The Meteoric Rise and Spectacular Fall of Peer to Peer Lending in China

When we started LendIt in 2013 I had no idea that China was a hot bed of peer to peer (p2p) lending. But there I found myself talking with several leaders from the Chinese p2p lending industry at the first LendIt back in June 2013. We did no advertising in China but many got wind of the event and traveled to New York City to be there. It was then that I found out the massive scale the industry had already achieved in the world’s most populous country.

I first wrote about the Chinese p2p lending industry later that year and introduced the west to CreditEase, the company that was the largest p2p lending platform in the world. Over the next couple of years the industry thrived with thousands of platforms launching and the total loan volume skyrocketing to over $150 billion in 2015, which was four times the loan volume of 2014. In hindsight, we should have known that kind of growth in a lending industry is not just unsustainable, it is highly risky.

China’s Biggest Ever Financial Scandal

We got the first inkling that something was not quite right when China was rocked by the biggest financial scandal in its history. Ezubao, one of China’s largest p2p lending platforms, collapsed as it was revealed the business was nothing more than an elaborate Ponzi scheme. Around 900,000 investors collectively lost $7.6 billion in what was the second largest Ponzi scheme the world had ever seen (Madoff being the largest).

But the industry rationalized this away as just one bad apple. The regulators had just announced draft rules for the industry at the end of 2015 and there was a sense that the strong platforms would adapt and continue to perform well. And that is what happened for the next year or so. But by 2018 serious problems began to emerge. That year ended up being the year of reckoning for the industry.

The p2p lending industry had grown to around 4,000 platforms at its height which everyone agreed was not a sustainable number. The weak platforms were not going to make it but the trouble was as they failed they often took investor money with them. While there was definitely some fraud there were also cases of platforms that meant well but were simply unable to make online lending work.

Life Savings Invested in P2P Lending

Many investors had put their life savings into a single p2p lending platform believing that their money was safe. Some platforms said they would guarantee investor principal and others implied they were backed by the government. What these investors did not understand was that once the platform went out of business these guarantees were worth nothing. But they truly believed the platforms should guarantee all these investments. CNN had this piece about several unhappy investors who lost money in one of the many platform failures. Reuters, the South China Morning Post and many other news outlets have reported similar stories.

Despite these challenges, I was still confident the industry would be ok over the long run. I wrote this piece in the summer of 2018 in support of the Chinese p2p lending industry. Even then I thought the leading platforms would continue to do well and the industry would emerge with a sustainable number of successful platforms. I was wrong.

Everything has come to a head this month. We learned last week that Hunan province is banning all forms of p2p lending even from companies based outside the province. I have spoken to people inside China this week and the sense is that other provinces will be following Hunan’s lead.

But the big news came this week. The South China Morning Post is reporting that loans above an APR of 36% will now be illegal and any company charging rates higher than that will be prosecuted and executives could face up to five years in jail. Many p2p lending platforms offer loans above that rate (particularly when considering origination fees) and so this will make it even more difficult for even the large platforms to survive.

Not only that but Bloomberg is reporting that the government now wants existing p2p lending companies to become “small loan companies” or micro-lenders. Companies that don’t fulfill these requirements will be pushed to exit the industry. The details are not clear on how this will work exactly but it likely means these platforms will not be able to raise money from the public. This is yet another ominous sign for the industry.

Keep in mind that some of the largest p2p lenders have millions of investors and just as many borrowers. Some have loaned out several billion dollars this year so there is further disruption ahead. While many of the leading companies have diversified into wealth management and other services they are still providing capital to millions of consumers. If they are forced to stop taking on retail investors there is no institutional investor base ready to step in to fill the void like there is in the West.

When speaking with an industry insider in China yesterday there was a sense of impending doom for p2p lending and that “maybe 20 or 30 companies will survive”.

What Went Wrong

I reached out to Martin Chorzempa, a research fellow at the Peterson Institute who is finishing up a book on the Chinese fintech sector and is one of the leading western experts on fintech in China. He has studied p2p lending since its infancy. He said, “Peer to peer lending was a failed experiment in China. It became so tainted by fraud and illegal activity that even the well-intentioned platforms have struggled.”

When I asked what could have been done differently he said, “This has been one of the worst failures of the regulatory system. In 2013 the People’s Bank of China (PBOC) had identified many of the problems with p2p lending but did not do anything about it until it was too late.”

The reality is that it is really difficult to underwrite loans well. You need a lot of expertise, particularly when it comes to risk management, and only a small number of platforms fully realized this. In the go-go days of 2014 and 2015 what was rewarded most was size. Chorzempa again: “There was no signal of how trustworthy you were except for your size. So, there was a mad rush to grow very big, very quickly and there was little incentive to be a good actor.” Many platforms that actually had effective risk management in place were overtaken (in size at least) by these young upstarts. It was a house of cards and in hindsight it was no surprise that it all came crashing down.

There Will Be No LendIt China in 2019

We have held LendIt China every year since 2016 in Shanghai and I am sad to report that in 2019 there will be no event. While we have expanded beyond online lending it still represented a significant part of our business in 2018 but given the recent challenges we expect no lending companies will be interested in speaking, sponsoring or even attending this year. So, we made the difficult decision to cancel the event. We will regroup in 2020 and hopefully will be able to bring our unique event back to China.

To witness firsthand the amazing growth and then sudden decline of the p2p lending industry in China has probably been the most remarkable experience of my career. The level of excitement in 2015 and into 2016 was unparalleled globally as dozens of companies went from zero to a billion dollars in loans in less than a year. Now, we see the exact opposite as so many failures have led to a similar level of despair.

Most p2p lending executives that I met in China over the last six years had good intentions but many failed to fully grasp the fundamental truth of any lending business: while it is easy to give money away it can be very difficult to get it paid back. The story of peer to peer lending in China will now be remembered more for financial ruin than for the amazing innovations and badly needed capital it supplied to consumers and small businesses. With bold and decisive action by regulators it could have been a different story.

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Robert Leonard
Robert Leonard
Oct. 23, 2019 6:12 pm

To say China’s experiment in P2P lending may be just the tip of the iceberg could massively overstate iceberg tips. I would not be surprised in hindsight over the next few years to come to view China’s entire economy as one gigantic Ponzi scheme resting on an almost unfathomable mountain of debt. We live in interesting times.

Le Crowdlender
Nov. 1, 2019 9:04 am

Very interesting article.
The question is now, could this happen in Europe ? The p2plending market is growing well in Europe. I am personally invested in 8 different platforms and earning good money every month.
I hope we will not witness the same level of fraud and bankrupcy that happened in China.

Yiting Pan
Yiting Pan
Nov. 1, 2019 6:06 pm

What’s important is that in Chinese economy there is true need of small/micro business lending, which banks have no true intention to cover. And the health and growth of small/micro businesses is important to the society. There is a need for the alternative lenders to exist and serve this sector. With majority of P2Ps gone, it might be good for the bigger and more experienced players to do things right. But it depends on how the regulators think about this issue and what they decide to do next.