Credit cards in China need cautious view

THERE ARE GROUPS of planners in various consumer banks around the world that are sleeping much less than they should.

The China Banking Regulatory Commission has recently indicated officially that there is a possibility for foreign banks to issue credit cards on the mainland 'in the near future', and these planners are scrambling to understand the implications and develop scenarios for entry, depending on what the final official rulings are.

Generally, there is a widely accepted notion that the demand and supply gap for credit cards is enormous, especially in richer cities where wealthier consumers are increasingly experiencing the inconvenience of carrying a lot of cash when they buy big-ticket items.

There is also a general belief the growth for credit cards beyond filling this demand-supply gap will continue exponentially in the foreseeable future, unless something happens that drastically halts the economic growth of the mainland.

As income grows, card spending as a percentage of total spending also increases, because consumers will be spending proportionally less on stable items such as food and transport and more on dining out and luxury goods.

Additionally, as the use of credit cards become more of a habit, the portion of card spending that is unpaid at the end of the month, revolving balance, also tends to rise.

All these trends suggest the growth of credit card revenue will be much faster than the already dizzying growth in income and consumption.

But how big is the market really?

Market researcher McKinsey & Co estimates there are fewer than one million credit cards and the revenue generated is less than 160 million yuan (HK$150 million).

This is, of course, the result of a strict regulation on card issuance that is about to be alleviated.

By examining credit card penetrations, patterns of card transaction and revolving balance, and per-card volume of other economies with similar spending power and looser regulations, my rough estimates indicate that, if credit card restrictions are removed now, there will be about 150 billion yuan of transactions on credit cards in the mainland's urban areas, with about 30 million cards in circulation.

Assuming the typical industry merchant discounts, interest margins, and annual fees, the mainland card market could be worth about 10 billion yuan a year if it was opened up now.

Sounds like a big business? Not really.

The 150 million yuan of card transaction is roughly about the same as the transaction amount in Hong Kong.

Making money from credit cards in China will be no easy task.

First off, these 30 million potential card accounts are scattered across hundreds of cities, and identifying the households who are rich enough to be profitable for the banks would be a challenge, and some of them just do not want themselves identified.

Even after identifying who the right customers are, running credit checks and approval procedures on them will also prove difficult.

Some banks may limit their initial investments by focusing on just the largest cities in the beginning, but that is not justifiable for most banks.

My estimate is that the top three cities on the mainland may have enough wealthy households to support only about five million to six million card accounts.

Because running a credit card business requires considerable investment in operations and technology, typically 300,000 to 500,000 card accounts per company is the minimum for breakeven, and the figure might be even higher initially in China because consumption and revolving balance per card are lower.

Throw in the fact that many merchants, now operating in cash mode, will need substantial convincing to allow banks to take a percentage off their top line and to leave electronic trails of their transactions for the tax authority's scrutiny, you now understand why midnight oil is being burned at these aspiring consumer institutions.

I suspect some of these banks will charge full steam ahead at the aspect of, for the first time, establishing direct contacts and billing relationships with the Chinese consumers.

The other ones, perhaps the smarter institutions, will take a follower strategy and let their competitors do all the hard work before entering themselves.

Ken Lo is the managing director of BusinessDevelopmentConsultants & Co, a strategy and management consultancy firm