China Opens Up To Foreign Issuers

  Payment cards probably weren't what Mao Tse-Tung had in mind when he announced in 1958 The Great Leap Forward, a socialist-inspired economic plan for the People's Republic of China. Nor were they a topic of discussion in February of 1972, when Richard M. Nixon became the first U.S. president to visit the People's Republic since it was established in 1949.
  China now has the world's hottest economy. The National Bureau of Statistics says China's gross domestic product expanded at a blistering 9.1% pace in 2003.
  This growth has sparked a rapid expansion of China's middle class, particularly in the country's coastal cities where young, well-educated, high-income people live. And unlike their parents, they are not averse to borrowing money, according to a recent story in The Economist, a respected British business magazine.
  American Express Co., Citigroup Inc. and HSBC Holdings Plc now have permission for the first time in China's history to offer revolving credit cards in this rapidly growing market. Over the past year, Peoples Bank of China, the central bank, and the China Banking Regulatory Commission gave the issuers permission to form partnerships with state-owned banks to offer credit and charge cards in China. Those decisions also were historic for reasons that have nothing to do with cards.
  China's decision to allow foreign banks to issue cards stems from its admission to the World Trade Organization in 2001. As a WTO member, it is required to fully open its retail-banking sector to foreign banks by Jan. 1, 2007. Government officials are putting pressure on Chinese banks by allowing more competition.
  A Changed China
  Citigroup, HSBC and AmEx had set up banking operations in China before the Mao-led revolution. The communists expelled foreign banks because they were "deemed a part of the Western imperialistic intrusion into China since the 1800s," says Yuwa Hedrick-Wong, economic advisor for MasterCard International's Asia Pacific Region in Singapore.
  In today's much-changed China, Citigroup, HSBC and AmEx are seeking new sources of profits, but the task won't be easy, according to experts familiar with China's financial scene.
  In January, HSBC, which is based in London, unveiled its new card, the Shanghai International Credit Card that it is offering with Bank of Shanghai. HSBC owns 8% of Bank of Shanghai, and there are regular media reports that HSBC wants to buy more. The Shanghai card can only be used outside of China; its transactions are settled in U.S. dollars.
  A month later, Citigroup took the wraps off the card it's offering through Shanghai Pudong Development Bank. Citigroup owns 4.62% of SPDB. Unlike the HSBC/Bank of Shanghai card, the Citi/SPDB card is a dual-currency product that cardholders can use both in and outside of China. Transactions either can be settled in renminbi, China's non-convertible currency for purchases inside China, or U.S. dollars for purchases outside of China.
  Citigroup and SPDB are offering two types of credit cards-a gold card for people ages 25 and up, and a standard card for those 21 and up. HSBC has since submitted an application to the People's Bank of China to issue a dual-currency credit card, according to an HSBC spokesperson.
  A Complex Market
  And on March 30, AmEx announced that it would begin offering cards through the Industrial and Commercial Bank of China sometime this year. But unlike Citigroup and HSBC with their partners, AmEx didn't buy a stake in state-owned ICBC, China's largest card issuer. Instead, ICBC joined AmEx's global network.
  The agreements AmEx, Citigroup and HSBC have with their Chinese partner banks highlight their different approaches to the complex market. For example, ICBC may issue either an AmEx-branded dual-currency revolving credit card or an AmEx-branded dual-currency charge card. And while HSBC and Citigroup announced their partnerships in Shanghai, China's financial capital, AmEx and ICBC announced their partnership in Beijing, the nation's political capital.
  Shanghai Pudong Development Bank has 290 branches nationwide that will allow Citigroup to offer cards across China. ICBC, AmEx's partner, has 24,000 branch offices in China, which will allow it to offer cards in every nook and cranny. On the other hand, Bank of Shanghai, HSBC's partner, only has a license to issue cards in Shanghai, though that is no small market with 16 million people.
  Citi, AmEx and HSBC emphasize that their roles are advisory and that their Chinese partners are calling the shots. AmEx and HSBC spokespersons say any decisions on whether cards will have chips are up to their partners. But Citi says Shanghai Pudong Development Bank only plans to issue magnetic-stripe cards.
  Citigroup and HSBC are both issuing Visa-branded cards, although Citi is known primarily as a MasterCard issuer in the U.S. HSBC and Citi gave Foster City, Calif.-based Visa International bragging rights, not to mention a charge-volume advantage, over MasterCard International, its Purchase, N.Y.-based rival. Visa International for China reported that in 2003 charge volume topped $1 billion for first time since it opened an office there in 1993. Chinese banks pumped out 600,000 new Visa credit cards in 2003's fourth quarter.
  Beginnings
  The ZhuHai branch of the Bank of China issued China's first credit card in 1985, says Henry Tsuei, president for China/North Asia in processor First Data Corp.'s First Data International unit. A year later, Bank of China renamed the card the Great Wall Card. China's other banks, primarily Guangdong Development Bank, ICBC, China Merchant Bank and Bank of Communications, have issued credit cards since 1995, says Albert Shiung, Visa's vice president and country manager for China.
