A major development this year in the Chinese banking sector is the mushrooming of direct banks. By the end of November, 13 such banks were established, mostly as subsidiaries of traditional banks.

Direct banks are not new. As a bank operating without any physical branch network, they became popular in the United States and Europe in the late 1980s.

A direct bank offers its services remotely via online banking and telephone banking and may also provide access via automated teller machines, mail and mobile phones, though online banking is the dominant service model. By eliminating costs associated with bank branches, direct banks can make significant savings that they may pass on to clients via higher interest rates or lower service charges.

A direct bank is more than just online banking. The difference is that a bank's online banking service only caters to clients who have opened accounts or cards at that bank, but direct banking allows operators to reach out to any client even if the client doesn't have that bank's account.

The business model allows small banks to bypass their disadvantage of having a small branch network and helps them reach out to more clients. In addition, clients from direct banks are mostly young people, such as university students, who are Internet- and tech-savvy. Although they are not financially strong, these young people are future big clients.

Direct banks therefore are competitors to national players and help remove geographic restrictions for small banks.

China is a latecomer to the sector, but the emergence of direct banks marks a leap forward in creating a competitive banking market with the help of the Internet. This competition is good for the overall development of China's long-monopolized banking industry and is expected to intensify by the end of the year or early next year as more private banks are established.

To understand why direct banks inject competition into the market, one must see who is establishing these direct banks.

In September of last year, the Bank of Beijing opened the first direct bank in China. That was followed by more than 10 other lenders from Industrial Bank, Jiangsu Bank, Chongqing Bank and China Resources Bank of Zhuhai. All are commercial banks at the city or provincial level.

These direct banks offer an array of services such as credit lending, money transfers, deposits and wealth management for mostly individuals and small businesses.

In contrast, none of the Big Four national banks－Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China－have set up a direct bank.

For years, small banks were eager to increase their capital and client pools to break up the long-time monopoly of big players. When liquidity becomes tight in the capital market, small banks often have to rely on interbank borrowings from larger counterparts to stay afloat. To attract capital, small banks are always willing to raise their deposit rates to the upper end of the government-set band to attract capital, while big players usually keep their rates at a discount of 10 percent. But with a much smaller branch network, small banks are still minnows that can do little to change the industrial landscape until they find direct banks to be a possible game changer.

Last year, Internet companies, such as Alibaba, Baidu and Tencent, launched Internet financial projects. Among them, the most famous one is Yu'erbao, designed jointly by Alibaba and a fund company.

The money-market fund product gained in popularity quickly by taking advantage of Alibaba's large online user base.

Online financial products offered by Internet companies prompted a capital migration, which saw depositors moving their money from banks to Internet financial products. Traditional banks felt the pinch. Small banks were particularly hit hard as those products took a share from their already small money pool.

Competition breeds changes. That is why small banks acted swiftly this year to launch direct banking units, a form that offers an array of services that include online finance and traditional banking. In this sense, direct banks are a product of increased competition in the Chinese banking sector.

Large banks will have to change accordingly to cater to the market. If they stick to the old mode, their advantages may be gradually weakened by Internet companies, small banks and private banks.

The authors are analysts at Shanghai based Universal Consultancy. The views do not necessarily reflect those of China Daily.