China is the second largest economy in the world with a GDP of $11.8 trillion, and it’s the home to many mega banks and lenders. Like the US, savers investing in bank deposits were not getting good enough returns and small borrowers were being crowded out of the formal lending system by big corporations. P2P lending looked like the perfect solution; it cut out the middlemen and democratized borrowing. As a result, China rapidly became the largest P2P market in the world. But the explosive growth of the P2P market in recent years has exposed the gulf of problems that have been plaguing the online lending market in China.
Numbers don’t lie
According to Beijing Bureau of Financial Work, nine out of 10 P2P lending platforms will find it difficult to survive 2017 once the government fully rolls out its stiff regulatory supervisions. Only 500 (approx 10%) P2P companies out of the total 4,856 across the country are expected to remain in operation after this year, according to the same report.
Chinese regulators have introduced tougher requirements for P2P lenders to stay in business. Every P2P lender now needs to appoint a custodian bank and needs to provide a full disclosure of the use of deposits. There are other variables like risk management, shareholder credibility, and the scale of business in play, as well. A lender not passing the review will eventually have to liquidate.
In the beginning of 2016, Ezubao was one of the largest P2P lending platforms in the country. It was launched in 2014, but because it offered a lucrative rate of return (9%-15%) it quickly managed to attract a lot of investors. The company was actually running a Ponzi scheme and scammed 900,000 investors out of over $7.6 billion. It was the biggest Ponzi scheme in Chinese financial history. Reports said 95% of all listed borrowers were fraudulent. Such a massive fraud obviously woke up the regulators, and they came cracking down on the entire industry.
Fall of the giant: Hongling Capital
Hongling Capital was founded in 2009; it was one of the earliest and biggest P2P lending platforms in China. The pioneer P2P lending platform, once considered a benchmark in the industry, declared it will exit the online lending business and pay off investors by selling collateral properties. Though Hongling Capital was the largest P2P platform in terms of trade volume, the platform has barely made any profits. In 2016, the platform lost 183 million Yuan ($27.4 million).
Hongling Capital was established to provide small and medium enterprises easy access to capital, something they were not able to get from traditional banks and financial institutions. But it was its “guarantee of principal and interest” which set the platform apart from its contemporaries.
“Big Loan Model”
Another bet that went wrong for Hongling Capital was its “Big Loan Model.” Projects which required financing over 100 million CNY were considered “Big Loans” and Hongling matched the investor money with big projects. Considering that the majority of these projects had been rejected by traditional banks and were subprime meant it was a risky proposition from the get-go. The company, for example, granted 50 million Yuan in loans to China Huishan Dairy Holding. The company defaulted on its debt in late March. Loans like these were a major reason for Hongling Capital’s deep troubles.
The platform now has over 20 billion Yuan ($3 billion) assets to settle, which includes 5 billion Yuan ($750 million) of non-performing assets and 800 million Yuan ($120 million) of bad debts. As of August, Hongling Capital has 1.85 million investors, and the accumulated trade volume is 274.7 billion Yuan ($41 billion).
Regulation by Chinese Banking Regulatory Commission (CBRC)
In August 2016, CBRC released “Interim Measures for the Management of Business Activities of Internet Lending Information Agencies.” The report clearly stated “on a single platform, the personal borrowing balance shall not exceed 200,000, and the enterprise shall not exceed one million” and “p2p platform must not provide vouching or principal and interest warranty for investors.”
This regulation hit the two cornerstones of Hongling- guaranteed payments and big loan models and rendered the company’s business model obsolete.
The online lending industry knows there are more restrictions to follow. People’s Bank of China and 17 other regulatory authorities issued a notice in July stating: “Effective measures must be taken to ensure that the number of internet financial entities and the scale of business operation are cut down.”
This goes to show that there is a concerted effort by the regulators to curb the P2P lending sector and ensure that all non-serious and fraud actors are removed from the ecosystem
Well, it is clear that Ezubao is not the only bad apple in the system. There are hundreds of P2P lenders which have evaporated in thin air and the existing regulations will lead to a major shakeup. Though this might be detrimental in the short term, it was necessary for the survival of the industry in the long run. Now investors will understand the risks facing them while investing in such schemes, and would be focused on collaborating with only compliant P2P lenders. It will force platforms to re-look at their business models and ensure sustainability is given precedence over growth.
Written by Heena Dhir.