-Up Internet Micro Credit Companies, Nov. 21, 2017; (7), Notice on Regulation and Rectification of "Cash Loan" Businesses, Dec. 1, 2017. Sources: State Council, People's Bank of China, China Banking and Regulatory Commission, and other authorities.
We expect the "edges" will be increasingly trimmed as fintech companies have an increasing overlap with traditionally regulated areas. Some large tech giants already hold multiple regulated licenses, including bank licenses. At the same time, banks will become more tech savvy in order to meet the competitive challenges of big data and digital banking. In the fintech world, those that do not adapt fast enough to operate in a regulated environment will face a destabilized business position. Among banks, those that do not innovate fast enough will be marginalized, by either shrinking market share or decreasing profitability.
APPENDIX
Table 1
| China Has Granted Numerous Financial Licenses To The Internet Giants | |||||||
|---|---|---|---|---|---|---|---|
| Some of the major financial licenses held by top internet companies in China | |||||||
| Bank | Third-Party Payment | Internet Fund Distribution | Internet Microcredit | Mutual fund | Insurance | Insurance Brokerage | |
| Ant Financial | X | X | X | X | X | X | X |
| Tencent Inc. | X | X | X | X | X | X | |
| JD Finance | X | X | X | X | |||
| Du Xiaoman Financial | X | X | X | X | X | ||
Table 2
| Major Internet-Finance-Related Policy Circulars Over The Past Three Years | ||||||||
|---|---|---|---|---|---|---|---|---|
| Date | Regulators | Policy action/summary | Circular name* | |||||
| 7/18/2015 | PBOC, MIIT, MPS, MoF, SAIC, Legislative Affairs Office of the State Council, CBRC, CSRC, CIRC and CAC with approval from the CPC and State Council. | Promulgation of the guiding principles for internet finance regulation in China, regarded as the "Basic Law" in the field. This delineated and allocated regulatory responsibilities of different internet finance operations to respective regulatory entities. Payment should be overseen by PBOC; lending by CBRC (later CBRIC); crowdfunding for equity investment by CSRC; sales of fund products by CSRC; insurance by CIRC (later CBRIC); trust and consumer financing by CBRC. | Guiding Opinions on Promoting the Sound Development of Internet Finance | |||||
| 4/12/2016 | State Council with 17 other authorities | Issues an umbrella rectification plan based on the "Guiding Principles". Areas focused on include P2P lending and crowdfunding for equity investment; internet-based asset management; third-party payments; and advertisements for internet finance. | Implementation Plan for Special Rectification on Risks in Internet Finance | |||||
| 8/26/2016 | MIIT | Establishes the National Committee of Experts on Internet Financial Security Technology. Technological Platform for National Internet Financial Risk Analysis was first introduced to the public. The Platform monitors internet finance platforms for technological risks. | National Committee of Experts on the Internet Financial Security Technology | |||||
| 6/30/2017 | PBOC and 16 other authorities | Extends the special rectification (see above) on internet finance for one to two more years. | Notice on Further Effectively Conducting the Special Corrective Action, Review and Overhaul in Respect of Internet Financial Risks | |||||
| Payments | ||||||||
| Date | Regulators | Policy action/summary | Circular name* | |||||
| 12/28/2015 | PBOC | Classifies personal payment accounts as I, II and III. A category I account has the lowest payment cap, limited function and requires the least rigid identification process while category III, to the opposite, is a fully fledged account with strictest identification requirements. | Administrative Measures for the Online Payment Business of Non-Bank Payment Institutions | |||||
| 4/13/2016 | PBOC with 13 other authorities | Implementation of a detailed rectification plan on non-bank payment institutions based on the umbrella rectification plan issued by the State Council. Focuses on client deposit management and third party interbank clearing transparency. | Implementation Plan for Special Rectification on Risks in Internet Finance | |||||
