Caixin
Jan 19, 2017 06:36 PM
POLITICS & LAW

PBOC Rules Set to Shake Up China’s Payment Landscape

(Beijing) — A recent policy from China’s central bank may mark the beginning of the end for many payment companies in the country, judging by the effect it’s likely to have on their business models.

More than 260 third-party payment firms in China provide services as diverse as facilitating online and offline transactions, and issuing prepaid cards that can be used to buy groceries in brick-and-mortar stores.

Their services are hugely popular and ubiquitous in China as users download a payment app on their phones and link their bank cards to the account. They are used to pay at major shopping websites, convenient stores, coffee shops and even street vendors.

According to iResearch, payment companies in China made nearly 14 trillion yuan ($2 trillion) in transactions in the second quarter of 2016. The two biggest players were Alipay, owned by billionaire Jack Ma’s Ant Financial Services Group, and Tenpay, the payment subsidiary of internet giant Tencent Holdings Ltd. Tenpay is better known for one of its services called WeChat Wallet, a build-in feature in Tencent’s popular messaging app, WeChat.

Payment firms in China are similar to worldwide online payments system PayPal in many respects, but there are important differences. While they all provide payment services, most Chinese firms rely on the interest banks pay on their clients’ funds, rather than fees charged for enabling transactions, as their main source of income.

China’s central bank tolerated this when the industry was young. Now, however, it seems to have decided that it must change, as many companies seek to keep their clients’ funds in their accounts as long as possible. This “deviated from their main operation of providing payment services and caused to some extent disorder and confusion in the payment service market,” the central bank said last week.

The new regulation will see the interest that companies can earn on their client’s funds gradually reduced to zero. The change will likely have little impact on customers, at least initially. In the long run, analysts say, only a handful of companies will survive, and the world of payments in China will look very different.

What can third-party payment firms do in China?

The existence of third-party payment companies provides an extra layer of safety for buyers by helping insure sellers deliver goods and services as promised. Unlike PayPal, which is largely used for online purchases, third-party payment services in China have been widely adopted by offline merchants. A user can pay for services and goods with payment apps installed on their smartphones by scanning a quick-response (QR) code or having the merchant scan a QR code on their phone.

To make it even more convenient for users, payment companies direct users to a wide range of services that receive third-party payments, including movie theaters, car-hailing platforms and utility companies, on their mobile applications. Most importantly, all these services provided by third-party payment companies are free.

So how do they make money?

Payment companies’ profits come largely from interest generated by their clients’ funds. When a customer uses a payment firm to purchase goods and services, their money is stored in the payment company’s bank account until the transaction is settled. Currently, even though the funds belong to the customer until the transaction is completed, the customer is not entitled to the bank interest paid on the deposit. Instead, the interest goes to the payment company.

Payment companies also make money from merchants who allow their customers to use third-party payment apps, but the fees are meager compared with how much PayPal charges. According to an Alipay employee who spoke on condition of anonymity, Alipay requires a merchant fee that is only 0.6% of each transaction, whereas PayPal in the U.S. charges merchants a 2.9% fee and an additional 30 U.S. cents for each sale.

In recent years, payment firms have gradually diversified their businesses, some branching into wealth management and investment fields.

What’s wrong with the current business model?

According to the People’s Bank of China, reliance on interest for income creates the wrong incentive for companies, as it leads companies to constantly seek expansion and look for ways to hold clients’ money for as long as possible.

In addition, payment companies open multiple bank accounts to store their clients’ funds, posing a regulatory challenge for the central bank as it strives to keep track of how funds are used. The central bank revoked operating licenses for three payment providers in 2014 after they were found embezzling client’s funds.

“Once there is a liquidity risk (at one third-party payment firm), it may quickly grow into a systemic disaster,” a PBOC official said.

How much money will the policy change affect?

By the end of the third quarter of 2016, funds temporarily stored in the bank accounts of third-party payment firms amounted to 460 billion yuan ($67.2 billion). Alipay and Tencent’s Tenpay combined made up 70% of the total.

Many small companies have relied heavily on interest earned by those funds. Nearly 85% of the net profit all third-party payment firms made in 2015 came from interest payments, official data from the central bank shows.

What will happen after the policy is implemented?

The policy change will most likely have a negative effect on the smaller players whose profits mostly come from interest, analysts said.

The new regulations stipulate that as of April 17, all third-party payment companies will need to deposit 12% to 24% of their client payment funds into specialized interest-free accounts with a designated bank and the ratios will be gradually raised to 100%. The initial ratios depend on payment-related services offered and levels of risk control ability. Caixin has learned that Alipay and Tenpay qualify for the lowest ratio.

Tang Ling, vice president of Lakala Payment Co. Ltd. — a major third-party payment platform — estimated that the policy will force most small companies out of the market and only larger firms will survive.

Contact reporter Chen Na (nachen@caixin.com)

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