Creating Higher Levels of Financial Inclusion in China

Transcription

1 Creating Higher Levels of Financial Inclusion in China 2014

2 Executive Summary China's impressive economic growth has dramatically reduced poverty; however, it has also increased income and social inequality. This is not a China specific issue, more developed economies like the EU and US are also grappling with the issue of inclusive growth. Global organizations like the World Bank have identified high levels of financial inclusion as one path to inclusive growth and reducing inequality. This paper focuses on how China's leadership can drive higher levels of financial inclusion in the country, which would mean access to and usage of the complete financial system that includes payments, lending, investments and insurance. The opportunities in financial inclusion are found across China. In rural areas, people lack basic financial services like a bank account, and in urban areas, mass penetration of more sophisticated financial products including credit, investments and insurance is still lacking. Small and Medium-sized Enterprises (SMEs) in China also lack full access to financial services like low cost borrowing. Three principles are really important for China to drive higher levels of financial inclusion, and underpinning them is the notion that the private and public sector working together can be a very powerful force in promoting financial inclusion. Financial needs must be addressed as a hierarchy with owning a payment transaction account and having the ability to make electronic payments being the most foundational needs. People are at different levels of the financial needs hierarchy across China; therefore financial inclusion is not limited to rural areas. Each stage of the hierarchy must emphasize both access and usage of financial products. The public sector can play an important role in closing the gap between access and usage. Banks will continue to play an important role in driving financial inclusion, but the role of innovative non-bank companies cannot be ignored. China's leadership should focus on creating an environment in which these companies can thrive. 1

3 Higher levels of financial inclusion are important for inclusive growth An important factor that drives inequality is the significant disparity in the levels of access and usage of financial products and services among people. Recognizing this, the World Bank has made financial inclusion one of its core topics given its implications for reducing poverty and boosting shared prosperity. It recently announced a new initiative to provide universal financial access to all working-age adults by 2020 with the help of technological innovations such as e-money accounts and e-mobile wallets. Even standard setting bodies like Bank of International Settlements (BIS) are incorporating considerations of fairness into financial sector policy as a means to equitable growth. Implicit in this focus on equitable growth is a recognition that financial exclusion carries risks to financial integrity, given that the cash based world of the financially excluded is not transparent and poses risks to financial stability [4]. In the last 30 years, China has been dramatic in reducing poverty in the country. In 1981, two out of three mainland Chinese lived below $1 a day [1]. By 2010, the country had lifted an astonishing 680 million people out of poverty more than the entire current population of Latin America. This cut its poverty rate from 84% in 1980 to below 10% now [2]. China alone accounts for around three quarters of the world's total decline in extreme poverty over the past 30 years. The Chinese government has a strong commitment to poverty reduction; the scale and funding of its poverty reduction program and the sustained reduction of absolute poverty over the last twenty years of reform are exemplary by any standards. The sustained growth of China since the early 1980s has led to impressive efforts in eradicating absolute poverty, but it has also created much inequality in income, arguably also leading to inequality in opportunity and social mobility. However, this is not a China specific issue; more developed economies like the EU and US are also grappling with the issue of inclusive growth. The Europe 2020 strategy developed by the European Union for smart, sustainable and inclusive growth sets targets to lift at least 20 million people out of poverty and social exclusion and to increase employment of the population aged to 75% [3]. In the US, President Obama has linked declining social mobility to rising income inequality, pointing out that Americans born in the bottom fifth income quintile have dramatically lower odds of moving upward than do those born closer to the top. The US president also observed that greater gaps in incomes cause American to distrust their institutions, creating a cultural divide that is bad for the country. This paper will focus on how China's leadership can drive higher levels of financial inclusion in the country to achieve more inclusive growth and reduce inequality. While China has made significant progress in providing its people with access to bank accounts, and the World Bank estimates 64% of Chinese people have an account at a financial institution [5], the leadership will miss a big opportunity if it defines financial inclusion narrowly as "access to a bank account". Full financial inclusion implies access and usage of the complete financial system that includes payments, lending, investments and insurance. The opportunities in financial inclusion are found all across China. In the rural areas where a large portion of the population resides, people do not have access to basic financial services like financial accounts; China Banking Regulatory Commission (CBRC) figures in 2011 showed that ~1700 townships in China did not have access to local banks [6]. In urban areas, mass penetration of sophisticated financial products including credit, investments and insurance is still lacking in China among the banked. Moreover, the opportunity in China is not limited to individuals; Small and Medium-sized Enterprises (SMEs) in China also lack full access to financial services. For example, 's paper at the 2013 China Development Forum described lack of access to low cost financing as one of the biggest obstacles for SMEs in China, with SMEs accounting for only 20-25% of bank loans despite driving a much higher share of GDP. 2 3

