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This article was first published in the February 2016 China edition of Accounting and Business magazine.

China’s peer-to-peer lending market is the largest in the world. Although there is currently no verifiable data on volume, it could be as high as US$20bn-US$40bn based on news reports.

Growth has been rapid, driven by the supply of funds from retail investors and demand for access from the owners of small and micro businesses and private individuals. Would-be borrowers can turn to a range of peer-to-peer lending providers in China. Although there are relatively few dedicated online technology providers, a large number of hybrid wealth management companies and informal banks have entered the sector, operating a range of models (see box).

As estimated in a new ACCA study, business borrowers – mostly owners of small and micro businesses – could account for up to 40% of peer-to-peer borrowers in China. The research report, The rise of peer-to-peer lending in China: An overview and survey case study, draws on interviews with lending providers and an online survey of 935 borrowers and lenders from China’s first online direct peer-to-peer lending company, Paipaidai. The research was undertaken by Luke Deer, a post-doctoral research associate at the University of Sydney and the University of Cambridge; Jackson Mi, an assistant professor at the Shanghai Maritime University; and Yu Yuxin, a lecturer at Shanghai International Studies University.

‘The rapid growth of China’s peer-to-peer lending and wider finance sector has gained a lot of attention in China, but many people remain unsure of the benefits and risks of these new financing models,’ says Deer. ‘We hope this study contributes to understanding of peer-to-peer lending in China, including its role in increasing access to much needed finance for SMEs and consumers.’

Low business revenue

The online survey produced some intriguing findings. Around 10% of respondents said they were borrowing to finance their business. Most borrowers reported very low business revenue for their most recent complete financial year: 45% reported earnings of RMB20,000 or less, so these could perhaps be side businesses, with the owners having other sources of income. At the other end of the scale, 14% reported earnings in the range of RMB100,000 to RMB500,000.

Asked why they needed the loans, the most common reason given by business borrowers (65%) was to meet daily short-term cashflow needs. Most needed their loan for less than 12 months (87%), with the largest share (39%) seeking loans for three to six months. They were typically paying interest at a rate of between 8% and 12%, and the largest group (36%) were borrowing at the RMB3,000 to RMB5,000 range. Asked why they decided to use an online provider such as Paipaidai, the vast majority of business borrowers surveyed cited the low threshold and easy audit process (87%). Most business borrowers (73%) said they had no previous experience of borrowing from other financial institutions but most had some form of trade credit line.

Business borrowers were asked what factors they thought could lower their Paipaidai loan interest rate. A majority identified good loan payment transactions on the platform (87%); more detailed business operating information, such as their transaction history on the business-to-consumer online trading platform Taobao (70%); and detailed personal or business credit reports from the People’s Bank of China (57%).

The survey included a small number of respondents who were both borrowers and lenders; most of these had their own enterprises. Among this group, the most common reason for borrowing was to accumulate credit worthiness (77%). Among individual (non-business) borrowers, the most popular main ‘loan use’ identified was again to accumulate credit worthiness (51%). The report authors consider this to be a surprising response, noting that it applies to borrowers at all levels of income and across the range of interest rates being paid. They therefore suggest that, in the absence of widely accessible formal credit sources in China, individual borrowers are prepared to pay high transaction costs in order to secure better financing terms in the future.

This is particularly relevant in the context of peer-to-peer lending, which is often offered on an unsecured basis and therefore relies on trust generated through intangible collateral, mostly in the form of reputational capital. It may be that borrowers in China see repeated use of peer-to-peer borrowing as a way to accumulate a favourable credit history by creating a record of loan repayments.

Credit rating concern

Their expectations are supported by the responses of individual lenders when asked about the factors they considered when making their lending bids on the Paipaidai platform. The borrower’s credit rating was identified by 72%, a factor having equal popularity with Paipaidai’s loan security guarantee (72%).

‘Peer-to-peer lending has enabled many thousands of small Chinese businesses and individuals, who would normally find it impossible to access finance, to fund their business activities and generate more economic activity,’ says Rosana Mirkovic, head of SME policy at ACCA. ‘With this becoming an ever more important sector, there is a need for policymakers, regulators and bodies such as ACCA to ensure there is further reliable data on the development and outcomes of this form of finance and help to identify “best practice” for regulating new alternative financial services for individuals and SMEs around the world in future.’

The evolution of China’s peer-to-peer lending market continues. After allowing some years of rapid growth in this and other forms of internet finance, China’s central government introduced a broad internet finance ‘guidance’ policy framework in July 2015. This encourages the growth and development of internet finance, including peer-to-peer lending and equity crowdfunding, while introducing relatively light regulation. Lending providers must now hold borrower and lender funds in custodian accounts with registered financial institutions. This raises the hurdles for providers and is expected to lead to some market consolidation, while creating the foundations for further growth in China.

Sarah Perrin, journalist