Interviewed By The Asian Banker Live
Soul Htite, an original co-founder of Lending Club and now the founder of Dianrong, a marketplace lending platform in China, compares the development of peer-to-peer lending between the US and China, and reveal plans for a new supply chain financing platform in the country.
Here is the transcript of the video.
Emmanuel Daniel (ED): I’m very pleased to speak with Soul Htite, an original co-founder of Lending Club and now the founder of Dianrong in China – progressing the peer-to-peer (P2P) platform universe and probably one of the few people who are familiar with how it’s been developing in the U.S. and now in China. Tell us what comes to the top of your mind in terms of the biggest difference between peer-to-peer in China, as opposed to how it is evolving in the U.S.
Differentiating P2P between China and the US
Soul Htite (SH): In the U.S., the idea of a peer-to-peer company is to create a good product both from the borrower side as well as from the lender side that did not exist before. We improved the level of finance industry that was happening in the country. But in China, that same idea is about building an infrastructure that did not exist before. When in the U.S., we are able to reduce the interest rates for a borrower by 4 or 5 points; in China, we are able to give loans to people that were not able to get a loan before.
That is because of the structural imbalances of the banking system in China, where you are left with two choices. You are either someone who has assets and can apply for a loan at a bank and if you’re not accepted, you have no choice but to go to the shadow banking.
ED: So it is more of a financial inclusion than in China – Bringing on board an entire part of the population that has not seen credit before?
SH: Not exactly. The financial inclusion is definitely there. But it is more about building infrastructure to make retail lending, especially to consumers a reality. China has not been known to have a very strong retail lending business…
ED: To start with.
SH: To start with, exactly. So these solutions that we built in the retail market are applicable both for core industry, as well as for financial inclusion.
ED: You are trying to bring this conversation with banks into the picture in China, where actually that conversation is further down the road in the U.S. In fact, sometimes, marketplace lending can be said to be an originator for banks. That is how banks seem to be relating with the P2P players; whereas in China, that whole origination process is still in its infancy. It is huge. It is self-sustainable. They don’t need to have that conversation with the banks.
SH: Right. Back to the same point again, U.S. banks have a history of 30, 40, or 50 years of retail banking. They know how to get assets by themselves. When we came in, we focused mainly on what I call the “logistics of finance”. Reduce the cost: the cost of acquisition, the cost of preparation, and the cost of getting access to a diversified portfolio. In China, again, we created a market that did not exist before and that is the key.
So, if I have to find another analogy, I would compare it to what Alibaba does in e-commerce, where they had to create payment logistics and everything all together with Amazon; where they just focused on the choice of the product and how to make the experience seamless. But they relied on FedEx and other institutions to do the rest. That is the main difference between the two.
ED: Being a founding member of an industry as a whole in 2007 or 2008, what was it like then? What is it like now in the U.S.? Why was not possible for Lending Club to go into China as a lending club?
SH: It has been exactly ten years since we started Lending Club. Five years in the U.S., five years in China. I saw a shift in the way the business model is done in the U.S. Originally, when we started, it was a marketplace where borrowers are individuals and lenders are individuals as well. But the pressures on these companies to have more volume and competing over capital have made them choose to work with institutions. So, not necessarily banned, but they also work with whatever capital is – hedge fund, large family offices.
You saw at one point, Lending Club, for example, was originating more than $1 billion a month. Half of it did not come from retail – it came from institutions. The interesting part in China is we might think that we have a problem on the borrower side. But the biggest problem in China is you have so much capital in people’s hands, but no investment opportunity. So there is a report by Oliver Wyman that is loans that should have been given, but they are not financed. It’s a perfect ecosystem environment for –
ED: The Chinese are responding to that by recreating themselves as a wealth management place to some extent and even institutional investment platforms, rather than peer-to-peer. In the U.S., I think, we sort of kept that… as far as possible. What’s happening at the back end of the mechanics? Because part of the reason for the institutional fund managers and hedge funds to come and put in bags of cash in front of these platforms is because of the return, right?
ED: Given in the markets you have much lower interest rates and that the whole process is a very relationship-driven back of the scene, non-technology-driven dynamics.
SH: It’s more finance than technology.
ED: So, what’s happening in that and how it is different in China as opposed to –
SH: First of all, I don’t believe that companies in China are moving to wealth management and not focusing on P2P. To start with, we focus 100% on P2P. We have other verticals as well. But we’ve been doing super well and it’s been attracting 3.7 million lenders. It works. We’re not going to change it. We’re going to continue growing it. It’s a good part of our business. But I think what happened here is we are teaching investors for the first time how easy it is to use your mobile phone to access investment product. So, it is natural that they’re going to ask for more and more investment assets that they can relate to.