4 Having successfully lifted the country out of absolute poverty in the past decades, China's leadership has started on the path of achieving more inclusive growth. This is reflected in its goal of completing the building of a moderately prosperous society by 2020 (doubling the country's 2010 GDP and per capita income for both urban and rural residents), and making China's development much more balanced and inclusive. The Third Plenum of the 18th Party Congress that was held in late 2013 has set the tone for continued market reforms, emphasizing fiscal and rural domains, and a more open, inclusive and sustainable economy. The bold economic reform agenda encompasses price liberalization measures, opening up the market to private and foreign competition, SOE reforms, fiscal reforms, improving urbanization process through land and hukou reforms, and putting greater focus on farmers' property/land rights and access to public services by both rural and urban residents. In addition, China has been participating in the global dialogues and frameworks for driving financial inclusion through initiatives like the Global Partnership for Financial Inclusion (GPFI) that was established by the G-20 countries in This paper based on global case studies will discuss ways in which greater financial inclusion may be achieved through a combination of guided innovation and unleashed market forces. Efforts required for putting China on a path to more financial inclusion The determination of China's leadership to create a stronger focus on market discipline and greater inclusion in the economy is unmistakable. However, there is opportunity to do more for driving higher financial inclusion while preserving the political, economic and social stability of the country. At we have accumulated much experience in working with national governments and agencies around the world in expediting financial inclusion and realizing its benefits while minimizing shocks to the system. Three principles are very important for China and they apply not only to consumers but also to businesses, especially small-medium-sized businesses or so-called SMEs. The Chinese leadership must also note that success would be difficult without the active involvement of the private sector. Governments generate a bulk of the financial flows and have the ability to create the right incentives through policy. The private sector, on the other hand, can provide the innovations, distribution, efficiencies and expertise to reach the financially excluded. Therefore, public-private partnerships are critical for elevating financial inclusion in China. The three principles are : 1. Financial needs must be addressed as a hierarchy Financial inclusion should be considered a progression that must be addressed in steps versus with a "do it all" mentality. There are two reasons that support this principle. First, consumers give different priorities to their different financial needs. Basic needs like owning an account to hold funds and making electronic payments are typically their most important needs, followed by sophisticated needs like borrowing, investment/long-term savings, and insurance. Therefore, in any market, there is a hierarchy of consumer financial needs that starts with two foundational needs 1. Owning a secure transactional account to receive and hold funds, and 2. Making electronic payments starting with everyday needs (peer-topeer and bill payments). The more sophisticated needs like borrowing, investment/ long-term savings and insurance follow the foundational needs and are likely to vary by market (Figure 1). Penetration of financial products among adults in the bottom 40% income quintile globally also supports the notion of a hierarchy of needs (Figure 1) 4 5

5 The second reason is that approaching financial inclusion along the hierarchy of needs is likely to have higher probability of success, because: People are likely to be more focused on addressing their basic needs first and more receptive to solutions that address these needs, and More importantly, by serving people's needs in the order defined by the hierarchy, more of these needs are likely to be met. For example, if consumers' payments can be tracked, that information can be used to assess their risk and extend loans to them. If people can obtain credit, they will have greater opportunities to create wealth and save, which in turn will create a need for insurance products. Figure 1: Hierarchy of Consumer Financial Needs An important implication for China is that financial inclusion is a much broader issue and is relevant in cities as well as rural areas. People are at different levels of the financial needs hierarchy across China. Most people in rural areas are at the bottom of the hierarchy without formal bank accounts. Urbanites have moved up the hierarchy by securing bank accounts but many still lack access to sophisticated financial products like investments. For example, most Chinese primarily save money by depositing it with state banks that pay a significantly low rate of return due to government interest rate caps. They do not have access to more sophisticated products like investment trusts, like the wealthy Chinese. Taking advantage of this disconnect, China's biggest digital company, Alibaba, has launched a deposit product for the mass population that pays them an interest rate that is more than two times what banks pay. In the first three weeks of the launch of service, users deposited $1 billion with Alibaba and deposits were growing by $45 million each day [7]. Penetration of financial products among the bottom 40% income quintile globally hints at a hierarchy of needs As China drives higher levels of financial inclusion, it is important for its leadership to focus on two critical aspects : Recognize the hierarchy of financial needs and the fact that people across China are at different levels of the hierarchy. First, this will ensure that success is quicker by enabling the right products for people based on their level. Second, it will ensure that the success is not narrowly focused on rural areas but also reaches the urban areas. Realize that the government will play a critical role in driving financial inclusion, but it cannot do it alone. The role of the private sector will be important and public-private partnerships would be a recipe for success. Pathway to Full Financial Inclusion Insurance Investments/ Long-term Savings Borrowing Electronic Payments starting with everyday needs like P2P payments and bill payments Secure transactional account that receives and holds funds (e.g., salaries, remittances, benefits) More complex needs, order may vary by market Basic Money Managementfoundational for all market 5% of adults in agriculture have crop or livestock insurance 8.3% of adults have saved for future expenses at a formal financial institution 7.6% of adults have a loan from a formal financial institution 12.4% of adults make electronic payments 38.3% of adults have an account at formal financial institution 25.8% of adults use the account to receive wages, benefits or remittances Source Advisors Analysis 2014, World Bank Global Findex Database

