Editorial: Beware of the Fintech Roller Coaster

The two-year boom of unsecured short-term small loans, known as cash loans, ended abruptly recently after the central bank and the banking regulator jointly suspended the issuing of such loans, which are often made on the internet and on smartphones.

This is one of the concrete moves that authorities have made after the National Financial Work Conference in July and the Communist Party’s 19th National Congress in October warned of pending financial risks and urged prompt action. Strengthening supervision of the emerging fintech sector has become the front line of authorities’ latest battle to prevent systemic financial troubles.

Small cash loans, or microloans, are the latest form of the fintech business, extending loans to anyone — without the borrower needing to provide collateral or to specify how the money will be used. These microloans have helped many people who have difficulty borrowing money from other conventional channels. The business has seen explosive growth in the past two years, attracting huge amounts of capital.

The transaction volume of microloans is relatively low compared with the entire financial sector. However, many low-income people have been involved in microloans, which means a jolt to this business could have large-scale social repercussions.

Numerous media reports have told stories about young people being lured into overborrowing and then being unable to repay because of the loans’ skyrocketing interest rates. These people, many of them students, faced strong-arm debt-collection techniques, and some female students have been threatened with having nude photos of themselves published online.

Legitimate financial institutions such as banks, trusts and consumer finance companies have also played a role in the growth of microloans by helping microlenders get money or investing in asset-backed securities products backed by microloans. The arrangement allows financial risk to spread to these licensed financial institutions.

The latest polices laid down detailed measures related to cash-loan issuance, such as forbidding peer-to-peer (P2P) platforms from acting as middleman in loans with unspecified usage, forbidding banking institutions to outsource credit review and risk-control services, banning microlenders from enhancing leverage through asset-backed securities and forbidding strong-arm debt collection. These well-meaning policies are not too late to save the microlending business from getting out of control.

Still, it is worth reflecting on why internet-based financial services like P2P lending and microlending have repeated the odd life cycle in which they saw explosive boom in the beginning and then an abrupt crackdown as risks quickly built up.

When these new financial services were first created and spread, they were deemed financial innovations. But these new services, boosted by technology, often evade regulatory oversight in their earlier stages. As financial repression still prevails in China, Chinese authorities have been generally tolerant with financial innovations. But those that grow with rapidly building risks and show pronounced negative public effects will certainly draw swift regulatory action. It has become an important and difficult task for regulatory bodies to prevent financial innovations from creating financial problems.

Internet finance, which is based on internet platforms and big data technology, cannot deviate from the essence of finance, which is serving the real economy. Because of the high risks in this sector, it should require licenses and be subject to strict supervision. The latest polices have placed obtaining a license at the top of the list of six requirements for microlending services.

The microlending business has revealed shortcomings in existing financial regulations. Because of the lack of coordination among central regulatory bodies and among the national and local regulatory bodies, microlenders have been evading supervision by taking advantages of loopholes.

Some of the companies appeared to be legitimate entities in the booming microlending business. But they have made use of the absence of national rules to obtain from business licenses from some local governments that are more lax than they are elsewhere.

China’s National Financial Work Conference, held in July, stressed that national rules must be followed to clarify local governments’ regulatory responsibilities. If the local regulatory bodies’ responsibilities are not clear, the loopholes will not be closed. Even after the latest round of crackdowns on microlending, it is still possible that a new species of internet finance may emerge. Warnings of the comeback of high-interest rate loans in another form outside regulatory oversight can still be heard and may come true. The situation indicates that the existing financial services still cannot meet the demand of lower-income groups.

It is an unavoidable trend for commercial banks to lean toward retail banking services by catering to individual consumers. Authorities should also issue more licenses to lenders as long as they meet rules, particularly in shareholder qualifications and operations. The move will increase financial services and enhance their scale and coverage, as well as squeeze out illegal businesses. This is also in line with the reform spirit of the 19th National Party Congress. The easing of access should also be supported by regulatory innovations that enhance efficiency and power by using big data technology.

Beside “correction” moves after risks build up, authorities should also put out a comprehensive regulation to clarify rules for lenders. This regulation has been delayed for a long time.

Internet finance such as microlending has broken geographical barriers by making use of the internet. Different agencies and authorities at various levels must work together to effectively supervise internet finance so that no “dead corners” are left, as central bank Governor Zhou Xiaochuan said. The public hopes the State Council’s newly established Financial Stability and Development Committee can make a difference in this area. It will be an ongoing challenge for authorities to achieve a subtle balance between leaving enough space for financial innovation without leaving blind spots in supervision.