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Digitization & trends in Banking industry in China to promote digital-only banks in future

“Digital China” was treasured in the country’s 2016–2020 five-year economic plan and is a top economic priority at present. The "China's digital transformation involves the use of technologies that include the mobile Internet, Big Data, the Internet of Things, Cloud computing, block chain and artificial intelligence which are now being embraced by the Chinese banks as well.

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Definition / Scope

Different types of Bank in China are:

  • Specialized banks – The four specialized banks in the country are the Agricultural Bank of China (ABC), Industrial & Commercial Bank of China (ICBC), and the Bank of China (BOC)
  • Specific lending purpose banks – These include the Agricultural Development Bank of China (ADBC), and the China Development Bank (CDB)
  • Commercial banks
  • Foreign banks

China has the biggest bank loan market across the globe, whereby the banking system is heavily regulated and has been dominated by the big five state-owned commercial banks.[1] These commercial banks to the investment banks and the private bank have been early adopters of financial technology.[2] 2017 is the breakaway year as the Central Bank of China continue to secure the digitization in payment and banking sector through reinforced regulation.[3]

Market Overview

China’s economy is now undergoing profound structural changes. The Belt and Road Initiative, as one of China’s key national initiatives, is expected to have a significant impact on China’s economic development[4].

Besides that a digital transformation is the center of new model in China. Which is also known as the 'new economy' whose foundation lies in innovation and domestic demand. “Digital China” was treasured in the country’s 2016–2020 five-year economic plan and is a top economic priority.[2] 2016 Wall Street Journal headline declared, “The Future of Banking is in China.”[3]

Key Metrics

Metrics Value Explanation
Base Year 2018 Researched through internet


Market Risks

As of 2011, one hundred and seven countries currently provide some form of deposit insurance, according to the International Association of Deposit Insurers (IADI). China does not insure its deposits, but according to the IADI, that country and 23 others have systems pending or are planning to create deposit insurance.[5]

The liberalization of interest rates have led the banks to not only diversify their income structure but also weakened the position of bank as an intermediary. The net interest margins have narrowed and there have been frequent cases of high NPL (Non- performing loans) in banks. This has created the need of effective risk management systems to be implemented in overall banking system in China.[6]

For Chinese retail banks, operational risks and fraud are often a bigger challenge than customer default. Thus, there is a need of an effective risk management system to be employed.[7]

In the present financial system the traditional banks are issuing checks that brings risk of fraud. There have been instances of circulation of fake checks in the banking system.[8]

Top Market Opportunities

The liberalization of capital account and the repeated interaction with foreign capital markets have brought opportunities to the banking industry.[6]

As the emerging consumer class is the next big thing in China, Banks have an opportunity to explore the consumer market with the credit card, car loans and mortgage schemes[9], over the next decade, it is estimated that more than 50 percent of credit card revenue growth will come from deepening existing customer relationships.[7]

Banks must venture into alternative multichannel multi-access platforms like mobile banking, ATM penetration, internet banking etc. and cater it to their customers because these are gaining popularity amongst customers and thus is essential for a next generation banking.

Facial recognition is one technology that is soon to replace the old usual Know-Your-Customer (KYC) process to open bank accounts. It is high time for the banks to adopt this technology by working with the government linking the national ID cards of Chinese residents to their respective systems.[10]

As the third party payments is forecasted to reach $1.2 trillion and is largest in the world, it is high time for the banks in China to partner with the respective payment companies who have been catering to the segment of P2P payments or else a huge consumer market segment will be lost to these banks.[2]

Market Drivers

For Chinese banks, in order to seize an opportunity to earn more profits they need to plan a new model and consider changing factors such as maturing marketplaces, and a retail landscape marked by changing customer behavior, rising funding costs, intensifying competition, technological innovation etc. and use these components to generate value in their businesses

A survey which was conducted has found that 12 of the top 15 loyalty drivers in banking are customer-experience related. Therefore, delivering a quality, class and end-to-end customer experience is a critical building block in acquiring and retaining primary banking relationships.[7]

The focus of multiple banks at present is to transform their business networks. They are offering range of financial products such as payments in addition to traditional functions. They are forming a base of most diversified customer base and using innovative IT tools to provide facilities to the customers.[4]

As Central Bank of China has introduced the block chain system and trying to build a digital currency backed by central government. Moving online reduces costs, increases transparency and limits fraudulent activities. The idea is to promote digital-only banks in future.[3]

Market Restraints

The banks in China are not able to perform well because they are suffering with the problems of bad debts. Usually they grant loans to state owned enterprises that have well known history of defaulting in loans.

