The P2P Lending Market in China: A Parable for Indian Policymakers – Part 2

In the first post of this two-part series, we tracked the explosive rise of the P2P lending market in China, which took place in the absence of any regulations. In this post we look at the series of regulatory measures introduced by the Chinese authorities in the wake of high profile platform failures and mounting outstanding debt levels.

Changes in the Regulatory Environment  

The China Banking Regulatory Commission (CBRC) first began addressing the issue of P2P regulation in official speeches in 2014. The speeches marked “red lines” lenders should not cross and outlined principles for the industry.^[1] However, it was not until July 2015, with outstanding P2P loans at 200 billion RMB that the first intentions to regulate the industry were articulated. The People’s Bank of China (PBOC) (the Central Bank) along with the China’s State Council and other key financial regulators such as the China Securities Regulatory Commission and China Insurance Regulatory Commission jointly issued the Guiding Opinions on Promoting the Healthy Development of Internet Finance ^[2] to encourage financial innovation, promote the healthy development of Internet finance, clarify the regulatory responsibilities, and regulate market order. The CBRC was officially made responsible for formulating and administering policies on the behavioural supervision of P2P lending platforms. Some of the key proposals included the following:

• P2P platforms were to become “information intermediaries” and not financial intermediaries as was the prevalent industry practice.
• In order to put a stop to fraudulent platform operators stealing funds, all client accounts were to be parked at custodian banks.
• Platforms were also precluded from offering “credit enhancement” or guaranteed returns by covering losses themselves.

In 2016, a PBOC-led group of regulators began a rectification campaign for the Internet finance sector. Local governments were given orders to survey the online lenders, crowdfunding platforms, private equity funds, and more complex financial firms operating in their jurisdiction to get a clearer picture of what regulation is needed. Major cities stopped registering new firms in this field, stricter rules on advertisements came out, and reports even circulated of internet finance firms being ordered to vacate office buildings in busy districts due to fear that they would become targets for protests staged by defrauded investors if the platforms failed.^[3]

Based on the 2015 Principles, on 24 August 2016, the CBRC, the Central Ministry of Industry and Information Technology (MIIT) and the Cyber Administration of China (CAC) jointly released the Interim Measures on Administration of the Business Activities of Peer-to-Peer Lending Information Intermediaries (the “Interim Measures”).[4] The Interim Measures comprise the first comprehensive legal framework specifically regulating peer-to-peer lending activities in China.^[5]

Under the new rules, an “internet lending information intermediary” – namely a P2P lending platform – means a validly established company that specialises in acting as an intermediary provider of online lending information – “online lending” means direct lending made amongst individuals through an Internet platform. Individuals include natural persons, legal persons, and other organisations.^{[6] [7]}

Some of the key requirements of the Interim Measures included:

1. The capping of the total amount that an individual can borrow on a single platform at RMB200,000 (~29,000 USD), and RMB1 million (~143,000 USD) on multiple platforms. The respective caps for a corporate entity are RMB1 million and RMB5 million (~718,000 USD).
2. P2P lending platforms must now hold borrower and lender funds in custodian accounts with ‘registered financial institutions’ instead of in the platform itself. The custodian account acts as the fund transfer mechanism between lenders and borrowers, and serves as an escrow account for all transactions between both sides.[8]
3. Other operational obligations on platforms included filing with local financial supervisory authorities[9], obtaining permits from relevant telecommunications authorities and releasing of, for public record, information on direct lending and borrowing transactions.
4. The scope of operations was demarcated — prohibiting P2P lending platforms from selling asset-backed securities or financial instruments such as insurance, trust products and wealth-management products and the prohibition of conducting offline promotion of financing projects.
5. Standards for data management were put in place — focusing on proper KYC and data protection.^[10]

The Interim Measures provide a 12-month transitional period for existing P2P lending platforms to achieve compliance.

The new rules also set out authority among Chinese regulatory agencies — financial regulators at the provincial and city level will be primarily responsible for registering and overseeing P2P lending platforms. This offers the benefit of more direct supervision; however China experts[11] highlight graft and fraud among mid-level bureaucrats as being still relatively common at the local level.

