China Takes the Lead in Payments Innovation

By Nicholas Borst and Sean Creehan

In the fifth episode of our series on financial technology, we sat down with Zhong Wang, Head of Strategy and Overseas Payments for Baidu Wallet and Payment Services. Zhong is a veteran of both Silicon Valley and the Chinese tech industry and is an expert on the retail payments sector in China.

We invited Zhong to speak with us about why innovations in payments are occurring so rapidly in China, the competitive threat that new payment companies represent to banks, and how developments in payments may impact other parts of the Chinese financial system. The conversation covers a number of interesting topics. For example, can new payments technologies help bring financial services to China’s large underbanked population? Is there a generation gap between the young and old in terms of adopting mobile payments? Will Chinese payment companies be able to expand to other rapidly developing Asian economies? Zhong also explains what he sees as some of the biggest differences between Silicon Valley and tech companies in China.

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Nick Borst:

Welcome to Pacific Exchanges, a new podcast from the Federal Reserve Bank of San Francisco. I’m Nick Borst.

Sean Creehan:

And I’m Sean Creehan. We’re analysts in the Country Analysis Unit here at the San Francisco Fed. Our job is to monitor financial sector developments in Asia, and as part of the Fed’s public mission, share information and analysis with listeners like you.

We inaugurate the podcast with a series of episodes that look at the state of innovative financial technology, commonly known as fintech in Asia.

Nick Borst:

Fintech is a buzzword that gets thrown around a lot, but what exactly is it? One simple definition would be the use of software to provide financial services online, or through mobile phones.

This could involve banks, but just as often involves startups. Fintech firms operate in a number of sectors ranging from lending to personal finance, digital mobile payments, and virtual currencies.

We’re excited for you to join us in the episodes to come as we explore how fintech is impacting people’s lives in Asia.

In today’s episode, we sat down with Zhong Wang, Head of Strategy and Overseas Payments for Baidu Wallet and Payment Services.

We invited Zhong to speak with us about the rapid development of digital payments in China, the impact payments technologies can have on the rest of the financial system, and the difference between cultures of innovation in China and the United States.

Thank you very much for joining us today, Zhong. As we start out, maybe we can first talk about why China. The adoption of new payments technology in China seems to be evolving very, very rapidly.

We see huge numbers of new users with these technologies. Why is this level of innovation taking place in China rather than other parts of the world?

Zhong Wang:

Happy to be here. The first question actually has been asked before. Is China unique? Is the adoption faster than other parts of the world?

I would say there’s three factors here. On the consumer side, or say on the C side, we’re seeing a very fast software and also hardware enablement. On the merchant side, a lot of the merchants, we call them “0-2-0” or online-to-offline type of merchants. A lot of the merchants are also adopting, or say taking mobile payments. Also, the third factor is there are still underbanked population in China.

I would say these three factors combined together contribute to the fast mobile payment adoption. Let me expand into each of these factors. You’re seeing pretty fast growth of average income in China, the GDP growth. Also, at the same time, the cost of smartphones are actually coming down. Not only there are Apple and Samsung, but also Huawei, Xiaomi. They’re actually able to make pretty well-made phones with a low cost, especially Xiaomi. The cost, or say if you look at the amount of a salary you have to pay to get a new phone is actually not that high now in China. Also, same is true for some other parts of the world. Therefore, the threshold for consumer to adopt mobile payment is lower and lower.

Also, on the merchant side, the second factor you’re seeing more and more payment scenarios can be done on a mobile phone, or say paid by a mobile wallet app. For example, the Uber alike which is Didi Kuaidi in China, and also take out delivery in-house or in-restaurant dining, they can all be paid via mobile phone in a few clicks, which is very convenient. You can also buy movie tickets and also select your seat on your mobile phone and then pay with one or two clicks. The merchants, the big merchants and also the small merchants are taking mobile payments for their own benefits, that also helped the mobile payment adoption in China.

The third factor is, if you look at the banked population, it’s true most of the Chinese have access to bank resources, but credit card penetration is still sort of low compared to US. If I’m not mistaken, the average credit card per card population is about one, one card per capita in China, and the number is probably four in US. The credit card penetration is still sort of low and mobile payments actually fill some of the gap here. Again, these three factors I would say are contributing to the fast growth of mobile payments in China. Of course it’s a very big market, therefore sometimes the economic scale makes sense for mobile companies to expand and also to acquire users at a very fast pace.

