Introduction to the consumer credit market in China

Nowadays referred to as an emerging economy, China represents a very exciting business proposition for investors around the world. The Chinese consumer market is constantly expanding. This expansion must be met by credit cards nowadays. There are millions of credit cards issued in China at present. However, the majority of these plastic cards are yet unused, seeing that the Chinese people are a conservative lot that would not easily trust in plastic money with a host of privacy issues.

What is more, the country has not by now developed a proper “credit check industry,” and neither has the banking industry invested heavily thus far in consumer education. In the absence of credit risk management, a massive “consumer credit crisis” may be in the offing. South Korea and many other examples are before China in this context. Now, if a consumer credit crisis were to hit the most populous nation in the world, it would not only hurt the economy of China, but also have an enormous impact on the global economy which relies on the cheap products and services of the emerging economy.

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Moreover, a consumer credit crisis would most likely threaten the stability of Chinese society – the kind of happening that the country has had painful experiences with through its history (“800 mln,” 2005). China’s big loans market is already suffering from a huge amount of bad debts. The China Corporate Credit Risk Management Survey of 2005 showed that bad debts are constantly on the increase. In fact, one hundred percent of the survey participants had an “overdue problem” (“Corporate Credit”). This is the reason why investors are worried that the Chinese experience with credit cards would also be mismanaged and corrupted.
In terms of its new trend to increase Credit Risk in China 2 the number of credit cards issued, the country is often compared to South Korea. Pesek (2005) writes: From the ashes of the Asian financial crisis, South Korea quickly emerged as a role model for the region. It rebounded by strengthening its financial system, reducing foreign debt and reining in the conglomerates that dominate the economy. It encouraged banks to stop lending to shaky businesses, which had been a cause of the crisis. Yet efforts to restore proper risk management in its banking system backfired. When they
halted lending to the corporate sector, bankers turned their sights on households. Individual loans mushroomed, as did the number of credit cards lining consumers’ wallets. The trend proved disastrous. Soaring household debt and default rates drove the economy into recession and led to billions of dollars worth of bailouts for credit companies. Before the crisis, South Koreans had little experience managing debt, to say nothing of high-interest-rate credit card debt. The lack of sophisticated systems for checking creditworthiness complicated matters. Walking the streets of Seoul between 1999 and 2002,
one confronted a barrage of hawkers handing out credit-card applications. It hardly helped that the government was encouraging credit card use with tax benefits. That drove banks and nonbank lenders to step up marketing efforts. Feeling guilty and realizing how big a problem it had on its hands, the South Korean government organized bailouts. That sent a terrible message to markets. Credit card issuers extended credit to just about anyone who wanted it, and were left with surging delinquencies as the economy slowed and households couldn’t service the debt.
Credit card companies over-leveraged to an extent that investors and regulators did not realize. Many of the loans were securitized through asset-backed securities. Most of the debt was short-term and had to be rolled over, meaning that the assets were not fully taken off balance sheets. And then, the government saved these gamblers. Only now is South Korea shaking off the effects of these blunders. At last, its economy is growing again and households are confident enough to increase spending. While Chinese demand for Korean goods is certainly a factor, so are improved consumer finances.
China must be careful to avoid a Korea-like debt meltdown. With the benefit of hindsight, China may indeed do that. Besides, there is no guarantee that Chinese will take to plastic as, say, Americans have. The increasingly affluent middle class may, but will hundreds of millions of Chinese warm up to high-interest-rate debt? Understandably, such risks aren’t deterring credit card companies. The Chinese already rank among the world’s most influential shoppers, buying more cell phones and televisions each year than U. S. consumers do. Yet Chinese demand is a small fraction of what it might be in 10 years.
Think what it would mean for issuers if even 20 percent of Chinese put two revolving credit cards in their wallet. And think of the consumption multiplier-effect that debt can Credit Risk in China 3 produce. Debt, managed responsibly, has the potential to add momentum to Chinese consumption trends. Serious consumer education, however, is needed. MasterCard International, for example, is working with banks, the media and universities to inform Chinese about the intricacies of debt management. China’s government also has a big role to play. Such concerns may be overdone, of course.
