February 2, 2016
News of the shutdown of the P2P lending platform, Ezubao, following investigations by Chinese authorities have shocked the world. Small investors in China were allegedly scammed out of more than $7 billion in what is now called "a giant Ponzi scheme".
But I wasn't very surprised by the news. As I mentioned in my report, P2P lending in China has reached a tipping point and there is a dark side to the industry as it continues to be fraught with fraud and embezzlement. Widespread fraud tarnishes the entire industry, damaging well-run marketplaces as well as immediate victims of fraud. Many P2P lending platforms with unsound business models have operated for years without any backlash, violating regulations with impunity. Some of these platforms used money from new investors to pay off existing investors—like what Ezubao did—or invested lenders' money in the volatile Chinese stock market. These unstable platforms were simply ticking time bombs.
However, the fall of one P2P lending platform does not signify the fall of the entire P2P lending industry in China. Instead, the shutdown of Ezubao:
- Signals the Chinese government's resolve to enforce regulations. In late December 2015, the China Banking Regulatory Commission (CBRC) drafted new rules calling for closer supervision of the P2P lending sector. However, "law without enforcement is just good advice". Thus, there was a level of skepticism surrounding what impact these new rules would have on unlawful P2P lending companies. Therefore, the shutdown of Ezubao is significant in that it signals the regulator's resolve to enforce these rules, sending a strong message that violation of these regulations is a criminal activity and there will be consequences, which is positive for the industry.
- Will create urgency for existing P2P lending platforms to be more transparent. Many of the existing P2P lending companies in China are not transparent, they also fail to disclose their revenues, expenses or fund allocation. Given that the fall of Ezubao would have some investors worried, P2P lending platforms in China face a challenging task of assuaging investor fear by becoming more transparent.
- Will determine which P2P lending platforms will survive. While many P2P lending companies in China will fail, only those that are well-governed, abide by regulations, and have a sound business model will survive. These are the platforms that will overcome challenges in the external environment that they operate in such as fraud and regulation, as well as operational obstacles that they face such as accurate risk evaluation and the high cost of physcial distribution. P2P lending platforms backed by well-established companies are better placed to succeed.
While this piece of news portrays the Chinese P2P lending sector in a bad light, I think P2P lending in China has its merits as it helps to solve both investor and lender problems. Enforcement of regulations is extremely crucial in ensuring that Ponzi schemes like Ezubao are not pervasive. We shouldn't let one bad egg destroy the entire industry. What do you think?