Photo by Wu Yi on Unsplash KEY POINTS From 2007 to 2020, China's Peer-to-peer lending market experienced a drastic boom and bust, and ended up with zero surviving platforms. The key reason for the collapse of China's P2P sector was that almost all P2P platforms deviate from the role of information intermediary and became shadow banks offering principal guarantee. As the number of P2P platforms increases, each platform has a greater incentive to offer principal guarantee in responses to fierce competition and the lure of financial fraud under limited regulatory capacity. This hurts the investors’ and social welfare. The existence of naïve investors makes offering principal guarantee more attractive to platforms. Promoting information disclosure may not solve the problem. ISSUE Peer-to-peer (P2P) lending is an important Fintech innovation in retail banking. P2P platforms use information technology to match lenders and borrowers and facilitate online transactions that enable individuals (or firms) to lend money to other individuals (or firms) without the intermediation of traditional financial institutions. Compared to traditional banks, P2P platforms have a particular advantage in providing small-sized loans and expands financial inclusion. Yangguang Huang Why did the Peer-to-peer Lending Market Fail in China? THOUGHT LEADERSHIP BRIEF SPRING 2022 no.61 PDF & Additional Materials iems.ust.hk
01/2012 01/2013 01/2014 01/2015 01/2016 01/2017 01/2018 01/2019 01/2020 3,000 2,500 2,000 1,500 1,000 500 0 No. of platforms SPRING 2022 NO.61 / THOUGHT LEADERSHIP BRIEF 2 Figure 1 shows that P2P platforms can provide loans at lower interest rates than private lending without the platforms. For lenders, investing via P2P platforms did not require large amounts of money or a long duration, and the interest rate was much higher than those offered by banks. The rapid development of information and financial technology and the unmet demand for credit gave rise to a large P2P credit market in China. From 2007 to 2020, China's P2P lending market experienced a drastic boom and bust. The market started to flourish in 2013 and reached its peak transaction volume of CNY 2.8 trillion in 2017. Thousands of P2P platforms connected over 4 million lenders and borrowers and provided billions of loans to individuals and small- and medium-sized enterprises (SMEs). At its peak, the total amount of P2P lending in China was 10 times greater than that in the US. From 2013 to 2018, the P2P trading volume in China was larger than the sum for the rest of the world. Despite that the P2P lending market had promoted financial inclusion in China, it was highly risky and volatile. Instances of platform collapse and fraud occurred frequently, causing substantial monetary losses for millions of individual lenders. As investors gradually lost confidence in P2P lending, the market size continued to decline and ultimately collapsed. On November 27, 2020, the China Banking and Insurance Regulatory Commission (CBIRC) announced that the number of P2P platforms had fallen to zero. However, P2P lending is still an active industry in the US and other developed economies. What are the differences between the Chinese P2P market and those in the developed countries? We develop a theoretical model of the P2P lending market that explains how different market environments can lead to two vastly different outcomes. Why did so many P2P platforms collapse in China, while most platforms in developed countries were able to persist? ASSESSMENT The major reason is that China's P2P platforms deviated from being information intermediaries and started to offer principal guarantee terms. A classical P2P lending platform serves as an information intermediary that provides information about borrowers without taking liability for borrower default. However, the role of P2P platforms in China started to change after 2012 as the competition among platforms became increasingly intense. To compete for funds from lenders, platforms offered principal guarantee to lenders that promised to repay the principal to lenders even if borrowers defaulted. As a result, platforms took on the responsibility for borrower default and exposed themselves to credit risks that were thus shifted away from lenders. By 2016, almost all platforms had become shadow banks. Figure 1. Interest Rate Comparison in China Table 1. Total Amount of P2P Lending (million USD) Figure 2. Monthly Number of Active P2P Platforms in China Country 2013 2014 2015 2016 2017 2018 China 5520 23,820 97,580 201,310 327,800 207,590 USA 3176 8742 21,282 23,420 17,340 27,420 UK 751 2135 3667 4810 6005 6359 Japan 79 108 326 171 236 873 Germany 48 116 205 227 448 813 France 57 117 181 277 431 494 Australia 2 16 70 165 365 321 New Zealand 14 245 178 242 222 Sources: Cambridge Centre for Alternative Finance. Sources: WDZJ (www.wdzj.com), People's Bank of China, and Wenzhou Municipal Government Finance Office. Wenzhou index is the interest rate of private lending estimated by Wenzhou government (www.wzpfi.gov.cn) P2P interest rate Wenzhou index Benchmark interest rate Interest rate (%) 25 20 15 10 5 0 01/2014 01/2015 01/2016 01/2017 01/2018 01/2019
3 As shadow banks, platforms formed their own reserve funds by pooling money from lenders to hedge borrower default risks. For example, Ppdai reported to the US Securities and Exchange Commission (SEC) that it had a quality assurance fund and investor reserve funds (www.sec.gov/Archives/edgar/ data/1691445/000119312517309953/d285990df1.htm). These reserve funds were similar to the deposit insurance in the traditional banking sector. Lenders are exposed to less risk from borrower default under principal guarantee but face the possibility of platform collapse. If the platform fails, lenders cannot regain their principal. Many P2P platforms lacked professional risk management and sufficiently large reserve funds. Therefore, when there was a shortage of new investors or economic downturns, a small number of borrower default cases could quickly deplete the reserve funds and cause panic among lenders. As lenders lost confidence in the