On our platform, for example, I always have 20% to 30% more capital than assets. So, yes, we do get phone calls from our customers who are interested in making investments outside of China. Do you have any investments related to real estate? There is. These requests come in. The demand on the capital side is really big.
Industrialisation of the credit business
ED: What would you say would be the big challenge in the industrialisation of the credit business on the borrower side? Again, what would the difference be between the U.S.?
SH: We go back to the model that the U.S. created, which is a credit bureau. Everybody has a FICO score. With that, I can do a lot. It does not exist in China, even though China has the world’s largest credit bureau, because we have shadow banking. If you ask the companies that participate in shadow banking, which are small loan companies and guaranty companies, to start reporting back to the credit bureau, it’s a nightmare. It’s not going to work because you have to make sure that they’re reporting correct and they don’t have enough operations capability to do it.
We’re going to live with this shadow banking, which is about 25 percent of all the financial transactions that happen, for a while. Innovation is really starting there because that’s where the need is. Anything and everything we do on the borrower side, whether for inclusion or for everyday business, is to reduce the cost that the borrowers have to pay. We need to reduce it enough to make them capable of paying back the loans. We need to reduce it enough and use data instead of using assets to do business with them. In that sense, we are discovering a new market, a greater and new market…
ED: Consumer credit… for paying in terms of cost of credit is different from small business?
ED: What do you, at the top of your mind, think would be a sustainable credit cost in an emerging market and in a developed market?
SH: Really look at the inflation and you can try to come up with a number. But I’d like to stress one point, a very important point. It’s not a question of capital, but it is a question of product. I’ll give you an example of a very successful product. We give loans to restaurants. The typical loan is that you make monthly payments. This qualifies as a small business loan. We came in and we created a new product where the payment is daily because the cash flow of the restaurant is daily. With that product, we reduce the interest rate by 25%, so the all-in cost used to be 40%, 50% from shadow banking.
We gave them a 14 or 15% cost of capital. We are able to scale it to a very large amount. What is needed is product. In order to create this product, you have to create infrastructure that allows this product to exist. That is why it is much larger than any other market…
ED: What seems to be happening in the developed world – and it’s not just the U.S., but Europe as well – is that because of competition and because it is such a narrowly defined industry, the industry seems to be going into more and more high-risk credit, like car loans and resale car loans. Do you think that is a necessary path? Do you think that more and more P2P players in the West will be taking on higher risk products?
SH: They don’t need to. Take the example of Lending Club and Prosper in the U.S. Ninety percent of the customers are transfers. It’s easy for them to take customers away from banks. You have $20,000 credit card balance; I’ll give you a 4% or 5% discount to bring it back to my platform. The efficiency savings between marketplace lending and the typical bank loan that was provided to the customers – the difference is big enough for them not to have to go to these risky assets. But what you call risky assets, I call markets that have not yet been served. Car loans could be very safe if you have the right products. Car loans could be very safe with the right pricing or the right credit risk management.
Ensuring a secure P2P platform
ED: You’ve watched how the Chinese flavour has been evolving. If you remember, Ezubao, the big fraud that happened – the world’s first large-scale Ponzi scheme on peer-to-peer. That’s the big fear that lots of investors have about peer-to-peer platforms and almost anywhere where it’s new. What are the safeguards? How do you separate the good boys from the bad?
SH: Yes, that was a very sad example. Ezubao happened in fintech, but it could have happened in other industries. The criminal mind always thinks of ways to fraud people.
ED: But just the governance structure – in China, there was no law until this year or last year.
SH: Right. So, if you take the regulatory guidelines that came out eight or nine months ago, there will never be another Ponzi scheme. The solution is very simple. We require all platforms to use a custodian bank account. If you have a custodian bank account, we would know because we go through the banking system on who you’re sending money to. If you have fake assets, we would know. If you have real assets, we would know. The thing that impresses me the most is that how regulators are actually looking at our problems and directing us.
Out of those… regulators, there are five items that I thought were amazing. The first one is the custodian. Another one is as an industry, you say that you are helping consumers and small businesses. How about if I give you a maximum that you cannot go beyond? That way, we understand that we want you to go into that direction. Third one, as a borrower, you cannot borrow from more than five platforms. How do you think our industry is going to be able to impose that? It’s by having a central place that counts how many times did you borrow?
That is preparing us to become a contributor to the credit bureau. We are growing, we are maturing. The regulators are actually helping us having good layers of the…
ED: When you think about the traditional credit bureau model that the banks use, when you think about the P2P lenders like today, maybe that’s exactly where the problem was because on the one hand, the banks have industrialised credit using the credit bureau scheme, but it only reaches a certain class of customers. The reason there’s a business case of P2P is because of the paling of the traditional credit bureau. You seem to be suggesting that a shared infrastructure for credit is the same thing that you need to recreate now for P2P.
