In just five years, online non-bank lending has gone from a cutting-edge investor favorite to disgrace, scandal and collapse.
From LendingClub in the U.S. and Funding Circle in the U.K. to Chinese peers Dianrong, 51 Credit Card and Yirendai, they have all disappointed those who cheered them on, including me. They either keep racking up losses or are facing an existential crisis or both. In China, many P2P company founders have been jailed and the sector is facing bans from a growing number of local governments.
How did things get this bad? In hindsight, online platforms overestimated their ability to differentiate good borrowers from bad. Talk of combining this artificial intelligence system and that algorithm turned out mostly to be hot air, to put it bluntly.
Data on the "subprime" borrowers who were driven to turn to P2P lenders is not hard to come by, both from their activities on social media and e-commerce sites and from conventional loan application question responses. But while a borrower's ability to repay a loan could be measured relatively easily, it has been harder to predict their willingness to repay.
In theory, lenders can readily set interest rates to match the risk level of each borrower, but this is precisely where most Chinese P2P platforms ran into trouble. The higher interest rates charged to risky borrowers often pushed them into default.
Online lenders were supposed to be more efficient as new, high-tech players. But that was premised on their achieving a certain scale. Few if any online lenders anywhere have gotten there yet.
Another premise was that any given delinquent loan would not have much impact because online loans are relatively small and borrowers would be spread out geographically, reducing concentration risk.
But instead, collections have been comparatively expensive because the process of chasing delinquent small borrowers is labor intensive. Some Chinese P2P platforms used a "name and shame" approach to publicly pressure borrowers to repay. This tactic backfired, with the lenders, not the borrowers, coming under criticism.
I have seen how hard it is to run a debt recovery business in this country over the past two years as vice chairman of YX Asset Recovery. Leftist media, delinquent borrowers and loan cheats have united to campaign against "high-yield lenders" and debt collectors. A heavy-handed police approach to regulatory compliance has also scared legitimate collectors.
Given the nature of subprime loans, with short terms and high default rates, higher interest rates should be appropriate. For a platform to break even on a three-month, 5,000 yuan loan, an annualized interest rate of roughly 100% would be needed.
This would mean the borrower would pay about 1,250 yuan in interest, along with repaying the principal, at the end of three months.
But that is all too much for consumer groups and government officials. The Supreme People's Court earlier imposed an annualized interest rate cap of 36% which has started to get enforced more rigorously of late. This has been painful for all but the most well-capitalized platforms like New York-listed Qudian and Lufax.
At the same time, it has to be acknowledged that many Chinese P2P platforms were little more than unscrupulous Ponzi schemes. Most of these naturally collapsed, taking with them both their investors' cash and the reputation of the whole sector.
In hindsight, P2P lending may prove to have been an unsustainable business model.
The high ratio of loan losses and even higher share of loans overdue has been too much to bear for the investors who put up cash for lending through China's P2P platforms. To keep funders engaged, most platforms quietly absorbed loan losses at great cost but recent regulations have banned such practices.
The current regulatory campaign is set to force the P2P platforms still in business to convert into licensed microcredit lenders within two years. P2P lending itself would disappear.
The P2P platforms though deserve more, well, credit than they have gotten as they have been a major catalyst for change in China.
The country's banks have been nudged into beefing up their online services in response to noisy fintech newcomers. Virtual credit cards are taking hold even as conventional credit cards are made more accessible for small-scale consumer borrowing. Banks appear to be waking up to the importance of consumer lending just as borrowing by companies slows and their bad debts grow.
The P2P saga has also taught hundreds of millions of borrowers as well as savers valuable lessons about finance, investment and self-protection. Hardly a day has passed since 2018 without domestic media stories of an online lender overcharging borrowers, of police arresting debt recovery agents for misbehavior in collections or of a reckless borrower getting bailed out by his poor parents.
Intriguingly, many Chinese fintech operators are now exporting their expertise and tricks to Southeast Asia and other developing countries.
All in all, despite manipulative and dishonest practices by many operators, the fintech revolution on balance has been a positive force for China. When the dust settles some years down the road, we will find that lenders have become humbler and the public more knowledgeable. This should eventually translate into cheaper credit for disadvantaged consumers and small business which would compensate for the sector's current pains.
Joe Zhang is vice chairman of distressed-debt recovery company YX Asset Recovery and an investor in fintech companies including Hangzhou Pailie Technology, Cuimi Tech and Qudian.