The credit card industry in China The rise of a national champion and challenges for the future
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Student Research Projects/Outputs No.040
The credit card industry in China
The rise of a national champion and
challenges for the future
Javier L Santomá Vilaclara
MBA 2009
China Europe International Business School
699, Hong Feng Road
Pudong, Shanghai
People’s Republic of China
11. Introduction
The growth in China in the last thirty years has been impressive and has been achieved
through a combination of government and private initiative. The growth numbers in
China have been impressive and if the trends stay as they are now it will surpass the
US as the biggest GDP country in the medium term.
As the country developed the central government realized the need of establishing
credit and debit cards. There were already players in this market that are global
companies and quite established as they have been in the business for a long time. The
principal players are VISA, MasterCard and American Express.
Instead of approaching the means of payment business with one of these players and
through the bank the Popular Bank of China PBOC decided to impulse a Chinese
platform. The result of these efforts was China Union Pay. It was born as an initiative of
China and the principal banks quickly accepted.
The analysis is going to focus on the actual situation of penetration and usage of credit
and debit cards and also is going to look at what the next steps are going to be. This
analysis is interesting because China is a country where the bancarization has
happened relatively late but also very fast.
It is going to be structured this way. In the first part the business model and ecosystem
for the credit and debit cards will be assessed. Once the way the business works is
clarified will delve deeper in what is the situation right now and how is the outlook for
the future. It also will check what are the advantages and disadvantages of the
electronic payments. To close up we will finish with a note on what are the challenges
being faced because of all these changes and all the future trends.
22. The business model
To clear an electronic transaction with the credit card the infrastructure you need is
composed by a Point of Sale (POS) terminal, a card linked to an account and an
electronic data transmission going back and forth to confirm the validity of the
transaction. The clearance system is composed by the technological standards inside
the POS terminal and the language used to clear the transaction once the card has
been swiped. As the shops don’t want to have many different machines for each of the
technologies they either pick a system of payments or use terminals that are valid for
different cards.
In the past the POS terminals would only accept one type of credit card and to accept
different cards the shops needed different terminals. Technology though has enabled
terminals that can accept different credit cards and have helped expand that types of
cards that can be accepted. Even with this technological advance there is only room for
so many companies in the electronic clearance system as a big critical mass is required
to allow the model to function.
It is very important to see the distinction between credit and debit cards. Debit cards
clear the transaction almost in real time and will not work if the account balance is not
enough to pay for the transaction. It is almost like paying with cash but instead the
amount is deducted from the bank account. On the other hands credit cards work
different and the amount is charged against the credit of the card and is normally
cleared once a month adding up all the expenditures made with the card up to the
date. This means the consumer can spend money even if the bank account linked to
the credit card doesn’t hold enough to pay for the transaction
One of the critical aspects in this business is the network or penetration measured by
the numbers of retailers or POS that accept the card. It is a critical measure because
for the customers it becomes really frustrating not to be able to pay in certain outlets
because the card is not accepted. This translates into the network being a key issue for
the acceptance of the card. The other side of this equation would be the number of
cardholders. Merchants do not feel compelled to install the POS terminal if the
3number of card members is not big enough. As you see when you implement a system
of payment clearance you have to grow both sides more or less at the same rate
although the merchants are more critical because their switching costs are higher.
Once they have the machine and the systems in place it is more difficult for them to
change the payment system than to a cardholder to change their card.
Another important aspect of the card from the customer’s point of view is whether he
will be able to use it to get money out of the ATM system. In this case though it is
easier to achieve penetration because the partnership has to be only with the banks
and then the banks change the ATM network so that they can accept the credit cards.
The banks are also very important in the system because they are normally the card
issuers and can push a type of card to their customer base. As a result of this the credit
card companies have always been trying to get the different banks to give cards with
their clearance system to the customers. The customer normally accepts the credit
card that comes by default with the products he has at the bank and thus it is an
important part of the business to have the support of the banks
3. Why is there a big potential for the credit card business in China?
The penetration of credit cards is almost inexistent compared to the US (0,9
percent compared to 300 percent in the US)
Even though China is a market where credit is not used as often as in the US
and the Chinese consumer is more savings oriented than in the US. The average
unpaid balance, credit left revolving in the cards instead of being used is only
2.5 billion RMB. If the tendency is similar to the one seen in more developed
economies there will be a very big growth on this numbers as consumers start
using the credit cards to carry balances.
