As China evolves from a nation of savers to one of borrowers and investors, banks are salivating over the prospects, but risks loom in a market where consumer credit is a novelty and competition is intensifying.

By global standards, China's 1.3 billion people have only dabbled in financial services. While households have stashed away some $2 trillion in savings, rates of credit card usage, mortgage loans and car ownership are among the lowest in the world.

That is changing fast as China's surging economy creates an expanding consumer class. JP Morgan expects retail lending in China, including mortgages, credit cards and car loans, to grow from US$247 billion currently to US$1 trillion by 2010.

Consumer loans are equivalent to just 14 percent of gross domestic product in China, compared with 59 percent in Hong Kong and 65 percent in South Korea, while the market for investment products is also underdeveloped.

The consumer business is in an early stage, Richard Stanley, China chief executive at top global financial firm Citigroup told the Reuters China Century Summit this week. In the long term it will be our biggest business in China.

Bank of China, which is the country's number-two lender but has only issued about 1 million credit cards, compared with 95 million debit cards, expects retail loans to increase by 16 percent to 18 percent a year, much faster than growth in the economy and overall lending.

At rival China Construction Bank, half of the fee income it generated in the first half this year came from retail products such as credit cards and insurance, compared with 46 percent a year earlier.

Both banks are teaming up with foreign partners to beef up their credit card offerings, while they are also looking to leverage the opportunities presented by their vast branch networks to sell more insurance products.

The key issue in the Chinese market is that it doesn't have enough products, Zhu Min, executive assistant president at Bank of China, told the Reuters Summit.

OPPORTUNITIES AND RISKS

The first dual-currency credit card in China was issued in late 2002, and industry players estimate that the number of Chinese packing plastic has risen to about 25 million.

But unchecked growth in consumer lending can backfire, as South Korean banks learned the hard way. The country's economy has only recently recovered from a burst credit bubble in late 2002, when reckless card loans and cash advances led to many card firms seeking bailouts from shareholders and creditors.

In China, individuals are only beginning to embrace the concept of revolving credit. The novelty of consumer lending means banks have access only to rudimentary credit data, although default rates on mortgages and cards are said to be very low.

You'll see a lot more focus going forward on credit bureaus, Citigroup's Stanley said.

Bank of China's Zhu said cards are a tantalizing business given their high interest rate, but banks need to be wary. It's a very high risk business, because a lot of young people don't have a credit history but have a credit culture, he said.

Interest rates on cards are fixed at an annual rate of 18.25 percent, limiting the flexibility banks have to segment product offerings, although it is rumored in the market that the rate may soon be floated or made more flexible.

Germany's Volkswagen, the top foreign car maker in China, set up its local finance arm in 2004 and said 10 percent of all cars sold in China are financed, compared with rates of 60-70 percent in Europe and 80-90 percent in the United States. It expects the China figure to rise to 30-40 percent in 2010.

The loss rate per customer and per contract is at European levels. But we had to implement suitable processes in China, which take into account that the credit history of the typical customer here is very short, if at all available, compared to what we are used to in Europe, Winfried Vahland, Volkswagen's China chief executive, told the Reuters Summit on Friday.

COMPETITION RISING

Competitive risks also loom as domestic and foreign institutions all battle over the wealthiest customers.

At number-three state lender China Construction Bank (0939.HK: Quote, Profile, Research), so-called VIP individual customers make up less than one percent of its total but account for 27 percent of retail assets, Chairman Guo Shuqing said in a Reuters Summit interview.

There is very great potential for wealth management, asset management, individual investment management services, he said.

Citigroup's Stanley said that while his bank will initially target the high end of the market, over the longer term its pool of prospective Chinese customers could number 300-400 million.

Qiu Zhizhong, China chairman at Dutch bank ABN AMRO, which targets customers in China who earn more than $100,000 a year, said the challenge is in meeting the needs of clients in a market where there is no established formula.

The competition will not be on pricing ... but your capability to provide solutions, he told the Reuters Summit.

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