DECEMBER 2004

Retail Financial Services in China

A new report from McKinsey & Company lays out a case for China as an ideal market for global financial services firms looking for strong growth opportunities. McKinsey analysts David von Emloh and Yi Wang forecast that China will be Asia's second largest market for personal financial services by 2010, following Japan. Currently, about 15 million urban Chinese are considered affluent (annual income in excess of $9,000) or "mass affluent" (annual income in excess of $4,500). The segment is doubling in size every four years. To illustrate the enormous opportunities for product penetration, only 0.5 percent of Chinese consumers hold a credit card, compared to 65 percent of neighboring Taiwan consumers.

Emloh and Yi cite strong economic growth and deregulation as primary factors that will propel the retail banking sector. GDP growth in China is being driven by consumption growth and has ranged from 7 to 9 percent annually in recent years. Loans to consumers for homes, consumer durable goods and credit cards will growth accordingly. In addition, they foresee that within the next 5 to 7 years, the Chinese government will gradually deregulate interest rates, which will effectively redirect more loanable funds into retail banking.

Affluent customers make up only 2 percent of all retail customers at Chinese banks, but account for 55 to 65 percent of retail-banking profits. The mass affluent segment makes up an additional 18 percent of all customers and 40-50 percent of profits. The remaining 80 percent of retail banking customers are largely unprofitable. Three quarters of the affluent segment live in Beijing or the major coastal cities, and consequently don't require a far-flung network of branches to service them. At the same time, the existing domestic Chinese banks lack the risk-assessment skills and cross-sell/service culture to effectively market an array of financial services products to them. McKinsey surveys of Asian banking customers reveal that affluent Chinese are less satisfied with the level of service they receive as compared to their counterparts in other Asian countries, and admit to a willingness to switch to banks that provide better service even if it means higher fees and interest rates. For all these reasons, Emloh and Yi argue that foreign banks now have a golden opportunity to enter the Chinese market by targeting affluent customers. This will allow them to have partnerships and operations well-established when the rest of the consumer market starts to expand over time.

Partnerships with Chinese banks are a regulatory prerequisite for offering most financial service products. Many of these restrictions (such as a ban on foreign banks issuing local-currency credit cards) are scheduled to disappear in 2007. However, Emloh and Li argue that partnership now with a Chinese bank would give a foreign bank access to an established group of customers to cross-sell between now and 2007. If foreign banks wait until 2007 to enter, many of the best customers will already carry credit cards and other products from existing banks.

Partnerships that are successful in gaining approval from the Chinese regulator (China Banking Regulatory Commission) will most likely be those that are structured to improve the Chinese partner's performance by providing new skills or technology. At the same time, the foreign bank would be wise to structure the relationship so as to maintain operational control. The authors write "The key to making a card partnership work is making it function seamlessly within the Chinese banking system, so that the operating license belongs to the Chinese bank, the cards bear its brand name, and card balances appear on its balance sheet. In reality, though, the foreign player will probably run much of the card operation." The authors also warn that structuring such partnerships is not easy. Chinese banks may need long advance times (as much as a year) to negotiate the terms of a deal. And, the foreign partner must structure the deal so that it is the sole partner-provider of the product for the long term. Otherwise, there is risk of being dumped after a few years when the venture starts to reap substantial profits.