The development of payment system shapes people’s consumption scenario, then the scenario’s stability will affect consumers' payment habit. China, based on a late start advantage, has leapfrogged to mobile payment.
In the Series Report on Ant Financial, Part I, the article gave an industry overview of the fintech business, researched on Ant Financial’ s shareholding structure and executives profile, and introduced the business ecology (products, services, and technologies) of the organization.
In this article, we will continue on the Ant Financial topic to further illustrate one of its most important services in the business ecology - payment service (Alipay). Quoted from Goldman Sachs, the third-payment volume in consumption-related in China is expected to reach USD 4.6 trillion in 2020, from USD1.9 trillion in 2016. The key drivers would be e-commerce growth and increasing penetration in offline retailers as third-party payment replaces cash.
Alipay is currently the largest player in third-party mobile payment, accounts for 51.2% of the total market in China. It not only functions as a mobile payment provider but also acts as a huge entrance for its users to multi-scenario applications on financial services, medical services, public welfare, dining, gaming, online shopping, transportation, etc.
Before going to the details of Alipay, the article sorts out the payment history of both China and US to illustrate an overview of its development, which would be very helpful to understand the current status of the world payment market and some of the interesting facts such as why US consumers are slow to adopt mobile payment and why China can leapfrog from building a credit-dominant consumption scenario and directly entering the mobile payment scenario?
The graph above shows the McKinsey’s Global Payments Map 2018, which gathers and analyzes data from more than 40 countries in four regions: APAC (Asia Pacific), North America, EMEA (Europe, the Middle East, and Africa) and Latin America. From the labeled number we see the consumer payment revenue generated by credit card in North America is as high as 35% compared to the Asia Pacific area with a percentage of 6%. Clearly North America payment market is still in its credit-driven state.
Moreover in this graph above, while the overall number of transactions continues to increase, the true driver of payment increase is the electronification of transactions. The cashless revolution, as the mobile payment witnessed in markets such as China, will serve as the largest cause of global electronification. The share of electronification in China has increased more than ten-fold over the last five years, from 4% in 2012 to 34% in 2017.
So why China leads the world in mobile payments? Let’s get started from the very beginning.
The Development of China’s Payment System
Payment is the trade of value from one party such as a person or company to another for goods, or services, or to fulfill a legal obligation. Payment can take a variety of forms. In ancient times we trade goods (some use shells) for goods, then we evolved to Gold standard by which the value of a currency was defined in terms of gold until now we exchange paper money issued by central banks.
The development of payment methods is inseparable from the continuous development of trading scenarios. The change in trading scenarios stems from the continuous development of the payment system. Now, most people in developed countries or big cities are familiar with transactions through bank accounts. An important function of the bank is to provide customers with services for clearing and settlement. These services are not arranged by one bank but are carried out by transactions between different banks in different regions and countries.
In the 1990s China, however, there was no unified clearing and settlement system among banks, and cross-bank card consumption offline could not be realized. So it’s very common to see a merchant counter with several POS machines under different banks. People can only use the bank cards of the POS machines of the corresponding bank, which is very inconvenient whether it is for consumers or banks.
China UnionPay was established in 2002 under such circumstances to solve the problem of cross-bank clearing at the time. (The Fedwire, which is the UnionPay in the United States, was established in 1914, almost 100 years earlier.)
UnionPay cards have officially become a bridge to the clearinghouse between different banks. Consumers only need to have a bank card with the UnionPay logo to spend in any shopping malls with only one POS machine. This also marks the entry into the double-labeled card era.
Right after UnionPay’s appearance, the Internet in China has entered into a rapid developing speed and the demand for small-scale but large-volume transaction begun to soar online. China’s payment industry officially ushered in the era of e-commerce. The e-commerce websites were born during this Internet momentum. eBay, Taobao and 8848 are companies who focused on serving C2C, also the online game and virtual coupon trading represented by Tencent, NetEase, etc. made their debut in public.