Nick Borst:

For mobile payments in China, is that a leapfrog to a completely new type of technology or does it still rely on credit cards and debit cards and those sort of more traditional payment systems?

Zhong Wang:

Most of the funding instruments are still debit cards and credit cards, which is to say eventually it has to come from a bank. I like the word leapfrog, and I would say the mobile payments actually leapfrogged the PC payments in China. Actually, the second half of the PC adoption is sort of skipped in China. If you look at the number of PC per household, it’s probably lower in China than the US or other parts of the world, but also that means you have less baggage actually to work on when you develop new ways to pay. I would say that also helped.

Sean Creehan:

Piggybacking on that question, when you talked about the fact that these new services are conducive to the use of mobile phones and also the development of e-commerce is accelerating use of digital payments, I’m wondering is there also a generational phenomenon in China? Do you see higher use of these sorts of digital payment services amongst the younger generation, or is it really broader than that?

Zhong Wang:

That’s a very insightful observation. It’s true the younger generation, for example students and also the core workforce group, they adopt mobile payments faster. But you also see for example my parents, they use mobile payments, like they send P2P payments on their phone and they pay for Uber-like services using a mobile phone. You’re also seeing adoption on the long-tail generation, the age group. I would say there is no significant difference, but in terms of the level of adoption, in terms of usage frequency and the skill, yes. The “Venmo generation”, the young generation, are faster and they’re more actually used to make mobile payments and they are less prone to carry cash around.

Nick Borst:

How have banks in China responded to what’s going on in the payment space? Do they see this as a threat or is this really an opportunity for them to transform their businesses?

Zhong Wang:

That’s a very insightful comment too. It’s true, in the early days the banks helped the PSP, Payment Service Providers, or say the wallet companies. Now, I would say the trend is, the market is being refined. Banks focus on what they do best and the PSPs for example they take more of the convenience payments or small ticket payment scenarios. But in the long run, I think they will still work with each other, there will be competition, but there also there will be cooperation. For example, like we said earlier, the funding instruments are still most likely debit cards and credit cards, which is to say the banks will have to open up APIs or interface for the PSPs to do a add card. Also, they will have to allow or work with the PSPs for the deposit or the withdrawal process. On the other hand, the banks will need the volume, the customers from the PSP to be successful.

Also, we’re seeing somewhat of a lower fraudulent rate on mobile payments compared to card swiping because you have more information about the user to detect fraudulent activities. Another way to cooperate is actually, some banks are launching their new cards, especially credit cards using wallet as a marketing channel or launch channel, or user acquisition channel. This is also a way, you’re seeing they’re coming closer to each other. Also one trend is, the banks are also improving their own services. For example, most of the large banks have their own wallets and I would say some of the wallets are pretty sophisticated, I mean wallet app. Some of the large PSPs are actually launching their own online banks or they’re doing some of the bank’s drops. They’re coming closer to each other, they’re working with each other, but also on some segments they will compete with each other.

Sean Creehan:

One topic we’re interested in here is the opportunity for synergies between payments and other types of financial technology. I’m wondering if you could talk a bit about how you see advances in payment technologies affecting other parts of the financial system, other fintech sectors, for example, lending.

Zhong Wang:

It’s interesting to see not only in China but probably around the world, payment is typically the first demand to be disrupted by new technology or new ideas. Then it’s gradually really is through other demands, for example lending, wealth management. I would say payments help other sectors in several ways.

The first way is the accounts accumulated. No matter what you do, lending or loss management, the first thing especially for online services, the first thing you need to do is actually to acquire accounts. For financial services, the accounts are … you have actually more requirements, especially due to risk consideration, the accounts must be more protected and payment is actually a very low-cost and a smart way to actually acquire these customers to get their real names, their real phone numbers and also to accumulate accounts in a fast way because you’re giving the users the convenience. On the other hand, let’s say if you’re a lending company and you plan to acquire lots of customers or accounts, without any other services or without a payments service to start with, you will probably see some resistance there.

