Can China’s peer-to-peer lending industry be saved?

The prospect seemed far-fetched just a few months ago, when P2P platforms were failing by the dozens and angry investors were protesting in major cities across the country. But after a nearly two-year government campaign to root out fraud and improve lending standards, a potential path to recovery for the world’s biggest P2P market is becoming clearer.

Industry insiders are betting that a handful of closely regulated players will emerge from the cull. They envision a revamped model — similar to the one adopted in America — in which P2P platforms match small borrowers with institutional money managers and banks, instead of individual savers. That would allow China to keep funneling much-needed credit to small companies, while at the same time containing exposure to investors who can bear the risk.

“I see it going in the same direction it went in the U.S.,’’ said Soul Htite, a co-founder of San Francisco-based LendingClub Corp. who now runs Dianrong, a Chinese P2P platform backed by Tiger Global Management.

Policy makers in Beijing, who have been working on a P2P licensing system for at least a year, have so far kept quiet about their long-term plans for the industry. They’ve been trying to strike a balance between containing financial risk and exploring new ways to fund small businesses, including through technology.

The National Internet Finance Association of China, set up by the country’s financial regulators to help oversee the P2P sector, didn’t reply to an email seeking comment.

Here’s a closer look at the industry’s history, and what the future may hold:

The Rise

Born during a wave of deregulation that spawned China’s $9 trillion shadow banking system, P2P platforms were meant to help boost financial inclusion in the world’s second-largest economy. They gave savers access to double-digit yields, while adding a new financing channel for small borrowers who lacked connections at state-run banks. The industry had more than $150 billion of loans outstanding and upwards of 50 million investors at its peak, more than the populations of New York state and Texas combined.

Investors plowed an average 22,788 yuan ($3,370) into the platforms, according to Shanghai-based WDZJ Research, a significant sum in a country where per-capita gross domestic product was about $9,600 last year.

Given the widespread assumption that regulators would step in to prevent defaults, savers saw little downside to shifting their funds from bank deposits to higher-yield products.

The Fall

At first, P2P platforms worked mostly as intended. But as news of fraud and defaults spread and the market became ensnared in President Xi Jinping’s crackdown on financial risk, the industry began to shrink. The fallout has continued this year, with Chinese police freezing about 10 billion yuan of assets across more than 380 P2P lenders since June. The investigation has led to more than 60 arrests. “Every time a platform goes bust, protests and other social problems emerge,” said Zhang Yexia, Shanghai-based director of WDZJ Research Center.

The number of platforms may decline by 70 percent this year to 300, according to WDZJ Research. About 50 will ultimately survive, Citigroup Inc. analysts said in November. At its peak, the industry had about 6,600.

The Future

The biggest players have already started increasing ties with large institutions. Yirendai Ltd., China’s first publicly traded P2P business, said in March that it received a 10 billion yuan credit line from banks. PPDAI Group Inc., another New York-listed operator, said it expects institutions to contribute 30 percent of its funding this year after the proportion doubled in 2018.

Only about 5 percent of Chinese P2P lending was funded by institutional creditors in 2016, compared with 70 percent in the U.S., according to the latest data from the Bank for International Settlements.

“It’s something that we created for people to access, but it’s actually the big investors that are buying it,” said Dianrong’s Htite. “Whether you want to say sadly or successfully, it is what it is.”

— With assistance by Jun Luo, Alfred Liu, and Samuel Dodge

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