Private online lending deserves credit(3)

Rating borrowers

The well-developed credit market in the West provides easy access to individuals' credit ratings, but Chinese websites need to come up with their own ways to rate the borrowers.

Among the several risks listed in the regulatory commission's notice, one crucial point covered the businesses' difficulty in controlling risks. "Individual credit reports in China are not as well developed as in the US, and they are only available to commercial banks," Zhang of ppdai said.

Both ppdai.com and Renrendai said their default rates remain around 1 percent, but checking borrowers' background information and verifying loans will become more costly as their customer bases grow.

Most sites remind their individual lenders to diversify their risk by bidding more often to different borrowers, and they have their own responses to loan default. Ppdai.com compensates lenders and puts the personal information of a defaulting borrower on its blacklist. Renrendai works with debt collection companies for its delinquent loans.

No one in charge

None of these lending sites comes under the scope of financial regulatory agencies. The banking commission also warned that during times of tight credit, such websites could be turned into illegal financial institutions if they solicit investments from the general public.

"The lack of a well developed credit system also has pushed many such websites to go offline to attract users and provide other services," Bai said. "The problem arises when a peer-to-peer lending company does not just connect lenders and borrowers."

In China, P2P lending platforms have moved beyond emulating the foreign sites. Some sites charge a fee to provide a credit guarantee for borrowers. Some lend their own money to borrowers and transfer the creditors' rights to investors. In that case, Bai said, "They changed from an information intermediary to a player in the game."

All these companies are providing innovative financial services without a license. "It's like driving a racing car on the street without a driver's license," said Chen Guang, a lawyer at Zhong Yin Law Firm. "As the money pool grows bigger, it becomes riskier."

Chen said these websites could also become a money-laundering channel for illegal activities.

In September, the founder of the P2P site was arrested on suspicion that he borrowed money from other lending sites without paying it back and used that money to set up his own site to attract investors.