Jiedaibao’s Woes Highlight Growing Risks of P2P Lending

(Beijing) — Only 31 years old, Chen Wei has led a colorful life — a soldier in Tibet, a construction worker in Qatar and a sailor on the Atlantic Ocean. Now he’s toiling as a courier in Beijing to earn enough money to sue Renrenxing Technology Co. Ltd., the operator of Jiedaibao, one of China’s most popular peer-to-peer (P2P) online lending platforms, and the borrowers he claims owe him 427,300 yuan ($62,100).

The tale of how a young adventurer ended up in this legal and financial quagmire illustrates yet again how regulators are failing to keep up with the fast-changing world of internet finance and how the desire to turn a quick profit often ends in tears.

Chen, who hails from Sichuan, the southwestern province famous for pandas, chili peppers and hot pot, was working for an electronics manufacturer in Shenzhen when he was lured into the world of finance with the promise of easy profits using a new smartphone app called Jiedaibao.

Launched by Renrenxing in June 2015 with catchy slogans like “Everyone can be a financier,” Jiedaibao aimed to facilitate lending and borrowing primarily among family, friends and acquaintances. But concerned that borrowers wouldn’t use the app very often, Renrenxing also allowed borrowing and lending between strangers.

The key attraction was the moneymaking possibilities for users, who were free to set their own interest rates. Renrenxing called this function “Zhuan li cha,” roughly translated as “pocket the difference.” By borrowing at lower interest rates and then relending the money at a higher rate, users could make a profit on the interest-rate spread.

The company made money by charging a fee to those who defaulted on their debts.

To register on Jiedaibao, users had to provide their real name and their ID card number, and also had to verify their identity using facial recognition technology. Borrowers couldn’t see who was lending them money, but creditors could view the identities of their debtors although they didn’t have access to their credit history.

To soothe concerns about risk, Jiedaibao said it had a multilayer risk-control system that included a call center, complaint center and collection teams throughout the country to help lenders recover their money if borrowers failed to repay. China doesn’t have a fully developed credit reference system for individuals, and Jiedaibao was supposed to carry out background credit checks on users and undertake additional vetting procedures to assess their risk of default.

By the end of 2016, the app had attracted 135 million users, and 100 billion yuan worth of loans had been brokered on the platform. At its peak, the value of daily transactions reached 1 billion yuan, according to information that Jiedaibao provided to Caixin.

Easy Money

Chen joined the platform in August 2015 and quickly became hooked. “It was incredible,” he said. “As long as I could find people to borrow money, I could profit from the interest-rate differential.”

Taking out relatively small loans averaging about 11,500 yuan each, over time he borrowed a total of 3.6 million yuan from other users at an average interest rate of 16.2%. About half of the money was re-lent at an average interest rate of 30.2%, with the average size of loans amounting to just under 5,000 yuan.

But things eventually turned sour when debtors started to default. Chen said 28 people failed to make repayments amounting to 427,300 yuan. Without that money, Chen couldn’t pay back some of his own loans.

In September 2016, he received a subpoena from a court in Shijingshan, a district of Beijing, informing him that he was being sued by Renrenxing for the recovery of 489,400 yuan in loans he had failed to repay, according to documents Chen provided to Caixin.

Furious, he moved to Beijing to fight the action. Although the company dropped the case against him on Jan. 6, Chen decided to stay in the capital to save up money to fund his own legal action against Renrenxing for repayment of the money he says that borrowers on the platform owe him.

He is not alone. In January, 35 users took Renrenxing to court in Beijing demanding the company pay them a total of 22.5 million yuan they claim was owed by debtors who failed to make repayments.

According to Renrenzhui.com, a website unrelated to Renrenxing that connects lawyers and creditors, as of Dec. 4, more than 1,200 Jiedaibao users had sought help from the website to recover loans worth a total 800 million yuan.

The media started to probe Jiedaibao’s practices. In November, state-run China Central Television (CCTV) ran two programs about the platform’s operations.

