President of the China Microcredit Companies Association
I am so honored to discuss the business model of microcredit companies with you. As the representative of the China Microcredit Companies Association, we are facing the same problems as our members - that we are not a fully legalized entity. All data used today has been obtained from recent research conducted by our association, rather than the government database.
I. Basic condition of Chinese micro-finance companies
The market for micro-loans has experienced significant growth in recent years, with the number of companies increasing from only 497 in 2008, to 9420 by the end of 2014 (Figure 1). However, the quantity started declining in the second half of 2014.
Figure 1 the statistics of the growth of microcredit companies over the years
The challenge of quantifying microcredit companies has haunted us thus far. There are three methods that we can refer at the moment. First, the People’s Bank of China published quarterly data, which is relatively smaller than the other two sets. Second, Inclusive Finance Division of China Banking Regulatory Committee (CBRC) surveyed the number of microcredit companies in the first quarter nationwide and concluded that the number was 10,928. Third, our association collected data from the industrial and commercial registration system to acquire the largest population so far. This may be explained by a loss of data caused by failure of companies and delay of data written off in the system.（Figure 2）
Figure 2 the amount of microcredit companies
Figure 3 represents the distribution of the Chinese microcredit companies. Most companies are located in the northern region of China, particularly in the Northeast.
Data Source: The Industrial and commercial registration system
Figure 3 the distribution of the Chinese microcredit companies
The pie chart below shows the capital distribution of microcredit companies. More than half of the companies contribute 50 to 200 million Yuan in registered capital.（Figure 4）
Data resource: the investigation of the CBRC in the year 2015
Figure 4 the capital distribution of microcredit companies nationwide
From 2009 to 2014, the average growth rate of microcredit companies was 70% per annum, while the loan balance grew by 50% per annum. The members of our association spread over 36 provinces with 130,000 employees in total. The primary source of funding for microcredit companies is shareholder capital. External financing depends mainly on bank loans. Only 10% of funding for microcredit companies comes from banks. The SMEs that were beyond the financial support of commercial banks are major target market of microcredit companies in our survey. The credit available to SMEs represents approximately 43% of the Bank’s outstanding portfolio. Among those SME loans, 33% are agricultural business loans. The proportion of agricultural loans differs greatly between provinces. In terms of the policy environment, microcredit companies take the same responsibility as general businesses do on taxation. The comprehensive tax is about 20% to 30% of income. In the meantime, only 5% of the microcredit companies have access to the national credit reference system.
II. Chinese characteristics business model of microcredit companies
1. Business model of microcredit companies
Depending on the measurement of loan amount or of the number of valid customers, a micro-credit company can be categorized under two models: the banking model and the microcredit model. As we know, more than 90% of companies belong to the banking business model. For instance, the banking model is based on the analysis of capital flow through shareholders’ supply chain. Based on the deeply embedded banking practice, up to one-third of the microcredit companies with banking model applied bridge loans. Microcredit model, on the other hand, takes account of only 5% of the microcredit companies in operation that fully or partially in their loan portfolios. In fact, the microcredit model can be considered an imported good that developed from international experiences [at developing countries such as Bangladesh], some of which are related to the charity association. (Figure 5)
2. Customers of microcredit companies
The customers of microcredit companies are mainly microenterprises and individuals. The services include mortgage loan, credit loan and consumer finance.
Figure 6 Service Types of microcredit companies
Now I will share with you a problem discovered in the research. We, microcredit companies, prefer secured loans. However, the quality of collateral of our members is always low. This is because banks only take high quality customers and collateral. In this case, some practitioners propose a focus on credit loans, considering the banks have overwhelming superiority in the field of mortgage financing. When it comes to credit loans, new difficulties emerge. Due to a lack of sophisticated credit reference systems, good credit products are not available for microcredit companies. There are many other problems not mentioned here.
Speaking of mortgage loans, microcredit companies prefers physical collateral such as houses, vehicles, and equipment in the service of personal mortgage loans. For example, some companies still regard property as their first choice of collateral. Complicated operating procedures, long periods of assets realization, high litigation costs, tax costs taking 20% of the property, and other costs such as time, make property a bad choice as a guarantee.
Unlike the situation of mortgage financing, the market prospect of credit loans is promising, particularly for companies doing individual consumer finance in cities that covers variable fields such as shopping, renting, education, decoration, and tourism. However, consumer finance companies authorized by CBRC and P2P platforms are great competitors in this field, relying on the lower cost of capital and greater service efficiency. We still need to find a suitable model for our microcredit companies.
3. Operating cost of microcredit companies
Compared with banks and consumer finance companies, microcredit companies has higher operational cost. There is a common misconception by people, including supervision departments, that the profits of microcredit companies are equivalent to the profit that disclosed to the supervisors . However, this is not the case. Shareholders calculate the average financing cost of their core business before they consider whether an investment in microcredit companies is profitable or not. Only when the profit exceeds average financing cost, the investment is worthy. Otherwise, what are the incentives for them to invest in microcredit? The external cost of funding microcredit companies is over 12%, which is quite high for the shareholders. Furthermore, since we are not financial institutions, we must pay 5.5% of business tax and surcharges that apply to general enterprises, as well as 25% of income tax. In general, the total operating cost is up to 10%. Additionally, bad debt write-offs and NPL provision coverage also contribute towards tax costs due to their non-financing nature. The last part is the external financing cost. As we all known, funding in our society is abundant, but resources are very unevenly distributed [across the counties and provinces across China and segmented industry]. It is extremely difficult for microenterprises and microcredit companies to get external funding. Although the bank used to support some financing until recent years, the funding provided by banks has decreased gradually, particularly last year. Imperfect information, lack of a uniform rating system, and irregular operating, create a distrusting relationship between banks and microcredit companies.