| 1/13/2017 | PBOC | Requires that portions of the client deposit in third-party payment institutions need to be placed with the PBOC through custodian accounts in certain commerical banks. These accounts do not generate interest. The required percentages are: (1) internet payment business: 12%-20%; (2) bank card clearing: 10-18%; (3) prepaid gift card service: 16%-24%. | Notice on Matters concerning Implementing the Centralized Deposit of the Funds of Pending Payments of Clients of Payment Institutions | |||||
| 8/4/2017 | PBOC | Requires that internet settlements should start be cleared through NetsUnion Clearing Corp. (NetsUnion) from June 30, 2018. NetsUnion is a settlement agency for nonbank internet payments. PBOC and other government affliates together have a 37% share. Alipay and Tenpay have 9.61% shares respectively. UnionPay has 1.55%. Other nonbank payment agencies take the rest of the shares. | Notice on Switching Non-Bank Payment Institutions' Internet Payment Business from Direct Channel with the Banks to NetsUnion Channel | |||||
| 11/13/2017 | PBOC | Mandates investigation of licensed payment instututions on possible illegal transactions with non-licensed institutions. | Notice on Further Strengthening the Disciplinary Action against Unlicensed Transaction of Payment Business | |||||
| 12/31/2017 | PBOC | Increases client deposit reserve ratio by 10% every month from February to April 2018 to reach new requirements which are:(1) internet payment business: 42%-50%; (2) bank card clearing: 40%-48%; (3) prepaid gift card service: 46%-54%. | Notice on Adjusting the Centralized Deposit Percentage of the Funds of Pending Payments of Clients of Payment Institutions | |||||
| 6/29/2018 | PBOC | Increases client deposit reserve ratio by month from July 2018. Target is to achieve 100% client deposit reserve ratio by January 2019. The accounts should get settled through UnionPay or NetsUnion. | Notice on Centralized Reserve on All Funds of Pending Payments of Clients of Payment Institutions | |||||
| Micro Credit | ||||||||
| Date | Regulators | Policy action/summary | Circular name* | |||||
| 4/13/2016 | CBRC with 14 other authorities | Issue of detailed rectification plan on P2P lending based on the umbrella rectification plan issued by the State Council. Aimed at classifying exisiting P2P lending platforms as "compliant", "needs improvement", "blacklisted" according to rules previously set by the CBRC. | Implementation Plan for the Special Campaign against Peer-to-peer Lending Risks | |||||
| 8/17/2016 | CBRC, MIIT, MPS, CPC | Stresses internet lending platform's function as information media. Such lenders are not allowed to finance themselves using funds from clients; to guarantee investment gains; to promote its products in a brick-and-mortar style; to provide unauthorized loans; to distribute financial institutions' wealth management products; to conduct asset securitization activities; to operate crowdfunding for equity investments; or to serve borrowers with use of proceeds in high-risk investments. | Interim Measures for the Administration of Business Activities of Online Lending Information For Intermediary Institutions | |||||
| 10/28/2016 | CBRC, MIIT, SAIC | Set principles on the registration rules of online lending information for intermediary institutions and P2P companies. All details are set at the local CBRC and SAIC levels. | Guidelines for the Registration and Licensing of Online Lending Information For Intermediary Institutions | |||||
| 2/22/2017 | CBRC | Rules that internet lending platforms should set up one and only one custodian account in a commercial bank. Custodian banks do not provide any type of guarantee. Lending platform is prohibited from using the custodian bank in advertisements. | Notice of the General Office of the China Banking Regulatory Commission on Issuing the Guidelines for the Online Lending Fund Depository Business | |||||
| 8/23/2017 | CBRC | Intermediary institutions engaged in online lending are required to disclose publicly their registration information, ownership and organizational structure, staff information, branch information, official website and app, audited financial statements, compliance reports, detailed lending facilitation information (volume, value, pastdue volume and value, overdue 90 days volume and value, single name concentration, related party transaction, etc). They are also required to disclose detailed information on the projects to investors. | Guidelines for the Disclosure of Information On the Business Activities of Online Lending Information For Intermediary Institutions. | |||||