  China's credit cards, estimated to number between one million and three million, are akin to secured credit cards in the U.S. A cardholder has to deposit money into a savings account to cover charges. Debit cards are common. In fact, there are an estimated 600 million of them, according to Shiung. The cards have little utility at the point of sale; their main use is at automated teller machines.
  The other thing the issuers agree on is that they believe China is the mother lode as far as cards are concerned.
  "It's the enormity of the market," AmEx's spokesperson exclaims. "China is the world's sixth-largest economy."
  During a ceremony in Shanghai to celebrate the launch of the Citigroup/SPDB card, Charles "Chuck" Prince, Citigroup's chief executive, who flew in for the event from New York City with other bank executives, gave a speech that underscored China's importance to Citigroup's credit card business.
  "As consumer spending becomes an increasingly important driver of economic growth for China, credit cards will have an ever-increasing role to play," Prince said.
  Citi/SPDB then presented their first card to Chen Xieyang, conductor of the Chinese Symphony Orchestra, during a colorful ceremony that included a parade along Shanghai's waterfront.
  China holds many attractions for card issuers that are always searching for new and expanding markets. The country's 1.26 billion citizens have an estimated $1.3 trillion in personal savings and there are 60 million households that have an annual, middle-class income of more than $6,000. The size of the middle class is expected to reach 250 million by 2015.
  The budding Chinese credit card market, however, offers as much risk as it does rewards. "A major structural problem is that China does not yet have the extensive and relatively reliable lists of prospective cardholders like the ones issuers routinely rely on in the U.S. "There just aren't any good mailing lists in China," Shiung says.
  In addition, national credit-reporting agencies don't exist. Citigroup and HSBC may have established Shanghai as their beachheads because until recently it was the only city in the country that had a credit bureau, Shanghai Credit Information Services Co. Ltd., according to Alex Boorman, financial analyst for Datamonitor Plc, a London-based business information company and author of the study, "Revenue vs. Risk in Asian Credit Cards."
  "I would therefore be surprised if the new operations did not focus on Shanghai first and then spread out around the country as more credit information becomes available," Boorman said in an e-mail.
  That is what's occurring. In its literature, Citigroup/SPDB say their cardholders must be permanent residents of Shanghai and have a resident certificate to prove it. Visa's Shiung agrees with Boorman's take on the situation and adds that China's government will begin replicating Shanghai's credit bureau in other cities. Beijing Credit Bureau Co. opened last July but is just ramping up operations.
  Boorman also fears that Chinese policymakers are creating the same climate for massive chargeoffs that South Korea's government set in motion. The government has taken the controversial step of encouraging its citizens to use credit cards, especially in advance of the 2008 Summer Olympic Games in Beijing. The South Korean government tried that policy, and it helped lead to the recent collapse of Korea's card industry under a huge pile of bad debt.
  People's Bank of China also has limited issuers to charging a fixed, 18% interest rate on unpaid credit card balances, according to Shiung. "Banks cannot charge higher or lower rates, so it's not very competitive," he says.
  To be sure, the mandated rate paves the way for profitability. Issuers' funding costs are only 2%, according to Shiung.
  Another major issue facing foreign card issuers is that the renminbi is not convertible. But Willie Fung, MasterCard International's general manager for Greater China, believes that the problem will be solved over time.
  Cash Reigns
  "It is certainly more desirable for China to have a flexible and freely convertible currency," Fung said in an e-mail. "These are no doubt China's long-term goals. In the short-term, however, it is likely that China will relax the trading band of the Chinese currency to improve its flexibility. Full convertibility will take a lot longer because the issue is tied to the restructuring of China's state banks."
  The currency issue is a concrete problem, but issuers also face some fuzzier but no less real ones. One involves credit in a society in which cash reigns. "Many older Chinese consumers also are familiar with a time prior to the 1970s when most transactions in China were conducted on a barter basis," Datamonitor's Boorman says.
  But MasterCard's Hedrick-Wong believes that revolving credit cards will appeal to China's educated young people who live in coastal cities. "They want cards to shop, dine at restaurants and go out like young people everywhere," he says.
  The annual per-capita income in the coastal cities is about $7,000 compared with China's national average of $1,100.
  But right now, having a credit card in China is like having money to spend but no place to spend it. Hotels and airports accept credit cards, but few merchants have the terminals to accept cards.
  "Only 2.3% of merchants that are capable of accepting cards in China take them," says Matt Mecke, president and CEO of card processor Asia Payment Systems Inc., citing a Canadian business study.
  Tsuei, of First Data International, which processes cards for China Everbright Bank, says card acceptance varies from city to city. "Ten percent of merchants in Shanghai accept cards compared with 30% in Shenzhen," Tsuei says.
  Meanwhile, AmEx, Citigroup, and HSBC say they will play the roles of both student and teacher in China. They especially will assist their partner banks in marketing the cards. And on both the issuing and acceptance sides, there's a lot to learn.