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China's P2P Lending Market 4X Compared to US, but There's Another Side to the Story

China is the largest peer-to-peer lending market in the world. In China, loans to entrepreneurs through Internet-based peer-to-peer lending totaled about $42 billion last year. Although analysts predict the US to be the pathfinder for peer-to-peer (P2P) lending, China’s P2P market is almost four times that of the US. Three years ago, there were only 50 P2P Platforms. By the end of 2014, there were 1,575 P2P platforms operating in China, according to Wangdaizhijia, a data provider.

P2P lending has taken off in China

Source: Wangdaizhijia, Morgan Stanley

The demand of P2P lending in China has overshadowed that of the US where the model was first developed. By the end of 2014, Lending Club and Prosper Marketplace—two platforms that dominate the US market—had cumulatively issued roughly $10 billion worth of loans. In the same time period, P2P lending in China had reached more than $42 billion.

Monthly P2P loan balance change

Source: Wangdaizhijia, Morgan Stanley

The growing market is attracting big-name investors from Tiger Global Management to Alibaba Group Holding Ltd.

Soul Htite, the Lending Club co-founder who left to form Dianrong.com about three years ago, said that he believes that the momentum is just picking up. The market in China is more profitable because costs are lower and the growth is much bigger, Soul Htite said to The Australian Financial Review. Dianrong has facilitated about 1 billion yuan ($209 million) of loans which were mostly for business, charging lower rates than the shadow banks. Interest rates of shadow banks can go up to 50% whereas there are people with good creditworthiness who need not pay such a high interest rates. The actual range should vary from 5 to 12%.

For Chinese investors, P2P lending fetches higher interest rates than they would get leaving their money in the bank (with the promise of lower risk than putting their money in China's volatile stock market). Lenders claim they lower the risk of default by spreading cash across a large number of loans.

But there is another side to this story.

Given the explosive growth, fraud and other problems have occurred. According to the Morgan Stanley report, more than 370 P2P lenders have already shuttered since China’s first peer-to-peer lending website launched in 2007 and more than 270 platforms failed in 2014.

The dramatic increase in failures has alerted investors as well as regulators; China’s government says it is paying attention. In January, 2015, the China Banking Regulatory Commission announced it was setting up a division to monitor peer-to-peer lending and said it would put forth new lending rules for the sector by the second half of 2015.

Fraudulent operators in the online funding space have remained endemic in China for quite some time. Recently, a director at the Economic Investigation Bureau stated that approximately 70 P2P platforms involving approximately 6 billion yuan were under investigation.

The growing number of competing sites has increased competition. Bai Chengyu, General Secretary of the China Association of Microfinance, has estimated that 80% or more of these P2P platforms may fail if regulations are not strict.

But why are P2P lending platforms failing in China?

Proprietary lending technology and analytics are used to aggregate and analyze thousands of data points to assess the creditworthiness of small businesses and borrowers in the US. P2P operators typically give potential borrowers a score based on all the data points. Lenders decide whether to lend based on a borrower's credit score. Data in China's credit bureau is incomplete, making additional vetting and sometimes, other types of reassurance—like collateral—necessary.

The new regulation, which is expected to arrive shortly, will boost investors and lenders sentiments. Moreover, it will reduce frauds to a great extent and will make online lending more structured.

Some of the major online P2P lending companies in China:

CreditEase

my089.com

Lufax

PPmoney

Dianrong (formerly SinoLending)

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