Introduction

China has by far the most spectacular growth in P2P of any country worldwide (Tables 1, 2). This tremendous growth has, however, taken place within what was effectively a regulatory vacuum. The recent establishment of a regulatory regime for P2P lending in China, following a wave of scandals in the sector, is now resulting in a sharp contraction in Chinese P2P lending.

Table 1 Volume of P2P SME lending in the leading nine countries around the world.
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Table 2 Volume of total P2P lending in the leading nine countries around the world.
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This article reviews the rise of peer-to-peer (P2P) in China and the prospects for its future following the recent regulatory reform.Footnote 1 It views these developments from the broader perspective of financial regulation and the light of similar challenges of regulation of P2P lending in the other leading jurisdictions for P2P lending, such as the USA and the UK.

The paper is organized as follows. ‘The growth of P2P lending in China’ section describes the growth of P2P lending in China. ‘The belated regulation of Chinese P2P lending’ section documents the emerging problems with P2P business models in China and the resulting new regulatory regime that aims to prevent further problems. ‘International comparisons: regulation in the USA and the UK’ section compares this new regulatory regime with that established in the USA and the UK, arguing that while representing a major step in the right direction, the Chinese authority has not gone far enough in investor protection. ‘The future of China’s P2P sector’ section assesses the uncertain future prospects for Chinese P2P lending. ‘Conclusions’ section is a summary conclusion.

The growth of P2P lending in China

This section describes the rapid growth of P2P lending in China and explores the reasons for its spectacular rise and the weakness of the business models adopted in Chinese P2P lending. China’s first online lending platform, PPDAI group, was launched in 2007. The industry has grown spectacularly over the subsequent decade, with the number of platforms reaching 2595 in 2015 [29]Footnote 2, and the volume of lending is the biggest in the world ([29] Table 1). Even as late as June 2018, the industry reportedly channelled loans from 4.1 million investors to 4.3 million borrowers [31].

Table 3 provides some more detailed statistics on Chinese P2P lending.

Table 3 Development of Chinese P2P lending.
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This rapid growth of the Chinese P2P sector is commonly attributed to two intertwined factors:

  • China’s inefficient financial system.

  • The Chinese authorities’ hands-off approach to its regulation.

We discuss each of these in turn.

China’s inefficient financial system

Despite the transformation of the real economy, the Chinese financial system can still be characterized as one of ‘financial repression’, i.e. with laws and policies instituted in developing economies to control financial systems by preventing them from functioning at their full capacity [23]. In a seriously repressed financial system, the interest rate is kept artificially low by the state so that cheap loans become available to borrowers, a de facto tax on savers. The policy of financial repression has been implemented by the Chinese government since the establishment of the People’s Republic of China (PRC) in 1949. Banks had to comply with a floor for lending rates and a ceiling for deposits imposed by the People’s Bank of China (PBOC). (The floor has been removed since 2013 but the ceiling remains.)Footnote 3 The deposit rate has been kept low, to the extent of real interest rate being negative in some periods [17]. The emergence of P2P sector met Chinese savers’ demand for a better investment alternative and therefore attracted millions of retail investors in only a few years. It is reported that more than 60% of the China’ P2P platforms offered an annual yield in the range between 12 and 18% or between 18 and 24%, which is considerably higher than the 3.3% paid by commercial banks [25, 26].

China’s financial system is dominated by state-owned banks which has a preference for lending to state-owned enterprises (SOEs) or large private companies and leaves a large number of small- and medium-sized enterprises (SMEs) under-served.Footnote 4 Only 25% of Chinese firms report having a loan or line of credit; amongst small firms, the figure was 14% [16]. In the Enterprise Survey, Chinese firms report access to finance as their biggest business environment obstacle. Amongst small firms, just 4% use banks to finance investments, and bank financing accounts for less than 1% of funding for investments [16].

Apart from political bias, SMEs financing is a worldwide challenge. Lack of credit information and under-collateralization are considered to be major factors accounting for the financial constraints faced by SMEs. Traditional banks have been proved to be ill-equipped to tackle this challenge. P2P lending platforms seemed to offer a better solution by utilizing automated processes to reduce costs and credit risk models that use non-traditional data. Quick decision making and no collateral requirement rendered P2P sector an important financial source to SMEs in China, with 20 to 40% of all loans flowing into SMEs, a sharp contrast with the USA (ACCA 2015, Tables 1, 2 above [1]).

