Could China be the cure for what ails the U.S. electronic payments market?

First published in Transactions Trends, By Julie Ritzer Ross

Sunday, January 01, 2012

- Within the next two to four years, China’s online payments market will surpass that of the United States. Experts predict a 20 percent annual growth rate for credit and debit cards in China.

- Major obstacles render China’s card and electronic payments sector more challenging—among them, trade barriers, a “saver” mentality, and lower merchant fees.

- Issuers and acquirers should think in terms of what they can learn from and offer to the Chinese market to optimize their involvement.

“In terms of transactions and overall users, China’s credit and debit card market is already as big [as] or bigger than in the U.S.,” and elsewhere, observes Dave Carini, managing director at Beijing, China- based Maverick China Research. “But within the next two to four years, China’s online payments market will surpass that of the U.S.” Last year, transactions executed through China’s online payment companies totaled more than $156 billion for the first time, a figure Carini says will triple in the next two years, while cards accounted for about 35 percent of retail spending versus zero percent 10 years ago.

Moving forward, “we are looking at a 20 percent annual growth rate for credit and debit cards in China,” concurs Feng Lin, general manager, Greater China, for international payment systems provider ACI Worldwide. Lim notes that credit and debit card penetration in China’s four largest cities—Beijing, Shanghai, Guangzhou, and Shenzhen—now exceeds 30 percent. A majority of these cards are held by members of the younger generation, who want to leverage them in traditional brick-and-mortar retail environments as well as online, Lin says.

While the data appears promising, major obstacles render China’s card and electronic payments sector both less lucrative and seemingly more challenging:

Trade barriers.

China has only one domestic bankcard association— China UnionPay. Founded in March 2002 and operating under the auspices of the People’s Bank of China (PBOC), China’s central bank, China UnionPay is, with the exclusion of Hong Kong and Macau, also China’s only interbank network.  It links the ATMs of nearly 200 banks throughout mainland China and functions as an EFT-POS.

“China UnionPay has partnered with banks like Citibank, as well as with Visa, MasterCard, and, more recently, American Express, to bring co-branded cards to China, but at least for now, that is where it has stopped,” says Paul Avery, regional director, Asia, for Retail Decisions Inc., an international provider of payment and fraud solutions. “It has the entire monopoly over domestic pricing and services. Additionally, foreign companies cannot issue cards denominated in Chinese currency.”

Complicating matters even further, non-Chinese companies can’t build networks to support credit cards or process transactions. Only licensed organizations— 24 exist now—can function as third-party payment providers. Providers backed by foreign money must obtain special permission from the Chinese government to go into business, and foreign backing must comprise only a minimal portion of the total investment.
Banking issues.

Chinese banks have less experience on the consumer lending front and are more riskaverse than their counterparts in many other nations. China is probably better suited to embrace a European acquiring model that calls for direct merchant relationships with banks than to adopt a U.S. acquiring model, where ISOs function as the intermediaries between banks and merchants.

“In the short term, banks will be reluctant to do anything that doesn’t give them the ability to establish a direct relationship with and ascertain the risk of a merchant,” says Souheil Badran, senior vice president and general manager of Digital River World Payments, a global ecommerce solutions provider. Managing merchant risk and fraud is a significant issue since there are so few merchants accepting cards today.”

Lower merchant fees.

The lower fees make acquiring a less lucrative proposition. Fees typically range from 1 to 2 percent but, in some cases, are set at 0.6 percent. Government regulations stipulate that 70 percent of merchant fees be remitted to issuers; 20 percent to acquirers themselves; and 10 percent to China UnionPay. Saver mentality. While Chinese consumers are indeed warming to the idea of credit, China is, according to McKinsey & Company, a nation rife with “savers” as opposed to “spenders.” Chinese households generally save about 25 percent of their discretionary incomes— about six times the savings rate in the United States and three times the rate in Japan. Many consumers, McKin

“We are looking at a 20 percent annual growth rate for credit and debit cards in China.” A majority of these cards are held by members of the younger generation, who want to leverage them in traditional brick-and-mortar retail environments as well as online. —Feng Lin, ACI Worldwide
sey’s research indicates, would prefer to use savings or borrow money from relatives rather than incur credit card debt to purchase high-ticket items. They are even less inclined to carry balances. According to McKinsey, a mere 6 percent of all transactions are executed with credit cards, and outstanding credit card balances account for less than 0.1 percent of the GDP.

But wait, there are opportunities as well—if not now, then down the road. Creative thinking is required. “U.S. issuers and acquirers will have a hard time in China unless they look beyond the transaction and partner with local banks,” Badran asserts. “Issuers and acquirers should think in terms of what they can learn from and offer to the Chinese market to optimize their involvement.  For example, are there services like risk management that could be carved off from stable U.S. and European Union businesses and offered within the larger Chinese payments ecosystem?”

Monopoly no more.

A World Trade Organization (WTO) dispute settlement panel formed at the behest of the U.S. Trade Representative’s office is working to loosen China UnionPay’s monopoly on the nation’s domestic card market. Several years ago, China pledged to the WTO that it would open its payment market, but it has yet to deliver on that promise. “It is quite likely that the threat of economic sanctions might move China in the direction the U.S. card associations want it to go,” Avery says.

