The rise and fall of P2P lending in China

When contemplating FinTech in China, Alibaba and Tencent – among the world’s largest FinTech disruptors – will most likely be at the forefront of discussions. With market capitalizations of around half a trillion US$, the two tech giants account for over 90% of mobile transactions in China (through Alipay and WeChat Pay). However, mobile payments constitute just one aspect of China’s booming FinTech industry. In this blog post, we will have a closer look at another significant, prosperous, and dynamic industry, which has recently experienced critical turbulence in China: The Peer-to-Peer (P2P) lending sector.

P2P lending, at scale

P2P lending is generally considered as a method of debt financing that directly connects borrowers, whether they are individuals or companies, with lenders. It cuts out the middle man (e.g. banks) and presents itself as an efficient form of alternative finance. It is worth mentioning that the size of China’s P2P industry is larger than that of the rest of the world combined, with outstanding loans of US$217.96BN.

The boom years

China’s online P2P lending industry grew rapidly between 2011 to 2015, with the number of P2P lenders growing from 50 to nearly 3,500 respectively.

Several factors contributed to the rapid rise of P2P lending in China:

• China was historically a cash heavy country and rather adverse to credit. The development of new payment methods (e.g. AliPay, WeChat Pay) has helped change the Chinese mindset and paved the way for the growth of the P2P lending sector.
• The initial absence of lending regulation sparked growth and encouraged firms to innovate and expand.
• Commercial banks in China have for a long time focused on servicing Chinese state-owned enterprises, leaving consumers and SMEs in the lurch. Addressing the growing financial needs of both segments, P2P lending companies have been successful in filling a gap in the market.
• The base interest rate used to be kept low by the government; P2P lending therefore appeared tempting and an easy investment alternative with loans promising returns of 8-12% or more, fuelling enthusiasm for P2P lending.

Reality check

Despite its significant success recently, not all is rosy in the Chinese P2P lending sector. Trouble started brewing in China back in 2016, when statistics released by the Chinese Banking Regulatory Commission showed that about 40% of P2P lending platforms were in fact Ponzi schemes. Consequently, this has forced authorities to tighten regulations with the introduction of over 100 new rules, gradually implemented in order to eliminate fraudulent or poor business practices that plagued the industry.

This triggered the shutdown of P2P lending platforms; over 900 closed by the end of 2016. For 2018, only 1,021 providers remained in place.

For this year, the government expects the number of P2P platforms to be around 50-200.

Source: Bloomberg News

Despite the challenging environment, some P2P lenders managed to perform well.  Lufax, for instance, has grown into one of the largest Chinese FinTech companies, with a valuation of US$38BN, 4.6 times larger than Adyen, the highest valued FinTech unicorn in Europe. Lufax’s success is partially down to its strict requirements for applicants, which has helped the FinTech maintain a lower bad debt rate (0.3% for Lufax compared to the industry average of 1%). Additionally, Lufax is also diversifying out of its core business into areas that successfully complement and add value to their primary activities such as wealth management. Following its success in its home market, the FinTech is now planning international expansion, having recently acquired a capital market securities license from the Monetary Authority of Singapore.

“Cross the river by feeling the stones” (摸着石头过河)

While regulatory concerns are the main obstacle in the Chinese P2P lending sector, it is claimed that in 2019 the industry might suffer a further blow due to macroeconomic challenges, such as the current trade war between China and the US, with a potential global financial crisis around the corner. In fact, Lufax and other lenders deciding to postpone their IPOs last year demonstrates the current uncertainty in the industry. However, these challenges are reminiscent of the Chinese proverb “Cross the river by feeling the stones” – allowing mistakes to a certain degree in the interest of long-term progress and innovation.

With further consolidation expected in the P2P lending industry, this is a great opportunity for the companies left in the game to spread across the pitch. Furthermore, efforts from Chinese authorities to weed out fraudulent actors and unsustainable businesses will strengthen the industry in the long run. In addition, the government’s recently launched social credit system, despite significant criticism from Western media, might help to reinforce the lending sector and be a driver for the industry in the future.