Also, I would say payment experience of fintech companies will also improve the risk handling capability of these companies for several reasons. One is again, you know a lot more about these users, not only their real names or real phone numbers, but also their payment histories and their habits so you can customize your service for these users and also use the historical data for your risk models. When you actually build your risk model for payment services, you sort of strengthen your own skills, modeling skills or statistical skills for your lending or loss management service. I would say most of the large fintech companies probably will have, especially in China, they will have a payment service to start with or to … as infrastructure as underlying support to bolster their other financial services.

But also you have to be aware that the profit level, or say the marginal payment is low, especially in China, the margins is really thin. The profit will have to come from somewhere, like lending and also loss management. Doing payment alone is probably not going to be sufficient or sustainable, therefore you will have to expand it into other demands or sectors, but payment will continue to be a very strong support when you move forward.

Sean Creehan:

Just picking up on a point you were making about the role of payment data and other alternative data in helping perform risk assessment, I’m wondering if you could talk a little bit about that for the benefit of our listeners. I was reading before our interview an interesting statistic. In December of last year, Fitch estimated about 35% of Chinese consumers had a formal credit history, versus 90% here in the United States. Clearly there’s a gap there in terms of the average consumer having an active credit history. Could you talk a little bit about the role of alternative data and data from payments operators for example in helping to bolster that credit risk assessment?

Zhong Wang:

Yes, thanks for this question. In absence of publicly acquirable credit history in China, payment history or say payment data can actually be very, very helpful. We mentioned again, you get real user information, while sometimes it’s now that easy, but payment give you that sort of close access to a user. It’s actually more than just payment. If you looked at the other side for example credit card payments, mobile payments give you a lot more, especially about the user.

Also, you’ll be able to get geolocation information, also history and the user’s habits and even what actually leads the user into the current merchants or say the current payment scenarios. Sometimes that’s very critical to know. Mobile payment data tends to be more structured compared to probably the traditional way of payments, in my view. Again, the skills you accumulated by processing payment data will actually give you some advantage or will make you more experienced when you have to process the data for other type of financial services, so it’s quite related.

Nick Borst:

You mentioned earlier the problem of having a relatively large unbanked population in China. Can you describe how maybe innovation and payments can fit into this? How can these new technologies bring new financial services to these people?

Zhong Wang:

Again, let me explain myself here. I think in terms of debit card penetration or coverage, it’s pretty good already in China with a combination of national banks and local banks and community banks, but credit card penetration, there is still a way to go. For example, one way the mobile payment or say mobile wallet can help is to give mobile, or digital credit or online credit to this population. Actually, there is a variety here.

For example, maybe you’re a student and you need to pay a tuition and there is actually tuition loan that the wallet can offer, or there’s also such type of, we call it a no scenario type of landing, you just leave some cash and we’ll be able to actually offer credit service at a faster speed, faster decision speed than the traditional bank to this group of users because we know more information from the user than the traditional banks. I would say mobile payments or mobile wallets or the new fintech are not going to replace the traditional type of services, but they will find their own strengths. The market is being refined. They will actually find the segments that are the strongest and then the market will evolve from there.

Nick Borst:

They’re a supplement, not a replacement.

Zhong Wang:

Correct, yes. Exactly.

Sean Creehan:

What about the rest of Asia? Do you see similar opportunities for payment technologies already happening or in the future?

Zhong Wang:

Interesting you asked that. In my past three years in Asia, actually I’ve been to quite a few countries. I also noticed other countries moving very fast or picking up very fast. While some people say the India market, India mobile payment market is exactly like China’s three or four years ago, there’s a large population base, income level is increasing while the mobile phone price are actually decreasing, the banks are also catching up in terms of services. Also actually, one important factor is the usage of a mobile phone, or say the data plan is also becoming cheaper and cheaper. That also helped. All these factors are contributing and I wouldn’t be surprised at all for a fast maybe a 30% growth year-over-year in countries like India, Indonesia, Vietnam, I very much look forward to that.

Nick Borst:

Do you see an opportunity for domestic Chinese payment firms to expand overseas into some of these markets? Are there opportunities as well as challenges that they’re going to face?

