Last month, China’s leaders revealed details of the nation’s 13th “five-year plan,” which is to guide the economy’s trajectory until 2020. Gone are the directives to expand industrial production at a breakneck pace that characterized previous five-year plans — now the focus is on achieving sustainable long-term growth, underpinned by domestic consumption, a stronger services sector, entrepreneurship and innovation.
The Internet — which already has more than 680 million active users in China — is to play a key role in facilitating this shift. In particular, online peer-to-peer (P2P) lending, a streamlined approach to credit allocation, might hold the key to expanding and deepening China’s financial sector, enabling firms to grow and innovate, and bolstering domestic consumption.
In online P2P lending, individual — and, lately, institutional — investors provide funds that can be lent out to individual borrowers, without involving a traditional financial intermediary. Loans can range from 100 yuan to 1 million yuan (US$15.6 to US$1.56 million), and target small and medium-sized enterprises (SMEs), as well as individual borrowers, that struggle to access credit through traditional institutions.
Over the past three years, China’s P2P lending sector has been growing at an astounding average annual rate of 245 percent, with its total value reaching 253 billion yuan last year.
Even so, P2P lending still accounts for just a small fraction of overall lending in China. Last year, total loans issued through peer-to-peer networks were equivalent to just 1.5 percent of the 15.1 trillion yuan in consumer loans issued by Chinese banks. Clearly, there is plenty more room for growth.
However, growth must be carefully managed. The factors that enable online P2P platforms to deliver loans quickly and broadly — that is, their reliance on consumer credit-rating databases, while eschewing collateral and guarantees — can generate risks.
The risks have already begun to materialize. According to P2P lending database Wangdaizhijia, since 2011 more than a third of registered platforms experienced serious problems. For example, investors reported difficulties withdrawing funds on more than 300 platforms and platform operators absconded with investors’ money on more than 300 others. For the industry as a whole, high-quality, easily accessible data remains difficult to come by.
Fortunately, these shortcomings can be overcome. Regulators can look to traditional bank lending to individuals and SMEs as they devise new measures to minimize risk in the P2P sector.
In a study of loan data from five Chinese banks, a team of researchers and I identified five factors that influence the emergence of non-performing loans. Some were fairly obvious: Larger loans and higher leverage ratios contribute to higher rates of non-performing loans. Other factors — such as the existence of guarantees or collateral, lending to small companies instead of company owners, and lending to borrowers who are geographically farther away — were less obvious.
The lessons are clear — Institutions should aim to issue a higher number of smaller loans to local individuals, while depending less on guarantees. To aid in this process, lending platforms need better channels for sharing credit and leveraging data, and they must build up identity verification systems. That would require coordination between the government and the private sector, as well as dedicated networks for sharing information.
Regulations also have to be improved in many areas. For example, all online P2P lending platforms, regardless of the scope of their business, should be required to register with regulators. They should also receive training, provided by a professional association for the sector, aimed at preventing money laundering and the financing of terrorism.
However, a thicket of regulations is unnecessary and should be avoided, as the systemic risks that P2P lending poses to the wider economy are small. Instead, regulators should adopt a flexible approach.
A tiered licensing system would work best to address the varying degrees of financial complexity and risk among platforms. Under this scenario, platforms that function as information intermediaries between borrowers and lenders, but are not directly involved in loan transactions, would be free from virtually all regulation and supervision.
Platforms that offer basic deposit and loan facilities should be classified as banks, whose transactions entail credit, liquidity and trading risks that merit prudential supervision. Nonetheless, it is important not to overburden these firms with complex capital-adequacy requirements that would impede their operational flexibility.
Finally, platforms with business models that involve higher degrees of financial complexity must be watched carefully, as they are the most likely to conduct proprietary trading without adequate expertise, or offer guaranteed returns without appropriate risk assessment and control.
P2P lending has its pitfalls, but the sector will undoubtedly continue to grow, fueled by those whose financing needs have been overlooked by banks. This will help to secure a major role for the sector in the Chinese economy.
Liu Mingkang, a former chairman of the Chinese Banking Regulatory Commission, is BCT distinguished research fellow at the Institute of Global Economics and Finance at the Chinese University of Hong Kong.
Copyright: Project Syndicate
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