6 2. Each stage of the hierarchy must emphasize both access and usage of financial products Establish policies that encourage usage of products by creating value for participants involved in the solution (e.g., consumer, merchant, provider). South Korean government has a long history of creating incentives to reduce cash. The first of these began prior to the 1988 Seoul Olympics, and offered tax incentives for businesses that accepted cards, coupled with audits for those who refused to accept them. Incentives to consumers included lotteries and tax breaks. Recently the government has spurred further expansion by allowing for the payment of school tuition and utilities with cards. [8]. The second principle is that each stage of the hierarchy must emphasize both access and usage of financial products and services to realize the benefits of financial inclusion. There is little benefit from giving people access to products if they do not use them. Here, access is defined as the formal ownership of a financial product and usage as demonstrated use of the product over time. Therefore, the focus of achieving greater financial inclusion should not only be on driving higher access, but also on driving the usage of products; as only then benefits of financial inclusion will be realized. Today, a big gap exists between access and usage. For example, today, only 38% of the world's adult population at the bottom 40% income quintile has an account with a formal financial institution [5]. But of those, only 68% use it to receive and hold funds [5]. The situation is similar in China, where only 48% of the 64% adults with a formal financial account use the account to receive and hold funds [5]. 3. Market driven innovations from non-bank companies would play an important role Banks would continue to play an important role in driving higher levels of financial inclusion in China. By adapting their infrastructure and offering services like mobile banking and agent banking, banks will continue to drive methods to cost efficiently serve the unbanked people. There are three things China's leadership can do to close the gap between access and usage : But just as governments can't do it alone, banks can't go it alone either. New business models, innovations, and products are needed that are economically not viable for banks to produce given their existing infrastructure and customer base. Non-traditional players or non-banks that rely on innovation to develop new products different from those that banks offer would play an important role and should not be ignored. The current wave of internet financing in China in which new players like AliPay are enabling lending and savings is an example of such market-led innovation, but the opportunity is much greater. Recognize that usage like access has to be proactively emphasized through initiatives and measured. Most financial inclusion initiatives around the world are focused on only ensuring access to products like a bank account and assume that usage of these products will follow. But this is not happening and is reflected in the big gap between access and usage that exists today. Ensure all financial interactions in which the government is involved emphasize usage. One example is to mandate that government benefits and payroll be electronically deposited into people's accounts. Governments in both developed and developing countries including US, Nigeria, India, and South Africa are aggressively moving in this direction. 8 9

