China Boots Up an Internet Banking Industry

Tencent and Alibaba Usher In Cyberspace Borrowing

Premier Li Keqiang recently launched a new era for banking in China by ceremonially pressing the "confirm" button for a 35,000 yuan loan issued to a Shenzhen truck driver.

Li's gesture on January 4 on behalf of Shenzhen Qianhai WeBank was the inaugural transaction for the country's first no-bricks, no-mortar, 24-hour, Internet-only bank.

The ceremony underscored a government decision to let up-and-coming Internet banks focus on lending to blue collar workers and small business owners. WeBank also hopes to break new ground by using technological gizmos such as online face recognition to confirm the identities of loan applicants.

Regulators approved WeBank, which is affiliated with the WeChat social messaging app operated by Tencent Holdings Ltd., in December. Next in line for inaugurationexpected in late February, a source close to the matter saysis Zhejiang Internet Commerce Bank (ZICB), which is controlled by an affiliate of e-commerce giant Alibaba Group Holding Ltd.'s Ant Financial Services Group.

Because these banks are still negotiating their legal limits and business models with government regulators at the central bank and other agencies, WeBank and ZICB have yet to fully disclose their plans for future financial services. It's not clear, for example, when or even if the firms will offer basic bank deposit accounts to individuals.

In fact, WeBank sources said, the online bank so far has no timetable for launching financial products, although its formal business startup is set for April 18. A WeBank employee said "many products are still being tested and will be launched after tests have been completed. But no timetable has yet been set."

The only certainty is that these banks are ready to extend credit to a generally underserved clientele, such as the Shenzhen trucker and other owners of small trucking companies.

WeBank Chairman Gu Min said the bank will function as an online platform and is "not a show-stopper" for the financial sector. And WeBank to date has no plans to lend to government agencies, big companies, or the wealthy.

"A customer base that's too big would create a capital burden for WeBank," said a source at the bank. "We are positioning to be a light-asset bank."

Nevertheless, according to people including a China Postal Savings Bank (PSB) source, WeBank and ZICB are in talks with state-owned PSB about starting credit card businesses. PSB has 39,000 branches nationwide and a strong presence in rural areas.

WeBank is also looking at partnering with established banks to offer wealth management and low-risk investment products, the sources said. WeBank's contributions to a joint venture could include an online platform, rating services, and risk control for these products.

A source at a joint-stock bank who asked not to be named said that his bank would be willing to cooperate with WeBank for various services.

All New Game

Overall, Internet banking is being embraced as a new avenue for financial system reform in China. Current business models, for example, are pushing forward work on new regulatory standards, said WeBank President Cao Tong.

"We need to redefine the scope and models for financial supervision of the Internet" due to the wide gap between online and traditional banking business models, Cao said.

A government official said regulatory departments are working on rules and guidelines for Internet bank accounts, especially how to securely handle electronically transmitted contracts and signatures.

Wang Yonghong, director of the central bank's technology department, recently wrote in a financial journal backed by the central bank that Internet banks would have to meet traditional requirements, such as capital adequacy ratios, provisioning, and leverage ratios. However, he wrote, special characteristics of this new business would be written into updated rules.

"Internet banks will have a profound impact on China's banking sector, as well as on the supervision model," Wang predicted.

One rule that's getting a close look is the 30 percent limit for each stakeholder in an Internet bank. Some experts have said the rule may stifle growth at these new banks.

Tencent owns 30 percent of WeBank, which has 3 billion yuan in registered capital. Its investment partners include Shenzhen Baiyeyuan Investment Co. and Shenzhen Liye Group, which each control 20 percent. Similarly, Ant Financial has a 30 percent share in ZICB. Other ZICB investors include a Fosun Group subsidiary and Wanxiang Group.

Zeng Gang, a banking expert at the Chinese Academy of Social Sciences' Institute of Finance and Banking said the 30 percent limit is designed to prevent any one shareholder from dominating the bank.