The Chinese authorities’ hands-off approach to its regulation

Chinese authority’s hands-off approach to regulation has been a further driver for the rapid expansion of P2P sector. Prior to July 2015, the P2P sector was completely left unregulated. This seemed to be odd at first given China’s financial sector has always been tightly controlled by the government. Chinese government’s laissez faire attitude appears to have been based on two considerations. The first one was to find an alternative financing source for SMEs. SMEs now play a significant role in China’s economy: they contribute 70 per cent of employment, 60 per cent of GDP, 50 per cent of tax revenue, and holding 65 per cent of patents [27].

Recognizing their economic significance, over the past two decades, the Chinese government has made various attempts to ease the financial stress faced by SMEs, especially after the 2008 financial crisis which led to a significant decline in China exports. However, none of these measures seemed to work effectively. As a result, the majority of Chinese SMEs had to heavily rely on informal lending (minjian jiedai) (interpersonal lending based on social network) for external financing [2]. Things got worse when the market for informal lending was hit by a crisis originating from Wenzhou in April 2011 and peaked in September of the same year. Although the first P2P platform appeared in China as early as in 2007, it was not till 2012, i.e. after the Wenzhou financial crisis, that the industry really started to surge (as shown in Tables 1, 2). If the government’s inaction during 2007–2011 was largely due to the negligible size of the industry, its continual non-interference after 2012 is most easily understood as a purposive strategy that tries to develop the P2P sector into an alternative financing source for SMEs.

The second reason behind the initial laisse faire approach was the Chinese authority’s failure to understand the risk emerging from P2P lending. Although the China’s P2P sector has become the largest market in the world, it remains a minuscule slice of overall borrowing: as of July 2018, it accounted for only 0.7% of total bank loans and 0.5% of total bank assets [19]. The relative small size of P2P sector led the Chinese authority to believe that there was no serious concern about substantial risk, and in the worst case, it could simply close the whole industry down.Footnote 5 However, this assessment was based on its understanding of traditional financial service which later proved to be a considerable underestimation of the scale of risk relating to Fintech-enabled financial services.

In the absence of regulation, the majority of Chinese P2P platforms deviated from the original information intermediary business model and adopted the ‘guarantee’ model in order to attract investors.Footnote 6 Under the guarantee model, a P2P platform not only matches lenders and borrowers but also provides guarantees for the lender’s principal and interests usually by themselves, or by cooperating with an associated guarantee company [24]. If a loan default occurs, the platform or the guarantee company compensates lenders and the lenders transfer the loan claims to the platform or the guarantee company for the follow-up debt collection. In addition, a platform, not the lender, often becomes the one that originated loans to borrowers. As a result, there is no direct contractual relationship between the lenders and borrowers; instead, they transact with the platform separately [24].

By adopting the guarantee model, most China’s P2P platforms were actually playing a similar role to that of the traditional bank, but subjected to no regulation. Chinese P2P platforms usually set up and registered themselves as consultancy firms, and therefore their average size has been small. As of the middle of 2014, the averaged registered capital of the platforms was about RMB23.7mn ($3.8mn) and most platforms had registered capital between RMB5mn ($0.8mn) and RMB20mn ($3.2mn) [25, 26]. Only 54 platforms had registered capital of above RMB50mn ($8.1mn) [21]. It is hard to conceive how these platforms could fulfil their promises to investors with this thin capital base. They have either to rely on their shareholders for financial assistance or to pay the earlier investors with funds from more recent investors, that is, running a Ponzi scheme. Many platforms, as revealed later, were indeed scams from the outset.

The belated regulation of Chinese P2P lending

This section describes the emergence of problems in Chinese P2P lending, the subsequent and ongoing efforts at regulation and the consequences for the industry.

Rising levels of platform failure

Problems with the business models of Chinese P2P lending first came to prominence in 2015 when around 896 P2P platforms got into trouble [28], of which more than half was due to fraud. In particular, the downfall of Ezubao at the end of this year (2015) put the troubled industry in the spotlight.