7 's paper at the 2013 China Development Forum discussed how Small and Medium-sized Enterprises (SMEs) are a key driver of innovation globally including in China. Most of the non-bank players start off as SMEs, and it is important that China's leadership creates an environment for SMEs to thrive by addressing the two obstacles they face 1) Lack of access to low-cost financing, and 2) Significant inefficiencies in the financial supply chain. Some of the initiatives discussed in last year's paper from that the leadership could pursue included : Global case studies that could benefit China for addressing most important needs 1. Secure transactional accounts for rural population A major trend in China over the past decade has been rapid urbanization. The percent of China's population in urban areas has increased from 35% in 2002 to 53% in 2013 and is estimated to increase to 61% by 2020 [9]. This equates to close to 250 million more people living in urban areas since 2002 [9]. While this has significantly benefited the Chinese economy and helped to elevate the financial status of millions of people, this physical mobility has not necessarily been accompanied by financial mobility, thereby limiting the full benefits of urbanization. China has successfully created an infrastructure for native urbanites to get foundational services like ownership of a bank account, but the immigrants have struggled because requirements in cities restrict them. Even the small fraction of immigrants who had accounts in their hometowns often forgo them because the products are not portable. Removing the significant structural advantages of State Owned Enterprises (SOEs) over SMEs - There are several examples of countries like the UK that have made this transition by privatizing their SOEs without resulting in political instability Building an SME banking focus by beefing up small local banks and by improving SME banking capabilities and motivations of large banks Reforming the current interest rate regime that guarantees healthy interest margin making lending to large SOEs very attractive financially for banks Enabling electronic payment innovations to reduce significant inefficiencies in the financial supply chain that are magnified for cross border trade China needs to move faster to ensure its entire people and businesses have the foundational financial services like ownership of a financial transaction account. A financial services platform that can cost efficiently deliver financial services in rural areas and is portable enabling people to move their financial relationships as they migrate to cities is needed. Financial services through a mobile phone is one such platform and given China's 85%+ mobile penetration could be one way of achieving this in China [10]. Let us discuss some global innovation case studies that may serve to inspire similar models adaptable to China. The examples highlight pathways to achieve greater success in fulfilling the three important financial needs at the bottom of the hierarchy

8 Some recent statistics certainly show mobile payments growing exponentially M-Pesa is certainly the largest success story, but is not the only one globally. in China: AliPay under Alibaba group grew by more than 500% year on year Below are a number of other success stories from around the world that are to reach RMB900 billion in transaction volume, making it the largest digital gaining traction (Table 1): payments company in the world [14]. Similarly innovative players like WeChat are transforming peer-to-peer payments (p2p) through mobile solutions. It is clear that innovation in mobile financial services is accelerating in China and the private Table 1: Other prominent mobile money platforms besides M-PESA sector is having tremendous success. But most of the impact has been in the urban areas, and while people away from the urban centers are starting to see the benefits, the mobile phenomenon has not reached the financially unserved in the rural areas in a meaningful way. The question in China is whether and how mobile Country Zimbabwe Solution EcoCash Launched 2011 Users in million 3.0 Implied Share of Unbanked 58% penetration can deliver financial services, payments and beyond, broadly across the country, especially to the financially unserved. It is unlikely that the private sector or the Chinese government can do it on their own. Public-private partnerships that Colombia Haiti Daviplata TchoTcho % 14% create the right incentives for all stakeholders would be needed in China. Bangladesh bkash % Several countries have already had success with mobile financial services not Pakistan EasyPaisa % just for the foundational needs but also moving people up the hierarchy through more sophisticated solutions like lending and savings. M-Pesa, the mobile money Sources: World Bank, GSMA, Financial Inclusion.org, Solution Press Release, solution in Kenya is probably the biggest success story of offering financial services Advisors Analysis through a mobile phone. The solution initially started as a domestic remittance service that gave a better option to urban workers to send money home to their families in rural areas, but has gradually expanded into offering savings and loans. In the few years since its launch in 2007, M-Pesa has penetrated over 70% of the country's adult population and processes over 10% of Kenya's total consumer payments annually [11]. Additionally, within six months of launching its saving and lending service m Shwari, it accumulated deposits equivalent to over 1% of total bank deposits [12] and had over 4 million loan accounts penetrating nearly 10% of the population [13]