Zeng said the rule creates a shareholding structure that's less efficient than a bank could be with a single major player. And if a stakeholder has a separate investment in a business that competes with WeBank or ZBIC, he said, the stakeholder would have to carefully weigh priorities.

Some of Tencent's existing businesses, for example, could wind up competing with WeBank. For example, Tencent's wholly owned, third-party payment service Tenpay has partnered with several banks to provide wealth management product, credit card, and money transfer services. These businesses operate through the WeChat platform.

"If Tenpay can do it by itself, why do we need WeBank?" asked a banking industry source.

Sorting out these various business targets and services will be central to the Internet banks' ability to compete with traditional, brick-and-mortar banks.

Traditional banks have been paying close attention to the rule-writing and business model-building tied to the emerging Internet banks. Many have already launched their own online services, although they've also faced regulatory hurdles and operational issues.

WeBank is waiting for regulators to clarify rules for online accounts, credit assessments, and payment systems, sources said. It also wants to know how WeBank might be affected by the government's monetary policies, foreign exchange regulations, and money laundering laws.

On a broad scale, Internet banking is expected to advance financial system reform by offering credit and other services to small businesses that otherwise might not be eligible for loans from traditional banks.

At the WeBank launch ceremony, Li called the start-up "a small step for WeBank, but a big step for financial reform." Internet banks, he said, have been designed "to push forward reform."

WeBank executives said their business is all about innovation. The bank "will be totally different than traditional banks in terms of products, risk control, and operating models," one said.

Clicking On Clients

WeBank and ZICB plan to use new, Internet-linked data mining tools to assess loan applicants. Various online platforms, such as the 600 million-user WeChat app, will be used to collect information about a potential client's financial behavior and credit history to help loan officers work out a credit rating.

The Shenzhen trucker was selected for the inaugural loan based on data provided by a Tencent-invested logistics platform called Huochebang, or Truck Club. Huochebang's app links logistics providers with truck driver companies that need to ship cargo. As of September, its platforms were serving 167,000 logistics customers and nearly 1 million drivers with 650,000 trucks.

Some drivers have to borrow money to pay in advance for the freight they're hauling, said a Huochebang staffer. WeBank can thus fill a need by lending small amounts to drivers who might not be eligible for bank loans to fill their special needs.

Huochebang has a large data bank that contains information about each club-member trucker, such as total travel distances, what kinds of orders they've handled, and cargo volumes, the source said. "WeBank uses this data about driver operations and makes a credit rating based on financial models," he said.

Today's traditional banks also use online data services, but they are mainly tied to paper-based ways of assessing a customer who applies for a loan.

With a huge amount of personal data that is registered with effective identity certificates on Tencent's social networking platforms, WeBank is working to comply with and adjust rules governing credit risk control.

A 2010 China Banking Regulatory Commission (CBRC) regulation on personal loans says bank employees should visit every loan applicant at his job or business, and then personally witness the signing of each application. They must also verify the accuracy of all documents. The regulations also say a potential customer cannot open a bank account without being physically present at a bank teller's window with all pertinent personal documents.

An online bank without branch offices would be hard-pressed to meet these requirements. So regulators are mulling whether to leave out physical presence requirements when the final rulebook is written for Internet banks.

A CBRC official who asked not to be named said online banks "should follow their own rules. There is no need to rigidly enforce the regulations," especially since Internet bank loans would be relatively small and based on credit assessments made through data mining.

WeBank's Cao discussed these and other issues with central bank officials on January 5 in Beijing. Three days later, Internet banking rules were the focus of discussions between central bank and traditional bank officials concerning the physical presence rule.

Sources said that WeBank officials were the only bankers at the table that did not question the idea of scrapping the physical presence requirement.

"The key question is whether an account opening without a client present should be allowed under current risk control and money laundering regulations," said an executive at a joint-stock bank. Other bankers said physical presence is needed to guarantee an applicant's identity because the country's credit rating system is sorely lacking.

