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Falling Dominoes

Interest rates promised by P2P companies seemed too good to be true. They were. Now many mom and pop investors stand to lose their life savings

By NewsChina Updated Sept.1

Over the past few years, 69-year-old Ding Baona from the eastern Chinese port city of Qingdao, has enjoyed an average 10 percent return on her 1.2 million yuan (US$175,000) in life savings by using a Chinese peer-to-peer (P2P) lending platform. But in the past months, Ding has become increasingly nervous as Chinese P2P companies began to fall like dominoes.  

Ding considers herself lucky as the P2P company she entrusted with her savings is still in operation. But millions of individual investors just like her have already seen their savings wiped out – and Ding is unsure whether she will still have her money when her investment matures in one and a half years.  

According to the data compiled by p2peye.com, an online lending research company, 251 P2P companies were identified as “problematic” in July alone, which meant they had trouble paying investors, had attracted police investigations for fraud or had their operators flee with client funds.  

Before it toppled in July, Niubanjin was a giant of the industry with a lending volume of 39 billion yuan (US$5.7b) involving some 820,000 individual investors, according to the company’s website. On July 3, the company issued its first notice of default, and a few days later, local police in Hangzhou arrested six of the company’s senior managers on fraud charges.  

The July figure almost tripled that for June, which saw 84 platforms labeled “problematic.” Analysts say this demonstrates the shake-up of China’s peer-to-peer lending industry is accelerating at a rapid rate. 

But the problems with the online lending sector have been simmering for the past couple of years. Data from p2peye.com shows that by the first week of August, a total of 4,572 online lending companies have either halted operations or been identified as “problematic.” Among them, 62 percent of fund operators have become “uncontactable,” in some cases fleeing with clients’ funds, and 21.4 percent have encountered liquidity problems.  

Data collected by wdzj.com, which is similar to p2peye.com, show that by the end of July, 58 percent of some 4,000 online lending companies covered by the website had failed.  

Rapid Rise and Fall
China’s first online P2P company, the PPDAI Group, emerged in 2007. Within a financial system dominated by banks, particularly State-owned banks that favor large and State-owned enterprises, the emerging P2P company was welcomed as a financial innovation to meet the needs of small and mid-sized companies, which account for about 60 percent of China’s GDP, but only obtained 20 to 25 percent of bank loans by value.  

Without an effective national credit system, the sector grew slowly for the first couple of years. By the end of 2010, China only had 10 P2P companies. However, when the government started to encourage the development of internet finance, the sector seemed to boom overnight.  

Offering annual interest rates of 8-12 percent – much higher than the rate for fixed deposits of less than three percent offered by most banks – the sector attracted a range of individual investors. In a few years, the number of P2P companies had exploded, reaching several thousand in 2015. At its peak, it is estimated the P2P sector was a US$192 billion industry.  

But it was a poorly regulated one. Scams, illicit behavior and Ponzi schemes dressed as lending companies flourished alongside legitimate ones in the sector. Ezubao, once the biggest online lending company in China, was revealed in 2015 to be a Ponzi scheme that had scammed 74.5 billion yuan (then US$7.6b) from more than 900,000 investors.  

Theoretically, the P2P platforms serve as a mere intermediary between borrowers and lenders. But in reality, as the government took a hands-off approach to internet finance, most P2P companies resorted to raising funds before they had found borrowers. This led many to promise high returns from dubious or non-existent projects and then to run off with funds raised from depositors.  

‘Regulatory Issue’
Amid a public backlash, the authorities finally started to tighten regulation in 2016, while clamping down on illegal and risky behaviors. Interim measures launched in October 2016 banned the platforms from pooling funds, and required them to establish custody accounts with commercial banks and to fully disclose their use of deposits by the end of June 2017.  

Obviously, these measures were not effectively implemented. According to a report issued by the State-owned China International Capital Corporation (CICC), three in five online lending platforms still in operation do not have custody accounts with commercial banks. 

“It is mainly a regulatory issue,” Liu Junhai, a Professor of Law and Director of the Business Law Center at the Renmin University of China told NewsChina. “It is a result of a mentality of the authorities that prioritizes development and growth over supervision and regulation,” Liu added. 

This remains true even after the authorities started tightening the screws on the sector. According to 2016 measures, online lending companies must register with provincial and local financial regulatory authorities, which were expected to complete a review of local P2P platforms and formulate regulatory policies based on regional conditions.  

This has not happened. As many provincial and local governments face serious debt problems, they appear reluctant to curb the development of P2P lending sectors, which are deeply involved in the real estate sector, which itself has been a major revenue source for the provincial and local governments.  

On the contrary, the registration of lending platforms with local authorities has been interpreted as proof the government has recognized the quality of the company – some have hinted that registration means the local governments guarantee their liquidity.  

Delicate Balance
As interim measures appeared to have failed, China’s authorities opted for a crackdown. On June 14, Guo Shuqing, head of the powerful China Banking and Insurance Regulatory Commission (CBIRC), China’s new financial regulator, warned at a financial forum in Shanghai that investors should place a question mark on any financial products that promise an interest rate of six percent or more, clearly referring to the online lending sector. 
“If the interest rate is over eight percent, it will be highly dangerous; If it is over 10 percent, you should expect to lose your principal,” Guo said. 

On July 9, the People’s Bank of China (China’s central bank) and other top financial regulators held a meeting on how to manage the P2P sector. According to Pan Gongsheng, vice governor of the bank, the deadline for review of all P2P platforms by local authorities has now been postponed. But Pan pledged the authorities would establish a permanent mechanism to deal with the risks involved in internet finance within “another one or two years.” 

On July 16, the CBIRC held another meeting. While no official documents were released, sources told NewsChina the authorities discussed establishing an exit mechanism to allow P2P lending companies to gradually “exit” the sector. Such efforts are already underway in some places. In Beijing, authorities have issued a “guideline” to online lending companies on how to exit the industry, and started to establish a white-list mechanism in the sector.  

The new approach may reflect growing concerns over the financial risks posed by the sector. Although P2P lending remains a relatively small part of China’s financial industry, there are concerns that its collapse could trigger systematic shock ��� particularly when the government tries to tighten monetary policy, leading to a tightened credit environment, which is believed to have kicked off the spate of P2P lending company failures in the past couple of months.  

Yin Zhentao, Deputy Director of the Research Center for Financial Law and Regulation at the Chinese Academy of Social Sciences told NewsChina the authorities aim to have most online lending companies leave the sector in an orderly fashion, in order to defuse the financial risks the sector poses, while also preventing its sudden collapse.  

According to China International Capital Corporation, only one-tenth of P2P lending companies –less than 200 – are likely to be in business in three years. 

But since there is no detail on this proposed exit mechanism, it is unclear how that would impact the financial market and investors. According to the data compiled by p2peye.com, of the 4,500 lending platforms which have halted operations since 2007, only 1.15 percent of them have exited the industry without issues.  

For millions of investors across China, the next few years will be a time of anxiety, if not pain.