China’s consumer lending has been expanding rapidly and shows strong growth potential due to economic growth and government policy, according to a recent report by Boston Consulting Group (BCG). Though it is still nascent, the Chinese market for mortgages, credit cards, automobile loans, and unsecured personal loans has showed enormous growth in recent years.
A booming market with explosive growth
China’s strong economic growth has spurred a rise in income, wealth, and consumption. After many years of concentrating on exports and investment, the national government is actively encouraging consumption as well.
The report said that from 2005 through 2010, China’s consumer lending balance grew at an average annual rate of 29 percent. The RMB7 trillion market today is expected to reach RMB21 trillion in 2015, at a growth rate of 24 percent over the next five year. Now China already represents the largest loan balance in Asia after Japan.
An expanding market of such vast size offers unique opportunities not just to local incumbent banks, but also to foreign banks and to relatively small or new local players. But in order to seize these opportunities, banks must select their chosen product and consumer segments carefully, and must adapt their business model accordingly.
Companies must tailor their strategy and execution to the particular behaviors and priorities of different groups of Chinese consumers. Doing business in China can be more complex in some respects than many other countries, so banks must also muster the patience and commitment to invest for the long run.
The foundation of consumer lending is economic and personal income growth, and China has been strong on both counts of late. China’s economy was among the first to recover from the financial crisis.
Along with a strong economy came rising levels of income and consumption across the social strata, powering a more than 18 percent rise in retail sales in 2010. China’s wealth has experienced a remarkable 20 percent annual average growth in the past five years.
The BCG research shows that the wealth of affluent households (over RMB500,000 in investible financial assets) and middle-class households (RMB200,000 to RMB500,000 in investible financial assets) are expanding rapidly—at roughly 15 percent in the past five years. These households typically have a high propensity to spend and also a great demand for consumer credit products, providing tremendous opportunities for banks.
However, consumer lending product penetration in China is still low when compared with overseas markets. Consumer lending in China started almost from scratch a decade or two ago. Credit cards were only broadly introduced to retail customers in the early 2000s, and mortgages were not that popular until recent years.
As a result, consumer loans accounted for just 18 percent of GDP in 2009 (though up from 11 percent in 2004). That is far lower than other more developed Asian markets, e.g., Hong Kong, South Korea, Taiwan, where the penetration reaches 40-50 percent.
Another factor is government support. Domestic consumption in China has been growing rapidly in recent years, spurred by the national government’s active promotion. Related government initiatives are stimulating consumption of cars, electrical appliances, and home furnishings.
Moreover, consumer lending products offer a favorable risk-adjusted return compared to corporate lending.
With China’s regulations now allowing more flexibility in risk-based pricing, the economics of consumer lending is expected to become even more attractive to banks. PBOC has loosened the interest band control, setting no upper limit for a loan interest rate by financial institutions (except for credit unions, which have a cap of 2.3 times of the benchmark rates). More banks will apply risk-based pricing, which is likely to improve profitability.
The report, based on a comprehensive market research study with 1,623 respondents in 15 cities, found that only 2 percent of the respondents have ever used a consumer-lending product, compared to 64 percent for credit card. However, 8 percent do plan to use a consumer finance product in the coming year.
Mortgages will dominate in size. While mortgages came on the scene only recently, they now constitute 84 percent of consumer lending market by balance. The mortgage market is estimated to grow at an annual rate of 21 percent, from RMB6.0 trillion to RMB15.5 trillion, during the period 2010 to 2015.
Auto loans will remain the smallest share of consumer lending. However, since 2008 the Chinese government has implemented new polices to promote development of the domestic auto industry. These stimulus measures have boosted the growth rate by a couple of points in the past few years, and auto loans over the next five years are expected to grow at around 30 percent annually.
Credit card will continue strong growth, but at a lower rate. Credit card receivables have been growing at close to triple-digit rates in the past five years, driven by rising consumption and the market penetration, and are now the second-largest market for consumer lending products.
Consumer finance should outpace the other categories. Current penetration of consumer finance—short term loans for personal consumption of durable goods or services such as education, health care, or house renovation is quite low, accounting for only about 4 percent of the total consumer lending balance, compared with up to 10 percent in more developed markets like Hong Kong. Consumer finance is estimated to ride the wave of expanding domestic consumption, growing at 45 percent over the next five years, the highest rate of all consumer-lending markets, according to the report.