Ezubao used to be one of the highest-profile platforms, by 8 December 2015, its trading volume totalled at RMB 74.568 billion, involving some 909,500 investors [4]. It was found that 95% of projects financed through Ezubao were fake, fabricated by the platform. Ezubao scandal soon became frontpage news on all of China’s tech sites and tens of thousands of angry investors went on street to protest. Some of them even travelled to Beijing to protest outside the central government offices [4]. The scale of platform failures and their economic and social consequences was far greater than the government had anticipated. As described in the next subsection, it responded with the introduction of a rigid, comprehensive regulatory regime.

The number of platforms that ceased trading further increased in the following 3 years 2016–2018 (Table 4). 2018, as the new regulations came into effect, saw a major increase in the number of affected investors and volume of loans on failed platforms. In total, by mid-2019, more than 2 million investors with loan investments totalling some RMB117.21bn ($26.9bn) had been caught up in failing platforms.

Table 4 P2P platforms failures.
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Regulatory reform

With the increasingly visible problems with P2P business models, the Chinese government quickly abandoned its laissez faire approach and established a detailed, comprehensive regulatory framework, beginning in July 2015. It consists of four key documents (referred to ‘1 + 3’ framework):

  1. 1.

    The 2016 Interim Measures on Online Lending (2016 Interim Measures);

  2. 2.

    The 2015 Guideline on the Administration of Recordation and Registration of Online Lending Information Intermediary Institutions (2016 Guideline on Online Lending Registration);

  3. 3.

    The 2015 Guideline on Custodian Business for Online Lending Funds (2015 Guideline on Custodian Business); and

  4. 4.

    The 2017 Guideline on Information Disclosure by Online Lending Information Intermediary Institutions (2017 Guideline on Information Disclosure).

Of these, the 2016 Interim Measures is the corner stone of the regulatory regime. It contains a total of 47 articles that cover all important aspects of the online lending industry. Contravention of the 2016 Interim Measures can lead to administrative or even criminal penalty.

The three guidelines are implementing rules of the 2016 Interim Measures, and each focuses on a particular issue. In addition to these regulations that are specific to online lending industry, P2P platforms are also subject to general legal rules, in particular Company Law, Contract Law, Anti-competition Law, Consumer Protection Law and Anti-Money Laundering (AML) Law.

The regulatory model created by the 2016 Interim Measures is sometimes described as a ‘dual supervisory model‘. At central level, the China Banking and Insurance Regulatory Commission (CBIRC) acts as the lead regulator for P2P industry, responsible for developing rules for supervision and administration of the business activities of platforms as well as carrying out regulation of business conduct. In the meanwhile, provincial governments are authorized to supervise P2P platforms within their respective jurisdictions, in particular regarding their recordation and registration. They also have the power to impose penalties on misbehaving platforms. Any particular platform is therefore subject to a dual supervision of the CBIRC and provincial government where it is registered.

In addition, the National Internet Finance Association (NIFA) run by the central bank and with 400 members was also recruited to regulate China’s P2P sector. Article 34 of the 2016 Interim Measures delegates the NIFA the power to establish rules of self-regulation and industry standards, to accept complaints and reporting, to conduct self-inspection, and so on. Given the limited resources of regulators and the challenging nature of the P2P industry, the NIFA is expected to play an important role under this new current regime.

The regulation aims to eliminate fraudulent or poor business practices that plagued the industry and re-establish all platforms as information intermediaries. Under the current regulation, a P2P platform must separate its own funds from the funds of lenders and borrowers.Footnote 7 The funds of lenders and borrowers must be in custody of a qualified commercial bank.Footnote 8 As an information intermediary, a platform is now subject to an obligation to make truthful, adequate, complete and timely information disclosure to the public concerning the platform itself such as organization and operation.Footnote 9 It is also obligated to disclose basic information regarding the borrowers to lenders ex ante, and to make continuous disclosure regarding borrowers’ financial status and factors that may affect their repayment capability.Footnote 10 A platform needs to submit an information disclosure announcement together with relevant documents periodically to the local government where it is registered and places them at its registry house for public inspection.Footnote 11 In addition, the information submitted by a platform must be verified by a third-party intermediaries like accounting firms, law firms.Footnote 12

