In China's burgeoning retail-banking industry, the credit card market represents one of the most enticing opportunities for foreign banks. Credit cards are already the fastest-growing consumer credit product in China, and all signs point to explosive growth in card usage and profitability over the next decade.

Despite the market's attractiveness, however, it poses significant challenges for foreign credit card issuers. A recent McKinsey survey of Chinese cardholders shows that certain dynamics in China's market tend to favor large domestic banks, with their extensive branch networks and ready-made customer relationships. Foreign providers also face some problems arising from economic factors, such as the high percentage of unprofitable customers and a downward trend in interchange fees.

By 2013, China's consumer credit market—encompassing credit cards, mortgages, and other personal loans—will account for 14 percent of profits in the banking sector, up from just 4 percent today. Credit cards, today barely a break-even business in China, will be second only to mortgages as the most important consumer credit product, representing 22 percent of consumer credit profits, or about $1.6 billion.

By mid-2003, 3 million credit cards had been issued to Chinese consumers; that number quadrupled to 12 million two years later. Ninety percent of China's credit card holders belong to either the mass-affluent (consumers with an annual household income of between $4,000 and $6,500) or affluent (those with a household income exceeding $6,500) consumer segments. Conveniently, 35 percent of mass-affluent and affluent consumers reside in China's four big coastal cities—Shanghai, Beijing, Guangzhou, and Shenzhen.

Even more encouraging to foreign card issuers is the propensity of Chinese cardholders for acquiring new cards and then switching a large fraction of their spending to those cards. Customers have shown little loyalty to their primary credit cards, and issuers have not made much effort to retain them.

Although potential customers are conveniently located and not brand loyal, winning them over will be difficult for foreign issuers. Work site marketing, by far the dominant channel for customer acquisition, accounts for as much as half of card issuances. Customers often sign up for cards because a bank will come to their workplace. Large Chinese banks have a clear advantage in this area, thanks to their strong corporate relationships.

In China, 66 percent of cardholders prefer to pay their credit card bills in cash at bank branches; the second-most-popular repayment channel is automated teller machines. Thus domestic banks, with their widespread distribution networks, have yet another advantage.

In addition to customer acquisition challenges, foreign banks have to be prepared to contend with less-than-ideal economics. More than half of Chinese cardholders are unprofitable customers; a mere 2 percent classify themselves as "frequent revolvers"—consumers who almost always leave a balance on their credit card—while more than 85 percent of cardholders pay their entire bill each month.

Profitability is hurt further by falling interchange fees. Merchants and retailers are pressuring banks into reducing already low fees, which in China average around 0.7 to 0.8 percent of spending, compared with the 1 to 1.6 percent typically found in other international markets.

Against this backdrop, foreign card issuers would do well to collaborate with local companies instead of going it alone. Multinationals can either acquire an equity stake in a domestic bank or form a marketing alliance with companies outside the banking industry.

The first option has a greater likelihood of success, for a number of reasons. By purchasing a stake in a local bank, a foreign provider can enter the market now—as opposed to waiting until regulations change in 2007—and have access to an existing customer base. A foreign bank must choose its partner carefully, however. The attractiveness of the credit card franchise varies significantly from one Chinese bank to another. In general, compared with city commercial banks, the national banks have a larger and more affluent mix of retail customers, stronger corporate relationships, a more robust payment infrastructure, and more consumer credit history data.

If a foreign bank chooses to go this route, it should negotiate the credit card partnership at the same time as the equity acquisition to take advantage of the brief window of opportunity for striking a favorable side deal. Such a deal could allow the foreign bank to attain a large share—ideally around 50 percent or more—of the card business, either immediately or in the near future.

The second form of partnership—allying with companies outside the banking industry—allows a foreign card issuer to enter the Chinese market without an equity investment. Our survey indicates that car ownership and high mobile-phone usage, for example, are good predictors of high credit card spending; a co-branded card with a mobile operator could therefore be an effective avenue for gaining access to high-quality customers. Chinese card issuers are already exploring this approach, but many foreign providers have the marketing knowledge and the experience in managing partnerships to outdo local players.

Regardless of how a foreign provider chooses to enter the market, it must invest in the right skills. Since Chinese employees have virtually no skills in the credit card business, most card operations are run by people with a commercial-banking background. A foreign provider would need to bring in skilled people to run critical areas such as marketing, risk management, and product development.