Social Networks, Not Banks, Drive Fintech Innovation in China

The Chinese market has significant potential for consumer financial technology firms. Startups can leverage the massive amount of data that Chinese consumers share online to pick up the slack in the consumer finance sector, where incumbent banks have historically been absent, said Anju Patwardhan, senior partner at CreditEase, speaking at the CB Insights Future of Fintech conference.

Joining Patwardhan on the panel were Mike Armstrong, president of ZestFinance, and Tom Stafford, partner at DST Global, in a conversation moderated by Selina Wang of Bloomberg.

Major Chinese banks historically reserved credit for the elite, Armstrong said, and so they have not built up decades of data on large swaths consumers as banks and credit bureaus have in the US.

So, what companies do have detailed consumer data?

Internet companies and social networks.

“That’s why the Baidus of the world are the ones driving [fintech] in China,” rather than financial companies,” Armstrong said. He mentioned studies showing that Chinese consumers are also far more willing to share personal data with technology companies than are consumers in Europe or the US.

Furthermore, the panelist agreeds that China’s regulatory environment favors fintech innovation. “Backward-looking” regulating bodies in China allow room for forward-looking startups to experiment without being regulated in their early stages, according to Stafford.

“In Europe and the US, there are boxes of regulatory frameworks, and if you’re outside a box you’re illegal. In China, you can start a new box, and it will be made legal or illegal after the fact,” Stafford said. This institutionalized “launch first, ask regulatory questions later” system encourages a bias toward action and rapid product iteration.

China’s regulations also tend to be simple, according to the panelists, while the US environment today is uncertain.

“It’s better to have clear regulations, whatever they are, than to have something hanging over your head,” Patwardhan said, mentioning that new lending regulations have been discussed in the US for a while but the details and timeline remain hazy.

Facing such a large opportunity in China, Stafford cautioned US companies against trying to enter China independently. He recommended they partner with Chinese companies, but explained that since so many Chinese companies operate in numerous verticals – think of Alibaba, Baidu, etc. – US firms need to give Chinese companies a compelling reason to partner with them instead of the Chinese firm just launching a product/service themselves.

“All Chinese tech companies are trying to go international, so some form of reciprocity” can be an appealing reason for them to partner, Stafford said.
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Transcripts

Selina: Hi, everyone. I’m very excited to be joined today by Mike Armstrong, who’s the President of ZestFinance, the machine learning platform that improves credit underwriting. We have Anju Patwardhan, Senior Partner At CreditEase Fintech Fund and Fund of Funds, and I’ll leave it her later to explain all that CreditEase does. And Tom Stafford, who’s a managing partner at DST Global.

So, bouncing off of the presentation we had earlier, China, by any measure of size, has really become the global leader in financial technology and innovation. But there are so many competing views as to how China had such a meteoric rise, all the different factors that led to such widespread adoption. So, I’m going to give each of our panelists the challenge of, if you can manage in about 30 seconds, your take on why there’s been such a rapid rise and why there’s been so much widespread adoption. So, we can start from any end.

Tom: So I can take a stab, first would be like any emerging market or developing market, a lack of critical financial services infrastructure day one. So, as an example, in 2014, there was only 8 bank branches per 100,000 people in China versus 28 in the U.S. or Europe. So, access to actually the physical infrastructure or the existence of a structure wasn’t there.

The second thing is the Chinese consumer generally, and this is not just Fintech related, but generally, is more trusting or more open to sharing their data than in most places. So, there’s a Harvard Business Review done a couple of years ago whereby consumers were asked to put a dollar value on their data. So, what would they pay to protect their data from companies? And the delta between a German consumer and a Chinese consumer, even GDP or purchasing power priority adjusted, was an order magnitude, it’s a 10X difference. So, Chinese consumers are more willing to share their data.

I think the third thing that really drove it in China as well is that the platforms have actually pushed digital payments, digital finance, were the largest internet platforms, the largest reach platforms. So, Tencent and Alibaba pushing payments is the same as Facebook or WhatsApp pushing payments, which simply hasn’t occurred anywhere else in the world. And therefore, it is a different kind of scale of push behind it.

Fourthly, I think would be the entrepreneurial culture in China is innovate, innovate, innovate, or iterate, iterate very quickly. Go very wide in product scope and reach, and be willing to break things, which I think Fintech X China and sort of X developing markets, it’s much more about single product, don’t break it.

And then the final thing is a regulator in China. The regulator in China tends to be somewhat backward looking. So, they allow a sub-sector to develop, they watch it, they learn, they see how it’s developing, and then they regulate. In Europe and the U.S., it tends to be there are boxes of regulatory frameworks in which you can operate. If you operate outside of those, you’re illegal, you operate inside them, you’re legal.

China is very different. You can create a new sub sector and then a regulator will make it legal or illegal after the fact.