Interviewed by the station, Zhu Wei, a law professor at the China University of Political Science and Law in Beijing, said that Jiedaibao had failed to meet its obligations to vet the backgrounds of lenders and borrowers and so should take responsibility for users who abused the platform and profited from the information asymmetry between creditors and debtors.

Yang Dong, who leads the internet finance and cybersecurity research center at Renmin University of China, told CCTV that P2P platforms promoting the practice of allowing users to profit from the interest-rate spread on loans were “definitely violating regulations.”

Nothing Illegal

The negative publicity from the CCTV investigations forced Jiedaibao to pull the “pocket the difference” function from the app.

But according to Liu Jinyi, a lawyer specializing in finance at Dacheng Law Offices in Beijing, Jiedaibao did nothing illegal.

“It met the government’s requirement to just be an intermediary,” said Liu, who is not involved in the case. “Although allowing users to profit from the interest spread may have been harmful to the real economy and brought increased risks of default, there are no regulations stating that such a practice is illegal.”

Weng Xiaoqi, senior vice president of Jiedaibao, told Caixin that the company had abided by all regulations, but he did not explain why the platform shut down the function allowing users to profit from the interest-rate spread.

Asked whether Jiedaibao does assess the ability of borrowers to repay their loans, Weng said that “most” users’ credit records were vetted, although he declined to elaborate.

Other P2P platforms have criticized the “pocket the difference” product. Although China currently has no regulations governing the financial practices Jiedaibao was promoting, the explosion in this kind of lending has only increased the risk of defaults, said Xu Jianwen, CEO of Renrenjucai, another online P2P lending service. Once one user defaults, it can trigger a domino effect that quickly spreads through the entire lending chain, he said.

This isn’t the first time Jiedaibao has hit the headlines. In mid-2016, local media reported that loan sharks using the platform were demanding that borrowers, mostly female college students, submit nude photos of themselves as collateral. They threatened to make the pictures public if debtors fell behind on their repayments.

The company denied its direct involvement in the scandal and said the arrangements between creditors and borrowers were made offline.

The dispute over Jiedaibao is the latest in a string of controversies and scandals to hit internet financing and online P2P lending. Encouraged by the government as important channels of financing for individuals and small businesses shut out of the conventional banking system, the number of platforms has surged.

At the end of last year, there were 2,448 P2P platforms, up from 1,575 in December 2014 and just 200 in 2012, according to Wdzj.com, a P2P lending portal and data provider.

Loan Sharks

But the industry’s explosive growth has left the country’s financial authorities in the dust. Lack of regulation and supervision has led to a proliferation of fraud and risky activities. Smelling the chance to make money and take advantage of unsophisticated users, loan sharks have flocked to these platforms.

“The biggest problem with P2P online platforms is that they haven’t proved they have an edge over traditional offline P2P lending,” said Yang Tao, a researcher at the Chinese Academy of Social Sciences. With access to big data, online P2P online platforms should, in theory, have been able to link people who need a loan with potential lenders and better facilitate the lending process, he said. But in reality, the industry became a victim of exploitation due to the lack of regulation.

According to a report released jointly by Wdzj.com and Shanghai Yingcan Business Consultancy Co. Ltd., between 2013 and January 2017, around 478,000 people, or 4.5% of P2P investors in China, were hit by various kinds of fraud.

Authorities started to crack down on internet financing platforms and online P2P lending services in August, issuing a set of tough new regulations and pledging heightened supervision of the industry.

For P2P platforms, that has included putting a ceiling on the amount of credit that borrowers can take on and curbing the types of products that can be offered. Companies are now also limited to providing intermediary or matchmaking services between lenders and borrowers, and are barred from offering protection to lenders against losses.

The new regulations is already leading to a shakeout in the industry, but whether they will be enough to tame the worst excesses of P2P lending and curb fraud remains to be seen.

Contact reporter Chen Na (nachen@caixin.com)