P2P Companies: The Movers and Shakers of China’s Shadow Banking
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P2P Companies: The Movers and Shakers of China’s Shadow Banking

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Credit in China is like a leaky spigot–impossible to turn off all the way. When major banks were told to stop or slow lending this spring, shadow banking emerged to fill in the gaps.

P2P has become an emerging piece of the shadow banking puzzle. P2P companies, in this context, are online platforms that serve as credit matchmakers: they evaluate creditworthiness and bring together individual and business borrowers and interested lenders. The borrower signs an agreement with the individual lender, and the P2P firms pocket transaction fees.

P2P lending is good for both parties: borrowers without access to bank loans can get capital, and lenders can receive much higher returns than they would via other avenues. Caixin cites an October 2013 report by National Business Daily and wangdaizhijia.com which found that 87 percent of P2P investors received yields higher than 18 percent.

P2P lending represents a small sliver of shadow banking, though it’s growing rapidly. Credit Suisse estimates the total value of shadow banking is 22.8 trillion yuan (approx. $3.7 trillion), and Caixin estimates that P2P lending comprises 60 billion yuan of that figure.

The first P2P lender in China was PPDai.com and CreditEase has emerged as one of the leaders, with estimated monthly loans of 100 million yuan, as of 2011, according to Caixin.

So who are these borrowers and lenders? The borrowers are individuals or businesses that have found it otherwise impossible to find credit. In many cases, this is because state-owned banks direct much of their funds to state-owned enterprises (SOEs), despite recent pushes to fund small and medium-sized private enterprises. Additionally, after what many saw to be an emerging bubble earlier this year, the central government slammed the brakes on available credit. 

The lenders are looking for better returns than are available nearly anywhere else, due to extremely low savings interest rates, volatile stock markets, and crackdowns on real estate investment. Interestingly enough, many are middle-class Chinese. The National Business Daily and wangdaizhijia.com report found that 60 percent of lenders make less than 100,000 yuan (approximately US$16,000) a year.  

It’s not all smooth sailing, however. Or rather, it’s best not to expect smooth sailing in the future. The China Banking Regulatory Commission issued a risk notice for the sector in August 2011, pointing out a number of structural issues. Many P2P companies guarantee loans, and there is concern that companies could default on these loans. They are allowed to guarantee up to 10 times their capital, but Caixin quoted Xu Jianwen, Renrenmoney.com’s CEO, as saying that “most” P2P companies have “far exceeded that limit.”

There is also concern that the lending creates continued investment in overheated sectors, exacerbating existing economic problems. 

As is wont to happen, the industry has also diversified into other investment products, such as loan packaging (creating wealth management products). As Caixin notes, “many such websites in the country have taken on businesses they are not allowed to operate, such as packaging loans into wealth management products that investors are very willing to snap up, soliciting deposits directly or in disguised form from the public, and providing unrealistic loan guarantees.” There is also the issue of loan maturity mismatches within these wealth management products: short-term funds are invested in long-term projects, meaning the investors earn their returns before the project legitimately does so.

Future regulation of the sector is murky: it is unclear which branch or department is responsible for monitoring these types of websites. Caixin observes: “if the authorities decide to group P2P lending websites under asset securitization institutions, as in the United States… the CSRC would be responsible for regulating them.” It’s worth noting that some companies are taking the initiative to strengthen themselves by working with licensed loan guarantee companies.

Shadow banking and P2P lending platforms are serving an important function in the economy: giving individuals and small businesses access to credit. However, the sectors are also wildly unregulated and failures within these sectors could be detrimental to the economy. Only time will tell whether they have a net positive or negative effect on China’s financial system.

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Tom F
October 20, 2013 at 08:19

@Eve Cary – "Shadow banking and P2P lending platforms are serving an important function in the economy: giving individuals and small businesses access to credit"

The quoted sentence just about sums it up from what I hear. Chinese citizens from all demographics are prodigious savers, and the shadow banking world is just one of many channels that the savings end up in. 

In Singapore, New Zealand and Australia, Chinese have cleaned up the premium properties stocks and despite this being a work in progress, premium Auckland property prices are rumoured to have appreciated over 20% year on year for the last 5 years. Imagine the world turmoils when this tap is turned off, it would make the GFC look like a picnic in the park.

Sure, this is a structural problem the US would like to have (ie excess capital) but it has no predictable trajectory and one that is going to dictate world affairs for years to come. When a centrally controlled government (with the iron grip reputation of the CCP) 'gives up' (or ignores) one of the most important aspect of financial regulation (ie prudential regulation and licensing), it highlights just how crucial shadow banking is to the Chinese economy and social stability.

When you consider that a large part of the funds flowing through the shadow banking system actually comes from legitimate sources (eg state bank lend to SOE, SOE 'improves' asset ratio and on-lends to non-SOE, who then on-lends to man on street….), and state also lend to foreign nations (eg the huge holding of US treasury bonds), you know China and its shadow banking system is very much a part of the global financial system. Tightly woven, and pervasive.

On the other hand, the US, the most powerful nation on earth is playing politics with its own financial wellbeing and that of the rest of the world, over a piece of healthcare regulation that is purely a function of services delivery efficiency. You know it's it's an 'efficiency' thing when the front page of the New York Post carry a story on a rich doctor's kid rather than say the impending debt ceiling reset, ie you know you have a problem when your doctors get paid so much that their kids has 'rich girl' issues with the rest of society and it lands on the front page of the New York Post.

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