Microlending in China and US – an Essential Pillar of Economic Growth?
Digging into one of the most important segments of the fintech industry in the two countries.
As the coronavirus is spreading all over the world right now, many industries have been thrown into turmoil. In the first country to weather the storm – China – we saw offline businesses suffer first, including restaurants, manufacturing and retailers. Next came Europe, and now is the United States, the country with the highest number of cases currently. Leading up to April 4, jobless claims surged to 6.6 million in the US, as countless businesses came under siege, especially smaller ones.
It is not only the US. Small and micro enterprises in each epidemic-affected country are wandering to the edge of death. With no income and still facing rent and human costs, at this moment most small businesses need loans to survive. 'Microlending' has been put in a more important role as a means of funding than usual, which brings a window of opportunity to providers.
As a critical member in the fintech family, microlending leverages technology a lot during loan processing, risk control and other aspects of the process. The fintech sector of which it is a part is increasingly active in major world economies, and often gets support from the government.
Overview of the story
Small and micro-level enterprises contribute a lot to the economy. In China, these tiny players contribute (in Chinese) 60% of GDP, 50% of taxes and 80% of urban employment. Any business with an employment rate under 80, whose total assets do not exceed CNY 10 million (USD 1.41 million) and whose annual taxable income does not exceed CNY 300,000 (USD 42,299) is regarded as a small enterprise, and micro enterprises often have an employment number of under 20 people or annual revenue that doesn't exceed CNY 500,000 (USD 70,499). Among small and micro enterprises, small enterprises account for (in Chinese)14.88%, and micro enterprises account for 85.12%, a total of over 90 million. The situation in the US is pretty similar, over 99 percent of America's 28.7 million firms are small businesses, contributing to nearly 45% of GDP and 48% employment, according to JP Morgan Chase.
According to Crunchbase, the investment into lending companies in China has not been as hot as that in the US, except in 2016. Funding in the US market hit a record high in 2019, and shows continued trending in 2020, as the total funding amount in 2020's first quarter was close to the total funding number in 2018 and exceeded 2014 and 2016.
While they are vital to the economy, these companies' financing road isn't smooth, and the process rate is about 30% as nearly half of them submit applications to banks. Microlending fintech firms began to close the gap, having the features of being faster, having lower barriers and being able to give micro amounts. During the development of micro lending, the US financial institutions began the practice in 1995, when the first player was Wells Fargo. And China began this journey ten years later, in 2005, when the CDB (China Development Bank) introduced IPC technology. Up to now, China and the US have differentiated their respective approaches in several ways.
Characteristics of the market in China and the US
Regarded as the two biggest economies on the planet, China and US vary a lot in the micro lending sector, spanning from the market development stage to the business models of individual players.
Data acquisition differs
For the data acquisition, Internet giants in China's micro lending market acquire data from their own business departments, while the US fintech actors need to cooperate with other third-party firms to get more dimensional data, including logistical data, financial info, credit scores and social media. In the case of Kabbage, it had to establish strategic cooperation with logistics company UPS, accounting software company Quickbook and likewise partner with Facebook and Instagram – but for MYbank, it wasn't necessary.
Role of the fintech giants
Major marketers in China's micro lending area are fintech giants, growing faster and generating more innovative fintech methods to measure risks and provide loans. The most famous one is MYbank, owned by Ant Financial. In 2019, it served (in Chinese) a total of 16.56 million small and micro customers throughout the year, an increase of 80% year-on-year; cumulative loans were CNY 1.7 trillion (USD 240 billion), an increase of 72% year-on-year. Besides, these Chinese Internet giants are now beginning to provide an integrated service for their borrowers such as sales channels and digital transformation, while the US ones prefer to provide enterprise loans and then personal loans like P2P. There are obviously less competitive fintech players in the Chinese market compared to the US. Moreover, their interest rate varies a lot. MYbank's APR (Annual Percentage Rate) is around 3% to 4.5% while Kabbage's average APR is nearly 40%. The overall APR of micro lending fintech firms in the US is much higher than in China.
Role of bootstrapped startups
Market participants in the US are typically microlending fintech firms which often cooperate with large banks to increase their own funds. Well-known names include Lendio and Kabbage, their large cooperators being PayPal, America Express and Mastercard. In April 2019, Kabbage has said it has now loaned more than USD 6.5 billion to over 170,000 small businesses on its platform since it was founded in 2009.
Role of financial incumbents
For the US microlending market, incumbents also take a place – like Wells Fargo, which has focused on providing microloans since 1995 and occupies nearly 30% of market share. In China, the incumbents have less incentive to do this business and are one step behind the fintech giants. But after the Chinese central government assigned the loan amount 'task,' they began to cover much more SMEs, especially for 'first loan' ones. For these SMEs (Small and Micro Enterprises) suffering during the virus, the People's Bank of China set up a special refinancing of CNY 300 billion (USD 42.3 billion) for epidemic prevention, more than half of which will be invested in small and medium-sized enterprises; the newly re-discounted refinancing amount is CNY 500 billion (USD 70.5 billion).
Why are the two national systems and markets so different?
The first is the establishment of a credit system. The US began to establish a credit system in the 1860s, over a century ago. And the US also set up an SBA (Small Business Administration) to provide guarantees for SME loans. People can apply for an SSN (Social Security Number) and then all the credit records are tied together with this number. A low score will increase your interest rate, rejected by banks or even rent houses. Thousands of credit information service companies have the credit history for 170 million people, and support the most widely used FICO score. But in China, the market hasn't yielded a commonly recognized credit system or score, and penalties are also relatively weak. Since China just began to set up the system in 2003, there's still a long way to go, and the data should be available to banks, businesses and individuals.
The second is the ecosystem of Internet giants. Players in the Chinese market have established their own business ecosystems so that they can get the information they need from users. Ant Financial, for example, has the credit system Zhima credit, and payment and loan products and a sales channel – so it is not like Kabbage which needs to cooperate with other companies. Ant Financial can acquire data mostly from itself.
As for annual percentage rates, China's government and central bank keep an eye on these companies and control the range of rates, while the US is more market decided. Moreover, Kabbage uses a more delicate way to address such a high rate. The company provides loan-similar loans but calls them commercial advance fees, which are used to purchase part of the store's operating income in the future.
The next step
The players in the China and US market vary a lot. While China is mostly dominated by fintech giants spreading in the market, the US is filled with incumbents and lending-focused fintech firms.
In the future, the Chinese microlending market is more likely to be monopolized by fintech giants, and they are heading to provide additional services for enterprise users based on their advantages in a huge ecosystem. And the US market will probably remain diverse, with players more likely to cover enterprise loans and personal loans. The one-station enterprise service is more likely to be provided by incumbents who own financial and data ecosystems, just like the Internet giants in China.