China’s recent accession to the World Trade Organization (WTO) will create opportunities for foreign and domestic players seeking to tap into the country’s booming market for retail financial services. But before these companies can cash in, they will have to overcome some hurdles, even as the demands of China’s most profitable banking customers redefine the competitive landscape. Indeed, a recent survey suggests that changing consumer preferences may have a more immediate impact than the WTO-mandated regulatory reforms.

Although some product markets will open up for foreign institutions, the playing field will not be as level as many had expected. Foreign banks won’t, for instance, be able to collect deposits in China’s currency, the renminbi, until 2007, which will limit their ability to finance such potentially lucrative products as mortgages and car loans. Yet Chinese banks, which make little attempt to target particular customer segments, will have to become far more savvy or risk losing their local dominance. At stake is an enormous, largely untapped market for financial services: only 1 percent of China’s consumers hold credit cards, for instance, versus 62 percent in Taiwan.

Several years of rapid economic growth and rising household incomes are putting these markets up for grabs (Exhibit 1). Today, about 30 million urban households are considered middle income or above, defined as earning more than $4,300 a year—enough to make them targets for many financial products. This segment is growing rapidly, roughly doubling in size every two years. Further, as many as 4 percent, or 1.2 million, of these middle- and upper-income households hold deposits of $100,000 or more. In fact, this affluent subsegment holds fully 50 percent of all retail bank deposits in China and generates more than half of the profits of the country’s entire banking sector.

In addition, Chinese consumers are becoming enthusiastic borrowers—and investors. In a 2001 McKinsey survey of the attitudes of middle- and upper-income urban consumers toward retail financial services, 38 percent of the respondents considered it unwise to borrow money except for a house, down from 52 percent a year earlier. They also proved to be more risk tolerant than their counterparts in other Asian markets: only 39 percent said that they preferred bank deposits to securities (as opposed to the Asian average of 63 percent), and 38 percent of upper-income Chinese actually hold securities, the highest percentage in Asia (Exhibit 2). Banks that partner with securities brokers, insurers, and other providers of investment products stand to gain from this risk-taking impulse.

Wealthier customers tend, however, to be less loyal than others; they are constantly searching for better alternatives. Fully 73 percent of the respondents—well above the Asian average of 56 percent—agreed that shopping around for financial products is worth the effort. These upscale customers opened new accounts at more than twice the overall rate of Asian consumers (Exhibit 3).

But such Chinese customers don’t necessarily open their accounts at their current banks. About 20 percent of the best customers of one traditional, "big four" Chinese bank, for instance, have switched their primary banking relationship since 1999. Government regulations make the product offerings and interest rates of Chinese banks basically identical, so these churn rates suggest deep dissatisfaction with the incumbents’ service standards. Indeed, many affluent Chinese customers have fled the large banks for new, consumer-oriented competitors.

These changing consumer attitudes and behavior bode ill for the large, traditional Chinese banks. Meanwhile, competitors seeking to tap the growing market in China will need to know where the real opportunities lie. Identifying the most profitable product areas and those that will open up to new local entrants and foreign institutions most quickly is crucial. Clearly, one product to start with is credit cards, whose interest rates are fixed by law at 16 percent, allowing companies that manage risk well to earn lucrative returns.

Chinese banks, for their part, must do several things to prepare for global competition. First, they should upgrade their customer databases and management information systems to assess the performance of each branch or product line more satisfactorily, to identify their best customers, and to track the profitability of various customer segments. Then they must segment their customer base quickly and offer more distinctive, higher-quality products and services to the most attractive segments. If Chinese banks don’t do so, their competitors will happily cherry-pick the most profitable customers.