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Central Bank Raises the Red Flag over P2P Lending Risks

People’s Bank Finds Peer-to-Peer Loan Practices May Amount to Illegal Fundraising

A recent report by the central bank about peer-to-peer (P2P) lending websites in China has shed light on some severe problems in the business for which there is, as yet, little regulation.

The original idea for P2P lending websites was that they were only a platform to match people with spare cash and those who need to borrow money. A typical transaction could see someone with cash to spare lend 5,000 yuan to a young couple wanting to decorate their new home.

The attraction for lenders is that expected rates of return are mostly above ten percent and some exceed twenty percent. In contrast, the annual interest rate on a one-year term deposit at banks is 3.25 percent.

The industry started to take off in 2009, and now it is worth nearly 60 billion yuan.

However, as the central bank points out in its report, many such websites in the country have taken on businesses they are not allowed to operate, such as packaging loans into wealth management products that investors are very willing to snap up, soliciting deposits directly or in disguised form from the public, and providing unrealistic loan guarantees.

The best the bank can do at the moment, however, is call attention to the problems and hope financial regulators, including the China Securities Regulatory Commission (CSRC), can work together to devise targeted regulation.

The report is based on the central bank’s surveys this year of P2P lenders in Hunan Province, Shanghai and Chongqing.

In Chongqing, it found two P2P websites touting wealth management plans, which pool small sums of money from their website users and extend loans. In this way, investors are spared the trouble of looking for borrowers themselves. They are promised an annual return rate ranging from twelve to twenty percent and are asked to send their money directly to the P2P companies’ account. Not much information is disclosed about who receives the loan.

On the surface, the wealth management schemes appear to be an innovative investment tool with high expected returns, but the risk is enormous because money pooled this way is vulnerable to mismanagement, said Liu Yannan, CEO of Yooli.com, a P2P lending website.

Common misuses include investing short-term funds into projects that only start paying off in the long term, he said. This could be a problem if newly raised cash falls short of covering the payment of maturing schemes, he said.

Another cause for concern is the lack of restraint on how the P2P companies use clients’ money. Most P2P companies claim that they entrust the money to a third-party payment company. However, Gu Chonglun, vice president of Renrendai.com, a P2P lending website, said the arrangement is no guarantee that investors’ money is safe.

Usually, a P2P company controls the third-party account it opened, and investors’ requests for fund transfers are relayed by the website to the account. In other words, Gu said, it is still possible for P2P companies to misappropriate client money.

Some small lenders have lost their money. In late 2011, the founder of Angel Plan, a P2P lending firm, shut its website and disappeared, leaving behind at least six million yuan of unpaid debt owned by investors who bought into the company’s wealth management products. The police investigated, but have not recovered any money.

Some P2P companies are still offering wealth management products. In March, Oldai.cn introduced plans with an expected annual yield of twenty-two percent. Investors snapped up all the products in three days, the firm said.

Renrendai.com is also in the business. Since it was established it has sold at least twenty-four wealth management products with expected annual yields ranging from twelve to fourteen percent.

Gu said the service was meant to serve users whose investments are large. Compared with similar services at other P2P companies, investors on Renrendai.com are better informed about how their money is used, he said.

Illegal Fund Raising?

There are also questions as to whether most P2P lending companies can, as they claim, repay investors their principal if a borrower defaults on a loan.

Only licensed companies can guarantee loans, and they cannot guarantee more than ten times their capital, said Xu Jianwen, CEO of P2P website Renrenmoney.com. Most P2P lending companies, however, have far exceeded that limit, he said.

The central bank’s surveys show, for example, the annual turnovers of five P2P companies were in the range of eighty million yuan to 500 million yuan, while they had only three million yuan to ten million yuan in registered capital. That means at least some of them have guaranteed loans worth more than ten times their own capital.

Providing loan guarantees is an industry norm and those who do not cannot attract users, Liu said. Usually, a P2P company charges one to two percent of an investment and put the money in a reserve fund, but that is far from enough to cover losses, he said.

The average bad loan ratio in the industry is higher than three percent, Xu said, even though most companies said theirs are below one percent.

Even industry leader CreditEase is not exempt from the problem. The firm’s office in Changsha was forced to suspend operations temporarily last year because its bad loan ratio reached five percent, a source familiar with the situation said.

To control risk, more and more P2P lending firms, including Yooli and Renrenmoney, have opted to cooperate with professional, licensed loan guarantee companies. But it is too soon to tell whether this model works.

The central bank also criticized certain P2P companies for undertaking other operations, which analysts say border on illegal fund raising.

It highlighted one such operation involving pre-paid “consumption cards,” which, depending on the issuing firm, allow holders to dine at restaurants or shop at malls, among other things. Investors buy those cards at a discount and can sell unused credit on the card back to the issuer at a premium as if collecting an interest payment.

Yang Zhaoquan, a lawyer at Beijing VLaw Law Firm, is among a number of experts who says the practice fits the description of illegal fund raising.

“It takes place without (regulatory) permission, borrows money from nonspecific people and promises repayment of principal and interest payment upon maturity,” he said. That is a disguised form of illegal fund raising, he said.

The central bank says in its report that the operation “has become a new way of fund raising for merchants to sell pre-paid cards to the public through intermediaries.” It has required all P2P lending firms to review such business and bring them in line with regulations.

Critics say attention should be paid to the fact that the borrowing on P2P websites is no longer limited to individuals. Small companies with demand for cash of up to several million yuan have emerged on websites where you might also find that young couple seeking to decorate their home. Investors put up their money for making loans the same way they buy into units of a securities investment fund.

This also fits the definition of illegal fund raising, said Zhang Luqiao, a lawyer with Winners Law Firm in Tianjin.

The Regulation Question

Despite all the problems raised in the central bank’s surveys, the bank said there is no consensus regarding which institution should oversee the business and how it should be regulated.

A source close to the bank said it convened a meeting in May to try to figure out a solution to the regulatory gap. But most officials at the meeting said it would be premature to draw up a specific regulation because the size of P2P lending was too small compared with the markets for trusts and securities funds.

If the authorities decide to group P2P lending websites under asset securitization institutions, as in the United States, the source said, the CSRC would be responsible for regulating them.

Bai Chengyu, secretary-general of China Association of Microfinance, said there is no need to create new regulations and all the industry needs is stronger self-discipline and clear-cut boundaries between its function as a platform and other services that should be monitored by regulators.

“Some are selling wealth management products and guaranteeing loans under the banner of P2P business,” he said, “but they have gone beyond the scope of P2P lending.”