Despite risks, online lending ready to revamp China's financial sector

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THERE are two phenomena in China's financial market today: the lack of investment options and funding channels.

Investors are between a rock and a hard place. The Shanghai Composite Index has dropped by as much as 20 percent during the past year, banks' annual deposit rate is less than 1 percent, and property market is still expensive despite the government's effort in cooling down this sector.

As borrowers, banks are reluctant to lend money to persons with little creditworthiness, or to small- and medium-sized enterprises (as well as microenterprises) with no collateral. The export market continues to slow down, but borrowing demand does not. So what are the alternatives?

A new business model was introduced to the world in 2006 by Zopa, a British pioneer in online lending, or commonly known as peer-to-peer (P2P) lending. Simply put, through P2P, loans are arranged between borrowers and lenders without the middleman, which makes them cheaper to the borrower and more lucrative to the investor.

With today's technology, all of the transactions can be executed online, through internet. That is, borrowers and investors don't even need to meet face to face and have their business completed. Ever since Zopa made its debut, this new growth engine is widely accepted and adopted elsewhere, including China.

The beauty of online lending (and investment) is its simplicity. There are no complicated procedures and long waiting time like borrowing from banks, or complex investment instruments that investors find difficult to understand. The key factors that need to be known to both borrowers and lenders are: the price - a mutually agreed interest rate; the risk - the creditworthiness of the borrower; and the tenure - the duration of loan. There is no official figure for the number of online lending operators in the country, but an estimate of active lenders are over 100, with the leading top five operators already making profits.

Unregulated segment

Since this market segment is unregulated, these companies are in general startup, formed as an IT, consultant or investment entity. Similar to other countries, personal lending and borrowing is legal in China, which is what makes growth possible in this lending segment in the first place. Although non-bank operators such as microcredit and guarantee companies do cover this lending market which traditional banks have neglected, for example, individuals and enterprises without credit history or collateral. The P2P lending market provides an arena that matches funding supply and demand, with a convenience unmatched by other operators.

Similar to financial organizations, the success of online lenders depends on how well they manage risks, both internally and externally. Almost all of the P2P operators review the loans, through assessment of individual borrowers and subsequently provide a risk rating that matches the respective credentials, credit history, household income and other factors. Naturally, too many dishonest borrowers who don't pay back will certainly damage the lending site's reputation. Through word of mouth via internet, it won't take long before the poorly performing operators lose business credibility.

With an increasingly competitive environment in this new market, it is becoming a common practice that loan guarantee is part of the service. For example, the principal and interests are guaranteed by the P2P lending site as insurance for investors.

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