Industry: Dianrong taps unbanked and underbanked population

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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 9 - 15, 2017.


Chinese investors are turning to viable alternative assets to grow and inflation-proof their wealth. Peer-to-peer (P2P) lending platforms seem like an attractive option as they offer returns of about 8% for minimum investment amounts of as low as RMB100 (RM64.75). 

There are currently more than 2,500 active P2P lending platforms in China. However, not all the lenders are of the same ilk. In fact, investors stand to lose their capital if they invest in a dodgy platform. 

Kevin Guo predicts that more than 90% of the online lending sites will be wiped out in the next three years, leaving about 200 platforms on the scene. In 2012, the former lawyer and fund manager co-founded P2P lending platform with US investor Soul Htite. 

Htite had co-founded Lending Club — the largest P2P lending site in the US, which is listed on the New York Stock Exchange — before joining Guo in China. Today, their company has more than 3,300 employees in 29 offices all over the country, with a monthly transaction volume of more than RMB1.5 billion. 

Investors are piling in. The list includes US investment firm Tiger Global and Standard Chartered plc’s private equity arm, which has invested US$207 million. According to the 2016 Top Markets Report: 

Financial Technology published by the US Department of Commerce in August last year, there were three major players in China’s P2P lending segment and Dianrong was the market leader.

Guo has a solid reason for his prediction. “Unlike Dianrong, which provides relatively small loans, many of these platforms are still focusing on large loans, such as RMB15 million and above. The Chinese regulator has imposed new regulations on the P2P lending segment. Their [the other P2P platforms] business models are mostly unsustainable under the new laws,” he says.

There are currently about 10 million active investors in China’s P2P lending segment. Guo admits that it is still a relatively small market compared with the Chinese stock markets, which have more than 100 million investors. But it is a good start as these platforms are tapping the almost 70% unbanked and underbanked population in the country. 

“Most of the traditional financial institutions do not provide services such as lending to the unbanked population as they want to keep their risk low. They may lend to the underbanked population, but probably only cover a portion of their financial needs. This is where Dianrong comes in,” he says. 

While regulations do not allow online lending sites to guarantee a return, Guo says the company generally provides investors with an annual return of 7% to 9%. When the platform was established, it provided a whopping 16%.

“That was the time when financial institutions were providing returns of about 10%. P2P lending platform operators needed to offer higher rates of return to compete for funds. Four years down the road, we have gained credibility and trust from investors. Our return rates are competitive compared with the 3% to 4% currently offered by financial institutions,” he says. 

“Previously, it was common for P2P lenders to offer a return of 30% to 40%. Some even went as high as 90% just to attract capital from investors. However, most of these platforms did not survive as their business models were not sustainable.” 

According to the China Banking Regulatory Commission’s figures, the country had 1,778 “problematic” online lenders as at August last year. China’s biggest Ponzi scheme was exposed after internet lender Ezubo allegedly defrauded more than 900,000 people of the equivalent of US$7.6 billion. Following a series of default and fraud cases, the Chinese authorities are scrutinising the loosely regulated online lending segment.

According to Guo, the Chinese regulator has imposed limits on P2P lending. The platforms are barred from taking public deposits to fund their own projects or sell wealth products. The new laws also require them to appoint qualified banks as custodians and improve information disclosure. 

He says Dianrong has been ready to embrace such regulatory changes since it was established as it had seen the trend coming. Moreover, the platform is actively playing a role in enhancing the credibility of the P2P lending segment and attracting more investors by setting a legal precedent. 


Breaking new ground

Leveraging Guo’s legal background, Dianrong filed China’s first online lending default lawsuit in 2013. It sued a borrower who had taken a loan of RMB500,000 and stopped making payments after two months. Despite the year-long litigation process, the company won the case.

“It is not easy to file and win such cases. No P2P platform has done this before because there are some obstacles. The investors are all over China and it would be impractical to gather all of them in court to file the lawsuit. Moreover, the cost of litigation is so high that the outcome may not justify it,” he says. 

