Chinese experience: how they saved the country from microcredits

2024 Author: Seth Attwood | [email protected]. Last modified: 2023-12-16 15:55

Initially, the Chinese authorities viewed microloans as a useful tool in the fight against poverty and even advertised them in the state media. But soon this instrument got out of control and began to threaten the country with a comprehensive catastrophe: from massive national protests to a collapse in financial markets, similar to the American crisis of 2008.

Chinese authorities are cleaning up consumer lending and microloans. The PRC Banking Regulatory Commission and the People's Bank of China jointly adopted the document “Notices on the Streamlining and Regulation of Microfinance Institutions (MFOs). The new rules, the full text of which will be published later, establish the maximum permissible interest rate for microcredits, clarify the procedure for granting loans, restrict the work of collectors, and establish the rules for the formation of the capital of such organizations. For creditors, the measures can be called draconian. But they had to be taken urgently. According to Chinese regulators, indiscriminate consumer lending is driving citizens into a credit trap and threatening the stability of the country's entire financial system.

iPhone at the cost of life

A 19-year-old student from Shanxi just wanted to buy an iPhone 6s Plus. She lacked 12 thousand yuan (about $ 1,800). She was embarrassed to ask her parents for money - the parents were peasants and so saved on everything, so that only their only daughter received a good education. On the university campus, she saw an advertisement for microcredit. The company offered to issue a loan in 15 minutes for any purpose without collateral and guarantors.

The trusting girl turned to the organization and really received the money in a matter of minutes. Apparently, the student did not read all the terms of the agreement. It turned out that, in addition to the loan body of 12 thousand yuan and almost 40% per annum, she still has to pay a certain "service fee" of 4000 yuan. The girl realized that she would not be able to pay off on her own, and took another loan to pay for the previous one, then again and again. As a result, the debt for the iPhone amounted to more than 230 thousand yuan (about $ 35 thousand).

The situation seemed hopeless. And the student decided to commit suicide. Fortunately, her father noticed her with a bottle of sleeping pills in his hands in time and dissuaded her from such an act. The parents spent every penny of their savings, but still owe about 60 thousand yuan (about $ 9000). This story has spread on Chinese social media. Internet users were advised to go to court.

Perhaps now the student's parents have a chance to win the case. Such high interest rates were previously prohibited by law, and under the new rules, MFIs cannot issue loans to people who do not have a stable source of income.

Don't buy - buy

Historically, living in debt in China was considered shameful. Generations of Chinese people have worked hard and saved money for a rainy day. Therefore, the country had an extremely high accumulation rate and low consumption. But that all changed when the 90s generation entered the market. They grew up relatively well off and used to consuming much more than their parents. Typical logic of the current generation: you have to live not later, but now. Money depreciates, it must be spent, and not saved for later.

Financial structures took notice of this trend back in the mid-2000s. Then banks began to issue credit cards to students, often attracting them with various buns: cashback, discounts in stores when paying by card, gifts from the bank. For financial institutions, Chinese students have become a real boon. Already in 2008, 15% of all retail purchases of consumer goods were made using credit cards, while two years before that there were only 4.8%. Two years of rapid growth in consumption on credit - just at the time when banks were actively issuing credit cards to students.

But soon the dizziness of success gave way to disappointment: young people ready for unrestrained consumption had not yet become financially successful, so they still could not provide a high consumption rate for their own funds. Parents sometimes took from their children a dozen different credit cards, with the last funds they paid off their debts, which reached several hundred thousand yuan. Then the financial authorities responded in time, and in 2009, the Chinese Central Bank banned credit cards to students without a source of income, as well as to those under 18 years old.

At that time, microfinance organizations began to appear, but their popularity was low. Few people thought about what risks their activities may carry. The need for tight regulation of this industry was not clear. The official document regulating the activities of MFOs - “Guiding Opinions of the Banking Regulatory Commission of the PRC and the Central Bank of the PRC on testing MFOs” (关于 小额 贷款 公司 试点 的 指导 意见) - appeared in 2008. But he described only the basic principles - what an MFI is, how the capital of an MFO is formed, which department their regulation belongs to, and so on.

So, for example, the document says that the funds of MFOs are formed at the expense of the authorized capital contributed by shareholders, voluntary contributions from shareholders, as well as at the expense of bank loans. But an MFI can take out a loan from no more than two banks. And the amount of the bank loan should not exceed 50% of the company's net capital. To whom to issue loans, what is the debt collection procedure, what interest rates can be - nothing of this is regulated by the document.