Moreover, an official at the central bank's money laundering prevention bureau said Internet banks should not be allowed to skirt the strict standards in place aimed at preventing fraud by controlling how new bank accounts are opened.

"In theory, an online bank account should follow the same standard with accounts that are opened at a bank counter," said Xiao Bing, a vice president at the U.S. bank Wells Fargo & Co. in the capital. "Banks should be responsible and understand the sources of their customers' capital."

Xiao also thinks safeguards must be in place "to quickly identify financial criminals and prevent asset theft."

"Opening a bank account is already quite simple in China," said a banking regulator. "If it's allowed with just one click, how can we prevent risk?"

The answer, said one WeBank employee, may be face recognition technology. This technology, which can be used online, may provide the necessary risk prevention since "remote interviews are still face-to-face," the employee said.

Tencent has developed face recognition technology that can be applied and used with any computer or mobile terminal. It reads facial characteristics and compares them with what appears in photos on personal identification cards and in police databases.

A central bank official said questions still remain about the reliability of Tencent's technology. Another issue is privacy protection. Wang Qiang, a vice president for overseas data at Wells Fargo, said face recognition technologies are rarely used in the U.S. financial sector.

Sources said that after their January meeting with bankers in Beijing, central bank officials asked WeBank executives to come up with a bank-account opening plan based on face recognition technology and identity documentation using the Internet. Once the plan has been drafted, a central bank team is expected to conduct an evaluation and launch a pilot project to test the waters.

If the physical presence hurdle can be overcome, said a source at a state-run bank, WeBank and ZBIC might be able to sign up millions of clients.

"We hope to work out a set of rules for long-distance account opening based on WeBank's studies," said a central bank official. "It would apply to Internet and commercial banks. Then the dispute would be settled."

Underserved Sector

Face recognition technology and data mining were used to assess the Shenzhen trucker's creditworthiness before he got the loan from WeBank. He did not have to put up collateral and agreed to a 7.5 percent interest rate.

Xu is the kind of customer that WeBank wants. Gu, the chairman, said the bank is aiming for a customer base that includes young urbanites, blue-collar workers, and small businesses, many of whom may not be eligible for loans through traditional banks.

About 500 million low- and middle-income Chinese do not have credit records, and thus might be hard-pressed to qualify for traditional bank loans, according to the central bank.

A WeBank source said a survey of one company's young employeesall born in the 1990swould be interested in borrowing about 50,000 yuan every year. But they're able to borrow only about 5 percent of what they want from banks.

"This is a huge market," said a WeBank source. "We need to find out how to reach it."

One way might be through a WeBank product called WeCash, which would offer small loans quickly to select customers.

Meanwhile, ZICB is getting help from Alibaba to connect the bank to Alipay, which has about 300 million users. These users may use the service to pay for movies, restaurant meals, hotels, and taxis.

Tencent is luring businesses to connect with its WeChat users. The company hopes to make WeChat a platform for accessing all kinds of services, including financing and payments.

Internet companies are closer to the services needed by customers, and that's their advantage" over traditional banks, said an online banking expert at a state-run bank. "Internet banks will serve customers who have higher potential for cash flow in the future. Traditional banks are eyeing on high-wealth customers, but this group will shrink in the future."

Another business channel for Internet banks involved credit-data sharing. On January 5, the central bank gave eight companies including Tencent and Ant permission to pursue personal credit data businesses. These companies are likely to be the first to run commercial operations that collect and analyze individual and business credit data, most of which is now controlled by the central bank.

An Ant subsidiary called Sesame Credit Management Co. is offering credit ratings on people and companies that use Alibaba services. The data base includes details about more than 300 million people and 37 million small to medium-sized enterprises that have done business through Alibaba's e-commerce platforms.

And a senior payment operations director at Tencent, Wu Dan, said the company can analyze potential clients for loan default risks based on data collected from online gaming and social networks.