China’s First Internet Bank and Other Informal Financing Channels

Banks and lending institutes that exist solely on the Internet have started to gain popularity in China. Here is an overview of Internet banks and other informal financing platforms

By Liu Yang, a PhD candidate in the School of Accountancy, CUHK Business School

Last December, China’s Premier Li Keqiang kickstarted the issue of China’s first-ever Internet bank loan to a truck driver by pressing a button on the keyboard. This loan, totaling RMB35,000, was issued through Webank, China’s first Internet bank. The whole process did not involve any physical bank or tellers. As soon as the driver’s face was scanned using the camera of the computer, Webank’s big database was able to decide whether he qualified for the loan and determine the amount he would receive.

“Are we a bank? Are we an Internet company? We are an Internet bank!” This tagline appears on Webank’s homepage[1]. Launched on December 28, 2014 by China’s Internet giant, Tencent, and two other shareholders, Webank is a new form of informal financing in mainland China and an online bank that relies heavily on big data.

The purpose of Webank is to help small enterprises and individuals to borrow small sums of money in a quick and convenient manner at a low cost. The system is connected with the China’s Public Security Bureau. When a borrower applies for a loan, Webank would request a photo of this person to be taken. Matching the photo with the Public Security Bureau’s database would show whether the person has ever committed a crime. After that, Webank will collect the person’s QQ and WeChat chatting history using big data analysis programs to evaluate the person’s credit rating and provide the person with an appropriate amount of loan.

Besides Webank, there are similar Internet financing platforms, such as Alibank, Huabei and Baitiao. Alibank is quite similar to Webank, but its big data source is different—it comes from bidding data from Alibaba and Taobao, China’s major online auction and shopping sites. Huabei and Baitiao provide small amounts of credit to online shoppers. On certain shopping sites, consumers have the choice to pay the bills with Huabei and Baitiao, which lack like a credit card. Usually, there are 50 days of interest-free period when using Huabei or Baitiao.

Crowdfunding

As elsewhere in the world, crowdfunding is an innovative informal financing channel in China. People who have business ideas but lack the money to do so can post their ideas on a crowdfunding platform. On this platform, potential investors can read about the ideas and get more information about risks and returns of the projects. If the potential investors are satisfied with a particular business idea, its returns and risks, he or she can inject money into the project. The minimum amount of investment starts from RMB1. The risk is undertaken entirely by the investors. Generally, the return is higher than bank deposit rates and lower than 15 percent. This way, creative and promising business ideas will find a channel to materialized, and the risk can be diversified. The money could be used more efficiently. There are several well-known crowdfunding platforms in China, namely, Tongbanjie, Lujinsuo, Zhongchouwang and more.

‘P2P’ Financing

Internet banks and crowdfunding platforms are just two channels under the so-called “P2P” (peer-to-peer) financing method. P2P is a buzzword in China nowadays. It has a narrow definition that refers to the Internet platform for lending and borrowing. A broader definition refers to the use of the Internet to perform any financial activities, such as crowdfunding, money exchange, donations and more.

P2P financing activities are not limited to mainland China. The largest P2P company, Lending Club, had its IPO on the New York Stock Exchange on December 12, 2014. The IPO raised about US$9 billion. The key characteristic of P2P is disintermediation, meaning, all traditional financial transactions can be performed on the Internet without the traditional financial institutions. P2P is so popular because it reduces the costs for both the lender and the borrower and provides a new convenient way for money exchange, donations and other financial transactions.

As of the end of April 2015, the balance of P2P activities in China amounted to about RMB198,757 million[2]. The number of P2P companies reached 3,054. It is important to note, though, that while the growth rate of P2P financing is rapid in mainland China, the credit database of each participant in the marketplace is still underdeveloped. As such, this is prohibiting the growth of the P2P market. It is also worth bearing in mind that all risks in P2P transactions, such as debt defaults, are under taken by the lenders themselves.

Underground Financing

Prior to the emergence of P2P financing, the most popular informal financing mechanism in China was underground financing, which took the forms of money exchanges, pawn shops and more. This kind of financing has been very prevalent in Zhenjiang province. The lending parties take deposits and issue loans at an interest rate that is much higher than the official interest rate—sometimes even higher than 30 percent. The lending and borrowing parties are mostly acquaintances. Therefore, their long-term relationships somehow guarantee the repayments. However, it is not uncommon for a borrower to run away when he or she cannot pay back the loan.

Group financing is another kind of informal financing. In China, it is not uncommon to see several firms joining as a group. The owners of each individual firm are often friends, classmates or from the same hometown. When one firm finds itself in financial stress, other firms will chip in to provide financial help. For example, Yu Minhong, founder and CEO of New Oriental Education & Technology Group, the most known English training institution in China, was faced with a financial crisis in 2003. Because of SARS, many students asked for a refund of their tuitions at the same time. Niu Gensheng, Yu’s friend and founder of China Mengniu Dairy, lent him RMB10 million a day after Yu called him up about his financial difficulty. No contract or no promise of interests was ever signed in this lending activity, just plain old-fashioned trust. In 2008, when Mengniu was faced with the melamine crisis, Niu was driven into financial distress, and Yu lent him RMB 7 million immediately without any written contracts.

In recent years, another type of informal financing—small loan companies—have appeared in the market, especially in Guangdong and Zhejiang provinces, where small businesses are concentrated. This kind of companies lend money with a lower interest rate than what is commonly charged by underground financing entities. They are also protected by the legal system as long as they charge an interest rate lower than 24 percent. Default risks are undertaken by the small loan company itself. As such, the company needs to have professionals to oversee risk management. The advantage of this kind of informal financing is that, when a small firm cannot afford the high interest rates in underground financing, and if it doesn’t belong to any powerful business groups, it can then turn to small loan companies, who are willing to conduct site visits, evaluate risks and provide an appropriate amount of loans at an reasonable interest rate. Meanwhile, unlike underground financing, the whole lending process is protected by law. In recent years, small loan companies have replaced underground financing to a certain extent. Underground financing, especially when the interest rate is very high, is increasingly used by those who find themselves in emergency situations.

Even though some forms of informal financing exist in a gray zone in terms of their legitimacy, overall, informal financing benefits a lot of SMEs and individuals, propelling the rapid growth of China’s economy.

Reference

[1] http://www.webank.com/

[2] http://www.p2p001.com/bbs/thread-88817-1-1.html