Since November 2017, China’s financial regulators have imposed a series of restrictive rules on the country’s rampant online micro-lending industry. The new rules allow only licensed lenders to issue credits, cap interest rates, and limit the geographical areas they’re allowed to conduct the lending business. I’ll briefly share my views to interpret these regulatory moves and their implications for a fast-growing consumer credit sector in China.
A brief history of online micro-lending in China
The origin of China’s online lending can be traced back to the beginning of Alibaba’s micro-credit business around 2010. Back then, as more and more merchants were joining the wave of the fast-growing e-commerce industry in China, there was an increase in their need for financial services such as loans. However, due to the lack of credit history, it was very difficult and expensive for these merchants, usually micro-entrepreneurs or small businesses, to obtain credits from the traditional banking sector.
Get a banking license from the central bank was close to impossible for Alibaba. So instead, it turned to local regulators that were authorized to issue a license called “Micro-Lender License”. In 2011, the municipal government of Chongqing (a major city in southwest China) issued an unprecedented “Online Micro-Lender License” to Alibaba. While the conventional micro lender license only permitted giving out loans within a certain geographical area, the online micro-lending license had no such restrictions.
These online micro-lender licenses quickly surged in demand. There are two reasons for this phenomenon: First, there is a huge credit gap in China for small businesses and individuals not met by brick-and-mortar banks. Technological innovations e.g. in online payments can create access to this lucrative market. Second, applying for a formal banking license was getting very difficult as financial regulators tightening supervision on traditional financial institutions.
However, risks emerged as more and more online lenders entered the market. There were no unified standards for the requirements of obtaining the online lender license. Quality and credibility of these online lending platforms were not guaranteed. Not only that, it was inclined to corruption and moral hazard as companies bribed officials for licenses. Furthermore, some fintech companies that were only supposed to serve as the information intermediary platform between banks and borrowers, have started to function as guarantees providing credit intermediary capabilities (partly because the banks requested them to do so in order to reduce their own risks). However, credit risks of these platforms accumulated.
The role of cash loans in the digital era
Our research shows that cash loans in China are usually unsecured, short-term credit within 12 months’ term and below the amount of 5000 yuan (approx. 760 US dollar). Most of them are paid back within one month. The concept is similar to payday loans in Western countries.
An important reason for the rise of cash loans in China is a large number of Chinese do not have credit cards. It is a drawback of China’s financial inclusion. Now this demand is met by cash loans. In a way, cash loans play a similar role to credit cards for millions of Chinese who are in need of credit services.
The evolvement of cash loans is associated with the fast adoption of e-commerce and digital payment in China. Around 2014 and 2015, JD.com and Alibaba, who run the two largest e-commerce platforms in China, started to offer their consumers the options to shop on credit through their corresponding financial arms - Ant Finance and JD Finance. It was an important strategic move for the two tech giants, because they started to gather more and more data on their consumers – what they buy, how much they buy, and when they pay back. Consumers, on the other hand, began to build up their virtual credit scores with the company as they shop online. Supported by this development, subsequently in 2015 and 2016, Ant Finance and JD Finance launched their online consumer loan services which are called Jiebei (meaning Just Borrow) and JD Jintiao (White Tape, which is a Chines connotation for IOU). A prerequisite of applying for the loans is the borrower needs to have passed a minimum virtual credit score threshold on Alibaba or JD.com
Another important factor is the increase in smartphones users in China beginning around 2014, the same period as the uptake of digital finance. With smartphones people can save and spend money conveniently with their mobile wallets. These transactions produce data which provides the basis for establishing a personal credit system. This means that migrant workers and people living in remote areas, who are not covered by the traditional credit system, can also start to build their personal credit profile with their mobile phones. It has significant implications.
I believe online micro-lending, or cash loans play an important role in improving China’s personal credit information system. On the other hand, the development of cash loans and micro-finance also relies on a robust personal credit system, which enables these products to break the restrictions of traditional loans in requiring guarantees. Recently, the National Internet Finance Society of China (China's online finance regulator) announced the plan of launching a personal credit information platform driven by big data technology to serve online lending firms. The system is meant to fill the gap of the personal credit system, which is of great significance to the future of China's financial services industry.
Legislation on micro-credit lending interest rates
According to the stipulation and the interpretation by the Supreme People's Court, loan interest rate under 24% is protected by laws. For interest rate between 24% and 36%, the excessing part is neither protected nor banned. If interest rate is higher than 36%, the lending contract is invalid.
In accordance with the contract law, an intermediary may charge “a certain amount of remuneration”. This in fact affirms the legality of service fees charges and provides the legal basis for separate calculation of service charges and interest rates.
When it comes to the legitimacy of interest rates, I think that the standards need to be differentiated. According to our research, the general acquisition costs per customer for micro-lending platforms is about 50 yuan (7.7 US dollar). If this cost is accounted for into interest, the annual interest rate will be very high considering the lending period is usually short. So the 36% cutoff, in my opinion, is not reasonable.
I think there are two potential solutions to regulate interest rates: We can take out the service charge of micro-lending platforms (based on Article No. 426 of Contract Law) when calculating their interest rate. Or, regulators can reexamine the restrictions of 36% by allowing qualified fintech companies to run their business within a controlled environment (e.g. learning from UK’s Regulatory Sandbox). In this way, we can set up the thresholds, time limits and clear selection mechanism to allow innovations to develop, while protecting the consumers.
Further Regulatory Recommendations
Vice Dean of Law School of Renmin University of China; Director of Centre for Fintech and Internet Security. Professor Yang was a key member of the task force that contributed to the revision of China’s Anti-Trust Law, with a focus on e-commerce regulations.
This article is a summary of a public lecture of “FinTech 20 Series” Global FinTech Lab co-hosted with the FinTech Research Center of Renmin University of China International Monetary Institute. The FinTech 20 Public Lectures are a series of public lectures featuring industry leaders, entrepreneurs and academics in China’s FinTech sector.