(Bloomberg) -- When Chinese liquor store owner Lu Ruibo saw a loan offer pop up on his mobile phone, it was far from the perfect deal: the annualized interest rate was more than 20 percent.

But Lu’s shop in Henan province was going through a cash squeeze and he needed money for family purchases like books and clothes, so he decided to borrow for the first time in his life.

Pre-approved based on criteria including his history of making payments through a mobile-phone application and the size of his online social network, Lu accepted a 500 yuan ($78), two- week loan. “In the past, if I was short of cash, I wouldn’t buy,” he later said.

Chalk up another victory for the companies mining data to find and vet customers among the nation’s famously credit- starved small businesses and the 500 million Chinese citizens who the central bank says have never borrowed from banks.

Regulatory Challenge

Channeling credit to people and businesses left out of the traditional lending system may be key to engineering a transition to a consumer-driven economy just as growth sags to a 25-year low. At the same time, unconventional funding poses challenges for regulators who are trying to come to grips with China’s ballooning shadow banking industry.

“Financial inclusion has got to be celebrated -- getting more people into the banking system, funding entrepreneurship, hopefully will help consumer demand,” said Keith Pogson, a Hong Kong-based senior partner at Ernst & Young LLP. Still, he cautioned that novel methods of finding and vetting borrowers may have been “over-hyped” and were yet to be tested in conditions of stress.

“Let’s say that GDP growth slumps to minus 5 percent, would these people who are asset-light be able to repay their loans?” Pogson asked. “The big banks, traditional banks have got lots of collateral -- their mortgages are very, very deeply in the money.”

The targets for lending include the 84 percent of Chinese families who, according to a 2014 survey by the Southwestern University of Finance and Economics in Chengdu, have never borrowed from banks.

No Collateral

But individuals are only part of the story. About 80 percent of 50 million so-called micro firms can’t get bank loans because they lack collateral, according to a China Guangfa Bank Co. study published this year. The lender estimated the businesses’ unfilled demand for bank credit at 22 trillion yuan a year.

Liquor-store owner Lu’s money came from Shanghai-based China Rapid Finance, a peer-to-peer lending platform backed by private equity firm Broadline Capital. The company used data from Internet company Tencent Holdings Ltd. to pre-approve 50 million potential borrowers, based on information including frequency of instant messages, number of online friends, length of phone registration and use of mobile shopping and games.

China Rapid Finance has also tapped data from Baidu Inc., the nation’s largest search engine, to find potential borrowers.

Photography, Hiking

People whose searches focus on photography or hiking are more likely to want unsecured small loans, usually their first, than those looking for information on cars or scuba diving, said Zane Wang, the firm’s founder, who advised the People’s Bank of China on building its credit database.

Searches for “lottery tickets” may signal a borrower that the firm wants to avoid, Wang said.

In another example of the new role for data, in Shanghai a peer-to-peer lender mined transaction records to quickly approve a loan to a restaurateur who’d earlier walked away empty-handed from a traditional lender.

Dianrong.com analyzed a year of transaction data from restaurateur Cai Fuquan’s two outlets and also records from his sales through channels such as the mobile-phone application Ele.me, or Are You Hungry? The analysis took 30 minutes, according to Dianrong.com, and Cai says he got his 1.5 million yuan loan within 10 days. On-site checks were also part of the process.

Ning Jie, director of product management at Dianrong.com, said that traditionally banks have focused on securing collateral because company information such as financial statements may be unreliable. Access to a restaurant’s sales data through a third party may be a better guide, he said.

Slicing, Dicing

“We slice and dice the data, looking more deeply and broadly, and therefore we have more confidence in assessing a borrower’s repayment ability, rather than resorting to requiring collateral," said Ning, formerly a product manager at Standard Chartered Plc. in Shanghai.

According to Soul Htite, the LendingClub Corp. co-founder who set up Dianrong.com, a wave of financial innovation is helping to serve people in China’s growing services sector who haven’t been catered for previously -- everyone from doctors and lawyers to migrants who have just arrived in big cities.

“That new economy needs forms of financing. Before we came you have to go to the bank and wait weeks and months,” he said. “Today you apply and you get an answer in 24 hours, yes or no.”

While expanding access to credit may boost gross domestic product and help to erode inequality, the gains may also come with challenges.

Financial Stability

In a report in November, the European Central Bank said increasing leverage and a large shadow banking sector were among signs of rising risks to China’s financial stability. The largely unchecked rise of margin lending, which helped to inflate a stock bubble that burst this year, showed how Chinese regulators sometimes struggle to contain risks.

Back in Luoyang city in Henan, Lu, the shopkeeper, says that since a government campaign against profligacy damped cadres’ appetites for his alcohol, he’s shifted to operating a printing business in the same 100 square meter shop where bottles of high-end Jiannanchun liquor previously gathered dust on the shelves.

Lu said that he’s never missed a repayment on one of his micro-loans. He’s confident that he’s a good risk.

--With assistance from Enda Curran.

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