Anju: Yeah, those are great points, and I would just add two other things to it from China context. One is that the large banks in China typically were not operating in the consumer lending space or even consumer finance, and most international banks, like I used to work with Citibank and with Standard Chartered, most foreign banks were also not allowed to offer too many services in China.

So, there was a huge gap unlike other emerging markets. And the advent of infrastructure such as cloud services, smartphones, a huge penetration of smartphones in China. There are 730 million users today and 95% of them access internet using their smartphones. So, a combination of these things is what really helped Fintech take off in China.

Mike: I would echo all that, and it’s all going after just a massive opportunity. When you take a look at non-mortgage household debt in the U.S., it’s something like 17% of GDP. When you take a look at it in China, it’s 4.5%. And, you know, you have just hundreds of millions of potential consumers in China, and igniting a credit expansion there has all kinds of positive economic benefit for their lives and for the Chinese economy.

Selina: Anju, could you talk a little bit about CreditEase? It’s been around for 11 years, which is a pretty long time for a Fintech company, and it does everything from wealth management to PDP. And, you know, tell us a little bit about it and what you credit its longevity to.

Anju: Sure. So, we are a Fintech company from China. Started 11 years ago as a peer-to-peer lender. It’s now probably the largest consumer, small business marketplace lender in the world. And then a few years ago, the company also expanded into wealth management and asset management, and we are one of the largest players in China in that space now. We just got an award yesterday for the Best Wealth Management Product in China by Euromoney. We are rated the Best Non-Bank Wealth Management Product in China.

And as part of those services to our wealth customers, we also offer them the ability to invest in overseas investment opportunities for our high net-worth and ultra-high net-worth clients. That includes areas such as Fintech Fund, which is what we work with. It’s $1 billion fund which started early last year. We’ve made 14 investments in the last one year, and I’m very pleased to say that all except one were on the Fintech 250 list. I’m hoping the one that was missing will make it next year.

We also have Fund of Funds, which invest in VC firms, private equity firms, real estate funds, so we are LPs in over 25 VC funds now. We’re also LPs in private equity funds like KKR, Blackstone, Carlyle, etc. We do have one of our subsidiaries on the lending side is listed on NYSC under the name Yirendai, and our insurance subsidiary just got listed in China. And we never show up on any of the CB Insights Fintech maps, because Annan has this rule that if your parent or your subsidiary is listed then you are excluded from the private market map. So, we don’t show up. I wish he would change the rule though.

Selina: I think Annan, that’s a shout-out to you on the live screen. So Tom, as a global investor, you’re seeing a lot of innovations in China, and you mentioned earlier a lot of the differences, but do you think some of those innovations will come to the U.S. and if…are there any manifestations of that already happening?

Tom: Maybe. I think the, rather than and to target individual product features, I think one of the things that will make it across to Europe and the U.S. is already in Brazil with Nubank, and in India with Paytm, etc., is the idea of trialing and doing a lot of testing around new products. So, not being a mono-product company. And I think historically, short history, but historically in Europe and the U.S., Fintech companies have tended to be very mono-product orientated. And of course, that has advantages in focus, etc., but has disadvantages in, for example, customer lifetime value, repeat rates, engagement rates, etc.

And I think what you’re starting to see, particularly in Europe with some of the neo-banks and prepaid debit card providers is actually this willingness to try and be more than just a single product, and that’s really a key criteria of what it is in China. Like we just heard about CreditEase, which I think does everything almost across financial services, maybe bar being a current account. And I think you’ll start to see that coming through in Europe and the U.S. and you’re already starting to see it in some of these guys in Europe right now.

Selina: Mm-hmm. And Mike, ZestFinance works with both Baidu and JD in China. Can you talk a little bit about those partnerships and what it’s taught you about the Fintech environment in China?

Mike: Sure, just quickly, ZestFinance, we offer a machine-learning powered underwriting platform that stretches the full stack of lending from marketing to fraud detection, to underwriting service and collections in account management. With Alibaba, excuse me, with Baidu and with JD.com, we were fortunate that those two companies sought us out. They’re obviously premier technology companies. They had sophisticated machine learning operations. What they didn’t have, is they didn’t have the experience in applying machine learning to credit underwriting, which is fraught with all kinds of possible pitfalls. So, they reached out to us and leveraged Zest tools to help get up the learning curve and to accelerate their entrance into the credit market in China.

Specifically, what we do is we work with all the data that they have. So, in the case of JD.com, the online shopping, browsing, transaction, purchase history, and it’s a pretty rich source for informing underwriting decisions. And in the case of Baidu, we leverage, in the search data across thousands of their online properties to do the same.

Selina: Mm-hmm. And what’s been the most challenging part of working with these two Chinese companies? I mean, what lessons have you learned so far?

Mike: Well, I think most of it’s been really great. They definitely have a technology band, so just to echo what we’ve heard up through already, the culture in China, they have a bias for action, a bias for speed and a bias for results going against the big opportunities. They work really hard. The technology has been great to work with, leveraging our tools, adopting them, putting the models into produ