China Issues New Rules to Clean Up Online Microloans

China’s top financial regulators issued new rules Friday to ban unlicensed operations and cap borrowing costs in the country’s burgeoning online microlending market in the latest effort to clean up unregulated lending activities and rein in financial risks.

The new rules came a week after China urged provincial governments to suspend license approvals for new online small loan companies, signaling the country’s tightening oversight of the fledging sector.

The recent moves reflect regulators’ mounting concerns over the boom in online microlending. The business often involves small, unsecured loans with periods of six months or less targeting people with limited access to credit services such as students and rural migrants. Known as cash loans, these credit services usually require no collateral but charge high interest rates.

“Amid the rapid development of cash loans – while they have played a role in meeting the normal credit needs of some groups – problems such as over-lending, repeat borrowing, improper collection, abnormally high interest rates, and privacy violations have become prominent, posing relatively high financial and social risks,” the China Banking Regulatory Commission (CBRC) and the central bank said in a joint notice.

A recent report by China’s National Committee of Experts on Internet Financial Security Technology, a government-backed industry organization, estimated that there were 2,693 online platforms in China offering short-term loans to nearly 10 million clients. But many of the platforms are unlicensed to do such business.

Under the new rules, license issuance for new microloan companies will be suspended, and unlicensed operators will be banned. Existing licensed players are required to comply with the new regulations.

The new rules forbid lenders from charging interest rates that do not comply with the law. All interest rates, which include up-front fees charged for loans, must be within the legally allowed limit, and terms and conditions of loans must be clearly communicated to borrowers, the banking authorities said.

The maximum allowed legal annualized interest rate in China is 36%. But many online lenders charge annualized rates exceeding 100%, despite advertising seemingly low daily interest rates.

Lenders are not allowed to offer loans to borrowers who have no source of income or to mislead clients into over-borrowing, or to conduct violent debt collection. Lenders must fully and continuously assess borrowers’ creditworthiness, ability to repay debt and use of funds, according to the notice. A loan shouldn’t be extended more than twice.

To prevent excessive leverage, regulators tightened scrutiny of the capital sources of microlenders, forbidding banks to invest asset management funds in securitization products backed by cash loans.

The notice also forbids any institutions from abusing client privacy or illegally trading clients’ personal information.

A detailed implementation plan on cleaning up microloans will be issued soon, said Feng Yan, vice chief of the Financial Inclusion Affairs Department of the CBRC, in a briefing.

The total amount of unsecured short-term loans offered by online lending platforms has already surpassed 1 trillion yuan ($151 billion), according to statistics compiled by research firm Wangdai Zhijia.

Amid the regulatory storm, PPDAI, a leading online lending platform whose shares debuted in New York this month, dropped 8.3% Friday, extending declines since its IPO to more than 30%. Qudian, other U.S.-listed online lender, climbed 1.32%, but the stock has still lost almost half its IPO value.