Does the Chinese online lending crisis represent an opportunity for global fintech?
Phil Toth calls on fintech firms to seize the Chinese opportunity.
The recent upheaval in the Chinese alternative lending industry is of paramount importance to alternative lenders and fintech companies worldwide as China – not the United States or Europe – is the world’s largest online lending market. It isn’t even close! The Brookings Institute estimates China accounts for a staggering 75 per cent of the total world market. What makes the market so large and how might an enterprising company benefit from the current crises?
A population willing to embrace a digital lifestyle
The pent-up demand for alternative finance would never been realized if the 750 million plus Chinese internet users were not ready for digital financial services. Behemoth conglomerates including Alibaba and Tencent made that possible using their gigantic online marketplaces and social media platforms to promote digital transactions.
Alipay (Ant Financial), a part of Alibaba, started to establish trust for Alibaba’s e-commerce platform. With Alipay, users may obtain consumer credit or loans often unavailable via banks. Alipay works for offline or online purchases, particularly on Alibaba's e-commerce websites. There are an estimated 520 million active users on the platform.
Perhaps even more profound is Tencent’s WeChat and WeChat Pay. WeChat Pay is the payment arm of Tencent, within the WeChat ap. The app gives WeChat users the ability to send money to one another, with or without the use of a bank account. WeChat Pay can also be used offline and online; the latter frequently used to purchase goods promoted by the company. There are an estimated 600 million monthly active users.
A large underbanked population
An estimated 50 per cent of the Chinese population has a disposable income less than $15,000. Of that, a low percentage meets a threshold of approximately $7,500 for wealth management products. This leaves a vast pool of idle savings eager for returns. Technology platforms offer an attractive outlet by their simplicity and ubiquity.
Similarly, many consumers and small businesses find it difficult obtaining loans from China’s traditional financial sector – namely, from banks. The four largest banks - Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China and Bank of China (all over $2 trillion in assets) focus mostly on State-owned-enterprises (“SOEs”) and larger businesses. In the past, that pushed individuals and small-to-medium businesses to borrow from unregulated entities at very high interest rates. With the advent of peer-to-peer (P2P) lending companies like Yirendai, Lufax and others, smaller borrowers with little to no collateral have found themselves able to borrow for the first time.
Need for better risk management
Rapid expansion of credit products offered to investors leaves elderly and non-educated citizens attracted by “high yields” vulnerable. These unsophisticated investors often expect guarantees such as those offered by Lufax – a division of Ping An (one of China’s largest insurance companies). Lufax uses Ping An’s balance sheet to guarantee its loans. Not all platforms have the same security or risk pricing services as Lufax. In fact, several platforms have not only failed to perform due diligence, they created fraudulent portfolios causing more than one million people to lose money.
There is a need for better consumer credit information (only 25 per cent of Chinese people have a credit history versus 90 per cent in the United States), risk-weighted pricing and fraud detection. Enterprising risk analytics, KYC, compliance and surveillance companies should view this as a tremendous opportunity.
A regulatory authority seeking answers
Responding to unsavory practices, what started as government support turned into interference vis-à-vis licensing requirements, interest caps, and shutdowns. The first step was suspending approval for new internet micro-lenders. Moreover, lenders no longer lend to customers with no income and total (all-in) interest rates must fall below a legal rate an annual rate of 36 per cent. Banks may no longer fund unlicensed institutions and extensions may be limited to a maximum of two times.
Stricter rules forced hundreds of companies out-of-business reducing the number of platforms from roughly 3,000 to 1,500 or fewer. It’s difficult what to make of this other than the government is trying to reign in lending and improve credit quality. Expect consolidation to continue as the new policies support economies-of-scale offered by the larger firms favored by the government.
Venture capital and banks continue to invest
Despite setbacks, venture capital firms continue to pour large sums money into the space. Investment in Chinese fintech strengthened further in the first half of 2018. In addition to Ant Financial’s $13 billion deal there were four other $100m+ deals this year – $290m to Dianrong, $160m to WeCash, $130m to Meili Jinrong and $100m to Tiantian Paiche.
Banks also continue to pursue digital transformation strategies. They have invested in a myriad of areas, including blockchain, big data and AI. It makes sense as Chinese banks have considerably higher margins than EU or US banks and can afford such investments. Higher margins allow Chinese banks to invest in technology and offer low-cost or free services to penetrate new markets.
Is this the opportunity of a life time?
Mobile banking technology not only disrupts financial services but the entire e-commerce supply chain. In that area, Chinese firms are far ahead. At the same time, Chinese companies can learn risk management, capital markets diversification and credit from Western firms. We saw in recent years many Chinese companies listing on the US Exchanges to diversify funding and improve reporting. They may also consider tie-ups with American or European firms reaching new markets much like Alipay, WeChat and others are doing in SE Asia.
Companies fusing the best practices of Chinese and Western financial services firms have the potential to become global household names with nigh unlimited potential. Think JP Morgan, Amazon, Facebook and Apple all rolled into one!