The trend could merely be part of China’s evolution toward developed-economy status. As its consumers become worldlier, credit card usage may be a sign of economic maturity. Yet if South Korea, a far more advanced economy, could get into such trouble with credit cards, one wonders about China. Will a sudden taste for debt lead to financial troubles among Chinese consumers? The risk is one more to consider when assessing China’s outlook. Today, China acts as a hotbed for foreign direct investment. But, what if a consumer credit crisis were to really hit the nation?
Indeed, this would reduce the tremendous attraction that the emerging economy currently holds in the ‘bank accounts’ of global investors. Most importantly, there is no data available on how well the Chinese government is planning to handle a credit card crisis, if and when it occurs. Although the Chinese economy competes with the United States economy for the highest consumption in the world, the emerging economy cannot legitimately be compared to the economy of the United States, and also cannot be trusted to support itself like the latter in the event of a crisis.
Hence, investors are concerned that the emerging economy could suddenly collapse because of mistakes that are made today in the Chinese credit market. After all, China has introduced credit cards as though it had known them all along! Reality is, however, that the country lacks experience in handling credit risk at this point in time. Banks would like the credit card business to fund their future growth, as well as to improve their current financial positions. At the same time, the government would like to promote consumer spending in an effort to boost the economy.
Even so, it remains a fact that the Chinese banks have no experience whatsoever with credit cards (“Credit Cards,” 2003). Credit Risk in China 4 The banks of China have millions of individual depositors. These banks were pushed into the credit card business or consumer lending only after the People’s Bank of China’s issuance in 1999 of the “Guidelines for Conducting Consumer Credit. ” The document allowed all Chinese banks to offer credit to consumers, leading to an immediate increase in consumer credit over the next few years. In the year 1997, consumer credit in China amounted to only U. S. $2.
1 billion. Four years later, the amount of consumer loans outstanding had increased to U. S. $84. 8 billion. Still, consumer credit represented only ten percent of the Chinese banks’ business at the time. Most of the outstanding loans were big business credit (“Credit Cards”). Moreover, as discussed previously, a large number of big business loans in China continue to default in our day. As a matter of fact, given the bad debt history of Chinese big business loans, it is easy to understand the concern of the investors that increasing consumer credit might somehow turn out to be a huge failure for the emerging economy.
China should have developed a better credit risk management system for its big business loans before it ventured into the credit card business. If the country had learned to manage the credit risk with big business loans, it would have been easier to manage the risk with plastic money nowadays in the hands of consumers. Today, the banks of China are known to be aggressively promoting the use of credit cards in order to support the policy of the government to increase consumption across the nation.
All the same, this “aggressive campaign” on the part of Chinese banks is still compared to the experience of South Korea after the 1997 financial crisis. Although a Chinese worker may now obtain a credit card that is ten times his monthly salary; the fears of investors are not alleviated (Chan, 2006). Credit Risk in China 5 China’s credit card industry has also received an enormous boost from the nation’s entry into the World Trade Organization. “Liberalization of the financial sector” as a result of China’s entry into the WTO has attracted a lot of attention from financial institutions worldwide.
In order to allow the global financial institutions to trust the Chinese consumer credit market, however, the nation would have to develop “an updated and comprehensive national consumer credit database” (Xu ; Liu, 2006). Xu ; Liu also suggest the “use of credit risk modeling and scoring in predicting consumer behavior. ” The government of China is presently holding conferences and inviting speakers from abroad to discuss credit risk management. According to Chan, consumer credit risk management may very well turn out to be a priority area in Chinese policymaking in the near future.
Today, China ranks behind the United States as the Number Two issuer of credit cards (Worthington et al. , 2007). According to DaCosta ; Foo (2002), unless the country “undertakes serious and timely banking reforms,” its financial institutions would remain vulnerable to enormous crises. With a population of 1. 3 billion, a consumer credit crisis in China would be a disaster. At the same time, however, business researchers insist that the banking crisis to hit China next may have to do with big business loans rather than credit cards.
