The Future of P2P Lending in China: Is There a Time After the Great Cleanup?

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Chinese crowdfunding and especially the peer-to-peer (P2P) lending industry in China has experienced some turbulent years – and probably will in the coming years as well. From being almost nonexistent in 2012, China has developed into the world’s largest market for p2p lending (also known as marketplace lending or crowdlending) through incredible growth rates. However, this development has been possible largely due to the lack of regulation and governmental oversight. A comprehensive cleanup in the industry is now taking place with great consequences for both investors and platforms.

A Crowdlending Market in Turmoil

The spark that ignited the turmoil in Chinese peer-to-peer lending happened in late 2015 when investors on the P2P lending platform Ezubao was suddenly unable to withdraw their funds. Ezubao was later revealed as responsible for the biggest Ponzi scheme ever in Chinese history involving $7.6 billion and 900.000 investors. Thus, in August 2016, as part of an overall effort to reduce financial risk and as a response to previous cases of fraud, like Ezubao, Chinese authorities began tightening regulation in the peer-to-peer industry.

The heavily intensified focus on regulating the peer-to-peer industry and a general governmental crackdown on high-risk financing has caused the bankruptcy of many hundreds’ P2P platforms with severe consequences for especially Chinese investors, who in many cases have suffered life-altering losses. This has led to protests and civil unrest in several cities initiated by angry investors demanding a government bailout and the Chinese government has struggled to control the anger over the P2P lending crisis.

As the crisis unfolded, panic in the broader market led investors to withdraw their money enhancing the vicious cycle by causing a liquidity crisis among many – especially smaller – P2P platforms. The platforms able to stand the storm might, therefore, end up as winners as a large percentage of P2P companies has already – or are in this risk of – shutting down, either because they are not able to meet the stricter regulation and/or because of a lack of liquidity.

According to a Bloomberg article on the P2P lending crackdown by Chinese authorities based on research by the Shanghai-based research firm Yingcan Group tracking the p2p industry, we have already seen an immense drop in the number of Chinese P2P lending platforms by 50 % to 1,021 during 2018. In 2019, a breathtaking drop of 70 % is predicted leaving only 300 P2P platforms in the market. In comparison, the number of platforms peaked in 2015 with 2.595 p2p platforms operating in China according to wdzj.com, a Chinese online lending industry observer.

Many prominent peer-to-peer companies have already closed down or are experiencing significant trouble. At the beginning of 2019, Yidai – a company with 32,000 lenders and an outstanding principal of ¥4 billion ($581 million) – announced they would close down. Later in the same week, another large-scale P2P platform, Xinhehui, announced it was experiencing troubles repaying 17.000 investors. So far, Xinhehui has conducted P2P lending for more than ¥210 billion ($30.6 billion). In April 2019, 41 people associated with the P2P lender Tuandai was arrested after being put under investigation for illegal fundraising. Tuandai was one of the earliest entrants in P2P lending and had, as of February 28, matched 220,000 lenders with 370,000 borrowers facilitating loans for ¥14.5 ($2.2 billion).

At the same time, some of the biggest peer-to-peer lenders are turning their back on their core business. An example of this is Lufax, the world’s largest P2P lending platform and the supreme market leader within P2P lending in China in 2018 with a market share of 22%. At the beginning of 2017, Lufax started pivoting away from P2P lending to focus instead on Chinas booming retail investment market.

Together with the many bankruptcies of big P2P lending platforms, Lufax’ pivot away from P2P lending raises serious questions about the long-term sustainability of the peer-to-peer industry in China. On the other hand, as we will see below, P2P lending is crucial as a source of finance in China.

Why P2P Lending is Essential for China

In 2015, the former Governor of the People’s Bank of China (the central bank of China), Zhou Xiaochuan, and the Premier of China (leader of the State Council and the second-ranked member of the powerful Politburo), Li Keqiang, both supported peer-to-peer lending as innovation within the financial field that should be encouraged.

The conditions for the growth of peer-to-peer lending have been especially good in China because of an emerging middle class skeptical of investing their money in China’s volatile stock markets or speculative real estate markets. In other words, there is a lack of attractive alternative investments, why people are prone to invest in peer-to-peer platforms promising high and stable returns. At the same time, the investment threshold in P2P investing is very low enabling even very small investors to engage themselves with peer-to-peer lending. Also, rural residents and small-to-medium sized businesses have difficulties accessing consumer credit as China still lacks a unified credit rating system, which makes P2P lending an attractive alternative to the traditional banking system – and possibly the only solution for many borrowers without significant credit history. Despite an attempt from Beijing to promote lending to SMEs through the traditional banking system, half of the new loans issued by China’s six largest state-owned banks went to individual property buyers.

