beyond cash: china’s emerging payments market

Beyond Cash: CHINA’S EMERGING PAYMENTS MARKET

RESEARCH SUMMARYwritten in collaboration with The Economist Intelligence Unit

First Data Beyond Cash: China’s Emerging Payments Market 3

Foreword

With over one billion bank cards issued in China and banks and regulators encouraging an increased number of merchant acceptance points, the cards industry is growing exponentially and is gaining considerable attention.

As new local and foreign banks accelerate their plans for market entry, we wanted to gain some perspective and benchmark the opportunities and challenges incumbents and new entrants face as they offer new payment options to consumers in this rapidly growing economy. As a result, First Data International commissioned this report to highlight the views of foreign banks and retailers on the prospects for China’s cards and payments industry.

The vast majority of our survey respondents see opportunities for their business in China, naming credit cards as the primary segment for future revenue potential.

First Data truly agrees with this assessment. As early market entrants to China ourselves we introduced the concept of outsourcing into the Chinese payments industry where the service is being increasingly used both by newcomers and well-established issuers.

Like the multi-national banks already active in China, we also leveraged international best practices and payments processing expertise from other markets for the benefit of our Chinese customers. First Data offers a range of infrastructure, operations, licensing and outsourcing solutions from card issuing to merchant acquiring and ATM processing for organisations looking to develop their cards and payments business in China.

We are committed to the Chinese market and look forward to working with all stakeholders – regulators, banks, merchants, and cardholders – to ensure the ongoing successful development of the industry.

I hope this report will provide an interesting perspective on the views of foreign banks and merchants active in China at this critical time of development in the payments market.

Pam Patsley President First Data International

First Data Beyond Cash: China’s Emerging Payments Market 4First Data Beyond Cash: China’s Emerging Payments Market 4

Preface

First Data International commissioned the Economist Intelligence Unit to write Beyond Cash: China’s Emerging Payments Market, an in-depth review of the burgeoning payments market in China.

With the exception of the “First Data Insights” sections in the text and sidebars of the report, the views and opinions expressed herein are those of the Economist Intelligence Unit. The Economist Intelligence Unit executed the online survey, conducted the interviews and wrote the report. The findings and views expressed in this report do not necessarily reflect the views of the sponsor.

The research drew on two main initiatives:

– The Economist Intelligence Unit conducted a wide-ranging online survey of 152 senior bankers from around the world in March and April 2007. All respondents represent banks that either operate in the Chinese market already or plan to enter the market within the next three years.

– To supplement the survey results, the Economist Intelligence Unit also conducted in-depth interviews with 20 senior banking, retail and payment services executives from firms currently operating in China, or intending to enter the market within the next three years.

We would like to thank all the executives who participated in the survey and interviews for their time and insights.

› June 2007

Who Took Part In The SurveyA total of 152 banking executives worldwide took part in this survey, all from banks either in China or planning to enter the market by 2010. Around 34% of respondents were based in Asia-Pacific, 32% in Europe and 26% in North America, with the balance from the rest of the world. All respondents came from management positions, with C-level executives accounting for about 30% of the total and senior vice presidents, vice presidents, director, heads of business units or heads of departments accounting for a further one-third. In terms of size, firms were split roughly evenly between those with revenue either above or below US$1bn; nearly one-quarter had revenue of more than US$10bn. Retail bankers accounted for 38% of the sample.

First Data Beyond Cash: China’s Emerging Payments Market 4First Data Beyond Cash: China’s Emerging Payments Market 4 First Data Beyond Cash: China’s Emerging Payments Market 5

Table of Contents

06 Executive Summary – Sound practice: five tips for foreign banks entering the Chinese payments market

09 Introduction

09 The evolution of the Chinese payments market – China’s card market at a glance: Cards issued and transaction volume – Boom time in China: GDP growth from 2005 to 2010

11 Opening up the market – Entry strategies – Partnering for success

14 The potential opportunity – Holding an edge

16 Operating a cards business in China – Payment fees and incentive structures – Slim margins: China’s interchange rates set by PBC – Card processing – Merchant card acceptance and ATM use – Do you take cards? Card acceptance on the rise in China

20 Numerous challenges remain – Top challenges for payments – Risk management – Regulatory restrictions – Talent and IT – Savings culture

24 Bringing merchants on board – Merchant acquiring – Co-branded cards – The network experience

26 The outlook for the cards business in China – Short-term pain... – ...for long-term gain – The rise of e-commerce and alternative payment platforms

30 Conclusion – Regulatory recommendations – China Merchants Bank: a model for the future?

32 Appendix – The first wave? Foreign investment in mainland Chinese banks – Making the leap. Foreign banks with announced intentions to enter China’s retail banking sector

Executive Summary

As China’s economy continues its robust expansion, and as its banking sector finally opens up to foreign competition, the demand for credit is taking off. Local banks have ramped up their operations for the last three or four years in preparation for increased competition from foreign rivals. As their efforts bear fruit, the potential for China’s payment cards market has never looked better.

Nowhere is this more so than in China’s emerging market for debit and credit cards. With more than 200m new cards issued last year alone, China’s total number of plastic cards broke though the one billion mark in 2006, with no sign of the pace abating. While a relatively tiny portion of this total—some 50 million—are currently credit cards, growth rates for the sector (both in terms of spending and transaction volumes) are now much higher than for the mass-market debit cards that form the bulk of cards in circulation. No surprise, then, that foreign banks are now eyeing this space for opportunity.

The main findings of our research are as follows:

– Retail banks are very bullish on consumer banking in general—and credit cards in particular... For many of the retail banks surveyed for this report, credit cards are the main priority. When asked what products they believe hold the greatest prospects for China’s personal banking industry, retail bankers were most optimistic about credit cards and bank accounts. Fifty-five percent of study respondents believe the prospects for these consumer banking products are ‘highly promising’ over the next three years. Debit cards are seen as the next most promising item (45%), although these are directly linked to the prospects for basic bank accounts, followed by wealth and investment management (40%). In fact, respondents report overwhelmingly positive views for all aspects of the consumer banking sector.

– ...But the outlook for profits is less certain. When it comes to profits in the credit card market, our survey respondents are less confident. Forty-three percent agree that it would be difficult to make a profit in the credit card market over the next three years, compared with 36% who remain uncertain and just 21% who believe it is possible. The key issue is tough competition for customers between local banks growing their market share and foreign rivals trying to establish a beachhead in China. This competition inevitably leads to lower card fees, which keeps earnings low (or negative). In addition, banks are grappling with low rates of revolving credit on cards, resulting from a cultural aversion to accruing debt, together with low fees and interest rates that issuers are allowed to levy on merchants and card users.

– Infrastructure is key to growth in the cards market. According to the executives surveyed for this report, improving infrastructure – encompassing both merchants and ATMs—will play the biggest role in encouraging the increased acceptance of card payments in China. Fully 83% of retail bankers polled chose this as an essential requirement. This component scores far ahead of any other criteria, for example better collaboration between key stakeholders such as banks and payment processors (48%) or publicity campaigns (33%). When asked what the Chinese market needs to support a payments infrastructure, half of the survey respondents selected better availability of consumer credit-history data.


– Merchant acquisition is a major hurdle. Convincing merchants to accept credit cards is a major challenge for banks. Eight out of ten retail bankers polled for this report say that local retailers’ preference for cash is either a ‘very significant’ or ‘significant’ barrier in operating cards and payment services. In part, this is because retailers don’t yet feel much pressure from customers to provide payment card facilities in a society where cash is traditionally preferred.

– Despite an opening financial market, much risk remains. More than half (53%) of bankers polled for this report selected political risk, relating to policy and regulation, as the biggest existing or potential risk associated with their firm’s operations in China. Retail bankers in particular listed licensing risk (chosen by 43%) as a major concern, second only to political risk, highlighting the difficulties associated with getting permission to expand into new regions or markets. Along with this, 41% of the respondents expressed a general concern about the outlook for China’s banking industry.

Much work needs to be done to promote a plastic card payment culture in China. More than anything else, a more extensive card network and infrastructure must be rolled out to promote consumer usage. Along with this, databases of consumers’ credit and transaction histories require expansion. In addition, Chinese consumers must be encouraged to make the switch from cash-based transactions to plastic cards.

Despite these challenges, growth is already strong. And in cities such as Beijing, efforts to prepare for the 2008 Summer Olympic Games will help create an environment that supports card payments. Although foreign banks entering the market will have their work cut out, the opportunity is simply too big to ignore.

Sound practice: five tips for foreign banks entering the Chinese payments market

1. Don’t arrive expecting fast profits. The opportunity is huge but the China market is a marathon, not a sprint.

2. Choose your partners carefully. All domestic banks are not created equal. Find one that has strategic goals similar to your own and be wary of those looking only to extract your expertise for their own purposes.

3. Bring skills with you. The shortage of local talent means that foreign banks must bring in skilled personnel from abroad to supervise important operational functions. Also aim for high rates of local staff retention, both by offering competitive salary packages and structuring employment contracts to discourage defections once employees have been trained.

4. Maximise use of the Internet and other technology. This will help to compensate for lack of physical branch networks and provide a higher standard of customer service than that offered by local rivals.

5. Be focused in choosing your market. Rather than selling to a mass audience, creatively explore alternative marketing channels. Target market niches and seek co-branding partnerships with local companies offering client bases with attractive demographics.

First Data Beyond Cash: China’s Emerging Payments Market 06 First Data Beyond Cash: China’s Emerging Payments Market 07


Recommendations for Foreign Banks�– Respect the culture – China is a very specific market with characteristics unlike most other countries

�– Leverage best practice from your bank’s operations in other countries (e.g. marketing, risk, IT)

�– Build in reasonable timelines for a return on investment

�– Build and develop a dialogue with regulators and keep them updated on your progress

�– Focus on customer service – it is still a major advantage for foreigners over local banks

�– Leverage banks’ focus on wealth management to deliver high-end card products. High net worth customers are also a major source of fee income even if they don’t revolve their card balances

�– Be prepared for competition – Chinese banks are learning very quickly.

