How China is pioneering alternative finance and P2P lending – an analysis of the first ever Asia-Pacific industry report
The Asia-Pacific alternative finance market grew 323 per cent last year, to $102.8bn. China was responsible for 99 per cent of that, with four-fold growth to $101.7bn in 2015. Yesterday, the first regional report, Harnessing Potential, was released by Judge Business School and the University of Sydney. I spoke to co-author Bryan Zhang of the Cambridge Centre for Alternative Finance to tease out some of its most interesting findings.
The report, which is the first to benchmark China’s market using a set of comparable international standards, confirms that it is by far the largest alt fi market in the world. P2P lending is the biggest market segment, with consumer lending accounting for $52bn and business lending $40bn (equity-based crowdfunding is not yet legalised in mainland China, although draft rules were released last year). This is still minute compared to the total volume of bank lending in China – household deposits at the end of 2015 were equivalent to $8.8 trillion, to put it into perspective. But it is still widespread and, certainly if you compare to India, a comparable country in terms of population, alt fi has taken a strong hold in China.
The first reason for this is the size of China’s economy, which has meant strong demand for more flexible credit from SMEs and individuals, and an increasing number of retail investors looking for returns above bank deposit rates. The second is down to the extent of internet and smartphone penetration. “Lots of platforms were built with a mobile interface and plug into social media. In terms of products, this is a market that’s considerably more advanced than the UK or US,” says Zhang. Moreover, the level of competition between platforms is so high that innovation is constantly advancing.
The third reason for such rapid growth is that alt fi in China has “been mostly unrestricted and unchecked” until recent guidelines from regulators, which also accounts for the other side of the market’s story: that of very poor due diligence, risk models, credit analysis and underwriting practices. While there are some admirable platforms out there – Zhang picks out Jimubox, which sends underwriters out on site and uses photos and GPS technology to verify assets – numerous investors have had their fingers burnt by Ponzi schemes promising unlikely returns. “We’ve already seen a lot of platforms collapse because of fraud and malpractice. Lots have no credit risk control mechanisms at all, and their ability to control risk is a huge challenge. We don’t know the exact default rates, but they are likely much higher than in the UK and US.”
Building to last
And this illustrates a crucial point about the future of alt fi in China: that growth rates will not last. Imminent regulations around platform practice and payments systems will to some extent neuter the extreme boom and bust of the current market. There will also be rules around what can be facilitated without bank involvement, and the outlawing of capital pools will restrict platforms evolving towards asset management.
Elsewhere in the region, growth is also impressive. Excluding China, volumes grew 313 per cent to $1.12bn in 2015. In per-capita terms, New Zealand has the second-largest alt fi market, at $59.37. This, the report says, is likely down to a carefully considered regulatory regime. “The authorities were early movers and really spent time creating a bespoke regime for equity crowdfunding. That’s in stark contrast to Australia, which is not really punching above its weight. Up until this year, equity crowdfunding was illegal there,” explains Zhang.
Yet there are some interesting reasons why Australia is more constrained than other developed nations. “Australia’s economy has been mostly sheltered from the financial crisis – it was never in terrible shape when others were, and there was no big decline in bank lending and VC funding. As a result, there is no institutional distrust of banks – the economic and cultural reasons for excitement around alt fi over here simply aren’t as present there,” says Zhang.
In contrast, lending participation in China is predominantly retail, with institutional funding remaining very low (10 per cent, rather than the 63 per cent elsewhere). And yet institutional ownership is very high. Fifteen per cent of platforms are owned by e-commerce or VC firms, and 23 per cent are bank-owned. Across the rest of Asia, that institutional ownership figure is just 6 per cent. “This is a new channel of shadow banking,” says Zhang.
And the e-commerce interest – which includes giants like Alibaba and JD.com – is fast demonstrating how a challenge (in the shape of poor credit analysis) can be turned into opportunity. “China lacks the well-developed credit systems we’re used to,” says Zhang. “That’s why we’re seeing platforms backed by e-commerce firms using people’s transaction data to verify creditworthiness.” Meanwhile, other platforms are turning to social media for behavioural indications around credit analysis. One platform even forces borrowers to link to a social media account, with late payments and defaults broadcast to friends and followers.
In China’s case, the challenge of nurturing the industry sustainably remains acute. But despite consumer protection issues, in the face of a booming innovative finance market, platforms are creating other tech-enabled products that could enable them to leapfrog more robust markets – and in more than just alt fi.