Banks enabled, not stifled, the rise of Alipay – Part 1

The state-owned banking network in China has long been criticised for blocking innovation; however, without their support, third-party payment platforms such as Alipay would not have been able to flourish like they are now.

Unfortunately, many commentators have overlooked this fact.

Many of the online and mobile payment technologies were developed and piloted in the US or Western Europe. Such innovations were adopted in China, gradually overtaking their originating countries, catalyzed by ‘market forces’.

However, ‘market forces’ is just the surface, deep down the core is still the state-owned economy that is quite unique to China.

Now, while praising the convenience of Alipay and WeChat Pay, many consumers are at the same time criticising the banks and other big institutions, who are falling behind in the era of breathtaking innovation.

The truth is, Alipay overtook their foreign peers not by its own, but by standing on the shoulders of the state-led banking system.

Now, what does third-party payment platform mean: they are parties outside the banks and the final customers.

Banks in China undertake two fundamental tasks for the third party payment platforms: 1. KYC and 2. Settlement.

Without these two, there is no way you can have a safe and convenient third-party payment system.

Currently to use any of the fast mobile payment methods, you need to provide the following:

1. Identity card (or other identification documents)
2. Bank card (credit or debit)
3. Mobile number

The online or mobile payment platforms in China have two unique characteristics, compared to their foreign peers:

1. Using mainly debit cards, which are widely adopted in China
2. Able to transfer money instantly, a key for the platforms’ fast adoption

Now we analyze each of these two characteristics.

Debit cards – well we can say that China has the most convenient debit card system in the world:

1. No barrier – anyone can get a card for free
2. You can get the card immediately upon opening the account

Many banks in foreign countries can’t achieve this because of the associated costs. To issue a massive amount of debit cards, you need to have the card supply chain cost, ATM and branch network, cash management system and all the operations and maintenance costs.

Meanwhile, there is no guarantee that each card will bring in the deposit that justifies its cost of issuance and maintenance. Worse, the overflow of accounts will take up the banks’ resources which they would rather use to serve their premium customers.

As a result, all the customers who have financing needs but no money to deposit are denied banking services.

In China, the state-owned commercial banks (Bank of China, China Construction Bank, Agricultural Bank of China, Industry and Commercial Bank of China, Post Office Savings Bank, Bank of Communications), under the guidance of the central bank, have been issuing UnionPay bank cards without counting the cost.

This not only gave basic financial services to the masses, but also grew UnionPay to one of the biggest card networks in the world very quickly. At the moment, China probably has the highest number of bank cards per capita.

The convenience of bank cards are also demonstrated by the ATMs, as this graph shows:

You can see of all the ATM being put in use, 25% are in China.

Naturally, with the proliferation of bank cards, security becomes a big issue.

Although SIM cards and bank cards are registered with ID cards, third-party payment platforms can’t authenticate a link between a mobile number and a bank card.

So, banks, with their thousands of branches across the country carry out the authentication. They do this through face-to-face verification:

1. When you obtain a new card an SMS verification of your mobile phone number is done on the spot.
2. If you want to add/modify your registered mobile number, you have to go to the bank and do it face-to-face.

The bank branch network is connected to public security ID network, allowing fast comparison and verification. Therefore, the security of the account is verified.

This KYC work is distributed to more than 220,000 bank branches across the country.

Imagine, if Alibaba and Tencent have to do this task themselves, would they still be able to develop their mobile payment system?

Such investment in a seemingly useless process is not part of the modus operandi in most foreign banks.

Even at the current stage, there is still room for improvement:

The key verification method is still SMS, which was really an old technology and not very secure. In addition, the bank systems are vulnerable, especially when so much personal financial information is accessible through mobile phones with SMS verification.

To solve this problem, the Public Security Ministry developed a more sophisticated authentication system; however, due to issues including hardware requirements, this system is not yet widely used by third party platforms (such as e-commerce).

European and American banks would not even bother with such investments which do now show any short or medium term ROI.

Therefore, from a security point of view, the banks, with its massive branch network, did most of the heavy lifting, allowing third party payment platforms to leap further ahead.

Now, about the convenience of third-party payment systems, we need to look at the settlement business. This allows money to flow fast and freely between different accounts, and thus enables all the payment services on third-party payment platforms.

How do all these transfers (or remittances) work? Join us in part two of this feature to find out how, and why, these work the way they do.

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Thanks for reading The Lowdown, insight and inside knowledge from the team at Momentum Works. If you’d like to get in touch with us about any issues discussed in our blog, please drop us an email at [email protected] and let us know how we can help.