9 While mobile money solutions are growing rapidly and there are over 100 globally, less than 10% have gained traction with over 1 million active customers or significant penetration of a nation's unbanked segments [14]. Analysis of the successes as well as the many failures reveals a number of key success factors that emphasize access and usage of the solutions, innovations from non-bank players or SMEs and public-private partnerships: 's papers at the previous China Development Forum meetings emphasized the importance of open payment systems and standards in China to sustain economic growth and for global leadership. It is also important for driving higher financial inclusion for inclusive growth. As China considers advancing mobile payment solutions for the rural people, it is important for the leadership to ensure that there is a focus on making these solutions open and interoperable. A favorable private and public sector partnership model resulting in a moderate regulatory environment. The government provides guidance and advocacy without restricting development or allowing it to "run wild". An initial strong use case driving usage with appeal at the lowest level of the Financial Needs Hierarchy (see Figure 1). New use cases may be expanded when the initial needs gain traction Significant distribution locations providing access e.g., mobile network agent locations An innovative business model creating value for all ecosystem participants, including merchants, consumers, and the distributors of the service Unfavorable economics for traditional banking and payment solutions to serve the unbanked e.g., due to small transaction size 2. Full Digitization enable greater electronic payments and reduce cash usage China has made significant progress in shifting cash to electronic payments, but the fact remains that 90% of all payment transactions in China are still made with cash (this is based on number of transactions versus the dollar value of payments) [15]. Cash takes time to get at, is riskier to carry, facilitates corruption, and by most estimates, costs society as much as 1.5% of GDP [14]. Reducing cash in the Chinese economy by enabling more electronic payments can boost economic growth, while advancing financial inclusion. China can benefit from several success stories as it tries to reduce cash. A key driver of electronic payments in China has been the significant growth in payment cards. Debit card and credit card transactions increased five-fold from 2006 to 2011, with debit cards accounting for 88% of volume [15]. To accelerate this trend and take a bigger share from cash, China needs to further invest in merchant acceptance of cards, which remains relatively low compared to developed countries like the US. For example, POS terminal penetration based on adult population in the US is six times greater than China [16]. In addition, these solutions continue to focus on driving higher usage. For example, in many cases solution providers are realizing that a closed loop design significantly limits their utility. Here, "closed loop" means that the mobile money solution requires both the sender and receiver of the money to have an account with the mobile money provider; sending money to a receiver of another mobile money scheme is not allowed ("open loop"). Therefore, many solution providers are transitioning to "open loop" solutions. M-Pesa is now offering open loop payment cards linked to their mobile wallets. Several "open loop" mobile money solutions have also been launched such as by Western Union in Italy and in Africa. And mobile money is not the only place where this transition to "open loop"is happening. Transit payment systems globally (e.g., Suica Card in Japan, Octopus Card in Hong Kong, Metro Card in New York) are already recognizing the benefits of open payment solutions and are transitioning towards them

10 Mobile Point-of-Sale solutions (M-POS), such as Square that started in US and izettle that started in Sweden, enable micro and small merchants quickly and cost effectively accept cards using their mobile phones. Despite launching in the US market with high traditional merchant card acceptance, Square is a successful case study. Since starting in 2010, it has expanded to Canada and Japan, processes $15 billion payment volume annually and is used by 2 million merchants [17]. Similarly, izettle has expanded to Norway, Denmark, Finland, UK, Germany, Spain, Mexico, and Brazil since its launch in Disbursements of wages to card-based mechanisms will likely drive high access and usage in the following conditions: Government and/or large corporate leadership in shifting their payroll to cards driven by financial inclusion agenda and administrative cost savings Significant ATM and Point of Sale infrastructure to provide access to the funds Positive value creation for all value chain parties involved in the disbursement process Enhanced functionality through the payroll card that encourages subsequent use and creates greater value for the ecosystem participants. Examples include the ability to remit funds, pay bills, and provide integrated national identification Encouraging Mobile Point-of-Sale solutions (M-POS) deployments can expedite merchant acceptance in China, especially given that China has nearly twice the number of SMEs compared to the US [8]. High access and usage of M-POS solutions is rendered feasible by the convergence of five key developments: Another key source of cash across the globe is its heavy use in the B2B supply chain. Reliance upon cash in the chain between buyers and suppliers results in challenges around inefficiency, risk, and liquidity. There is an excellent example involving a beverage distributor in Brazil where a formerly cash based process in the supply chain was converted to an electronic solution resulting in 40%+ cost savings for the distributor : [8] Scalable technical costs (e.g., inexpensive dongles, mobile data networks) Simplified pricing and packaging (e.g., one flat rate, minimal to no set up costs, no merchant account requirement) Evolved risk modeling (e.g., inclusion of non-traditional data like social media, spending limits) Efficient distribution models (e.g., online/mobile, retailer locations) Broad understanding of benefits of electronic payments among merchants and consumers Instead of using a paper ledger the distributor employee tours its retailer locations with a smart device and records demand for restocking Subsequently, properly supplied hand cart representatives visit the stores to restock new drinks. They also carry a portable POS terminal with them to allow settlement with a card Selling locations may be given a "house card" used to settle specifically with the distributor when the deliveries are made, or they could use their own personal or business card Payments are made using the portable POS system Another key source of cash in a market is how funds are disbursed for payments, like payroll wages. A large number of employers around the world including China are paying their unbanked people in cash. For example in China, over 80% of adults at the bottom 40% income quintile receive their wages in cash [5]. However, this is changing as both private and public sector employers around world are realizing the costs of cash and benefits of electronic disbursement. In Russia, most of the unbanked receive salaries electronically on payroll cards. UAE, in 2009, passed the Wage Protection System law that required its over 5 million unbanked foreign workers to receive their salaries via payroll cards [8]

