Soul Htite, founder, Dianrong

When the board of Lending Club, a San Francisco-based peer-to-peer lender, turned down co-founder and chief technology officer Soul Htite’s proposal to expand the company into China, he decided to launch an entirely new lending business there himself.

Since founding Dianrong in 2012, the company has booked more than RMB32bn (US$4.7bn) in loans and signed up more than 3.8 million lenders.

What Htite perhaps didn’t expect is that Dianrong would expand from peer-to-peer lending to individuals into supply chain finance for smaller companies. Today, SCF is a key part of its business.

Spotting the SCF opportunity

Htite spoke at the Asian Banker Future of Finance Summit in Singapore in June and explained how SCF works at Dianrong. He gave the example of Fochuda, a small company in China which makes components for the Apple iPhone and which needed to borrow RMB3m (US$440,000) to pay its employees. Banks turned the company down because it didn’t have collateral. Funding in the shadow banking market was too expensive. And even Dianrong initially declined to make a loan because it didn’t have enough data to evaluate the firm.

Looking at it as a potential new opportunity, however, Dianrong checked with Foxconn and confirmed that Fochuda was indeed a supplier of components for the iPhone. Foxconn only funds 15% of its suppliers, however, and Fochuda was so small that it didn’t qualify.

Dianrong decided on a new approach: based on confirmation of its steady business as an iPhone supplier as well as a guarantee from Foxconn, the firm decided to meet the small company’s funding needs. Supply chain finance for this company and other suppliers in the same predicament has now become a significant business for Dianrong in China.

A key reason Dianrong was able to start the new SCF business, Htite said, is that it has invested in building infrastructure. While it may not be easy for a peer-to-peer lender in the US such as Lending Club to launch a new product, the infrastructure Dianrong has developed makes it easier.

Regulations in China require that a borrower be an actual person so even Dianrong’s SME loans are to individuals rather than companies as such. And whereas consumer loans average RMB30,000-40,000 (US$4,400-5,900), Htite said loans to small businesses average RMB300,000-400,000 (US$44,000-59,000).

Reasons for doing business

There are four main reasons why individuals and companies go to Dianrong for loans, Htite said: “One, with a bank, the process is not predictable. People want to know if it is yes or no. Second, time: how long will it take to fund me. I have an opportunity waiting. Third, the interest rate. Fourth, I’m going to give you my information: I want to make sure you don’t share it.”

Bringing in new customers is relatively inexpensive. Htite said it costs about RMB40-70 (US$6-10) to get a lead on the borrower side, and the company converts 20%-25% of leads into borrowers. On the lender side, it costs RMB60-70 (US$9-10) to onboard a lender who will lend RMB10,000-15,000 (US$1,475-$2,200) over the course of 18-24 months.

Supply chain finance customers are slightly different, Htite said, as they often come to Dianrong through a franchise model from companies that rely on Dianrong to fund their suppliers.

Dianrong now has 560 employees, many of whom are data scientists or former bankers. The risk management and underwriting processes, which analyses the probability of default and uses risk-based pricing, has resulted in a default rate of just 2.3%.

New financing models in China

A key reason for Dianrong’s success, Htite explained, is that China is a “very special” country. “For the last 20 years, people have been in jobs that gave them cash. There was not a lot of investment opportunity. Now, there are 1.4 billion people ready to invest. You will see an influx of capital.” In fact, Dianrong receives RMB200m (US$30m) more every month than it can easily deploy.

The pattern of those investors have changed, he said. Five years ago, there were few lending platforms in China. Moreover, people would not invest in the platforms unless they could make a return of 14%. Today, investors are more accepting of the platforms, even though they only make 6%-6½%, and often prefer to make peer-to-peer loans rather than putting their money in a bank.

“A bank sits on a balance sheet,” said Htite, explaining why he thinks the Dianrong model is better than the bank model. “They will not be able to lend US$10bn tomorrow. That capital is sitting, doing nothing. They have to pay a cost. That is a waste. The bank and balance sheet model is not efficient enough.”

By design, Htite said, Dianrong doesn’t have a balance sheet. “We don’t start with capital. We start with the borrower. We want people to do business between themselves. We are a platform.” That new model gives Dianrong a tremendous advantage, which benefits lenders and borrowers alike. And it is the only model that will be able to service the growing demand for funding that is coming, he believes, in the rapidly-growing shared economy of the future.