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China and peer-to-peer lending

JWG analysis.

Peer-to–peer lending has grown at a rapid rate in China over the last two years, with more than 2000 peer-to-peer platforms in operation.  But the sector has been plagued by questionable sales techniques and rogue operators taking a fly-by-night approach and disappearing with customers’ funds.  In addition, regulators are worried that an industry – known for lending money with few barriers to lower income individuals – will spiral into a hole filled with debt and high risk consequences.

In reaction, Chinese regulators have written rules to constrain more risky online lending.  It is hoped that the regulation will standardise operations and remove it from the shadows of the banking sector.  By eliminating the unregulated vacuum and legitimising an increasingly popular and fast developing part of the finance industry, the market could shake off its reputation as a cowboy operator.

The Central Bank will oversee online payments, while the China Banking Regulatory Commission will supervise online lending and peer-to-peer platforms and the China Securities Regulatory Commission will be responsible for crowdfunding and the online sales of funds.

The new rules seek to separate peer-to-peer lending from retail banking.  Central points are:

  • Funds must be held at established banks
  • Platforms are to offer higher level of disclosure concerning risks
  • Platforms are forbidden from taking deposits or providing guarantees
  • Platforms are not allowed to raise funds for their own projects.

These latest guidelines are fairly broad with more specific details to follow in the next few months.  However, there is a worry that the regulations will be too inflexible for the fast growing online finance industry.

Of specific concern are the rules on the right to act as custodians for the funds that lenders deposit.  Under the new regulations, only banks can provide a custodian service for investors’ deposits.  It is argued that this restriction does not match the operational reality of the online lending service and will, ultimately, restrict any future development in online financing.  But it could also be argued that this is a necessary and sensible step towards adequately protecting investors.

Additionally, there are the downsides, as with most new regulatory initiatives at the outset, i.e., increasing operating expenses.  Such costs represent a double edge sword – they will increase entry barriers and, therefore, decrease competition, but will also rid the market of weaker and less reliable players.

It is clear that China wants to make robust changes to a fast growing, but potentially high risk, industry that is made up of both legitimate and illegitimate market players.  Yet, despite it being a new and fast developing area, some long-standing ways of regulating are seemingly being introduced and, with those, the age-old problems of balance and cost.  Whilst this is, no doubt, a step in the right direction, changes will have to be made along the way to account for market development and to accommodate the need for the flexibility that is usually demanded by a new financial industry player.  We shall await the inevitable changes and details with interest.

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