4. Actual cost of microcredit companies
The average annual interest rate of a loan from microcredit companies is between 18%-24%. In fact, apart from contractual interest, the company has to undertake some other expenses, such as commission charges. In addition, I learned something interesting called equal payments of principal after I joined the microcredit industry, whose interest rate is higher than its monthly repayment and single end-of-term repayment. This increases the flexibility and profitability of microcredit companies, but exploits borrowers who are in need of a short-term or emergency loan. This is shown in Figure 7.（Figure 7）.
Figure 7 actual costs of microcredit companies
5. Interest rate of microcredit companies
In line with the interest rate, microcredit companies employ three strategies. The lower the interest rate, the harder it is to obtain cheap funding. In that case, an appropriate interest rate is significantly important. Many companies think that the only method of covering investment risk is to adopt a high interest rate. However, the high income comes with high risk, which is common sense in economics. According to statistical research from the microcredit industry, starting from an average interest of 15%, an increase of one percentage point will lead to a 1.2% to 2% growth on the rate of non-performing loans; if the average interest rate reaches 18%, the relative growth would be 2% to 3% in the relationship mentioned before. To put it simply, higher the interest rate, riskier the business.（Figure 8）
Data resource：Shaofeng JI - Nan Jing Jingdong Microcredit Company
Figure 8 Interest rate of microcredit company
6. Loan balance of per manager in microcredit companies
The loan balance managed by oneloan officer in microcredit companies insignificantly changed recently. This figure means the growth of the industry was driven not by the efficiency of loans of distribution, but by total volume of loan distribution. The leverage ratio also brought my attention in evaluating the health of our [microcredit] industry. It can be seen in Figures 9 and 10 below that the leverage ratio has continued to decline since 2012, because it has become increasingly difficult for us to access external financing.（Figure 9-10）
First quarter in 2012 First quarter in 2013 First quarter in 2014 First quarter in 2015
Figure 9 Loan balance of per manager in microcredit companies
First quarter in 2012 First quarter in 2013 First quarter in 2014 First quarter in 2015
Figure 10 the nationwide leverage ratio of microcredit companies
III. The prospect of microcredit companies
How to choose the suitable business model for the microcredit company? To answer this question, we should rotate the pyramid 180 degrees, and it becomes the pyramid with a black solid line (Figure 11). At the top level of the pyramid, competition from the banking and other large financial institutions makes it impossible for us, microcredit companies, to survive. In the middle part, the existence of P2P platforms cannot be ignored, as well as their influence. The third level of the pyramid is just in the shortage of financing support and service. The bottom is also not the target customer for microcredit companies, considering the basic threshold, that it should be profitable regardless of the business model. We are not a charity organization and business sustainability should be taken into consideration. As mentioned above, the middle part of the pyramid might be the ‘blue ocean’ for microcredit companies.
Figure 11 pyramid chart of microcredit
What is the best business model for microcredit companies?
Figure 12 choose best business model
Shareholders should first think about the strategic positioning of the companies as priority. We ought to think clearly about the reason why we invest in microcredit companies. As the owner and the founder of microcredit companies, you are telling the executives to determine the vision of the company and therefore execute the risk control methods. It is challenging to initiate and execute such strategies given the limited resources to run the [microcredit] company. According to our [association] statistics, on average, each firm only employs 12.2 workers. It is not easy to a company to execute a sound strategy with equivalent capacities including risk control, technology advancement and market positioning.
There is a lot we can learn from good practices worldwide on human resource management and technology advancement in the microfinance sector. Product innovation is another short plank for the microcredit company. In the research, most companies are still in the state of “Copycat”, particularly in the aspect of product innovation and channel innovation. I am glad to find some insightful lenders had their own methods that are worth being learnt. It is a good beginning. The last factor I would emphasis is capital of registration. It determined the capability of risk mitigation for our members as well as the capacity of leveraging from external funding partners. In my view, the microfinance market will further transform and segment through M&A, MBO, and other form of restructuring in the near future. Few companies might even evolve into holding groups. Variable sub-fields emerge such as supply chain finance, consumer finance, country-based microcredit, tech-based microcredit, commonweal microcredit, internet-based microcredit etc. Of course, there are still parts of microcredit companies following the local business model, who only server the small-scale and acquainted clients. Finally, the company with the fittest business model will survive.
IV. Responsibility of the association
1. The regulation of promoting relevant industry
We had solicited the advice from all the provincial governments over the nation on microcredit regulation last year, and the twelve departments of the central government have reached an agreement with only a few different opinions on the detailed implementation. It was suggested that a superior law should be issued on SME lending before further augments arise on the regulation of microcredit companies. Actually, depending on my thirty-year working experience, it does not matter. We are still working on the promotion of the relevant industry regulations. After all, something is better than nothing.
Figure 13 relevant industry regulations of microcredit companies
2. Reinforce the infrastructure construction
We are determined to advocate the wider accessibility of credit infrastructures for our members including the credit reference system. Our proposal will be published shortly on our website for membership services including standard rule of submitting statistics, intra-firm network service and data processing systems, assign ratings of all the members, promote the development of credit reference system, uniform the elements and format of the business documents of microcredit services as well as those of the loan contact.
3. Establish the training system
In the aspect of training, we have executed customized training in Da Tong, Shan Xi province. The second course will start next week.
Figure 14 training system in the microcredit industry
4. Strengthen investigation and propaganda
Right now, there are four main research topics: research on the taxation of microcredit companies，bank financing of microcredit companies, the construction of microcredit companies’ industry fund, and the further development of the business model. Parts of the local associations will participate in this investigation together.