A Study on the Financial Risk and Legal Supervision of P2P Lending Model in the Context of Internet Finance

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1 A Study o the Fiacial Risk ad Legal Supervisio of P2P Ledig Model i the Cotext of Iteret Fiace Jiafeg Liag 1, Jiawei Wag 2 1 Shijiazhuag Tiedao Uiversity, Shijiazhuag , Chia 2 Xigtai Uiversity, Xigtai , Chia Abstract I Chia, peer-to-peer ledig (P2P ledig) adopts a large umber of offlie credit checkig models based o maual due diligece. Compared with the traditioal fiacial idustry, the comparative advatage of Iteret fiace ca ot be achieved. The importat cause for the rapid developmet of P2P ledig i Chia lies i the "fiacial disitermediatio". Admissio restrictios have led to high profits i Chia's fiacial idustry. While P2P ledig coducts busiess similar to commercial baks i a "regulatory arbitrage" ad thereby gets relatively high profits. I this cotext, Chia's P2P ledig model is of typical Chiese characteristics, ad the risks ivolved are more complex. I this paper, the author aims to solve the fiacial risks i the P2P ledig model i the cotext of curret Iteret fiace ad promote stregtheig legal supervisio over it. Firstly, the defiitio ad commo mode of P2P ledig are summarized. Relevat fiacial risks are aalyzed ad effective legal supervisio measures are put forward. O the basis of this, aimig at the fiacial risk of P2P ledig, the risk cotrol model is costructed i order to effectively reduce the risk of P2P ledig ad create a stable eviromet for P2P ledig. Keywords: P2P Ledig Model, Fiacial Risk, Legal Supervisio, Risk Model. 1. BACKGROUND 1.1 Literature review P2P ledig is peer-to-peer ledig directly realized based o the Iteret platform, the ledig ad borrowig process of which eeds o ivolvemet of fiacial itermediaries. I foreig coutries, the rise of P2P ledig stems from the maturity of credit iformatio system ad the progress i Iteret techology. The maturity of the credit iformatio system makes it possible for pure olie borrower credit audit ad loa iterest rate determiatio. The progress i Iteret techology has reduced the cost of iformatio trasmissio ad realized automated credit approval as well as supply ad demad matchig. Sice the rapid developmet of P2P ledig i Chia i 2013, there have bee frequet platform risk evets (Zhou, 2016). Especially after eterig the secod half of 2015, the umber of platforms with problem have rise dramatically. Accordig to the data from data.01caijig.com, from 2013 to April 2016, there were at least 218 platforms that were closed dow for rectificatio, or with difficulty i cash withdrawal, rus o deposits, bakruptcy ad eve ruaway. The umber of platforms with problems reached 26% of the total, equivalet to 1 out of every 6 platforms has a risk evet. From the ed of 2015 to the begiig of 2016, there was a massive explosio of risk evets i P2P ledig i Chia. Amog them, i October 2014, the umber of ewly added issue platforms was 28: i November 2014, the umber of ewly added issue platforms reached 45, which meas that o average, there is a daily risk evet o oe platform. Although P2P ledig has bee i Chia for 7 years, o substative regulatory system has yet bee formed ad regulatio is i the form of restrictio by some laws related to this (Fu, 2016). However, the existig laws ad regulatios ca ot effectively address the special busiess model of P2P ledig, resultig i a large umber of platforms at the edge of the law. However, P2P ledig has obvious fiacial attributes ad high exteralities. If left uregulated, it may have adverse social impacts. 1.2 Research objectives As Chia s P2P ledig risk evets occur frequetly, the regulatory authorities have issued some regulatory rules. I December 2014, the Paymet & Clearig Associatio of Chia, uder the guidace of the People s Bak of Chia, established the Iteret Fiace Committee ad formulated the idustry stadards ad covetios. I 628

2015, the State Coucil made clear that the CBRC (Chia Bakig Regulatory Commissio) is the regulator of P2P ledig i Chia. CBRC publicized the 4 red lies that P2P ledig platforms must follow (Yag, 2014).