Zhong Wang:

This is my favorite question because this is what I work on. For cross, we call it cross-border payments or say expansion around the world, I would say there’s three opportunities here. One is the one I think you have mentioned, to expand into oversea domestic markets. I would say, yes there are those investment and also business opportunities there, but I would say local partners or funding the right local partners is key. We’re talking about local banks, local PSPs and also merchant acquirers to work with and maybe also the global card networks to work with.

Also, attention has to be paid to the local regulations. I noticed actually each country is different and the local regulations are also actually quite different. That’s also a factor to consider. In terms of what we bring, yes it’s technology, know-how, and also sometimes it’s the business know-how, but I would rather say it is more efficient to actually work with a planner and then contribute rather than to directly target those markets. This is the first way actually for Chinese payment companies to expand overseas.

The second way is actually to serve the Chinese group, for example outbound travelers by enabling them to use mobile payments rather than cash or cards when they travel abroad. Typically we can offer a better foreign exchange rate. Just to give you an idea, last year there were about 140 million Chinese travelers who went abroad, and the average spending is above 2000 US dollars in some destination countries. That’s actually a pretty big population compared with some of the local populations. It’s not a small market to work on. That’s for travelers, but also we can also serve the online buyers, especially import buying shoppers, which is actually a very popular group, very large group in China now. You know Baidu is a search company and search and e-commerce has a very natural synergy in-between so we believe we can also help our customers there.

Sean Creehan:

You mentioned a few factors that you would look at when you were considering other markets that could be adapting these sorts of payment technologies quickly, so demographics, maybe rapidly growing income, widespread adoption of phones that are able to use these sorts of digital payment technologies. Is there anything else that you look at, certain aspects of the financial system, the role of banks? I’m just curious if you could talk a little bit about that aspect.

Zhong Wang:

The banks will have to be able to support this kind of growth, or I’ll say they’re willing to participate. I see that coming. Actually, some banks also sensed opportunities here. They’re working with the local PSPs, but also some of them are actually developing their own mobile payment infrastructures. It doesn’t have to be the way everywhere has to follow what has happened in China, but I think between PSP and banks, it’s more of a collaboration to refine the market in a more efficient manner.

Nick Borst:

Zhong, you’ve worked here in Silicon Valley and also in the Chinese tech world. I was wondering if you could talk a little bit about what you see as the big differences and the similarities between the two?

Zhong Wang:

Yes. I spend my last two years in China and also previously 10 years in the Valley. I would say both are moving, especially adopting new technologies at a very fast pace, but if you compare the two, China is more market-driven or say there is a marketing vacuum, or there’s a marketing opportunity and tech companies are actually jumping into the market to solve the user pain points. In the US it’s more technology-driven, it’s about new technologies being applied to existing market or existing problems. If you compare the two, so the market-driven approach is sometimes more dynamic. You’re racing against your competitors because typically they will also see the market opportunity here and it’s a race.

For technology-driven opportunities, typically you have the know-how and it’s not that easy to be grabbed by competitors. I would say the expansion of technology-driven type of business is more predictable and again you’re disrupting a mature market, which tends to be slow-moving. On the other hand, in China sometimes you’re not really disrupting a market but you’re creating a new market. In China, you tend to see maybe more of a winner-take-all for market-driven. Maybe not winner-take-all, but winner-take-a-lot, or winner-dominates.

Another thing I would like to mention is because of the population base, you see faster social expansion or viral marketing. When you have a large population base, the virtual distance between people is closer probably, if I can say it. Also I would like to add, companies in China are probably more risk taking because when it’s market-driven you tend to have a bigger upside when you take the same amount of risk, so it makes sense to take more risk.

Sean Creehan:

Thank you very much for joining us. We look forward to monitoring developments in the payment space and wish you best of luck in your various activities.

Zhong Wang:

Yeah. Since we’re doing rotation and I’m glad to comment or contribute here.

Nick Borst:

Thank you.

Sean Creehan:

We hope you enjoyed today’s conversation with Zhong. For more episodes like this, you can find us on iTunes, Google Play and Stitcher. For even more content, look up our Pacific Exchange blog, available at frbsf.org. Thanks for joining us.


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