Up until a few months ago, Shanghai-based Amy Wang was perfectly happy with the credit card she had been using for the past 10 years. The Visa card, from China Merchants Bank (CMB), has a RMB 25,000 (US$3,676) credit limit and allows her to take out cash in foreign currencies when traveling abroad. But as more and more banks began pitching new cards with tempting financing deals, the 36-year-old marketing executive decided last summer to shop around for another card and had a shortlist of four. The deciding factor? Bank of China’s online shop that let her use her new card to buy an iPhone with interest-free, monthly installments.


Wang is in good company. The number of credit cards issued by China’s banks has skyrocketed to more than 170 million credit cards last year, from 60 million just three years earlier, and the number of cardholders doubled over this period, to 40 million from 20 million, according to Celent, a research and consulting firm.


Even more growth is expected. Experts such as Celent predict that both the number of cards issued and cardholders will increase rapidly over the next few years as banks continue their aggressive pursuit of consumers with new card offerings. And relatively speaking, China has lots of catching up to do — in 2008, credit and debit card transactions in the country totalled US$24 billion, compared with Japan’s US$209 billion and South Korea’s $203 billion, according to a report on card payments in Asia-Pacific published by consultants at KPMG last year.


But bad debt is rising in China. The percentage of unpaid bills of more than 180 days increaed from 2.5% in the fourth quarter of 2008 to 3.4% (or US$1.1 billion) in the third quarter of 2009, leaving observers to reckon the country could be entering a delicate phase of consumer credit development. While the government is introducing regulations to address concerns, keeping the credit card market on track will likely require banks to develop more sophisticated risk management strategies than what’s currently in place.


“This is not going to be easy as it means quite a radical change in the credit card industry’s behavior,” says Pascal Nouvellon, from Cofidis, a Europe-based consumer finance service provider. “Until now, [banks’] credit card departments managed to convince their stakeholders that market share acquisition was the only strategy, at the expense of profitability. But the rising cost of risk may force them to review their model.”


The challenge will intensify as more and more of China’s banks become heavy credit card issuers. As of the end of 2008, five banks in China had issued more than 10 million cards — Industrial & Commercial Bank (ICBC), China Merchants Bank (CMB), China Construction Bank (CCB), Bank of China (BoC) & Bank of Communications (BOCOM), according to Celent. In the next four years, Celent expects eight more banks to join “the 10 million card club,” and 30 banks will have issued over one million. 


Risky Business

At first glance, rising consumer debt seems like an unusual problem for China to be facing. After all, the average per-capita savings rate is as high as 40% among some consumer segments. It’s also estimated that only around 30% of credit cards issued are active and of those, only 10% are running balances.


But while older generations still save as much as half their paychecks, many younger consumers, who may expect their incomes double or triple over the next five years, are less cautious. In fact, white-collar workers under the age of 30 are the most enthusiastic card users, particularly single women, according to Frankie Leung, a Hong Kong-based partner at Boston Consulting Group (BCG). “Those people have a stronger desire to spend when they find something that is interesting to buy rather than thinking, ‘I need to raise my family or pay tuition for my kids,’” he says.


What’s more, some banking experts reckon bad debt could continue to rise. Speaking at the 2009 Credit Card Forum in Shanghai, Yang Ke, CEO of the credit card center at China Min Sheng Banking Corporation (CMSBC), the first nationwide joint stock commercial bank with non-state-owned enterprises as shareholders, predicted that if the economy falters, “it will go up to more than 5%.”


The amount of bad debt is important for banks, not least because they are required to hold reserves worth 150% of their nonperforming loans. “Given that banks cannot price their risk as the credit card revolving [interest] rate is fixed at 18.25%, the cost of risk at 3.4% is now pretty much the maximum banks can take to stay profitable on their revolving clients,” notes Nouvellon.


One way banks can address the situation is by generating more fee income by, say, start charging for previously free services, such as providing account information over SMS. But this is easier said than done without losing customers to competitors offering better deals.