2 2015, the State Coucil made clear that the CBRC (Chia Bakig Regulatory Commissio) is the regulator of P2P ledig i Chia. CBRC publicized the 4 red lies that P2P ledig platforms must follow (Yag, 2014). Sice 2015, CBRC has held a umber of relevat discussios, which have give great importace to P2P ledig. Zhag Xiaopu from Bureau for Policy Aalysis of CBRC puts forward 12 priciples of Iteret fiacial regulatio. I this paper, the author discusses the geeratio logic of Chia s P2P ledig, aalyzes the potetial risk poits ad puts forward the correspodig regulatory measures, which aims to provide a referece for the regulatory authorities to make policies. 2. AN OVERVIEW OF P2P LENDING MODEL IN THE CONTEXT OF INTERNET FINANCE 2.1 The cocept of P2P ledig The P2P ledig model, developed i the cotext of the Iteret fiace, is a typical Iteret platform model used i the fiacial field ad maily refers to the direct ledig betwee idividuals through the Iteret platform. Compared with the traditioal fiacial ledig model, the core cotet of P2P ledig is that the iformatio processig ad risk assessmet are coducted through etwork. Meawhile, the term ad quatity of capital supply ad demad are matched without ay itermediaries such as baks or broker ad the supply ad demad parties ca make a deal directly. The P2P ledig model to some extet effectively solves the problems of small ad micro-eterprises ad idividual busiess i gettig loas, ad ca save the operatig costs of fiacial itermediaries such as commercial baks. It is cosidered by the maistream as a typical represetative of disitermediatio i Iteret fiace ad also a beeficial complemet to the bak. 2.2 P2P ledig model There are maily 3 kids of P2P ledig model i Chia. Firstly, the platform model, which is maily based o foreig busiess model ad also the most pure P2P model. I this model, platforms are ot egaged i guaratee, but simply match the iformatio, helpig both borrowers ad leders to make better fud matchig. The essece is direct fiacig, ad the most represetative oe is ppdai.com. Secodly, the guaratee model - P2P platforms provide ivestors with guaratees of pricipal or eve iterest, ad ivestor's ivestmet decisio is also shifted from the basis of their ow ability ad borrower iformatio disclosure to the trust i P2P compaies. At preset, most P2P compaies i Chia adopt this busiess model (Sog ad Zou, 2014). Thirdly, the agecy model represeted by lu.com, yooli.com, etc. which sells the credit assets of fiacial istitutios or quasi-fiacial istitutios to ivestors through the Iteret platform i a more flexible maer. The commo P2P ledig models are as show i Figure 1. Figure 1. P2P Ledig Covetioal Model 3. FINANCIAL RISKS OF P2P LENDING MODEL IN THE CONTEXT OF INTERNET FINANCE 3.1 Iformatio asymmetry causes moral hazard Fiace is a idustry based o trust, ad moral hazard is a typical risk of violatig trust mechaism. Because the tradig mechaism of P2P ledig is built through platforms, ad compaies which ow such platforms ca alter 629