As of 2007 the Chinese domestic banks had still not made profit with the credit
card business. The reason they are pushing this issue is because they see it as a
potential profit making activity in the futures. For the multinational banks
operating in China the outlook is a bit different as they are already making
4profit on their credit card business. This is probably because of the customers
in average are more sophisticated.
If we use Hong Kong as a reference point to where mainland China wants to
head we can see that at the end of 2004 in Hong Kong 20% of the purchases
made had been made with credit card.
4. China Union Pay
China Union Pay (CUP) is a government initiative to create a Chinese clearance system
for payments. The Popular Bank of China (PBOC) backed the initiative and got the
biggest Chinese banks on board for the initiative. The initiative launched in 1992 and
has been really successful as it is the reference card now in China. It is also expanding
internationally as their customers will travel more and more often. As such CUP was
not established until March 2002.
Its mission states that one of the goals is “create an independent bankcard brand of
China by cooperating with commercial banks to push forward the sustainable and
healthy development of China’s bankcard industry”
The government support to CUP has factually blocked the entrance of any other
competitor in the electronic clearance market. This has caused the US administration
to present a complaint in front of the World Trade Organization (WTO). The complaint
claims that the government in this case has caused a “de facto” monopoly for the
credit card payment. In china this is actually a reality, CUP is everywhere and even
though they have agreements with other companies to process their credit card
payments it is CUP who has a hold in the market. With the time it takes to the WTO to
process a complaint even though the US might be right in their claim the result for
China will be a big fine and an imposition to open thir market for the electronic cards
5payment. Even if they open their market in some years it will not be so important
because the footprint of CUP is already very high and will become even higher.
CUP has signed agreements with different partners (VISA, Mastercad, Amex) to allow
Chinese cardholders to use their credit cards in the partner’s systems while abroad and
to allow the customers of these companies to use CUPs system when in China. These
agreements make sense for both parts because it expands the region where the cards
are useful. The result is normally a card that haves the two standards CUP and VISA for
example. Another possibility is to emit two different cards to each customer in case
the customer wants to travel.
Recent developments have shown that these partnerships can go sour and the
partnership CUP and VISA is an example of this as recently VISA announced it would
reject CUPs overseas channel. This translates into the VISA system not accepting any
more transaction made by their global customers through the CUP system with their
dual cards. This measure started applying after august the first of 2010.
This is a direct result of the two conflicting business model and a move by VISA to try
to retain their profit share. VISA earns money when they process the transaction
through their system and thus allowing CUP to process their customers doesn’t report
them any monetary benefit. The cardholder here is the one who ends up suffering
because he will not be able to use his credit card anymore in the CUP system. The
official reason for VISA to justify this movement is that the security of the CUP
clearance system is not enough to assume the risk.
Some data that can document the exponential growth of CUP as the card system of
reference in China are the following. At the end of June of 2009 1,570,000 merchants
had affiliated with CUP translating into 2,410,000 POS pieces. The ATM network had
reached 215,000 pieces. This numbers when you compare them to the numbers in
2001 before CUP was established as such are around 10 times more for merchants and
POS terminals and 5 times more for the ATM network. Of course here there are two
effects mixed the economic growth of China that has increased the numbers of stores
and ATMs and also the penetration of CUP once it was decided it would be the
6clearance system of choice for China. As for the transaction money in 2009 it reached
the RMB 7.7 trillion and that figure is 83.7 times the one that we had in 2001.
The international acceptance network now reaches 98 countries for CUP. This figure is
very likely to keep increasing in the next years until they reach all the countries
because all the national banks in the different countries are willing to accept the card
that has become the standard in China. The selling argument is very easy once you
realize that the Chinese population is starting to travel and that their card is the CUP.
The strengths that CUP has enjoyed are the following
Government backing, as a company CUP was founded once it was decided that
China needed its own clearance system for its population and to compete with
the international companies. The PBOC supported the creation of CUP and so
did the central government and all the different regional agencies. It is critical
in China to be aligned with the political institutions as the economy is less
liberalized than in other countries. There are also a lot of State Owned
Enterprises that have a political agenda as well as the business one.
Low penetration of credit cards, traditionally the Chinese conducted all the
transactions in cash. For the businesses cash transaction have an advantage
against card transactions because there is no discount fee that goes to the card
company. It was hard for the foreign companies to make the merchants realise
the advantages of the credit card. CUP has probably had this problem also but
being a Chinese initiative the resistance has probably been less intense.
