China's Poor Are Finally Getting A Fair Shot At Borrowing Money

16 August, 2017

Original Source: Forbes

China has struggled to extend loans to low-income groups since reform began in 1979, but government regulation, coupled with financial technology, is now helping to address this class of borrowers. Microloans are increasingly available to a wider group of people, rendering higher risk borrowing methods obsolete.

Borrowing from the curb market

Ten years ago, the poor were forced to borrow money from a variety of sources in the informal market, including from family and friends, rotating credit associations, pawn shops and loan sharks, since these individuals usually lack a strong credit history and collateral. In some regions, interest rates reached very high rates, and no matter how hard one worked, bank loans were difficult to obtain and insufficient to meet borrowers’ needs. My dissertation research 12 years ago was on this topic, and I found that borrowers had to take out several loans from different places in order to satisfy basic cash flow needs.

Things have changed in recent years, however. The government’s campaign for inclusive finance that began in 2013 and ramped up in 2016 has encouraged banks to set up inclusive finance units, and has given rise to new types of finance, such as online lending firms.

Although previous calls by the government to induce banks to lend to lower-income groups had been made, these were relatively unsuccessful because banks didn’t have a way of controlling risks. Now, thanks to developments in financial risk assessment and e-commerce, both traditional banks and fintech firms can determine a customer’s risk level.

Government campaign for inclusive finance

The ongoing government campaign for inclusive finance has been more far reaching than ever. First, the State Council issued a five-year plan for financial inclusion for 2016-2020, which promoted the establishment of diverse financial institutions and financial innovation. The policy also promotes full coverage of financial services to rural areas and to the poor, entrepreneurs and disabled individuals. Banks, small loan companies, pawnshops and financial leasing companies have been called upon to expand their services to enforce the policy.


Second and more recently, guidelines were published in May requiring medium and large-sized banks to expand loans to the agricultural sector, the poor and small businesses. These rules stipulate that large banks must set up these services by year end, while policies should be put in place to control for risk. The guidelines permit banks to have a higher level of non-performing loans in lending to lower income sectors, and leave room for the government to support inclusive finance efforts through monetary and credit policy incentives.

Finally, the chief governor of the central bank, Zhou Xiaochuan, encouraged the development of fintech business to address financial inclusion at the National People’s Congress this past March. Zhou stated that fintech companies should create new products aimed at those normally left out of the financial system.

Fintech addressing microloan risks

Meeting Governor Zhou’s call, some fintech firms are helping to make finance more inclusive. A growing number of such fintech firms uses sophisticated data modeling to assess the risk of small borrowers in order to provide these normally left-behind groups with cash. One of these rising firms is Magic Fintech, a Shanghai-based business that has successfully combined its management’s financial expertise with credit risk assessment.

Magic Fintech lends to both prime and subprime borrowers. Bin Xu, director of Magic Fintech told me in an interview, “our loans are microloans. Our average amount is $150 to $160 —1,200 RMB. [Our customers are] mostly the general population of China.” Xu’s colleague, Di (August) Zhan, director of business development, adds, “to be more specific, young people at an average age from 25 to 30 and amongst salaried people, about 3,500 RMB, which is around $500. Most of them are living in tier 2 through tier 4 cities.”

Magic Fintech is able to address these subprime borrowers by using risk-based pricing that provides different interest rates depending on customer information. The company has over 10,000 pricing models to fit individuals with varying credit profiles. Loans provided to low-income individuals helps them to provide for themselves and their families until payday.

Without the greater use of well-functioning risk assessment models like the ones Magic Fintech has developed, the inclusive finance revolution might fall short of taking hold. Using sophisticated software modeling, some financial firms are increasingly able to bypass the sky-high transactions costs of lending to small borrowers.

Moving forward

The aim right now should be able to expand the risk modeling capabilities held by a few fintech firms to traditional financial firms and to larger segments of the population. Regulation of online payments that would require large e-commerce firms like Alibaba to share their data on a central platform is likely to help more financial firms understand their customers’ risks.

In addition, the creation of a social credit system, which will contain information about individuals’ financial and legal standing, will further promote the roll-out of inclusive finance. This bodes well for China's vast underbanked.

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