Business of Fintech, Member Exclusive

While the US fintech gets its act together after valuations tumble, is China leaping forward?

  • As the fintech industry expands in China, will the US stand out from the rest of its competitors?
  • The pandemic caused higher interest rates, lower valuations, and economic uncertainty – which has been cited as the reason behind the failure of fintechs – but maybe it is time to rethink that premise.
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While the US fintech gets its act together after valuations tumble, is China leaping forward?

Not long ago, the FT reported that almost half a trillion dollars were wiped off from US fintech valuations, leaving the industry in a state of panic – although over 30 new fintech companies have been listed in the US since the start of 2020. The pandemic created an opportunity for higher interest rates, lower valuations, and economic uncertainty. That may be the obvious cited reason behind the failure of fintechs, but maybe it is time to rethink that premise.

While fintech companies in the States fail to retain their worth, is the center of financial technology gradually shifting eastwards – hint: China?

Folks in China split restaurant bills, invest their paychecks with the click of a button to start earning interest immediately, get a shared ride, and pay for lunch by scanning a QR code — all through mobile apps like Alipay, WeChat Pay, and DiDi.

The world’s second-largest economy has blazed a trail for mobile payments, and is by and large cashless.

What would happen if Amazon and Google actually wanted to make money in banking? If Apple opens a bank account or if Twitter has a channel to pay bills? They would likely shake up the payments landscape – so did China's big tech. 

Payments is king in China’s fintech landscape

In 2014, two of China’s major tech companies – Tencent, the parent company of the messaging app WeChat, and the e-commerce platform Alibaba Group, which spun off its fintech holdings into the Ant Group – entered the payments space. Today, Alibaba's Alipay is the world's largest mobile payment platform.

Mobile connections in China were equivalent to 113% of the total population in January 2022. The number of mobile connections in the country increased by 29 million between 2021 and 2022.

Moreover, China’s fintech market size is projected to reach $85.7 billion by 2022, as per China’s Fintech Development Plan for 2022-2025, released by its central bank.

The big techs that entered financial services using platform-based technology to facilitate digital payments subtly expanded into other areas, such as lending, asset management, and insurance services. This move threatened the banking sector in China – and banks' credit card revenue slumped because people replaced it with mobile transactions. However, banks stayed relevant by investing heavily in digital capabilities, and by launching fintech services to rival big tech offerings – while smaller banks relied on partnerships with big tech companies.

Alipay is a mobile wallet that allows users to store debit or credit card details to make online and in-store purchases using QR codes. It works similarly to Apple Pay or Google Pay. Since Alipay works with Visa, Mastercard, American Express, and more than 180 other international FIs, it remains the most popular payment gateway for all of China.

WeChat is a super app that people treat as a social media platform like Facebook, Twitter, or Instagram to connect socially. It can also be used for payments, wealth management, and lending – together with other services such as ride-sharing, food ordering, travel bookings, paying electricity bills, paying in shops, and so on.

WeChat Pay and Alipay function in a similar way.

In 2020, Chinese regulators probed the internet finance industry, which led to the suspension of Ant Group’s $37 billion IPO.

“In my book, Cashless: China's Digital Currency Revolution, I've mentioned 'analog regulators met digital fintechs' – and if analyzed properly, what the Chinese regulators did prior to the cancellation of the IPO, was an effort to make headway for fintech companies,” said Richard Turrin, best-selling author and fintech advisor.

Banks are traditionally slow-footed in complying with new regulations. When dealing with digital platforms that expand by the month, regulators couldn’t keep pace. It was hard to believe for many that Alipay and WeChat Pay, which launched in 2014, would become tech giants in a span of three years, and all the major cities in China would go cashless by 2020. When the Ant IPO was canceled, the tech institutions had already become so massive that regulators couldn't keep up at the time. 

By 2021, WeChat Pay and Alipay accounted for 91% of all digital payments in China. Mobile payments have upended physical money in the country – residents of even the most remote villages are able to make digital payments using their phones. It is estimated that digital transactions could make paper money disappear in the next 5 years.

In the same year, government watchdogs in Beijing began limiting big techs’ power and mitigating systemic risks in fintech. Internet conglomerates Tencent, Alibaba, and DiDi, in addition to cryptocurrency companies, were under the microscope – and hammered with fines.

“The Chinese Banking Association and the People's Bank of China are vocal about the fact that they don't hate fintech – what they are worried about is that fintechs have a regulatory advantage over banks,” elaborated Turrin.

Banks skate on thin ice dealing with the web of back-end transactions, high fixed costs, and strict regulations when lending money. This way they manage their risk and exposure to failure. Hence, it was decided that fintechs need to undergo the same rules and regulations.