Microcredit against poverty

At the time, the Chinese authorities viewed microcredit as a useful tool in the fight against poverty. And this is quite logical: the first MFIs in the world were created precisely for this purpose. In the 1970s, Bangladesh economist Muhammad Yunus began lending his money to low-income entrepreneurs to use to grow their businesses. It was he who became the founder of Grameen Bank, the first microfinance organization in the world, and received the Nobel Prize for his contribution to the fight against poverty.

China decided to take advantage of world experience. In 2015, the State Council of the People's Republic of China published the Program for the Development of a Financial System Accessible to All Populations 2016–2020 (“国务院 关于 印发 推进 普惠 金融 发展 规划”). Microcredits played a significant role in it. “It is necessary to stimulate the creation of innovative products by financial structures, including the promotion of micro-credit products, micro-life insurance companies. It is necessary to expand the financing channels for microcredit companies and pawnshops,”the program says.

The focus on microcredits was primarily in the fight against rural poverty. The country's main news agency Xinhua (新华社) reported how the happy farmer easily got a loan through the Ant Financial mobile app (蚂蚁 金 服, part of the Alibaba group; 阿里巴巴), bought a three-wheeled motorcycle with a trolley and began to make a living small cargo transportation. He lives quietly in his small homeland, he no longer has to go to coastal cities to earn money. Ant Financial works in the 245 poorest regions and has provided loans to 160 million farmers in partnership with the China Fund to Fight Poverty (中国 扶贫 基金会), Xinhua reported.

Enterprising financiers quickly picked up on this signal. First, in 2007, p2p lending platforms appeared in China, and the market began to grow rapidly, at an average of 234% per year. By early 2017, it had reached $ 290 billion. Regulators did not intervene until, in 2016, there was a scandal with the then largest platform Ezubao (租 宝), which turned out to be a financial pyramid. The company stole $ 7.3 billion from 900 thousand investors.

Then the Banking Regulatory Commission issued rules according to which individuals cannot borrow more than 200 thousand yuan (about $ 30 thousand) on one p2p platform, and the total amount of debt on all platforms should not exceed 1 million yuan. In addition, p2p platforms were prohibited from accumulating capital, each p2p company must now conduct its activities exclusively through a depositary bank, and there is only one for each platform.

In such conditions, it became unprofitable for p2p platforms to work. Then the companies themselves began to directly provide consumer loans to the population.

The number of MFIs began to grow rapidly. In addition, former p2p platforms such as PPDAI (拍拍 贷) have also switched to microloans. Technological giants Alibaba and Tencent (腾讯) were not lagging behind, providing users of their e-wallets with the opportunity to instantly receive a certain amount of money for purchases, moreover, with a grace period of repayment - in fact, such an alternative credit card.

All this has led to the fact that consumption, which the Chinese authorities have long hoped as the future engine of GDP growth, has finally begun to grow. According to the Ministry of Commerce of the PRC, the share of consumption in GDP growth in 2016 was 64.6%, in 2017 it is expected to exceed 70%. Retail sales of consumer goods will surpass 37 trillion yuan this year, according to the ministry. At the same time, the total volume of microloans issued without collateral and guarantors, according to CpC estimates, reaches 1 trillion yuan, and in total there are more than six thousand MFOs operating in the country at the moment.

Microloan sharks

Later, however, the media began to surface eerie details of the work of MFIs. The largest online lending platform, Qudian, which, incidentally, recently went public in New York, extorts nude photos from female students as collateral for loans. Then the MFIs hire dancing and singing grandmothers who dance around the debtor's house and intonate to the whole district about the dishonest behavior of the owner.

Some companies even began to attract HIV-infected employees as collectors, who visit debtors' houses with signs “I have HIV”. The collectors promised to stay in the debtor's house until the debt is paid off. Otherwise, the collectors threatened, they would grab onto all objects and dishes with their hands and thus infect all family members. This frightened farmers who were not very versed in medicine.

Why would MFIs go to such bizarre debt-kicking measures? The fact is that back in 2015, the Supreme Court of the PRC ruled that the total cost of a loan cannot exceed 36% per annum. This means that it is simply impossible to solve in the legal field the problem of non-payments on loans with a higher interest rate. Therefore, the only way for an MFI to demand payments from a debtor on a loan is to contact collectors and use such non-standard methods.

On the one hand, almost anyone can get a loan from an MFO without collateral or guarantors. On the other hand, when applying for a loan, the organization requests a large amount of personal data from the client. In addition, with the development of the Internet and mobile payment technologies, companies have a huge array of diverse information. After all, a mobile phone knows almost everything: where a person is, with whom he communicates, not only in social networks, but also live (by comparing data on geolocation), what purchases he makes and what is his average monthly turnover of funds.