3 all kids of data i backstage records, eve make up ad fabricate some data (Li ad Ji, 2014). At P2P platforms, credit loas are betwee stragers ad the trasactio data ad credit approval rights are uder the cotrol of platforms, ivestors have o way to effectively review such trasactio iformatio ad ca ot judge or track the autheticity of actual use of their fuds, thus are i a disadvatageous positio. 3.2 Iadequate platform maagemet ad risk cotrol I Chia, may P2P ledig platforms have low access threshold, low capital requiremets, ad the maagemet teams' abilities to cotrol risk are far apart. Due to lack of experiece, some platforms are with ureasoable tradig mechaism desig, ofte caot effectively idetify potetial risks at the begiig of the busiess process. The expected rates of retur o ivestmet are too high, ad due to the split of the rights of creditor ad term mismatch, liquidity risk icreases. Whe borrowers are difficult to maitai performace ad caot make repaymet o time, it could lead fud chai breaks of platforms, causig egative ews ad leadig to a ru o deposits. The cotiued ecoomic istability i fiacial markets i 2016 has a huge capital withdrawal effect o P2P ledig platforms. I particular, the borrowers with irratioal debt structure have fiacial strais. Overdue ad roll-overs evetually lead to ruaway ad shutdow may small ad medium-sized platforms due to rus o deposits. P2P platforms with problems caused by difficulties i cash withdrawal accouted for 39% of the total, icreased compared with that i 2015 (Guo ad Li, 2014). Figure 2 below shows a typical multi-platform selffiacig ad self-guaratee operatio model, i which there is a extremely serious potetial fiacial risk. Figure 2. Multi Platform Self-fiacig ad Self-guaratee Operatio Mode 3.3 The curret credit iformatio system is ot good eough As Chia's credit iformatio system for P2P ledig model is ot good eough, there is o complete iformatio disclosure system, which lacks public iformatio ad has a limited coverage of groups of idividuals. The idividual credit iformatio collectio, assessmet ad trackig maily follow the traditioal offlie credit iformatio reportig model, that is, depedig o offlie team or exteral cooperatio agecies, ad a lot of mapower ad time are put i to collect, review ad assess borrowers' credit iformatio. However, due to the fact that the Iteret model has broke the restrictios of regioal ledig, the traditioal credit iformatio reportig model ca hardly meet the demad for credit iformatio collectio of the curret debtor-creditor relatioship ad at the same time geerates high credit referece costs (Yua, 2014). Moreover, although the data of the PBC Credit Referece Cetre cover 800 millio people, oly 290 millio actually have records ad 500 millio have o credit records at all. The credit record data iclude oly two categories: oe is the basic persoal iformatio, ad the other is credit card paymet ad repaymet records. For some P2P ledig platforms that have bee coected ad shared with the credit iformatio system of the PBC Credit Referece Ceter, the data used to determie borrowers' credit iclude 44 categories of iformatio such as mobile phoe umber, persoal icome certificate, social security iformatio, family members iformatio, driver's licese iformatio ad so o. Apparetly, the credit referece data from the PBC are too simple to play a vital role (Wa, 2015). Therefore, the data obtaied by the P2P ledig platforms will lead to serious iformatio asymmetry ad ca ot meet the demad of risk judgmet. It affects ot oly the loa efficiecy but also the loa quality, ad directly leads to the lack of iformatio exchage amog differet regios ad platforms. What most commoly occurs is "multiple ledig to the same perso", "to rob Peter to pay Paul" ad other udesirable pheomea, which further icreases the liquidity risk ad credit risk of the platforms, ad such a vicious spiral will icrease P2P ledig platforms' bad debt rate ad evetually leads to ruaway ad shutdow. 630

High-quality professioals do ot oly have fiacial expertise ad improve busiess efficiecy, but also reduce the moral hazard to a certai extet because their earest attitude ad resposibility to work

4 4. LEGAL SUPERVISION MEASURES OF FINANCIAL RISKS IN P2P LENDING MODEL IN THE CONTEXT OF INTERNET FINANCE 4.1 Create a professioal team ad ehace level of risk cotrol A P2P platform trusted by ivestors must have a efficiet, high-quality ad professioal team. High-quality professioals do ot oly have fiacial expertise ad improve busiess efficiecy, but also reduce the moral hazard to a certai extet because their earest attitude ad resposibility to work (Zhou ad Ga, 2015). It is also ecessary to establish a comprehesive ad practical tradig mechaism. The geeral tradig mechaism icludes: audit of borrower's iformatio autheticity, loa cycle limit, iterest rate system, risk bearig capacity, compesatio system, historical credit ad so o. Figure 3 shows the details of the curret legal supervisio model ad departmetal resposibilities i Chia. Figure 3. Chia's Curret Fiacial Legal Supervisio Model A good tradig mechaism is the ability of P2P platforms to attract ivestors. The supervisor should have a systematic ad thorough uderstadig of the related busiess i charge ad develop a good commuicatio ad feedback mechaism for dowward extesio. O this basis, regularly assess ad compare the admiistrative efficiecy ad make cotiuous improvemets. Secodly, whe deliverig ad dissemiatig various admiistrative tasks, the itegrated maagemet departmet should improve the admiistrative efficiecy by formulatig appropriate workflows for differet positios ad ature of work (Zhag, 2017). Fially, the admiistrative work betwee departmets should be formulated for the iteral admiistrative processes ad admiistrative work scope, to avoid iefficiecy caused by uclear resposibilities. 4.2 Actively iovate, improve ad stregthe various systems Fiacial services ad the fiacial system are operated uder the istitutioal framework. I additio to adjustig to market chages, the iovative bakig system ca also improve admiistrative efficiecy. Uder the existig system, the fiacial market system ad the fiacial orgaizatio system should be gradually improved, the iterest rate liberalizatio will be realized evetually to keep pace with the ecoomic ad fiacial globalizatio, so as to promote the sustaiable developmet of commercial baks. Baks should improve their maagemet efficiecy by coordiatig iteral resources ad iovatig fiacial products effectively (Wag, 2017). Fiacial iovatio is a importat way to promote the developmet ad efficiecy of commercial baks. Figure 4 shows the reform of Chia's P2P ledig fiacial risk supervisio system. Figure 4. Fiacial Style Legal Supervisio Reform System 631