Mobile payment adoption.

“China is easily the world’s largest single mobile market, with more than 868 million cellular subscribers (as of March 2011)” and annual mobile payment volumes likely to exceed $8 billion by 2014, notes Jake Saunders, vice president, forecasting and operations, for ABI Research, a technology research firm.

China’s mobile payments industry is “burgeoning,” luring myriad players from three disparate camps attempting to assume “first-mover” advantage and jostle for a bigger piece of the pie, says Saunders. Contenders include financial institutions like China UnionPay, as well as third-party mobile payment service providers and mobile network operators (MNOs) like China Mobile, China Unicom, and China Telecom.

China UnionPay is flexing its muscles here with the debut of an NFC-enabled Android phone that supports its mobile payment standard. Manufactured by Taiwan-based HTC, the phone features the bank’s NFC application on microSD cards to be issued by its banking partners. The microSDs for the unit are designed to work with the built-in NFC chip and antenna in full NFC phones.

China UnionPay also has launched a program to allow its POS terminals to accept contactless payments. The bank was expected to have converted some 700,000 individual units to contactless payment acceptance status by the end of 2011.

Some sources say China UnionPay has a leg up on third-party mobile payment service providers and MNOs because a majority of Chinese consumers buy their cellular phones from retailers, rather than from mobile payment service providers. Moreover, while few, if any, of China’s mobile payment service providers subsidize consumer cellular phone purchases (as is a common practice in the United States), the bank has the power to do so. “There will almost certainly need to be some kind of partnership model with mobile payment service providers due to the power” China UnionPay has and in light of its progress on the terminal retrofitting front, Avery says.

Others suggest MNOs will win mobile payment dominance in China, however, as a result of concerted efforts to further develop their 3G subscriber bases and partner with remaining key players and industry participants to drive NFC usage. Among steps in this direction, China Mobile last year bought a 20 percent stake in Shanghai Pudong Development Bank as a component of its venture into the mobile payment sector. 

However the scenario plays out, expect an ongoing battle between the proximity payment technology standards—RF SIM versus NFC, operating on the 2.4-GHz and 13.56-MHz band frequency, respectively.  “Operators, vendors, and consumers are often confused and torn between the supposedly better payment technologies that each has to offer,” Saunders explains. “This not only delays the commercial rollout of these payment services; it also prevents further development of the mobile payments value chain and business models.”

NFC add-ons.

Saunders says that NFC “enablers” and solutions providers will, “while waiting for the official NFC deployment to occur,” benefit by providing “bridge” solutions as technicalities are ironed out and as handsets embedded with NFC technology penetrate China’s subscriber base. Among these solutions are NFC handset add-ons, most notably contactless SIM cards. Saunders cites SIMpass, a SIM-card based mobile proximity payment solution from global manufacturer Watchdata Technologies, as a key example, noting that it has garnered strong interest from China Mobile, China Unicom, and China Telecom alike.

“The Chinese government has made it abundantly clear that it favors an NFC device solution utilizing the 13.56-MHz frequency band,” Saunders says. “The bridging solutions break the chicken-and-egg development cycle. It bodes well for those that want to get in on the game that hence, more NFC handset add ons are shipped compared to NFC enabled mobile handsets, which are mainly smartphones—3 million add-ons versus 45,000 handsets in 2010.”

Terminal upgrades.

While observers have expressed uncertainty as to whether Chinese merchants will migrate from their existing feature-rich POS terminals—many of which tout more functionality than that offered by models available in the United States—to jump on the contactless bandwagon, the consensus appears to be that this will not be a barrier to adoption.

“Issuers and acquirers should think in terms of what they can learn from and offer to the Chinese market to optimize their involvement.”
—Souheil Badran, Digital River World Payments

“In China, terminals are typically owned by acquirers rather than by merchants, and are thrown in along with low fees as part of an enticing package,” Avery says. “If new terminals will, in merchants’ eyes, bring business in, they will demand them.”

“Merchants—and the authorities—do consider their systems to be ‘better-than-U.S.,’ but the Chinese market has not had to contend with legacy terminals” as the United States has, Saunders says. “Mobile payment is likely to grow at a cautious pace, on a ‘per head of the population’ basis, but once you take into account the size of cellular market in China, the numbers can pack some weight.”

For his part, Badran predicts that increasing mobile payment penetration will give rise to a new breed of online Chinese shoppers—individuals who access the Internet exclusively via their cellular phones, instead of occasionally or entirely though a personal computer. Online merchants may need to adapt their offerings to accommodate this growing target audience, possibly yielding additional entrée into the market to solutions providers.

In short, sources agree, the mobile piece of China’s electronic payments puzzle is a microcosm of the entire market. “Things are opening up slowly, but they are opening up,” Lin concludes. “In six to seven years, we could be seeing U.S. entities conducting business very freely. Time will tell.” TT

Julie Ritzer Ross is a contributing writer to Transaction Trends. Reach her at