The market segment
The report found that opportunities vary substantially by wealth and age, where the young and affluent segments have the strongest current demand and future potential. Residents of the largest cities show higher demand for lending products.
The report analyzed the borrowing behaviors and attitudes of different Chinese consumers. Results show that opportunities vary substantially by wealth and age.
The affluent segments, especially the young affluent, have the strongest current and future demand across all products. They have the highest future penetration potential, based on their survey answers.
Affluent Chinese typically desire a better lifestyle, have greater confidence in their income growth, and spend more on big-ticket items such as houses, cars, education and luxury goods. They are more sophisticated in managing their wealth and more apt to use a bank loan or installment plan to fund a purchase.
The young affluent segment holds the greatest growth potential. Consumer lending penetration should rise from 27 percent to 43 percent among these Chinese, representing the highest future penetration and increase. They are particularly enamored of credit cards, which have a roughly 80 percent current penetration rate and close to a 90 percent future penetration.
Residents of the largest cities show higher demand for lending products now and in the near future.
Opportunities abound in other segments as well, however. For instance, product innovation and bundling could be attractive for middle class, middle-age segments.
“Although opportunities vary by customer segments, we found interesting similarities across segments in their buying behavior,” said Frankie Leung, a BCG Greater China based partner and co-author of the report. “Understanding these consumer traits is prerequisite to building any sustainable business model.”
Consumers’ concerns
The top two reasons that Chinese consumers consider borrowing are to buy a residence, and purchase of a car, with more than half of survey respondents naming one of those two, the research said.
The report addresses several questions related to consumer demand, such as how consumers select lenders, obtain product information, and what their pain points are.
Branding, simple applications processes, convenient repayment, and reasonable interest rates top the list of how consumers select lenders.
Brand is the primary selection criterion for mortgages, auto loans and credit cards, with more than half of respondents citing brand as affecting their choices, regardless of segment or city tier. This finding differs from more developed markets, where consumers often weigh interest rate and efficiency more heavily than brand and reputation.
China’s consumers value convenience when they need money. They seek out efficient processes allowing them to obtain a loan quickly, and avoid complicated document requirements and tedious applications.
Price ranks among the top three selection criteria for all products except credit cards, where it ranks fourth. And when choosing a credit card provider, China’s consumers give careful consideration to the branch network.
To seek out information, China consumers from a wide range of channels ranging from traditional word of mouth and advertising to Internet search engines. Among Chinese consumers, the survey shows that the two most common channels are bank consultation and word of mouth from acquaintances and friends.
For individual products, other channels also thrive, such as agency referrals for mortgages and auto loans, and online channels for credit cards and consumer finance. Online channels matter most to young consumers, particularly for credit card information.
Consumer lending is still developing in China, and most institutions have not yet optimized their business and service model. There is widespread dissatisfaction on a number of fronts: cumbersome and long application processes, low-quality service including lack of useful product information, perceived high interest costs, and, for mortgages, rigid repayment terms, said the report.
Credit cards constitute the second-largest consumer lending market by balance. But it’s a market that requires huge investments in order to find profitable growth.
To build a successful credit card business clearly requires close attention to many activities, from acquiring customers and promoting card use to encouraging revolving balances and managing risk. Lenders will have to master loyalty programs, merchant partnerships, data mining and analysis, and risk scoring.
Additional value can come from leveraging the credit card platform to cross-sell consumer finance products, but that business also involves a whole new set of skills and investments. Lenders that can bridge the gap and execute effectively stand to create enormous value.
Next moves for lenders
The report said that developing a successful lending business will depend on understanding how consumers select financial institutions (“lenders”), obtain product information, and what their pain points are. Different types of lender will have to choose their next moves carefully, prioritizing their resources for the right mix of segments, products, and geographies.
“Despite the phenomenal growth of consumer lending in China, not every financial institution is well-suited to compete in every product line or geographic market,” said Richard Huang, co-author and a BCG partner in the Bei-
jing office, “Only a thorough understanding of the market characteristics of each lending business will allow a lender to build a sustainable business model in the chosen market.”
