The scale of the fraud is breathtaking. Around 900,000 individual investors have collectively been bilked out of US$7.6 billion, according to Chinese officials, in one of the largest Ponzi schemes ever conceived.
While the total money involved is less than the infamous Madoff Ponzi scheme the number of people involved is far greater. Ezubao, until a couple of months ago one of the top 10 largest P2P lending platforms in China, has been shut down and 21 executives have been arrested. Even though Ezubao only launched in July, 2014 it quickly grew, attracting hundreds of thousands of investors with promises of 9-15% returns.
It has been reported that an estimated 95% of all borrower listings on Ezubao were fraudulent. Meanwhile the top executives used investor money to enrich themselves – spending on items and gifts including real estate, cars and luxury goods, according to the Xinhua news agency.
A Blow to P2P Lending in China
The Ezubao fraud is big news inside China – it has been reported as the largest financial fraud in Chinese history. I spoke with a colleague in Shanghai last night and he said that it is the lead story on all the major TV networks and newspapers. There are even protests being reported in Beijing and outside the company headquarters in Anhui Province.
All this comes as the Chinese government has just formulated new potential rules for P2P lending, having sought industry feedback with a deadline of just last week. So, new regulations are coming but these actions are obviously too little, too late for the investors in Ezubao.
When I was in China last month I spoke with people who told me that it is too easy to start a P2P lending platform there. You need just US$1,000 to create a smartphone app, then obtain a very inexpensive business telephone license and you can be up and running. This has lead to several thousand platforms being established in just the last three years. Clearly, this is all about to change.
The government will need to enforce some strict rules to safeguard investors. Some of these rules have already been proposed such as segregating investor money from operational money, borrower loan limits, more data transparency, no outside funding, no other investment products and much more. There was over 40 recommendations in the draft rules document.
The Difference Between the US and China
One of the stats I have heard used is that when it comes to borrower defaults around 50% occur in China because of fraud whereas in the US that number is more like 1%. Clearly, more work needs to be done in China with regards to identity verification and credit underwriting to make investing in p2p lending platforms more safe.
Another big difference is the difficulty in establishing a P2P lending platform here. There is a well-developed ecosystem in the US for both consumer and small business credit and appropriate lending licenses need to be obtained in most states before a company can begin operations.
Could this level of fraud happen in the US? I think it is highly unlikely. Most consumer lending platforms partner with regulated banks like Cross River Bank or WebBank. Their due diligence process is extremely rigorous and they force companies to become compliant with all national and state regulations. On the small business side there is even less fraud – maybe because of the wealth of financial and other data available on any business today that makes loan fraud that much more difficult.
P2P Lending Will Continue to Boom In China
Despite this major setback I think P2P lending will continue to grow and prosper in China. Regulations will likely get implemented quickly and they will be quite strict. But my conversations with Chinese P2P lending insiders indicate that the government is still supportive of the industry as a whole.
One the unique things about China is that its banking system primarily supports large government run businesses. By and large the middle class has not been served well by Chinese banks when it comes to credit – these P2P lending platforms are filling a real need.
We should not let one bad apple tarnish the entire industry. There are so many great companies run by reputable people doing ground breaking work. Companies like CreditEase, China Rapid Finance and Lufax, who recently raised $1.2 billion at an $18.5 billion valuation, are leading the sector forward in China. Lufax has indicated they intend to go public later this year and Yirendai, the online arm of CreditEase completed an IPO a few weeks ago on the New York Stock Exchange.
China clearly has a long way to go. Regulators let the industry run largely unchecked for several years and this has led to widespread fraud and platform failures. But taking a long term view, once regulation is in place and investors feel their money is safe, the Chinese P2P lending industry will continue to grow and dominate the world of P2P lending.
Whoa. You’re really downplaying this. “…one bad apple..” This was more than an apple. $7.6B fraud is a very big deal. A horror. Thousands of individuals lost considerable amounts of money. For some, no doubt, their life savings. This does much more than “tarnish”. The whole Chinese P2P industry is apparently completely unregulated and unsafe. Much of it is surely rotten. The wake up call had to happen, and now it has. Now that it is clear to everyone that such fraud is possible, many more of these companies will collapse. The Chinese government’s lack of oversight allowed this to happen. Some government regulators need to lose their jobs over this.
Of course China isn’t the only country where new kinds of financial business don’t get properly regulated. Japan allowed MtGox.
I’m happy to live in a country where there are more serious government regulators, even if they don’t get everything right the first time. (Yes, even if they did screw up big-time on Madoff.)
Hi Fred,
Fair enough, I didn’t mean to downplay how bad this is. This does bring a cloud over the entire P2P lending sector in China. The point I was trying to make is that there are still good companies there despite this complete lack of regulation.
And yes, the government screwed up here. They should have moved quicker and tried to prevent something like this from happening. No doubt, just like in the Madoff scandal some people have been financially ruined by the greedy action of a few people. We should not downplay that aspect.
Having said all that, I am still bullish on the overall P2P lending sector in China but this is a major setback that will have lasting ramifications I expect.
I agree Fred – if there is one company that is engaged in fraud, there are likely multiple ones that have yet to survace!
China has a very serious P2P lending bubble which has grown on top of its general credit bubble as well as its issues with its currency (“hard landing”). This does not impact the US platforms in any way, though many people will probably see the term P2P and imagine (incorrectly) that there is possible contagion – totally different ballgame over here, though, with only a handful of P2P platforms, all of which are super-regulated (LC and Prosper were – and probably still are, though I haven’t seen it mentioned in a year or so – quite literally the most voluminous filers of SEC compliance documents in recorded history – they can’t get up and go for a bathroom break without checking with SEC and doing a filing, first)… And that doesn’t count the various other direct/indirect oversights from FDIC, CFPB, etc…
There will be more Chinese “P2P” (and I use that term very loosely here, as the Chinese do) platforms failing or being exposed as having no meaningful risk management in place, due to total lack of regs…
A lot more, unfortunately…
How can we ensure that this does not happen in the countries we operate in. This has always been a concern, which is why at marketfinance.in, we put a lot of emphasis on due diligence for our lending partners, and take part in the risk sharing.
Nonetheless, it is something we will continue to work hard on, as emerging markets do still present this as a huge challenge.
An easy solution is to require the money to be hold by an accredited, independent third party who sends statements. It’s called a Qualified Custodian in the U.S. (Lending Club and Prosper both use a custodian named Millenium Trust)
As stated above – when one player gets caught committing fraud its dang good bet they are not the only one. The scary thing about this is that usually the dumbest ones get caught first, not the biggest and most ‘well respected’ player.
It’s a shame that such a large case of fraud took place, especially with so many people being affected by it. Hopefully with a greater emphasis on regulation, China will be able to overcome this and improve the situation surrounding their P2P lending.