Recommendations for Local Banks�– Consider remote distribution channels, not just branches

�– Differentiate your product offering

�– Use your branch network to exploit market opportunities outside the four main cities

�– Centralise your IT infrastructure and mine your databases

�– Improve customer service

�– Ensure your technology is easy to use for customers with limited technological skills.

Recommendations for Both Types of Banks�– Change the cultural perception on revolving credit

�– Leverage alternative distribution channels

�– Cross-sell – credit cards are a very useful product to use as a base for cross-selling or to sell to existing customers

�– There are a limited number of skilled people with payments industry experience – recruit talent, and retain them

�– Build risk capabilities

�– Build a card acceptance network – fast

�– Look at opportunities to sell card products to companies – commercial cards help companies manage cash flow, are a short-term source of funding, offer management information on employee expenses and help to manage suppliers better

�– Learn from the credit crises that have hit many emerging markets – ensure you have good risk management practices before you start lending to consumers

�– Be prepared to work with regulators pro-actively to help stimulate the market for all players.

First Data’s Recommendations

First Data International Insights

The size and rapid growth of China’s economy has led many foreign banks to enter the market in the last five years. As shown by the result of this survey, two of the most profitable business segments - retail banking and credit cards – rank at the top of the banks’ agenda.

Banks surveyed view their investment as a long-term play. This is a wise strategy in a market that is still in the early stages of development. However, both local and foreign banks are conscious that this is an opportunity too big to pass up..

There are now over 1 billion payment cards in issue across the country. Although only 50 million of these cards are full revolving credit cards, it is not surprising that many of the bankers surveyed see credit cards as one of the most promising products in Chinese retail financial services.

Experience from other emerging markets in Asia, Central and Eastern Europe and Latin America has shown that the credit cards offer huge revenue potential from both interest and fee income. In addition, banks can cross-sell other banking products to credit cardholders, something that few banks in China are doing now.

For foreign banks focusing on the Chinese market, credit cards are an excellent entry product. As standalone products they do not need to offer an account package or a local branch network to market to or serve cardholders. While most foreign banks are currently issuing cards in partnership with local banks, this may change as they become more established in the market.

While Chinese banks face challenges in getting customers to activate and use their cards frequently, the growing card acceptance infrastructure will make this task easier. Banks surveyed rightly highlighted this as a major issue. However, it is a challenge common to many other emerging payments markets. Interestingly, progress in the country’s main cities has been very rapid. Some 30% of all payment transactions in big cities are now carried out by cards.

From First Data’s experience of operating in China, one of the biggest challenges faced by banks is risk management. This is also a major finding of the survey. The introduction of data analytics solutions to help reduce card application fraud will provide tremendous benefit to the industry. Banks also need to monitor transaction information and develop strong collections capabilities. Knowledge sharing in this area has been a big part of the co-operation between Chinese banks and their foreign partners. This will certainly pay dividends in reduced credit losses and better fraud prevention as the industry develops and transaction volumes increase.

The report rightly points out the key role of merchants in developing China’s cards industry. As in many emerging markets, cash is still preferred and the favoured means of payment for many retailers and other merchants. Experience in other countries has shown that the industry needs to engage with the merchant community to clearly educate and communicate the benefits of accepting cards. These include higher transaction volumes, reduced cash handling costs and less risk of theft.

As the survey shows, payment cards have a major role to play in the profitability of the Chinese banking industry and its on going development. The foundations for a profitable cards industry have been successfully implemented. By focusing on resolving the highlighted challenges such as expanding the card acceptance and improving the banks’ risk management and marketing effectiveness the industry will be well set for further growth.

Introduction

Five years after joining the World Trade Organisation (WTO), China introduced regulations to open its retail banking market in December 2006, taking a major step towards the liberalisation of its financial services sector. Although some restrictions remain, the change in the rules finally permits foreign banks to provide renminbi-denominated accounts to the market.

Many of the banks entering the market are looking at the potential of the burgeoning credit card market. Of the 152 banks surveyed for this report, about eight out of ten rate the prospects for credit cards as either ‘highly’ or ‘somewhat’ promising. As might be expected, most foreign banks are targeting their activities at China’s wealthier customers.

“We think there is a big opportunity [for credit cards] because of the low penetration so far,” says Manuel Galatas, head of Asia at a Spanish bank, Banco Bilbao Vizcaya Argentaria (BBVA), which acquired a stake in CITIC Bank last November. “The Chinese have on average less than one bank card per person, compared with 1.9 in Hong Kong and 3.87 in the US.” Mr Galatas adds that credit card payments account for just 1% of total consumer spending, compared with about 20% in the US.

Foreign banks are not alone in targeting the market. Domestic banks also see great opportunity, albeit often in partnership with foreign banks. “I believe the credit card business is most promising and will create more profits,” says Hong Lin, a deputy general manager at the Bank of China, which has several overseas stakeholders.

But it is still early days. Much work remains to be done, not least in terms of convincing China’s swelling population of affluent but fiscally conservative consumers of the merits of switching paper for plastic.

The Evolution Of The Chinese Payments Market

When the Bank of China issued the mainland’s first credit card in 1986, the event passed with little fanfare. Just 36 venues scattered around Beijing accepted the card, and payments could be made only by way of China’s old Foreign Exchange Certificates, an abandoned form of convertible currency that Chinese citizens could not legally possess.

How times have changed. By the end of 2006, some 50m credit cards had been issued in China, including 30m dual-currency cards, and a further 19m ‘quasi-cards’ that combine the functions of debit and credit cards (see table: China’s card market at a glance). Indeed, the number of credit cards in circulation at the end of 2006 represents a 39% year-on-year increase. However, these figures are dwarfed by the scale of China’s debit card market, which accounts for the majority of cards in circulation.



China’s card market at a glanceCards issued and transaction volume

Cards issued, Cards issued, RMB purchasing 2006 (m) total (m) volume transacted, 2006 (trn)

Credit cards 30 –

Quasi-credit cards (combined credit and debit cards) 19 –

Debit cards 200 1119 –

Total 215.6 1175 1.89

Source: China UnionPay, Xinhua.

The surge in credit card issuance illustrates the buzz across China’s consumer lending market. In recent years, activity across the sector, including auto and mortgage lending, has grown substantially, from just 6% of total bank lending in 2000 to 11% in 2005 , as China’s emerging middle class begins to demand better banking services. This comes on the back of impressive economic growth, which is expected to continue. GDP per capita, for example, is predicted to more than double from US$1,740 in 2006 to US$3,790 in 2010 (see table: Boom time in China).

Boom time in ChinaGDP growth from 2005 to 2010

2005 2006 (a) 2007 (a) 2008 (a) 2009 (a) 2010 (a)

GDP (US$ bn, at current market prices) 2,278 2,689 3,209 3,794 4,390 5,089

Real GDP growth (%) 10.4 10.7 10.2 9.3 8.6 8.1

Population (m) 1,307 1,314 1,323 1,331 1,336 1,342

GDP per capita (US$ at market exchange rate) 1,740 2,050 2,430 2,850 3,280 3,790

(a) Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

With strong prospects for growth and a population of more than 1 billion, China’s consumer banking sector has unsurprisingly drawn the attention of foreign banks. They are attracted not only by China’s vast domestic market, but also (and in contrast to other domestic consumer sectors) by the fact that the retail banking sector has been underserved for so long. For example, even though banks in China issued more credit cards in 2006 than existed in the whole country as recently as 2004, the total number of credit cards in circulation, at about 50 million, at end-2006 pales in comparison to the 640 million credit cards currently circulating in the US. If banking services in China are eventually to emulate the structure now seen in the West, where most bank profits come from consumer lending, the current market can be seen as a near-vacuum waiting to be filled—one of the last great land grabs in the Chinese economy.

John Shelley, the executive vice president who directs the Royal Bank of Scotland’s recently-established private-banking partnership with the Bank of China, comments: “This is not a short-term game, but it’s tremendously exciting, a huge opportunity for the banks that can focus and go about it in an organised way.” One report projects that China’s domestic credit market will grow from just US$2.8trn in 2004 to US$45trn by 2050.

15.6

0 10 20 30 40 50 60 70 80 90 100

Access to a larger customer base

Rapid growth of the Chinese middle class

Our regional clients expect us to have a presence in China

Lending potential to Chinese companies

Lending potential to foreign companies in China

Lending potential in consumer-credit markets

Distribution capabilities of large local banks

Taking advantage of the historic WTO-related market opening

Lending potential in mortgage markets

Other

67.2%

55.2%

25.9%

24.1%

24.1%

24.1%

12.1%

8.6%

6.9%

1.7%


Of the banks surveyed for this report, the majority (57%) are already active in China, while a further 43% plan to enter between now and 2010. For these banks in general, access to a larger customer base and the rapid growth of the middle class are China’s key attractions. For retail banks in particular, lending potential in the consumer-credit market is high on the list (24%), on a par with opportunities to lend to either Chinese companies or foreign companies in China—and far ahead of the mortgage market, selected by just 7%. A significant minority (12%) also see the distribution capabilities of large local banks as a key attraction.

Major attractions to marketWhat were/are the major attractions for your firm in deciding to invest in China?Retail bankers only

Opening Up The Market

New rules introduced in December 2006 under the terms of China’s 2001 accession to the WTO now allow foreign banks to incorporate locally and to create retail businesses. Indeed, if foreign banks want to enter the credit card market they must incorporate locally.

As this report was being written, an initial group of four banks had already received approval to incorporate locally, and a further eight were still completing official paperwork. Several more had plans to incorporate in the near future (see Appendix for a full list). Although this first wave of entrants must still wait for final amendments to domestic regulations, and final approvals to allow them to operate branch systems, foreign banks can now effectively compete on an equal basis with local banks.

First Data Insights

It’s A Long-term Play

84% Percent of respondents are optimistic about the prospects for credit cards in China

Foreign banks give long-term prospects of the credit card industry in China a strong vote of confidence, but recognise that it is a long term play. Right now, credit cards are a marginally profitable business for most issuers, with the programmes of some new entrants still loss-making.