SH: I probably have a different answer to what you’re expecting me to say. In my opinion, the real value of the credit bureau in the U.S. is not only the pricing. Yes, I know the FICO score, I know the DTI. You have to pay 17.35%. The real value of the credit bureau is the collections. As a customer, you borrow from me, whether you borrow $20.00 or $100.00 or $100 million, it costs me absolutely nothing to report that you are not paying back your loan. So, it’s a very strong collection tool. In China, I cannot use that same thing because even if I report back to the credit bureau, you have 25% of the market that you can borrow from.
What we need to do is not to take what works in the U.S. into China, but to find solutions. How do I do collections –?
ED: And how have you been finding solutions?
SH: That is a very good question. If you are a borrower on our platform, we choose to work with you through a company that you work with. With the announcement that we made today, where there’s a strong relationship between you as a supplier and the core company, so you have all interest in making sure that you pay back your loan. Otherwise, you are risking the relationship between you and your supplier. Or if you are a truck driver for a logistics company, you need to fill your truck with gas all the time. If you don’t pay back your loan, you’re going to get punished by the logistics company…
ED: So, you’re working out the supply chain?
SH: That’s one example. But the philosophy is the same.
ED: In China, the supply chain works. In other words, as long as you belong to a supply chain of distributors and manufacturers and so on, you can work that. Actually, several of the peer-to-peer players take that model from different supply chains….
SH: I think what you announced today is much bigger than that example. But let me not confuse you. Let me bring you back to how do we make sure we get collections for almost free. Our way of acquiring borrowers is not to go directly to the borrower and have him borrow directly from us. We work with large companies. A logistics company, for example, has thousands of truck drivers that deliver to thousands. They always need gas to deliver. So we are happy lending money to these drivers.
They’re not employees of the logistics company, but if they don’t pay their loan on time, they will not get any business back again from the logistics company. The logistics company wants us to pay them because it increases their…
ED: Have you tested this proposition in other large markets? India, Indonesia, Brazil, South Africa? Countries with more than 100 million people? Are they all the same? Is it generally applicable?
SH: I would guess it is, but to be honest with you, China is just a big market that it can keep us going and busy for many –
ED: Is China another extreme of the spectrum?
SH: We chose China to do our business because of three reasons. The first one, internet is available and we are an internet company. Second, there is a very good system of laws. So even before we –
ED: An identity.
SH: Absolutely. So, even before we arrived, if you borrow money from me and you don’t pay, I can sue you and go in front of the judge who passes the rule. The third one, Chinese and the Chinese culture, creates people that have an entrepreneurship mentality.
ED: Using the money for something.
SH: Yes, I have to make more money. In Europe, people are more focused on joie de vivre, on enjoying life. It’s not really the same hungry mentality that we need to create things. China is perfect in that sense for our business.
ED: Do you think that with interest rates on the uptrend, led by the U.S., it will have an effect on fintech? Because of investments that fintech can when interest rates are low and the cost of funds is low and the difference between the kinds of money that we need available as the cost of funds goes up? And the lending business itself, especially with the uptick on interest rates.
SH: We always get asked that question. We always try to answer that the beauty of the marketplace lending business model is to never have a balance sheet. So, you’re not really affected by interest rates going up or interest rates going down. What you do when interest rates fluctuate, you adjust your pricing accordingly. If people are able to borrow at 3% more than what they were borrowing, you have to adjust your rates.
ED: So the rates will always be transparent and –
ED…Will always move. But the people lending would then have other sources of attractive income.
SH: True, but the difference between the asset class that we created is a fixed income product with attributes like no correlation between the asset and very predictable. Yes, you can even make the points before interest rates change. Why not invest in the stock market? Because you want to diversify. You want to have this type of investment and you want to have fixed income. There are different reasons why. We are not saying that one asset class is better than anyone else. It’s better today. It’s competitive tomorrow and it’s not.
ED: But in China, a lot of that lending and borrowing doesn’t actually take place on the platform. The credit checks that we need to do are done manually. The lenders are coming with… money to ask you to deploy that. How much of lending takes place on the platform?
SH: In general, 100%. Our model does not start from the capital. Our model starts from the asset. We are a pure P2P platform. That’s why we are classified No. 1 in compliance and No. 1 is transparency. We start from the borrower. We underwrite him, we get all the information, and we price him. So, because you’re 32 years old, you’ve been living at the same place for 12 years, you have two kids, you’re stable, you’re going to pay less than another person. We put him on our platform and we don’t make the decision for lenders. They look and they pick.
