How China's P2P crunch helps deleveraging drive

As Beijing steps up its efforts to wean the Chinese economy off an excessive debt-rich diet it seems ready to exchange short-term pain for long-term gain.

That includes killing off some peer-to-peer lenders and by extension paring down some of the higher-risk debt in the comparatively neglected household sector.

For the most part, public discussions around China’s deleveraging campaign have been at the institutional level, namely Beijing’s attempts to place a tighter grip on local government financing, rein in corporate debt, and press state-owned enterprises into debt-for-equity swaps.

In that respect China has made some progress, with corporate debt as a percentage of GDP holding at around 160% for the last two years even as the real economy has grown by nearly 15%.

However, relatively little attention has been paid to China’s soaring household debt as credit has continued to expand at a retail level. China’s household debt-to-GDP ratio reached a record 53.2% as of the end of last year, up from 18.2% before the 2008 global financial crisis.

To be sure, a large part of that increase is attributable to the sharp rise in property prices seen during the period, causing homebuyers to take on bigger mortgage loans.

But another contributing factor is the rise of internet finance, which has made it easier -- in some cases a lot easier -- for people to access loans.

The rapid development of online peer-to-peer lending platforms, in particular, expanded the pool of Chinese borrowers by including those with no prior access to bank credit. This includes rural residents, people with poor credit scores, and borrowers seeking only small sums of money.

As a result, P2P loans in China grew by 128% between 2014 and 2017 on a compounded basis and reached Rmb1.2 trillion ($176 billion) as of the end of last year.

The boom in P2P lending is not unique to China. What perhaps sets it apart, though, is that much of the borrowed money was invested in stocks, bonds and properties, rather than used to fund consumption, as in the US.

The worst part is that P2P loans allow borrowers to extend their credit. As with credit cards, Chinese P2P borrowers can take out loans from new P2P lenders to pay out their existing debt, potentially masking any underlying problems. So in essence these P2P lenders may have been largely financing each other’s liabilities.

It didn't go unnoticed by the authorities, which is why the China Banking Regulatory Commission published a set of guidelines in August 2016 to regulate internet-based financial intermediaries.

Some industry experts believe that move -- which has led to the collapse of a large group of under-qualified P2P lenders -- represents Beijing’s best effort so far to temper household debt, given how little success efforts to rein in house prices have had to date.

And that's despite the fact China’s outstanding P2P debt accounted for less than 0.5% of its total debt as of the end of last year -- although that also helps to keep any adverse spillover on consumption to a minimum.

As weaker P2P lending platforms with flimsier risk-management controls are squeezed out, so the proportion of loans going to weak borrowers and questionable small companies should fall, thus helping at the margins to improve asset quality.

As such, China's P2P crunch is a natural adjunct to China’s broader deleveraging campaign; whether its debt-laden zombie firms at the institutional level or P2P borrowers at the retail level, it is always the weakest credits that get exposed first when the tide goes out.