At present, the Chinese cards market depends heavily on fee income while interchange rates have already fallen to levels more common in highly developed credit card markets. However, the mix of profitability in the Chinese cards industry may well change in the future. This would happen if the Chinese government decided to relax its interest rate policy, allowing issuers much more leeway on the interest rate they charge for credit card lending.

The industry’s big problem is that so few cardholders currently revolve their balances. This leaves the credit card industry in China without one of its major sources of revenue and profits. The challenge for issuers in China is to develop pricing and marketing strategies that can sustain profitability over the long term.

Banks in China need to realise that interest income is not the only revenue they should be looking for. Fee income is also important. Payment products offering valuable sources of fee income include:

– Prepaid cards (e.g. top-up fees, balance checks)

– Commercial cards – as well as helping companies manage cash flow and expenses more effectively, commercial cards generate substantial fee income for issuers

– Charge cards (e.g. issuing fees, late payment fees, etc)

– Money transfers – these account for up to 40% of fee income at some Central and East European banks

– Foreign exchange fees.

Partnership with a national bank

Partnership with a city commercial bank

Joint venture with a national bank

Strategic equity stake in a Chinese institution

Joint venture with a city commercial bank

Wholly-owned branch network

Other

22.2%

20.6%

19.0%

15.9%

11.1%

9.5%

1.6%

0 10 20 30 40 50 60 70 80 90 100


Entry Strategies

Banks that have already entered the market have clearly defined strategies. In general, most respondents to this survey either opted to take a strategic equity stake in a Chinese institution or engage in a partnership with a national bank. Interestingly, for those banks already established in the Chinese market, the highest majority (26%) believe an equity stake in a local bank presented the best way to enter the market. However, for those banks still planning to enter, the majority believe that a partnership, either with a national bank (22%) or a city commercial bank (21%), offers the most feasible route for entry. The bigger foreign banks such as HSBC and Citigroup are adopting strategies that combine strategic equity stakes with organic growth.

Overall, just one in ten banks plan to go it alone, primarily because the scale of the Chinese market makes it unfeasible for all but the largest banks. “You cannot really work in China without a partner,” says BBVA’s Mr Galatas. “For global banks that have been in China for years it is possible. For the rest of us, we can do it by ourselves, but it is a very, very long-term strategy.”

Market entry strategyIn light of recent market-opening measures, what entry strategy would you consider to be the most feasible for a foreign bank or cards issuer?

Local-foreign bank alliances have been in place since 2001, when HSBC made the first such investment in the Bank of Shanghai. The increase in the number of alliances is more recent, however. In 2003, Citigroup purchased 4.6% of the Shanghai Pudong Development Bank, which was followed by HSBC’s 19.9% stake in Shanghai-based Bank of Communications (BoComm) the following year. Both investments were made with the specific goal of kick-starting co-branded credit card units in an environment where neither Chinese partner had significant card businesses before the alliances were formed. The Citigroup unit launched in early 2004 and has since expanded to ten cities. The HSBC/BoComm credit card centre began operating in late 2004, and by March this year had issued more than 2m dual-currency credit cards. Both operations have placed emphasis on developing sophisticated online banking capabilities, partly as a result of building their infrastructure from the ground up and partly to create distribution channels to compensate for their lack of extensive branch networks.

Partnering for success

Equity tie-ups allow banks entering the market to generate instant economies of scale by leveraging their partners’ existing distribution channels, client bases, and local business and political contacts. According to a director at a French bank currently looking for an investment partner, “China is huge and we are a modest European bank. No modest European bank has ever managed organic-only growth in China. You need to know the language, people and clients very well.”

Branch Networks

Direct Selling

Telemarketing

Postal Campaigns

E-mail Campaigns

Internet

Highly Effective Limited Effectiveness

Moderately Effective Don’t Know

0 10 20 30 40 50 60 70 80 90 100

35% 52% 6% 7%

25% 49% 17% 9%

11% 24% 55% 10%

12% 27% 48% 13%

11% 29% 50% 10%

12% 41% 36% 11%


Survey respondents also acknowledge the importance of branch networks when it comes to marketing and distributing payment cards. Nine out of ten retail bankers polled for the report rated branch networks as either ‘highly’ or ‘moderately’ effective, with direct selling the only other channel that was positively rated, by 80% of respondents. Alternative channels, including the Internet, e-mail, postal campaigns and telemarketing, were rated as effective by less than half of bankers.

Marketing/distribution channelsHow effective do you consider the following marketing and distribution channels for payment cards in China to be?

The benefits of partnerships for local banks are equally clear—the chance to learn the ropes from experienced counterparts in areas where they are weakest, such as credit and risk management, development of IT systems, and cross-selling and other marketing strategies. One senior executive at China Construction Bank explained that his bank’s alliance with Bank of America has helped to develop their expertise: “[Their] credit card management techniques and expertise helped us enhance our own credit risk control capabilities.”

Needless to say, partnering with local firms is not without its challenges—and risks. One concern is simply the number of available partners, which is steadily declining as more foreign banks enter the market. Another is that deals can take a long time to conclude. According to Gerard Van Empel, director of development at Holland’s Rabobank, which finalised a 10% investment in Hangzhou Rural Cooperative Bank last November, the deal took several years to complete. Others warn about having to deal with much bureaucracy, especially within larger banks.

But those banks that have concluded successful deals with local Chinese banks have been encouraged by progress so far. “There’s a real desire and willingness to take on new ideas,” comments RBS’s Mr Shelley. “We have long debates about individual points, and reaching a decision on something sometimes takes a long time, but once a decision is made I’ve been very impressed with the speed with which they execute.”

To Partner Or Not To Partner

Although a very attractive market for foreign banks, there is no clearly favoured market entry strategy.

The message is clear – most respondents say that the main attraction of the Chinese market for them is access to the country’s huge customer base. Far less obvious from the survey is a clear preference among foreign banks for a specific route to market entry.

Almost all first and second-tier banks are now in strategic alliances with foreign partners. Credit cards are often the first product on which both partners work together, but an increasing number of foreign banks are now preparing to launch their own credit cards in China.

There are three ways that banks usually enter the China market: (1) direct investment in a bank; (2) partnership with a bank; (3) being a wholly owned foreign entity (WOFE) that conducts business by themselves. As “all roads lead to Rome”, all three ways can provide a bank a start to its business in China. Both central and local governments are very supportive of both partnerships and of WOFEs establishing operations in China.

Our experience of entering into the China market is initially-go-alone. First Data has had success in bringing international expertise into the China payment market. After five years of being in the market, we are also looking into establishing partnerships in different areas of electronic payments business.

First Data Insights

Revenue Growth

Profit Growth

0 10 20 30 40 50 60 70 80 90 100

2% 2% 1%

4% 2% 1%

Highly Optimistic Neutral Highly PessimisticSomewhat Optimistic Somewhat Pessimistic Not Applicable

29% 59% 8%

29% 46% 27%


The Potential Opportunity

For those banks that have made the decision to enter the Chinese market, there is much optimism. Nearly nine out of ten banks (87%) polled for this report say they are optimistic about their firm’s revenue growth in China between now and 2010. But this optimism is tempered with realism, with about twice as many (59%) respondents saying they are ‘somewhat’ optimistic, rather than ‘highly’ optimistic (29%).

Profit/revenue prospects How optimistic are you about your firm’s revenue and profit growth prospects in China over the next three years?

This uncertainty is especially true when it comes to generating profits. Although two-thirds of bankers say they are optimistic about their profit growth prospects in China over the next three years, just 21% say they are ‘highly’ optimistic and nearly half (46%) say they are ‘somewhat’ optimistic.

The main reason is competition. China’s banks have made remarkable operational advances in the five years they have had to prepare for market opening, and they retain one major advantage: a huge branch network that dwarfs that of the foreign banks. Indeed, the first four foreign banks to obtain licences now have just over 100 branches between them. By contrast, the Industrial and Commercial Bank of China (ICBC) has 18,000 branches, the Bank of China (BOC) has 11,000, and the Agricultural Bank of China (ABC) has nearly 25,000. All of China’s ‘big four’ banks (ICBC, BOC, ABC and China Construction Bank) now have foreign stakeholders, which will gain access to this branch network. The banks’ grassroots reach, together with the depth of their existing client bases, virtually guarantees that local players will remain in the driving seat for the foreseeable future.

For many foreign banks, credit cards are the main priority, providing a self-contained business line that allows them to build brand, gain experience and establish a beachhead to the high-medium end of the market. Retail bankers are most optimistic about both credit cards and bank accounts, with 55% saying that the prospects for these products are ‘highly promising’ over the next three years. Debit cards are seen as the next most promising item (45%), although these are directly linked to the prospects for basic bank accounts, followed by wealth and investment management (40%). Indeed, there are overwhelmingly positive views of the prospects of every field across the consumer banking sector.

Bank accounts

Debit cards

Credit cards

Co-branded cards

Prepaid cards

Mortgages

Personal loans

Financial planning/wealth management

Personal investment services

Vehicle financing

Highly Promising Limited Prospects

Somewhat Optimistic Don’t Know

0 10 20 30 40 50 60 70 80 90 100

Risk management

Product development

Distribution

Marketing

Customer relationship management

Ability to derive income from service fees

Ability to derive income from penalty charged

0 25 50 75 100

Very Good Fair Very Poor

Good Poor Don’t Know

55% 28% 7% 10%

45% 43% 5% 7%

55% 29% 9% 7%

30% 37% 18% 16%

26% 37% 25% 11%

26% 49% 18% 8%

33% 55% 7% 5%

40% 26% 25% 9%

40% 35% 16% 9%

26% 47% 19% 9%

14% 40% 29% 10% 7%

3% 16% 36% 33% 3% 9%

12% 21% 45% 14% 9%

3% 19% 41% 26% 10%

7% 14% 41% 31% 12%

14% 45% 21% 2% 19%

7% 9% 31% 31% 3% 24%


Prospects for products How do you view the prospects for China’s personal banking industry?Retail bankers only

Nevertheless, when it comes to profits in the credit card market, the outlook is less certain. Fully 43% of respondents agree that it would be difficult to make a profit in the credit card market over the next three years; 36% remain uncertain and just 21% disagree.

