Regulation desperately needed for peer-to-peer lending

By Tian Lei, Zhonglun W&D Law Firm
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Peer-to-peer (P2P) lending means an individual or a corporate body lends to, or borrows from, another through an independent third-party online platform. That is to say, a P2P lending platform serves as an intermediary platform on which a borrower offers a bid for borrowing, while investors bid for the borrowing and lend it to the borrower. In this online lending method, the lender earns interest income and bears risk, while the borrower repays the principal together with interest when due, and online credit companies charge an intermediary fee.

A P2P lending platform was established in 2007 in China. Several years later, there were few online lending platforms in the country, with few entrepreneurs involved. It was not until 2010 that entrepreneurs began taking a fancy to online lending platforms and testing the water. Online lending platforms entered a period of rapid development in 2011, with a batch of enthusiastic lending platforms going online.

田磊 Tian Lei 中伦文德律师事务所 合伙人 Partner Zhonglun W&D Law Firm
田磊
Tian Lei
中伦文德律师事务所
合伙人
Partner
Zhonglun W&D Law Firm

Speedy growth

Development accelerated further from 2012 to 2013. Especially after September 2013, online lending platforms were growing at a speed where three to four platforms were being launched every day. According to www.01-DataStorage.Com, there were nearly 700 types of online P2P lending platforms across the country by the end of 2013, more than five times the total of 110 platforms in 2012, while annual turnover amounted to about RMB110 billion (US$17.8 billion), 10 times the turnover of RMB10 billion in 2012.

The growth rate of P2P offline lending platforms was more or less the same as that of online lending platforms. The total amount of borrowings from the top five P2P companies with a large turnover ranged from RMB60-80 billion approximately. The total number of lenders in the industry was between 100,000 and 200,000, and the total of investors was about 1 million.

Internet finance increased in popularity during the first half of 2014. The 2014 First Half Report on China’s Internet Lending Industry, released by the website www.wangdaizhijia.com, suggests that there were 1,184 P2P platforms across the country in the first half of the year, with a trading volume of RMB81.83 billion in the first half. The huge potential of P2P lending for development has won the favour of various capital market players, such as private equity and venture capital institutions. However, investors must be cautious of the risks associated with this sector.

High-risk exposure

Coming along with the explosive growth are scandals involving some online lending platform companies, such as misappropriation of funds, unauthorised offline lending, executives fleeing from troubled companies, and bankruptcy.

Credit risk. P2P lending relies heavily upon the credit system and the environment of integrity. In North American and European countries, there is an impeccable credit service system as a support, and personal credit data are relatively comprehensive and accurate. However, under the current credit environment in China, the lack of credit data and lack of a long-term culture of integrity has given rise to a greater credit risk exposure for P2P lending.

Qualification risk. P2P lending is different from financial institutions in the way that financial institutions are based on “net capital” management. Whether a financial institution is a bank or a trust company, it must have its own registered capital – which amounts to at least several hundred millions of renminbi or as many as dozens of hundred millions – that is not used for operations, but acts as a guarantee and a “threshold”.

Frauds and escapes

However, due to the low thresholds for P2P lending companies and inexpensive platform software, a lot of people who have a lot of debt in private lending have purchased a platform to act as virtual borrowers, to mortgage virtual goods and to attract investors with high interest rates. These access restrictions without any qualification “thresholds” have given rise to frauds and escapes due to bankruptcy.

Management risk. P2P lending sounds simple, but it is actually more complex than banks and other financial institutions, as far as its model is concerned. It has a short development period such that the market has not reached a mature stage, the management system is not comprehensive, and there is a lack of credit risk management professionals in the organisational structure, and of knowledge and qualification of credit risk management, thus resulting in relatively high management risks.

Rules urgently needed

China does not have any relevant legislation to explicitly regulate P2P lending, with the Notice of CBRC [China Banking Regulatory Commission] Office on Risk Alerts for P2P only saying that P2P platforms are credit intermediary services companies. Where inter-enterprise lending is expressly banned under current legislation, P2P lending is taking an approach of personal borrowings, without any clear legal restrictions on the methods and platforms for reaching a loan contract.

The author believes P2P lending should be regulated in the following aspects.

Set up access thresholds. Since P2P lending platforms leverage a huge amount of market money, and a lot of them are directly involved in the loan lending relationships or act as guarantors in such relationships, the regulatory authorities have an urgent need to define the legal status of P2P lending platforms, set eligibility conditions and impose restrictions on the access of P2P lending platforms to the market.

Call on online lending platforms to govern borrowers. In order to guard against the risk of default of borrowers, P2P lending platforms should be required to improve their mechanisms for credit and identity verification by verifying the identity, credit status, income details, purposes of borrowings, and business scope of borrowers.

Step up legislation to determine which principal parties are to be regulated. Introduce appropriate legislation as soon as possible for the effective control of possible risks, regulation of business processes, methods of money depositing, and positive identification of any possible illegal acts in order to effectively facilitate the regulation and standardisation of the P2P lending sector, to prevent the occurrence of systemic risks and to safeguard the legitimate interests of borrowers.

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