Over the past month, the peer-to-peer (P2P) lending industry in China has collapsed. It’s left tens of thousands of investors penniless. There’s rioting in the streets. The turmoil has driven chief officers of major P2P platforms underground.
What we’re seeing is a modern bank run.
It feels like Black Tuesday, the apocalyptic moment in American history. Investors are rushing to withdraw their funds. But it’s too late. By the end of this disaster, Chinese investors could lose over NZ$250 billion…
The problem began with small and mid-size Chinese businesses. They struggled to borrow from the major Chinese banks. Because the banks preferred to work with state-owned enterprises or large companies.
Evidence of a developing economy outstripping lending capabilities.
This opened a gap for ‘shadow lending’, specifically P2P lending. Instead a bank middleman, P2P allows lenders to interact directly with the borrowers.
On a P2P platform, borrowers make an initial application. They receive an interest rate based on their situation. Once they’re accepted, their loan reaches the marketplace. Lenders with funds can check out loans that need funding.
They become loan officers…analysing the underlying assets, why the company needs the funds, the reputation of the company, etc…
If they like the opportunity, they invest.
It’s attractive for lenders because these loans offer big benefits. Think 8–16% interest per annum and a duration of a year or two. The epitome of ‘get rich quick’.
For borrowers, it opens up a whole new realm of capital that would otherwise be beyond their grasp. Major lenders rejected many of these companies for being too small, too young, or too risky.
Plus, with P2P lending, borrowers are often able to get what they need within 24 hours. Whereas with a major lender, it could take months to get everything squared away.
The last element of the process is the platform itself. Platforms are websites that create a channel for lenders to find borrowers. A digital marketplace.
So far so good, right?
Nothing wrong with wanting to invest in companies…and make a return while you’re at it.
In fact, P2P lending is like crowdfunding. Maybe you’ve heard of crowdfunding platforms like Kickstarter or Indiegogo.
On these platforms, start-ups and entrepreneurs can pitch their idea to normal folks. If people like the idea and want to invest, they can put a little skin in the game. In return, they get equity in the company.
And that’s the difference. With crowdfunding, investors get equity in return for funds. With P2P lending, investors receive back their capital plus interest.
Both are popular forms of alternative financing.
Now, the problem with P2P lending in China is that, up until this winter, these lending platforms have been more-or-less unregulated. It’s been the Wild West.
Imagine thousands of Chinese people busting open their piggy banks. Competing to give their savings away. Making deals left and right. Promises of big returns in no time at all.
You can see how the lack of oversight could open a door to fraudsters and conmen.
And it wasn’t just borrowers in on it…
The number of platforms skyrocketed from 93 in 2013 to nearly 4,500 five years later. Thousands of new platforms offered different perks…all in return for a small commission.
The industry exploded. And the state noticed…
The China Banking and Insurance Regulatory Commission stepped in around December 2017. They created a complex registration process for platforms. Then they demanded that existing platforms comply. The deadline was June 2018.
Most platforms failed to meet the deadline…resulting in heightened panic among investors.
It’s also put the state in an awkward position. Because while they are trying to provide oversight, they don’t want to claim responsibility for the fallout. Nobody wants to stick their neck out and enforce the new regulations.
The outcome has been pandemonium
In July, local government set up temporary complaint centres. Victims of troubled online platforms filled two stadiums.
In Beijing, irate investors protested in the financial district. The police shut it down.
When lender Qian88.com defaulted, local police intervened to calm down an angry mob at the firm’s office.
Across the industry, lending platforms have closed their doors to investors. It’s prevented anyone from withdrawing from their accounts.
Other platforms have simply gone AWOL.
Bloomberg recounts the story of one victim (emphasis mine):
‘David Gao, 30, who works in the financial industry in Beijing, invested 1 million yuan of of [sic] his savings in P2P loans facilitated by a Hangzhou-based platform in November and has been unable to retrieve his principal and interest. After traveling 700 miles to the company’s office with other investors last week, he found it deserted.’
Another lending platform, Huoq.com, went into liquidation on 11 July 2018. The owners of the platform disappeared into thin air. Neither the company nor investors could find them.
And now, I’d love to say that the Chinese government is trying to bring these thieves to justice…
But the sad truth of the matter is that few investors will ever see another penny. The bandits have run off with their bags of cash…and the authorities have washed their hands off the matter.
For many, it’s a disappointing end to an exciting journey they started not too long ago.
For you, it’s a reminder that if something seems too good to be true, it probably is.
Stay safe out there.
Editor, Money Morning New Zealand