On November 2nd, 2020, the Chinese Banking and Insurance Regulatory Commission published a draft of new rules concerning online microlenders. Online microlenders refer to companies that give out or facilitate the issuance of small loans online, which includes Ant Group due to the scope of activities carried out by the company's CreditTech platform. The new rules established will significantly alter the way in which CreditTech operates. Consequently, the China Securities Regulatory Commission has put Ant Group's IPO on hold in order for the company to adjust its business model to be in compliance with the new regulations before resuming the process of going public. Microlending companies that are already in operation will have a three year transition period to reach full compliance with the new rules.
In this article, we provide a summary of the new regulations concerning online microlenders in China. The scope of the new regulations include microlenders' locations, sources of funding, loan purpose and amount, as well as the ownership of any microlending sub-companies. We also discuss how these regulations could potentially affect Ant.
Note: large-scale microlending companies in China all operate online, so in this article, microlenders and online microlenders have an equivalent meaning.
Background information on Ant Group's microlending business:
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Location
Online microlenders can only issue credit in the province they are registered in. To lend cross-province, microlenders need to seek approval from the China Banking and Insurance Regulatory Committee. This will most likely not be a significant hurdle for Ant.
Loan Purpose
The new guidelines for loan purposes are as follows:
Loans cannot be used to finance investments, such as the purchases of bonds, stocks, financial products in general, or investments in other asset classes
Loans cannot be used to fund real estate down payments or mortgage payments
Microlenders must clearly specify the purpose of each loan in the loan contract, and must also monitor the usage of each loan to ensure that the money lent out is being used in accordance with what is specified in the contract
How Does This Affect Ant?
Huabei was always used for consumption and functions as a virtual credit card, allowing consumers to pay for purchases from Alibaba or partner sellers in installments. The three conditions above are thus easily satisfied. However, for Jiebei, Ant usually asks potential borrowers to include the purpose of the loan in their application, but does not track how the money lent is being spent. There have been many instances of borrowers taking money out via Jiebei for non-consumption purposes, such as investing in the stock markets, paying a down payment for a home, or even opening a milk tea stall. Ant will have to tighten its monitoring of Jiebei loans, although this is a challenging task for any microlender as well as for the regulators.
Loan Amount
Guidelines have also been published concerning the loan amount granted to individual and business borrowers.
Loans to Individual Borrowers
The maximum loan amount granted to each individual cannot exceed the borrower's average annual income over the past three years or RMB300,000, whichever is lower.
Loans to Businesses
The maximum loan granted to each organization cannot exceed RMB1 million
Lenders should carefully evaluate each borrower's financial capacity, including the borrower's assets, liabilities, and income
How Is Ant Affected By These Changes?
With regards to individual borrowers, the loans granted via Jiabei and Huabei are usually much lower than the RMB300,000 cap (see here), so Ant will probably not be significantly affected. However, the new regulations do require Ant to check each borrower's employment and income level, which Ant did not do before. Consumer loans on CreditTech were typically granted based on borrowers' credit scores determined by their credit histories on the Ant-Alibaba ecosystem.
With regards to business loans, Ant lends to small- and medium-sized businesses via MYBank, which is regulated as a bank and is thus not affected by the new regulations for microlenders.
Sources of Funding
New Funding Requirements
Online microlenders must now comply with the following requirements for funding:
The total funding obtained from bank loans and money from shareholders that are used for microlending cannot be greater than the net assets of the microlender
The total value of loans securitized by a microlender cannot be greater than four times the microlender's net assets
Microlenders must take on at least 30% of the share of any syndicate loans issued
Note: with regards to requirement (2), many microlenders have traditionally been very highly leveraged due to the use of off-balance-sheet financing. Specifically, loans were securitized and taken off-balance-sheet through special purpose vehicles (SPVs), so the proceeds from securitizing these loans and selling the subsequent securitized products were lent out again as new loans, which are then also securitized, and so on.
Our Insights: the pre-existing funding structure of online microlenders in China is very reminescent of the funding structure of financial institutions in the US leading up to the global financial crisis (GFC). Moreover, given that SPVs tend to be more opaque and subject to less stringent regulations, we think that requirement (2) is very prudent and conducive to financial stability. Restructuring the funding structures of online microlenders now can play a role in warding off a potential GFC-like crisis in the future.
Note: with regards to requirement (3), syndicate loans refer to loans offered jointly by a group of lenders.
What is Ant's Funding Structure Like Now?
Currently, only 2% of the total loan amount enabled through Ant is funded by Ant itself. The remaining 98% are either securitized or funded by partner financial institutions. With regards to syndicate lending, Ant tends to supply a very small fraction of the loan but keeps 25% to 30% of the profit. Ant has the upper hand in the sense that the company has more user data than partner banks, so they are, at least in theory, more able to analyze and predict borrowers' levels of creditworthiness. Consequently, banks choose to cooperate with Ant in spite of these (from the partner banks' perspectives) not very favourable terms since they may not have a better way of reaching out to a large customer base or a more effective way of accurately gauging risks.
Of course, there is naturally a very significant moral hazard problem here since Ant is able to take a large share of the profits while only having a very small stake in the risks. This could lead Ant to aggressively give out good ratings to otherwise not so creditworthy borrowers.