| 11/21/2017 | the Office of the Leading Group for the Special Campaign against Internet Financial Risks (PBOC and other 16 authorities) | Suspends issuance of all new internet micro-loan licenses. | Notice on Immediately Stopping to Set Up Internet Micro Credit Companies | |||||
| 12/1/2017 | The Office of the Leading Group for the Special Campaign against Internet Financial Risks (lead by PBOC )and the Office of the Leading Group for the Special Campaign against P2P Lending Risks (lead by CBRC). | This tightens regulations on micro-loans including on their funding sources, pricing caps, and maximum financial leverage. This includes online micro-loans, often for consumer purposes. | The Regulation and Rectification of the “Cash Loan” Business | |||||
| 5/27/2018 | CBRIC, Ministry of Education, Ministry of Human Resources | Decrees that internet micro-credit providers are not allowed to do business on campuses unless with regulatory approval. | Notice on Further Strenthening Campus Loan Regulation and Administration | |||||
| Others | ||||||||
| Date | Regulators | Policy action/summary | Circular name* | |||||
| 4/13/2016 | CSRC with 14 other authorities | Issues detailed rectification plan on crowdfunding for equity investments based on the umbrella rectification plan. Focuses on the following illegal practices: (1) de-facto public offering of stock; (2) offering privately raised funds to inapproriate audiences; (3) offering security underwriting, brokerage or advisory services; (4) misleading or fradulent advertisement; (5) misappropriation of AUM. | Implementation Plan for the Special Rectification of Risks in Equity Crowdfunding | |||||
| 4/13/2016 | PBOC with 17 other authorities | Issues detailed rectification plan on internet asset management based on the umbrella rectification plan. This focuses on investor qualifications and investor total-number cap for privately raised funds; unlicensed distribution of financial products; firewalls among business segments; AUM custody management. | Conducting Asset Management through the Internet and Engaging in Financial Business in a Crossover Manner | |||||
| 9/4/2017 | PBOC, CAC, MIIT, SAIC, CBRC, CSRC, CIRC | Puts an immediate stop to Initial Coin Offerings (ICO) and suspends all crytocurrency exchanges. Prohibits all financial institutions and nonbank payment institutions from being involved in any crytocurrency-related activities. Insurers are not allowed to provide insurance that covers crytocurrency-related activities. | Preventing the Financing Risks of Initial Coin Offerings | |||||
| 6/1/2018 | CSRC | Sets a same-day (t+0) redemption cap of single investor's single money-market fund through a single channel at RMB10,000. Settlement reserves are strictly prohibited to avoid misappropriation. No institutions other than banks with fund-distribution licenses can make advances to redemption claims. | Guiding Opinions on Further Rectifing Money Market Fund Internet Distribution, Redemption And Related Services | |||||
| *Please contact us if you wish to see circular names in Chinese. PBOC--People's Bank of China. MIIT--Ministry of Industry and Information Technology. MPS--Ministry of Public Security. MoF--Ministry of Finance. SAIC--State Administration for Industry and Commerce. CSRC--China Securities Regulatory Commision. CBRC--China Banking Regulatory Commission (old). CIRC--China Insurance Regulatory Comission (old). CBRIC--New combined Banking and Insurance Regulatory Commission. CAC--Cyperspace Administration of China. CPC--Chinese Communist Party. P2P--Peer to peer. AUM--Assets under management. | ||||||||
This report does not constitute a rating action.
| Primary Credit Analyst: | Harry Hu, CFA, Hong Kong (852) 2533-3571; harry.hu@spglobal.com |
| Secondary Contacts: | Ryan Tsang, CFA, Hong Kong (852) 2533-3532; ryan.tsang@spglobal.com |
| Xuwen Luo, Beijing (86) 10-6569-2732; xuwen.luo@spglobal.com |
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