China’s farce of a banking system, afflicted by corruption, is not yet prepared to battle against change and competition.[9]

China is a vast country with uneven regional development, in such case overall diffusion of internet finance cannot happen overnight. This is a pain point in the banking sector.

The main consumers of financial products, middle-aged and older adults are still hesitant to accept digital financing.[4]

The Chinese Banking system is still heavily dependent on the paper and dated communication means like fax despite of four banks listed in top global banks list.[11]

Industry Challenges

There is presence of mutual co-operatives that are carrying out banking activities in various rural areas of the country. The lending function is concentrated too much in these institutions which implies high risk of rural business and also lack of competition due to the less presence of formal banks. There is low coordinated development of banking system in rural and urban areas. It is due to lack of sound infrastructure development in rural areas of the country.[12] On the other hand in order to reduce poverty, Fintech in China is in a verge to become a leader in a microfinance revolution.[2]

Many fintech companies such as Alipay and Tenpay are using the mobile internet and artificial intelligence, which is eventually causing the bank branches to extinct in near future. These fintech companies have introduced concepts like We Bank and MY bank. Gradually, the banking institutions are transforming into cost centers as they are unable to attract high segment customers with use of such technologies.[4]

Internet usage in banking is present is first- and second-tier cities only. The payments, direct banking are the channels that can address small loans and transactions but still the large loans, wealth management and other issues cannot be addressed with online channels for that banks have to still depend on the traditional brick and mortar system of branches catering to customers.[4]

According to the China MSME report of 2014 almost 80% of SME's are not served by the Chinese banks. These segments along with micro lending and consumer credit are not popular in banking channel because of complex KYC procedure used by the banks. As a result the entire P2P segment is left unexplored despite of having a great potential.[13]

Technology Trends

Especially for emerging markets like China, there will be increased importance of the mobile channel and increasingly the growth of smartphones changing access to banking service. The use of new ways to interact with customers, and increasingly the use of chatbots, will be a key trend.[3]

Penetration of ATM machines rose from 53 percent in 2007 to 84 percent in 2011; telephone banking, from 4 to 12 percent; Internet banking, from 3 to 18 percent; and mobile banking, from 1 to 3 percent.

Through effective data-mining and stringent execution, it has been observed that a joint stock bank successfully convert 15 percent of its mortgage customers to mass affluent wealth-management customers.[7]

Technological trends that are emerging in the retail banking in China are:

  • The ability to address customer needs in real time
  • Cloud computing
  • Online and mobile payment
  • Crowd funding
  • Real-time settlement
  • Marketing campaigns through the Internet
  • Data-driven risk management
Technology trends.jpg

Regulatory Trends

On regulatory front, there are payment companies in China that have already taken a quarter of all the transactions in China within 5 years of operation are getting good support on the regulatory front as the regulator have given them free will to leverage the payment flows into activities such as cross-sell investment, insurance, and lending products to customers, threatening the core of retail banks’ business.[7]

A major decision of deregulation of banking system in 2009 was the main cause to increase market share and competitiveness of joint-stock banks in China. This led to an increase of 26.3% on number of new opened bank branches and an increase of 68.2% on the outstanding loan amounts. Further it also led to an increase of approximately 6% in new banks share of firms’ bank loan debt.[1]

The Central Bank of China has introduced a new technology called block chain system which is expected to kick off soon. It is an infrastructure of a system that issues digital checks based on a block chain with smart contracts technology. This is to solve the issue of fraud check in Chinese market.[8]

The traditional Chinese banks are under a very constricted regulations regarding the loan/deposit ratios, KYC, AML and so on but very little regulation exists in the P2P lending sector as it doesn’t even have a capital requirement.[13]

Other Key Market Trends

In 2016, the Chinese central bank launched the Macro Prudential Assessment (MPA) system began to assess the overall financial health of banks which is an IT related scheme used to access the lending of banks.[6]

Intelligent banks featuring advanced technologies. According to a survey of Chinese bankers, in the technological area banking based on big data has attracted the highest amount of attention.

From a Banking product perspective, wealth-management products, including mutual funds and bancassurance, and consumer finance such as credit cards, personal loans, and auto loans, will be the fastest-growing product categories between 2010 and 2020.[7]

Other Banks such as China Construction Bank just opened China’s first automated or self-operated bank outlet supplied with facial-scanning software, a virtual reality room, a hologram machine, and answering questions using voice recognition, and also offers touch screens for paying utility bills.[10]

The fintech companies are initially targeting the marginalized communities and are expected to change the overall old financial system within a period of next 10 years[2]

The Central Bank of China also known as People's Bank of China is exploring and researching the possibility of introducing its own digital currency.