Thus, China is facing the challenge of enforcing a regulation that will punish the bad players in the industry while supporting the trustworthy and reliable P2P platforms making essential financing available. If P2P lending were to disappear in China, small- and medium-sized enterprises would lose an important source of finance, which would hurt the real economy.

The Development of Regulation in Chinese P2P Lending

After the first steps were taken in late 2015, Chinese authorities are still struggling to regulate the peer-to-peer industry in a way that will enable a healthy market going forward and not cause panic among investors with the potential of further social unrest.

On August 8 2018, Chinese regulators came up with 10 measures to reduce risks in the peer-to-peer industry and secure social and financial stability. Here, local governments are required to set up communication windows with the purpose of responding to request by P2P investors and conducting compliance inspections on P2P platforms. Likewise, a ban on establishing new peer-to-peer companies was issued. The measures also address borrowers trying to avoid repaying their P2P loans by placing them on the blacklist of China’s social credit rating system.

Another interesting measure that the authorities want to enforce is better education of investors with the aim of increasing public awareness on the risks of peer-to-peer lending and investing in general. Also, it is mentioned that authorities want to pursue ways to resolve risks regarding liquidity in the P2P industry and protect the legal rights of investors.

The measures proposed by the central government has been deemed credit positive by the global credit rating agency Moody’s. Thus, according to Moody’s, these measures will reduce risk in the broader financial system and protect individual lenders.

Later in 2019, a stricter licensing process is planned to be put into action for the remaining P2P platforms in China. This process will most importantly force peer-to-peer companies to hold a general risk reserve of 3% (1% for regional platforms) of the lending facilitated and a loan loss provision for lenders of 6% (3% for regional platforms) of each borrowing, but also categorize the P2P platforms into regional and national and clarify their business boundaries and the registration threshold. There will also be an investment cap for individual investors of ¥200,000 on each platform and ¥500,000 across different platforms.

Where is China’s P2P Lending Market Heading?

The effect of regulation has already caused the number of P2P platforms in China to shrink dramatically and exposed numerous cases of fraud – and in February 2019, Chinese police froze around 10 billion ($1.5 billion) of assets across more than 380 P2P lending platforms in an operation codenamed “Fox Hunt” investigating illegal activities tied to peer-to-peer lending.

The regulation process is still underway, and we will most likely still see platforms shutting down and illegal activities being uncovered. However, there is a real demand for borrowing from P2P platforms. The government of China wants to improve conditions for SMEs but struggles to come up with solutions to meet their financing needs – a problem the peer-to-peer industry can help solve. It is, therefore, unlikely we will see the whole sector go up in flames. What we might see, however, is more P2P platforms returning to their original purpose of lending to SMEs to bring real value to the market and thereby minimizing their risk of further governmental crackdowns.

Financing through peer-to-peer still only accounts for a negligible size of the overall borrowing market in China, so there is no need to think that the market cannot develop further in the future when the regulatory storm calms. Also, it is important to remember that even though the bankruptcies of many large platforms cause devasting loses to the investors involved and has negative impacts on the overall Chinese economy, it can most likely be contained within the sector. As more platforms are closing, we will definitely see some sort of consolidation by the biggest P2P platforms, but acquisitions and mergers will probably be limited by regulators to a size that will not pose a threat to the general stability of the Chinese economy in the case of platform bankruptcies. Here, robust P2P lenders with risk-management capabilities and stable funding access must be expected to gain market share.

The main challenge faced by the Chinese authorities is to secure a transparent and sustainable industry going forward while getting rid of platforms contaminated by illegal activities and unsustainable business practices. According to an in-depth study from May 2019 by Singaporean bank DBS Bank of the Greater Bay Area – Asia’s most populous and largest urban area located in The Pearl River Delta in the South of China encompassing Hong Kong, Macau, Guangzhou, Shenzhen, Zhuhai, Zhongshan, Dongguan, Huizhou, Jiangmen, and Zhaoqing – P2P lending will be the fifth-fastest growing industry with the potential to reach 1 trillion yuan by 2030. Stronger regulation will, therefore, almost certainly be positive for the P2P industry over the long run, but in the short run, there could still be trouble lurking around the corner.

You can read more about crowdfunding in China here.

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