Banking & Finance

Bargaining chip

How NXP dominates China’s credit card market

A man works on a tent for NXP Semiconductors in preparation for the 2015 International Consumer Electronics Show (CES) at Las Vegas Convention Center in Las Vegas

Around 95% of China’s ‘smart’ bank cards use NXP chips

The Economic Information Daily started the year with the sort of statistic that gets international executives salivating. It described an industry in which a foreign player controls around 95% of the Chinese market, and which in the coming year may generate local sales of close to 2 billion units.

WiC was stunned by these figures, particularly as the multinational in question is not one that we have mentioned previously in our six-year publishing history.

It turns out the company is a Dutch firm called NXP Semiconductors, which was originally part of Philips but has been a separately listed Nasdaq firm since 2010.

NXP has a broad array of products, but the one in which Economic Information Daily claims it is most dominant in China is the smart chips now being embedded in credit cards and bank debit cards.

China has around 3.4 billion cards in circulation, and the majority still use magnetic strips. In early 2011 the central bank ordered the country’s financial institutions to migrate their card bases away from this older technology to cards using chips. Under the plan, cards are supposed to be chip-based by the end of this year, with all of the current cards relying on magnetic strips to be suspended.

Why? Security, in a word. Magnetic strip credit cards are prone to counterfeiting and fraud. So China’s central bankers have looked to Europe where the switch to ‘chip cards’ is most advanced. In France – where a nationwide migration was first completed – the rate of bank card fraud fell from 2.7% to 0.18% of transactions.

But Europe’s headstart has also ensured that some of its firms are enjoying a notable advantage in smart chip production. Aside from NXP, Germany’s Infineon is also selling its chips to card issuers in China, for instance. European producers enjoy economies of scale and technical advantages. Another factor for their success in the Chinese market is an international certification process that validates their product.

In the first three quarters of last year banks in China purchased 130 million, 150 million and 170 million smart chips respectively – a trend which the Economic Information Daily says “shows a significant acceleration of issuance”. It also reckons there are now one billion new cards being used in the country, with NXP having provided the chips for 95% of these.

The rest are provided by other multinationals (Samsung is cited as another main player). Almost totally absent: Chinese manufacturers.

A top executive with Shanghai Fudan Microelectronics Group told the newspaper that Chinese firms like his have lagged behind because of their late start in the chip design and manufacturing industry. However, as of last June, there were still six local firms producing smart chips which comply with China’s security standards. Homemade chips, for example, are already embedded in 1.2 billion Chinese ID cards, as well as featuring in almost 630 million social security cards.

However, the chips’ inclusion in Chinese bank cards is proving more elusive – somewhat to the chagrin of the central bank.

When the People’s Bank of China first pushed for the migration to smart chips it had hoped local manufacturers would be the chief beneficiaries. Instead it has found that the Chinese banks are reluctant to use homemade chips. Despite pressure from the regulator, the banking industry only began trialling them last April.

Their reluctance stems from a number of commercial factors, but the main argument again relates to international certification. The key body here is the CCRA (Common Criteria Recognition Agreement), which has been established by the main international payments systems. NXP’s bank card chips received certification from the CCRA back in 2001 but Chinese manufacturers have found it tough to receive similar accreditation. Local players say it can take them two to five years to navigate the process, while more established international players can get their newer products certified in as little as three months.

So far only one Chinese firm has got a smart chip design CCRA-certified – Shanghai Huahong Integrated Circuit. But it has failed to dent the dominance of firms like NXP. In fact, rival maker Nationz Technologies – which has also spent a lot on CCRA certification – warned the Economic Information Daily that firms like his face a vicious spiral. Sun Yingtong, its president, says the technology is advancing rapidly and even when the authentication is granted, the China version lags.

He concludes that as long as the Chinese banks insist on buying CCRA-certified chips it will mean that the foreign manufacturers’ dominance of the local market will become more entrenched.

Local experts cite a few reasons why the bank bosses are inclined to shun Chinese-designed chips (which is not the same thing as being Chinese-made; NXP employs 7,000 people in China). A staffer with UnionPay says the first-mover advantage of the established chipmakers is hard to dislodge, even when the central bank is lobbying for the homegrown players. Local banks, he says, have a “preconceived security prejudice” against chips designed by Chinese firms. And unlike the multinationals their chips have never been put into large scale use, “so their reliability has not undergone the test of large scale applications”.

This is a serious commercial concern. If there does turn out to be a problem with the chips, the banks will have to foot the bills for replacing the faulty cards and they will take a reputational hit with their client bases. Best not to be the first mover, then, in adopting Chinese chip technology (this school of thought was probably bolstered by what bankers saw in the telecoms industry when China Mobile was forced by regulators to adopt a homegrown 3G technology; it worked less well than foreign standards, and China Mobile lost market share to its two rivals).

Of course, there is something of the classic chicken-and-egg theory to all of this: until a local smart chip is mass-tested, there won’t be confidence from bank procurement departments that they are safe to buy. A bit like the old maxim ‘You never get fired for buying IBM’, the managers face little risk if they buy from the established giants. But if they buy a homegrown alternative, it might not work. Potentially worse, some may fear that they’ll be investigated and even accused of taking kickbacks from the local supplier.

Nor can China’s manufacturers – late to the field and technologically lagging – match the likes of NXP in terms of economies of scale. Thanks to its critical mass in the marketplace, local media estimates NXP can price its chips at half the levels currently envisaged by its Chinese rivals. Even selling their chips at an entry price of Rmb10 ($1.65) apiece, the Chinese firms would be looking at years of losses.

For the bank procurement departments it all looks a bit of a no-brainer (Securities Times points out that chips account for 80% of the cost of the cards). As a result Economic Information Daily thinks that NXP will continue to provide most of the 2 billion chips that China’s banks are expected to purchase this year.

Changsha Evening News is one of the voices in the media that worries about the use of foreign technology. It would like to see banks made to use locally-designed chips in the interests of national security (a view the central bank also takes).

The newspaper writes: “From the perspective of the commercial banks, it is reasonable that they will use cheaper chips that get more certifications. The problem is that domestic banks have ignored the most crucial issue: if Chinese cards continue to use foreign chips, their security will be seriously threatened – if these foreign chips are installed with a ‘back door’ by those with ulterior motives. The consequences could be disastrous.”

It likens the situation to the world of computer operating systems, where China is reliant on foreign products to power their PCs and smartphones (i.e. those made by Microsoft, Google and Apple). This is an area where the Chinese government has made plain its desire to promote a domestic OS, particularly in the wake of Edward Snowden’s revelations. “How can we forget the lesson of this,” Changsha Evening News asks. “We can no longer let our own bank card security be held in the hands of others.” It then suggests that government action is required and that the authorities in Beijing order that banks use homegrown chips that have passed domestic security tests, even if they are not yet CCRA-certified.

The news about the chip cards has led to some soul-searching online too.

“Do not say how great China is,” one netizen complained. “That even a small bank card that we use is made in foreign countries can only show that we have a long way to go.”

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.