Chinese authorities arrested executives from online peer-to-peer (P2P) lending company eZubao in early February after the company stole an estimated $7.6 billion from 900,000 investors.
EZubao, which claimed to match investors with high-return projects, instead used its cash to pay out earlier investors and shower executives with high salaries and lavish perks. Only one of the 207 companies listed on the site had actually conducted business with eZubao.
Peer-to-peer lending in China has grown rapidly, with 2015 volume reaching $33.2 billion—versus $23.2 billion in the US, according to Morgan Stanley estimates. Low standardized return rates on bank deposits have encouraged investors to seek out higher returns, and small Chinese companies struggle to get funding from the country’s large banks.
A study by consulting firm Oliver Wyman and the Fung Global Institute found that small and midsize enterprises in China contribute 70% of employment, 60% of GDP and 50% of tax revenue, and hold 65% of patents, but they receive less than 20% of bank lending.
Because peer-to-peer lending companies theoretically match lenders and borrowers directly, they can circumvent most financial industry regulations, including deposit rate limits and capital requirements. But they have limited access to credit information, making risks difficult to quantify.
Regulators have taken notice. In December the Chinese government released draft rules on P2P lending that prevent companies from guaranteeing returns or pooling funds to invest in company projects. The rules would also require P2P companies to deposit investment funds in traditional banks rather than holding on to them or channeling them through a third-party payment company.
The expanded regulatory framework and stepped-up enforcement for companies like eZubao will present significant challenges for P2P firms, which are already operating in a highly competitive environment. The sector will likely survive, though, writes Zhi Ying Ng, e-business analyst at Forrester Research.
“While this piece of news portrays the Chinese P2P sector in a bad light, I think P2P lending in China has its merits as it helps to solve both investor and lender problems,” he says.