11 Some of the critical success factors for high access and usage of digital B2B supply chain solutions appear to be : Industries in which physical goods move at a high velocity through the supply chain (e.g., perishable goods) and in which the retailer base is not very concentrated A stable risk environment where distributors are comfortable giving retailers cards and accepting them for payment Affordable and reliable mobile point of sale devices for accepting electronic payments An economic model that creates value for all stakeholders including the distributor and merchant In China, only the most qualified SMEs can get loans from banks, hence SMEs account for only 20-25% of bank loans despite driving a much higher share of GDP [18]. In addition, the interest rates for loans to SMEs in China are significantly higher than those to large corporations. For example, SME loan interest rates by banks were estimated to be about two times of the rates enjoyed by large corporations (i.e., rates for SMEs were often 20%-50% over the benchmark rates set by PBOC, while the large corporations may receive up to 30% discount off the benchmark rates) [19]. Many SMEs cannot obtain bank financing even at such rates, and have to seek out so-called "social lending" that carries much higher rates. On the consumer side, based on World Bank's Global Findex study 2011, 8% of adults at the bottom 40% income quintile in China are able to secure a loan from a formal institution compared to 12% in UK and 17% in US [5]. All the three case studies discussed above emphasize: The value of public-private partnerships e.g., in UAE, the government passed the wage protection law and the private sector provided the solution (e.g., payroll card) The role of non-bank companies or SMEs in driving market led innovations (e.g., izettle, Square) The need to focus on access and usage e.g., salary cards have been successful in Russia and Mexico because of employer focus on usage through policy and incentives versus pure access 3. Borrowing - greater and more efficient credit options for SMEs and consumers The situation is more dire in rural areas despite government efforts since 2007 to promote more financing options for the development of agriculture and farmers commonly known as 'San Nong' in Chinese. The four big banks withdrew the investment below county level in the past few years due to the risk-return profiles leaving only Rural Credit Cooperatives (RCCs) to provide loans to the farmers. However, these RCCs were capable of providing only around RMB 500 credit per household [20]. Some urban and commercial banks also transferred the funds collected in the rural areas to big cities and other economic development areas through their inner systems. These kinds of activities caused massive deposit outflow, and created difficulties in financing rural areas. Consequently, rural enterprises, mostly farmers, were forced to borrow the high interest rate bearing loan from local people to meet their financial needs. 's paper at the 2013 China Development Forum discussed the challenges SMEs face in getting financing and the obstacles they create for innovation and overall economic growth. Difficulties in lending to SMEs and consumers are also impediments to a more inclusive growth in China. We will first recap and expand the challenges highlighted in the 2013 paper and then discuss ways China can address the financing challenges for SMEs and consumers

