The New Look Of Chinas Shadow Banking

The Rise of Peer-to-Peer Lending in China

With government crackdowns on investment trusts and risky lending looming ever nearer, it appears the Chinese government may have more issues to deal with soon.

Person-to-person lending platforms have noticed the insatiable desire from Chinese investors to find sources of high returns and have begun to establish themselves in the country.

At first glance, this seems to go almost directly against recent government initiatives to cut down on risky lending and stifle the flow of cheap and easy credit to local governments and poorly financed enterprises. The Chinese government recently let a failed investment trust’s loan come dangerously near to failing, which could have instilled panic within the Chinese credit market.

Officials had better keep their eyes focused on the up-and-comers too, though. Lending Club’s founder, Soul Htite, has founded a similar P2P lending platform in Shanghai, called Dianrong. TechinAsia reports that it was the first of many Chinese P2P platforms to gain funding in 2014.

While these lending platforms do offer a tremendous option for cash-strapped startups and small and medium size enterprises, the loans can come with harrowing interest rates. This is a natural aspect of all loan markets, but usually those unable to obtain loans from reputable sources such as banks are well-recognized as being a risky bet.

In China this is not necessarily the case. Because the government backs all bank loans (at the moment they are moving away from this model), it is impossible for a bank to go bankrupt, or for lenders to really face default on their loans. However, the government does limit the amount of money available for lending. Both of these circumstances combine to form solid incentives for banks to lend to state-owned enterprises and/or local governments who may not use the most profitable business structure or plan, but who are backed by the central government.

Thus, the potentially more profitable and sometimes arguably safer small and medium size enterprises are being overlooked by banks that can offer affordable loans, and instead being picked up by loan sharks, investment trusts, and now P2P lending platforms that offer higher interest rates, and thus create a scenario that stifles small and medium size business growth.

Ultimately, this is not the fault of the P2P lending platforms, but the fault of the government for incentivizing banks to offer cheap credit to the oftentimes riskier debtors. However, this also does not mean that until the government fixes its own issues it should simply overlook the establishment of so many new P2P platforms.

If anything, these platforms are creating another loophole in the current system for loan sharks and other risk-accepting investors, and continuing to offer expensive loans that are ruining the growth of domestic small businesses.

In the long run, China needs to correct its course on this matter, or it will certainly face a stagnant economy that lacks disruptive startups and small businesses and instead relies on bloated, inefficient state-owned enterprises.

Follow me on Twitter: @c_h_wood