Other charges are unlikely to help generate more income either. For example, the fees they get from merchants accepting their cards, for example, range between 0.5% to 1%, compared with 1.5% or 2% charged in other countries, and seem unlikely to change. “It’s going to be low for quite some time,” says BCG’s Leung. 

Stiffening Competition?

Against this backdrop, the banks also need to be looking over their shoulders as non-bank lenders try to get a toehold in China’s credit card business. One thing working in the non-banks’ favour is the decision last year by the China Banking Regulatory Commission (CBRC) to allow four cities – Beijing, Shanghai, Tianjin and Chengdu – to take part in a pilot project and host new companies dedicated to consumer financing with access to debt capital. Loans from these so-called consumer finance companies (CFCs) — which will be free to price their risk — will have several safeguards against bad consumer debt. For example, CFCs have to build up a portfolio of customers who have repaid secured loans before they can be offered unsecured loans. “If the tests are successful and more CFCs are allowed to get started, it will pave the way for a sound development of consumer finance with a new China model,” says Nouvellon.


BCG’s Leung, however, doesn’t see the CFCs posing an immediate threat to credit card issuers. Rather, he reckons they will probably focus more on becoming conduits for white-goods manufacturers or retailers to finance installment plans for their customers. But that could change if banks begin aggressively targeting the same lower-income consumers as the CFCs.


Whatever the shape of the competitive landscape, the government now wants more responsible credit card use. The Supreme People’s Court recently spelled out the penalties for an offense called “malicious overdraft”: Consumers who fail to pay credit card bills for more than three months will not only have to pay late fees and finance charges, but could also face a prison sentence.


As for the lenders, the CBRC now prohibits banks from issuing cards to students younger than 18 years old and requires the parents of young adults to be guarantors of their card debt. In addition, banks are not allowed to use third parties to sell new cards as they have in the past or issue credit to anyone who does not have a fixed job, a stable income or “a reliable insurance for repaying debt.” Face-to-face meetings to open accounts are now also required.


The Learning Curve

Alongside that, much deeper changes will be needed. By late September last year, Nouvellon says, most credit card limits were RMB 7,200 (US$1,054), about three times the average urban monthly salary. “Banks will have to lower the limits on new credit cards and learn how to manage increasing credit limits over time given the profile of the cardholder,” he notes.


For many banks, the learning curve will be steep, according to a November 2009 report on China’s retail banking sector by Moody’s Investors Services. Only but the largest banks currently have analytical software enabling them to crunch information about their customers. And matters are not helped by the inability of banks to share credit risk information with each other. Hampering customer risk management further is the absence in the country of Western-style credit bureaus, such as Equifax, Experian and TransUnion — something that the government is currently working on.


Also a work in progress is the modernization of the country’s current credit card statutes, which date back to 1999. “China’s credit card regulation is seriously lagging behind the practice, which could create a negative impact on the industry going forward,” noted CMSBC’s Yang at the Shanghai conference.


According to Nouvellon, “People in the industry are secretly hoping that the new law will come sooner rather than later and that it will force the industry out of exuberance and into a market where banks are forced to charge for their services.” That could, for example, include setting minimum limits for annual card fees.


It could also mean targeting different customers than they have in the past, particularly if they want to improve their bottom line. “The real challenge for the industry right now is the banks have to improve their profitability,” says Darwin Tu, founder and CEO of 51credit.com, an online consumer finance platform for banks and consumers in mainland China. “The banks now have almost covered the high-end population with relatively stable and high incomes. However, banks can’t make much money from those people, because now most banks don’t charge annual fees if a card is used several times a year and the commission is less than 1%, therefore, the non-interest income is not sufficient to cover the cost.”


The key, he says, could lie in reaching out to the “other 50 million potential revolvers who are young white-collar workers… These people are riskier than the wealthier people, but this requires the banks to develop better and more scientific data mining and decision-making tools.”


Put another way, says Tu, “it means that credit card centers should now be asked to do what they have been originally designed for: Deliver value.”