Irrespective of the regulatory crackdown, China has been a hotbed for fintech investments – growing from a total of $900 million in the second half of 2020 to more than $1.3 billion in the first half of 2021, according to an analysis by KPMG.

At present, Tencent has tightened its belt as the Chinese tech industry faces a downturn following a property dip and unexpected new waves of Covid forcing lockdowns from Shanghai to Shenzhen. The company released nearly 5% of its workforce – the first quarterly drop in staffing since 2014. Revenue slumped 3% to 134 billion yuan ($19.8 billion) while net income also took a dive of 56% in the June 2022 quarter. However, the fintech and business services segment, which includes cloud computing, is now Tencent’s driver of rapid growth.

What can the US learn from China's fintech landscape?

Mobile payments, popularized in China, are actually an American creation. The Chinese market leveraged this mode of payment with speed and advanced technology, reaching a level where technologies such as big data, cloud computing, AI, and blockchain have all been tested, adapted, and practiced in its fintech landscape.

At the same time, China is serving its SMB market and unbanked population. The gap between fintech loans and traditional loans allows poor people with no credit scores in second or third-tier villages to get underwritten, although the world's largest unbanked population exists in China, even with Alipay around. 

The country has been making strides in digital payments systems and is taking the same route with the launch of its digital currency this year. 

Meanwhile, the American payments system still lags – however, under Biden’s Executive Order, a digital dollar is being examined to support efficient and low-cost transactions, particularly for cross-border payments, which are otherwise expensive and slow. Despite the White House's guidance, the US central bank currency may take forever and a day to come into effect.

Additionally, China has built comprehensive ecosystems with super apps like WeChat, serving diverse consumers’ needs across different financial services. 

“China is at least a decade ahead of the EU and the US in fintech, flat out – and people will argue about this,” said Turrin. “It's gone cashless, has digital services, embedded financial services, and embedded insurance, which is a hot thing in the West right now.”

After strengthening regulatory supervision, China passed two laws that were implemented in 2021. The first is the Personal Information Protection Law, which guarantees that a user’s private data is confidential and cannot be sold off without consent. The other is the Algorithm Law for AI, designed for more transparency over how the algorithms function and providing users more control over which data companies can use to feed the algorithm.

“These are the same issues that the West is dealing with right now – converging to artificial intelligence. Why is it that people of color in the US are discriminated against when using artificial intelligence?” Turrin asked.

China's fintech innovation may provide more financial products for consumers, but at the same time, it brings other concerns for its citizens in the pursuit to build a sound social credit system.

Why is China's social credit system tangled?

Developed western economies like the US already had computerized credit analysis by the 1960s – and the scoring systems, such as FICO, stood out in the late 1980s. In Europe and the US, people are familiar with credit checks. Data brokers rank and give scores to each citizen in the form of a credit report. Credit scoring models generally look at how late a person’s payments were, how much was owed, and how recently and how often she missed a payment – all of this measures the risk level to lenders or mortgage providers to decide a rate of pay for services, whether to loan money or to enter into a business agreement with the other party.

Contrarily, China's social credit scheme has been in the works since 2014, which more likely serves as a tool for the country's surveillance program and moral education.

Apart from giving an insight into a person’s financial health record, the scoring system is applied across all facets of life – to monitor and assess behavior and control the trustworthiness of not only individuals, but also companies and government entities. The corporate social credit system collects and analyzes data from businesses to create a score that decides on either rewards or punishments for citizens.

The “good” citizens with good social credit can get discounts on energy bills, rent things without deposits, and get better interest rates at banks.

Conversely, the ones falling in the other category may get “punished” for playing loud music on public transport or not paying a speeding ticket by being denied their other rights, like being barred from getting business class train tickets or booking a flight, or being cut off from high-speed internet, for example.

When it comes to businesses, the system focuses on ensuring that they follow laws and regulations and pay taxes on time, along with providing quality products and services.

Government officials’ assessment criteria hinge on the degree to which they carry out orders from the central government.

Local governments have their own social record systems that work differently, while there exist unofficial private sectors such as Ant Financial's Sesame Credit that aren’t part of the official system, but are involved with government schemes. These private systems use invoices, taxation, and shopping and eating habits among other data to report credit-style scores with user consent – as they claim – to the government. However, there is no distinguished nationally coordinated system for credit scoring, and the pilots that do exist don't work in cohesion.

To date, the developing social credit system of China remains a jumbled mix of national-level targets and guidance, clashing regional pilot programs, and disintegrated mass data collection systems.

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