Peer-to-Peer Lending in China

shanghaiIn performing our due diligence of smaller companies, we sometimes run across peer-to-peer lending (P2P lending). It’s a concept that wasn’t prevalent when we started in China in 2003, but it’s since become a significant source of financing for small companies who can’t obtain bank loans as banks tightened their credit policies and focused their lending efforts on larger companies and state-owned enterprises.

Peer-to-peer lending is a fast growing financial segment that first began in China in 2006. In P2P lending an intermediary, or microfinance company, connects lenders and borrowers for a fee, ranging from 1% to 4%. Lenders, seeking to loan small amounts of money, and achieve superior returns on their loans, are connected with people who are looking to borrow small amounts of capital. P2P lending is largely used by those who can’t obtain a bank loan, but don’t want to pay the exorbitant rates charged by shadow bankers.

Microcredit companies are not unique to China, and even exist in the U.S, Germany, and the United Kingdom, for example.  However, China provides a far greater opportunity for such lenders, as their interest rates average about 20%.  According to Simon Rabinovich of the Financial Times, China has 60 million micro-entrepreneurs in cities and 200 million rural poor who can take advantage of P2P lending. There are currently 200 P2P lending websites and 4,144 microfinance companies in China. Microfinance lending in 2012 amounted to 369 billion RMB, up 87% from 2011. Even though this is a huge sum, loans can be quite small, in many cases under $100 USD.

Unlike banks, a micro-lender’s loan is unsecured and the industry is unregulated by China’s Banking Regulatory Commission (CBRC). The reason for this is that the CBRC lacks authority over micro-lending platforms. In addition, the Supreme People’s Court in China has ruled that an intermediary, between a lender and borrower, is not responsible for a defaulted loan.

Borrowers who default can be taken to court by the lender, but a lawsuit is usually too time consuming and expensive given the amount borrowed. So far, defaults don’t seem to be widespread. CreditEase, the largest of the micro-lenders, with over 5,000 employees, estimates that only about 2% of the loans they arrange are overdue.

Part of the reason for this is that, in obtaining a loan, all prospective borrowers are screened and their credibility is checked, sometimes by reviewing utility and tax payment records. According to Li Xiaoxiao of MarketWatch, good credit risks include those who are members of the Communist Party, the well-educated, and blood donors!

But defaults inevitably happen. When they do, the primary weapon of the micro lender is the blacklist, whereby a borrower’s default is made public and their name is posted on the P2P site’s bad credit list. Generally, anyone who is delinquent for more than 30 days will have their name, cell number, China ID card details, and other personal information posted on the P2P website. This turns out to be a significant deterrent to many Chinese who don’t want their financial default to be publicized, which causes them to lose face.

Since most bank-lending in China is directed toward businesses controlled by the state and large to medium sized companies, small entrepreneurs have been forced to look elsewhere for capital. P2P lending fills an important niche between banks and shadow bankers, allowing small businesses and entrepreneurs to obtain un-securitized loans to grow their businesses.

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