Risks, opportunities in China’s growing P2P lending market

In China, online peer-to-peer (P2P) lending has been growing rapidly since around 2010. If the country’s P2P lending industry can successfully control risk while capitalizing on innovation, it should help alleviate chronic funding difficulties of small and midsize enterprises.

Internet finance’s domain in China is expanding into P2P lending and crowdfunding against the backdrop of Yu’E Bao’s widespread popularity.

P2P lenders provide a platform for individuals to lend to and borrow from each other online.

Although an exact count of P2P lenders (platform providers) is unavailable, the People’s Bank of China (PBoC) reported that more than 350 were in existence as of the end of 2013.

According to the P2P portal site Wangdaizhijia, the number of P2P lenders at the end of June was 1,184, up from roughly 800 as of the end of 2013. The best known P2P lenders include Paipaidai, Lujinsuo and Yixin.

According to Wangdaizhijia, 189,000 P2P borrowers borrowed a total of about 81.8 billion yuan from 443,600 investors at an average interest rate of 20.17 percent in the first six months of 2014. P2P loans outstanding at the end of June totaled 47.7 billion yuan.

Online investment products that offer liberalized interest rates have become widely popular in the wake of last year’s Yu’E Bao boom. P2P lending is a key driver of market-led interest rate liberalization.

Recently, however, many P2P lenders are broadly gathering funding via the Internet and lending those funds to individuals or small businesses instead of merely serving as a platform to facilitate lending and borrowing between individuals.

Some are even ambitiously scaling up their operations through such means as telephone sales. P2P lenders are now competing for borrowers with incumbent microfinance companies.

Conversely, some P2P lenders have started to form alliances with microfinance companies in the aim of combining their microfinance partners’ lending know-how with a P2P funding model.

MIXED BAG OF RISKS, OPPORTUNITIES

The fact that P2P lending is basically unregulated in China has long been a concern.

Last year, as restrictions on bank lending to finance local government projects were tightened, funding for such projects started to flow through P2P channels to circumvent the restrictions. Such circumventive lending, one form of shadow banking, is a problem.

Additionally, some P2P lenders are essentially loan sharks that use the Internet to access funding. In 2014, in particular, an increasing number of P2P lenders have abruptly closed up shop and vanished after becoming unable to collect from borrowers amid China’s economic slowdown.

Egregious fraud has also been reported, including cases where P2P fraudsters absconded with investors’ money on the first day that they opened for business.

Some have questioned P2P lending’s legality, given that pooling and lending funds gathered through P2P channels is tantamount to gathering deposits from the public without a banking license.

Another point that has been raised is that providing principal guarantees to investors, as some P2P lenders do, normally requires regulatory authorities’ approval.

On the positive side, P2P lending has the potential to alleviate chronic funding difficulties of small and midsize enterprises. By using the Internet, P2P lenders can advantageously obtain funding on a large scale and at low cost.

If they adroitly pair this online funding model with credit screening and lending know-how, as some of them are already endeavoring to do by partnering with microfinance companies as mentioned above, they would be able to provide a new funding channel to small and midsize enterprises hitherto unable to borrow from banks.

REGULATION, INFRASTRUCTURE REQUIRED

Chinese financial regulators fully recognize P2P lending’s potential to benefit small and midsize enterprises. They are not inclined to categorically ban P2P lending just because it entails risk. In fact, the China Banking Regulatory Commission (CBRC) is researching how to rationally regulate P2P lending.

Recent developments in Internet finance have led to fragmentation of financial services hitherto vaguely regarded as banking services.

Regulations consequently need to be based on a functional classification of financial services instead of on whether they are provided online or through traditional channels.

Regulators are committed to fairness as a regulatory principle, implying that they intend to apply identical rules to online and offline financial services that are functionally equivalent.

Regulators must also ensure that new channels for lending to small and midsize enterprises take root.

Given that P2P lending’s risks are exacerbated by a complete absence of regulatory barriers to entry, regulators are likely to set market-entry standards, such as minimum capital requirements.

Other potential regulatory initiatives include a qualified investor program, which some P2P lenders have already voluntarily implemented, and mandatory reserves against loan losses and other risks.

In terms of infrastructure, the P2P lending industry needs to develop credit information systems because it serves borrowers that banks are loath to lend to.

China’s existing credit information services include the PBoC’s Credit Reference Center (CRC). CRC subsidiary Shanghai Credit Information Services, established in July 1999, has built a nationwide P2P credit information system, the Net Financial Credit System (NFCS).

The CRC and NFCS are independent of each other, but if they were to link up, credit information would become more readily available throughout China.

In sum, P2P lending in China is a mixed bag of risks and opportunities at present. The Chinese P2P lending industry is in its infancy, unregulated and without adequate infrastructure. How successfully the industry channels funding to small and midsize enterprises while keeping risks under control bears watching going forward.