Chinese Banks support, once CUP was created it received the support of the
main 14 banks in China. These banks have their customers and once they
adapted CUP they passed it on to their customers. This way the merchants
were more prone to accept the system because potentially so many customers
would have it. This also translated into some of the doors being closed for the
international companies as the banks had already made explicit they sided with
CUP. Some products of internationals companies are also being offered at
these banks but only for a very specific segment of the population that travels
or has a very high income.
7 Good technological standards, the system works and it is safe and convenient.
If the system hadn’t worked CUP would have encountered a lot of trouble and
resistance from all the stakeholders, customers, banks and merchants. The
launch didn’t happen until the product was robust enough and this way they
ensured there would be no problems on this side.
Financial capabilities, CUP had enough cash at the beginning of its operation to
pay for the installation of the network and the POS terminals. It had to spend a
lot of cash in setting up this infrastructure and had it nod been properly
financed it could have run out of cash. The revenues on the card model don’t
show up until some years later especially in countries with low penetration so
they had to be ready to invest a lot of cash into the system.
5. Challenges
The debit card business main challenge is growing the network of POS that accept the
credit card and growing the number of customers. Paying with plastic offers a lot of
advantages against the more traditional methods, it is convenient, the records are kept
of all the transactions and it is safer than paying with cash. Specially the pin enabled
terminals that require the customer to input their personal number when doing the
transaction.
Credit cards are a different issue as the banks push them because they bring in really
good profits. The commission charged for the transaction is higher than with debit
cards. The main source of profitability though comes from the customers who use the
cards as a mean of financing the purchase. The cardholder will not pay the whole debt
in the due date and will pass the debt to the next month. The issue here is that the
interest rate required to finance this debt revolving is considerably higher than any
other interest the customer could access. The Chinese government has already
realized that and is trying to control a little bit who receive the credit cards to avoid
very difficult situations where the cardholder can’t cope wit the debts. The measures
they have passed include the following. The banks should not give gifts to new
8cardholders for signing up for a new card. The staff in the banks will not have a sales
quota for credit cards. Another measure is that they will not give credit cards to
anyone under 18.
One of the goals in the Chinese agenda is to increase the internal consumption as the
middle class grows in China. Credit cards will definitely boost consumption as
consumers spend more when they use credit cards. It is important though to make
credit card holders aware of the advantages and disadvantages of the credit cards so
that they can take an informed decision.
6. Conclusion
CUP has been a success and is achieving the goal it had set for itself to become the
reference in China for card payments. Card payments help an economy develop as
they take risk out of the transaction and increase consumption, it also help both the
merchants and the card holder keep a better track of their spending, reduce the
paperwork and increase the transparency. As China develops the penetration of CUP
will increase as they are already positioned to be the reference card in China and in the
future in south East Asia.
The clearance system will have a positive impact all over China as it is more convenient
for everyone involved provided the fees to the merchant are not excessive. CUP has
had a very transparent policy about fees and fees are in lowest range in the industry
especially for debit cards. This in turn will further increase the acceptance of the cards
as the merchants adopt the technology and so do the customers. One of the
advantages in china is that it is jumping from cash to plastic payments and has skipped
in big part the whole check book as a mean of payment.
With an increasing customer base and wealth the penetration of plastic payments will
grow in the coming years until it reaches a plateau. This is still down the line as the
9difference between the China figures and the ones in the developed world is very
thing.
107. Bibliography
Redemption behavior for credit card reward programs in China
Type: Research paper
Author(s): Matthew Tingchi Liu, James L. Brock
Source: International Journal of Bank Marketing Volume: 27 Issue: 2 2009
Do credit card redemption reward programs work in China? An empirical study
Type: Research paper
Author(s): Matthew Tingchi Liu
Source: Journal of Consumer Marketing Volume: 26 Issue: 6 2009
The Top Ten Global Retail Banks
Business Insights
Datamonitor 360º
China Union Pay website
http://en.unionpay.com
Growth in credit card usage in China
http://seekingalpha.com/article/175425-growth-in-credit-card-usage-in-india-and-
china
11American Express figures on China
http://home3.americanexpress.com/corp/pc/2004/pdf/cc_market.pdf
Article about the competitive environment in China
https://www.mckinseyquarterly.com/Competing_for_Chinas_credit_card_market_171
3
China cracking down on credit card issuers
http://www.nytimes.com/2009/08/14/business/global/14card.html
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