Holding an edge

Foreign banks believe they hold a significant competitive edge over their local rivals. This is especially true when it comes to risk management and product development, where 39% and 36% of retail bankers respectively rate the capabilities of domestic Chinese banks as ‘poor’ or ‘very poor’. On most measures, the majority of survey respondents rate local banks as ‘fair’. However, when it comes to distribution, one-third of retail bankers rate their local rivals as ‘good’ or ‘very good’, higher than any other capability, given the substantial advantage of domestic Chinese banks in this area.

Rate local banks In your view, how good are the current capabilities of domestic banks in China, with regards to the following aspects of consumer lending?Retail bankers only

Finding Ways to Reach Out

Branch networks are effective distribution channels for payment cards – the internet and direct selling are also well regarded

The opportunity to market and distribute payment cards to 1.3 billion consumers expected to have per capita income of $5,000 in the next 10 years is a major attraction for local and foreign banks.

Reaching many of these potential customers will be a challenge. Given the huge branch networks of China’s largest banks, it is not surprising that 87% of survey respondents see branches as either highly or moderately effective distribution channels.

However, this advantage could be leveraged far more effectively. Up to now most bank branches have been run as autonomous units or even separate businesses. Centralising and analysing the data in each branch could provide a ready-made credit card target segment for institutions of all sizes. This would enable banks to segment their customer base, develop product propositions and cross-sell card products to existing retail banking customers.

Branches are not the only distribution channel for card products. China has the second largest number of Internet users in the world.

Offering financial services by mobile phone is another viable option, which would enable banks to get around the absence of – and the cost of building - nationwide branch networks. This would be especially valuable in provincial areas, where mobile phones are widely used.

Also, interesting distribution partnership models are developing in other markets that may be relevant to China. Some banks are now partnering to share expertise. For example, one bank could manufacture a card product for distribution by a partner organisation. This happenes in Europe where Barclaycard manufactures revolving credit card products for distribution through Swedbank branches in the Nordic countries. As the trend for banks to do everything from manufacturing, distribution and processing themselves becomes less prevalent, this model will gain ground and could be of major interest to foreign banks looking to partner with local Chinese banks.

(continued on next page)

First Data Insights

0 10 20 30 40 50 60 70 80 90 100

Bank accounts

Debit cards

Credit cards

Co-branded cards

Prepaid cards

Mortgages

Personal loans

Financial planning/Wealth management

Personal investments services

Vehicle financing

Credit/debit card merchant acquiring

Already offering

Plan to start offering within 3 years

No immediate plans to offer

36% 45% 19%

25% 48% 27%

20% 48% 32%

9% 41% 50%

6% 42% 53%

19% 40% 40%

24% 46% 31%

15% 46% 40%

18% 44% 38%

11% 37% 53%

11% 44% 46%


Operating A Cards Business In China

Eight out of ten retail banks surveyed for this report either already offer basic bank accounts or plan to start doing so within the next three years. Beyond that, about three out of five either offer or plan to offer debit cards, with about two-thirds either already offering or planning to offer personal loans and credit cards. These account for the dominant products being offered by retail banks, with mortgages, wealth management services and other retail banking services all trailing behind.

Dominant product offeringsWhich of the following is your firm offering in China, or planning to start offering within the next three years? Retail bankers only

All banks entering the cards business will need to deal with one key player: China UnionPay, or CUP, the Chinese equivalent of Visa or MasterCard. Any renminbi-denominated card issued in China, whether a debit or credit card, carries the CUP brand. Since its inception in 2002, CUP also operates the key payments network in China, providing an inter-bank and inter-country card network, which enables interoperability between different banks and cards. In this aspect of its business, however, there is no competition in China, as CUP currently operates as a monopoly. “There is only one network, period,” explains an executive from an international card issuing company.

First Data Insights

It should be noted that Chinese banks have not used direct mail to market cards. However, several issuers have started to use lists bought from list brokers. Also, Chinese banks are using specialist service providers who do card acquisition to recruit new customers.

Finally, other possible distribution channels include non-bank partners, such as retailers and mobile phone providers. This would enable banks to reach a much wider customer base.


ATMs were introduced in China 20 years ago, but they only became truly convenient in 2002 when CUP was set up and established a network that linked them all together. The CUP network facilitates any inter-bank card transaction made through an ATM or within a retail outlet. The only exception is for travellers in China carrying a card issued outside of China, which is then processed through the relevant card company’s international network.

Rival international card brands, such as Visa and MasterCard, can only issue cards in China (via their member banks) that are denominated in another currency, such as the dollar, euro or yen. Alternatively, their member banks can issue a single card that is dual-currency, including both a renminbi-denominated account and a foreign-currency-denominated account, in conjunction with CUP, so that the card bears both brands. All this makes CUP the dominant player in the overall Chinese card market. In 2006, its member banks issued 144m new bank cards, accounting for about 68% of the total for the year. In credit cards, however, Visa and MasterCard are leaders, in terms of the number of cards issued, although CUP is working to catch up. By the end of 2006, there were some 3m “UnionPay” credit cards, a ten-fold increase on the previous year.

The implication for banks setting up in China and wanting to issue renminbi-denominated cards is that they can only issue CUP-branded cards, unless they wish to provide foreign-currency-based cards. In addition, all transactions conducted with any renminbi-based card, whether CUP-branded or dual-branded, will be conducted through CUP’s network.

For its part, CUP is working to expand acceptance of its cards in the international market. By the end of 2006, it had concluded deals in 24 countries, providing acceptance for Chinese tourists or business travellers carrying a CUP card within some 55,000 merchants and more than 235,000 ATMs. As might be expected, transactions from CUP-branded cards have soared: in 2006, some Rmb25.5bn (US$3.3bn) was transacted on these cards in markets outside of China, a 99% increase on 2005, according to CUP.

Payment fees and incentive structures

One of the realities for banks issuing cards in China is the low fees that are set by the central bank, the People’s Bank of China (PBC). The maximum interest rate for card borrowing is set at a relatively modest 18.25% annually. By comparison, international practice commonly charges several hundred basis points more for less-creditworthy customers or different types of loans such as cash advances.

Government rules also stipulate what merchant acquirers can charge merchants. In most countries, the biggest component of this fee (known as the interchange rate and paid by the merchant acquirers to the card issuers) is dictated by market forces. In China, however, maximum interchange rates for all local-currency transactions are set by the PBC. While these rates vary slightly depending on what type of product or service is being purchased (see table: Slim margins), they generate inefficiencies, according to an executive with a major foreign card company, because they do not reflect the actual cost to the issuer. For example, merchants are charged the same rate for debit card and credit card purchases, despite the fact that respective transaction costs differ. Nor do Chinese interchange rates reflect varying risks that different types of transactions may represent.


Slim marginsChina’s interchange rates set by PBC

Merchant type Issuer interchange China UnionPay reimbursement fee service fee

Public hospital and public school 0 0

Supermarket, airline, tour operator, gas station 0.35% 0.05%

Other retailers (department stores, etc) 0.70% 0.10%

Hotel, restaurant, entertainment, jewellery 1.40% 0.20%

Wholesale Maximum Rmb16 Maximum Rmb2

Source: PBC.

Chinese interchange rates are not only already lower than international norms (which are currently about 0.7–0.8% per transaction, compared with an international average of 1-1.6%), but competition between local banks is increasing the pressure to reduce these rates further.

Banks setting up a cards business in China will also struggle to attract customers. Strong competition in the market means that few banks can charge cardholders annual fees. Indeed, most have taken to offering special promotions to draw new customers. Some banks use this to try to boost card usage, by offering to waive card fees as long as customers use their cards a certain number of times per year.

In other examples of margin-cutting incentives, Standard Chartered, offers gold bowls to customers opening fixed deposit accounts with at least Rmb80,000 (about US$10,000). Meanwhile, London-based HSBC and its Chinese partner, BoComm, launched a campaign in 2006 offering credit card clients interest-free installment payments on purchases of Rmb1,500 or more (US$195). Customers pay a monthly service charge of up to 0.72%, but are exempted from the annual 18.25% interest charge as long as they pay their monthly installments. Such price wars are widespread in Chinese consumer markets and commonly lead to long periods of losses for participants. “Chinese customers in general are savvy and are looking for interest-free, fee-free debt, and less for revolving debt,” explains one executive at a major European bank.

Another group of customers that requires incentives (typically through discounted rates) is the retail community. Three out of four retail bankers surveyed for this report agree that card issuers will have to offer strong incentives to merchants to encourage the adoption of payment cards within their businesses.

Card processing

A key barrier to growth in the market selected by bankers was China’s underdeveloped or immature back-end banking infrastructure, such as payment processing. In taking this on, many executives try to meet the challenge by handling the job in-house. Just 5% of retail banks polled say they have outsourced their card processing in China so far, although a further 17% expect to do so. Nearly one-third say they will not outsource, and about the same proportion do not know.

For some, card processing is a core capability: “We think that card processing is an area where we have strategic expertise,” says one survey respondent. But for others where this isn’t the case, the outsourcing of card processing makes sense. As another respondent points out, “The initial set up cost [for outsourcing] is high without a medium-sized customer base.”

0 10 20 30 40 50 60 70 80 90 100

Very significant

Significant

Not significant

Don’t know

22%

59%

7%

12%


This view was reflected by other executives interviewed for the report. “We are developing our own credit card offering at the moment,” says Yaming Zhu, head of the consumer clients division at ABN Amro Van Gogh Preferred Banking in China. “We are likely to partner with one of the major credit card companies. We are innovative, but we are not interested in reinventing the wheel.”

Merchant card acceptance and ATM use

When compared with international markets, relatively few merchants in China currently accept cards for payment although, the growth rate is strong. By the end of 2006, the number of merchants accepting bank cards in China had increased by 34% from 2005, to more than half a million (see table: Do you take cards?), according to CUP. During the same period, the volume of cross-bank point of sale (POS) transactions increased by some 57%. This increase in acceptance is surely helped by the increased competition between merchant acquirers, which has driven down transaction fees.