Though UnionPay solves the inter-banking transaction problem, the People's Bank of China (PBOC) or the China Central Bank who runs the large-volume and small-volume payment systems were not ready for such a large scale of transactions generated by e-commerce. By that time lots of settlement were still manual. Therefore the bank system's payment settlement efficiency is low, this problem has severely restricted the further development of the scale of e-commerce. (At the same time in the US, PayPal had already made an initial public offering in NASDAQ.)
In February 2004, the Alipay, which was considered China’s PayPal, made its appearance to the public to take over the small-volume large-scale transactions in China while UnionPay was indifference with this “dirty work”.
Alipay proposed the innovative concept of virtual account, through which the user can transfer the money from the online bank to the Alipay virtual account for direct consumption, and all the transfer information is transmitted to the bank in electronic form. Manual reconciliation clearing through bills is replaced. This has contributed to the completion of the bank's electronic clearing system and the pillar state of Alipay in the third-party or mobile payment market.
In 2013, so-called China’s PayPal overtook PayPal as the world's largest mobile payment platform. As of March 31, 2018, the number of Alipay users reached 870 million. It is the world's number one mobile payment service organization and the second largest mobile payment service organization in the world.
If you wondering what is the difference between Alipay and UnionPay, that would be very reasonable since they both function as the connection portal of different banks.
To put it in a simple way, there are two such modes, one is the public interface mode dominated by the communication network, and the other is the bank-oriented adapter mode. The main difference between the two modes is the difference in dominant position. UnionPay is under the approval of the People's Bank of China, in this case, it is obviously the public interface mode that all banks should be made into the clearing system proactively. While Alipay belongs to the adapter mode when Jack Ma first started the service, Alibaba had to reach to banks one by one.
As of today, the interbank clearing system in China consists of three main players: UnionPay Interbank Clearing System (established in 2002), third-party payment system (Alipay launched in 2004 and Wechat Pay launched in 2014), and the PBOC's online payment interbank clearing system (超级网银 launched in 2009). The third-party payment system has dominated the market for more than 90% of usage.
At present, the world's major economies have formed a multi-level payment system (clearing and settlement system), these levels are the clearing between commercial banks, the settlement of payments between banks in a certain region, the connection of national payments between regions, and the global clearing network. The US bank clearing system not only includes the above functions but also plays a central role in the global banking clearing system.
The Development of the United State’s Payment System
In 1800s United States, the clearing and settlement cross banks were also manual and inefficient. On one day, the staff of two different banks squatted on the way to each other’s bank with the bills of payment and happened to walk into the same coffee shop. During the chat, they found the interesting situation and took the opportunity to exchange bills at the coffee shop, which saved the time for the commute and the payment business. After that, the coffee shop naturally attracted other peers in banking, and they together made the embryonic form of a clearinghouse.
In 1824, the Suffolk Bank of Boston, Massachusetts, along with six other banks, created a system that required country (non-federal) banks to deposit reserve balances in one or more of the participating banks, which guaranteed that each country bank could redeem their banknotes in specie and in time.
Though Suffolk System was banned under national regulation, it is the predecessor to modern banking practices and led to the creation of the Federal Reserve of the United States that still operates today.
On October 11, 1853, 62 banks in the basement of 14 Wall Street, co-founded in the New York Clearing House, resolved the disorderly transaction clearing of banks in New York City, marking the bank's independence in the interbank clearing. Its clearing system called CHIPS (Clearing House Interbank Payments System) settles over 250,000 of trades per day, valued in excess of USD1.5 trillion in both domestic and cross-border transactions.
In 1914, the Federal Reserve Wire Network (later called Fedwire) was founded by Federal Reserves. Before its foundation, banks generally did not liquidate according to the face value of the bills. Fedwire required all member banks to settle the bills issued by other banks according to their face value. A weapon to build more trust with banks nationwide.
