China’s Internet payment systems environment is developing quickly. This article looks at China’s national bank card system, B2C payments gateways plus other market developments.

By Chen Lei, origionally published on GTNews.com

To comprehend the Internet payment systems in China, several factors have to be taken into account. Bank cards are not new in China, though credit cards have been increasing in popularity in the past few years. By the end of 2002, there were 500 million bank cards in circulation, only 0.3% of which were credit cards. Furthermore, the purchase volume of bank cards accounted for only 1.6% of the total transaction volume in 2002. It’s reasonable to say that the bank card is a substitute for the deposit book rather than a payment tool because of its heavy cash usage(1).

In addition, the cheque, as an important non-cash payment tool, is hardly used for retail purchases but primarily for B2B transactions. As a result, when ecommerce emerged and created demand for new payment methods at the end of the 1990s, there were no mature non-cash retail payment tools that could be easily adapted to the electronic environment.

Considering the payment habits, most Chinese consumers feel more comfortable initiating payments themselves through personal passwords or paper-based bank documents, than being charged by the sellers or billers. In other words, the credit transfers are more popular than the debits and the credit card transactions. Those factors have also effected the development of the online payment instruments in China’s market.

Banks’ B2C Payment Gateway

Fundamentally, the Internet payment systems in China are developed and pursued by the banks individually, in comparison to the major card companies in most of the credit card markets and other cross-bank organizations, such as NACHA, who usually act as the market organizers and set up policies and operating rules for participants involved in their business.

China Unionpay, the nationwide integrated bank card system, was established as late as 2002. Commercial banks took advantage of this situation where there were no widely accepted standards, and developed their individual Internet payment schemes. The B2C services were developed and used as an extension to their e-banking business, as well as a weapon to differentiate themselves from the competitors, by offering online payment gateway services which enable merchants to accept payments from consumers’ bank accounts. Bank of China (BOC) first established this business in 1998 and other leading commercial banks followed quickly.

The transaction flows of a bank’s B2C payment gateway are shown in Figure 1. To accept payments, the merchant has to install an application to establish the communication with the issuer’s gateway and also to identify himself to the issuer. The consumer, pressing the ‘CheckOut’ button of an order on the merchant’s website, will be redirected to a webpage hosted on the issuer’s gateway server. The related order information, such as the purchase amount and the buyer’s name, will be submitted to the gateway through hidden fields. Then the consumer will be asked to present a bank account number and a password to initiate the payment. After successfully authenticating the buyer, the issuer’s gateway will send a positive message to the merchant and redirect the consumer to a URL pre-designated by the merchant. The entire process can be carried out in one minute.

Figure 1 – Transaction Processes and Message Flows: Bank’s B2C Payment Gateway

To receive payments, the merchant is required to open a settlement account with the issuing bank. After the buyer initiates a payment, the issuer will debit the buyer’s saving or debit card account promptly. Although the seller may receive the funds immediately, the issuer always credits the merchant’s settlement account with a delay, depending on the agreement between the merchant and the bank.

The payment processes described above come down to an inter-bank credit transfer from the consumer to the merchant. The biggest advantage of such a payment model is that the merchant will never collect consumers’ bank account information. In addition, after successfully authenticating the buyer, the issuing bank will guarantee the payment. Therefore the merchant will be able to ship the goods immediately (and digital goods will be delivered in real time) as soon as it receives a YES message on an order from the issuer.

The webpage generated by the issuer’s gateway is encrypted by secure sockets layer (SSL) to ensure security. Some banks provide local wallet applications, also known as the PRO version of personal banking systems, to enhance the authenticating procedure by digital certificates or USB (universal seial bus) devices. Such systems usually embody more personal financing features and unlock money transfer limit.

Third Party B2C Payment Gateway

In order to process multiple brand bank cards, a merchant has to install various applications from respective issuers which will increase the complexity and the cost of the merchant’s system. As a result, the third party payment service providers, which integrate several issuers’ payment gateway into one single interface to online merchants, emerged as the resellers. In the mean time, they became the competitors to the issuers themselves.

