Fall of $7.6b Ponzi scheme Ezubao is bad for all of China’s P2P lending companies

Photo by Mike Poresky

Well, it has finally happened. After months of rumblings that major Chinese P2P lending company Ezubao was engaged in fraud, Chinese state media announced Monday that police have found “substantial evidence” that the company cheated more than 900,000 investors out of US$7.6 billion. The Xinhua article quotes a senior manager at the company as saying that “95 percent of investment projects on Ezubao were fake.” Yucheng Global (Ezubao’s parent company) president Zhang Min says the online lending site was really just a Ponzi scheme.

The fall of Ezubao

The problem seems to have been caused by Ezubao’s promise of unrealistically high guaranteed returns on its investment products. Ezubao promised around seven times the normal interest rates offered by banks, but with China’s economy flagging, returns on actual investments couldn’t match Ezubao’s claims. The company’s solution? Create fake investment products, and use the money new investors placed in those products to pay back older investors…or just line one’s own pockets. Despite knowing that the company was in dire financial straits, senior executives at the company were still cutting themselves massive salaries. Zhang Min herself took a US$83 million cash bonus, in addition some other perks like cars, jewels, and a villa.

When the proverbial feces hit the fan, Ezubao executives began hiding and destroying evidence. Police found about 1,200 financial documents, for example, buried six meters underground in travel bags. It took two excavators 20 hours to dig them out.

The company also may have been going after media outlets that reported on its problems in an attempt to keep its name clean and bring in more money. Back in December I wrote about a Chinese media site that saw its door vandalized in a very creepy way, as well as suffering hacking attempts and some scary phone calls, on the same day it posted a negative report about Ezubao indicating the company was suspected of fraud.

21 suspects at Yucheng Global and Ezubao were arrested earlier this month. The investigation is ongoing, but given that the Xinhua report quotes several of the company’s own executives admitting to extensive crimes, it’s probably safe to say that Ezubao is dead. Police say they’ll try to get as much of investors’ money back as they can, and victims will soon be able to register on China’s Ministry of Public Security website.

Photo by Txopi

Bad news for the P2P lending sector

China’s P2P lending sector exploded in 2015. The industry broke records, and we saw dozens of different P2P lending startups raise big rounds: Jimubox, PPDai, Dianrong, China Rapid Finance, FirstP2P, Yooli, Yinker, Baocaiwang, and the list goes on and on. Yirendai even became the first Chinese P2P lending company to IPO in the US. As of November 2015, China had 2,612 active P2P lending platforms, according to Xinhua.

The downfall of Ezubao is likely to hurt all of them. First of all, it will significantly decrease consumer confidence in the P2P lending model. Ezubao is certainly not the first P2P scam we’ve seen in China, but with more than US$7 billion lost it appears to be the biggest, and the scandal was frontpage news on all of China’s tech sites on Monday. Given China’s slowing economy, the scares China’s A-series market has given investors over the past year, and the conservative attitude many Chinese have towards investment and savings, investing with a P2P site already looked like a risk. Now, P2P lenders are going to have to work very hard to prove to would-be clients that they’re not up to the same dirty tricks as Ezubao.

But perhaps more significantly, the investigation of Ezubao will likely lead to a regulatory crackdown on the P2P lending market, which has grown faster than regulators can keep up with. Authorities already had plans to tighten up oversight of the sector, and the Ezubao news will be interpreted by many as further evidence that stricter regulation is necessary.

In the long run, this is probably a good thing for the companies that can survive it: a more well-regulated industry means fairer competition, more confident customers, etc. But in the short run, it could mean strict crackdowns or even freezes as China’s regulators attempt to put the brakes on the industry, and new expenses for P2P lending firms as they attempt to get in compliance with the new rules. Companies that don’t have the funding runway to weather a few regulatory bumps in the road could be in trouble. And with Ezubao’s scandal fresh in the headlines, venture capital investors may be more hesitant to back P2P lenders until it’s clear how the regulatory picture is going to shake out.

In other words: winter is coming, and P2P lending firms that aren’t ready now could get left out in the cold.