Seeing that credit cards continue to represent only ten percent of the outstanding loans of banks; the credit risk related to plastic money is definitely not as huge as the credit risk that is associated with big bank loans. Besides, only three percent of the consumer spending in China is presently attributed to credit cards. Despite the fact that there were 110 Chinese institutions issuing credit cards in the year 2004, and card circulation had been estimated at roughly 714 million; the data on the Credit Risk in China 6
general lack of use of credit cards in China should serve to alleviate the fears of global investors for the most part (“Chinese Credit”). In point of fact, it may be inferred that the consumer credit market is not thus far facing a monstrous amount of credit risk anyway. Even if a banking crisis does occur, the credit card market of China may find itself insulated from disaster seeing that it is just not moneyed or important enough at present to fail miserably. Another feature of growth in the Chinese credit market since the nation’s entry into the WTO concerns automobile consumption loans.
China is expected to compete with the United States as well as Japan also in terms of the use of the greatest number of cars. Once again, in order to support the increasing consumption, the government of China has vowed to allow easy automobile consumption credit to the Chinese people. Foreign financial institutions that operate in China are required by Chinese promises to the WTO to be treated in the same way by the government as the local financial institutions are treated. Therefore, foreign financial institutions are also expected to show great interest in the automobile consumption credit market in China, especially in the coming years.
In fact, the Chinese government is banking on foreign financial institutions to get the ball rolling for the new automobile consumption credit market very soon (“China’s Auto Credit,” 2002). The Chinese government would like the credit market of the nation to function by the law of demand and supply. In order for there to be an “abundant supply” of credit throughout China, the government would like to open up information channels to distribute credit information among the potential lenders as well as borrowers. Such ‘open, credit information’ would constitute knowledge about where to get consumer credit, small loans, and big loans (“Three
Credit Risk in China 7 Mechanisms,” 2004). Clearly, the government would like to develop the economy of China beyond measure. At the same time, it is important for the Chinese government to develop a database on borrowers that would be made available to all lenders, both local and foreign. This database on borrowers would make it easy for the potential lenders to understand consumer behavior with regards to credit risk management. Furthermore, the economy would be able to reduce its potential losses in the credit market by a large extent through such developments.
Indeed, the Chinese government is deeply enthusiastic about further developing the economy of China. Small loans in the country are usually reserved for the poor and hardworking people, who actually represent the majority of the population. The following is a brief report on the use of a small loan by a poor Chinese farmer who has changed his standard of living, thanks to the small loan: Kong Keming, a poor farmer in Yongjing County in northwest China’s Gansu Province, is now leading a better life thanks to a loan provided by the local agricultural bank. Kong used to lead a very hard life.
Last year, he built eight warehouses to grow vegetables in with a loan from the county’s agricultural bank and earned a good income at the end of the year. Like Kong, more than 150,000 families in poor areas across the province also were able to break the chains of poverty through planting vegetables, growing herbs, farming, raising livestock and opening businesses with financial assistance from the local agricultural banks. The system of small loans was introduced to China in the mid-1990s. In Gansu, the agricultural banks started to give loans to poor farmers in 1998. So far, more than 397 million
yuan (US$47. 83 million) in loans have been awarded. According to local officials, most of the poor families, which have been given small loans, were able to use the money to successfully increase the amount of money they make and live a better life (“Small Loans,” 2000). Credit Risk in China 8 Of course, China is home to a considerable number of poor farmers. The country is similarly home to a significant number of poor women. In the year 1978, there were around 250 million poor females in the nation. In 2004, the number of poor women in China had dropped to 26.
1 million. This change came about also through the new economic policies and decisions that were made during the 1990s. The decision to expand the credit market during that time included a plan to increase the number of small loans to poor women in China. Similar to the experience of Bangladesh’s Grameen Bank with micro credit – the small loans that China made available to poor women led to small business growth in the country, apart from poverty reduction from thirty percent to almost three percent. The province of Anhui in East China, for example, distributed approximately U. S.
$310 million among 2. 6 million women as small loans to achieve U. S. $143 million in economic returns. What is more, China has invited foreign funds to support its poverty reduction campaign through the granting of small loans to poor women. The country additionally believes that the poor women of China must be taught new skills in future to control poverty with greater intensity than before (“Small-sum Loans,” 2005). China’s experiences with small loans have generally been positive. There is little credit risk attached to these loans. In the Chifeng City of China where U. S. $4.
