Weathering the storm in China’s financial industry: An interview with Violet Chung

2022 was a challenging year for China’s financial sector. What should domestic incumbents do to become more resilient and weather the storm? How can multinational financial institutions compete in China?

In this edition of “Inside the Chinese Boardroom,” I discussed these and other questions recently with Violet Chung, a Partner based in McKinsey’s Shanghai office who leads our Fintech Practice in Asia.

I’ve also included an edited video excerpt from our conversation which you can watch here:

Joe: Today, I'm very pleased to be joined by Violet, a partner in our Shanghai office who is one of our deepest experts in banking and insurance. A lot of people feel like right now is the most challenging time for the financial sector in China. What are you seeing? What’s shaping the industry right now? Is this really a bad time for the industry?

Violet: I think the industry is definitely undergoing some of the greatest challenges that we've seen in decades. There's huge changes in consumer behavior in a very meaningful way. We’ve already seen that seven or eight years ago in China, but I think that has really expedited.

The second thing is the macro changes and the measures around COVID-19 have had a bigger impact than what most people expected. Third, we went through a few decades of high growth. In the past two or three years we’ve seen a downward trend in the industry, but it’s been expedited.

Joe: The Chinese banking industry has been sheltered by regulation, and has been hiding behind a lot of very profitable corporate loans for many years. All that's coming to an end. How do you think the industry is going to change in the future in terms of competition? For a while there were a lot of fintechs that came up, but it seems right now it’s not very easy for them to grow. The incumbents are also trying to go more digital. What will the landscape look like three or five years from now?

Violet: Lower ROI is already an accepted by the industry. Having said that, I think all players are realizing that essentially they're going from a stage where scale, and not having to do personalization, or not being very focused on segmentation, to needing to do mass personalization and maybe even a segment of one.

So that's very important because that whole concept is going from not having to necessarily do a lot of capability building internally to being able to be much more specific on their skillset.

And it went from the stage where running the business just required a lot of what we call “guanxi” (relationships) and personal business judgment, to something that's very data-driven in terms of decision-making.

Regulators want to see a healthier, better-performing sector, and something that's benefiting the broader economy. So mainly the mass, mass affluent, and SME. That's fundamentally their starting point as they come out with many of these regulations.

They want to make sure, one, the fintechs are not doing something "funny" at the benefit of their own; that is not necessarily benefiting the whole ecosystem. Secondly, they do believe that, especially the better-performing banks, would need to have some of the core capabilities to better serve the mass and SME segments better.

Hence you see a lot of banks going through digital and analytics transformations in the past few years. And that trend, I believe, is going to continue. Many of these financial institutions have been going for too long just relying on big corporate lending. Having to transform themselves actually requires quite a bit of work.

Having said that, I would say that some of the leading financial institutions have already invested, and are actually calling themselves more AI-led. And I think that's a very important thing because we talked about being able to do personalization at scale. Secondly, being able to use data to make decisions and being very AI-led, instead of experience-led, in decision-making.

Joe: Where do you see consumer finance going in China, and who will be the winners in that segment?

Violet: The growth in consumer lending is still expected to be around 15-16%. With the overall market not necessarily growing as fast, I still think this is going to be one key source of growth.

Secondly, which institutions will be behind this? I think the majority is still going to be the banks. Because a lot of this is actually satisfied through credit cards, secure lending that the banks provide. The banks really need to change a few things to be able to build their capability around this.

They need to cut down the barriers between business units (BUs). In most financial institutions in China right now, there's still a lot of barriers between how a credit card department does underwriting versus the unsecured lending department does underwriting. How do we make sure that barriers are cut and they are really looking at it from a customer-centric perspective?

Secondly, I think in terms of the fintechs or some of the consumer lending companies, I still believe instead of a few giants that you've seen in the past, I think the push is for a healthier environment, where there's going to be a few more sizeable players versus the landscape before.

Joe: A few years ago, I think the fintechs in China were the innovators in the industry, and in some ways were leading the world in what they were trying to do. Obviously, that is now going to be much slower based on regulation. Where do you see innovation in the financial world in China going from here?

Violet: We're starting to see that the banks are opening up and accepting having to work with others. This is actually a very fundamental change because I think banks in the past were very used to doing everything on their own. But now they realize that they do need to create a semi-open banking platform. They need to be quite adapted to APIs connecting with other platforms, creating a more holistic value proposition with others. You see a lot of innovation that comes out of this. I think some of the leading joint-stock banks are doing that quite aggressively.

I think the second thing is, some of the leading financial institutions are changing their operating model and talent structure in a very meaningful way. In the past, tech and data talent at traditional banks probably constituted10 percent, or at best 20 percent, of a bank. You're starting to see some of the leading banks are actually shifting that percentage to 30, 40, or even close to 45, which is matching many of the fintech players on that.

And I think that's where you're going to get the magic of really creating the bank capability, some of the core capability, to much more like a middle platform. So they work more like a platform. You're essentially treating financial institutions almost like a retail or e-commerce firm. You think where your customers are coming from, how do you manage them along the value chain? How do you grow the customer lifetime value? How do you think about online and offline? How do you make decisions that are data-enabled? How do you trade off with the merchants or partners that you work with based on an understanding of your customers?

Joe: Let's switch to the multinationals. Obviously they're very frustrated in terms of not being able to grow in China as much as they thought they were going to. What's the future of multinationals in the banking industry in China?

Violet: Obviously, I think with the economy and also some of the measures from the regulator, it's getting tougher as an environment, I think for everyone, but probably even more so for MNCs. They probably feel it more so than some of the incumbents. But having said that, I think this is the time where it's quite important to focus on specialty capabilities.

Some of the leading banks that we know are essentially quite specialized in, for example, corporate investment banking, especially the cross-border transaction banking that they do. Because?they have a lot of business flow from Southeast Asia or from Japan or Northeast Asia. The other example is what we've seen with some of the more recent entrants where they might have invested a stake in some of the city commercial banks.

Because they're very good at consumer lending. We know there's a few companies that are like that, they have invested city commercial banks as a stake, as the entry point. And now they're doubling down on one or two particular product lines that they feel very comfortable and has specialty in.

Joe: Lastly, COVID. It has been a difficult year for China with zero-COVID. Any advice you give your clients around resilience during this time and how to ensure that we all have a through-cycle view of the growth and potential in China?

Violet: This is probably the most important question I think many of our client CEOs would have on the top of their mind. I would say there's a few things. One is to really think about efficiency and productivity. Really think about the ROI from what one is investing in both on a short-term basis and also longer-term basis. But being able to essentially gain efficiency in the short-run to invest for the longer term is extremely important.

The second thing is, with the whole digital analytics transformation, the need for innovation will be super important in the years to come. There's no turning back. This is something that one would have to invest in to be able to just even catch up, so that one becomes much more data-driven in terms of decision-making.

The third is around organization. This is probably one of the most important things because in times like this, there's a lot of doubt in an organization. There's a lot of mistrust between departments. People are insecure. I think this is a time where leadership would really need to step up and think about sort of who are my key talents, right? What is the culture that I want to create, especially in times of difficulty?

Joe: I agree that resilience is probably one of the key values right now that everyone's got to dig deep on. I think the first level of resilience is just to survive. In a lot of Chinese conversations, the first key message is basically just to survive. But I think that most sophisticated players are really thinking about resilience as how do I emerge out of this stronger than when I entered?

And I think that really comes back to digital innovation, the organization, and the agility that everyone is working on to develop. Let's see how this pans out for the industry for the rest of this year.

Joe Ngai is the Chairman of McKinsey Greater China. Violet is a Partner in McKinsey's Shanghai office.