SHANGHAI -- China's 1.2 trillion yuan ($189 billion) internet finance industry has reached a turning point as regulators tighten regulations after one too many cases of bankruptcy and fraud.
Some analysts are predicting a shakeout in the sector, which has already seen notable scandals such as that of Qbao.com.
On Jan. 21, founder Zhang Xiaolei appeared on state-run China Central Television from behind bars to confess that the popular site had broken the law. He turned himself in at the end of 2017 and was later arrested on suspicion of running a massive fraud.
Also known as Qianbao, Qbao.com raised 30 billion yuan by touting improbably high rewards -- on the order of 40% a year -- to users that performed such tasks as watching online advertisements or answering surveys. Users paid a deposit to be introduced to such work.
The Chinese internet is rife with illegal schemes that prey on consumers' lack of financial knowledge. They use various tricks, including claims that they invest in safe government-affiliated projects and that recruiting more members will raise returns. Many of these platforms pass themselves off as peer-to-peer lending sites.
According to Wangdaizhijia, which tracks peer-to-peer lending platforms, 645 internet finance businesses suffered problems such as missed principal and interest payments in 2017. That is about one-fourth of the nearly 2,000 such businesses in operation.
Online financing keeps growing in China despite frequent incidents. The industry had 1.22 trillion yuan in assets as of the end of 2017, 50% more than a year earlier. Its average stated yield of about 9% is far higher than China's standard 1.5% interest rate on one-year deposits and the average 5% return on so-called wealth-management products sold through banks.
China's underdeveloped social security programs create financial uncertainty that drives people to chase high-yielding investments. But responsibility for allowing normally cautious savers to flock to such promises of wealth also lies with Chinese authorities, who have prioritized only superficial investor protections while failing to provide the financial products that people need.
Regulators have finally sprung into action, banning internet finance companies from guaranteeing principal, thereby encouraging people to think twice before handing over their money. A de facto registration system for online finance companies will start around the middle of the year. Authorities will also step up surveillance to ensure that investor money is not misappropriated.
China is also urging online finance companies to improve transparency by going public. The government figures consolidation into a few major players will reduce the number of incidents like bankruptcies and fraud, in addition to making the industry easier to regulate.
China's bitter medicine is expected to reduce the number of legally operating sites to 800 by the end of 2018, Wangdaizhijia predicts. Some see the number going even lower.