The third party service provider’s payment gateway will route a request from the merchant to the corresponding issuer’s payment gateway, and will pass the issuer’s response to the merchant. The consumer has to select one in several card brands in a webpage generated by the service provider to proceed with the payment, and to submit an account number with password in the issuer’s webpage. The same process applies for initiating a payment.

In general, a third party service provider has to open multiple accounts with the correlated banks. In this case the merchant does not have to do so. The settlement process consists of two steps, an inter-bank credit transfer from the consumer’s account to the service provider’s account, and a credit transfer (could be a cross-bank transfer) from the service provider’s account to the merchant’s account. This is a two-step-settlement model. In practice, the third party service provider always settles the payments with the merchants periodically instead of trade by trade. In the early days, the payment between them was done by paper-based checks.

The first third-party service was established by the Capinfo Co., Ltd. in 1999. It set the tone for allowing non-banks to set foot in the online payment services market. The third party providers build their revenue by charging annual fees or other value-added services charges, and by sharing the merchant discounts with the banks.

Other Systems and Developments

Regional bank card centers have been exchanging messages among bank branches at a regional level. They also offered online payment services before 2002 as a third party gateway did, by facilitating ATM/POS transactions via the consumers’ PCs. Such systems were convenient for the local merchants prior to the systems’ merger into China Unionpay.

There are various approaches to processing credit card transactions. In most cases, the issuing banks acquire the credit cards themselves. Consumers only present card numbers to the issuing banks and authorize transactions by password, or even a string of random digits. Some third party providers also team up with acquiring banks to facilitate standard credit card payments. In such cases, service providers have to maintain a card number database.

Virtual cash schemes are very popular in larger websites and are widely used by the online game operators, such as QQ.com or ourgame.com, for in-site purchases. A few cross-site schemes, e.g. easecard.com, are also gaining ground in niche markets. Such systems essentially run on a prepaid basis and enable multi channel top-up methods including online funding via banks’ and third-party providers’ gateways.

Since the banks hardly allow merchants to initiate debit transfers or credit card charges, the online P2P payment services also run on a prepaid basis. To be exact, when the account balance is insufficient for the payment, the payer has to top-up the account first. Auto funding from bank accounts or credit cards are unusable. The tailored PayPal service in China and its major rival Alipay.com are all running in this way.

Some Findings

The online payment systems in China basically build on the individual banks’ online banking systems and highly rely on the credit transfer transactions. The system as a whole is similar to the electronic giro system in Finland(2) and NACHA’s upcoming pilot of its new Internet payment application(3). Because the four largest state-owned banks and several major commercial banks jointly hold almost all the consumer accounts and the merchant accounts, the system is natural and effective.

While several groups of entities, including the banks, the third party gateways, China Unionpay and their subsidiaries and other value-added service providers offer crossover services to the merchants by owning unequal resources respectively, the merchants may encounter confusions when looking for payment services. In many cases the merchants still team up with more than one service provider to maximize their capability of card acceptance.

The fact that the overwhelming majority of online payments are based on the savings and the debit card accounts has two main effects on China’s infant ecommerce market.

The credit transfer style transaction model means that the funds will actually depart from the consumer’s bank account once the buyer initiates a B2C payment. This kind of quasi-cash transaction is more propitious for the merchants than the consumers, because of a lack of chargeback mechanism associated with the credit card transactions. It has been considered as one of the main barriers of China’s ecommerce market.

On the other hand, selling low-value digital goods (such as telephone card, online game points, online content access rights, etc.) is gaining the critical mass in China’s online bazaar. The consumers are willing to taste small ticket purchasing providing that they can enjoy the convenience of instant delivery. CnCard, a leading digital content reseller, claimed that the firm handled 25% by volume of all online transactions of China’s market in 2004, which accounted for less than 4% of the total market by value. The average transaction amount is RMB35, which is far lower than RMB490, the average value of a China Unionpay card transaction (2005).

(1) Data about bank card market in China come from the China Unionpay.

(2) “Electronic giro system in Finland” was mentioned in Payment Culture Matters, Background Paper No. 4, ePSO, 2001.

(3) http://www.nacha.org/News/news/pressreleases/2006/Pr031506/pr031506.htm