12 Lack of information that banks traditionally use to extend credit is the primary reason for this challenge. For consumers, China's central bank managed credit bureau is estimated to have coverage of about 30% of the population which is relatively low even compared to other developing economies such as Brazil (50%) [21]. The information is also limited to the negative activity of consumers in contrast to developed markets like the US, that significantly limits lender's ability to underwrite risk. Additionally, many consumers have little formal credit history (i.e. a "thin file"). These include recent entrants to the labor market (e.g. graduates and returning homemakers) and immigrants. In the case of SMEs, it is the lack of substantial capital, an earnings track record, or state guarantees to protect them from loss that large enterprises typically offer. Lenddo is a direct lender that has developed an online platform for the emerging middle class in developing countries, to help people build their creditworthiness based on their social connections. A basic premise is that it is very difficult to fake a social network online. Lenddo's members are typically middle-class individuals who are employed and well-educated but under banked. A "Lenddo Score" of the creditworthiness of would-be borrowers is primarily based on 3 factors: (i) social media activity (Facebook, Yahoo, Gmail, Twitter and LinkedIn); (ii) character references from close contacts; and (iii) past performance, if applicant has borrowed previously from Lenddo. Lenddo already has over 250,000 members globally since its launch in 2011 and is currently active in Colombia and the Philippines [22]. 's 2013 paper discussed several ways of addressing the SME lending difficulties, including developing a local banking model and enabling lending through non-traditional methods, like new payment innovations. This paper will further develop the idea of leveraging non-traditional methods for lending, given its broad applicability to both SMEs and consumers. Entrepreneurial Finance Lab (EFL) focuses on SME lending and has developed a computerized credit application that utilizes psychometrics to analyze aspects of entrepreneurship. Its test takes minutes to complete and follows a "question and answer" format. Applications scored by EFL are available to the lender in as little as minutes. EFL has launched with 5 credit issuers across 22 countries, mainly in Africa and Latin America, and has shown to reduce default rates by 35-40% and interest rates by half. It has made $250 million in loans to date, with an average amount of $7,500 [22]. There are several non-traditional and innovative lending techniques that China can encourage to alleviate the financing problems for SMEs and consumers. Cignifi has developed algorithms that recognize patterns in mobile device use (phone-calls, text messages and data usage) and can profile someone's lifestyle and corresponding credit risk profile. It has built its models using data on more than 100 million mobile phone subscribers [22]. A "Cignifi Risk Score" is calculated for mobile users that measures the risk of loan default. Cignifi is already helping lenders in Brazil, Chile and Mexico and has shown to increase loan acquisitions by 25% without additional credit risk [22]. Finally, electronic payments provide better information that could be critical for lending. Innovative payment players like Alibaba have leveraged their payments infrastructure to successfully expand into SME lending. By controlling credit risk through visibility on SME sales information, Alibaba's SME financing business has grown rapidly, and is well-received by its SME customers. In Q1 2013, the business made loans to 25 thousand online retailers in average loan amount of 11 thousand Yuan [23]. Following on the heels of Alibaba, PayPal has recently launched its own SME lending initiative

13 Lending based on non-traditional data offers significant potential, but requires the right environment to be successful. As China considers further encouraging this practice, the leadership must be cognizant of the following key success factors that emphasize access and usage of the solutions, innovations from non-bank players or SMEs, and public-private partnerships : Privacy laws that strike the right balance between protecting privacy and encouraging lenders to develop innovative lending solutions using personal data Supportive regulatory environment that enables non-traditional players to lend and be successful Widely available digital infrastructure that reaches the broader population and that is highly secure resulting in high usage The role of non-bank companies or SMEs in driving market led innovations (e.g., Lenddo, EFL) Summary To ensure more inclusive growth, China needs to drive higher levels of financial inclusion. Our analysis shows that three principles are important for China's leadership to drive greater financial inclusion, and success would be difficult without active public-private partnerships : Financial needs must be addressed as a hierarchy with owning a payment transaction account and having the ability to make electronic payments being the most foundational needs. People are at different levels of the financial needs hierarchy across China; therefore financial inclusion is not limited to rural areas. Each stage of the hierarchy must emphasize both access and usage of financial products. China's leadership can play an important role in closing the gap between access and usage. Banks will continue to play an important role in driving financial inclusion, but the role of innovative non-bank companies cannot be ignored. China's leadership must focus on creating an environment in which these companies can thrive. Based on global case studies, we recommend that China adopt a number of measures to drive higher financial inclusion. These recommendations will ensure that growth in China will be more inclusive

14 Sources: 1. "Poverty Not Always with Us", Economist, June 1, 2013; based on 1993 price level 2. "Poverty Not Always with Us", Economist, June 1, European Commission ( 4.BIS Remarks at the GPFI Conference in Base in World Bank Findex Study, China Banking Regulatory Commission (CBRC) data released in January Quartz.com 8. Advisor Analysis 9. World Bank Indicators, ChinaDaily.com, GSMA Intelligence 11. M-Pesa, Advisors Analysis 12. Mobile Money for the Unbanked, M-Pesa 13. Business Daily Africa 14., Advisors Analysis 15. Advisors Global Payments Map 16. Lafferty 17. Company website, Techcrunch, Business Insider 18. Chinese Academy of Social Sciences and China Association of Microfinance 19. China Economy Website 20. Sun, World Bank, IFC 22. Company Website, Advisors Analysis 23. Technode.com 24

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