Other major criticisms of the measures centered on the absence of reporting requirements to a centralised database which records all P2P lending information (or an equivalent credit bureau).[12] This makes enforcing the borrowing cap impractical, as platforms cannot ascertain the aggregate outstanding debt of a borrower across multiple platforms.^{[13] [14]}

Nonetheless, in the long run, regulators believe that the ‘Interim Measures’ should help to ensure a healthier and a more sustainable market. These measures may likely bring about a reshuffling and consolidation of market players.

Lessons for Indian Policymakers

The P2P lending industry in India is tiny compared to China. At the end of 2015, for instance, there were 38 P2P lending platforms operating in India — compared to 2200 in China. But 20 of the new online P2P lending platforms were launched in 2015, suggesting that the market is starting to take off in India. In fact, projections expect India’s P2P lending market to swell to USD 4-5 billion in the next 5-6 years.^[15]

On April 28, 2016, The Reserve Bank of India (RBI) issued a public consultation paper on P2P lending regulations in India. Though the paper only states the proposed rules and solicits feedback/comments, it does give an idea about the RBI’s stance towards P2P lending — IFMR Finance Foundation conducted a detailed analysis in their response to the RBI’s consultation paper.

Nonetheless, the risk-ridden rise of the Chinese P2P lending market — characterised by explosive growth and spectacular platform failures — and the consequent attempts to regulate it, are relevant and timely parables for Indian regulators. Some of the key lessons from the Chinese experience are:

1. Clarifying the definition of a P2P lending platform and demarcating the scope of its business activities. For instance, the China regulations clarify internet finance to include incorporated businesses as lenders, besides individuals. Furthermore, P2P lending platforms were prohibited from taking deposits from members of the public or creating asset pools, selling wealth management products and transferring debts by issuing asset – backed securities.
2. P2P platforms should not be allowed to promise guaranteed returns to its lenders (as envisaged already in the RBI consultation paper). Chinese regulators have prohibited platform guarantees for borrowers (unless facilitated through a third party, such as a bank).
3. Proactive supervision of platforms’ lending activities and practices — by utilising mystery shopping and periodic filings with relevant authorities.
4. Need for implementing public disclosure of characteristics of the assets under management (AUM) such as number of loans, outstanding amounts, NPA ratios. In China, platforms are required to publically disclose information on direct lending and borrowing transactions; although it is unclear whether there is a requirement to disclose asset quality numbers.
5. Need for prudential requirements (in some form of a backstop) for systemically important platforms proportional to the total volume of lending activity being conducted. Chinese regulations have not incorporated such a requirement while UK has this for its loan-based crowd-funding platforms.[16] The RBI consultation paper considers a leverage ratio but it is unclear how the ratio will be applied since neither liabilities nor assets reside on the platform’s balance sheet.
6. Retail borrowers and retail lenders need to be provided with additional protections against being missold unsuitable products (loans and debt investments respectively). While the Chinese authorities require platforms to offer financial consulting services, it is unclear what these services involve. The UK’s FCA has taken steps to ensure suitability requirements on P2P platforms:
   • For Borrowers: The FCA’s Handbook on Responsible Lending specifies that “a firm, with respect to operating an electronic system in relation to lending in relation to a prospective borrower under a P2P agreement”, “must undertake an assessment of the credit-worthiness of the prospective borrower[17]. Furthermore, providers have to highlight[18] key risks to the borrower such as the consequences of missing payments or under-paying.
   • For Lenders: FCA specifies that where lenders have the choice to invest in specific P2P agreements, platform providers should provide information regarding the details of the creditworthiness assessment of the borrower carried out.[19] Moreover the FCA has mandated platforms to disclose[20] all relevant information to enable potential investors to make informed decisions on whether or not to invest.
7. Ensuring that all loan disbursements and loan performance details are reported mandatorily to credit bureaus. This requirement is currently absent in China.
8. Allowing P2P platforms to have access to credit bureaus records. Chinese P2P platforms have access to records of existing personal or business credit from traditional and non-bank financial institutions, including credit information from the central bank’s national credit-registry system.
9. In order to facilitate secured lending on platforms, there is a need to provide access to platforms to the CERSAI asset registry, potentially include them under the ambit of SARFAESI Act; Chinese P2P platforms have access to the central bank’s national ‘movable assets’ registry information for accounts receivables.[21]
10. As Platforms store and handle sensitive datasets there is an urgent need for proper data protection and security standards. Currently China’s regulations are focused solely on the accuracy of data being collected; however more detailed implementing rules are expected to be issued on data privacy and technological standards.[22]
11. Platforms should be stopped from using misleading promotions of services — UK[23] authorities, for instance, actively monitor financial promotions on platform websites and take action where firms do not meet their standards. The FCA has also released a guide on financial promotions in social media.[24] Chinese regulators have prohibited the offline publicising or recommending of projects that need funding (only electronic channels such as internet, fixed-line telephones, and mobile phones or via entrusting or authorizing a third party, are permitted), although the rationale behind this prohibition is ambiguous.[25]

