China’s Internet Banking Industry Exploding: Can They Have Global Success? Can U.S. Companies Have Success in China?

China is now “the undoubted center of global fintech innovation and adoption.”   That’s how it was phrased in a recent Ernst & Young / DBS Bank white paper, titled The Rise of fintech in China, which says they are “revolutionizing the industry” while the West is taking only incremental steps.

The reasons for this explosion, according to EY/DBS, include:

• An enormous unmet need among the Chinese population as well as among small-to-mid-size enterprises
• Regulatory facilitation by the government—or “regulatory acquiescence”
• Easy access to capital that has ignited many startups
• An environment where traditional services and startups collaborate
• High levels of internet and mobile use
• A population that embraces online transactions
• Dense hubs of skilled and agile-minded tech talent

Why does China rock Asia? The Chinese consumer—and there are many of them—is far more willing to adopt financial technology than their neighbors. They were ready.

With 700 million internet users—more than any other country – The Economist writes in In fintech, China Shows the Way, “A potential revolution beckoned but plodding state-owned banks were slow to respond.”

The advent and proliferation of smartphones in China played a big role in the use of digital payments, according to The Economist, which says many mobile devices were purchased by people who didn’t have computers. “Today 95% of China’s internet users go online via mobile devices,” The Economist reports. It’s not just computers that the Chinese have leapfrogged over. The Economist says a large percentage of borrowers served by online lending giant Ant Financial “had never used a credit card.”

Now, the EY/DBS paper continues, “Forty percent of consumers in China are using new payment methods compared to 4% in Singapore. Thirty-five percent are using fintech to access insurance products compared to 1% – 2% in many Southeast Asian markets. There are also significantly higher rates of fintech participation in wealth management and lending.”

“With high levels of internet and mobile penetration,” says the EY/DBS paper, “China is already the world’s largest and most developed retail e-commerce market, accounting for 47% of global digital retail sales—the result of a massive domestic retail market in a closed digital economy.”

“By the end of 2015,” according to McKinsey's What’s Next for China’s Booming fintech Sector, “the market size of the country’s internet finance sector was more than 12 trillion renminbi ($1.8 trillion), dominated by the payments sector.”

This fact is not lost on investors. “Venture capital investment in Chinese financial technology firms surpassed $6.7 billion in 2016,” according to Forbes. “The reason for this is simple: China is home to the largest markets for digital payments and online lending. About 40% of consumers use new payment methods. As a result, China boasts the world’s four largest fintech ‘unicorns,’ or startups valued at over $1 billion, including Ant Financial, Lufax, JD Finance and Qufenqi. These firms received large amounts of funding in 2016, with Ant Financial alone receiving $4.5 billion.”

“The largest Chinese fintech company, Ant Financial, has been valued at about $60 billion, on a par with UBS, Switzerland’s biggest bank,” according to The Economist.

What are the verticals?

EY/DBS lists the fintech verticals this way:

• Payments, remittances, e-wallets
• Supply chain and consumer finance
• Peer-to-peer lending
• Online funds
• Online insurance
• Personal wealth and finance management
• Online brokerage

Who are the players?

Ant Financial and Alibaba. Lufax, JD Finance and Qufenqi. Baidu and Tencent. All are among the big names in China’s fintech field. KPMG recently published a list of the top 50 fintech companies operating in China, along with some details on each and some trends.

“The application of advanced technology is leading major breakthroughs in the financial services sector, for example risk quantification models, which have helped shorten the approval time for consumer loans, or big data, which is being harnessed to detect fraudulent behavior more effectively,” KPMG says.

Potential weaknesses?

Every silver lining has a cloud. Here are some of them.