Nevertheless, the number of merchants accepting cards accounts for only about 4% of the total, according to bank executives interviewed for this report. To some extent, this reflects already razor-thin retail margins, meaning many merchants are reluctant to cut profits by giving a slice to card issuers. More fundamentally, however, slow uptake is simply a reflection of the novelty of credit card payments in a culture where cash is traditionally king. Indeed, eight out of ten retail bankers polled for this report note that local retailers’ preference for cash is either a ‘very significant’ or ‘significant’ barrier in operating cards and payment services.

Retailers’ preference for cashIn operating cards and payments services, how significant a barrier is Chinese retailers’ preference for cash transactions?Retail bankers only

However, the Chinese authorities are pushing more merchants to accept cards, especially in major cities—and particularly in anticipation of the 2008 Olympic Games. The central bank blueprint currently calls for at least 60% of merchants with turnover of over Rmb1m (US$130,000) in China’s large and medium-sized cities to be accepting locally-issued bank cards in time for the Olympics. In addition, it calls for bank card use to rise to 30% of retail sales in these cities, up from just 10% in 2005. “We see an aggressive rollout in point of sale infrastructure, with explicit targets set down in Beijing for the Olympics,” says Richard Williamson, a general manager for Asia strategy within the Commonwealth Bank of Australia.

The Foundation for Success Has To Be Strong

Using best of breed IT capabilities will be crucial to the development of China’s cards industry

Survey results show that banks have two major concerns about the cards market infrastructure in China – IT capabilities for transaction processing and settlement as well as the need to grow the card acceptance network.

Outsourcing is a very attractive option for local banks, especially those concerned that the ‘best of breed’ in-house capabilities of foreign banks could put them at a major disadvantage.

Outsourcing also works for foreign banks, keen to keep costs to a minimum as they build up their cards business.

Legacy systems are non-existent in China so the country’s banks can enter the cards market with best of breed solutions. However, there are challenges here too, such as:

– Lack of skills in many Chinese banks to run complex card management systems

– The ability of cardholders to adapt quickly to new means of payment

– For smaller merchants the investment costs to accept cards are too high.

As far as transaction processing is concerned, banks need to manage a wide range of issuing and acquiring services, including authorisation, account management, and transaction management. Support services such as customer service, collections, fraud and risk management, embossing, statement printing and mailing are also key elements of running a card programme.

Whatever their approach, it is in the interests of Chinese banks to migrate clients to more self-service channels. Branch-based services are expensive, especially in low-population rural areas.

Electronic channels (such as ATMs, point of sale transactions, mobile and Internet payments) are much more secure and cost effective. However, banks need significant card volumes to justify the deployment of self-service devices and to drive a more electronic-based strategy.

First Data Insights


Do you take cards? Card acceptance on the rise in China

Merchants Merchants Card-accepting Card-accepting ATMs, added ATMs, total accepting accepting POS terminals, POS terminals, in 2006 payment cards, payment cards, added in 2006 totaladded in 2006 total

114,000 520,000 188,000 810,000 14,000 98,000

Source: CUP.

ATM networks represent another area of strong growth, with some 14,000 new cash machines rolled out during 2006, bringing the total to nearly 100,000. This rapid rate of growth is likely to continue. Retail Banking Research, a British market research firm, predicts that 128,000 ATMs will be installed in China between 2005 and 2011. Meanwhile, the volume of ATM transactions is rising even faster, as the total number of transactions in 2006 grew by 67% over 2005.

According to the executives surveyed for this report, this increase in card-accepting infrastructure, encompassing both merchants and ATMs, will play the biggest role in encouraging the increased acceptance of card payments in China. Fully 83% of retail bankers polled chose this as the key factor, far ahead of anything else, such as better collaboration between key stakeholders such as banks and payment processors (48%) or publicity campaigns (33%).

Numerous Challenges Remain

While there are many reasons for optimism, foreign banks entering China also face significant challenges and risks. In general, when polled about risks in the Chinese market, survey respondents chose politically- and regulatory-related issues as their prime concern. More than half (53%) of bankers polled for this report selected political risk as the biggest existing or potential risk associated with their firm’s operations in China.

For those banks planning to establish a payment card business in China, the key challenges relate primarily to risk management, tough regulations, fraud and other issues. Nearly 60% of retail bankers chose risk management regarding the scoring of customer credit-worthiness as the biggest hurdle, far ahead of any other challenge. Their second-biggest concern also related to risk management, specifically the recovery of money lent to customers (41%). Beyond this, overly burdensome regulations (35%), fraud (26%) and problems regarding distribution, cross-selling and marketing (24%) were high on the list.

Poor profitability

Difficult risk management regarding scoring of customer credit-worthiness

Difficult risk management relating to recovery of money lent to customers

Overly burdensome regulations

High incidences of fraud

Problems regarding distribution, cross-selling and marketing

Cultural Issues (eg, poor customer credit culture)

High risk of default

Poor retail infrastructure (eg, card-accepting POS terminals)

Poor banking infrastructure (eg, cash machines, branches)

Strong competition from domestic Chinese rivals

Other

0 10 20 30 40 50 60 70 80 90 100

59%

41%

35%

26%

24%

21%

19%

19%

12%

12%

5%

0%


Top challenges for paymentsWhat do you see as the major challenges facing China’s cards and payments industry for the next three years?Retail bankers only

Risk management

One of the key issues relating to risk management is the limited availability of credit data. The shortcomings of local risk assessment practices are reflected in the survey results, with 41% of respondents ranking local practices as either poor or very poor and another 39% ranking them as only fair.

Banks continue to rely heavily on in-house risk assessments deploying subjective criteria that may or may not be effective. At more sophisticated institutions, credit-checking systems appear to work adequately. China Merchants Bank, for example, claimed non-performing loans (NPLs) for its credit card unit of just 1.53% in 2006, compared with an international average of 5–6%.

However, many domestic lenders continue to use less sophisticated, and in some cases quite inadequate, risk-assessment practices. “Risks stemming from the card business are a major concern of Chinese banks and their risk control capabilities leave much to be desired,” says Lin Bian, deputy general manager at the Beijing branch of China Merchants Bank. Others agree. Guoyong Shen, an executive of CITIC Bank, comments: “In their efforts to grab more market share, the domestic banks have placed disproportionate stress on the quantity of the cards issued at the expense of the quality.”


But why is this? One of the main problems is that Western-style consumer banking is simply so new. Even some larger banks, for example, have yet to adopt modern accounting practices such as net present value, instead relying on book value or on national loan guarantees that are probably not enforceable in the event of a loan default.

The currently low default rates reported across the consumer-lending sector in China may well be masking underlying problems. This could be because, despite reforms, old habits die hard. Altering working practices engrained by decades of government-directed lending, especially at the largest banks, will take a long time. Bank staff can therefore be slow to categorise debt as bad even when they should. As an executive at one card issuer says: “In the consumer finance business, banks have not yet fully embraced the idea that delinquent debts are simply a cost of doing business, so they tend be more conservative about delinquency defaults, not only with the cardholder but also with the merchants.”

Furthermore, with the consumer lending market emerging so rapidly and from such a low base, current statistics may not be very instructive. China Merchants, for example, reported that credit card lending in 2006 increased to Rmb155m (US$20m), up from just Rmb78m (US$10m) the previous year. With growth this fast, the majority of loans are so new they have had no chance to turn sour, thus distorting statistics. As the same executive says: “To look at the default ratio, you really need a substantive period of time. In the high-growth stage of the market like we have in China, a more meaningful time to look at those figures is two or three years from now—the denominators are growing so fast, sometimes you cannot tell the true long-term pattern.”

This issue is clearly recognised among bankers surveyed for this report. Asked what the Chinese market needs most to support cards-payments infrastructure, half selected better availability of consumer credit-history data. But progress is being made in this area. Credit databases covering specific cities have been in place for several years and are operated by both local and foreign entities, such as Experian. However, in January 2006, after a trial period, the PBC launched a new nationwide database that tracks the credit histories of some 530m people, along with tens of thousands of businesses. The database tracks consumer bill payment histories on loans and credit cards, as well as taxes, mortgages and utility payments, along with other data.

Nevertheless, the impact of this database has been patchy. While better-managed banks make good use of these records, the records are often incomplete. A senior executive at one foreign credit-card issuer comments: “The truth is that the credit bureaus take time to build their data and require diligent reporting of information by issuers and other lenders. At this moment [they are] not at the level of more developed countries like the US, so the limited information they provide isn’t adequate for an issuer to make a full credit assessment.”

As this data expands, banks will have an increasingly useful tool at hand for when they make credit risk decisions.

Regulatory restrictions

Another of the key challenges faced by banks is that of regulatory restrictions on their actions. Retail bankers see licensing risk as a major concern, highlighting the difficulties associated with getting permission to expand into new regions or markets. This issue crops up as a practical problem when trying to expand a bank branch network, for example. “It is not that easy to create or extend a branch network,” says BBVA’s Mr Galatas. Unlike in other developed countries, “the Chinese authorities must approve every opening or closure.”

Know Your Customer

Risk management skills in Chinese banks are rated fair or poor by a majority of foreign banks

Often perceived by foreigners as the Achilles heel of the Chinese retail financial services industry, effective risk management will play a crucial role in building a profitable cards business.

There are positive signs that Chinese regulators are taking risk management seriously. On 9 March 2007, the Chinese Banking Regulatory Commission (CBRC) ordered issuers to strengthen risk management practices.

All issuers were instructed to “know your customer” and “know your business,” and to make thorough investigations to verify the identity of people applying for credit cards. To combat application fraud, issuers must make clear to applicants what supporting documentation is needed. Banks were also advised to ask cardholders who wanted to apply over the Internet to download the form and mail it with supporting documents.

In addition, the CBRC warned banks to set credit limits only after fully assessing the applicant’s ability to repay. Crucially, in an effort to avoid cardholders taking on too much debt, the CBRC said that banks should not issue any further cards to customers whose credit lines with other lenders already exceeded the total ceiling that the client should be granted. Banks should not activate cards unless they are sure of the identity of the cardholder.

