The rapid growth and regulation of peer-to-peer online lending in the People’s Republic of China highlight its impact on financial stability and monetary policy transmission. This offers critical lessons for economies with expanding fintech sectors, emphasizing the need for balanced innovation and oversight.
The financial system plays an integral role in transmitting monetary policy to the real economy. In recent years, the rapid development of the financial technology (fintech) industry has greatly influenced the financial system.
Taking advantage of digitization and big data techniques, fintech has played an important role in boosting financial inclusion and improving access to credit for consumers, entrepreneurs, start-ups, and small and medium-sized enterprises at a lower cost.
On the other hand, the fintech industry could amplify the recent trend of credit intermediation shifting away from traditional banks to nonbank finance, leading to a more diverse financial system.
In this sense, fintech may also bring new risks to the financial system, which could pose challenges to central banks in achieving their mandates.
Among fintech businesses, peer-to-peer lending, allowing individuals and small businesses to borrow and lend on an online platform without the presence of traditional financial institutions, has been a leading alternative finance mechanism.
Benefiting from being a market leader in digital technologies and a looser regulatory environment, the peer-to-peer lending industry in the People’s Republic of China experienced rapid growth between 2014 and 2017, and was a leading driver of the global nonbank finance market.
The country’s peer-to-peer lending industry soared from a volume of CNY252 billion in 2014 to CNY2,804 billion by 2017, peaking at around 30% as a share of total new bank lending.
Regulation was introduced from the end of 2017 to reduce peer-to-peer-related risks across the country’s financial system. The regulatory measures covered several areas including cash loans, illegal financing, the use of funds for student loans, investment speculation, and downpayments on real estate.
By 2019, peer-to-peer platforms were largely converted into small loan creditors or completely shut down, essentially eliminating the peer-to-peer lending market as it once existed.
Set against this context, a recently published ADB Economics Working Paper explores the impact of peer-to-peer lending on monetary policy transmission in the People’s Republic of China, by employing a state-dependent local projection method.
The results show that the responses of industrial production and inflation to monetary policy tightening in a non-boom peer-to-peer lending market are statistically significant and larger in magnitude than the responses in a boom market. Indeed, the responses in the boom phase are mostly not statistically significant.
In particular, the inflation response peaks at 0.8% in response to an unanticipated 100 basis point monetary policy tightening in the non-boom phase, relative to 0.6% in the baseline model. Industrial production also significantly declines in the non-boom phase relative to the baseline case, especially for the initial periods.
In contrast, in the boom of the peer-to-peer lending market, we find that the negative response of inflation becomes statistically significant only after 10 months, while the responses of industrial production are also muted and are not significantly different from zero for most time horizons.
The findings indicate that the ongoing development of peer-to-peer finance can be negatively associated with the effectiveness of monetary policy transmission. As peer-to-peer lending functions as an alternative source of external financing, agents are less constrained by the rising cost of bank credit. This dampens the impact of contractionary monetary policy on the economy.
While the regulatory measures introduced on peer-to-peer lending in the People’s Republic of China helped to mitigate financial exposures, it may have also contributed to a more effective transmission of traditional monetary policy.
There are important lessons from this analysis for other economies that have growing peer-to-peer lending markets.
This is the case across many developing economies, including in India, Indonesia, Malaysia, the Republic of Korea, the Philippines, and Viet Nam. Central banks in these economies should be wary of the potential implications for the effectiveness of monetary policy, as well as financial stability.
Going forward, it will be important for central banks and financial supervisors to harness a landscape that can advance the benefits of continued innovation in the financial system. The challenge will be to balance this against well-functioning monetary policy transmission and mitigated financial stability risks.
Source : Asian Development Blog
