China Economic Review

Zennon Kapron on what’s next for Chinese fintech

The extraordinary rise of China’s financial technology—or “fintech”—industry shows few signs of slowing. Where once Chinese finance was almost a byword for backwardness, today the country is home to many of the most dynamic financial companies in the world.

Of the world’s 27 fintech unicorns—startups valued at over $1 billion— nine are based in China or Hong Kong, according to a 2017 report by TechCrunch, where they benefit from access to the world’s largest, and one of its tech-savviest, consumer markets.

Payments via third-party mobile platforms have grown at a three-digit annual rate for the past five years. Chinese consumers make more transactions through payment apps Alipay and WeChat Pay today than through cash and cards put together. Peer-to-peer lending, meanwhile, has exploded to become a $190 billion industry serving millions of credit-starved households and small businesses.

But what’s next in store for the industry? Is the recent wobble in the P2P market going to spread? Could a ramping up of regulation from Beijing put a dampener on the market’s red-hot growth? Stomping out risk from the financial system has become a key priority for policy makers over the past year, and the relative freedom fintech firms have enjoyed over the past decade may be about to take a hit.

Analysing these questions is all part of the day job for Zennon Kapron, the head of fintech research and consulting firm Kapronasia. In this interview with China Economic Review, Kapron gives his take on some of the market’s recent developments, and explains why China’s fintech industry is such an exciting space to watch.


Zennon Kapron, Director of Kapron Asia

CER: Fintech is a term that includes many different sub-markets. Which of these are the most relevant in China?

ZK: The basis of fintech in China is payments. Alipay, the most popular online payment system in China, was set up to solve the issue of trust in e-commerce. When the country’s first online retail giants started, the system was simply ‘cash on delivery,’ and of course there are a number of potential problems and inefficiencies with this. Alibaba launched Alipay to smooth out this process: you order something online, the money goes into escrow, once you receive the goods you confirm and the money is released, and if you don’t say anything within a few weeks it’s automatically released. That really gave both merchants and buyers more confidence and trust in the e-commerce system. This has since developed into m-commerce and offline-retail payments.

At the time Alipay was really gaining momentum, around 2013, interbank lending rates were quite high – with banks borrowing money on a daily basis to cover their capital requirements, etc. – so Alipay worked with Tianhong Asset Management and set up the money market fund Yuebao that trades on this bank lending behaviour. So all of a sudden, what do people have? A wealth management product. This is the second major segment of China fintech.

Ten years ago, if you wanted to buy a wealth management product, you’d have to go through a pretty painful process at the bank. You’d wait in line to talk with someone, who would print out a list of different options for you and there would be a sizeable minimum investment. After that your money would be locked up for six months, a year, maybe two years. Yuebao managed to capitalise on this situation. It offered high interest rates, perhaps 7 or 8%, with near instant liquidity. So someone could invest money one day, start earning interest on it tomorrow, and start withdrawing their gains within hours, even as little as Rmb 1. The result was basically the democratisation of wealth management.

The third aspect was credit. These growing technology companies now had access to a wealth of information on people’s financial situation and their daily spending habits, from how much they had in their accounts, to when and where they spent it. This gave them a really effective means of building an individual’s credit rating, and it was then just a small step to actually offering a lending alternative to the banks.


CER: Why is China so ahead of the curve when it comes to fintech?

ZK: I think there are a couple of different things. First of all, there’s a lot of friction in existing transactions. For example, if you want to make a card payment in China you still have to chip, then PIN, then give your signature; with Alipay or WeChat Pay you just scan a QR code and walk away, clearly removing all of that friction.

The second reason would be the country’s credit system. The People’s Bank of China has a credit database of less than half of the population – some 600 million citizens – and of these only half again have actual details of credit ratings and history. For me, having grown up in the US, I’ve had a credit card since I was young, so Equifax, TransUnion and other credit bureaus have a tremendous amount of data on me. There isn’t the same in China, and the result is huge swathes of this enormous population that do not have a credit history, which opened another niche for fintech lending platforms to move into.

One more important factor is the government’s ‘wait and see’ approach to the industry’s development. Alipay, for example, launched in 2004, but payments platforms were only regulated in 2011. Similarly, peer-to-peer (P2P) companies began to take off in 2007/2008, but regulation for them only really kicked in the last couple of years.

There are exceptions to this approach, however: Bitcoin was very quickly stamped out. Why? Well,  Bitcoin is a very elegant solution to a problem that doesn’t exist, and it serves very little value to the financial services industry. People speculate on it, but it offers nothing to benefit the wider economy.

Payments, on the other hand, have provided a necessary and visible boost to the economy. In Hangzhou, I met a salesman/repairman who previously only accepted Alipay and WeChat Pay, but had recently started borrowing some Rmb 90,000 a week with MYbank. The government is seeing the benefit of letting small lending companies help mobilise capital to small borrowers.