9 million had been granted in small loans to 42,300 poor women, the pay back upon maturity has roughly amounted to 99. 97 percent (“Small-sum Loans”). Despite the fact that illiteracy and corruption are rampant in the nation, given its poverty levels through modern history; the Chinese government does not have to fear the credit risk of small loans. Also according to our analysis, the government should not Credit Risk in China 9 be very concerned about the credit risk in the credit card business either, seeing that credit cards are still not used abundantly by the emerging economy.
Nonetheless, the essentiality of credit risk management systems remains. Knowing that the risks attached to small loans and credit cards are not significant enough to stop the expansion of the credit market in China; the Chinese government has planned to expand the credit market in an entirely new direction – this time to help out the unemployed persons with micro credit. The small loans thus granted would be used by unemployed people to start up their own businesses. In Shenyang, the municipal government has planned to offer U. S. $5. 5 million in small loans for this reason.
What is more, the local labor department has developed a priority list to offer small loans to everybody whose description could be found on the list, e. g. servicemen that have been transferred on to civilian work are allowed to borrow U. S. $2,500 for two years (“Small-Loan Scheme,” 2006). Although the credit risk with small loans and credit cards is thought to be quite low, analysts believe that the commercial banks of China are hesitant to grant micro credit because it is not very profitable. After all, there is a strict limit to the level of profits that can be made by granting loans to the poor and illiterate Chinese people.
Nevertheless, the government continues to assert its authority by pushing the financial institutions of the nation to support its poverty eradication program through small loans (“Small-Loan Scheme”). Indeed, China appears all set to allow its economy to grow by leaps and bounds. With the backing of countless foreign investors, the country is making economic progress all of the time. In spite of this, the experience of South Korea after the 1997 financial crisis is repeatedly brought to mind when considering the rapidity Credit Risk in China 10 of economic changes that China seems to be making in a positive direction.
It is possible that the present confidence of China would prove to be mere over-confidence, if not plain imprudence when the country does hit upon a crisis. Then again, if the Chinese banking sector were to develop a sound credit risk management system in the near future, investor confidence would not be easily turned away from China. In recent years, the China Banking Regulatory Commission has also been leading efforts to encourage commercial banks of China to offer loans to small businesses. Although these loans are not as cheap as micro credit is for the banks, offering loans to small businesses is a necessity in the emerging economy.
As a matter of fact, China is presently moving heaven and earth to become a high powered economy. For this reason, the banking regulator of China is working with the central bank to also introduce new channels of funding for small businesses. The new channels could take the form of “privately-owned small loan lenders. ” Regardless, the lenders in this section of the credit market must be prepared to deal with a credit risk that is greater than the risk of granting micro credit. Banks have experienced that seventeen percent of their outstanding moneys are with small businesses (Lei, 2006).
Hence, the credit risk of loans to small businesses is known to be greater than the risk of bad debts on credit cards and micro credit. Apparently, the credit risk of big business loans beats all degrees of risk attached to other forms of credit. Foreign financial institutions are showing interest in the credit card and the small loans markets of China because they are not as risky. Still, the investors’ concern about China remains. In particular, the global investor is responsible for answering the following concerns: (1) Is the growth of China sustainable? ; (2) Would the Chinese economy suddenly
Credit Risk in China 11 crash because of excessive lending in all directions at the same time? ; and (3) What would happen if the Chinese economy were to collapse in the near future? Naturally, investors in China must be able to deal with not only the credit risk on loans, but also the rampant corruption and illiteracy in the nation. China represents challenges for the global investor. Given the underdeveloped state of its economy, there are, in fact, unnumbered questions to be answered by the wise investor. Even so, the country is not about to back out on its commitment to boost its economy beyond belief.
Whether China fails to adequately compete with the United States, or eventually catches up with the superpower; it is obvious that the Chinese government also envisions the world’s most populous country as a potential superpower. In order to achieve its goals, however, the Chinese government would have to work on improving the regulatory environment in the nation. The introduction of reliable credit risk management practices would be a bonus in this regard. In point of fact, all investors in China are hoping for the Chinese government to better the regulatory environment for business and banking in the nation.
Conveniences that are taken for granted in the developed world – for example, solid credit risk management systems – are required on an immediate basis. At the same time, the investors are aware that the Chinese economic growth in recent times may not be able to keep up for as long as they would like. Therefore, the banking and business practices in China should be enjoyed for as long as they are in their high growth mode. Despite the fact that the Chinese credit market functions with greater credit risk than do the credit markets of the developed world; foreign investments in China continue to grow.