Moreover, the regulation also provides that the balance of loans of the same natural person on one online lending platform cannot exceed RMB 200,000; for a legal person or any other organization, the upper limit is set as RMB 1 million. There are further caps on the total balance of loans obtained by the same person from different online lending platforms: for a natural person, it is capped at RMB 1 million, and for a legal person, it is capped at RMB 5 million.Footnote 13

The above requirements, though they can be costly, are definite and clear and therefore relatively easy for platforms (at least those large, well-operating ones) to meet. The protracted and changeable scheme of registration, by contrast, has been a serious challenge to the industry. Art 5 of the 2016 Interim Measure provides that all platforms must conduct recordation and registration with the local financial regulatory authority at the place where it is based. A platform that fails to go through the new procedure will be banned from continual operation. More detailed requirements are laid down by the 2016 Guideline on Online Lending RegistrationFootnote 14, and the initial deadline for registration was set in June 2018. This was then delayed. On 13 August, the Task Force of Online Lending Rectification issued a ‘Checklist for the Compliance of Online Lending Information Intermediaries’ (108 Checklist) which established a uniform standard for recordation and registration for all P2P platforms in China and set a new deadline in December 2018.

This was followed by further delay and further change. On 8 April 2019, media revealed the details of a new pilot registration programme [32].Footnote 15 According to the pilot programme, platforms will be categorized as national and regional platforms. In order to register as a national platform, a platform must have a minimum paid-up capital of RMB0.5bn; for a regional platform, the threshold is RMB50mn. The pilot registration programme will require national platforms to hold general risk reserves equal to 3 per cent of the lending made through their firm and set aside an amount equivalent to 6 per cent of each borrowing as a loan-loss provision for lenders. The ratios for regional platforms will be 1 per cent and 3 per cent, respectively [32]. Although this document has widespread online, it never officially published which casts further doubts on the prospect of registration.

Consequences for the industry

The heavily intensified focus on regulating the P2P industry and a general governmental crackdown on high-risk financing have caused the close-down of many hundreds’ P2P platforms since 2015. It has already seen an immense drop in the number of Chinese P2P lending platforms by 50% to 1021 during 2018. At the end of November 2019, the number further shrunk to 369 [29].

Even the most prominent platforms have not escaped unscathed. These include the collapse of Tuandai and of Hongling Capital. The former firm had about 220,000 lenders and borrowers and a loan balance of RMB 14.5 billion, while the latter was one of the longest-operating P2P platforms in China.

Since 2017, the Chinese P2P market has been experiencing a dramatic shrinkage. Total monthly volume of China’s P2P lending has fallen from a peak of RMB253bn ($37.4bn) in June of 2017 to about RMB90bn ($13.1bn) in July of 2019; about RMB 667bn ($97.0bn) in loans is still outstanding in mid-2019, down from about RMB1, 060bn ($151.7bn) in May 2018 [29]. These are consistent with the annual figures shown in Table 1 and represent a fall in lending volumes to around one-third from their 2017 levels (though the volume of lending is still substantially greater than in either the USA or the UK, the countries outside of China with the largest P2P lending volumes).

The retrenchment of the market has severe consequences for investors, who in many cases have suffered life-altering losses [3]. This has led to protests by ordinary people that have verged on mass unrest. Last year, two sporting stadiums in the city of Hangzhou, where many P2P companies are based, were converted into makeshift petition centres in order to handle the volume of complaints against online lenders [3]. A number of business leaders in the P2P industry have fled China or vanished this year, while many others have been detained, prosecuted or convicted.

International comparisons: regulation in the USA and the UK

This section compares the new Chinese regime for regulation of P2P lending with that obtaining in the USA and in the UK. The key issue in both countries has been investor protection.Footnote 16 The main point emerging from these international comparisons is that, in both jurisdictions, the protection of retail investors has required substantial and detailed disclosure requirements. It is made more than clear to investors that what they are investing in is not a bank deposit and involves much significant investment risks.

As a consequence, the major platforms in both the USA and the UK have come to rely on institutional investors to fund a substantial proportion of loans intermediated on their platforms. In the USA, some two-thirds of funding on both Prosper and LendingClub is from institutional investors. In the UK, more than half of the funding of the two largest platforms, Zopa and Funding Circle, is institutional.