CER: What is driving Beijing’s recent moves to tighten regulation in the fintech industry? And do you think this poses a threat to the sector’s growth?

ZK: Generally speaking, the government wants to ringfence any source of potential risk. I tend to come down on Beijing’s side regarding a lot of their decisions in this area. The government is taking a very pragmatic approach to the economy and the industries within it, though of course not everything it has done has been positive – not keeping some of its promises to the WTO, for example.

But on the example of the recent 100% reserve requirement ratio for online payment platforms, I don’t think it’s a question of not being able to adequately monitor the risk levels associated with the lending firms – I’m certain there’s the infrastructure for that – but at this point it’s probably a good idea to tighten up a bit for the sake of building trust and stability, even if that cuts back a bit on the revenues of Ant and Tencent.

Do I think there’s any threat from this? I wouldn’t say ‘threat.’ It was impossible that there wouldn’t end up being some regulation eventually. This applies to all the different spaces within ‘fintech’.


CER: The government has hinted it may loosen restrictions on foreign third-party payment companies like Visa and Mastercard. Do you think these companies have a future in China?

ZK: This conversation has been going on for many years now, with the government every couple of years putting out a carrot to tempt the likes of Visa and Mastercard. There’s a lot of talk at the higher levels about opening up the market, but there are a lot of details and red tape that prevent it from being realised. You can tick all the boxes on your application form to the finance regulators, but then fail a security check at the last minute. To make something of a bold statement: I don’t think we’ll see any of the major card providers making inroads into China until 2020.

There’s also the issue of how these companies are going to even market their card to the Chinese consumer base. Up to a couple of years ago, there were dual-branded cards, like Union Pay/Visa, which were pretty simple to acquire and fairly popular. The government discontinued this about a year and a half ago, leaving the only option of a single-branded Visa or MasterCard, which is potentially not as attractive. There have been some attempts by Western companies to differentiate on brand-cache, so if people carry a Visa or Mastercard it looks like they’ve made it, but I really don’t think Chinese buyers will care at all about the brand name on their card. Furthermore, the global presence of UnionPay is on the rise, with global acceptance, at ATMs, restaurants, growing rapidly.


CER: In 2017, we saw around two dozen Chinese fintech companies make US IPOs, yet over half of them have seen their stock drop below the offer price. Why do you think that is?

ZK: When you look at the success of China’s tech giants – Alibaba, JD, Baidu – it makes sense that everyone wants a piece of the market. Everyone wants some exposure to whoever’s going to be the next Jack Ma. But with P2P, where so many companies are now listing, I do struggle to see how companies really differentiate. There is some specificity in terms of markets, like those that target university students, others that deal with predominantly SMEs. And there are certainly a few individuals with top-class management and services. But I think the quality of the firms just isn’t there.


CER: How worried should we be about the recent panic surrounding China’s small P2P lending platforms?

ZK: The fact that P2P lending platforms are failing is not surprising. Many of these platforms had inadequate internal operational processes, poor lending practices, and in some cases, were just complete scams. What will be interesting to see is if retail investors will still want to put new money on these platforms. I get the impression at the moment that many investors are just trying to get their money out. Even if the P2P industry manages to right itself, it may find that all the investors are gone.


CER: What are the most exciting innovations taking place in China’s internet finance space?

ZK: What stands out to me is big data. The ability to analyse massive amounts of information and come up with detailed conclusions about an individual’s financial profile. This has immediate practical applications for the tech companies themselves. As an example, many merchants that use Alipay use a personal account instead of a merchant account. Ant Financial realizes this and will look at a person’s transactions to understand more about who they are. Consider the average person’s Alipay activity: it will look like a huge mesh of transactions from your phone to merchants, to banks, to friends, from friends to you, to companies. From a merchants’ perspective the situation is more of a hub-and-spoke model. So by using big data and analytics, the payment companies will be able to identify who is or isn’t a merchant, and whether or not they are using the correct account.

However, the largest application for big data would probably be in lending to SMEs. China’s banks, despite all being listed, have significant state ownership and therefore lend predominantly to state-owned companies. Why would a bank lend to an SME at 7.5% when it can lend to PetroChina at 7%?

A lot of the applications for big data in China make use of a lack of infrastructure in certain areas, where in the West such infrastructure is already set up. A common credit database would be a good example of that, where in the US, Equifax has been offering reliable credit data for years. That’s not to suggest that one market is ahead of the other, but there are just different requirements.

Blockchain is there too, but I don’t see it having as big of an effect as its publicity might suggest. We’re certainly seeing some rudimentary applications of blockchain by the big non-bank lenders and asset managers. But at the end of the day blockchain’s benefits are inefficiencies, but it doesn’t have the ability to change things as fundamentally as, say, AI or big data.