It seems that the week is all about the Chinese news stories; largely because even the business news is otherwise dominated by the Boston Bomber saga. An example: when I checked the “Most Popular” section on Bloomberg this morning, there were three (three!!) stories on the “Boston hero Jeff Bauman” who “looked at guy with bag straight in the eyes”.

Anyway. Here is the intriguing headline:

“China Hot Market Without Profit Seen in Pretty Lady Card“

An important piece of information: the “Pretty Lady Card” is a credit card co-issued by Deutsche Bank and Huaxia Bank, which is meant to entice Chinese women by offering extra loyalty points (Discovery miles?) on cosmetic purchases and gym memberships.

This is topped only by the China Citic Bank credit card, which is apparently “dotted with swarovski crystals”.

Can’t see the swarovski in this one…

Some might say that the gimmicks smack of desperation…

The brief summary of the story:

  • Many banks are well excited to offer credit cards to the Chinese market (from yesterday’s post – almost a fifth of the world’s population live in China).
  • The Chinese government has only allowed two non-Chinese banks to offer credit cards solo (Citigroup and HSBC). The rest are reduced to collaborative effort with local banks.
  • However, very few of the banks currently offering credit cards are actually making profits out of their credit card divisions.

How Banks Make Money Off Credit Cards

Banks make money off credit cards in two ways:

  1. They charge you, the credit card user, interest when you “rollover” your debt (ie. when you don’t clear your credit card before the interest-free period ends, and your outstanding rolls over into the interest-bearing period); and
  2. They charge the shop a transaction fee for accepting the credit card.

Why That’s a Problem in China…for now

In order for the credit card model to work properly, you need to have both credit card users (you and me), and shops that accept credit cards. Here are the obvious questions to ask:

  1. If there are not many people using credit cards, why would a Chinese shop-owner organise to have a credit card machine? After all, if no one else is accepting credit cards, consumers will be used to walking around with cash/debit cards in their pockets…
  2. If no shops accept credit cards, why would people want to have one?
  3. It’s the economic version of the chicken and the egg.

There is a critical mass that needs to be achieved of both users and accepting merchants – the Tipping Point that Malcom Gladwell likes to talk about. It’s why the process begins by offering free stuff in order to lure in new credit-card folk – which is the economic version of the Big Bang and/or Intelligent Design.

But that is not all. There are some other reasons why the model is problematic:

  1. Interest rates are capped by the Chinese banks at 18% per annum – which does not allow for the kind of spread that banks like to earn on credit card debt.
  2. Between 92% and 97% of Chinese credit card holders will clear their outstanding credit before the grace period ends. Compare this to the US, where that number looks more like 60%.
  3. Almost half of the cards issued end up dormant* (or, to read between the lines, the cards are only taken by people wanting the free stuff).

But those are temporary problems. Because lower interest rates matter less when you can generate the volumes; and it’s relatively easy to pay off your credit card debt when your use of the credit card is minimal.

That will change when critical mass is achieved. Once you’re there, businesses that were once forced to accept risk can start passing the risk on to you by insisting that you pay by credit card. My personal pet hate where this is concerned: vehicle hire. Also, the more you use your card, the more you use your card. It becomes habit – and then suddenly, you actually can’t pay off the card that quickly.

Those Pretty Lady cards will soon grow up to become old crones holding all the cards: it’s a magnificent business model for banks.

It’s why they’re there. Or want to be.

*The actual statistic: 47% of cards issued in 2011 were unused by the end of the year.