I want to lend money to people that are coming from Shanghai. I want to lend money to women because I think women don’t have enough opportunity as much as men do and they are better borrowers, to be honest with you. So, it is a pure P2P platform. Everything for us happens on the marketplace.
ED: But there comes a point where regulators will say you may be an exchange, and they do this to traditional exchanges already, asking you to put capital into it, asking you to put liquidity into it. Almost as if you’re holding the risk.
SH: We see exactly the opposite. We see exactly opposite signs from the regulators. Again, part of the other five items that I was saying, I said three, one of the reasons you cannot guaranty anything, whether it’s returns or maturity. We want you to be a completely independent platform and do not participate in the transaction. No, I think they are really supporting the marketplace pure P2P model.
Blockchain and the P2P model
ED: You talked about how you’re building your supply chain-based network in China. One very interesting question I just wanted to explore with you is, do you think that blockchain would add to that at some point? Like is it a natural model for strengthening that approach?
SH: What we announced today is probably the biggest fintech project I’ve ever worked on in my life. It is really a revolution for how a supply chain works. Let me tell you what I mean by that. Suppliers are not created equal. There are different levels of suppliers. The car that is made by Ford, there is someone who delivers the dashboard. That supplier relies on other suppliers and other suppliers and other suppliers. In any country, whether it’s China, Mexico or India, only level 1 gets funded. People that are in level 1 are no more than 15 percent of the whole chain.
With our solution, with what we announced today, is it doesn’t matter which level you are in. It doesn’t matter how much you’re borrowing, whether it’s $300 million or $100,000. With our solution, we guaranty you that you’re going to get funded. Because with blockchain and the ability to create a trustable system that carries out the relationship between levels 1 to level 2 and so on, we maintain the creditworthiness of every supplier participating in that project directly linked to the core company. What we announced today is Fincon, which is the supply chain finance company and Foxconn, is part of the solution with us together. That is, by itself, a revolution in the way –
ED: The troubling thought about blockchain, and all people in finance speak about in blockchain is, they want to make themselves the centre of blockchain. Whereas, the original idea of blockchain was that there was no centre. There is no broker.
SH: There is absolutely no centre in blockchain. What blockchain is, if I had to find an analogy for blockchain, is the internet itself. There is no centre.
ED: Right, and so by taking that approach, you’re putting yourself in the centre of making that value chain work. Either that or you’re opening yourself to competition because anyone else who’s planning to do it can take your customer away from you.
SH: Absolutely, we are not saying that – in our statement today, we said that first, we are inclusive and we don’t say that we are the only one in the world that can do this. Other people can do it.
ED: It will be very interesting to see how you evolve if you keep the originality of your thought. Just two more questions.
ED: Your conversation with Chinese banks. And here, one thing at the back of my mind is this – they make as much money from trust companies as part of the –
SH: So you do know how the whole thing works.
ED: Yeah, so are you just another trust company?
SH: No. I’ll give you three examples of our relationship with banks. No. 1, Standard Chartered Bank and Qingdao Bank are investors in the company. No. 2, if you look at Suzhou Bank, which is a City Commercial Bank, Bank of Suzhou. We created their whole fintech platform. It’s the same technology that Dianrong has, we gave to them. And they are operating it as a marketplace. It’s growing. No. 3, with solutions like what we came up with today and with other solutions, we are helping banks to access good quality assets. I don’t believe that an economy can exist without banks.
I don’t believe also that what banks do offer today is enough of an infrastructure so we can fund all the billion people that are going to be living in the cities or the seven billion people we have around the world. If you double or even triple the bank capacity that we have today, there is no way we can help all those people that want to borrow money for a car or go to school. The only thing that I know of that has the ability to create a large-scale solution is technology. They know that as well. That’s why there are very interested in what we do.
ED: Final question. Your biggest competitors – Lufax, CreditEase, and now Alipay – they seem to have the payment component to what they do and you’ve not spoken about payments at all.
SH: I don’t think Lufax has a payment component.
ED: Sorry, credit.
SH: Alipay does.
ED: Alipay and the other one is China Credit has or Credit China, something like that.
SH: We think payments and credits are completely different.
ED: Sorry, Lufax and CreditEase talk about wealth and the other two talk about payments.
SH: I’m not saying we don’t have wealth management. I’m saying that P2P has been working perfect for us. Our default rate so far is 2.4% of everything that we issued, which is $26 billion. It’s not a research project. It’s a real business. It’s working for us. Our customers are happy. We’re going to continue growing. We are developing other things, including wealth management as well. The difference, I think, is that Dianrong, we have a strategy that we started four years ago and we maintain our focus on it. We keep building on it. We don’t change our strategy every three months, every four months. It’s really working for us and it’s solid and we’ll continue doing it.