Internet lending is a unique form of the credit market for bypassing banks in which borrowers generate online microloans without leverage or intermediation from financial institutions. Unlike the UK and the US, the Chinese P2P lending market is broader. Although the regulations concerning P2P lending are more comprehensive since 2015, there remains some regulatory gaps and failures, thus identifying these remaining regulatory gaps can help perfect the regulatory framework. This chapter provides a more detailed analysis and an examination of the Chinese legal framework related to P2P lending and identifying the vacuums in the existing framework. The theoretical contribution is primarily to the implications of the latest development of regulatory changes and the established individual credit reference system in China. Furthermore, the chapter also discovered three new regulatory vacuums (i.e., platform exit, a case report of financial crime, and consumer education), thus concluding with detailed insights on future approach towards perfecting the regulatory framework.
Top1. Introduction
Formal credit analysis focuses on the conduct of corporate finance. However, as new internet infrastructure progresses, more users prefer Internet borrowing. Internet lending is a unique form of the credit market for bypassing banks in which borrowers generate online microloans without leverage or intermediation from financial institutions. P2P (peer-to-peer) lending/borrowing is one system in which people lend money directly to individual creditors (Gomber, Kauffman, Parker, & Weber, 2018).
Most P2P platforms have been advocating their function as “cost-cutters,” implying that they can provide better returns to investors and cheap loans to borrowers by removing the middleman (banks). Economic developments in the years after the recession and increased mistrust of the banking sector led to the rise of a rising number of start-up technology companies directly involved in providing financial services and goods to end-users. In most cases, the main innovation embedded in its market was a technical infrastructure built and employed by these businesses, making it easier for end-users to access financial products.
The concept behind these platforms is that they serve an alternative, market-based financial intermediation mechanism which allows parties to circumvent the role that banks historically play in providing credit and taking deposits. In reality, alternative platforms appear to attract potential lenders by lowering the costs of intermediation and service and raising returns on deposits in terms of interest. At the same time, borrowers are granted more comfortable access to loans and better terms.
Peer-to-peer lending, also known as P2P lending, is an innovative Internet-based lending model that enables individuals to lend and borrow money without the intervention of conventional financial institutions (Serrano-Cinca, Gutiérrez-Nieto, & López-Palacios, 2015).
A potential borrower applies for a loan on a platform under a standard P2P arrangement. The borrower must usually provide credit information, which is processed and posted on the platform after being checked and accepted. At the opposite end of the platform, creditors (or rather investors) may choose from the available loans that suit their risk and return appetite.
Unlike the UK and the US, where few platforms mainly dominate the P2P lending markets, the Chinese P2P lending market is broader, where the top five platforms constitute only 15% of the lending market in China (Yan et al., 2017).
The development of P2P lending in China can be classified into four stages (Zhang et al., 2015). Stage one is from 2007-2012, with Paipaidai being the first P2P lending platform in China. Stage two is from 2012-2013, which features China's P2P lending sector's aggressive growth since 2007 (Yan et al. 2017), and from 2012 onward, witnessed exponential growth as revealed in Figure 1.
Stage three features an explosion of risk, which began in 2013. The aggressive growth prevented regulatory parties from setting adequate legislation to regulate this kind of novel industry (Buckley, Arner, & Barberis, 2016). Various media reveals several platform scandals such as capital misappropriation and high lousy debt rates. These events had a direct impact on investors’ confidence in P2P lending. Due to the increasing industrial risk in this area, regulatory parties began to interfere in 2014, i.e., stage four. Out of pressure, in July 2015, the Chinese government issued the Guiding Opinions on Promoting the Sound Development of Internet Finance to regulate the rapid development of Internet finance. Hence, the rapid growth rate of P2P lending has declined since then.
P2P lending can function with less overhead, contributing to higher returns for lenders and lower interest rates for borrowers. However, as the lenders know the borrowers and invest based on the limited information given by P2P lending platforms, profitable P2P lending often entails a high risk of lending due to information asymmetry. Therefore, assessing borrowers' credit risk and identifying non-creditable lenders becomes a significant issue for the P2P lending industry. The approaches used to determine the credit risk better (i.e., loan default prediction) are challenging to decide. P2P loans are also more stringent as most lenders on the market are non-experts with little experience and no formal training in evaluating lenders' value. In the meantime, the borrower community is complicated compared with conventional bank loan situations since the lack of compliance with credit requirements and borrowing does not enable any of the borrowers to accept traditional bank loans.