But he did it anyway. He had foreseen the need to initiate legal cases when he co-founded the company. So, before investors can invest in the platform, they have to sign a document authorising the company to file a lawsuit on their behalf in the case of a loan default. 


“The message we sent out with this legal precedent is loud and clear. A P2P lending platform is not something anyone can mess with,” says Guo. 

“Many borrowers pay off their bank loans, but not their online lender’s loans because the cost of default for the latter is relatively low. We want them to know that this is no longer the case. 

“If there is a default, we will take them to court like the banks do. The government and media agencies showed tremendous support for our legal action. There were several default cases initiated by our peers after that and most of them won their cases.” 

Did the legal precedent help to lower the default rate? Guo says the platform’s volume at the time was too low to see a noticeable drop in the default rate. 

The company is also trying to get the credit bureau of the People’s Bank of China to record online lending default cases in its credit system, he says. If the borrowers on online lending platforms do not pay off their loans, it will take a toll on their credit rating. 


Protecting investors

Dianrong has a stringent screening process for borrowers and an approval rate of less than 30%. It also encourages its investors to diversify by offering a patented diversification tool developed by in-house engineers. The tool automatically diversifies investments for investors when certain criteria is set. 

“Without the diversification tool, it would be very difficult to diversify as each borrower has different loan amounts and interest rates. This technology can support a massive volume of transactions and it enables our investors to diversify more easily,” says Guo.

Compared with its peers, Dianrong has a relatively low loan default rate because of its well-structured collection process, which is similar to that of banking institutions. Guo says the default rate is less than 2% for small and medium enterprises (SMEs) and 6% to 10% for individual borrowers. The average default rate of the platform is about 3%. 

Will investors lose money in the case of a loan default? He says this is not the case for now. Dianrong has set aside a reserve fund by pooling the interest paid by borrowers. So, even if a borrower defaults on a loan, investors will get what they were promised from the platform. Not many other P2P platforms in the world are able to do this. 

Guo explains how this works: “When a borrower comes to our platform, he pays an annual interest rate of at least 15%. We will keep at least 7% as investors’ returns and put 3% to 6% into a reserve fund, depending on the borrower’s profile. The platform only charges 3% or less for operating expenses.” 

The ability to set up a reserve fund drills down to how much Dianrong charges its borrowers. Guo says the platform offers a wide range of loan products targeting different groups of borrowers. For SMEs, the interest rate stands at 15%. Individual borrowers are charged 20% to 30%, sometimes even higher, depending on the borrower’s profile. 

Who are Dianrong targeting? When it started, the platform focused on the near prime borrowers who are underbanked as they are high quality borrowers, according to Guo.

But as the company has scaled up in the past four years, it has started to take more risks. In May last year, it opened its doors to subprime and deep subprime borrowers. From there, the online lender tried to determine a feasible risk model and scoring system to underwrite thin-file borrowers. 

Subprime and deep subprime borrowers refer to those who have a higher credit risk than normal borrowers while thin-file borrowers refer to those with a limited credit history, which makes it difficult for them to secure loans or other forms of credit. 

Guo admits that taking in these borrowers will increase the default risk. However, these are the people who really need online lending services as banks will not deal with them. He argues that the higher risk of default can be covered by loan products such as payday loans and merchant cash advances (MCA), which come with higher interest rates. 

The platform’s MCA product is being offered to small merchants, such as restaurant owners and service providers, who may be looking to grow their business. The company underwrites these merchants based on the data from their point-of-sales (POS) machines. It also collects payments via the machines, which saves both parties time and cost. 

“For example, if a convenience store chain wants to open new branches, it can take a loan from us and make payments when the new branches start generating income. With our MCA product, which allows daily payments, the interest is lower than those of products that require monthly payments. This lowers its cost of funding,” says Guo. 

While Malaysian investors are not able to invest in Dianrong yet due to technical issues, such as identity verification, Guo says he is always open to 

collaboration with local P2P players to develop the segment further.