China’s mobile payments providers have enjoyed a meteoric success among the country's citizens, with Ant Financial’s Alipay and Tencent’s WeChat Pay now dominating a market that saw Rmb277,000bn-worth ($40,000bn-worth) of transactions in 2018 alone, according to the central bank, the People’s Bank of China (PBOC). This represents a 27-fold increase over five years, with WeChat Pay reporting 200 million daily users in November 2018, while AliPay claimed a total of 230 million daily users in January 2019.
The central bank also reported a growth in mobile payment transactions from 1.67 billion in 2014 to 60.53 billion in 2018. Having achieved a monopoly on the consumer payments area, these fintech behemoths are now contemplating how they can expand into China's other underserved banking areas.
Targeting SMEs
China’s small and medium-sized enterprises (SMEs) are currently suffering a lack of financing, and are thus viewed as an opportunity for fintechs. SMEs have been hit by increased regulation by the China Banking and Insurance Regulatory Commission (CBIRC) designed to cut China's non-performing loans (NPLs). The rules require banks to reclassify loans that are 60 days overdue as NPLs – a significant cut on the previous 90-day deadline. In order to meet the tighter rules, banks have also reduced their riskier lending, hitting SMEs, which in 2018 had an NPL ratio of 6.2% and often lack collateral.
This lack of funding for small businesses has been partly blamed for China’s recent economic slowdown, as gross domestic product (GDP) growth in 2019 is expected to slip to 6%, the lowest level in 28 years. The government has started to take measures to counter this, announcing in January 2019 that it would free up Rmb800bn to support new lending to businesses and households to stimulate the economy.
The CBIRC has given banks a target of increasing lending to SMEs by 30% in 2019, and has offered incentives such as tax breaks on micro-loans. In the first quarter of 2019, the amount of outstanding loans to SMEs by the five biggest state lenders rose to Rmb1990bn, a 17% increase on the previous quarter.
Too late?
China's largest bank, ICBC, has announced it is actively increasing its support for SMEs. ICBC president Gu Shu says: “Loans to small and micro enterprises increased by 18% in 2018. In the first quarter of 2019, loans to SMEs continued to increase, putting the bank ahead of schedule to meet lending targets for this year.”
While the big state banks may have taken steps to increase lending, the banking sector as a whole has come in for criticism for not lending to more companies. The five biggest state lenders accounted for almost 20% of all SME lending at the start of 2019.
There are concerns as well that banks that appear to be primarily lending to SMEs are actually lending to subsidiaries of a larger parent company, or to companies that are essential to the supply chain of an important corporate client. Some analysts also believe banks may be reclassifying existing borrowers from 'large' to 'medium-sized' so that on paper they meet the government’s lending requirements.
However, Charles Su, global market research and sales managing director at China Industrial Bank, says while there has been improvement in SME lending, it still forms a low proportion of the overall lending market. “SME loans are not economically appealing to big banks,” he explains. “Banks have to spend a considerable amount of resources on a number of SMEs to see the same returns as they would collect from a single larger corporate.”
Maximising returns requires a low-cost model with a high turnover – which is where the fintechs come in.
Enter the fintechs
WeBank, Tencent’s digital bank, estimates that 80% of the 90 million smallest companies in China do not have credit with a bank, and with 38 million customers, WeBank is capable of capturing a significant share of these underbanked companies.
Establishing banking divisions has long been part of the plan for the parent companies of the payments providers. Tencent, the company behind the WeChat and QQ messaging apps, launched web-based WeBank in 2015. E-commerce company Alibaba soon followed, with its finance division, Ant Financial, launching MYbank. Both banking divisions aim to support under-served portions of the market.
With bank loans to SMEs drying up, this new breed of lenders has taken more market share. Shen Le, spokesperson at Ant Financial, says the loans that MYbank extends are designed to suit small business customers. “Most of the loans are below Rmb1m, with the average size of each loan at Rmb26,000 by end of 2018,” he says.
Since the loans are relatively small, MYbank's 2018 profits were a relatively small Rmb670m – but according to the company, making huge profits has never been its intention. Instead, it aims to assist small businesses that use Ant Financial payments systems, in a move designed to keep customers faithful to the various divisions within the Alibaba brand.
Fringe benefits
Marrying their payments platforms with their banking divisions also has additional benefits for small business owners and sole traders. Mr Shen says vendors can take out medical insurance through Alipay, as they accumulate medical insurance from each collected payment. The system is particularly helpful to internal migrant workers that have moved to large cities from rural areas. Under the 'hukou' system of residency, Chinese workers are registered for services such as healthcare in the region where they are born, sometimes making it difficult to access help in the location where they are working.
Meanwhile, interest rates applied to loans have been tailored to suit SME requirements, with interest charged daily. It means borrowers can repay as soon as they have the funds, reducing the amount of charges incurred. For example, at WeBank the price is set at between 2 basis points to 5 basis points for each day of the loan.
“SMEs can’t afford high credit or service costs,” says Mr Shen. “They do not have collateral for their businesses. Because of this, banks won’t provide loans to street vendors. Through using artificial intelligence [AI] and big data, MYbank can offer these customers lines of credit without collateral.”
He gives the example of a roadside snack vendor wanting a loan to increase inventory ahead of a public holiday. MYbank can examine the vendor's transaction history to check if the loan is in line with previous transactions. In this way, having verifiable data helps both lender and borrower.
As the neobanks have oversight on the number of transactions a small business is making, they believe they can make more informed decisions on the health of a company. Though the PBOC reported that the average NPL ratio for SMEs at the end of 2018 was 6.2%, WeBank reported an NPL ratio of 0.51% and MYbank 1.3% in their respective 2018 annual reports.
