China’s Burgeoning P2P Crisis
The travails of China’s finance sector continue. It is now the turn of microfinance or peer-to-peer (P2P) lending. The sector has grown explosively, having gone from 200 websites in 2012 to an estimated almost 4,000 earlier this year. In fact, loan values went from $20-40bn in 2014 to $200bn this summer.
By June this year it was the largest peer-to-peer lending market in the world with 4.1 million investors lending to 4.3 million borrowers in just one month.
This year, lending sites started to run into problems. Problems are defined as difficulty in withdrawing money, sites stopping operation, site managers disappearing, managers being arrested or executives fleeing with client funds. In 2017, 217 sites terminated. A further 28 sites closed this May and 80 in June. The number had reportedly fallen at mid-year by half from almost 4,000 to 1,836.
In July it was 218 collapses in a month, with well over 10 per cent of all sites closed in just 30 days. In fact, Wangdaizhijia, the industry research firm, estimates that by the end of June the number of troubled and closed lenders was 4,347. This suggests that the total number of sites launched is even higher than common estimates.
July was a scene of carnage. The failure of Tangxiaoseng for $5.5bn has been described as “probably fraudulent”. They offered rates of up to 15 per cent. Others have been hit by regulatory attempts to enforce deleveraging and reduce the role of the shadow banking market.
The list is sobering: Tourongjia collapsed and there is no sign of the chairman and no compensation in sight. Zhuaqianmao collapsed. Qian88 closed down blaming ‘investor panic’ and lqgapp was suspended owing over $750 million to 220,000 investors – almost a year’s average salary per investor.
A Beijing academic said consolingly that “survival of the fittest is a law that the development of every industry must respect”. In August, Peoples Daily added that “the retreat of some P2P lenders is part of a normal market clean-up.”
So, capitalism is the rule in China when socialism is too expensive. One estimate calculated that by the end of July failed PTP platforms had outstanding funds of $11.5 billion owed to 1.1 million investors. However if we recall the failure of Ezubao for $7.3billion in 2016 and Tangxiaoseng for $5.5 billion this July, they alone total almost $13 billion. Failures date back to at least that of Tongxin in 2016 which had been offering rates up to 18 per cent.
P2P sites were publicized in state media and executives were seen to be associating with government officials, lending a sense of government approval. As a result, there has been strong public dissatisfaction from investors and demonstrations at government offices, accompanied by demands for restitution.
Foreign media have said that many who lost their savings are asking why the platforms were allowed to portray themselves as government-approved. On 6th August, hundreds of police officers poured into Beijing’s financial district to prevent peaceful demonstrations against crooked P2P lenders being able to operate, imply government sponsorship and not return investors’ money.
One of the problems of a dominating state is that it claims credit for all positive developments. However, the negative is that the public will blame it for everything which goes wrong and often expects restitution. It can weaken the loyalty of the public to the state.
In late August, the Financial Stability and Development Commission (FSDC), China’s top financial regulatory body, commanded a “continuing crackdown on illegal financial activities and financial institutions to protect the interests of investors and safeguard financial and social stability”.
The problem is the “crackdown” on unorthodox lending is itself creating financial and social instability.
There are three reasons for these failures: policy initiatives to cramp shadow banking, poor regulation and outright fraud. P2P lending has been described as “one of the riskiest and least-regulated slices of the nation’s sprawling shadow-banking system”.
By the end of August, state regulators had encouraged the four large state-owned asset management companies – set up in 1999 to address the 1990s banking crisis – to wade in and even bail out failed P2P firms to avoid political embarrassment.
By the end of August it was possible for one economist to say quite ironically that the state is “paying more attention to the risks of de-risking”. However, bailing out poor and criminal lenders creates a degree of moral hazard.
Rather incredibly, according to the World Bank, shadow banking in China has been estimated at anywhere between eight and 88 per cent of GDP. This makes it possibly 25 per cent bigger than the shadow banking sector in the United States, despite the latter having a much larger economy. A reasonable guess is that the shadow banking market might be in the region of $10 trillion.
This causes serious potential problems, particularly for a still-developing society. In its cautious prose, the World Bank states that “the increased complexity of shadow banking makes supervision and risk assessment more difficult, creating additional vulnerabilities in the financial sector”. In other words, the explosion in shadow banking has seriously raised the risk level in Chinese finance.
Beijing understands this and has taken many measures to reduce the risk via deleveraging. However, the debt ratio does not appear to show any meaningful reduction. Furthermore, shadow banking is one of the channels for the private sector to fund itself, lacking in most cases the ability to tap state banks. If shadow banking is now cramped without state banks changing their lending stance, private banks will struggle even more to raise funding.
The Chinese authorities permitted P2P lending to develop very rapidly for several years without introducing any rules of engagement. When they did, in 2015, regulation was modest and partially deferred. The emphasis of the new guidelines was not on control but on encouraging growth in the new industry.
It did not take long for China’s characteristically weak regulation to engender trouble. There are also social factors encouraging the phenomenon. It should also be noted that consistently the authorities are not galvanized by the investor losses but the possibility of instability from the protests against official quiescence.
We have written several times about this feature of modern China. Indeed, weak regulation and patchy enforcement is one of many reasons why a totalitarian state can also be described as being “weak”. Corruption to evade regulation is another sign of state weakness.
To recapitulate, this is the world’s largest P2P lending market, recently worth $200 billion. By end July, failed platforms owed well over $13 billion to more than 1.1 million investors. On 6th August, Beijing’s financial district had to be “locked down” to prevent public demonstrations by aggrieved investors demanding compensation.
Beijing is desperate to demonstrate the elements of a new economy, but it lacks the judgement to decide how, what and when to regulate so as to encourage growth in a prudent framework. When a country has the world’s second largest economy, this is not the best way forward.
The scale of China’s contemporary financial problems seems to be size-for-size larger than its population would justify. The rest of the world has not come out of the last 20 years covered in regulatory glory but there is little point in saying that the US had some of these issues in the 19th century. We have all learned a little since then. Not a lot. It would be helpful to take some of the lessons to heart.