By analyzing this big data, a company can measure customer solvency better than any traditional scoring system. When a person's whole life is in full view, he becomes an easy target for collectors. Moreover, in China, companies are quite light on the issue of transferring personal data to third parties. The other day, for example, it was reported about the data leakage of users Wechat (微 信), Alipay (支付 宝) and Sesame Credit (芝麻 信用). In September, China Daily reported on the arrest of 410 people in Guangdong province who were trafficking in personal data from credit institutions. In total, more than 100 million files with personal data of users were confiscated.

All this creates great social risks. This is much more dangerous than labor conflicts, land disputes, defrauded equity holders. Because with the development of Internet finance, victims of microcredit can appear throughout the country, translating the conflict into a nationwide scale.

There is one more important point: since the state in China for a long time retained an absolute monopoly on any financial activity, the conviction still sits in people's heads that the state is responsible for everything and will monitor the observance of justice and their rights. That is why the state intervened now, until thousands or millions of bankrupt debtors went with a pitchfork to Zhongnanhai.

In addition, the activities of MFOs began to create systemic financial risks. The 2008 regulatory document regulated only the proportion of bank loans in the capital of MFOs. But nothing prevented companies from finding other sources of funding. MFIs began to replenish their balance sheets by issuing securities backed by these debts (ABS).

Let's say a microfinance organization has issued a certain number of consumer loans. It then sells the claims to SPV. SPV forms a pool of assets and issues ABS for them. Then ABS is transferred to a consortium of underwriters who provide placement of these securities. The placement can be private between a limited circle of investors. In addition, these ABSs are listed on the Shanghai and Shenzhen Stock Exchanges. For example, Ant Financial alone issued 149 billion yuan ($ 22 billion) of ABS backed by consumer loans. JD.com, China's second largest e-commerce platform, has released such ABSs for 9.5 billion yuan ($ 1.4 billion), while Baidu has released 1.3 billion yuan ($ 196 million).

Of course, subordinated tranches (the most risky ones) remain, as a rule, on the balance of the originator. Notably, however, local ratings agencies assign AAA and AA + ratings to senior and mezzanine tranches. The situation is even more perilous than the infamous US CDOs that sparked the 2008 financial crisis. CDOs were also assigned the highest possible rating, but at least they were backed by mortgages, where real estate was used as collateral. And then practice has shown that such bonds were unreliable. What can we say about bonds secured by microloans, for which there is no collateral at all.

Change of course

Now the Chinese authorities are trying to stop all these risks. According to new notices issued by regulators, the rate on microloans, including all payments and service fees, should not exceed 36% per annum. In addition, it is the annual interest rate, and not monthly or daily, that must be spelled out in the loan agreement. This is an important measure, since MFOs, taking advantage of the low financial literacy of the population, often indicate attractive interest rates per day, disorienting their clients (this problem is typical not only for China; in the Kommersant survey, only 22% were able to correctly answer the question: “What rate on a loan do you consider more profitable - 1% per day or 70% per year? ).

In addition, under the new rules, it is prohibited to provide microcredits to borrowers without a stable source of income: the unemployed, students, and so on. The loan can not be extended more than two times. According to the notices, companies should actively use new technologies, including more data, in order to carefully assess the client's solvency and not offer him more loans than he can afford. At the same time, the notices call for more attention to the protection of personal data and prohibit the illegal transfer of personal information to third parties.

Significant restrictions are imposed on the operation of the collectors. Now they cannot use violent measures, cannot interfere with the client's private life or exert moral pressure on him. In addition, from now on, they must communicate exclusively with the borrower about the repayment of the debt; pressure on a third party, for example, relatives or friends of the debtor, is prohibited.

The regulator also introduced measures to stabilize the financial system. While MFIs are still not prohibited from securitization, banks are now prohibited from investing funds from asset management funds in bonds backed by microloans.

Licensing for new MFIs will be suspended. Those organizations that operate without a special license are now outlawed, their activities will be terminated. And those MFIs that have already received a special license will be again checked for compliance with the new notifications. In the event of any violations, companies are threatened with sanctions: from the suspension of activities to the revocation of the existing license.

Of course, the new measures are aimed at protecting consumers. This is a big blow for MFIs and, as market participants believe, not many will be able to survive it. On the other hand, this measure will help to streamline the market, leaving only the strongest representatives in the game. It is already clear that large companies are unlikely to have problems with the implementation of the new instructions. Some even decided to play ahead of the curve. For example, Ant Financial announced that it would not provide loans at rates higher than 24% per annum, even a week before regulators intervened.