If fully implemented, the CBRC’s measures would be in line with international best practice, well positioning the Chinese cards market to manage risk as the industry continues to grow.

An example of what can go wrong when there is poor risk management in the cards industry occurred in South Korea during 2002. Poor lending policies, ineffective credit management and an inability to collect overdue debts led to a crisis in the country’s consumer lending industry. Losses totaled millions of dollars and a number of the country’s leading consumer finance companies had to be recapitalised or sold off at huge discounts.

Thankfully, examples like this are rare. Chinese regulators are wise to take action now to ensure that the country’s cards industry is not exposed to such risks.

First Data Insights


But for all bankers polled, licensing risk is second only to political risk defined as, policy and regulatory issues that could significantly affect a company’s operations in the country. Market analysts are nevertheless optimistic that the environment is improving: “I think the average bank is positive on the general regulatory environment, on where it is, the direction it is moving,” says Alistair Scarff, a banking analyst for Merrill Lynch.distribution channels to compensate for their lack of extensive branch networks.

Talent and IT

Despite China’s enormous population, talent is another issue that must be addressed. Local banks and foreign banks all compete for a relatively small number of people with relevant education and experience. “There are plenty of very bright people with good academic qualifications, but there is a shortage of those with experience of these newer areas of banking,” says RBS’s Mr Shelley. “So one of the big challenges we have is training up sufficient numbers to enter these new market sectors.”

Demand for skilled staff is strong. Among foreign banks alone, HSBC recently announced plans to increase its 3,000 Chinese staff by another 1,000 both this year and next, while Citigroup plans to add 1,000 more this year and the Bank of East Asia plans to add some 500-1,000. Standard Chartered is also believed to be planning substantial increases in skilled staff.

In addition, IT systems remain unsophisticated. Risk management, for instance, requires both good IT systems and staff with relevant experience. According to Mr Scarff, Chinese banks “don’t yet have the systems to manage the significantly higher volume of data required for credit card services. Banks must evaluate customer credit, monitor card use, and adjust credit ratings as time goes on. Each of these steps requires technology, market knowledge, and credit evaluation expertise. These are the key challenges.”

Savings culture

One final challenge is simply cultural—China has yet to become a consumer-oriented society. Even the approximately 76m Chinese that have annual incomes over US$5,000 usually prefer to save their extra cash. This fiscally-conservative tradition, reinforced today by incentives to build up precautionary savings to cater for individual medical, pension and housing expenses previously paid by the state, extends to a general aversion to assuming debt. When asked about barriers to growth in the market, the underdeveloped or immature consumer credit culture in China was rated highest by retail bankers, above tight regulatory restrictions and an undeveloped back-end banking infrastructure.

Even local banks recognise the cultural aspects of card acceptance. “The major problems besetting the development of the credit card business in China derive from the conflicts between the consumption culture of individual Chinese customers and [payment cycles] of credit cards,” explains Hua Chen, an executive within the bank card division of Shanghai Pudong Development Bank.

The result is that few Chinese card users currently carry revolving balances on their cards, preventing card issuers from levying the interest payments on outstanding balances that are the mainstay of profits in other markets. According to McKinsey, a consultancy, just 2% of domestic credit card users describe themselves as “frequent revolvers” (borrowers that carry forward an outstanding balance from one month to the following month’s bill), and 85% pay off their bills in full every month.

Know your market and know your customer

Strong cultural appreciation of the market is seen as one of the biggest contributors to success

The development of the payment cards market in each country is heavily influenced by the country’s culture, attitude toward money, and the evolution of the local banking sector. China is no exception.

Attitudes to credit in China are changing quickly, especially among the younger generation. Five years ago when First Data entered the Chinese market and established its operations centre in Shanghai, credit cards were still a new concept. Depositing money in banks and using cash to make purchases were commonplace, and brought people a sense of security. People were beginning to get familiar with using cards, but mainly debit or quasi-credit cards.

Now, all banks in the China market are competing for credit card wallet share. Credit cards have been widely accepted by Chinese consumers in bigger cities. With the dramatic economic growth, people are starting to practice the principle: “Use tomorrow’s money to satisfy today’s needs.” However, the credit card usage group is still the lower-aged groups varying from 20 to 40 years old.

Within this group of people, the 30–40 age group is relatively conservative compared to the younger 20–29 age group. This older group of people are mainly middle-management “white-collar” managers. Although they find credit cards convenient and use them on a daily basis, they behave as transactors, not revolvers.

The younger group is called the “Post 80s” as most of them were born after 1980. This group is the revolver group. As a matter of fact, the consumer behaviour of this group is more Western than Chinese. Banks love revolvers. However there is a thin line between cardholders revolving their balances and becoming a bad debt risk. As a result, Chinese banks should welcome the “Post 80s” cardholders but tighten up their risk policies and pay more attention to these cardholders’ behaviour scores and tendencies to prevent their credit from going bad.


First Data Insights

Department stores

Hotels

Supermarkets

Restaurants

Travel agencies (including airlines)

Petrol stations

Entertainment Venues (cinemas, sports complexes, etc.)

Other

78%

52%

47%

43%

24%

16%

16%

2%

0 10 20 30 40 50 60 70 80 90 100


At the same time, the levels of debt local consumers are allowed to assume remain low. Current regulations mean that all Chinese credit cards are subject to a lending ceiling of Rmb50,000 (about US$6,500)—a limit that prevents most consumers from running substantial balances. Card issuers point out that today many card users in China can afford higher limits (and need them too, for example when travelling abroad). However, although the government is considering an increase of this spending cap, it has given no indication of when this may happen.

Bringing Merchants On Board

If the Chinese market for payments is going to truly take off, a key prerequisite will be for retailers to provide customers with the facility to pay by card. This is particularly challenging in a country like China, which has large numbers of small retailers, and provides particular problems for card issuers trying to boost use of POS terminals in the marketplace. This is not simply a numbers game—smaller merchants are likely to be less sophisticated and harder to educate about the benefits of credit card payment facilities.

Once infrastructure is in place to service local customers, merchants should be more receptive to adopting similar POS equipment that services credit cards too. Of the various merchant types, those selling consumer goods see the heaviest credit card traffic, with relatively little usage in the service sector. This preference is reflected in the survey results, where almost eight out of ten retail bankers see department stores as the most promising target for card operators. Beyond this, hotels (52%), supermarket chains (47%) and restaurants (43%) are seen as the next most promising targets for payment card operators.

Retail outletsIn your view, which retail outlets in China are the most promising targets for payment-cards operators?Retail bankers only

Payment cards are relatively new in China, whereas the Chinese people’s strong tradition of saving goes back generations. Making the shift from cash to cards will take time. Developing a culture where people feel comfortable in using revolving credit or other consumer lending products will take much longer.

The signs are promising. Amazingly, at 2% of the cards market, China has a higher proportion of revolving credit card volumes than most continental European countries, where borrowing is concentrated on bank overdrafts. If Chinese banks want to develop a strong credit card lending culture they will need to look to organisations from credit card heartlands like the United States, Canada and United Kingdom for guidance. Leading credit card issuers from these countries are already active in China, as are a handful of European consumer finance specialists like Cetelem, the subsidiary of French bank BNP Paribas.

First Data Insights


Convincing the Merchants

Merchants’ preference for cash trans-action is a significant barrier to develop-ing card acceptance

China is not alone in facing the challenge of

developing a merchant acceptance network.

Almost every other emerging market in Europe,

Latin America or Asia has the same problem.

Banks in countries like Spain have managed

a massive migration of cash transactions to

electronic payments. They have treated the

investment in building an acceptance network

as a business that will generate steady cash flow,

not as the provision of a public utility, such as the

road and rail networks.

Accepting credit cards will enable merchants

to do business with many more customers. It is

in the interest of all banks to develop the card

acceptance network, both to reduce the cost

of accepting cash payments and to gain from

the revenue benefits of increased card fees and

interest income offered by credit cards.

Installing a POS (point of sale) network will

reduce the cost of handling cash for both

merchants and acquirers. It will also reduce the

risk of robbery and give the merchant a payment

guarantee. Electronic transactions also ensure

that there is a record of each transaction, thereby

reducing the size of the black market and the

problem of tax evasion.

Merchant acquiring is a critical component

of the cards business and core to its future

development. Industry regulators have high

expectations for the rapid growth of the card

acceptance network. For example, the People’s

Bank of China expects payments by bankcards

to have reached 30% of all payment transactions

in large and mid-sized cities by 2008. At present,

there are over 810,000 points of sale at 520,000

merchants accepting China UnionPay cards.

Compared to many other markets, merchant fees

in China are low, with a net average merchant

service charge (MSC) of 1%. This makes the

financial challenge to migrate merchants from

cash to card-based payments much less difficult

than in some other emerging markets where

MSCs can be over 3%. The big challenge is to

convince merchants that accepting cards is good

for their business and then training employees to

accept card-based payments.


Merchant acquiring

A relatively low proportion of banks appear interested in providing merchants with the necessary services that would permit them to accept card payments (merchant acquiring). Just 12% of bankers polled for this report say their firms are already offering such services, but 34% plan to introduce them within the next three years. However, more than half (54%) responded that they have no immediate plans to do so. Banks from the Asia-Pacific region appear keener to engage in this area than others: nearly 70% of Asian banks indicate they will provide such services, while just 45% of European banks think they will do so. Perhaps this comparison highlights the generally more cautious approach being taken in China by banks from Europe.

Banks offering the necessary services are targeting the richest parts of the country first, where the job is much easier. Rabobank’s Mr van Empel says his company invested in a rural co-operative bank in Zheijiang province which has seen growth of 15% over the past five years. “It’s a prosperous province with lots of [small and medium] enterprises and most shops accept debit cards.” In his view, “it has been an easy province to persuade merchants to accept cards.”