USA

From 2006 until 2008, US alternative lending developed with relatively little regulatory oversight other than that of existing banking and consumer lending regulation. Subsequently, two major developments stand out.

  • In 2008, Securities and Exchange Commission (SEC) ruled that the ‘notes’ (claims on payments of loan interest and principal) issued by platforms to investors were not exempt from securities laws and had to be registered with the SEC.

  • In 2015, the SEC issued detailed rules on how these securities laws were to be applied to alternative lending platforms.

This regulatory approach, imposing strong protections on the sale of notes to retail investors, has been one of the main reasons why alternative lending in the USA is now overwhelmingly an institutional investor not retail investor asset class.

The initial years for US alternative lending platforms 2006–2008, in a deteriorating credit environment, were difficult for the nascent industry with high default rates raising obvious concerns about investor protection.Footnote 17 A key development in investor protection regulation was in November 2008, when the SEC entered a cease-and-desist order against Prosper stating that it had been selling securities which must under US securities law be registered with the SEC [20].Footnote 18 In response, the legal compliance of platforms changed, with investors now required to hold non-recourse notes issued under a ‘shelf registration’ with the SEC (i.e. a single registration covering multiple note issues), each note representing claims on the payments of borrower interest and principal.

This was a material difference to their business models. In order to sell these notes to a broad investor based, the platforms had to comply with the demanding requirements for registration and provision of investor information under the Truth in Securities Act and Securities Exchange Act (1933) as well as complying with all requirements for offering advice in securities investment and further requirements if they support a secondary market for resale of investments.Footnote 19 The substantial burden of SEC registration together with the accompanying obligation to comply with investment advice and the ‘blue sky’ securities laws of all states where investor notes were sold led to rapid industry consolidation. This consolidation left only two platforms surviving—those of Prosper and LendingClub.

As both Prosper and LendingClub have demonstrated, there is a substantial market for investment in platform loans amongst institutional investors. Sale of notes to institutional investors or other ‘accredited investors’ does not require the compliance costs of shelf registration.Footnote 20

UK

Similar issues of investor protection have emerged in the UK, with a reregulation of the industry now taking place with the aim of ensuring that retail investors are adequately informed about the risks of P2P lending. The UK saw some of the earliest developments in alternative lending platforms, with the 2005 establishment of Zopa offering peer-to-peer personal loans followed by the 2010 launch of Funding Circle offering small business loans. More than one hundred platforms have now been started in the UK, and there has been rapid growth in total value of supported loans.Footnote 21 Only a few platforms though operate on any scale, and at end-2017 only three intermediated more than £0.5 bn loans on their platforms: Funding Circle (small business loans £1.6bn), Zopa (personal loans £1.2bn) and Ratesetter (both personal and small business, £0.8bn).Footnote 22

Three phases can be distinguished. Initially, alternative lending largely fell under the regulatory radar. It was subject only to general consumer credit regulation and the oversight of consumer lending by the UK Office of Fair Trading (OFT).. A second phase was the introduction of a first framework for regulation in 2014, with the transfer of regulatory responsibility from the OFT to the Financial Conduct Authority, and its subsequent development and implementation. This was given important political support by the 2010–2015 coalition chancellor of the exchequer (finance minister) George Osborne. His March 2014 budget introduced the Innovative Finance Individual Savings Accounts (IFISAs) for alternative lending platforms.Footnote 23 The third phase from 2016 to 2019 has been focused on strengthening of regulation, especially protection of retail investors.

The responsibility for regulation for alternative finance was transferred from the OFT to the FCA on 1st April 2014. The FCA introduced an initial framework for regulation of alternative finance covering both investment-based crowdfunding (equity crowdfunding) and loan-based crowdfunding (alternative lending).Footnote 24 Loan-based crowdfunding was explicitly excluded from the Financial Services Compensation Scheme (FSCS) which insures bank deposits. New regulatory rules were introduced to protect investors and ensure continuity in the management of their investments should a platform fail.

