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What's the Future of China's Online Peer-to-Peer Lending?
   2015-04-14 15:21:51    CRIENGLISH.com      Web Editor: Xie Tingting

By Zhao Yang (About the author)

As China pushes its economic restructuring, small and medium enterprises (SMEs) have taken on new prominence. Already responsible for 80 percent of the new jobs being created, the government is hoping that these enterprises will be the keys to a more efficient, innovative and entrepreneurial future. But, those SMEs have faced daunting obstacles in their access to capital.

The P2P Issue

China's financial sector, which relied heavily on State Owned Enterprises (SOEs) and local government borrowing, is reluctant to deal with the smaller loan sizes, processing and risk issues associated with SMEs loans. This has led to the rapid growth of China's shadow banking sector, of which P2P lending is one component.

In terms of SMEs financing, the government is pursuing a multipronged approach. This includes new special purpose banks; in part to prod the larger banks to move more quickly and also to see if more efficient and responsive financing approaches can be developed. The approach also includes more regulation of the under-regulated shadow banking sector. Meanwhile, as the National Development and Reform Commission (NDRC) ponders the question of how to balance the financial risks and the needs of SMEs, media salvos are being fired on both sides.

One major salvo was fired last week by Dagong Global, China's only independent domestic ratings agency. Dagong Global said that of the 1,587 P2P platforms that they monitor, 393 were on their blacklist and an additional 668 were considered "risky" - a staggering percentage of active peer lenders in the largest direct lending market in the world. Dagong's warnings indicated that more than half of the P2P companies have problems with unclear disclosure of information, insufficient risk controls and solvency issues. This has led some to speculate that China's P2P lenders could be facing losses of 100 billion yuan - approximately 16 billion USD.

P2P lenders and industry groups responded with their own salvos, a "don't throw the baby out with the bathwater" response. They emphasized the importance P2P platforms play in the current financing of SMEs, quibbling with Dagong's use of disclosures, rather than performance, to rate companies, hinting that drastic actions could drive smaller P2P players underground.

One caveat to that mentioned above - the larger more sophisticated P2P platforms have different interests compared to their smaller peers, especially if new capital requirements push the less well funded players out of the market or force them to merge.

A History of P2P Lending

In February 2005, the first P2P lending platform was started in England and spread quickly around the world. An off-shoot of the micro-lending/finance idea, it offered lenders higher returns, and borrowers lower costs; substantially better than either could get from a bank. Loans from family and friends have been a traditional part of Chinese business practices for centuries; blood or village relationships coupled with the concepts of face and honor made them relatively low risk loan arrangements. The idea of borrowing from individuals was thus very well established; the major defining difference today is that you don't know the person/company you are lending to and they don't know you.

These factors created a fertile field for the growth of P2P lending in China. In the fourth quarter of 2014, the P2P lending market handled 75 billion yuan (12 billion USD) in transaction volume in China, up 29.5 percent from the previous quarter.

But risks in the sector have also grown. Of the 1,936 P2P platforms operating in China as of the end of February 2015, 56 were "problem platforms", which experienced cash problems, shut down or saw their owners vanish. In 2014, a total of 273 P2P platforms had similar issues, most of whom were located in Beijing, Shanghai and south China's Guangdong Province.

The Actions of Regulators

China currently lacks clear-cut rules governing online financial services. The China Banking Regulatory Commission (CBRC) bans P2P lending companies from raising funds or providing guaranteed services and products to borrowers.

In assessing its next moves, China's economic regulator, the NDRC has looked at P2P lending markets, like those in the UK, which have managed to create stable returns for the lenders, while allowing borrowers access to the capital they need. The UK model involves more oversight and guarantees; but there is some dispute as to whether the NDRC will adopt portions or the whole system. Readers should note that elsewhere in the world P2P lending is having regulatory and return issues.

According to some officials with knowledge of the matter, the CBRC is considering a minimum capital requirement of 30 million yuan for online P2P businesses; limiting loan leverage to 10 times the P2P lender's registered capital. It is expected that the changes will take effect in the second half of this year.

The next question is: What else should the government be doing in this sector?

P2P lending platforms currently serve as matchmakers for cash-hungry businesses and cash-rich investors. Most P2P loans involve less than 100,000 yuan to individuals and small businesses at an annualized borrowing cost of about 20 percent. This is a market which is currently woefully underserved. While innovative banking and finance initiatives, like the e-commerce banks being started by Alibaba, Tencent and their partners, are on the horizon, they are not in a position to take up the slack created by a crackdown on P2P lenders.

Looking at the industry, there is little doubt that the government will be putting more emphasis on capital requirements and disclosure. And when the new rules come out, they will set off a round of mergers, as P2P lender's band together to reach the necessary financial requirements.

Like most of the efforts China is making to reform the economy, this will involve some pain but hopefully more gain. The pain will come as increased regulation and capital requirements set off a merger mania which will force P2P lenders to look critically at one another. Many will not pass the test and there will be losses, but the sector will emerge stronger. The potential downside: It might cost the sector in terms of innovation, as barriers to entry will be higher. But overall, individual investors will be better protected.

In terms of Dagong, at a time when many have doubts about the big western ratings agencies, their willingness to tell it like it is points to a refreshing approach to the future of China's financial markets.


About the Author

Zhao Yang hosts a China Radio International business flagship program Biz Today. Before that, she has been a financial reporter for CRI's London correspondent bureau. She was actively involved in reporting the financial market in the city of London, and the Chinese economy as well.


The opinions expressed here are only personal, and do not necessarily represent CRI's official policy.

Read all opinion stories by Zhao Yang

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