This article discusses the uncertainty of risk-sharing rules based on the developmental process of a private lending service center (hereinafter referred to as the “service center”) in City Y. The service center was established in 2012 as an institutional innovation of the government to promote local financial governance after the private financial crisis in City Y in 2011, and it aims to regulate the development of the private financing market.
The idea of the Y municipal government is to promote the establishment of the service center as a public service platform by introducing P2P financing information service intermediariesFootnote 12 and supporting organizations to attract private lending parties to the service center for transactions. In this way, the service center will record the transaction information, which is conducive to solving the problem of “two more and two difficulties”Footnote 13 and helps regulate and monitor the private financing market.
Nevertheless, the City Y government did not directly set up and operate the service center. Both the physical and online platforms of the service center are operated by City Y Private Lending Registration Service Co., Ltd.Footnote 14 P2P intermediaries and supporting services (such as notary offices and law firms) provide paid services such as loan matching, contract notarization, and legal consultation for both the supply and demand sides of funds on the platform. The platform mainly provides public services such as information dissemination, consultation, and registration. According to this organizational structure, the government seems to separate itself from the service center and lending risk, but it does not work in practice. The risk-sharing rules initially set by the City Y government and the service center can fluctuate in practice. A director of the financial office in the District Z of City Y spoke of the uncertainty of risk-sharing rules as a relatively common phenomenon, even for those not involved with the service centers.
As an institutional innovation in local financial governance, service centers happen to be at the intersection of local governments and private financial markets, which provides a good opportunity to study the uncertainty of risk-sharing rules and their mechanism. From 2012 to 2018, we conducted a longitudinal study of the service centers, with six fieldworks, using participant observation, in-depth interviews, and documents to collect detailed information on the development history of service centers. We paid special attention to the behavioral patterns, modes of expression, and dynamics of the interactions among government departments, service centers, intermediaries, and investors around risk-sharing rules.
Institutional contradictions
Service centers are rooted in the institutional structure of the private financial sector in China. The contradictions embedded in such institutional structures form the basis for the uncertainty of risk-sharing rules in the operation of service centers.
First, there is a contradiction between the expansion of market transactions and highly deficient laws. On the one hand, the scope of private lending transactions has expanded from traditional acquaintance lending and offline transactions to a wider range of stranger lending through online platforms, with new forms of online platforms surging rapidly, which brings about more risks.Footnote 15 On the other hand, laws regarding private finance are highly deficient (Chen 2008), and it is difficult to enforce a large number of private finance contracts effectively. First, China’s private finance has long been in a gray area of law, lacking a sound legal basis and a clear regulatory authority. Before 2016, P2P platforms were in the “three no’s” stage nationwide: no entry threshold, no industry standard, and no regulation (Huang 2012). Once the operation problems of intermediaries lead to risks of loss, it is difficult for lenders to clarify their responsibilities and legally obtain compensation in time. Second, the time cost of legal operation is high. Resolving private lending disputes through law often takes a long time, and after the outbreak of the civil financial crisis in City Y, the local financial judicial system was under more pressure, with a typical lending dispute taking as long as two years from filing and trial to final execution. It has encouraged lenders to seek solutions outside of the law.Footnote 16
Second, local governments have twofold pressure from financial governance innovation and local risk control. Under the overlapping financial management system of the central and local governments (Huang 2018), local governments need to explore innovative institutional arrangements for financial governance and develop local financial organizations, serve both the supply and demand of private funds, and regulate the private finance market. It is also necessary for local governments to take responsibility for local risk control, maintain social stability, prevent local financial crises as the bottom line, and play the role of a firefighter in cases where financial risks are transformed into social risks or even political risks.Footnote 17
In fact, before establishing the service center in 2012, the Y municipal government was already aware of this twofold institutional pressure, but they needed to explore innovations in local financial governance. Creating the service center was one of the few options in the context of the outbreak of the private financial crisis and the establishment of the pilot financial reform zone at that time. For this reason, they were compelled to rush the process of establishing the service center. In the early stages of the service center’s development, the financial office of District Z in City Y held weekly meetings at the service center to discuss how to innovate the business of on-site trading, focusing on various potential risks and their possible social impact.
