With the explosive growth over the past seven years, China has become the biggest peer to peer (P2P) lending market in the world. After introducing the four stage evolution in the previous article “The Evolution of Peer to Peer Lending in China”, we will now share the trends we discovered in the development of P2P lending market in China.
Continuously Strong Growth Boosted by Increasing Demand
The main engine of China’s P2P lending market is strong demand for consumer loans and huge supply of individual investments. Primary parties of the P2P lending market are micro and small enterprises, as well as individuals.
Micro and small enterprises are usually scattered in location with frequent and urgent demand for loans but a lack of collateral. This increases the cost of lending for financial institutions because they have to exert more effort on small clients, resulting in limited motivation to lend to these enterprises.
The same problems exist for individual consumption or operation loans, including high cost, high risk and low efficiency. Even though banks and financial institutions would have much more bargaining power in such situations, they are reluctant to work on these businesses. This means that the potential for micro and small business financing and individual financing is huge. Only a few products, such as the “Business Loan” from Minsheng Bank, are developed for the relatively untouched market.
On the supply side, the middle to upper class has been growing, leading to increasing demand for wealth management. However, professional wealth management companies are constrained by minimum investment requirements and limited securitized products, which are not suitable to this group of investors.
According to the 2014 Chinese Mass Affluent Report published by Forbes China and CreditEase, private Chinese invested capital reached 94.1 trillion yuan (around 15.2 trillion USD) by the end of 2013, with an annual growth rate of 13.3%. The mass affluent population was 11.97 million by the end of 2013 and is expected to reach 14.01 million by the end of 2014. P2P market satisfies the investment needs for the mass affluent.
Shift from Individual Borrowers to Corporate Borrowers
Since 2012, most P2P lending platforms started to make loans to Micro, Small, and Medium Enterprises (MSME). The trend was more significant in 2013, when P2B platforms were established, solely providing loans to MSMEs. The amount of a single loan can reach millions of dollars. The growth rate for the business was significantly higher than industry average. Some big platforms started to get involved in corporate loans. Third party payment platforms and institutional investors also showed strong interest in this area.
Because of the high loan amount, P2B operating cost is spread, which makes it lower than loans to individuals. The P2B model requires stringent credit assessment, which helps P2P lending to get normalized.
Credit risk is the core risk of all lending services. Under the current situation in China, P2P platforms have to perform extensive research and due diligence, which incurs high operating cost. To reduce the cost, some new platforms segment the market and focus on a specific region or subindustry. With rich experience and knowledge about a specified group of borrowers, the platforms developed a better strategy in making loans to a group with even higher cost efficiency than traditional risk management. Some more developed segmented platforms are looking for merger opportunities to consolidate the rich resources they have. Therefore, we believe in 2014, M&A among P2P platforms or with informal financial institutions will start to increase the concentration of the industry.
Advancement of Credit Assessment and Formalization
To deal with credit risk and improve core business, leading P2P platforms will focus on the technology of credit analysis through diversifying sources of credit information, integrating credit data, automating credit assessment and strengthening risk control in every procedure. P2P platforms will be formalized as financial professionals and get the ability to design their own products. We see three possible disruptions moving forward: the formation of a third party credit rating agency, the integration of unrelated databases being used in the credit scoring process, and greater competition for talent from the large financial institutions which are already well entrenched.
Vertical and Horizontal Expansion of Business
Some platforms have already begun expanding vertically, getting involved in third party credit scoring, third party payment, etc. Other platforms are turning into links between fund borrowers and suppliers, not limited to P2P lending. They start to sell trust products, open the system to small loan companies and escrow companies to match these companies with potential borrowers. Some try to establish independent trading platforms for small loan companies to operate on their own. Others are getting into the equity crowdfunding market.
Increase in Institutional Investors
In 2013, groups of investors got hands on P2P lending. These investment groups focused on new platforms and cooperated with the suitable ones during the promotion period. They usually had bargaining power due to their large supply of funds. But the strategy of these groups of investors is fast-in fast-out, which usually has a negative impact on the platforms. Group investment becomes less active as the business model is then questioned by investors.
However, we believe it indicates the trend of institutional investors getting involved in P2P lending, which is the case in US. In Lending Club, institutional investors usually can get the high return projects, leaving limited projects for individual investors. Lending Club apologized for the issue and is taking steps to help individual investors bid for good projects. There may be institutional investors in China’s P2P lending platforms already, such as trusts or private equities.
In the near future, we will see China’s P2P market continue to grow, moving towards a more formalized and regulated phase. More demand is coming from micro corporate borrowers, while institutional investors may get into supplying funds. Big data and other advanced techniques are being adopted to increase efficiency of credit risk assessment. Segmentation and consolidation are moving together, generating a booming P2P market in China.
(Editors Note: This is the 2nd installment in a series of articles that will explore the fast evolving space of peer to peer lending in China. The first of the series was; The Evolution of Peer to Peer Lending in China)