Cutting fraud
The neobanks are also ahead of the game when it comes to fraud protection. WeBank uses the transaction data from WeChat Pay to create a white list of users that can opt in to the loan service. When signing up, they provide consent for access to be given to their credit bureau and police bureau data, which is then used to verify their ID and ultimately provide a credit line.
Detailed analysis of user behaviour helps to keep fraud levels low, according to Henry Ma, chief information officer at WeBank. “Our white list risk model allows us to check the accounts for natural-use behaviour and to determine whether it is a shell account or not,” he says.
Making decisions based on data analysis has enabled neobanks to automate the system to a considerable degree. MYbank has a '3-1-0' model for loan approvals, meaning it takes three minutes to apply for a loan, one second to approve, and all with zero human intervention.
“By the end of 2018, MYbank had 720 employees, most of whom are data scientists and technical personnel, to serve 12 million SMEs,” says Mr Shen.
Where incumbents can act
While fintechs and their subsidiaries may be the interface that connects the customer to the loans, they are not the sole institution that provides the funds and this is where traditional banks come into play. The model deployed by MYbank, WeBank and JD Digits operates with the neobank supplying a pre-assessed customer to the bank. The bank then performs its own check on the customer to see if they fit within its risk profile before it decides whether to extend the loan. For providing the borrower to the bank, the payments provider takes a small fee.
The prospective customer does not have to be an existing customer of the bank. As the service is offered online, it has opened up new areas of business to the smaller city banks.
WeBank’s Mr Ma explains that the bulk of the business operates under a loan syndication model. “It allows regional banks to contribute their capital, which is directly disbursed to the borrowers. The customers know which bank their funds are coming from,” he says.
The business model is giving the neobanks access to a new space, and the traditional banks a pool of data they would not otherwise be able to access. Simon Li, vice-president of JD Digits, says: “JD Digits cannot compete with the state banks in banking services. We instead provide them with risk assessment services. The decision to provide a loan remains with the banks, and they take the risk if the borrower doesn’t make repayments.”
Even though the model is already fully operational, there are still some questions around regulation and how the regulator will react in the future. Yu Liang, director at S&P Global Ratings, believes the regulator is still learning how the system operates. “How banks manage their underwriting standards when partnering with fintech companies is an important area to understand. A bank with limited experience in consumer lending and an ambitious fintech company could potentially present a classic agency problem. We understand the authority is looking into this potential issue and seeking ways to mitigate the risks,” she says.
A new ecosystem
Having the latest technology and data-gathering methods is essential to obtaining the detailed data that makes this business model viable, and in order to have the greatest possible amount of data, the platforms need to be accessible across the whole country, from cities to rural communities. It would be impossible to reach scale with restrictive, centralised systems.
Ant Financial’s Mr Shen says: “MYbank is established on the cloud, making all aspects of the bank available to SMEs and farmers across the whole country.”
Mr Ma says cloud computing underpins WeBank, allowing funds to be better utilised within the business: “Operating on the cloud drives down the IT cost, and the favourable cost structure has made financial inclusion a sustainable business. WeBank’s 'technology first' preference leads 30% of its total investment into R&D to continuously improve customer experience.”
With this in mind, the fintechs have one eye on future developments. The innovation is driven by an awareness of their own limitations and the constantly changing nature of technology.
For example, e-commerce company and Alibaba rival JD.com rebranded its JD Finance business to JD Digits to expand its offering beyond lending and into sectors as diverse as agriculture and urban computing, using emerging AI and blockchain technology.
Mr Li of JD Digits says: “As a company we look to the future of payments. What if there was no mobile? We are actively exploring biometrics. We have facial recognition in operation at our 7Fresh stores, where customers use the technology at the checkout.”
The 7Fresh stores are also a step away from the online world. The company has established a chain of high-end supermarkets that utilise mobile technology and blockchain to provide consumers with detailed information on the provenance of the food they are buying, down to the farm that grew the apples or the boat that caught the fish.
Deciding to run all aspects of the business in house is not always successful, however. Joseph Ngai, senior partner for Greater China at McKinsey, says: “Some of the largest Chinese online retailers have their own logistics companies, but these are not always profitable. Some of the leaders have recently announced heavy losses and significant restructuring of their businesses. Logistics is a heavily congested market.”
JD.com has faced difficulties. It has a model that guarantees delivery across the whole of China, with a number of distribution centres around the country and delivery through its own JD Logistics service. In the face of debts of Rmb2.8bn at the start of 2019 for the logistics division, the company stopped providing its drivers with a basic salary. Instead, drivers are paid depending on the number of packages they deliver. In some situations it can be more profitable to outsource certain aspects of the business.
Outsourcing technology
As fintechs and their subsidiaries are aware that banks, which are often weighed down by legacy systems and financial constraints, cannot move as quickly in adopting new technology, they are actively supporting banks' adoption of technology. For example, WeBank runs its transactions along an open-source blockchain, with free software and an open interface, to enable other parties to easily connect and modernise their operations.
Mr Ma says: “We support the smaller banks in getting on the blockchain. The technology provided is entirely open source, meaning they can easily link into the system and don’t have to build it from scratch.”
The technology used by the fintechs has proven successful in dealing with real transaction environments, including during challenging conditions; for example, when there are online shopping promotions. Mr Shen says: “Banks are using the technology designed by Ant Financial in processing their own transactions. During the Singles Day shopping festival in 2017, Ant Financial processed 256,000 transactions per second. We are comfortable dealing with that volume of traffic. The systems have been speed tested.”
As the fintech behemoths look to expand their operational horizons, tapping into banks' technology interfaces through open-source platforms could be the next area that they explore.