Co-branded cards

One trend that has gained increased popularity over the past year has been for banks to issue co-branded cards in conjunction with merchants. Such deals not only help to retain customers by allowing the development of loyalty bonus programmes that provide rewards for card usage, they also help both issuers and merchants to develop brand images and target their services at particular demographic markets. Major credit card players have now formed as many as 20 of these co-branded engagements each. Notable deals include a November 2006 deal between Wal-Mart and HSBC/BoComm and a Citibank/Shanghai Pudong Development Bank card issued with Japan Airlines in March this year.

From the retailer perspective, those appealing to wealthier consumers are more likely to be courted by the banks, not only to provide card services, but also to offer co-branded cards. “We have been approached by a number of banks [to offer a co-branded card], but we have not made a decision about whether that would be the right approach,” says Albert Chan, managing director of a fashion retailer, Ports International, which operates with some 300 domestic stores represents the largest number of foreign-invested outlets in China. “We are considered a very prestigious fashion brand in China and the people who are fashion conscious tend to also be bigger spenders, and so banks do want to associate with companies like us.”

The network experience

The experience of merchants interviewed for this report in using local POS systems was generally positive. “Different cities have different rates of usage, depending on whether the banks are able to push their ideas onto their customers,” says Mr Chan. “Generally, though, the system works very well.”

First Data Insights


Others argue that the payments network has its “hiccups”, but is constantly improving. “Reliability is not as good as elsewhere in the world,” notes the CFO of a major British retailer that is expanding rapidly in China. “It is getting better though.” Local banks generally agree, although acknowledge that more still needs to be done. “Significant headway has been made in the ‘UnionPay’ project, yet much still remains to be done to popularise cross-bank and cross-region payment by bank cards and raise the success rates of such transactions,” says Guoyong Shen, an executive at CITIC Bank.

Inevitably, concerns about reliability are more prevalent in rural locations than in the cities. Also, declined cards are usually unlikely to be called in from the retailer, especially those in more remote regions, as they seek to avoid the costs of a long distance call. “There are no regional call centres you can use to verify transactions manually,” says one executive at a major foreign retailer operating in China.

Merchants also report a relatively low incidence of credit card fraud, possibly a reflection of criminal learning curves lagging card usage growth. One banker pointed out that current POS systems allow for SMS notification of sales transactions within minutes of their completion, which has helped to cut down rates of fraudulent use.

The Outlook For The Cards Business In China

There is much optimism about the payment card business in China, but both foreign and local banks have much work to do. For foreign banks, establishing a credit business is a daunting challenge. And for both local and foreign banks, the next steps will involve stimulating mass acceptance, and then, hopefully, developing profits.

At the same time, however, the credit card market is evolving rapidly. “At the end of 2006, [credit cards] accounted for only 3% of total cards that have ever been issued in China,” explains an executive at one large card issuer. “But they actually account for a third of transactions, not in terms of volume, but in terms of number of transactions conducted at the point of sale. So credit cards at the moment are the fastest growing payment product in China.” As one analyst explains it, considering their share of the market, “it was a clear indication that credit cards outperformed debit cards by wide margins.”

To grow their market share in this expanding credit card market, foreign banks seek to capitalise on their greater experience. When asked to choose key contributors to their success, 45% of the retail bankers surveyed chose name recognition/brand image, 40% selected distribution, typically done in conjunction with a local partner, and 38% chose product innovation.

As Chinese banks build their acquiring business,

they should be aware of some major trends

impacting their own market and the industry

generally:

– Merchant acquiring is becoming a commodity

– Acquirers need sophisticated and scale-

driven processing

– Regulators are taking a much closer look

at the card industry, especially interchange

rates and MSCs

– Establishing a robust merchant base will bring benefits to the government – taxes will be captured to improve the overall economy. For example, the Korean government gives incentives for merchants and cardholders to adopt the use of cards.

- Intense price pressures are eroding margins;

- The need for sustained, large capital investment will continue.

For international merchants such as Wal-Mart, Pizza Hut, Tesco and KFC there are opportunities to reduce costs through centralised and/or multi-country acquiring.

First Data Insights

Name recognition/Brand image

Distribution capabilities

Product innovation

Assistance of local partners

Technical expertise

Strong cultural appreciation of the market

Customer service expertise

Global scale

Human resource management

Good government relations

Good governance

Other

45%

40%

38%

29%

22%

21%

19%

16%

14%

12%

12%

2%

0 10 20 30 40 50 60 70 80 90 100


Contributors to successWhat has been (or what do you expect will be) the biggest contributors to the success of your business in China?Retail bankers only

Short-term pain...

However, few card operations involving foreigners are looking to break even any time soon. China Construction Bank, for example, whose own-brand operation boasted 6.34m users at the end of 2006, recently stated that its proposed credit card joint venture with Bank of America aimed to be profitable within seven years from launch.

There are several reasons for this poor profitability outlook. One is the simple need for economies of scale. Phang Yiew Kiat, deputy CEO and head of consumer banking at China Bohai Bank, in which Standard Chartered has taken a 20% stake, comments: “Our experience had shown that a bank has to build a credit card portfolio of greater then a million cards to be economically independently viable. In China, that number is significantly higher, in the multiple millions. Among other reasons, one critical element is the merchant fee – and [CUP] is driving it at 1% for most transactions and your issuer gets a maximum of just 0.7%”

Another reason is that although banks may be issuing credit cards liberally, consumers don’t always use them. In reality, according to bankers interviewed for this report, the number of Chinese credit cards in active use varies around only 35-50% of those issued.

Finally, average credit card spending remains low at about Rmb8,000 (US$1,000) per card annually in 2005, according to CUP. One reason for this may be that customers are signing up for cards in order to take advantage of bank promotions rather than with any long-term intention to use them.


...for long-term gain

The fact that profit prospects look bleak for the foreseeable future has not diminished bank confidence over the longer term. Few credit card issuers expect to make a profit in their first few years, and are therefore unconcerned at the prospect of early losses. Indeed, there are many reasons to be positive.

According to an executive at one card issuer, one cause of currently low revolving balances in China is that banks have targeted wealthy, high-end customers in their initial marketing strategies. Although these clients are sought after by banks for other reasons, such as cross-selling opportunities, “the high-end customers tend to use revolving credit facilities less frequently. But once you start to go down the demographic pyramid, the experience in other [Chinese markets], suggests that revolving rates will go up.”

In addition, although older card users may continue to spend conservatively, younger, better-educated consumers tend to spend in ways more comparable to Western consumers. This means that time is on the side of the banks. As more young, affluent people start to use cards, the proportion of those using them in ways that are profitable to card issuers will naturally increase (although whether they will prove to be good credit risks is another matter). Indeed, the trend reflected in official figures is already strong. According to a recent survey conducted by China National Radio and Beijing Sino Credit, 38% of credit card holders are now white-collar professionals in the 26-33 age group. Meanwhile, total revolving balances in China increased 50% to some Rmb15bn (nearly US$2bn) at the end of 2005, according to CUP.

Finally, some 35% of China’s most affluent consumers are located in the big four cities (Shanghai, Beijing, Guangzhou and Shenzhen) where foreign banks have already established branches tends to mitigate the problem of the lack of branch networks nationwide. By focusing on a handful of up-and-coming second-tier cities, they will still be able to cover a large percentage of their target client base without having to expand their branch networks across the country. Some of this will be achieved by tapping into China’s burgeoning e-commerce market (see box: The rise of e-commerce and alternative payment platforms).

The 3 Keys to Profitability: Volume, Portfolio and Usage

Innovation in product development and delivery will be key for driving profitability in the Chinese credit card market

The card business is a volume business. Besides volume, banks also look forward to a portfolio with a good portion of revolvers. With both of these in place, banks need to boost up usage to maximize profitability.

What can make a bank possess these three critical success factors? The answer could be many things, but above all, they are branding, product and service.

When Industrial and Commercial Bank of China (ICBC) issued its first American Express card in China in 2004, the product was positioned as “a lifestyle accessory for successful people in China.” This is still a very suitable description for all card products aimed at the top of the Chinese market.

While the vast majority of cards aimed at the mass market are standard products with ATM or POS functionality, segmentation is becoming increasingly important at the high end of the market. The leading local banks have launched innovating products with loyalty programmes, co-branded cards, and revolving credit gaining increasingly widespread acceptance.

Whatever the type of product, marketing is important throughout the credit card life cycle. Marketing initiatives are used not only to increase the acquisition rate but also to boost card usage and retain customers. Banks in China are developing value-added features and targeting market segments with different products.

There are some marketing methodologies widely employed in the United States, Canada and some European markets that have not been used in China. For example, balance transfer, mass direct mail campaigns, product development based on flexible interest rates, etc. We believe that with the further opening of the Chinese market, these marketing initiatives will play an increasing role.


First Data Insights


For example, in February 2007 Bank of Communications (BoComm) launched a co-branded programme with New World Department Stores across 15 major Chinese cities. With management and technical support from its strategic investor, HSBC, the programme was the first to feature a card with both chip and magnetic stripe technology.

In April 2007 China Construction Bank announced that it would establish a card company in association with Bank of America (BofA), another example of knowledge transfer between Chinese banks and their foreign investors. BofA also brings with it the premier product development, data mining and segmentation skills of MBNA, the world’s leading monoline card issuers before it was acquired in 2005.

We can expect similar co-operation on products such as commercial cards and prepaid products, not to mention mobile commerce where there seems to be major need for mobile-based payment services in provincial areas. The marketing initiatives will also have to take into account the changing consumer demographics, with younger people being far more comfortable with credit cards and preferring to use remote channels than bank branches. We’ve seen this strong trend in emerging markets such as Central and Eastern Europe as well as more mature markets in North America.

Many Chinese banks are making efforts to accelerate product innovation, upgrade service quality and drive market development in retail financial services. This will be especially important in the cards industry where the survey indicated great uncertainty over the ability of the Chinese cards industry to generate profits. Almost 40% of respondents say that they neither agree nor disagree with the statement that it will be difficult to achieve profitability in the next three years. Another third of respondents (34% to be exact) agree that it will be a challenge.

Banks in China should also look to cross-sell credit card products to customers, as well as target credit cardholders with marketing for other bank products. To do this successfully, banks with Western partners can tap into an available source of expertise.