So today, CHIPS and the Fedwire funds service used by the Federal Reserve Bank combine to constitute the primary network in the U.S. for both domestic and foreign large transactions denominated in U.S. dollars. The international currency status of the US dollar depends not only on the economic strength of the country but also on the development of a currency payment system. In fact, not only the United States but the other countries who have what be called the international currency, have a reputable payment system to support it.
For example, the British pound as an international currency is inseparable from the location of London's business as the most important foreign exchange clearing system in the world.
Another example is the euro. Germany is the most important member of the euro, so the euro payment clearing system TARGET2 is located in the European Central Bank in Frankfurt, Germany. It functions as the real-time gross settlement system (RTGS) for the Eurozone and is available to non-Eurozone countries.
Why Payment Behaviors Differ in China and the US?
China has leapfrogged from cash to cashless, or even cardless transactions, with the large addressable market and rapidly shifting share. The mobile payment is also expanding the pie in markets that were historically underpenetrated by banks.
This is starkly different from the most developed world. In the US and other western countries, one of the most persistent uses of cash remains the purchase of small ticket items. According to Goldman Sachs, only 16% of the USD 11.4 trillion third-party payment value is consumption-related, while in China, the number is 40% already, and is expected to reach 68% by the year 2020.
Some of the reasons that led to the fast growth of China’s mobile payment while the US remains a credit card driven country are listed below:
1. The development of one country's payment system shaped people’s consumption scenario, then the scenario’s stability will affect consumers payment habit.
The US payment system is highly developed, almost 100 years earlier than China. Credit cards, bank cards, various bills are very mature and widely applied across the country. Similar to Europe, Japan, and other developed countries, the well-built system can fully meet people’s daily needs.
China, in this case, has a low credit card penetration rate and the consumption habits can be easily transferred. Due to a relatively inefficient clearing system, the mobile payment companies successfully attract users with faster transaction speed and convenient app application.
Besides, mobile payment has low dependence on physical devices, which gives China the opportunity to skip the credit card payment and go directly to the mobile payment.
2. The coverage ratio of one country's credit scoring system as well will shape a country’s payment mode. China is also short of a credit scoring system with a shocking low credit coverage, for credit card companies and other institutions are unable to assess the likelihood that a consumer can or will be able to pay off any debts he accumulates. Again, China is leapfrogging it, as internet giants are developing private credit scoring systems based on big data solutions (Weak feature data), for example, Sesame Credit developed by Ant Financial Services Group. Plus the processing fees are also holding back the acceptance of credit cards.
The same thing is also happening in India right now. As the penetration of telephones in India is very low, instead of building wires and all the infrastructures for the wired telephone, India took a technology jump, skipping the wired telephone connection phase and straight jumped to mobile telephony.
3. The tax system affects the choice of small merchants’ payment selection. China's current tax system makes merchants more inclined to use mobile payment while for developed countries such as the United States, their merchants prefer cash for the sake of tax avoidance sometimes. The US taxation operation uses a declaration system, while China adopts an implementation system. The systematic differences in the taxation methods between China and the United States have led to the difference in the development of mobile payments.
4. Regulation plays a vital role in determining the fast evolution and innovation in the financial market. Especially from 2013 to 2015, the government and regulators in China have explicitly expressed support for financial innovation and internet finance and imposed far less regulatory constraints compared to banks. Until recently, the fintech regulatory environment has shifted from the initial free hand to promote growth, to a more balanced approach.
5. China's financial technology innovation has expanded to foreign countries, especially along the Belt and Road. countries along the route. Alibaba and Tencent are promoting their mobile payment systems to help foreign countries achieve financial technology innovation, and also strengthen their models by continuous experiment and optimization. Alipay and WeChat Pay are already available at physical retailers in 28 countries or regions outside of Mainland China. Alibaba also approaches to 9 countries in the South East and led a series of strategic investment in India, Korea, etc.
We will continue the topic in Part III on Alipay and its competition with TenPay and its globalization strategy by building the online payment infrastructure overseas.