• An array of risks. The McKinsey analysts write: “These include consumer irrationality, product defects, and even fraudulent activity, and require careful maneuvering. Players also should cautiously deal with the implicit credit risk and liquidity risk, and be aware that regulators are determined to strengthen the management of internet finance.” Complicating matters is a less robust culture of risk management.
• Intramural competition. “Banks are fighting back,” says The Economist. Banks are state-owned with well-endowed state-owned enterprises as customers. fintech companies are going at it, too, of course. The Economist notes: “Alipay, the payments arm of Alibaba, an e-commerce giant, soon became the mobile wallet of choice. But it quickly faced a challenge, when Tencent, a gaming-to-messaging company, launched a payment function in its wildly popular WeChat phone app, tapping its 500m-strong user base. Baidu, China’s main search engine, followed with its own wallet.”
• Increase in regulation domestically. This is particularly the case in the digital loan sector, according to Forbes.com. “Regulators, tolerant so far, are wading in,” says The Economist article.
• Less needy environments beyond their borders. The Economist points out that much of the success of China’s fintech players came from addressing deficiencies in China’s financial system. These deficiencies will not or may not necessarily be present elsewhere.
• Less friendly environments beyond their borders. “Anything that touches on core banking abroad will require local incorporation and adherence to local regulations—headwinds against global expansion,” The Economist says.
• Fits and start-Ups. According to The Economist, “More than a third of all P2P [lending] firms have already shut down. Yet P2P lenders still have a big role to play in China. Despite a string of headline-grabbing collapses, the industry has continued to grow.”
• Help wanted. Despite the hubs of skilled workers, Forbes says the size of the workforce is not keeping up with demand.
• Competition from outsiders. “We may also start to see more direct competition between the likes of Baidu and Google, Alibaba and Amazon, Tencent and Facebook,” EY/ DBS analysts say.

Can they go global?

“[J]ust like in China,” the EY/ DBS analysts continue, “business success overseas requires catering to the individual peculiarities of international markets and their consumers. Chinese companies cannot merely replicate and export domestic business models abroad. They need to adapt to local cultural norms and expectations, and focus on safety and security reassurance. To do so, they will need to collaborate with and invest in overseas comparators.”

What’s the prognosis for U.S. companies?

“Just as Chinese tech giants may enjoy greater success in seeking local collaboration, the same advice rings true for foreign firms trying to enter the Chinese market,” the EY/DBS paper reads. There are plenty of stories to learn from. PayPal did great in China. Uber? Not so great. Either way, the paper says, the market it simply too big and the payoff is too great for international companies to ignore.

Dan Harris is with the Seattle-based law firm Harris Bricken, and author of the popular China Law Blog, told the LexisNexis^® Corporate Law Advisor, “We are seeing a number of deals involving Chinese fintech companies looking to partner with American technology companies—either via joint ventures or licensing deals—to get access to software that will improve their financial and client risk modeling and analysis.”  

What’s the Prognosis for China?

In their article, McKinsey professionals Joseph, Luc Ngai, John Qu and Nicole Zhou, say, “China’s fintech sector will inevitably embrace fiercer competition and further industry integration.”

But, the McKinsey analysts see opportunity with the application of big data, which “allows financial institutions to collect and analyze customer data, providing more tailored products and services through a personalized marketing experience.”

This will help in risk management, too, the McKinsey team says, because “big data allows players to use advanced statistical models to better understand the correlation between factors and risks, based on both internal and external data. Combining this with cloud services facilitates real-time credit investigation and decision making at a low cost.  . . .  It’s perhaps no wonder that there’s a huge unmet need for big data analytics in China—and more and more companies are emerging to serve financial institutions unable to build this capability in-house.”

KPMG China’s Raymond Cheong, says: “The future of consumer finance hinges on the ability of fintech companies to leverage big data through customer profiling technology. This allows companies to provide more personalized credit services, improve scenario-specific services, and expand the pool of customers with access to better financial services to those that might traditionally have been excluded.”

Cheong adds: “Going forward, we expect to see more cooperation between fintech and financial services firms, especially as regulatory policies in relation to internet finance become clearer.”

The McKinsey analysts also see potential with so-called blockchain and related disruptive technologies. Blockchain technology—which allows higher security, unmodifiable transactions in the digital currency space—the McKinsey analysts say “enables point-to-point transactions without a clearing intermediary, substantially reducing transaction time and cost.” They see opportunity in the adjacent spaces of digital securities and online insurance.

While regulations are starting to tighten, due in part to some lending scandals, says The Economist, “Most of the rules are aimed at making fintech safer, not at curbing it.  . . . Regulations have placed speed bumps along their path. But the path is still there.

 “For years China has looked to developed countries for ideas about how to manage its financial system. When it comes to fintech, the rest of the world will be studying China’s experience,” The Economist says.