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.