The rise of e-commerce and alternative payment platforms

Fully half of all bankers polled for this report believe that the prospects for online commerce in China based on payment cards are either ‘strong’ or ‘very strong’, compared with just 18% who consider prospects to be ‘weak’ or ‘very weak’. When looking at the growth of Internet usage in the market, this is easy to understand. China has become the second-largest Internet market in the world, with around 10% of its population using the Internet. By the end of 2006, the market had an estimated 137m Internet users, according to the China Internet Network Information Centre, an increase of 23% on 2005. Of these, 104m used broadband connections, with 17m using mobile phones to access the Internet.

Driven by growing numbers of Internet users, more merchants offering online payment options, and more banks investing in online payment infrastructure, the online payment market grew more than 100% in 2006 to some Rmb32bn (US$4bn), according to CUP, representing about 3% of the value of bank card transactions for the year. Bankers, accordingly, are bullish. Rabobank’s Mr van Empel says e-commerce in China “will increase rapidly in the future, because Internet use is widespread.” And retailers agree. “There is a lower density of POS infrastructure in China and I could see that this would lead to the development of other types of electronic payment platforms,” says an executive at a major British retailer currently operating in China.

Looking beyond cards

While online commercial transactions have expanded in line with this upward trend in Internet usage, some innovative players have also moved to exploit the grey area between real and “virtual” money to take advantage of the gulf between the large number of Internet users and the relatively low number of credit card holders. The “Q-coin,” a unit provided by the dominant instant messenger service QQ, has gained popularity and can now be used to buy a number of real goods and services online, such as phone ringtones.

Plastic card payments are also less suitable in populous rural provinces, with a less evolved card payment infrastructure, while e-commerce is also unattractive, given limited Internet penetration. As a result, the development of alternative payment channels is now being promoted by China’s central bank, the People’s Bank of China.

One alternative is mobile phone-based payments, which are also growing rapidly. Subscribers to m-commerce payment schemes doubled in 2006 to more than 5m customers, according to CUP. Banks see this as an ideal medium for conducting marketing campaigns and wealth-management business models. As pf 2005, some 4.3m customers at China Construction Bank had signed up for mobile phone banking services.

More recently, a new type of SMS-based payment system has evolved. Users simply send an SMS message specifying the mobile number of the payee, the payment amount and their PIN, and receive confirmation of the transaction within seconds. Although still subject to security concerns, the system has major potential, given its simplicity and low cost—and the ubiquity of mobile phone services.

Other alternatives include a contactless mobile phone payment system, which is being rolled out in Shanghai later in 2007. CUP has developed a digital TV set-top-box payment service, which it plans to test as a trial in Qingdao this year.

First Data Insights


Conclusion

The general outlook for the cards business in China is positive, according to the bankers surveyed for this report. However, both local and foreign banks have their work cut out as they attempt to develop a profitable cards business in the market.

At a basic level, much needs to be done to convince consumers and retailers about the merits of switching from cash to card-based transactions. Doing so will require long-term effort. Fully 86% of bankers polled agree that they must educate consumers about payment cards now, before a widespread payments infrastructure is in place.

In addition, although foreign banks can, to a certain extent, deal with the problems of creating far-flung networks by teaming up with a local partner, they still face a barrage of risks—economic, political, regulatory and, most of all, from the market itself.

But although risks are high, the rewards for the winners will be equally large. Finding the right balance will ultimately be key. As Merrill Lynch’s Alistair Scarff says, “China’s move toward increased card usage is a very positive one. It is positive for banks, as a great source of revenue, and for customers, in terms of convenience and greater benefits and service. The potential for growth is there, but the challenge for banks will be to grow in a measured and disciplined way.” Banks will have to move quickly, but cannot sacrifice the quality of their assets by pushing forward too hastily.


Regulatory recommendations

China’s payment card market has been expanding rapidly over the past few years. The introduction of greater competition from abroad is likely to accelerate this trend, but increased help could also come from the government and market regulators.

1. Work to improve credit risk management and assessment capabilities, both at card issuers and at credit rating bureaus. Ensure that data held by credit bureaus is accurate and comprehensive.

2. Protect bank sector health by creating and implementing sound accounting and asset management practices.

3. Remove or reduce bureaucratic impediments to bank expansion plans.

4. Raise credit card borrowing caps from current low levels.

5. Continue campaigns to encourage more merchants to offer debit and/or credit card services, and to increase the value of urban non-cash transactions as a proportion of total spending.

China Merchants Bank: a model for the future?

If ever an exception proved the rule, the example of Shenzhen-based China Merchants Bank shows how credit card businesses can be run profitably in China. It has taken the domestic credit card market by storm since becoming the first Chinese bank to issue dual-currency cards in conjunction with Taiwan’s ChinaTrust Financial in 2002. With the card operation running smoothly, China Merchants severed the relationship with its partner and has since transformed itself into the nation’s biggest credit card issuer, with some 10m cards in circulation at the end of last year. Half of those cards were issued last year alone and China Merchants projects its card numbers will rise to some 15m by the end of 2007.

In 2006, according to its annual earnings release, the bank managed to double its credit card base and realised Rmb10bn (US$1.3bn) in card revenue, up 123% from the previous year. Credit card lending rose to 10% of total retail lending. The bank claims its credit card operation became modestly profitable during the year (its fourth since launch), with earnings of Rmb100m (US$13m), making it the first bank in China to operate its credit card division profitably, according to domestic press reports.

Targeting younger, wealthier consumers, business has thrived due to smart marketing campaigns such as co-branding with youth-oriented brands, like Hello Kitty, or specific market niches, such as an online travel agent, Ctrip. In addition, the bank has benefited from superior customer service and the largest credit card centre in China, which has generated half its customer base by using direct marketing campaigns. By concentrating on using an Internet-based servicing platform that allows clients to manage accounts online, the bank has reduced costs and managed to overcome the disadvantage of its relatively small branch network of about 500 branches.


Appendix

1. The first wave? Foreign investment in mainland Chinese banks As of April 2007

Chinese bank Foreign investor Stake US$ (m) purchased (%)

Industrial and Commercial Goldman Sachs, Amex, 8.45 3800 Bank of China Allianz Group

China Construction Bank Bank of America 9 2500 Temasek Holdings 5.1 1460

Dalian City Commercial Bank Bank of Nova Scotia 19.9 1747 International Finance Corp (IFC) 5 –

Bank of China Royal Bank of Scotland 10 3100 Merrill Lynch, Li Ka-Shing 5 1500 Temasek Holdings 5 1500 UBS 1.6 500 Asian Development Bank 0.24 75

Bank of Communications HSBC 19.9 1747

Shanghai Pudong Development Bank Citigroup 4.6% 67

Minsheng Bank IFC 1.6 23 Temasek Holdings 4.6 110

Industrial Bank Hang Seng Bank 15.98 208 IFC 4 52 GIC Special Investments of Singapore 5 65

Huaxia Bank Deutsche Bank 9.9 327 Sai Oppenheim 4.08 –

Shenzhen Development Bank Newbridge Capital 17.98 (will drop) 150 GE Capital 7.3 100 (pending)

Guangdong Development Bank Citigroup3 85 3100 IBM 4.74 165

Bank of Beijing ING Group 19.9 215 IFC 5 54

Bank of Shanghai HSBC 8 63 IFC 7 47

Bank of Nanjing (fka) Nanjing IFC 5 8.3 City Commercial Bank BNP Paribas 19.2 87

China Bohai Bank Standard Chartered 19.99 78

Hangzhou City Commonwealth Bank of Australia 19.999 778 Commercial Bank Asian Development Bank 4.99 30

Jinan City Commercial Bank Commonwealth Bank of Australia 11 17

Xian City Commercial Bank IFC 12.5 N/A Bank of Nova Scotia 12.4 N/A

Ping An Bank HSBC 27 N/A3Citigroup was allowed an expanded stake owing to the financial weakness of GDB.


Chinese bank Foreign investor Stake US$ (m) purchased (%)

United Rural Cooperative Rabobank 10 31 Bank of Hangzhou IFC 5 –

Nanchong City Commercial Bank Deutsche Investitions-und Entwicklungsgesellschaft (DEG) 10 4 Sparkassen International Development Trust 3.3 1.5

Ningbo City Commercial Bank Overseas-Chinese Banking Corp 12.2 70

China Everbright Bank IFC 4.9 19

Tianjin City Commercial Bank ANZ Bank 19.9 120

Shanghai Rural Bank ANZ Bank 19.9 252

CITIC Bank Banco Bilbao Vizcay Angentaria 5 648

Qingdao International Bank Hana Bank 72.31 25

Xiamen Commercial Bank Fubon Financial Holding 20 62

Nan Tung Bank Morgan Stanley 100 N/A

Chongqing Commercial Bank Da Shing Bank 17 89

United Commercial Bank Business Development Bank 100 205

Sources: KPMG; press reports.

2. Making the leap. Foreign banks with announced intentions to enter China’s retail banking sector

Early entrants (Incorporated as of April 2007) HQ HSBC Shanghai Bank of East Asia Shanghai Citigroup Shanghai Standard Chartered Bank Shanghai

The next round (Awaiting approval as of April 2007) ABN AMRO Shanghai Bank of Tokyo-Mitsubishi UFJ Shanghai DBS Bank Shanghai Hang Seng Bank Shanghai Mizuho Corporate Bank Shanghai JP Morgan Chase Beijing Wing Hang Bank Shanghai Overseas-Chinese Banking Corp Shanghai

Plans for entry Deutsche Bank AG BNP Paribas SA Overseas Bank Citic Ka Wah Bank Nanyang Commercial Bank 4 A joint venture between Hana Bank and ICBC, so Hana is allowed a controlling stake. 5 Could be acquired in its totality because it was already foreign-owned.

First Data Corporation 6200 South Quebec Street Greenwood Village, CO 80111 303.967.8000

www.firstdata.com

beyond cash: china’s emerging payments market

Business

chinese market

burgeoning payments

payments business

chinas cards

chinese payments industry

cards business

payments processingexpertise

cards industry