By Brad Walker, CEO of Income&
Chinese authorities finally promulgated the long promised new rules for P2P lenders in October. These new regulations are designed to minimize fraud, and to tamp down the rapid, uncontrolled growth of the sector by flushing out the numerous fly-by-nights and bad actors.
Financial regulators in China have issued regulations to put the brakes on the fast-growing P2P sector a couple of times in the last year or so, but have seen limited success. China watchers have noted that the relatively minimal efforts at regulation of marketplace lenders by authorities to date may relate to the fact that lending to small businesses has largely dried up outside the P2P sector, and Chinese economic planners don’t want to see economic growth drop too low.
That said, these new regulations are more comprehensive, and represent a more serious effort by Chinese regulators to slow growth and crack down on the notable amount of fraud in the sector. Financial analysts also suggest that these new rules will help standardize offerings in the sector and discourage P2P platforms from making excessively risky business decisions.
The new regulatory schema was published by the State Council on October 13th. The plan is designed to curb risk-taking and fraud across the Chinese fin tech sector, and applies to online finance sectors other than P2P, such as third-party payment firms.
"The launch of the plan is of great significance. It shows that the chaos in China's Internet finance sector will be rectified," Yang Dong, a professor at the Renmin University of China law school, explained in an interview.
Details of China’s New P2P Regulatory Scheme
For starters, the new Chinese government Internet finance sector regulations create a new category of restricted businesses for China-based P2P players, including illegal fundraising, forming capital pools and false advertising, among other prohibitions. Moreover, P2P firms may not offer other financial industry services such as asset management and share transfers without being fully licensed and approved by the authorities.
These prohibitions alone will winnow out a lot of the newer entrants into the field, as many firms were basing their business models on making substantial profits from providing other financial services besides facilitating loans between peers.
The new plan also mandates P2P firms deposit customers' funds with a third-party institution in order to guarantee the safety of investments.
The new regulations also limit borrowing to Rmb 1m ($150,000) for individuals and Rmb 5m for businesses. Note that this limit applies to total borrowing from multiple platforms. For lenders the limit is Rmb 200,000 for individuals, and Rmb 1m for companies per P2P lending platform.
Although some regulatory agencies and legal precedents have already put forth many of the latest rules in various forms, the new regulations are the first comprehensive schema for regulating Chinese P2P lenders.
The new rules also set out authority among Chinese regulatory agencies. Somewhat surprisingly, financial regulators at the provincial and city level will be primarily responsibility for registering and overseeing marketplace lenders. Local regulatory authority offers the benefit of more direct supervision, but China experts highlight graft and fraud among mid-level bureaucrats is still relatively common at the local level.
While the new rules for the internet finance sector in China are a big step in the right direction, it remains to be seen what degree of enforcement and compliance we will actually see.
Keep in mind that China's economy is clearly slowing down as the government is transitioning from a manufacturing-based economy to a consumer and services model. Slowing growth and mounting losses in many sectors of the Chinese economy means stagnant equity prices and a major flow of investment capital into the lending sector seeking higher returns.
All of this added liquidity in the last year or two is the biggest reason the Chinese P2P sector is growing so fast and risks are increasing.
However, the government crackdown on the P2P sector earlier this year and various earlier regulatory efforts have started to have an impact. Of the 2,417 marketplace lenders registered in China as of September 30, 2015, only 2,202 were in operation by the end of September 2016.
That is still a large number of firms even for large economy like China, and this new regulatory plan will shrink that number further. However, given the current glut of investment capital and strong demand for loans for small- and mid-sized businesses, the total amount loaned out by Chinese P2P firms may not shrink appreciably and even rebound to new highs as consolidation occurs and major players emerge.