Economic Watch: China's Internet finance thrives as fraud fades

Wang Pengfei, vice president of a leading Internet finance company, has seen the industry grow in China at a galloping pace, along with some shady practices.

After working at a state-owned lender for a decade, Wang joined Weidai, an Internet finance company whose name means "micro-loan," in 2014 when the industry was flourishing.

FAST BUT FRAUDULENT

The industry's burgeoning development came as no accident to Wang and other market observers.

China has four large state-owned banks, and state-owned enterprises generally have easier access to financing. Many small companies are troubled by the financing bottleneck, creating pent-up demand.

Meanwhile, working-class families struggle to figure out where to invest their savings to seek higher returns, and many of them move money online. The country, home to the world's biggest online population, also has a number of groups, such as college students, who are underserved by banks.

China has not established a sound social credit system, and credit cards are not as popular as in some advanced economies. Online payment has instead emerged as a well-received alternative to cash. Crowd funding has picked up momentum as a wave of entrepreneurship has hit the country.

Development of Internet finance has helped broaden the financial reach, improve efficiency of financial services, give Chinese more investment options, and help some small businesses get badly needed loans, but the boom has its costs.

The first peer-to-peer (P2P) lending platform was launched in 2007, and exploded in popularity in China, with the number of such platforms surging 18 times between 2012 and 2015 and the combined transaction volume jumping about 40 times over the period, according to data from the State Information Center.

P2P lending platforms helped link clients seeking better yields with borrowers starved for capital, but a report from leading industry information provider www.wdzj.com painted a grim picture. By March 2017, 3,607 Chinese P2P lending platforms had run into trouble or been forced to close, with only 2,281 platforms in normal operation.

With a relatively low barrier to entry in the industry, some high-profile fraud cases emerged and grabbed headlines, such as P2P lending platform Ezubao that cheated investors out of nearly 60 billion yuan (8.7 billion U.S. dollars) through fake investment projects.

Some bogus lending platforms diverted client funds for other purposes, while online Chinese loan sharks illegally demanded nude photos as a form of collateral from cash-strapped female college students. These cases have triggered the concerns of regulators and a year-long industry correction.

On top of P2P lending, Internet finance also covers business such as third-party online payment, crowd funding, and other financial services.

"In tandem with the rapid growth, China's Internet finance industry is afflicted with Ponzi schemes and some companies deviate from their main business to seek hefty profits," said Li Bo, a researcher with the People's Bank of China (PBOC), the central bank.

When introduced to a long list of wealth management products they have never heard of, many individual investors, such as retirees, have ended up as victims of unscrupulous online finance platforms, sometimes losing their life savings.

Chinese Premier Li Keqiang earlier this month cautioned that the country's financial sector was vulnerable to risks such as bad assets, bond defaults, shadow banking and Internet finance, with frequent illegal and corrupt activities.

Risk caused by the Internet finance industry has wide repercussions. Some P2P lending platforms resembled hybrid financial institutions providing clients with various financial services online, analysts said.

"Some online finance entities have performed illegal services, which creates contagion risk for banks, as financial agencies are intertwined with one another," said Ou Minggang, director of the International Finance Research Center at China Foreign Affairs University.

SUPERVISION TO CATCH UP

"Before 2017, the industry was full of fraud, such as problematic P2P lending platforms and fraudulent borrowers using false information. With strengthened and coordinated supervision among different regulators, the industry will embrace reasonable development," Wang said.

Wang found that some important industry regulations such as those on crowd funding took effect in 2014, and targeted regulations have been rolled out by national and local authorities since 2016 for some murky and less-regulated areas.

Regulations on Internet finance services such as third-party payment are relatively sound, but regulations in other areas need to be improved, said PBOC deputy governor Pan Gongsheng.

"The pace of business innovation has outpaced supervision in recent years, with companies producing new financial products to bypass supervision and hurt investors' interests," Ou stressed.

"Regulators face a steep learning curve, and they must keep abreast of the ever-changing industry landscape. They should focus on Internet finance companies' business and what their financial products really mean for investors," Ou added.

Businesses such as P2P lending, Internet-based insurance, third-party online payment, and online asset management were among key areas for strengthened supervision, industry observers said.

Internet finance last week appeared on the top banking regulator's list of ten most important areas for enhanced risk control, with targeted measures to be taken to stem emergence of a financial crisis.

For P2P lending alone, regulators have unveiled specific policies including 13 restrictions to prohibit P2P platforms from accepting public deposits, pooling investors' money for their own projects, providing guarantees for lenders, or selling financial products.

Wang also suggested learning from the experience of advanced economies and strengthening efforts to establish a social credit system with participation by both regulators and credit scoring companies.

Better consumer protection laws and regulations should be in place, and supervision of products from Internet finance companies must be strengthened, with better conflict resolution schemes to be established, Li suggested.

Wang said 2017 will be a watershed year for Chinese Internet finance as the rules are tightened, bringing the industry out of the wilderness. Endi