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Rakesh Gupta: P2P lending offers tempting investment option


By Rakesh Gupta    Source: Global Times    Published: 2015-11-9


Since the 1980s, Chinese society has undergone changes not only from a political perspective but also in terms of economics and regulation. The economy has seen annual growth rates of up to 14 percent and appears to be stabilizing at just under 7 percent per annum. The standard of living has rapidly increased and people have significantly more disposable income and savings than previous generations, and as a result people are spending more money on travel and entertainment. Similarly, individuals have more money to invest than in the past.

This rapid economic growth in China has two sides: Enterprises need capital for their business ideas and individuals are looking for potential projects in which they can invest their money. Instead of simply putting their money into bank deposits, individuals who have a higher risk tolerance can invest in the stock market. The market in China is largely perceived as speculative and it has a larger proportion of individual investors than in other large stock markets across the world.

The relative absence of sophisticated institutional investors can cause stock markets to process new signals inefficiently and thus distort prices away from the equilibrium prices of the stock. This has prompted some investors to move toward the real estate market, although it seems to be saturated at the current stage and now investors are looking for other avenues.

One option can be starting their own business ventures, but not all savers are prepared to do this, given the need for technical knowhow, management skills and other areas of expertise. So investors often prefer investing in new ventures offering potential returns. In the recent past, the venture capital business in China has grown to over 150 firms with a total of over $100 billion in venture capital.

Another aspect of the business is private lending. Big banks are generally not easily accessible for small business borrowers - only 2 percent of small businesses have access to bank borrowing, and they constitute approximately 60 percent of the economy. Historically a model of private lending existed in China based on individual relationships. This model did not require a strict regulatory system because of the involvement of personal relationships and low default rate owing to social pressure.

However, with the emergence of online commerce it has become easier to channel these excess savings from savers to borrowers. This on the one hand is cost effective and allows negotiation on returns based purely on anticipated risk and without any social pressure. However, the mechanism to assess the risk is limited. In the recent past, the number of lenders and the pool of money available for lending has increased hugely. Currently, this business is largely unregulated and the size of the market is hard to estimate.

Based on a Morgan Stanley report, although the first peer to peer (P2P) lending platform only opened in 2007, China had over 1,500 such platforms with $44 billion available for lending by the end of 2014.

But the absence of a sound regulatory system exposes these platforms to fraud. It is expected that approximately 90 funds will shut down each month with a potential loss of $3 billion every month. These are staggering numbers, and the government is planning a regulatory framework to address the issue, with guidelines expected to emerge soon.

One of the issues missing in the debate is about the development of other businesses that may provide services that could mitigate the risk. The market needs development of effective risk assessment models and businesses that can assist in proper assessment of the borrowers` risks.

This may include credit rating agencies that will develop credit rating databases for individuals and maintain and update credit ratings in a timely manner. The government also needs to develop an effective regulatory framework to protect against loan sharks and platforms that aim to collect deposits and shut down businesses immediately thereafter. Development of these systems and of the lending market will help in more efficient reallocation of resources and sustained economic growth.

At the same time, the government should avoid creating a regulatory model that is too restrictive and a hindrance for the development of business and reallocation of resources in the market place. If the cost from the regulations becomes too high, the incentive to invest in the business may not be sufficient.

The author is a visiting fellow of the Chongyang Institute for Financial Studies, Renmin University of China.

Key Words: P2P   investment   economy  

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