Credit cards come to China

Turning a profit in China¡¦s nascent credit card market could take a while; here¡¦s a shortcut.

Foreign financial-services players are turning their attention to the Chinese credit card market, which could well rack up more than $3 billion in annual revenues by 2010. If the current impediments to supply for instance, restrictions on foreign players, the local players? antiquated mind-set and inadequate skills, and a lack of consumer credit data are overcome more quickly than expected, those revenues could exceed $5 billion by the decade's end. This would be almost equal to the annual revenues of Taiwan's credit card industry at that point.

China certainly appears ready for plastic. It boasts a growing class of affluent consumers; the number of households with annual incomes of more than $6,500 will increase tenfold by 2010, to 30 million. Recent market data suggest that Chinese consumers are as likely to use consumer credit and to revolve their debt the key to success for a credit card business-as consumers in developed markets such as the United States. Even with a mandatory interest rate cap of 18 percent, the profit margins on credit cards, after adjusting for default, are 900 to 1,100 basis points for customers who carry their card balances, compared with only 300 to 800 basis points in the United States and the United Kingdom. According to our estimates, a company with a market share of just 10 percent of credit card receivables could make profits of more than $100 million a year by the decade's end.

The retail-banking market in China will open to outside competition by 2007. It will be a lucrative opportunity for multinational players. Foreign banks and credit card monolines companies that focus solely on credit cards instead of offering a full range of banking products are already staking out their territory. Citibank, for example, has acquired 5 percent of Shanghai Pudong Development Bank, with the aim of setting up a separate credit card business.

So far, though, only one million real credit cards circulate in China. Foreign banks are being held back by restrictive regulations as well as by the investments that are needed to build a customer base, a network of service branches, and a well-known brand. Local banks, on the other hand, are being deterred more by a fear of loan defaults and a lack of consumer credit skills. And the absence of an established credit bureau to provide both positive and negative information about prospective customers is frustrating all of the players.

One way to overcome these obstacles would be for a foreign bank and a Chinese one to form a joint venture to issue quasi-credit cards. Already popular in Europe, these debit cards allow users to maintain an overdraft amount, on which they pay an agreed rate of interest. Since approximately 450 million debit cards are already in use in China, a business issuing quasi-credit cards would require far less up-front investment and have lower ongoing operating costs than a conventional credit card business does.

By our estimate, most of the 80 million renminbi ($9.6 million) in IT investments needed to build a credit card business one of the biggest costs would be saved; customers who passed a simple solvency test could be given the added features automatically, a process requiring fairly simple modifications to a local bank's IT systems. The cost of acquiring customers (also among the highest expenses of issuing credit cards) would obviously be lower: the bank simply converts the holder of a debit card into a customer for quasi-credit cards. We estimate that a company issuing them could save 65 million to 85 million renminbi in annual marketing and other operating costs needed for traditional credit cards. The issuer thus could break even in 12 months, compared with three or four years for a credit card business.

Moreover, quasi-credit cards are less risky, "secured" as they are by the income flowing into the customer's account each month (no income flows automatically into a credit card account). They do involve some credit risk, which the issuing bank will need to manage. Although credit bureaus are not yet established in China, banks issuing quasi-credit cards can get around this kind of risk by setting low initial spending limits (an overdraft of $300 to $400, say, for a cardholder with a monthly income of $1,000 and average debits of $800). The bank could then use three to six months of subsequent transaction data to build models identifying the best credit customers and increase spending limits for those who qualify. While Chinese banks are unlikely to know how to gather information from early users and how to calculate risk, their foreign partners will have these essential skills.

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