Tightening regulation will negatively affect the Chinese fintech companies’ profitability. However, the impact on industry leader Ant Financial Tech is relatively small. The new rule will drive industry consolidation and benefit Ant Financial Tech in the long term.
New regulation hinders the fintech companies’ online lending business
The Supreme People’s Court in China has recently revised its regulation over private lending, which applies to the Chinese fintech companies’ online lending businesses. The new rule reduced the legal protection for the fintech companies if their customers default the loan payments, clouding their future profitability outlook.
The old regulation, which the industry refers to as “two lines & three zones”, was enacted in 2015 and has shaped how fintech companies set their lending rates. In the old regulation, the court will protect the lenders’ interest and require borrowers to pay the interest and principal in full if the loan’s annual interest rate is below 24%. If the annual interest rate is between 24% and 36%, the court will facilitate negotiation and settlement. If the annual interest rate is above 36%, the court will not support lenders’ claims.
The new regulation lowered the old “protective line” 24% to four times of 1-Year LPR (Loan Prime Rate). Based on the current LPR rate of 3.85%, it means that the court will only protect the lender if the loan that borrower defaults on has an annual rate below 15.4% vs. 24%.
The new regulation increases the risks for Chinese fintech companies, in terms of the default rate. Based on third-party data, most Chinese fintech companies’ consumer loan rates are well above 15.4%. For most of the products they offer, they peg the rates to the old 24% / 36% lines to maximize the profit within regulation’s risk protection. If the new rule is strictly enforced, these companies may have to lower their rates again, which will hurt their profitability.
Near-term impact on Ant Financial Tech is manageable, and the industry consolidation benefits the leader
On September 9, Ant Financial Technologies responded to Shanghai Stock Exchange’s several inquiries regarding its business as part of the listing process. Ant Financial Tech discussed the impact of the regulation changes on one of the topics, citing the new regulation regarding the lowering protective interest rate will increase its cost for regulation compliance, but not jeopardize its business model.
Despite the near-term headwinds from regulation, likely, Ant Financial Tech will eventually benefit from the potential industry consolidation and take more market shares.
First, most of Ant Financial Tech’s consumer loan products are already compliant with the new regulation. "Jiebei," the consumer loan product of Ant Financial Tech, now has the annual rate ranging from 6% to 20% depending on the customers’ credit scores, with most users getting quoted around 10-15%. Jiebei's rate is below the new 15.4% rate and well below industry competitors’ rate ranges.
Second, Ant Financial Tech has already successfully transferred its consumer loan business from to-C to to-B, which is less exposed to changing interest rates. Instead of interest income from loans, Ant Financial Tech’s loan business’s primary revenue now comes from financial institutions' commission fees by providing them with services including customer acquisition, credit checking, risk management, etc. As of June 30, 2020, the loan outstanding financed by Ant Financial Tech’s balance sheet only accounts for 1.68% of the total loan outstanding on its platform. The financial institutions provide the capital for the majority of the loans. They earn most interest payments and pay Ant Financial Tech mostly in commissions for the services.
Thus, the changing regulation on the interest rate will mainly affect these financial institutions. In contrast, Ant Financial Tech’s revenue exposure to interest rates is minimal. However, Ant Financial Tech may need to burden some of the costs from its partners. But Ant Financial Tech should have strong bargaining power, as it’s the most extensive online market place for loan products, and it has around 100 financial institutions as its partners.
Third, the smaller fintech companies will suffer the most from the tightening regulation, leaving more market share for Ant Financial Tech to pick up in the long run. Compared to Ant Financial Tech, most small Chinese Fintech companies have much higher operating costs. The disadvantage in business size, data technology, and sales channels leaves these companies with much higher costs for customer acquisition, capital introduction, credit inquiries, and online payments.
Besides operating costs, smaller fintech companies typically have much higher rates of the bad account compared to Ant Financial Tech. It is partially because of their inferior data analytic technologies and risk management and the lower quality of customers.
Most of the lower-tier Chinese fintech companies need an annual interest rate above 20% to maintain profitability. If the new regulation is strictly enforced, the overall industry’s profitability will be lowered to a level to push out many small players.
In conclusion, the new regulation is a headwind for the Chinese fintech industry and will accelerate industry consolidation. Despite the near-term challenges, Ant Financial Tech is likely to benefit from industry consolidation in the long run.
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