The biggest challenge facing China in its drive for financial inclusion has been how to expand banking services to private businesses and individuals.

The country’s financial sector is dominated by state-owned commercial banks, which favour state-owned enterprises. The system is imbalanced.

But the widespread adoption of internet-based technology, especially on mobile devices, is helping to close that gap.

 Investment in Chinese fintech firms has exploded in recent years
Investment in Chinese fintech firms has exploded in recent years
Image: Bloomberg

Web-based finance is growing rapidly and is supplementing the traditional financial system. And now the commercial banks are getting in on the financial technology - fintech - act, too, partly due to the regulatory push for financial inclusion but also because of their need to transform their business strategies.

The growth in financial inclusion in China has been remarkable. According to a survey by the Boston Consulting Group, the average Chinese adult now has 5.36 financial accounts. And as more transactions within the Chinese economy take place digitally, third-party payment companies such as AliPay and TenPay have expanded rapidly. These companies now boast more than 475 million users, and have greatly increased the penetration of basic financial services.

Something similar is happening in online wealth management. For example, Ant Financial Group - which operates AliPay - established money market fund Yu’E Bao in 2013. It is now the world's largest, with more than 300 million users and total assets under management of over RMB800 billion. Its investment threshold, meanwhile, is only 0.01 RMB - that's less than one US cent.

As for lending, besides the two giants of Ant Financial and Tencent there are now thousands of online companies competing in this field - and that has led to lower costs for borrowers. Online financing reached RMB1.16 trillion by the end of 2016. That’s important because the average number of credit cards is still only 0.29 per person in China, compared with 3.4 per person in the United States.

The fast growth in online lending has been partially due to an absence of government regulation - but that is changing. The regulators are now stepping in with a focus on illegal activities, which should help the nascent industry continue its growth in a more sustainable way.

The story is the same in commercial financing. Innovative companies are serving unbanked, or underbanked, privately owned small and medium-sized enterprises. They are helping not just with direct lending, but also in making them more attractive to lenders. LaKala, for example, is a third-party payment company that helps firms improve their transaction efficiency with data analysis, risk management and payment, and with gaining access to affordable financing.

Because of the immense demand for these services, China has become a hotspot for venture capital. According to a PwC report in 2016, half of all global fintech investments were in China.

But even with their rapid growth, these innovative players still serve only a complementary role in China. The traditional commercial banks - with total assets between them of RMB200 trillion - have a far greater potential for improving financial inclusion, and the government has been actively encouraging them to move in this direction.

In January 2016, for example, the Chinese State Council (the central government’s chief administrative authority) released a directive entitled “The Plan of Promotions for Financial Inclusion (2016-2020).”

At the National People's Congress and the People's Political Consultative Conference in early 2017, meanwhile, the State Council’s Premier, Li Keqiang, emphasised the role of large and medium-sized commercial banks in promoting financial inclusion. To make financing truly accessible and affordable, he said, the government had to enact supportive policies for these banks. As a result, starting in April 2016, the Industrial and Commercial Bank of China (ICBC), the China Banking Corporation (CBC), and other banks have created divisions focused on financial inclusion.

The government’s support is likely to be quite helpful. The China Banking and Regulatory Commission’s effort to promote agriculture financing, among other cases, has been regarded as a success.

According to Jiao Jinpu, former chief officer of the Central Bank’s Financial Consumer Protection Bureau, the level of financial inclusion in China is already above the global average. With this success has come expanded ambition: the government now encourages not just greater financial access but wider concepts, such as setting up channels to promote and enable initial public offering applications from poorer areas.

Besides this regulatory encouragement, commercial banks are promoting access and affordability for competitive reasons. If they don’t transform their business practices to promote inclusion, they may lose out in the marketplace. As a result, they are increasingly cooperating with fintech companies to better reach underserved groups and areas.

In 2016, CBC announced a landmark agreement with Ant Financial. The two companies are now cooperating in the areas of online-to-online financial services, electronic payments and credit scoring.

The result of all these efforts will be a richer and broader financial industry in China. The growing diversity of companies and business models means in turn a wider range of products and services are being offered to a larger user base. Both internet giants such as Ant Financial and Tencent, and the leading commercial banks, will play crucial roles in this ongoing expansion.