China's Lending Crackdown Is Notable for Three Reasons
Policy makers from the People's Bank of China and the China Banking Regulatory Commission convened in Beijing on Nov. 23 to discuss new measures to crackdown on online consumer loan platforms, including those for payday loans and peer-to-peer lending. On the same day, Alibaba Group affiliate Ant Financial said it will enforce a cap of 24 percent on interest rates charged by lenders on its website, or 12 percentage points lower than current rates. The lenders affected by the new cap include Qudian, which had recently listed on the New York Stock Exchange.
Although the measures haven't been made public, our industry checks suggest three notable changes. First, the issuance of new licenses to online micro-loan platforms is being suspended, suggesting that regulators are scrutinizing online lending practices. Second, banks and bank-holding companies are being told not to buy loans underwritten by online platforms because such assets are deemed too risky. Third, turning the loans into securities will be forbidden because regulators believe securitization amplifies risks and gives investors less of an incentive to perform due diligence on the underlying assets.
The purpose of the latest round of tightening is clear: the online consumer micro-lending industry in China has grown too fast and regulators haven't been able to keep up. So-called P2P online lending platforms have mushroomed from fewer than 10 to more than 2,000 in just over seven years, but only a few hundred operate with government-issued permits.
Three high-profile micro-lending platforms with a combined stock market value of $16.9 billion have conducted initial public offerings in the U.S. since late October: Qudian, PPDAI Group and Jianpu Technology. The IPOs put online lending in the social media spotlight in China. Most social media narratives have negatively portrayed the companies as akin to loan sharks, catching the attention of policy makers.
Officials were already concerned that consumers are borrowing too much and fueling a bubble in the housing market, which the government is determined to cool down. The big jump in short-term consumer loans last quarter to 1.53 trillion yuan ($231.9 billion) from 524.7 billion yuan represented a 300 percent year-over-year increase, which contrasts with a much more moderate 10.3 percent year-over-year increase in retail sales, including autos. This discrepancy raised a number of questions as to where the borrowings are going.
As recently as this summer, Chinese regulators had started investigating whether consumer loans were being used to fund home purchases. In 2014, when Yirendai Ltd. -- China's first P2P lender -- was listed in the U.S., my firm's research verified that a number of loans it made for the stated purpose of home decoration, vacations or other short-term uses were, in fact, used to fund home purchases. In theory, borrowings are supposed to be placed directly in the accounts of service providers, but borrowers will sometimes strike deals with the service providers to get access to the money by offering kickbacks. Although online loans typically range from about $8 to $150,000 per transaction, more than half of borrowers take out loans from multiple platforms simultaneously, according to a Beijing News survey.
The P2P crackdown comes just after the conclusion of the 19th Communist Party Congress. With the central leadership sealed and the consolidation of power complete, the PBOC can afford to take more forceful action in addressing structural problems in the economy such as excess leverage, bad bank assets and shadow banking credit growth. Deleveraging inevitably slows demand growth, and consequently affects both capital expenditures and credit-dependent consumer demand, including demand for residential housing.
Regulatory changes aside, the viability of the P2P industry both inside and outside of China faces serious structural challenges as well as doubts from capital markets. The poor share price performance of Lending Club and On Deck Capital exemplify the struggles of even U.S. financial technology companies.
Unlike a bank, such borrower-lender matching agencies do not generate revenue from interest-rate spreads on the loans, but from origination and service fees. Once the agency originates a loan and receives its fees, it wants to sell the loan as quickly as possible. It is in the P2P platform’s best interest to originate the largest possible loan volume with little incentive to spend time and resources verifying the creditworthiness of borrowers. The credit risk gets passed on to the purchasers of the -- possibly securitized -- loans, who have no insight into the creditworthiness of the borrowers.
The principal-agent dilemma of the loan originator not properly vetting borrowers and passing on the credit risk to third parties led to the U.S. subprime mortgage crisis starting in 2007 and the subsequent European debt crisis in 2010-2011. Just as important, the misalignment of interest between lenders and P2P platforms is only worsened by asymmetric information, sometimes caused by lax due diligence and other times by actual fraud.
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