Why P2P companies in China collapse en masse

We promised in a recent article that we would be explaining why many P2P companies went bust in China.

We promised in a recent article that we would be explaining why many P2P companies went bust in China.

History of felonies

The issue is actually related to the lack of good investment opportunities for retail investors in China. Stock market is volatile (and often not trusted), oversea investment is very hard with the current capital control in place, and ETF – who has heard of ETF?

Historically, fraudsters promising guaranteed high returns have been cheating retail investors with their life savings. The authorities used to see 非法集资 (illegal fundraising) as a serious crime where capital punishment might be applied.

This was highly controversial because many SMEs in China actually found it very hard to get loans from banks. And there are many SMEs in China which have to find other financing solutions – personal guarantees are also quite common.

Knowing that there is a problem where retail investors do not have good option to invest, and retail borrowers find it hard to borrow from banks, microcredit companies mushroomed.

Licences are issued locally and many good talent from local banks actually moved to microcredit companies where things are more flexible and the pay is higher.

Though there is a challenge. The performance of microcredit companies varies by economic cycle. When the export is impacted (as it currently is in the trade war), many SMEs get impacted and fail to pay back their loans.

Enter P2P

P2P actually grew with the mobile-based consumer payday loan. Consumer microloans are not cyclical and can be very profitable if internal risk control is good.

Even better, P2P companies in China in fact do not require a license, but only a ‘registration’ to operate.

Many entrepreneurs went into P2P, taking cash from relatives, friends and other retail investors, and invest the money into payday loan businesses.

The problem

When P2P companies, unlike other fundraisers or asset managers, actually delivered retail investors the high return they promised, more money poured in.

Colleagues at Momentum Works personally know a few founders of P2P companies, they all say that it is hard to turn down the money people want to give you.

However, as the asset base you manage (or passover) becomes bigger and bigger, it gets harder and harder to find the good returns they promised investors.

The money still keeps coming in.

There are two options for the P2P operators now:

1. Fraudulent assets
2. Take higher risk

Fraudulent operators fake assets or investment opportunities on the platform, and essentially turn themselves into a Ponzi.

You know that any Ponzi will eventually collapse, causing social instability which is the worst nightmare for the government in China.

The collapse of eZubao in 2015 sent shock waves across – but did not stop fraudsters from innovating.

Riskier & riskier

For those genuine entrepreneurs, failing to stop the money pouring in prompted them to take riskier and riskier bets, and be susceptible to any event that triggers chain effects.

For instance, the rush to buy properties earlier this year in Hangzhou caused many investors to try to withdraw money they put in P2P platforms. As a result, P2P platforms that could not deal with a bank run collapsed, causing many investors to lose their money.

Towards the end of last year, the tightening of payday loan (internet-based microcredit) licences also triggered chain effect, impacting the P2Ps which were supplying credit to the payday loan companies.

Regulators in SEA already ahead

Similar events by different cause would probably still happen over the next weeks, months and maybe years.

It is hard for regulators in China to balance the society’s demand for credit, the retail investors’ need to protect money against inflation, and avoiding systemic risk.

In that regard, some countries in Southeast Asia, including Indonesia & Malaysia,  are already ahead of China in regulating the P2P industry.

The challenge for any regulators is, P2P is such a fast evolving industry with positive or negative innovations spreading very fast. To not kill innovation, while still keeping the systemic risk low, requires a lot of thinking and effort.