Alibaba lends smarter in China; Lending arm uses information instead of assets to be sure of loans

November 5, 2013 2:27 pm

Alibaba lends smarter in China

By Paul J Davies

Lending arm uses information instead of assets to be sure of loans

Wantou is a small village in the flat farmland of Shandong province about 350km south of Beijing. It has little to set it apart from hundreds of thousands of similar Chinese villages but for one thing – a long tradition of wicker and straw handicrafts that are becoming hugely popular among online shoppers. The An family, the first to start selling their handmade homewares, have been profiled by a number of Chinese news outlets after becoming wealthy from their trade and encouraging friends and neighbours to follow suit. This has turned Wantou into one of retailer Alibaba’s “Taobao Villages”, where groups of people form a mini-industry by selling similar products online. Their activity can boost the local economy by creating demand for other goods and services.This is the private parallel economy that is one of the big reasons to be optimistic about China’s continuing development. Business is happening not only without the help of the state-owned banking and industrial complex, but even in spite of it.

How these villages work and particularly how some of their small businesses are being financed is a step straight into the future that sets an example not only for the developing world, but for the developed, too.

Five years on from the financial crisis, small businesses in the west still struggle to borrow money from banks. Recent figures for the UK, for example, showed that lending to SMEs from banks has continued to shrink since the crisis in 2008, though the pace of decline has eased.

This has led alternative forms of lending to grow substantially to help fill the gap. Asset-based lending is one big stand-in. This lets companies lease equipment and borrow against physical assets, or even financial assets such as credit card receivables, popular for restaurants and bars. There is also peer-to-peer lending, where small businesses or individuals can borrow from other individuals online. This credit is often secured against property or invoices, but the cost can still be high as borrowers compete for limited funds.

In China, the internet powerhouse Alibaba has come up with something quite different. The still small, but fast-growing lending arm of its Alipay business is using information instead of assets to be sure of its loans. It collects data from all the buying and selling on Taobao – which conveys 95 per cent of small business and consumer-to-consumer ecommerce activity in China – and from other ecommerce markets where Alibaba has a lesser share. Alipay itself has a 45 per cent share of the online payments processing market, according to analysis from RedTech Advisors for GK Dragonomics.

There are two vital pieces of data Alipay’s lending operation uses: the amount of business a prospective borrower does and its credibility rating among customers. The more trusted someone is to deliver the right goods on time, the more likely they are to stay in business and to repay their debt. EBay, Amazon and others generate similar information and it could be used in similar ways.

Betty Zhao, head of China banking at CIMB, says its use of Alibaba’s long history of customer rating records and its sophisticated data mining have enabled it to control bad loan risk.

Under Lucy Peng, the broader Alibaba Small and Micro Financial Services Group is about to launch a hunt for strategic external investors, a sign of the group’s ambitions to expand this business, which spans finance and retail investments.

So far its lending arm is funded only from Alibaba’s cash pile, but it has still grown rapidly. It made $600m of loans to the end of 2012 and is expected to have increased that to $2bn by the end of this year, according to RedTech.

It has plenty of sources of future funding, including potentially using the huge cash float generated by the escrow services that hold money for buyers until they signal they have received and are happy with goods they have bought online. This float already generates a healthy interest income.

Lending to small businesses is hard work. It takes plenty of due diligence to see how they are performing, and even then their size alone makes them less resilient to economic shocks. For this reason, most small business loans from banks are secured on homes or premises.

With banks in the west still unsure of property values, SME loans remain too risky to price affordably. Big banks in China have similar problems but even less information. In both worlds, lending based on smart information about the activity of small businesses rather than on the simple stock of collateral should be revolutionary.