China's peer-to-peer lending shrinks amid tighter regulations: Fitch

China's peer-to-peer (P2P) lending industry will continue to shrink and consolidate as tighter regulation and weak investor sentiment drive out operators conducting the riskiest activities, Fitch Ratings said in a recent report.

The number of P2P investors and platforms declined steeply last year and the ratings agency expected more platforms to close or consolidate in 2019, leading to a smaller, less fragmented market as the Chinese watchdog tightened its reins over the sector.

New business volumes and the scale of P2P lending relative to GDP also fell significantly in 2018 with the advent of new licensing rules to control P2P lending and limit associated risks to social and financial stability.

The rules were introduced after retail investors suffered widespread losses through P2P lending.

Fitch states that stronger supervision will be positive over the longer term for the industry, which has yet to be tested through economic cycles. It predicts that lenders with more robust business models, established risk-management capabilities and more stable access to funding will likely gain market share.

New regulations will also require many platforms to reduce their reliance on retail investors, leading to a shift toward wholesale or institutional funding sources.

In China, over 90 percent of P2P lenders' funding is from retail investors, in contrast to most other P2P markets like the US, which are predominantly wholesale-funded. Retail funding will be more prone to sudden weakening in investor sentiment, Fitch noted.

Moreover, it may be a source of moral hazard if P2P firms exploit retail investors' limited financial sophistication, potentially leading to social or financial instability if large numbers of retail investors suffer losses, the report added.

Increased institutional funding could significantly improve the Chinese P2P sector's funding profile, but the availability of such funding is susceptible to regulatory actions across the system.

Meanwhile, Fitch said the industry’s asset quality could deteriorate if tighter P2P lending rules reduce refinancing options for borrowers who rely on multiple facilities to roll over their loans.

Market data show that China's P2P lending sector has generally weak asset quality, with several leading platforms reporting loss rates of 7 to 10 percent.

Last year, nevertheless, saw a growing risk appetite among P2P firms, as the average term of Chinese P2P loans increased significantly, rising to over 15 months at end-2018 from 10 months at end-2017. However, the average investment yield rose just marginally to 10.2 percent from 9.5 percent, reflecting rising levels of stress in the market.