At present up to 10 banks in China are already looking to hire block chain professionals to integrate paperless, tamper-proof, auditable and secure transactions via block chain technology[11]

Ant Financial, Alibaba are few fintech companies has entered the loan market, possibly in consumer lending segment to drive e-commerce sales in its e-commerce platform.[10]

Market Size and Forecast

The policy banks of China as mentioned before are mainly established in 1994 and they promote international trade activities and oversee the policy operations of other state-owned banks in China. Regarding 2018, the overall revenue of the banking industry is $154 billion with a CAGR of 6.8% from 2013 to 2018. The industry generates 68,586 employment opportunities and a total of 2257 businesses are involved within this banking system.[14]

Profits in the Chinese commercial banking sector was US$240 billion in 2016. That’s an increase of 3.54% compared to the year before.[9] However the profit had increased by 14.5% and 9.7% respectively in the year 2013 and 2014. The profits were slowing because of the downward pressure on the economy.[4]

China will become the second-largest retail banking market in the world by 2015, with an annual revenue expected to reach around $280 billion by 2020.[7]

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Market Outlook

  • Deposit will shrink in the long run as more consumers are expect to spend rather than save.
  • Consumer finance will grow fast but remain quite small compared with cards.
  • Fee income as % of revenue will rise significantly driven by innovative and tech related products[7]
  • The assets of foreign banks increased the most, with a compound annual average growth rate of over 20% and have lowest NPL (Non-performing loan) compared to other categories of bank operating in China.[4]
  • Regarding, the disruption of the digital trends there are few banking related products which are going to face serious repercussions such as Personal loans, wealth management and SME loans followed by in store-payments (Debit & credit cards), International remittances and finally mortgages.[13]
Otlook.png2.png

Technology Roadmap

Till date the Chinese Banking system is still heavily reliant on the traditional ways of operating business. China at present is still going through the hype of block chain adoption before actual implementation comes around. The Regulator of banks in China is more than ever dedicated to spend on significant resources and bring up number of applications to drive the digital currency and overall digitization not only in banking industry but overall commercial industries in China.[11]

China's rapid technological progress has brought about a revolution in the country's banking industry.[6] Digitization is changing the structure and competitive dynamic of the Chinese banking sector.[2] without the use of business technology at core operational model, banks can hardly fulfil the growing consumer demand and their sophisticated needs.[7]

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Distribution Chain Analysis

The number of unbanked villages have declined by 434. A total of 88.09 million rural households are served by bank lending. The saving and loan amount in rural areas have also increased. The deposits have amounted to 10.6 trillion and 5.72 trillion respectively. The outstanding balance or rural and agricultural loan were 2.36 trillion and 1.31 trillion respectively.[12]

Hong Kong and Southeast Asia are home to most Chinese banking openings. As of the five major commercial banks of China, 71.4 percent of their branches were located in Asia and Europe at the end of 2015.[6]

The growth of retail banking in limited to the top 50 cities in China contributing about 46% of the increase in revenue. These 50 cities are expected to contribute 56% to revenue in next 10 years.[7]

Competitive Landscape

People's Bank of China (PBC) which is the central bank is the entity that is authorized to conduct banking related operations such as regulating lending and foreign exchanges between banks, representing banks in international forum and employing suitable monetary policy. The regulation and supervision of other concerned banks in the country in the Chinese banking system is the China Banking Regulatory Commission (CBRC), which is charged with writing the rules and regulations governing banks in China. It is involved in activities such as collecting and publishing statistics on banking system, expansion of banks, resolve liquidity and solvency problems etc.[5]

China has three policy banks, which make up this industry: The China Development Bank, the Agricultural Development Bank of China and the Export-Import Bank of China. Each of them are dedicated towards lending for specific purpose. Besides that there are four specialized banks established for the purpose of commercial activities are the Industrial & Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC) and Bank of China (BOC).[5]

China has also multiple joint stock commercial banking institutions and more than a hundred city commercial banks that operate in various parts of urban areas. There are also banks in China dedicated to rural areas of the country. Foreign banks were also allowed to establish branches in China, and to make strategic minority investments in many of the state owned commercial banks.

International Competition

Among the top 10 largest banks in the world: ICBC, China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC) are four banks that are in the list. [15]

Domestic Competition

At present, the market is at maturing phase however by 2020 the market of retail banking in China is expected to become highly saturated point. There was an Asian financial crisis in 2007/08 despite of that 7,340 new branches were opened in China in 2009 and 2010 alone. The number of bank branches per 10,000 people in Beijing and in Hong Kong was 1.8 in 2010. This suggests that the competition in retail banking in China is very fierce.[7]

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Competitive Factors

China’s banks are undoubtedly big. As, the world’s top four banks in assets are Chinese.[9] In 2009, Bank of China was known to be the second-largest loan provider in China.

