Micro and small enterprises (MSEs) as major employers in China, are a backbone of the economy. Despite their importance, limited access to financing still affects them. MSE financing is difficult, slow and expensive; thus authorities are drafting and enforcing policies to improve financing conditions for MSEs. On June 23rd, 2018, Chinese authorities released “Opinions on Further Deepening Financial Services for Small and Micro Enterprises”, looking to encourage financial support for small businesses as concerns of an economic slowdown and credit shortage rise.
By nature, MSEs operate in unfamiliar sectors and have less publicly available data, which leads to more information asymmetry, discouraging lenders. Besides lacking of good collateral and high bankruptcy rates, data insufficiency also prevents financial institutions from having effective programs to assess small business risks and conduct lending activities. With continuous technology improvement, especially in big data analytics, lenders can use more information to better evaluate MSEs’ operations and risks.
In addition to the traditional banking system, peer-to-peer (P2P) lending, designed to match individual borrowers and investors, flourished in China as regulators encouraged the application of financial technologies to expand services to MSEs and individuals. Some leading institutions, such as Youxin Financial, provide small-value inclusive financial information services for MSEs. By the end of March 2018, YouxinFinancial’s lending platform Renrendai had facilitated over $8.16 billion (RMB 54 billion) in loan principal and served over 13.9 million users. “In the last eight years, we focused on serving MSE owners and helping them go through difficulties while changing their lives, which gave us a sense of achievement,” said Jackson Cheung, co-founder and chief executive officer of Youxin Financial. The risks associated with MSEs are very high, but MSE owners are not highly leveraged and worthwhile clients, as they will begin new business ventures after previous failures.
China strengthening regulatory oversight over P2P platforms
Mainly because of tighter regulatory enforcement, 63 P2P platforms were reported to be problematic and 17 were restricted in June 2018. Since the start of 2016, Chinese authorities have heavily regulated the online lending sector due to liquidity and insolvency risks of the expanding sector. In August 2016, authorities reiterated that a P2P lending platform must serve only as an intermediary and information provider for investors and borrowers, banning guaranteed returns and collaboration with custodian banks. From June 2018, P2P platforms were barred from guaranteeing return on loans they facilitated, and loan limits were set: no more than RMB1 million for individuals and RMB5 million for corporates.
With these new policies, the number of P2P platforms fell from 2,799 in August 2016 to 1,836 by the end of June 2018, according to data compiled by wdzj.com. The sector is still reforming and many P2P companies are failing, but the large-scale participants are flourishing. “With stricter regulations, there will be less of a “bad money drives out good money” effect in this sector,” Cheung explained. He also stated they grew quicker during the low period and saw approximately 70% growth in 2016 and 90% growth in 2017. The new regulations will make the Chinese P2P sector more concentrated and eventually only the strongest companies can remain. This transition period is difficult for P2P companies but will make the sector healthier.
Data analytics and data privacy
In China, there are over 70 million MSEs owners, whose credit needs are not adequately fulfilled, giving opportunities to companies like Youxin Financial. Yet, the biggest challenge is how to precisely locate suitable clients and accurately identify risks. While banks use internal rating systems to assess credit risks, fintech and P2P companies apply computer algorithms to review data and improve their loan approval process. “Customers with poor credit quality will be rejected in seconds, and customers with good credit will get approval in one hour,” explained Cheung. He believes their comprehensive data capability is one of the major competitive advantages they have developed. Their data processing capacity helps them improve operational efficiency, reduce customer acquisition cost and enhance risk management.
With increasingly global digitalisation, data has become a major resource and commodity; but concern about data privacy is also at an all-time high following scandals such as the Facebook and Cambridge Analytica data leakage case. The EU General Data Protection Regulation(GDPR), came into effect on 25 May 2018, hoping to give consumers control of their personal data collected by companies. Currently, it affects organisations located within the EU and companies offering goods or services to customers in the bloc. It has a far-reaching impact and functions as an example of the global concern about data privacy.
Data accumulation in China happens rapidly as China is home to the world’s largest population of internet users. Effective data analysis helps client acquisition and risk management. However, during this period of increasing data supervision, the P2P sector will be improved with the removal of illegal data users. Cheung is optimistic, as he said, “with the standardisation of data acquisition, data analytics skills are increasingly important; we have an advantage with our accumulated abilities, especially when servicing MSEs owners.”
With the tightened regulations on P2P platforms, the sector is experiencing its largest upheaval and a number of collapses. The Matthew effect, meaning the rich get richer and the poor get poorer, describes this industry as the top players will become bigger and stronger. “Specialisation and focus, strict compliance with regulations and data driven risk management ability help us obtain a foothold in this industry,” summarised Cheung.
“In the last eight years, we focused on serving MSE owners and helping them through difficulties while changing their lives, which gave us a sense of achievement”