promise of principal guarantee, they started a “platform (bank) run” by withdrawing money from the platform. In addition, the relatively weak capacity of regulatory authority in China left room for fraud. The intense competition and investor naivety jointly further induce Chinese P2P platforms to choose the risky and unsustainable business model. Having a larger number of platforms also makes monitoring more difficult for the regulatory authority and therefore facilitates fraud. Figure 2 shows different reasons for platform collapse. A large proportion of failed platforms ceased operation for “normal” reasons such as liquidity problems, lack of investors, or failure to earn a profit. However, many platforms failed because of fraud. Among 6,292 events of platform collapse on record, 1219 (19.37\%) were caused by absconding by the owner(s) and 397 (6.31\%) were investigated by regulators for possible fraud such as Ponzi schemes and fabricating information about borrowers. Thousands of investors were exploited by these financial frauds. The existence of naïve investors further increases the incentive of platforms offering principal guarantee. Naïve investors hold the misperception that platforms always have the ability to fulfill the principal guarantee terms. Mandatory information disclosure can mitigate the problem only if the regulation can be successfully implemented to all possible options faced by investors. If mandatory disclosure is selective and cannot cover all platforms, then naïve investors can be attracted to the remaining platforms with perceived low risks. In contrast, P2P platforms in developed countries (e.g., Zopa, LendingClub, and Prosper) maintained their roles as information intermediaries and never bore liability for borrower default. The P2P lending market in the US and the UK were dominated by a few platforms that do not offer principal guarantee, and institutional investors are more. Therefore, compared with those in China, platforms in these countries face less competition, more sophisticated investors, and more stringent regulation, which led to different outcomes. Figure 3: Reasons for P2P Platform Collapse in China Table 2: Platform Collapse with More Than 1 Billion CNY Unpaid Loans: Platform Collapse time Unpaid loan (billion CNY) No. of lenders Fanya* 04/2015 33.8 135,000 Ezubao* 12/2015 38 895,000 Kuailu* 04/2016 10 – Qbao* 12/2017 30 – Shanlin* 04/2018 2.05 30,000 Tangxiaoseng* 06/2018 5.29 107,000 Lingqianguan* 06/2018 2.2 6,000 Caogen* 07/2018 9.7 130,000 Yindou* 07/2018 4.3 23,000 Jinyinmao* 07/2018 2.23 1,000 Jucaimao* 07/2018 1.14 9,000 Tourongjia* 07/2018 1.68 23,000 Yonglibao* 07/2018 1.64 33,000 Touzhijia* 07/2018 2.9 – Quark Finance* 08/2018 3.8 24,000 Leaderrcf* 09/2018 1.3 2,000 Yourongwang 01/2019 1.25 – Koudailic 03/2019 1.03 19,000 Tuandai* 03/2019 14.5 222,000 Xinhehui* 04/2019 2.25 15,000 Wanglibao* 05/2019 3.03 40,000 Credit Harmony* 05/2019 8.4 31,000 Jinxin99* 05/2019 9.7 50,000 Yinhuwang 05/2019 3.37 20,000 Niubangold* 07/2019 4.3 94,000 itouzi* 07/2019 12.9 – Houbank* 08/2019 1.18 16,000 Laocaibao* 09/2019 5 28,000 Mizlicai* 12/2019 1.32 12,000 Weidai* 07/2020 6 – Sources: Fintech-Book and various news outlets. SPRING 2022 NO.61 / THOUGHT LEADERSHIP BRIEF abscondence 19.37% Stop operation 13.75% Liquidity problem 18.53% Stop by owner 40.4% Fraud investigation 6.31% Transition 1.64%
4 Reference: Dingwei Gu, Zhengqing Gui, and Yangguang Huang, “Why did the Peer-to-peer Lending Market Fail in China?” Working Paper (2021). Yangguang (Sunny) Huang is Assistant Professor of Economics at the Hong Kong University of Science and Technology. He is also a research affiliate at the Center for Economic Policy and faculty associate of the Division of Public Policy and Institute of Emerging Market Studies at HKUST. Sunny received his Ph.D. in Economics from the University of Washington, Seattle. His research areas are Industrial Organization and Applied Microeconomics. The theme of his research is combining economic models and econometric techniques to study policy-oriented topics. His research projects tackle problems in auction, procurement, corruption, financial development, digital economy, online markets, and innovation policy. RECOMMENDATION 1. Excessive competition among P2P platforms can jeopardize investors interest and social welfare. It is important to enhance regulatory capacity. For example, to prevent platforms from absconding with investors' money, platforms should establish custody accounts with commercial banks and perform transaction through banks. 2. If the regulator cannot substantially increase its regulatory capacity in the short run, one way to avoid excessive competition is to raise the barriers to entry to control the P2P market at a modest level of competition. For example, the US Securities and Exchange Commission issued detailed rules on how existing laws on securities were to be applied to P2P lending platforms. 3. Providing financial literacy education and informational nudges can improve investors' awareness of the risk of platform collapse and financial fraud. For example, one major regulatory goal of the UK Financial Conduct Authority is to ensure that retail investors are fully aware that lending on P2P platforms is not like bank deposits. 4. In the long run, expanding the credit scoring system can fundamentally reduce the risk in P2P lending markets. In developed countries, individuals and small firms can earn credit records through mature a credit scoring system. As a result, the P2P market is very small relative to the entire credit market in these countries. However, in China, there is no universal credit scoring system for individuals and small firms. P2P platforms attract borrowers with high risk and weak credit records. SPRING 2022 NO.61 / THOUGHT LEADERSHIP BRIEF Read all HKUST IEMS Thought Leadership Briefs at http://iems.ust.hk/tlb T: (852) 3469 2215 E: iems@ust.hk W: http://iems.ust.hk A: Lo Ka Chung Building, The Hong Kong University of Science and Technology, Clear Water Bay, Kowloon With Support from
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