The Big and Scary Prize – Marketplace Lending in China
This is a two part investigation. Part two will be on Friday.
Big: a big and fast growing middle class and a banking sector that has been asleep at the switch on the consumer side; the idea of China as a consumer market is relatively new and Chinese banks are not known for being agile. Imagine the American market without Wells Fargo, JP Morgan Chase and Citi as competitors. According to Citi, 96% of e-commerce sales in China are done without a bank’s involvement.
Scary: just ask Travis Kalanick of Uber; the most full-steam ahead damn the torpedoes entrepreneur was beaten by Didi in China. His retreat will probably be a hugely profitable deal (like Yahoo and Alibaba) but it is still a retreat. It is really tough to compete in China. So, scary for Western firms. For Chinese firms, scary if you have to compete with BAT (Baidu Alibaba Tencent).
To understand where this puck is headed, we seek answers to the following 5 questions:
Will China MPL follow the Uber Didi trajectory?
How will global lenders get in on the action?
How is the progress from Wild West to Settler phase?
In Part 2:
Which Chinese Marketplace Lenders will emerge from consolidation?
What role will BAT (Baidu Alibaba TenCent) play?
Will China MPL follow the Uber Didi trajectory?
Trajectory: big Western firm spends a lot of money to get into the market and eventually cedes victory to a Chinese competitor and before retreating gets a big shareholding in the competitor that beat them.
You could argue either case:
Yes: look at the tribulations of other Western Internet firms in China. Google lost as did Facebook and Uber.
No: China has a lot at stake. If they have to trade off lower interest rates for consumers (benefitting hundreds of millions of Chinese) vs protecting a local firm, it will be a tough decision. Also, it is unclear why Didi beat Uber. Was this a level playing field where “the best man won” like on an English boarding school rugby pitch? Or was the referee biased to the local team? Baidu almost certainly won because the Chinese government wanted a search firm that was friendly to their interests. It is not clear if that is why Tencent won in messaging or why Didi won in car sharing. If it is a level playing field, a great Western entrepreneur can hire a great Chinese team to localise properly and can still win.
Western MPL has not yet made a serious crack at the China market; if you never attack you don’t need to retreat. It is hard to imagine the shareholders of Lending Club or Prosper backing a super expensive high risk entry into China – not after Uber got their head handed to them.
So, China MPL will NOT follow the Uber Didi trajectory, because that story will prevent any Western MPL from trying. The Uber Didi story has entrenched the view that you cannot win in China.
How will global lenders get in on the action?
China has a very high savings rate (30%), so local banks should have plenty of cash but most do not have the systems and processes to do consumer lending profitably at scale. So there is a window of opportunity for global lenders to get in on the action. They will do so when the Sherriff cleans out the bandits (see next section).
As the MPL market matures globally, we expect to see more platforms that allow a retail lender anywhere to choose which geographic market they want to lend into; for example, when a Chinese consumer can lend to a Swiss consumer and vice versa, MPL will have gone global and mainstream.
For example, Mintos connects investors with non-bank lenders from mutliple European countries.
Many consumer lenders tend to stick to their local market; over time we expect more will go where the risk adjusted returns are best – even if it looks “foreign” at first. For example, lending money at 26% on the P2P Lithuanian platform that shows us 4% default rates may look too exotic, but some savvy investors have already found this to be attractive.
We expect to see more of this cross border lending because MPL platform are competing with each other, margins narrowing and one avenue of growth will be by moving into other countries. There are still a lot of tax related issues that are unclear.
Most unclear is whether China will welcome cross border lending. This news about Yirendai’s parent Credit Ease investing in Prosper and Avant loans indicates financing flowing one way.
How is the progress from Wild West to Settler phase?
MPL in China is in the Wild West phase, with hundreds of marketplaces and lots of scams and very crude, violent debt collection practices. We know how this movie ends – the Sherriff rounds up the bad guys and the settlers move in and we get towns and cities and the big money is made.
Some progress is being made, some of it from the free market and some of it from the government.
“For thousands of years, debt collection in China has been a mafia business,” said Wen Yong, chief executive of Shenzhen-based ZZG360 (ZZG stands for Zhai Zong Guan which translates to “debt explorer”. ZZG360 list problem loans on MPL platforms and provide that data to debt collectors, which must agree to use legal, non-violent methods when recovering it.
The Government Regulators are also stepping up to the plate; the Sherriff has posted the new rules. Crowdfund Insider has a good report on the 12 commandments laid down in December 2015 by the China Banking Regulatory Commission (“CBRC”). Thou shalt not (my comments in italics):
- Use the platform for self-financing or for financing of related parties. (This stops the most egregious scams).
- Directly or indirectly accept and manage lender funds. (This is interesting. It prevents what in the West has become called Balance Sheet Alt Fi Lenders and it is unclear if that is a bad thing).
- Provide guarantees to lenders or promise guaranteed returns on principal and interest.
- Market or recommend loan investments to users that have not completed identification verification after registering on the platform
- Directly make loans to borrowers, unless stated otherwise by applicable laws and regulations
- Structure loans into investment products with liquidity timing that differs from the original loan term (“thou shalt not have have Asset Liability Mismatch” is another way of saying “thou shalt not have systemic risk”).
- Sell bank wealth management products, mutual funds, insurance annuities and other financial products (Hmm, so MPL can only be an exchange, China is banning the 20th century strategy of vertical integration).
- Unless stated otherwise by applicable laws and regulations, collaborate with other investment or brokerage businesses to bundle, sell or broker investment products (sounds like the sort of grey area that would make fortunes for lawyers and/or those with good connections).
- Provide false loan information or create unrealistic return expectations.
- Facilitate loans for the purpose of making investments in the stock market. (No borrower would offer this as a reason to get a loan, so this sounds like the Casablanca scene “I am shocked. Shocked!! to find that there is gambling going on”).
- Provide equity crowdfunding or project crowdfunding platform services. (Separation of asset classes by statute sounds like a hindrance to innovation).
- Other activities forbidden by applicable laws and regulations (legal catch all phrase).
This is a market without FICO that may invent a better alternative to FICO. That seems to be what ZZG360 is aiming for. The company is growing fast – with around 59 debt collection agencies and Rmb1.3bn ($195m) in debt on its platform. Like FICO, ZZG360 does not buy or sell debt. So it is not regulated, but by shining a data light on an opaque business it is part of the move from wild west to settler phase.
This clean-up phase also involves trading bad debt via online platforms. Companies with too much debt can sell unpaid accounts receivables or assets held as collateral in order to clean up their balance sheet. The banks have an unsustainable level of Non Performing Loans (NPL is officially 1.75%, but some analysts put the real figure as high as 15%). Internet Finance (the Chinese name for Fintech) may sort out this problem before the banks do.
On Friday, our investigation turns to Which Chinese MPL platforms will emerge from consolidation. Sign up to get our daily research delivered by email so you don’t miss this (link on top right of this site).
Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.