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About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect individuals accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.

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^[1] See:https://piie.com/blogs/china-economic-watch/p2p-series-part-2-regulating-chinas-plethora-p2p-players
^[2] See:http://hkmb.hktdc.com/en/1X0A34J5/hktdc-research/China-Issues-Guidelines-on-Development-of-Internet-Finance
^[3] See:https://piie.com/blogs/china-economic-watch/p2p-series-part-2-regulating-chinas-plethora-p2p-players
[4] For an English translation of the measures see: http://en.pkulaw.cn/display.aspx?cgid=278756&lib=law
^[5] See:www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
^[6] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
^[7] See: https://hk.lexiscn.com/law/law-english-1-2917482-T.html
[8] The CBRC recently issued the Guidelines for Online Lending Fund Depository Business; for more see: http://hkmb.hktdc.com/en/1X0A99GT/hktdc-research/CBRC-Issues-Guidelines-for-Online-Lending-Fund-Depository-Business
[9] For the purpose of these Measures, “local financial regulatory authorities” means the departments of all provincial people’s governments which undertake the functions of local financial regulation. See more: http://en.pkulaw.cn/display.aspx?cgid=278756&lib=law
^[10] See: https://hk.lexiscn.com/law/law-english-1-2917482-T.html
[11]See: http://www.nasdaq.com/article/new-rules-for-chinese-p2p-lenders-designed-to-minimize-fraud-slow-industry-growth-cm719480
[12] Although there have been suggestions that the CBRC will build a centralised database on the online lending industry. See more: https://www.nri.com/~/media/PDF/global/opinion/lakyara/2016/lkr2016235.pdf
^[13] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
^[14] See: http://www.globaltimes.cn/content/1003315.shtml
^[15] See: http://www.business-standard.com/article/pti-stories/startup-sees-peer-to-peer-lending-market-growing-big-in-india-116020700125_1.html
[16] See: https://www.fca.org.uk/publication/policy/ps14-04.pdf
The volume- based financial resources requirement calibration placed by FCA on P2P platforms is the sum of:

1. 0.2% of the first £50 million of the total value of the total loaned funds outstanding
2. 0.15% of the next £200 million of the total value of the total loaned funds outstanding
3. 0.1% of the next £250 million of the total value of the total loaned funds outstanding
4. 0.05% of any remaining balance of the total value of the total loaned funds outstanding above £500m

[17] See: 5.5, https://www.handbook.fca.org.uk/handbook/CONC/5.pdf
[18] See: https://www.handbook.fca.org.uk/handbook/CONC/4/3.html?date=2016-07-01
[19] See COBS14.3.7A (4) in: https://www.handbook.fca.org.uk/handbook/COBS/14/3.html
[20] See: https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
[21] See: http://www.accaglobal.com/content/dam/ACCA_Global/Technical/manage/ea-china-p2p-lending.pdf
[22] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
[23] The FCA highlights concerns regarding promotions that compare P2P lending in equivalence to holding money on deposit –as investors should understand that there are greater risks involved and they may lose some or all of their money. For more see: https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
[24] See: https://www.fca.org.uk/publication/finalised-guidance/fg15-04.pdf
[25]A plausible reason could be the prevalence of offline-online business models in China, where providers would promote their online services to customers through offline means.