To that end, the report went on to outline the characteristics of the competitive market as well as the different challenges faced by different types of lender.
According to the report, the market has the following five key characteristics:
First, Consumer lending is a scale business. Brand is the most important selection criteria for most loan products, and brands take time and resources to build. Substantial fixed investment in information technology (IT) systems is also required to build a business, including a customer relationship management (CRM) system, credit management system, and business process management (BPM).
In addition, a broad product offering could help lenders cross-sell products and increase share of wallet. As a result, larger competitors stand to reap the most benefits from broad brand recognition, scale economies, and breadth of product portfolio.
Second, all players can find attractive growth opportunities. Despite the importance of brand for selecting a lender, consumers are more willing to start a new relationship for lending products than for savings accounts. The current low penetration of and high future demand for consumer finance in China offers attractive spaces for new entrants and smaller players. Several Chinese city commercial banks (CCBs), for instance, have recently gone public and expanded beyond their initial geographic coverage.
Third, credit cards make a solid platform on which to penetrate consumer finance. The mass appeal of credit cards and their simple, fast processes make them a logical channel for consumers to arrange consumer finance. Lenders with a strong credit card business could use this platform to offer such products as installment loans. Established players thus have an advantage over those that would have to start from scratch.
Fourth, customer-friendly processes and good service are the key differentiators. Consumers in every segment complain most about cumbersome processes and poor service. Lenders that fix these problems stand to win over new customers, because word-of-mouth referral carries great importance in lender selection.
Fifth, three urban segments form the bulk of the market. The slower growth segment consists of lower-tier cities, where immediate demand for financing is relatively low. The highgrowth segment consists of top-tier and tier-1 cities in coastal provinces, typically served by large local and foreign banks with established networks, plus niche players competing for fast-growing opportunities. The specific segment consists of those home cities for smaller players that are trying to tap certain high-growth customer groups, like young affluents.
The “Big 5” banks, namely Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Bank of Communica- tions, also dominate consumer lending across all customer segments and cities, according to the BCG survey.
Though, the mindshare gap between the Big 5 and JSBs is smallest among the affluent and the young. These segments tend to be more open to trying new products, innovative features, and new providers, and they are also more heavily targeted by JSBs and smaller banks. The Big 5 have a commanding lead in tier-3 cities, with 81 percent mindshare, but other players have stronger standing in larger cities.
“The Big 5 banks command share of mind among our survey respondents in many product lines. Their main challenges to growth are aligning their vast organizations, managing the product portfolio, and improving service quality,” said Damien Ko, another co-author of the report, a BCG principal in the Hong Kong Office.
Leading JSBs should compete very selectively against large banks. Their challenges lie in service differentiation, market and segment selection, and better leverage of the credit card platform, the report said.
The report also believes that smaller and foreign banks should seek out niche markets. Their major challenges are to select the right markets and segments, leverage customer insights, and develop better niche products.
“Leading joint stock banks can compete selectively, if they can differentiate their services and leverage the credit card platform to enter consumer finance,” continued Damien,“Smaller banks, meanwhile, should seek out niche markets. They will have to rely on astute analysis of customer behavior to develop better niche products.”
Regardless of which strategic approach a lender will take, all players in consumer lending face a basic set of challenges, as shown in the report:
First, explore the needs and behaviors of customers. A thorough understanding of customer priorities should underpin sales and marketing campaigns and development of tailored product and services.
Second, align the strategy with resource allocation to maximize potential opportunities. Smart choices around which customer segment to target, which products to offer, and what cities or regions to compete in all bear on how resources will be allocated.
Third, establish core internal capabilities. Great strategy will fall flat without great execution. Banks need to determine which are the critical capabilities to build internally, and which to outsource, ranging from sales and channel management to risk management.
“As competition increases, no incumbent bank can rest on its laurels. Indeed, any lending institution that aspires to sustainable, profitable growth in this market must build a business model that’s premised on a deep understanding of consumer priorities and a differentiated product offering for the chosen segment,” said Frankie, adding that “BCG believes this is just the beginning of an exciting opportunity for China’s financial services market development.”