Dr. Mo Xiugen: Appreciate the Benefits and Risks of Microlending

About the Author:

Dr. Mo Xiugen is the Director of Research at the Chinese Academy of Financial Inclusion at Renmin University of China (CAFI). Prior to joining CAFI, Dr. Mo served in public sector and international and domestic NGOs in a variety of capacities including Deputy Department Director, Deputy Division Chief, Researcher, Project Director, and Policy Director, among other roles. He holds a Ph.D. degree in Economics from Department of Finance and Economics, College of Business, Mississippi State University, and an M.S. degree in Agricultural, Environmental, and Regional Economics (AEREC) from Pennsylvania State University. Dr. Mo’s academic endeavor focuses upon financial inclusion, rural economy, and the impact of projects and policies, and he particularly specializes in modeling and analysis methods of panel data, non-experimental data, time-series and spatial data.



Those who have ever used Ant Financial’s Huabei and Jiebei or WeChat’s Weilidai almost invariably sing praises for their utility and flexibility and cannot live without them once their use of these services becomes habitual. In actuality, there is a cornucopia of similar offerings in the market in addition to the aforementioned three, with notable examples being JD Finance, CredEx, and Ping An Puhui, all of which are provided by microcredit companies.


Although China’s microlending sector is far better developed than in many other countries, some consumers are nonetheless reluctant to take advantage of these service offerings that are the envy of the rest of the world, lest they are exposed to risks. The costs of this risk aversion are the embarrassment of living off of a shoestring budget and the failure to seize business opportunities due to liquidity constraints.


As a matter of fact, from a consumer’s vantage point, hardly does borrowing from a microlender pose any risk. It is the lender who, by lending to consumers, bears the risks. Taking risks and earning their own keep, microlenders provides a significant number of micro-, small, and medium-sized enterprises (SMEs) and disenfranchised populations with lending services that are fractional, dispersed, easy to use, and fast.  


Recently, in a joint effort with China Micro-Credit Companies Association (CMCA), Chinese Academy of Financial Inclusion at Renmin University of China (CAFI) conducted a survey on 399 microcredit companies and ran a reasonably vigorous quantitative analysis. We find that 49.85% of all the loans originated by microlenders are below RMB10000 and 48.17% fall within the range between RMB10000 and RMB50000, indicating a clientele mainly consisting of SMEs and other vulnerable segments. Moreover, microcredit companies also play an oversized role in promoting the adoption of Fintech, nourishing micro economy, and stabilizing employment.


Through its research, CAFI also identifies certain pattern that exists in the sector’s risk profile. A close scrutiny of the following 10 attributes of a microcredit company can tell us what potential risks a lender bears and what measures can be taken to tackle those risks.




Maturity of the Company

China’s microcredit sector is relatively young given that only after the passage of the Guiding Opinions on the Pilot Program of Microcredit Companies (CBRC Official Dispatch [2008] #23) in 2008 did the sector take off. Lending business is inherently risky and it takes time for a lender to accumulate experiences necessary to make sound judgment on a borrower’s solvency or cash flow of a business operation. Data show that the longer a microlender is in operation, the lower is its NPL ratio.   



Quality of the Workforce

The importance of the quality of the workforce is self-evident but workforce composition is also critical. According to CAFI research, some microcredit companies retain on their payroll considerable numbers of risk control staff but fail to lower their NPL ratios, and it is also true that increasing the portion of employees without college degree has no effect whatsoever on containing NPL ratio. What works is to increase the portion of employees with graduate degrees or higher in risk management functions.



Repayment Methods

Four repayment methods are widely used by microcredit companies, namely: repayment of principal and interest accrued at maturity; equal principal payments per time period; equal total payments per time period, and interest-only payments. Most of the lenders prefer either interest only payments or repayment of principal and interest accrued at maturity and lenders that adopt only one of these two repayment methods accounts 44% and 20%, respectively, of all lenders. However, these two methods prove having no effect in alleviating the lending risks and only equal total payment method can visibly reduce delinquency and default rates.



Loan Uses

The once attention-grabbing “cash loan” is a class of lending product that does not stipulate how the borrowed money can be used and is suspected to bear higher than usual risks. Our analyses find that lenders with higher portion of cash loans in their loan portfolio also have higher delinquency rates but their overall NPL ratios did not see significant increase. It appears that among the cash loan lenders, some did fail to make loan payments in a timely manner but rarely did they default outright. Moreover, cash loans only constitute a negligible portion of the sector’s total loan portfolio and therefore, does not merit much concern about their imposing significant risks.



Loan Terms

The most popular loan terms are between six and twelve months with over 80% of the lenders offering loans of such terms. This is sensible because it is noticed that as the percentage of three- to six-month loans in a lender’s loan portfolio increases, also increases the NPL ratio.



Loan Conditions

Collaterals and guarantees are trademark risk mitigation methods adopted by legacy financial institutions, whereas unsecured loans are generally viewed as highly risky. In reality, however, collaterals and guarantees could only lessen a lender’s losses but could not reduce the inherent risks. CAFI’s analyses find that increased percentage of unsecured loans in total loan portfolio does not significantly increase delinquency and default rates. 



Clientele Served

The stated mandate of microcredit companies is to serve the micro economy as well as agriculture, farmers, and rural communities, all of which are perceived as highly risky by legacy financial institutions. In reality, most of the microcredit companies succeed in adhering to this mandate, with 35% of all surveyed counting farming, forestry, animal husbandry, and fishing sector as their number-one priority segment, and 60% listing retail and wholesale trade among their top-three priority segments. 78% of all the loans originated by microcredit companies are used for SMEs and self-employed business operations. We did not find a visible correlation between such clientele and delinquency rate or overall NPL ratio.



Leverage Ratios

Due to the regulatory restriction on how much leverage a microcredit company can take, at present, the sector’s overall leverage ratio, below 89%, is relatively low and nearly 80% of all surveyed is not leveraged at all. When a lender’s leverage ratio increases, so increases its delinquency rate but its NPL ratio does not increase in tandem. Leverage ratio here is defined as debt-to-equity ratio, and the more debt a lender takes, the number of borrowers it serves also increases, and so do the stresses on its management capabilities, resulting in higher delinquency rate.



Web-Based or Brick-and-Mortar

Going online is a trend development that the sector adopts and at present 99% of the clientele microcredit companies served are online. This contactless service model looks suspicious to some people, who are skeptical of the service’s accountability and such skepticism on the counterparty’s good will is mutual. The reality proves a stark contrast: web-based lenders enjoy lower delinquency rates and NPL ratios than their brick-and-mortar peers.



Geographical Distribution

Microcredit companies in certain regions appear to be more susceptible to risk events than those in other regions. In regions where microlenders cluster and amount of loans originated per employee is relatively high, risk events also tend to abound and NPL ratio higher. It is probably because of the lack of regulatory capacities and could also be an outcome of differences in social, economic, cultural and financial environment differences or of fierce competitions within the sector.