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China's credit card debt fueled by shady business practice

'Cash-out service' lets small payment processors survive under shadow of Alipay

The performance of third-party payment processors shows that "cash-out services" are a significant source of financing for individuals and businesses during the pandemic. (Photo by Caixin)

An illicit business that has become a lifeline to many of Alipay and WeChat Pay's smaller peers has again caught the attention of regulators for contributing to China's ballooning credit card debt, a worsening problem amid the COVID-19 pandemic.

The business, known in China as "cash-out services," allows individuals and businesses to tap credit cards for cash advances at costs far lower than normal.

Some third-party payment companies or their agents facilitate this by allowing merchants to disguise these transactions as phony credit card purchases, taking advantage of lower bank fees for purchases than for borrowing cash.

In the past few years, cash-out services contributed between 1 trillion yuan ($141.4 billion) and 2 trillion yuan to China's payment market, equal to 2.5% to 5% of domestic credit card transactions in 2019, according to multiple estimates.

The size of the business could help explain why the People's Bank of China last month released draft regulations that urged banks and third-party payment companies to tighten supervision over credit and debit card transactions.

A close look at the cash-out business sheds light on how third-party payment companies and complicit merchants take advantage of loopholes to significantly contribute to China's rising credit card debt, a growing portion of which has soured during the pandemic. At the end of March, credit card balances at least six months overdue reached nearly 91.9 billion yuan, up 23.7% from the end of last year, according to central bank data. This marked the second-highest figure since data became available in 2008.

Some bankers are alarmed. "The risks will begin to threaten the financial system if 10% of cardholders who use cash-out services become high-risk clients who fail to repay their debts even after using new loans to pay old ones," an employee of a bank told Caixin. "At the national level, the government must fix the cash-out business to stop it from growing further."

Cashing in on cash-out

Currently, there are more than 230 companies in China licensed by the central bank to run third-party payment businesses, which include myriad services, such as online payments, mobile phone payments and bank-card transaction processing for merchants. Among them, only 62 are qualified to process bank-card transactions.

The problem for many is that China's most successful and well-known payment companies -- Co. Ltd., an affiliate of Alibaba Group, and Tenpay Payment Technology, the Tencent Holdings subsidiary that runs WeChat Pay -- have a stranglehold on the online payments business. By transaction value, the two dominate more than 90% of the third-party mobile payment market. Chinese have grown accustomed to making most of their payments through two mobile apps -- Alipay and WeChat -- instead of credit cards. The situation has left many smaller payment companies with few ways to make money.

Handling offline credit and debit card transactions is one option, but it is a tough business. The average service fee per transaction in China is about one-third to half that of some countries, which makes it hard for payment companies to make a profit, said Chen Qizhang, a senior industry insider. Moreover, payment companies only keep about 20% of the service fee for each transaction. They have to pass the rest to China UnionPay -- the only domestic bank-card clearing institution -- which takes about 10%, and the issuing bank, which receives about 70%.

However, credit cards do have one advantage over the apps in that they allow both individuals and businesses to take out cash. With few lucrative business opportunities, many other third-party payment companies have turned to cash-out services.

Most of the 62 third-party payment companies qualified to process bank card payments operate a cash-out service, which accounts for at least 70% of their total offline payment transactions, according to multiple sources. "Most payment institutions couldn't have survived if they just ran legitimate businesses, but they have made a good living running an illicit one -- the cash-out service," one source told Caixin.

How does it work?

In the cash-out business, third-party payment companies make money from the service fees they charge every time a cardholder makes a purchase. The payment companies have an incentive to see that merchants make as many transactions as possible, since they get paid for each one.

For the cash-out service to work, merchants have to be complicit because any sale exists only to disguise the transaction. No goods or services change hands. With a simple swipe on a point-of-sale machine provided by a third-party payment company, a cardholder walks away with cash in hand and a charge by the merchant.

This is actually an old game in China. For years, merchants have been misclassifying credit and debit card charges, so they can keep a greater portion of service fees for themselves. In the first half of 2014, UnionPay found that nearly 470,000 merchants had problems, including hiding the purpose of transactions in order to reduce service fees forwarded to UnionPay and banks, according to a report it released the same year. And about 77% of those transactions came from merchants working with third-party payment companies.

Although merchants play a role in the cash-out business, they are not needed to make it work. Payment companies or their agents can use fake merchant information to apply for POS machines on behalf of individuals and businesses that otherwise cannot accept cards, Caixin reported previously. In 2014, media in Shandong and Hebei provinces reported that agents of many third-party payment companies were offering to install POS machines for anyone with proper identification and a bank card. All other documents could be forged by agents.

Payment companies continue to provide this service to those who do not qualify for a POS machine, a convenience store owner in Guangdong Province told Caixin. Some businesses will then offer cash-out services to customers, through which they make extra money, the person said.

It appears the PBOC had the practice of forging merchant information in mind when drafting new regulations for ensuring the authenticity of bank card transactions. The regulations require payment companies to submit crucial information, such as a merchant ID and business owner ID, when installing a POS machine.

Risky business

The cash-out business is risky, not only because it provides businesses and individuals with access to cheap cash, but because borrowers can theoretically avoid paying them back indefinitely.

It has become common for cash-out customers to pay off the balance on one credit card with cash borrowed from another. With multiple cards, they can borrow even more, rolling over debts from one card to another. In one of the most extreme cases, a man in the eastern province of Shandong cashed out more than 10 million yuan from some 280 credit cards through more than 10 POS machines from late 2017 to early 2019, official media reported, citing police. Some of the cards belonged to other people.

With a POS machine, any individual or small business can tap their credit cards for cash advances without having to deal with a merchant. Over the last few years, the cash-out service has become a popular way for small businesses to get access to credit, as economic growth has slowed and obtaining loans from banks and financial institutions has become harder, sources in the payment industry say.

The performance of payment companies during the coronavirus pandemic indicates that the cash-out business continues to be a significant way of financing for struggling individuals and small businesses.

In March, Lakala Payment and Shenzhen RYX Infotech -- believed to be two leading players in the business -- racked up more than 81 million yuan and 63 million yuan in profits, respectively, from offline payment transactions, the highest among peers, according to a payment institution's internal research.

Even as the coronavirus epidemic ravages China's economy and sends brick-and-mortar retail revenue into a tailspin, RYX's offline transactions remained stable over the first three months of the year, according to UnionPay data.

All of this is problematic for banks. As the ultimate holders of credit card debt generated by the cash-out business, they have much to lose if users of the service stop paying off their balances. This should incentivize banks to keep a close eye on credit card transactions coming from third-party payment companies.

For the past few years, however, they have often turned a blind eye to the business. Several bankers told Caixin that banks tend to ease off oversight when their credit card businesses are struggling to meet revenue targets.

"For banks, it's a headache," a banker said.


Read also the original story. is the English-language online news portal of Chinese financial and business news media group Caixin. Nikkei recently agreed with the company to exchange articles in English.

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