Banks and Internet Companies: A Calculated Relationship
(Beijing) — Banks and internet companies are shaping up to be the new power couple in China’s much-coveted consumer finance space.
In late June, three tie-ups emerged within a week’s time: Industrial and Commercial Bank of China with JD.com Inc., Agricultural Bank of China with Baidu Inc. and Bank of China with Tencent Holdings Ltd. The list was in addition to another partnership inked in March between China Construction Bank and Alipay’s owner, Ant Financial Services Group.
For banks, their intentions are obvious. They want to reclaim customers who now prefer borrowing from online lenders that approve loans in minutes, saving them the hassle of doing paperwork and proving their incomes.
The internet companies are sitting on big data that provides them with invaluable, real-time insights into customers’ creditworthiness and spending patterns, which are crucial for designing financial products. Leveraging operational technologies also saves upfront development costs and time for banks.
But why are the internet companies saying yes now? For years, they have refused to work with formal lenders in hope to gobbling up the pie for themselves.
China’s consumer finance market has grown so quickly that internet companies, albeit cash-rich, may not have developed all of the banking expertise necessary to handle the ballooning volume of loans and the related risks. Meanwhile, partner banks can offer cheaper funding and lucrative service fees that are hard to resist.
“It will be a simple deal between the two,” said Wendy Liu, managing director at Nomura International (Hong Kong) Ltd. “Banks can enhance operational efficiency by utilizing new technologies. Their internet rivals, who are not competent in their experience to deal with retail customers, would have to choose B2B (business-to-business) partnerships instead of B2C (business-to-customer) services.”
A growing, yet still small, pie
Lending over the internet took off in China around three years ago. In the 12 months ending in May 2017, the country’s online lenders made 345 billion yuan ($50.7 billion) in new loans, or 7% more than the previous 12-month period, according to wdzj.com, which tracks online lending.
Although the 7% growth was dwarfed by a 50% increase in consumer loans in the formal banking system during the same period, the volume that online lenders handle is more than impressive given its short history.
A government crackdown on fraudulent online lenders also explains the tapering of new loan growth. The number of online lending platforms dropped to 2,114 by the end of June, down from around 4,000 two years ago. Some of them were shut down by the government, while others went under due to commercial reasons.
Having said that, consumers in China are still less leveraged on loans compared with more developed economies.
In 2015, a fifth of consumer spending in China was financed by borrowing, compared with 41% in South Korea and 28% in the U.S., according to Munich-based management consultancy Roland Berger.
Another consultancy iResearch has predicted that Chinese consumer loans will rise to almost 60% of the nations’ gross domestic product by 2020, up from 33.7% at the end of 2016.
Banks crave customers, technology, big data
Consumer finance, once a disdained business among banks given its relatively small scale and higher default risk, has become a coveted segment even by mega banks.
Before China scrapped its statutory ceiling on deposit interest rates in October 2015, banks were enjoying net interest margins, the key profitability metric, as high as 3% back in 2012. Online lending was not yet a thing. The sector essentially faced no competition.
However, with interest rates now liberalized, banks must compete for deposits by offering more attractive returns. Meanwhile, corporate and government lending has slowed as the country tries to deleverage its credit-fueled economy. This double whammy is squeezing banks’ interest margins hard. As of the end of 2016, the average net interest margin for 15 listed banks dropped to 2.07%.
“After all, retail business is the future battlefield for banks,” said Wang Dufu, president of ICBC Card Center.
However, many customers of online lenders are out of the reach of formal banks. These customers tend to be young, with short — sometimes weak — credit histories, such as students, low-paid urban workers or small entrepreneurs. Much of their day is spent on the online portals owned by those virtual lenders, which naturally sit on massive real-time data about their spending habits, preferences and even creditworthiness. These lenders have software that can churn out tailor-made investment products or loan contracts almost instantly. Coupled with convenience and speedy approval, formal banks are pretty much outclassed.
Wang Haixia, executive product manager of the e-finance department at Bank of China, said: “For banks, our future strategy on consumer finance must be exploring specific scenes of spending of our customers. We should target scenes such shopping, renovation, travelling and education, which makes crossover cooperation with internet companies ever more important.”
Thanks to the big data owned by internet companies, formal banks hope to ultimately come up with a “white list” of customers who are willing to spend more and have a sound credit history.Internet companies need banks too
As online lenders’ loan books grow, so do the risks. Many of the lenders have a short history of just a couple years, with a corporate structure designed to be as lean as a technology startup. Therefore, they may not have the best practices or even the financial capability to operate as a bank.
Last month, credit ratings agencies Moody’s Investors Service and Fitch Ratings expressed concerns about Baidu.com. These agencies said moving into unsecured consumer loans and selling uninsured wealth-management products likely introduces additional execution risks to the company, whose financial services arm is only two years old, but already accounts for 12% of the company’s assets.
Meanwhile, funding cost becomes a bigger issue when online lenders make more loans, especially the less-capitalized ones. After all, formal banks have a natural advantage of lower funding costs thanks to deposits and the interbank lending market.
When JD.com and ICBC signed a cooperation agreement in Beijing on June 16, the internet retailer’s founder Liu Qiangdong said: “JD Finance could take advantage of ICBC’s strengths in number of branches, clients and capital, to improve our own operational models on risk management. Thus, JD could provide cheaper and better financial services to our clients.”
Also, these internet companies can act like an outsourced technology consultant for banks, earning lucrative fees. An executive at WeBank, Tecent’s online lending unit, said many fintech companies are selling fintech solutions to banks just like IBM and EMC do.
Chen Huaisheng, product director of Ant Financial’s online lending service “Jiebei,” which means “just borrow,” said last month: “It is about complementing, not replacing, each other. There is room for cooperation between banks and Internet companies, such as in education, training, concerts, cosmetics or even orthodontic treatment.”
A road littered with landmines
As the nation continues to binge on debt, default risks could grow.
“Corporate debts has been tested by several market cycles, but consumer loans haven’t,” an executive from a major traditional bank told Caixin.
In fact, the default rate of online loans has been rising, said Lu Wangchu, the secretary-general of the National Internet Finance Association of China. Lu said the nonperforming loan ratio of 15 licensed non-bank lenders stood at 4.11% by September 2016, compared with 1.74% among formal banks by the end of 2016.
Market watchers say default the rate ought to be kept below an 8%-10% range for online lenders to remain financially resilient.
As online lending expands into third- and fourth-tier cities and villages, credit risks are bound to rise.
Sun Guofeng, director general of the research institute of the People’s Bank of China, called for a database exclusively for the creditworthiness of consumer loans to keep the risks of the sector in check.
Contact reporter Leng Cheng (firstname.lastname@example.org)
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