5 Iovatio i fiacial system, istitutio ad techology costitutes the mai cotets of fiacial iovatio. Moreover, the ew mode of operatio ad maagemet will icrease the assets ad profits of fiacial istitutios, which will help improve the quality of fiacial products ad services (Du ad Liu, 2017). I the ew istitutioal system, the promotio of fiacial istrumets, trasactios, techologies ad services will icrease the ability of commercial baks to accumulate fuds ad thus icrease their assets. Fiacial iovatio helps commercial baks improve their efficiecy ad ability to deal with challeges. 5. MODEL OF FINANCIAL RISK CONTROL OF P2P LENDING IN THE CONTEXT OF INTERNET FINANCE 5.1 Cocept of iformatio etropy measuremet method Although the uderstadig of the meaig of risk varies, it is geerally accepted i fiace that risk is liked to the ucertaity of loss, that is, the ucertaity of future returs due to market chages or ucertai future evets. Whether it cocers loss or retur, risk presets a ucertaity, which is the ature of risk ad coicides with the ature of etropy, but risk is ot equivalet to ucertaity. Therefore, the measuremet of risk is based o a decisio maker to aalyze the ucertaity of risk ad the losses ad returs it causes (Wag ad Li, 2017). I fact, there is a iseparable relatioship amog the ucertaity of risk, loss ad retur. The ucertaity leads to the loss ad retur of a evet. However, differet losses ad returs show the ucertaity of risk. Although loss ad retur are twis, their cotributio to risk is ot balaced, so they are relevat but have o complete reciprocity. Based o the uderstadig ad aalysis of risk, we believe that the method of measuremet aalysis should reflect the ucertaity, subject, amout of loss of risk ad the expected retur. The iformatio etropy fuctio is a measuremet tool that effectively ties these aspects together. 5.2 Detailed calculatio steps Mathematical formula of iformatio etropy For a discrete radom variable X, p 1, p 2,, p is the probability with possible outcomes x 1, x 2,, x, where 0 p i 1, (i = 1, 2,, ) p i = 1, the the iformatio etropy of discrete probability evet x is i=1 H = k i=1 p i l p i (1) Where k is a ormal umber that depeds o the uit of measure ad it is defied that 0l0 = 0. For a cotiuous radom variable X, its probability desity is f(x), the the iformatio etropy of X is: Compariso betwee etropy ad variace H = f(x) l[f(x)]dx (2) I fact, it is atural to thik of variace whe talkig about risk, because chages of loss ad gai i risk are radom variables ad variace is most commoly used i the statistical descriptio of a radom variable idex of characteristic (Wag, 2013). So let's start with the formula for etropy ad variace ad use a simple way to verify the similarities ad differeces betwee iformatio etropy as a measure of risk ad variace. Whe the risk variable X= (x 1, x 2,, x ) is a discrete variable, let the distributio law of X be {p i }, where p i = P(X = x i )(i = 1, 2,, ). The variace of variable X is: D(X) = E{[X E(x)] 2 } = i=1 p i (x i E(X)) 2 = p i [x 2 i 2x i E(X) + E 2 (X)] i=1 (3) Where E(X) is the mea value of the radom variable X. The the etropy of variable X is: = p i i=1 [ (p i 1)] + (p i 1) 2 H(X) = i=1 p i l p i = i=1 p i ( l p i ) 2 + (p i 1) ( 1) 1 (p i 1) R (p i 1) (4) 632

