Why Big Brothers Cannot Save P2P Lending?
Despite its impressive growth, the P2P lending industry is not airtight. Fraudulent practices are on the rise particularly in economies where credit reporting institutions and financial consumer protection regulations are not well-established. In 2015 alone, 1,253 out of 3,000 Chinese P2P lending platforms were discovered as problematic, involving multiple Ponzi schemes.
P2P lending platforms are often hailed as a key driver of financial inclusion as they tend to attract smaller and individual investors who are believed to be underserved. However, the notion that anyone—regardless of income, education, or savings—should be given equal access to high-risky financial products is groundless. By consolidating multiple lines of debt into a single monthly or yearly payment product, P2P lending platforms or their partner institutions create extremely complex investment schemes and transfer massive risks to investors. It opens door to abuse for ordinary people who have no formal financial training or substantial experiences in finance. Sometimes, these retail investors don't even understand what they are buying not to mention their ability of detecting fraud.
When there is a market failure, people often expect the Big Brother to clean up the mess. Indeed, a series of P2P lending frauds have caught the attention of authorities. In December 2015, China Banking Regulatory Commission (CBRC), along with several other government agencies, released a new rule, which suggests that P2P platforms may soon be obliged to submit their transaction information to a centralized database. Credit Reference Center (CRC) of the People’s Bank of China (“PBoC”, the Chinese central bank) is likely to play a crucial role in safeguarding the data. Unfortunately, government agencies often cannot evolved in parallel with the development of innovations. When it was initially set up, CRC (and its affiliated for-profit companies) was primarily designed for traditional financial institutions. P2P platforms have appeared to be much more sophisticated than banks or microfinance institutions. It requires further standardization and harmonization of data before they can be completely imported into and effectively analyzed by government systems.
In addition, fraud can also be a result of corruption. Many Chinese P2P platforms have been found to "bribe" local governments in order to receive huge subsidies and official endorsements. Those who are not bought off may still choose to ignore the risks pertaining to P2P lending. It's not because they have confidence in P2P lending, but because they want to use these platforms to create jobs, expand tax revenues or even finance their own projects. When scams are uncovered, these government officials may choose to stand by and keep silent. I never doubt Beijing's genuine desire to embrace innovations and deepen the economic reform. However, the good intention can also lead to bad consequences, especially at the local level.
In the war against fraud, the private sector is finding business opportunities. A handful of third-party technology providers have claimed that centralized cloud computing can bring transparency and safety to P2P lending. In theory, cloud computing is able to support extensive data analytics with low infrastructure costs. It ensures that P2P lending transaction data are current, available and secure. Nonetheless, because cloud computing services are provided by the servers owned by third-parties, when P2P platforms choose to connect to centralized clouds they risk losing physical access to the machines that host their data. Sensitive information could be exposed to attacks and platforms won’t be able to defend themselves. Scarier is the tendency of power concentration among technology firms. Across the world, tech giants are consolidating in the name of efficiency and safety. They can potentially possess and exercise monopoly control in the industry, which might end up with more abuse.
As John Dalberg-Acton once said, “Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men”. Centralization can make databases susceptible to manipulation and alteration by people who have the controls. While public authorities and tech firms can be great problem solvers, their own trustworthiness and competency are prerequisites for their values. In many situations, central controls can actually fuel the spread of fraud in P2P lending.
That said, decentralized P2P fraud prevention tools won't come easy. There have been recent advances in this area. Some may be simple and require only minor modifications of existing functions. Others could take a long time to take shape. Take blockchain, or the distributed ledger technology, for instance, a rapidly growing number of people have seen its potential. But where to start remains a tough problem for many financial institutions and regulators. They are still waiting for more use cases.