An interesting story in Caixin Global, a news source covering the Chinese market, talks about a trend where card processors, particularly Alipay and WeChat Pay, circumvent payment card industry standards on credit card cash advances.
- An illicit business that has become a lifeline to many of Alipay and WeChat Pay’s smaller peers has again caught the attention of regulators for contributing to China’s ballooning credit card debt. This problem has only grown worse amid the economic strain caused by the Covid-19 pandemic.
- The business, known in China as “cash-out services,” allows individuals and businesses to tap their credit cards for cash advances at costs far lower than normal.
If you look at your credit card agreement disclosure in any market, you will see that multiple interest rates are in effect. One rate covers merchant purchases, and the other covers cash advances through ATMs. Cash advances on credit cards have long been a high-risk indicator, and credit card issuers price for that risk. This difference may seem subtle, but many times there is a 500 basis point difference between the cost of using a card in a retail situation when compared to using the card at an ATM. Here is what has happened to cash advances in China over the past two years:
- In the past few years, cash-out services contributed about 1 trillion yuan ($141.4 billion) to 2 trillion yuan of China’s payment market — that’s equal to 2.5% to 5% of domestic credit card transactions in 2019, according to estimates by multiple sources in the industry.
- The size of the business could help explain why the People’s Bank of China (PBOC) last month released draft regulations (link in Chinese) that urged banks and third-party payment companies to tighten supervision over credit and debit card transactions.
And with rising credit card delinquency in the massive Chinese market, things are starting to boil. For delinquency, we are talking about enormous erosion.
- At the end of March, total credit card balances at least six months overdue reached nearly 91.9 billion yuan, up 23.7% from the end of last year, according to central bank data. The total was the second-highest figure since the data series began in 2008.
- Some bankers are alarmed. “The risks will begin to threaten the financial system if 10% of cardholders who use cash-out services become high-risk clients who fail to repay their debts even after using new loans to pay old ones,” an employee of a joint-stock bank told Caixin. “At the national level, the government must fix the cash-out businesses to stop it from growing further.”
Alipay and WeChat Pay are the big dogs in this market. And they generate plenty of cash from these transactions, which is a significant obstacle.
- The problem for most of them is that the country’s most successful and well-known payment companies — Alipay.com Co. Ltd., an affiliate of Alibaba Group Holding Ltd., and Tenpay Payment Technology Co. Ltd., a Tencent Holdings Ltd. subsidiary which runs WeChat Pay — have a stranglehold on the online payments business.
- By transaction value, the two together dominates more than 90% (link in Chinese) of all third-party payment companies’ mobile payment market. In China, people have grown accustomed to making the vast majority of their payments through two mobile apps — Alipay and WeChat — instead of credit cards. The situation has left many other third-party payment companies with few ways to make money.
- Moreover, payment companies only hold on to about 20% of the total service fee they charge for each transaction. They have to pass on the rest to China UnionPay Co. Ltd., the only domestic bank-card clearing institution, which takes about 10%, and the bank that issued the card, which receives the remaining 70% or so.
The technique of circumventing transaction codes is not new, but the proliferation of credit cards makes this a big issue.
- This is an old game in China. For years, merchants have been misclassifying credit and debit card charges so that they can keep a greater portion of services fees for themselves. In the first half of 2014, UnionPay found that nearly 470,000 merchants had problems including hiding the true purpose of transactions in order to reduce service fees they passed on to UnionPay and the banks, according to a report it released that same year. And about 77% of those transactions came from merchants working with third-party payment companies.
- “Most payment institutions couldn’t have survived if they just ran legitimate businesses, but they have made a good living running an illicit one — the cash-out service,” one source told Caixin.
Here are a few important takeaways. First, many Chinese credit card transactions appear to be miscoding the merchant type indicator, confusing risk, and pricing. This article suggests an impact of almost USD 300 billion this year. Instead of purchasing at the POS, cash advances are coded as merchant transactions— that undermines scoring and pricing systems. Second, according to China’s central bank, six-month credit card delinquency is up 23.7%, or 92 billion yuan (about USD 13 billion). Finally, managing the integrity of transaction coding is essential for risk management.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group