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China's leverage caps on microlenders bring Ant's regulatory risk to forefront

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China's move to cap the leverage for microlenders is likely to have only a limited impact on Ant Group Co. Ltd., analysts said, although the policy change highlights the regulatory risk that concerns some investors ahead of the company's upcoming mega IPO.

The China Banking and Insurance Regulatory Commission said Sept. 16 that funding from banks and shareholders should not exceed a microfinance company's total net assets. Funds from bond issuances and standardized securities should also not exceed four times a company's net assets. The rules, the banking regulator said, were "urgently needed" to help curb regulatory arbitrage and implement unified supervision while boosting services to small businesses and low-income groups.

Microlending surpassed mobile payments as Ant's biggest revenue contributor in the first half of 2020, according to the company's preliminary IPO prospectus. As of June 30, the Alibaba Group Holding Ltd. affiliate's balance of loans to consumers and small businesses totaled 2.154 trillion yuan, up 7.0% from 2.014 trillion yuan as of end-2019.

The policy did not say whether the caps apply to the parent company or subsidiaries that are directly facing the borrowers. Ant's end-June audited consolidated net assets attributable to the owners of the company totaled 208.26 billion yuan. The company did not disclose net asset figures of its microlending subsidiaries and the loan balance of each subsidiary.

"The Chinese regulatory landscape may be rapidly evolving, but it is still playing catch-up with the fast-changing fintech business models," said Sampath Sharma, an analyst at S&P Global Market Intelligence. "Ant has demonstrated in the recent years that it could quickly make adjustments to its business models and discover new revenue levers. While we think Ant will remain on the growth trajectory, investors should expect upheavals along the way," Sharma said.

Ant has already shifted its lending business toward a partnership model whereby most of its lending is underwritten by partner banks, Sharma said. "As its lending exposure through small finance units appears to be limited, this regulation itself may not have a significant impact on its business. That said, the company’s lending business faces a variety of headwinds, including regulatory risks and growth constraints."

Delicate balancing act

Since late 2017, Beijing has been trying to manage the growing financial risk of nonbank microlenders while maintaining funding access for individuals and small businesses that depend on them. Such a balancing act has become more delicate as traditional banks are reluctant to lend to clients with weak credit profiles amid a slowing economy.

"We feel the government is somewhat more comfortable with the risks based on the current set of regulations. Our impression is that it will be more about tweaking current regulations that are already there, than promulgating new regulations," said Zennon Kapron, Director of Kapron Asia, a Singapore-based financial technology consultancy.

Kapron said a number of small and medium enterprises and retail customers said they used these nonbank platforms "to really help them survive this market" while banks are pulling back and becoming risk averse.

Ant matches potential borrowers with about 100 banks and trust companies through its popular lending apps such as Huabei and Jiebei on its mobile payments platform Alipay. As of end-June, about 98% of its credit balance was underwritten by partner institutions, or securitized. Partner banks include its 30%-owned virtual bank Zhejiang E-Commerce Bank Co., commonly known as MYBank.

Ant conducts its microlending business through various subsidiaries including Chongqing Ant Shangcheng Micro Loan Co., Ltd. and Chongqing Ant Small and Micro Loan Co., Ltd., according to the prospectus.

Sensible business model

This business model "makes a lot of sense," Kapron said. "Ant's expertise is technology, while banks have large balance sheet oftentimes not fully deployed and have a lot of deposits. Also, in China, there is no robust credit database of [small and medium enterprises] and individuals, while individual financial institutions have their own database."

In the first half of 2020, Ant's revenue from microlending rose 59% to 28.59 billion yuan from 17.93 billion yuan a year earlier. Mobile payments, once the company's biggest revenue source, reported an income of 26.01 billion for the six months ended June 30.

Chinese microlenders were often seen as a source of hidden financial risk outside the formal banking system. High interest rates, over-borrowing and improper, sometimes illegal, debt collection practices also became a social issue. Thousands of peer-to-peer online lenders in China were shuttered over the past couple years.

The government recently created a framework to bring nonfinancial companies under the central bank's oversight. In response to that policy, Ant said in the prospectus that it plans to apply for a financial holding company license via a wholly owned unit, Zhejiang Finance Credit Network Technology Co., Ltd., which will be holding Ant's licensed financial services subsidiaries.

As of Sept. 16, US$1 was equivalent to 6.76 Chinese yuan.