6 Where R ( ) is Lagrage remaider. For the risk evet x, the correspodig distributio of returs is, the covetioal variace measure oly reflects the risk status with the mea as the referece poit, but the specific situatio of these risks i the fiacial system ca ot be determied, that is, what risk positio should there be i the fiacial system where this risk is i is abset, while iformatio etropy ca be used to measured the risk evet as a whole. Therefore, the iformatio etropy ca be regarded as a useful supplemet to the variace method. We propose the followig iformatio etropy-stadard deviatio model: R(X) = λh x (θ) + (1 λ)s x (θ) (5) The followig is a detailed aalysis of the model. (1) Traslatio ivariace: a R, r is a risk-free iterest rate, the R(X + ar) = R(X) proves S x (θ) = S x + ar (θ), accordig to which it ca derived that: R(X) = λh x (θ) + (1 λ)s x (θ) (6) R(X + ar) = λh x + ar (θ) + (1 λ)s x (θ) (7) For the risk X ad X + ar, H x (θ) = H x + ar (θ), therefore, R(X + ar) = R(X). This fully shows that the model does ot icrease fiacial risk i the process of icreasig cash flow. (2) Positive homogeeity: h 1 the R(hX) hr(x), which proves that S hx (θ) = hs X (θ), hr(x) = hλh X (θ) + h(1 λ)s X (θ) (8) R(hX) = λh hx (θ) + (1 λ)s hx (θ) = λh hx (θ) + h(1 λ)s X (θ) hλh X (θ) + h(1 λ)s X (θ) (9) For the risk X ad hx, H X (θ) = H X (θ), the R(hX) hr(x), the model shows that as the asset allocatio icreases, the risk also icreases, ad the risk of zero assets is still zero. 5. CONCLUSIONS Accordig to the aalysis of fiacial risk i P2P ledig mode ad legal regulatio i the cotext of Iteret fiace, it ca be fully cocluded that it still eeds to have desigated regulatory authorities to supervise P2P ledig. It is suggested that the cetral govermet, the People's Bak of Chia, the Paymet & Clearig Associatio ad the Iteret Fiace Committee, takig the characteristics of the Iteret ito cosideratio, take the objective value of fiacial regulatio i geeral as the priciple, establish the miimum stadard coditios from the aspects of registered capital, eterprise orgaizatioal structure, professioals, fudig escrow ad iformatio disclosure, make clear the scope of busiess ad risk cotrol requiremets ad the give local govermets the right to eforce. At the same time, the P2P ledig idustry self-regulatio associatio should strictly formulate codes of practice combiig the progress i the developmet of the idustry, e.g. blockig misleadig ads such as "pricipal ad returs guarateed", ad let ivestors be aware of the risk of P2P ledig itself ad joitly build a regulatory system for the healthy developmet the Iteret fiace. REFERENCES Du M.M., Liu S.M. (2017). Research o credit risk cotrol ad supervisio of Iteret Fiace i Chia - Takig P2P etwork ledig model as a example, Joural of North Chia Uiversity of sciece ad Techology (SOCIAL SCIENCE EDITION), 17 (04), Fu C.L. (2016). P2P etwork ledig operatio mode ad risk maagemet, Joural of Hua College of Fiace ad Ecoomics, 32 (05), Guo W.D., Li Y. (2014). P2P model of olie ledig platform, Chia circulatio ecoomy, 28 (06), Li Y.X., Ji Y.F. (2014). Iteret fiacial supervisio, Joural of Zhejiag Uiversity (SOCIAL SCIENCE EDITION), 44 (04), Sog P.C, Zou Z.T. (2014). The evolutio of P2P ledig busiess model i Chia ad Its Elightemet - Talkig about, New fiace by the tred of large fiacial istitutios ad Vc firm, (04),

7 Wa Z.Y. (2015). The demad for admiistrative supervisio ad crimial law examiatio of P2P ledig, Orietal Law, (02), Wag G.L. (2013). Risk ad regulatory path aalysis of Iteret Fiace P2P etwork ledig model, Sciece ad techology horizo, (25), Wag Q., Li M. (2017). Comparative study of Iteret P2P ledig ad traditioal fiacial credit busiess, Ecoomist, (06), Wag Z.L. (2017). P2P ledig platform risk ad cotrol research, Moder busiess idustry, (01), Yag S.Y. (2014). P2P ledig platform iformatio security risk aalysis, Moder ecoomic iformatio, (01), Ye X.R. (2014). P2P ledig model risk ad supervisio research, Fiacial regulatio research, (03), Yua J.X. (2014). Iteret fiacial developmet model ad its regulatory mechaism aalysis, Fiacial theory ad practice, (12), Zhag H.Y. (2017). Iformatio disclosure regulatio ad P2P ledig operatio model, Ecoomics (quarterly), 16 (01), Zhou H.M., Ga S.D. (2015). Aalysis of fiacial risk prevetio of P2P etwork ledig mode, Haia fiace, (07), Zhou J.Y. (2016). P2P ledig model of Iteret bakig risk ad regulatio aalysis, Commercial ecoomy, (02),

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