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UPDATED: August 6, 2014 NO. 32 AUGUST 7, 2014
The Dark Side of the Lending Spree
Supervision is badly needed to regulate China's burgeoning P2P lending industry from excessive exposure to risks
By Zhou Xiaoyan

According to Wangdaizhijia, a total of 58 P2P platforms went bankrupt in the fourth quarter of 2013. In the first half of 2014, another 47 P2P websites disappeared with money raised, were found to have committed fraud or had difficulty repaying investors.

In China, P2P lenders aren't classified as financial institutions, and there aren't any specific rules governing the sector, so these lenders function beyond the scope of regulators.

This absence of regulation has led to risky practices by P2P lenders, such as investing with clients' funds and failing to conduct due diligence on borrowers. When projects fail, lenders fail to get repaid.

In addition, the wild expansion and escalating competition in the industry have pushed up interest rates. Some P2P firms even promised annual returns of over 40 percent to woo investors, thus increasing default risks.

"Many P2P online platforms are just a transformation of former players in the private lending market, who lack a thorough understanding of liquidity management," said Xu Hongwei, a senior executive at Wangdaizhijia. He estimated that 80 or 90 percent of China's P2P companies might sink.

"No threshold, no industry standard and no regulation—these factors have contributed to the wild growth of the P2P industry," said Huang Zhen, a professor of law at Beijing-based Central University of Finance and Economics.

Systemic risks are building up due to the absence of regulators and the industry's frenetic need for growth to offset the risks, according to Bai Chengyu, Secretary General of the China Association of Microfinance.

How to regulate?

China generally encourages the development of P2P lending as it's a new type of financial product innovation that can prop up reform on the country's financial sector. But this is not to say Internet finance should be free from scrutiny.

The role of a P2P platform must be confined to just an intermediary, according to finance experts. These platforms are supposed to live by brokering agreement between borrowers and lenders, and are prohibited from pooling investors' money to fund their own projects. Otherwise, it would be illegal fundraising, a crime that can lead to years, or even life, in prison in China.

To deal with these problems, the China Banking Regulatory Commission (CBRC) said that it would lead a campaign to regulate P2P lending. In May, the CBRC summoned leaders of P2P websites to discuss on the market entrance threshold and regulation rules. An anonymous industry insider told China Business News that detailed regulations for the industry would come out at the end of this year.

The People's Bank of China has also indicated plans to introduce third-party custodians into the P2P lending industry to keep brokers from taking clients' money.

Yang Dong, Deputy Dean of the Law School at Beijing-based Renmin University of China, said that supervision over P2P websites should be focused on protecting investors. He suggests differentiated supervision should be adopted according to the type of P2P websites and their capital pools.

Xie Ping, Deputy General Manager of China Investment Corp., said that the key to supervision over the P2P lending industry lies in close scrutiny of information, necessitating the disclosure of data regarding shareholders, transactions and mangers.

"They should back up every transaction in case of future lawsuits or penalties from the government after the fact," Xie said.

"The current supervision framework by the government is designed for banks, securities companies and insurers. They don't apply to P2P lending platforms. I think P2P supervision should be considered on the basis of information, big data and full disclosure of information," Xie added.

Zhao Xijun, a professor of finance at Renmin University of China, suggests the government set qualification criteria for P2P lenders as with micro-loan companies and pawnshops. "The government can place requirements on registered capital, personnel qualifications and credit records," Zhao said. "It can also ask all P2P lending firms to register and report their data regularly. Licensing P2P firms is also an option."

Zhang Chenghui, Director of the Research Institute of Finance under the Development Research Center of the State Council, said that effective supervision over P2P lending should factor in six aspects.

"First, P2P platforms are intermediaries, so their risk control measures should be different from those designed for banks. Second, preventing fraud and protecting investors should be the core principle. Third, money laundering and illegal use of capital pool should be strictly prohibited. Fourth, there should be a national industry standard regarding P2P companies' daily operations, and transparency is key. Fifth, self-discipline within the industry should be strengthened. Finally, third-party evaluation should be introduced," Zhang elaborated.

"Supervising the P2P lending industry is a systematic project. The CBRC itself can't do the entire job. It also requires concerted efforts from industry associations, third-party custodians and P2P websites," Zhang said.

Email us at: zhouxiaoyan@bjreview.com

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