Alternative Financial Institutions in China

Abstract

This chapter introduces alternative financial institutions (AFIs) in China that do not fall within traditional financial institution (FI) models. We describe their business models and development dynamics in the context of economic and financial reforms and technological advancement. We find that various AFIs are formed based on social, business, and virtual networks to overcome capital allocation barriers, reduce costs, or improve efficiency, providing financial services for the underserved. However, without proper regulations, these AFIs could pose alarming levels of risk on financial stability. They repeat a boom-and-bust pattern, in parallel with the government's initial laissez faire approach but later harsh interferences: being taken over by formal FIs or shut down as illegal practices until the exceptional Ant-Financial case. Improving investors' financial knowledge and regulators’ competency is critical for China to advance its financial system and develop mature FIs and AFIs. We recommend key features required in such a regulatory framework.

Keywords: Alternative Financial Institutions, Informal Finance, P2P, Regulation, Market Design

JEL Classification: G2