A focus of the new FCA regime was on systems and controls: applying its general requirements for regulated firms on adequacy of systems and controls and paying particular attention to segregation of client assets (ensuring these are not commingled with platform assets), and arrangements for orderly transfer of business in the event of platform failure. P2P platforms (or what UK regulations terms ‘loan-based crowdfunding platforms’) are required to follow a scheme for segregation of client assets requirements (CASS or Client Asset Segregation Scheme) which applies to all regulated firms. Arrangements must also be in place to ensure that the servicing and administration of existing loans continue to be administered in the event of platform failure, with the transfer of loans to a third-party firm).

A major concern of the FCA over the following 2 years was ensuring that retail investors were fully aware that loan participations through alternative lending platforms are not at all similar to bank deposits. They are not covered by the Financial Services Compensation Scheme (the UK bank deposit insurance scheme), and projected returns are not guaranteed with the possibility that investors could lose some of their initial investment. All the well-established platforms make clear on their webpages and during the process of investment that they are risky investments.

Between 2016 and 2018, the FCA consulted on the development of a new more detailed regulatory regime.Footnote 25 The final rules were published in 2019.Footnote 26 These include a set of detailed and strengthened rules covering the wind-down of platforms. Here, every platform must have detailed policies in place in the form of a ‘resolution manual’ describing in practical detail how a wind-down will be implemented. This must: (i) describe arrangements that have been thoroughly assessed for their effectiveness, if necessary with external professional advice; (ii) give the regulators assurance that the contract terms agreed with investors and borrowers will be honoured even when the platform is no longer around to service them; and (iii) platforms must give clear information about the impact of any wind-down on both investors and borrowers. It will also contain much more explicit requirements on the systems and controls platforms need to have in place to support the claims they make to investors, for example about loan approvals and classifications and management of loan arrears.

The new regime also introduces much stronger rules on governance, aiming to bring platforms in line with the FCA’s expectations of governance in investment management or in dealing, i.e. where properly fulfilling the fiduciary duties of an agent operating on behalf of a relatively uninformed client. They must have clearly stated risk management policies. Also, amongst their operational staffing responsibilities, platforms must have independent risk management, regulatory compliance and internal audit functions. (For smaller platforms, these functions can be combined with other responsibilities.) Finally, they must demonstrate they are aware of and dealing appropriately with conflicts of interest, for example, opaque fee arrangements, participation in loans or loan markets by staff or family members or any other situation where decisions may potentially benefit a client or staff member at the expense of another client.

The future of China’s P2P sector

As described above, the China’s P2P sector has undergone a dramatic shake-out and there is still no sign of halt. A reading of the newly designed regulations suggests that the initial plan of the government was certainly not to kill the whole industry, but to banish smaller platforms that are not mature or well capitalized. (Note that JP Morgan highlights that the market share of the top 50 P2P companies in China has increased from about 35 per cent at the beginning of 2017 to 86 per cent at the end of last year [ [30].] If the plan goes as anticipated, the market will eventually stabilize with 100 or so survivors [30].

However, with the several changes of standard and repeated delay of deadlines since 2016, there is an increasing doubt in the industry in relation to the real intention of the central government. Recently, Hunan, Shandong, Chongqing and Henan provinces announced no single platform in their respective jurisdictions has passed the test for registration (that is to say, all existing P2P platforms in these jurisdictions must cease operating) [14].

Even if the central government indeed likes to retain the P2P sector, there is an increasing concern that whether there will be any survivor at all after the great cleanup? As the crisis unfolded, panic in the broader market led investors to lose confidence and pull their funds; this diminished operators’ liquidity and caused more failures of platforms, which in turn further undermined investors’ confidence, a vicious cycle. As a result, even many prominent platforms have already closed down or are experiencing significant trouble. This pessimism reached its new peak in July 2019, when Lufax, the subsidiary of PingAn the Chinese Insurance giant and China’s largest platform with outstanding loans of RMB 98.4bn ($14.3bn), announced its withdrawal from P2P lending. Some thought this might signal death of the industry [18].