Advancement in technology has made it possible for noncompetitive players before to create disruptive business models.[7]

ING, a direct banking brand doesn't have any branches and is coming up with seamless banking solutions such as it has cafes that offer customers banking business on public computers and advisors are available to assist those who want to discuss their banking matters.[4]

The major competitor of Chinese Bank is a company known as 'Tencent' which has got licenses for insurance, micro financing and most recently, the ability to sell funds directly to customers.

The all five big banks in China have associated with tech giants For example, Tencent is working with the Bank of China, one of China’s largest state-backed lenders, on a cloud platform that will provide internet banking and funding solutions.[10]

Payment firms have more retail customers than banks have and are now expanding into offline payments.[13]

Ant Financial launched online-only My Bank in 2016, issuing 870,000 loans thus far.[15]

Bank of China Implemented IT Blueprint Project for overseas branches, with key features including system standardization and database centralization. [16]

China Merchants Bank Strong emphasis on integration of most, corporate banking solutions on a single e-banking platform. [16]

China construction Bank Integration of e-commerce trading platform into businesses’ online banking platform, providing an avenue for distribution of products, trading, credit financing, and financial planning tools.[16]

Competition 2.jpg

Key Market Players

Policy Banks

  • Industrial & Commercial Bank of China (ICBC)-
  • China Construction Bank (CCB)
  • Bank of China (BOC)
  • Agricultural Bank of China (ABC)[15]

Commercial Banks

  • China Merchant Bank
  • China Citic Bank Corp.
  • Bank of Communications
  • Industrial Bank Co. Ltd
  • Postal Savings Bank of China

Non-Financial Tech Players

  • Ant Financial,
  • Alibaba (ALipay)
  • Tencent
  • JD Finance

Strategic Conclusion

In the future, Chinese retail banks must develop a thoughtful strategy on where and how to play. They have to be customer centric and technology centric at the same time and focus on growing consumer segment, new product lines, and geographies depending on their capabilities. Taking the next step in technology will require banks to revamp their business technology infrastructure and related operational processes, while setting up a truly innovative organization for the future. An “innovative institution” is the new requirement in the Banking Industry in China and this can be gained with the help of management processes and alliance with the emergent fintech companies.

References

  1. 1.0 1.1 http://www.ckgsb.edu.cn/uploads/201408/26/Bank%20Expansion_20170706_clean.pdf
  2. 2.0 2.1 2.2 2.3 2.4 2.5 https://www.gfmag.com/magazine/february-2018/special-report-digital-china
  3. 3.0 3.1 3.2 3.3 https://smart.gi-de.com/2017/02/digitalisation-in-china-trends-and-technology-for-2017/
  4. 4.0 4.1 4.2 4.3 4.4 4.5 4.6 4.7 https://assets.kpmg.com/content/dam/kpmg/cn/pdf/en/2017/08/2017-mainland-china-banking-survey.pdf
  5. 5.0 5.1 5.2 https://www.investopedia.com/articles/economics/11/chinese-banking-system.asp
  6. 6.0 6.1 6.2 6.3 6.4 http://www.china.org.cn/opinion/2017-05/30/content_40900601.htm
  7. 7.00 7.01 7.02 7.03 7.04 7.05 7.06 7.07 7.08 7.09 7.10 7.11 https://mck.co/2wVrJci
  8. 8.0 8.1 https://www.unlock-bc.com/news/2018-06-06/china-builds-a-blockchain-system-for-check-digitization
  9. 9.0 9.1 9.2 9.3 https://www.forbes.com/sites/peterpham/2018/03/15/how-does-chinas-banking-system-work/#5ba074e012d9
  10. 10.0 10.1 10.2 10.3 https://www.innovationiseverywhere.com/4-trends-asia-transforming-banking-industry-2018/
  11. 11.0 11.1 11.2 https://www.ccn.com/report-chinas-banks-turning-blockchain-technology/
  12. 12.0 12.1 http://www.cbrc.gov.cn/chinese/home/docView/200808075125011BBFDAFF41FF03A55504B7B800.html
  13. 13.0 13.1 13.2 13.3 https://www.alt-m.org/2016/05/11/what-china-can-teach-us-about-the-future-of-banking/
  14. https://www.ibisworld.com/industry-trends/international/china-market-research-reports/financial-intermediation/policy-banks.html
  15. 15.0 15.1 https://www.investopedia.com/articles/investing/082015/4-biggest-chinese-banks.asp


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