The Customer Effect

China’s recent crackdowns indicate growing pains for its advanced fintech industry

  • The latest Chinese government crackdown shows what happens when the industry reaches new levels of maturity
  • The Chinese central bank is reining in “social credit” scoring models by companies like Tencent and Alibaba that use consumer data from purchases and social behavior
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China’s recent crackdowns indicate growing pains for its advanced fintech industry

China has had a head start over its global counterparts when it comes to fintech innovation, but in recent months the government has been particularly strict on industry players across the spectrum.

The central bank is now reining in “social credit” scoring models by companies like Tencent and Alibaba that use consumer data from purchases and social behavior, as of the past weekend. These programs are designed to make up for the lack of institutional records of individuals’ creditworthiness in China’s financial system — something the central bank itself has tried to address with its own solution. Now the government is worried e-commerce-turned-fintech giants could use social scoring as marketing to sell their financial products.

The Chinese government has in the last few months said it would step in so it can monitor payments, forcing players like Alipay and WeChat to share vital information with the central bank and large commercial banks; halted IPO approvals for new online lending companies; and issued new rules targeting online micro-lenders.

The Chinese system is different from the U.S. and Europe in many ways; most obviously, it is not a free market economy and those favored by the ruling party have a lot of advantages. But the advantage to that is it has a regulatory environment that lets entrepreneurs and innovators build and develop things a little more freely, making innovations like social credit scoring available to pare back later when it’s necessary. The disadvantage, however, is that it runs a higher risk of issues like high volumes of fraud.

The U.S. and Europe have fairly robust bodies of regulation that fintech products are born into. But that doesn’t mean they don’t deal with fraud, said Brian Knight, program director for the financial regulation practice at the Mercatus Center.

“There’s a concern that there’s very significant potential for fraud in, say, the ICO space. Regulators are working on that, but the idea that they’ll be able to completely prevent fraud from happening is not really realistic,” Knight said. Our model of risks unduly favors incumbents because they’ve built their product to match the regulatory system as it currently stands. So even if a better thing comes along… there’s the possibility the incumbents can use regulation as a barrier to competition.”

China is a mobile-first nation. Mobile e-commerce took off there because its retail landscape was weaker and less efficient 15 years ago compared to that of the U.S. Mobile phones brought people online that were previously cut out and now, Asia’s technology landscape has a diverse portfolio of online businesses. The U.S. and China are on opposite ends of the behavioral spectrum; people in China and other emerging economies enter the fintech ecosystem without a pre-existing bias as to how they transact.

The U.S. and Europe have often looked to China as a model for how financial services could look fully integrated into the existing digital and e-commerce landscape, thereby generating more “alternative data” points and using them to bring more consumers, as well as new businesses, into the ecosystem.

But the latest government crackdown also shows what happens when the industry reaches new levels of maturity.

“Unlike developed markets like the U.S. where regulation is more stringent, the lax regulation in China enabled innovation that led to new business models and new players entering financial services,” said Michelle Evans, global head of digital consumer research at Euromonitor International. “The recent regulatory decisions out of China is likely a sign of the industry moving into its next stage of development.”

Ant Financial’s Alipay and Tencent Holdings’ WeChat control at least 90 percent of mobile payments in China, said Michael Moeser, an analyst at Javelin Strategy. “In addition to aiding commercial banks, the People’s Bank of China wants to monitor transactions and money flow in an effort to stem any money laundering that may be occurring through Alipay and WeChat. The real challenge will be for the [People’s Bank of China] will be to make sure the clearinghouse does not slow down the growth of mobile payments and that its infrastructure be able to handle current and future mobile payment volumes.”

There’s been an increasing number of questions and doubts by Chinese regulators and investors about the health and legitimacy of fintech business models thanks to growing closures of peer-to-peer companies and defaults of high-profile online investment products. For example, more than 60 percent of 5,890 online peer-to-peer platforms “that ever existed” have folded, according to an Oliver Wyman report.

One online lending platform Ezubao, raised more than $238 million in a year and a half before it was proved to be a Ponzi scheme and became the largest case of financial fraud in China.

“With maturity comes rules intended to protect consumers and investors alike,” Evans said. “The next stage of its development will require Chinese regulators to find the right balance that will be provide for consumer protection and fair operations while still enabling fintech the room to innovate.”

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