China's leading e-commerce companies are using their wealth of consumer knowledge to tap into the country's state-dominated banking market, introducing innovative new products that threaten to overshadow the more conventional offerings of local banks.

From a Boeing 737 to a paternity test and even a micro loan service, Chinese e-commerce giant Alibaba is expanding the scope of its cross-platform offering as it moves to take on the state-dominated banking sector. This push into banking follows rapid year-on-year growth, both for the company and for China's e-commerce industry as a whole.

China's e-commerce industry has seen annual growth of more than 70% since 2009, with the country projected to overtake the US in 2013 as the world’s largest digital retail market. On ‘singles day’ – a day of digital promotions in China held on November 11 and created to rival St Valentine’s day – Alibaba alone recorded sales of Rmb35bn ($5.7bn), more than three times the total amount recorded on Cyber Monday 2013, the comparable US digital shopping day.

According to consultancy Bain & Company, in a vast country not well served by traditional retailers, digital commerce has “furiously transformed shopping and purchasing habits, opening up vast opportunities for retailers and brands”. Annual digital sales in China are forecast to reach Rmb3300bn by 2015.

Pushing the envelope

The explosion of e-commerce, with broadband now reaching more than 30% of China’s 1.4 billion population, is helping to drive domestic consumption in the country as its government tries to shift the economy away from its over-reliance on public sector investments and exports. But Jack Ma, the 48-year-old founder of Alibaba, wants to go further.

In an interview with Chinese newspaper the People’s Daily, Mr Ma criticised China’s financial regulation for being “excessive” and said that the banking system failed to meet the needs of 80% of the population. This includes the growing number of small and medium-sized enterprises (SMEs) that struggle to get support from a banking system tailored to state companies.

Alibaba applied for a full banking licence in 2013, responding to a call by regulators for the private sector to enter the state-dominated industry. Among others that filed applications were home appliance retailer Suning, air-conditioner manufacturer Gree, and Tencent, China’s biggest internet company.

“Internet companies such as Alibaba have a clear advantage over banks, because they have real-time information on their business clients’ cash flow that banks will never have,” says James Antos, analyst with Mizuho Securities Asia. He adds that two major Chinese banks spoke about Alibaba’s founder during their financial results meetings “because they feel threatened” by the pace of change being brought about by the company's strategy.

Making headway

Alibaba's love affair with financial services began with the success of its payment service, Alipay, which was created to support the company's e-business. Alipay was launched in 2004, and was marketed as a third-party online payment solution that, similar to the US's PayPal, aimed to enhance consumers’ trust in online transactions by not sharing personal information with the recipient of the payment. This was seen as a crucial offering in a country known for its weak consumer protection laws.

Alibaba managed to pull ahead of PayPal owner eBay in China through a better understanding of local consumers, thanks in no small part to features such as its escrow payment service that allows consumers to unblock payment only once the product is received. According to market research firm iResearch, Alipay has now become the largest online payment provider in China, with a 49% market share.

“Alipay has made online payments more trustworthy, benefiting the whole financial industry,” says James Hardy, head of Alibaba in Europe.

A new target

The banking industry received another wake-up call when Alibaba started offering banking-type products to its large and growing client base, many of them SMEs requesting loans. Alifinance appeared under Alipay’s umbrella in 2011, providing micro-sized short-term loans for SMEs on both its Taobao B2B and Tmall B2C platforms. According to the Financial Times, the company has extended loans totalling more than Rmb100bn since its inception. The company now also provides a credit payment service, built on its own credit score.

Speaking about the company’s overall strategy, Mr Hardy says: “We use big data to take crucial decisions.” He adds that Alibaba’s nimbleness in decision-making is what has led to the company's global success. “What distinguishes us is speed. Our culture is made of little bets taken extremely fast to test out different ideas and geographies, by distributing responsibilities,” Mr Hardy says, noting that “embrace change” is one of the company’s “six fixed values” on which all employees are rated.

One of Alibaba's most recent innovations was its money market fund, Yuebao, which offers an interest rate of between 4% and 5% – far higher than the standard bank rate. Since its launch in mid-2013 it has attracted more than 30 million users, according to Chinese media.

“This could be a serious threat to the banking industry, especially as more players get involved,” says Zennon Kapron, managing director of financial consultancy Kapronasia in Beijing.

Reflecting the sensitivity of the issue, Alibaba declined to comment on its financial services and its relationship with banks.

Stimulating innovation

Some Chinese bankers see a positive side to the encroachment on banking services by digital-based companies. “They stimulated innovation that would have otherwise been much slower. Now you can see banks changing at a very fast pace, with many new services,” says an official at China Merchants Bank who asked not to be named.

A leading mid-tier bank, China Merchants Bank has seen online transactions on credit cards double in 2013. “Innovation also means that we can monitor transactions and analyse customer behaviour and collect data. We use social media to get information, not only about the individual, but the group they interact with,” the official says, but admits that while the bank can only see that a purchase is made through Alibaba, Alibaba itself knows the exact product that has been bought.

Some banks have tried to link up the forces of their own liquidity with e-commerce data. Minsheng Bank, a privately owned bank with a large SME client base, partnered with Alibaba on wealth management products, credit card operations and electronic banking.

Less successful was China Construction Bank, China's second largest bank by assets, which failed in its attempted collaboration with Alibaba, reportedly because the two parties could not reach an agreement over the financials of such a deal. Following this, the bank has made an attempt to break into digital on its own, by launching an e-commerce platform.

Friend or foe?

Tension is in the air and regulation will be the next battlefield. A liquidity shortage remains a major weakness of non-bank companies, so Alibaba – with sales accounting for about 2% of China’s economic output – is planning an initial public offering, which is expected to raise more than $100bn.

“We need regulation, not to monitor the entry, but the operations and the risk management of new entrants,” says the official at China Merchants Bank, echoing other concerns over unregulated shadow banking.

As more Chinese e-commerce companies gear up to expand cross-border, foreign banks will have a major role to play, leveraging their experience in other markets, says Bank of America’s Amit Sharma, head of e-commerce in Asia. Mr Sharma believes that when credit card acceptance and online banking matures in China and the fraud risk management environment improves, there will be opportunities in implementing next generation payment. “As a result, banks could potentially view third-party payment providers as partners, rather than competition,” he says.

Hong Kong’s Bank of East Asia sees internet companies, such as third-party payment organisations, as competitors and potential allies. “We can co-operate to open up new markets for each other,” says Charlie Zhang, the bank's executive vice-president.

Mr Antos, the Mizuho analyst, is sceptical, however. “I have never seen a bank joint venture that makes money for anyone: a partnership may benefit Alibaba but not banks,” he says.

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