Fintech Focus: Five things to know about online lending in China

China has seen explosive growth in online lending in recent years, with thousands of platforms springing up to serve a wave of new consumers eager to buy on credit. But risks have also exploded – from violent debt collection to ultra-high interest rates – and government regulators have followed with crackdowns.

Here are five things you need to know about how the fledgling industry has grown and what’s to come.

Why have online loans taken off in China?

In short, because the demand for credit far exceeds what traditional financial institutions are ready to offer. Low-income people find it difficult to obtain loans from the formal banking system. The growing consumer class is eager to splurge on luxury goods. Many small businesses do not have enough assets and collateral to obtain bank loans.

But traditional Chinese financial institutions have long been reluctant to meet growing demand due to a scarcity of credit information and the high cost of risk assessments. Alternative forms of financing have exploded, especially online. Last year, China’s Internet-connected population exceeded 770 million, according to data from China’s Internet Network Information Center, more than the entire population of Europe.

It is therefore not so surprising that China accounted for 85% of alternative finance worldwide in 2016, according to estimates by the Cambridge Center for Alternative Finance. The total amount of unsecured short-term loans offered by online lending platforms topped 1 trillion yuan ($151 billion) last year, according to statistics compiled by research firm Wangdaizhijia.

Several species roam the online lending zoo. Peer-to-peer (P2P) businesses provide an online platform that connects lenders, or investors, with borrowers. Microcredit companies lend directly to consumers, offering services similar to payday loans – small, short-term, unsecured loans. Online banks and consumer finance companies are also getting into the game.

What are the risks ?

Take your pick – high interest rates, excessive lending, “inappropriate” collection practices, privacy breaches and even fundraising fraud have all been highlighted by regulators.

A gaggle of unlicensed or unregistered P2P companies and microlenders have entered the industry, looking for easy profits. But as all loan sharks know, it’s risky to give unsecured loans to people who can’t get them from banks. Ultra-high interest rates are a means of hedging the high risk of default. If necessary, bad debts can also be sold to loan collection companies, who might be willing to use threatening or even violent methods. It has also been reported that some of these microloans were channeled into the real estate market, contributing to soaring house prices.

Loan renewal from one platform to pay loans from another has also become common. Some 2 million borrowers took out loans from more than one platform in the same month, according to an industry report released last year by China’s National Expert Committee on Security Technology. finance on the Internet. Half a million had taken out loans on more than 10 platforms in the same month.

How have regulators reacted?

Several new rules have been released in recent years to protect consumers against fundraising fraud and predatory lending, and to ensure that lenders have sufficient capital and do not take too much risk.

after the government reinforced regulations on P2P platforms in early 2016, the crackdown on unsecured short-term lending began in earnest last year. In late November, provincial governments were ordered to suspend licensing approvals for new online microcredit companies. A week later, the central bank and the banking watchdog published new rules banning unlicensed platforms and reiterating the 36% legal limit on the annual percentage rate (APR) – the total interest rate and fees charged. These rules covered both microlenders and P2P platforms that facilitate small loans.

How have the big online credit players coped?

Not too good. There was a surge of overseas listings last year by online lenders and P2P companies like China Rapid Finance Ltd., Qudian Inc., Hexindai and Ppdai. They caught the eye of investors — Qudian raised $900 million in its New York IPO, the largest ever listing for a Chinese fintech company — but November regulations hit these companies hardand their shares fell.

But big companies have the resources – such as access to finance, cost structure and staffing – to change the direction of their business. Qudian, for example, settles in providing financing services for budget car buyers.

And after?

Misbehaving online lenders in China have had their wrists slapped. But there is still plenty of room for growth in the industry. The millions of customers who want to access finance are going nowhere. The government is also keen to encourage consumption, as it moves away from an investment-driven growth model.

Some of the risks could be reduced with the country’s first centralized personal credit database, which will be operated by a new company set up in March by the National Internet Finance Association of China. This should help prevent consumers from borrowing from one platform to repay another without the knowledge of lenders. The database will focus on collecting data from outside traditional financial institutions to complement the central bank’s credit reporting platform and help online lenders better analyze consumer credit history before make loans.

Other types of data-driven lending could also allow the industry to trade risk more effectively. WeBank, which is backed by Tencent Holdings Ltd., has developed algorithms to quickly and automatically determine the creditworthiness of each user, and thus lend to individuals and businesses without requiring deposits or guarantees.

Contact journalist Ke Baili (gabriel@caixin.com)

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David A. Albanese