Our Insights: requirement (3) from above seems very prudent and rational. Ant has minimal "skin in the game" as a co-originator of loans, giving rise to significant potential moral hazard problems. Again, this is very reminescent of the events leading up to the global financial crisis, where loan originators were aggressively giving out loans even to less qualified borrowers since the originators didn't share much, if any at all, of the risks.
However, it is surprising that Ant does not have to hold onto any of the securitized products it issues. Once Ant securitizes the loans that the company gives out and sells the resulting securitized debt product to investors, Ant no longer bears any of the credit risk and is thus more likely to lend to risky borrowers. Microloans granted through the Ant platform are also unsecured, thereby increasing the risk of no recovery to investors who buy the securitized products. Although there is a limit to the amount of loans that Ant can securitize, whether or not this limit is sufficient may be tested during turbulent economic times in the future.
What Will Ant Have To Do Next?
As of June 30th, 2020, Ant has two companies set up for CreditTech's two consumer microlending products, Jiebei and Huabei. These two companies combined have net assets worth RMB35.8 billion.
Note: again, Ant also provides small business loans to SMBs (see here). However, this is done through MYBank, which Ant has a majority stake in, but MYBank is regulated as a bank and hence does not fall under the new microlending regulations.
The maximum total amount of loans Ant will be able to issue under the new regulations, as a factor of the two sub-companies' net assets, is consequently the sum of:
1 - the company can lend the amount of its net assets
1 - the company can borrow from banks and lend out funds from shareholders
4 - the company can securitize loans for up to four times the amount of its net assets
So, Ant can issue up to 6 times of RMB35.8 billion, which equals RMB214.8 billion.
Assuming Ant choose a syndicate structure for all of its loans, and given that Ant has to have a 30% share in the syndicate loan, the maximum volume of loans that can be enabled through the Ant platform is then RMB716 billion (with Ant holding a 30% stake of RMB214.8 billion).
Ant does not disclose its outstanding balance of consumer credit loans. However, as of the end of Q2 2020, the total consumer credit amount enabled through the Ant platform was RMB1.7 trillion (see here). During the 12-month period ending the same time, the total consumer and SMB credit enabled via CreditTech totalled RMB2.15 trillion (see here). Thus, it is extremely likely that Ant has been overlending based on the new regulations. To fix this, Ant will have to either increase its net assets or shrink its loan book (i.e. cut down on the volume of loans the company gives out).
Our Insights: the former option is probably more appealing to the company, but could have systemic risk implications with regards to the financial system as a whole. The latter is possibly a less attractive option for Ant, as the company would have to alter their CreditTech business model and seek profitability from other means. Options include functioning as a credit score provider to advise other financial institutions in their lending decision-making, or serving as a sales intermediary by matching borrowers with lenders without partaking in the loans. The sales intermediary model is similar to what Ant did with the CreditTech platform prior to the new regulations, although as stated above the company had a 25% to 30% share of loan profits and could refrain from sharing with its partner institutions most of the consumer credit information.
Our guess is that Ant would most likely try to pursue a combination of both options, perhaps with a greater weight on the latter since the company has (most probably) been very much overlending with respect to the new regulations. Given the systemic importance of the Ant-Alibaba ecosystem, it is also unlikely that the Chinese regulators would approve of Ant expanding too much further, especially with regards to consumer debt. We predict that the regulators would be much more supportive of expansion of SMB lending, which could be beneficial for China's economic growth (see here).
We also expect Ant to have be more transparent with borrowers' data in the future, especially in light of the new anti-trust law proposed this November.
Ownership of Microlending Sub-Companies
The new regulations state that each business entity can only be a majority shareholder for no more than two microlending sub-companies, or be the controlling shareholder (i.e. 51% ownership or more) of no more than one microlending company.
Our Insights: in addition to streamlining the regulation of microlenders, another useful purpose of this regulation is that companies will be encouraged to conduct greater due diligence in their lending activities. Microlending companies in China are structured as limited liability companies, so if many sub-companies are allowed, the parent microlender company would probably be less concerned with the default of just one or a few sub-companies since their other sub-companies would remain otherwise unaffected. Consequently, the parent microlender could be encouraged to take on greater risks and possibly more negligence in issuing loans.
How Does This Affect Ant?
Ant currently controls two microlending companies registered in Chongqing, one for Huabei and one for Jiebei. Under these new rules, Ant will have to merge the two companies.
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Conclusion - Our Insights
Generally speaking, the new regulations imposed on online microlenders are sound developments that are conducive to the facilitation of credit without compromising financial stability. The rules with regards to microlenders' sources of funding in particular target current regulatory weaknesses that are very reminiscent of the causes behind the global financial crisis. Caps on the maximum loan amount that can be given out, as well as the limitations placed on what loans can be used for, are effective measures that can help to prevent the buildup of excessive risk and a credit bubble. Suggestions for increased due diligence and monitoring of borrowers is of course prudent, but the latter can be difficult for microlenders to implement, and both are challenging for regulators to verify.
Ant's biggest hurdle will probably be satisfying the new funding regulations. The company's loan book is relatively large, and deleveraging will most likely hurt its profitability. Regardless, Ant will need to re-orient its CreditTech platform business model in order to fulfill the new regulatory requirements and continue to operate as a microlender in the Chinese markets. Once these requirements have been met, we could expect to see the company proceed in going public.
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