The Credit Risk in China 12 emerging economy is evidently making reasonably good profits for itself as well as foreign investors. China is, no doubt, playing a key role in the world economy. How long would this phase last? – One of the decisive factors in keeping China’s economy growing is the management of credit risk. Even though the new credit card business and small loans of China are not expected to hurt the Chinese economy any time soon; without a good credit risk management program, the country is still vulnerable to a banking crisis in the area of big business loans.
In the event of such crisis, the small credit market of plastic cards and micro credit would also make potential losses, given the intricate connection between the different services of commercial banks that engage in business with most types of loans mentioned in this discussion. In fact, if China fails to develop a credit risk management system now, its entire credit market could be at risk of complete closure. Commercial banks that would fail to sustain big business loans would certainly close down their credit card and micro credit services to boot. The latter are not as profitable for banks anyway.
The Chinese government’s concentration on credit card and micro credit expansion merely explains that these forms of credit are a necessity in the emerging economy which competes with the world’s business leader. Even so, the whole Chinese economy is at risk for as long as the country has not developed a sound credit risk management system. Credit Risk in China 13 References 800 mln bank cards in China, credit to grow within the next 2-3 years. (2005, June 15). IT Facts General. Retrieved 12 June 2007, from http://www. itfacts. biz/index. php? id=P3648. Chan, Anthony. (2006, December 22).
China 2007: Five Key Risk Areas That Will Shape Policy and Outlook. Retrieved 12 June 2007, from http://www. alliancebernstein. com/investments/us/StoryPage. aspx? nid=5343;cid=42339. China’s Auto Credit Market Has Wide Appeal. (2002, April 24). People’s Daily. Retrieved 12 June 2007, from http://english. people. com. cn/200204/24/eng20020424_94661. shtml. Chinese Credit Card Market Overview. Retrieved 12 June 2007, from http://home3. americanexpress. com/corp/pc/2004/pdf/cc_market. pdf. Credit Cards: Conduits for Value Creation in Chinese Retail Banking. (2003). IBM Business Consulting Services. Retrieved 12 June 2007, from http://www-
03. ibm. com/industries/financialservices/doc/content/bin/bae_credit_cards_chinese_retail. pdf. Corporate Credit Risk Management Survey. Retrieved 12 June 2007, from http://www. coface. com. cn/en/rub04_actus/crmsurvey2006. htm. DaCosta, M. , ; Foo, J. (2002). China’s financial system: two decades of gradual reforms. Managerial Finance, Vol. 28, No. 10, pp. 3-18. Lei, Chang. (2006, January 12). Banking regulator urges increased loans. China Daily. Retrieved 12 June 2007, from http://english. gov. cn/2006-01/12/content_156305. htm. Pesek, William. (2005, May 19). South Korean credit crisis offers a lesson for China.
Bloomberg News. Retrieved 12 June 2007, from http://www. iht. com/articles/2005/05/18/bloomberg/sxpesek. php. Small Loans Help Chinese Farmers Escape Poverty. (2000, November 16). People’s Daily. Retrieved 12 June 2007, from http://english. people. com. cn/english/200011/16/eng20001116_55320. html. Small-Loan Scheme Gives New Hope. (2006, April 7). Retrieved 12 June 2007, from http://www. womenofchina. cn/news/society/3132. jsp. Credit Risk in China 14 Small-sum Loans Help Chinese Women Shake Off Poverty. (2005, November 18). People’s Daily. Retrieved 12 June 2007, from http://english. people. com.
cn/200511/18/eng20051118_222285. html. Three mechanisms emphasized in China’s credit system construction. (2004, November 5). People’s Daily. Retrieved 12 June 2007, from http://english. people. com. cn/200411/05/eng20041105_162923. html. Worthington, S. , Stewart, D. , ; Lu, Xiongwen. (2007). The adoption and usage of credit cards by urban-affluent consumers in China. International Journal of Bank Marketing, Volume 25, Number 4, pp. 238-252. Xu, Xiaoqing Eleanor, ; Liu, Jiong. (2006, May). Consumer Credit Risk Management in an Emerging Market: The Case of China. China ; World Economy, Volume 14, Number 3, pp. 86-94(9).

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