The regulators’ proposed new draft rules may curb rapid growth of online micro-lenders.

The massive growth enjoyed by digital micro-lending and financial technology (fintech) companies in China will likely come to a halt as local regulators move to pass a new set of rules that tightens regulations in the digital lending sector.

In a report, S&P Global Ratings said it expects the local government to continue updating its regulations and guidelines to manage the growth and risks brought by the fast evolving fintech industry.

Recently, the government abruptly halted Ant Group’s $35b initial public offering (IPO) after regulators allegedly discovered anomalies and shortcomings in the group.

"The withdrawal of Ant Group's IPO underlines the uncertainties facing fintech companies as Chinese regulators seek to reduce uncontrolled technological disruption in banking and protect consumers from excessive borrowing," said S&P Global Ratings credit analyst Fern Wang in a report.

On 2 November, a day before Ant’s IPO was scrapped, the China Banking and Insurance Regulatory Commission (CBIRC) and the People's Bank Of China (PBOC) jointly announced a new draft rules on internet micro-lending, to be followed by a one-month consultation period.

“In contrast to the emphasis on innovation and risk-taking that fintech companies wanted, China's proposed rules on internet financing would constrain cross-provincial lending; limit maximum loan amounts; require a minimum 30% capital contribution to joint borrowing, restrict leverage including use of asset-backed securities instruments; and impose minimal capital requirements on the internet small loans companies,” the report noted.

If implemented, the regulation could severely weaken Ant Group's consumer and small and micro finance business. This segment contributed as much as 39% to its first half 2020 revenue and is the major growth engine of the group.

The rule change not just affects Ant Group, but the online lending world in general. S&P expects that, if passed, it would slow lending growth for the more than 200 licensed internet lenders in China.

Online lenders typically offer small, unsecured loans and are not permitted to take deposits. Their licenses were initially granted by local financial bureaus under relatively lax regulations compared with those for banks.

However, under the new regulations, such lenders face constraining leverages, and will have to limit consumer borrowing compared to before.

"Whilst pro-innovation, Chinese regulators' top priority is financial stability," said Wang. "They have a particularly strong incentive to manage fast-growing consumer lending to lower-income borrowers."

S&P’s analysis found that China's banking system is more exposed to technological disruption than those of other major countries. In a study of 22 different countries, China is the only one assessed as having a very high disruption risk from technology. This was due to the inroads made by big tech firms in fintech through their platform and heavy investment in technologies like big data, AI analytics, and loud computing.

"We expect the Chinese government will further update its regulations and guidelines to manage the growth and risks brought by the fast evolving fintech industry," said S&P Global Ratings credit analyst Ryan Tsang.

"The challenge for regulators is to find a fine balance in encouraging innovation and keeping associated risks in check to make sure financial system stability is not jeopardized,” he added.

Tsang also believes that regulators will seek to reduce opportunities for regulatory arbitrage to level the playing field in terms of regulatory supervision between fintech players and traditional financial services providers.