China’s peer-to-peer (P2P) lending sector has witnessed expansion in recent years, despite periodic clampdowns on excessive risk. This has led to on-again, off-again surges in activity in this shadow banking sector. In some cases, criminal activity has highlighted the perils of borrowing or lending through this industry, but the loan availability for borrowers and higher interest rates available to lenders have continued to render this business attractive.
The P2P lending sector began to increase in 2011, numbering 2,600 platforms by the end of 2015, but has experienced stops and starts due to issues in controlling for risk. It is quite significant that about 1,000 businesses have closed in the past year. Risk has been the main focus of both regulation and research, with attempts to understand and control for credit risk, liquidity risk, operational risk, and market risk. In terms of credit risk, data mining may provide a way to identify better borrowers, but this depends on availability and dimensions of data. Ratings models segment loans into various grades based on credit risk, although these models may fail to address characteristics of individual loans at a micro level. Standards to improve viability of P2P platforms such as transparency, requirement of loan loss provisions, and safety requirements are necessary to modernize and regulate the sector.
However, a uniform method of controlling for risk from a business or regulatory perspective has not been identified, and the variation in P2P lending models only increases this challenge. Some models offer direct connections between borrowers and lenders, while others are indirect, pooling lender resources and issuing loans to borrowers separately. Some use extensive offline investigation tools to ensure that borrowers are low credit risks, while others rely more on technology and data to assess customer creditworthiness. The P2P lending models in China are more diverse than in other countries, complicating regulatory responses.
In general, regulatory crackdowns have centered around reducing risk. The landmark Guidelines Concerning the Promotion of Healthy Development of Online Finance, published in July 2015, emphasize risk control, and encourage industry self-discipline. Regulations put forth in December 2015 require P2P firms to register with local financial authorities and to publicly disclose loan performance. Regulations on non-bank providers of online payment services were issued in the same month to specify how funds would be treated. Many banks shut down P2P third-party payment services at the beginning of 2016 in order to control risks, but these payments have been gradually resumed. Regulatory supervision of individual P2P companies has also tightened in the past year.
The P2P lending sector remains popular due to funding shortages for micro- and small and medium-sized enterprises, and for lenders, for its relatively high rate of return. P2P sector interest rates reflect those obtained on the curb market (i.e., outside of the formal banking system) and are higher than those associated with bank loans, weighing in on average at 15-18 percent. As on the curb market, many borrowers lack credit history of collateral. Participating in the P2P sector allows borrowers to obtain loans where they otherwise would not.
Still, P2P sector participants are potentially exposed to business collapse due to liquidity shortages or fraud, both of which are relatively common. Unlike the formal financial sector, the P2P lending sector suffers from a lack of self-discipline. It is not uncommon for business owners to flee when a loan fails. Therefore, even as the P2P sector continues to grow, many such businesses fail, and regulators are attempting to discipline the sector in fits and starts. Addressing all potential pitfalls is a challenge, as is implementing specific financial requirements. Given the pace of regulation, however, one may expect tighter rules to emerge in the near future.