More lately, on 15 November 2019, the China’s Internet Financial Risk Special Rectification Work Leadership Team Office which was launched by Beijing to mitigate risks in the online lending sector issued a notice of ‘Guidelines on Transforming Online-lending Information Intermediaries into Micro-loan Companies’ (No.83 Notice). In this notice, it stipulates the conditions and procedure of switching existing P2P platforms to micro-loan companies. In accordance with the notice, in order to turn into a regional micro-loan company, qualified P2P platforms need to meet a capital requirement of no less than 50 million yuan, and no less than 1 billion yuan to transition into a national micro-lender. Fraudulent platforms and firms that contain serious credit risks would be banned from making the transition and forced to close. This transition needs to be completed within 2 years. Whether No. 83 Notice is an official announcement of the death of China’s P2P sector still remains to be seen, and after all, it leaves for existing platforms themselves to choose whether or not to make such transition, not a mandatory requirement. It says nothing about those platforms that are not willing to switch to micro-lenders or spells out the future of P2P sector.

There might still be a hope for the P2P sector, although faint. This is based on two considerations. For one thing, a major difference from the UK and the USA is that years of financial repression are still limiting the supply of credit from the Chinese banking industry. As documented in the IMF’s 2019 Article IV consultation [15] bank lending in China continues to be dominated by loans to state-owned enterprises which are actually increasing as a share of total loans. Loans to private enterprises are concentrated on larger businesses, and there is a dearth of lending to SMEs. If the government believes that P2P platforms can still play a useful role in easing SMEs’ financial constraints, it might retain the sector a living space.

Another supportive factor is that the major Chinese technology firms are showing interest in P2P sector. Ant Financial Services, the parent of Alipay part owned by Alibaba, the leading Chinese e-commerce, is viewed by investors as the most valuable global financial technology company in the world. The opportunity to leverage value from its 1.3 billion users of AliPay has led it to be valued at $150 billion in 2018, 50% larger than the Goldman Sachs with a market value of $99 billion. Amongst several financial services activities that comprise Ant Financial Services is Zhao Cai Bao, launched in April 2014, a P2P lending facility embedded in Alipay that matches individual investors as lenders to individuals, micro-businesses and SME borrowers. Other P2P platforms may be supported by other major firms. The fourth largest Internet tech company in China Jing Dong (after Alibaba, Tencent and Baidu) acquired the Xiamen-based P2P platform Yilidai in April 2019.Footnote 27

A further likely development is an increasing participation of institutional investors in P2P lending as the Chinese investment industry itself matures shifting with the large volume of funds now being built up in new wealth management funds (Ant Financial Services rapidly growing funds such as Yu’E Bao a money market fund, Ant Fortune and AnTSDAQ are examples).

Conclusions

In this article, we reviewed the rise and fall of China’s P2P lending since 2007. In the absence of regulation, Chinese SMEs’ financial constraints and residents’ demand for higher capital return led to a spectacular growth of P2P platforms, with the volume of lending increasing 60-fold over the course of only 4 years from 2013 to 2017. However, this growth has been largely based on a fundamentally flawed business model and many platforms later proved to be fraudulent. The government introduced since 2015 a comprehensive regulatory framework which has led to a substantial restructuring of the industry with the number of platforms already having fallen by 90% and expected to fall further and the volume of new lending now becoming less than one-third of its 2017 peak. The Chinese government’s ultimate intention to P2P sector is still not entirely clear, although it has apparently lost enthusiasm for P2P lending. If the P2P sector can indeed survive, we expect it will become fairly concentrated with a small number of large players and dominated by institutional investors, subject to rigorous regulation. That is to say, it will look very similar to its US and UK counterparts in many aspects.

The rise and fall of China’s P2P sector offered an important lesson for financial innovation in emerging markets. The economic growth in these markets is often constrained by financial accessibility and weak financial regulation. Financial innovation (including but not limited to P2P lending) utilizing automated processes to reduce costs and requiring no collateral by relying on non-traditional data is considered by some as a useful means to circumvent the weakness of financial regulation and challenges of enforcement. The experience of China’s P2P sector, just like that of Thailand and other South East Asian countries in the 1990s, indicates that the opposite is true. Financial innovation poses particular danger of waste of economic resources when financial regulation is weak.

We therefore conclude that financial authorities in low-income and emerging market countries need to be especially careful about promoting and encouraging innovative Fintech activities. On the one hand, regulation should not be so rigid as to prohibit innovation entirely. On the other hand, when innovation does take place, the authorities must be especially vigilant in ensuring that these innovations do not threaten prudential safety and soundness or customer and investor protection.