Third, there is a contradiction between the formalization of financial contracts and the public’s expectation of government responsibility. It is a top-down requirement of the government system for local financial governance to regulate the development of private finance. The original idea of the service center was precisely to promote the standardization and transparency of private lending through standardized contracts, standard transaction procedures, and strict registration, which would enhance the effectiveness of dispute resolution and risk disposal by law through the formulation and implementation of risk-bearing rules agreed upon by all parties. However, as pointed out by the officials of the City Y government and the head of the finance office in their initial discussions with experts about the feasibility of the service center, the public’s expectation of government responsibility is deeply rooted. When they encounter difficult disputes, they will habitually seek resolution from the government. Even for financial disputes that do not happen on site, it is common for investors to seek help from the government. Therefore, if the government promotes the establishment of a service center, they will be even more likely to be involved in private lending disputes.
Double game
Risk-bearing: the parties’ ex ante agreement
The City Y government has always emphasized the risk-bearing rule based on the background discussed above. The service center also publicly declares that it is not responsible for bad debts, and they provide risk tips to lenders (see the following documents). Intermediaries will ask lenders to make risk-bearing statements on the risk-tip document. And lenders will make a clear commitment to bear risks on the risk-tip document and sign it before closing.
Risk-Tip Document
-
I.
Borrowing and lending instructions: borrowing and lending are risky and done at your own risk.
-
II.
Lenders require the following information about the borrower: (1) family situation, work situation, property situation, income situation; (2) credit situation, such as according to the credit report of the People’s Bank of China and the intermediary’s credit evaluation of the borrower; (3) borrowing purposes, repayment sources; and (4) collateral situation.
-
III.
Lenders require the following information about the intermediary: (1) the business process, service content, risk control means, and fees of the intermediary; (2) the responsibility of the intermediary (i.e., matching information for the lending and borrowing parties and consulting services and coordinating between all parties).
-
IV.
Lenders require information about the responsibilities of the service center: The service center only does the formal registration and filing work for the business and does not assume any risk.
According to the regulations, the lender must copy the following: “I have read all the risk tips, fully understand the information about the borrower and the intermediary, am willing to comply with all provisions of the contract, and voluntarily assume all the risks arising from this lending.” (Please copy)
Lender’s signature:
Date:
In addition, the lender is required to sign a customer statement prior to the transaction, and the intermediary is required to sign an intermediary statement form with the service center.Footnote 18 In short, both the government and the service center try to bind the lender’s behaviors ex post through these layers of formal agreements before the transaction.
Risk-sharing: default of lenders ex post
In the actual operation of the service center, however, the lender, aware of the high legal cost, will often breach the ex ante risk-bearing agreement and ask the intermediary or the government to share the risk when the borrower’s payment is late, or they disappear. How can lenders justify their defaults? The following is from a lender’s conversation with the authors:
I’m in a bad mood now, and I just want my money back. We trusted the center a lot. When people engage in these privately, we do not dare to do it … but this is led by the government. The city government and the provincial government support this, so we put our life savings here … we resort to the government first. It’s better that they can solve it, and we believe that the government can do it.
Regarding petition, if I don’t get the money returned, we will do it; we are sure to petition; how can he not return our money and we not petition? … the intermediary causes a problem, not the government. We are here to ask the government to help us solve this thing … we only knew that the government was leading, so we thought it was the government, and then I learned that the center is at the core, but it was when we had made the transaction … I don’t care as long as the money is returned to me. (Interview information: 20130807)
This conversation is typical among many lenders seeking solutions from the service center or the government and shows the various discursive strategies of lenders in playing the normative game with the service center or the government (Xiang 2020). First, a lender tries to eliminate the contract by tracing the premise of contracting. The lender emphasizes that the contract resulted from its trust in the service center, which is closely related to the government, thus highlighting the government’s responsibility to resolve disputes. Second, the lender denies knowledge of the corporate nature of the service center before the transaction by blurring the timeline of information acquirement to stress the connection between the government and the lending transaction. Third, by indicating the possibility of petitioning for rights, the lender urges the government to compromise. The lender expresses a request to the government and implies a possible risk to the government to urge the government to step in and solve the problem. In short, lenders seek legitimacy for their default by making arguments outside the contract. Such legitimacy claims have a strong impact, especially when the intermediary’s behavior is flawed.
Competition in rules: from the game of norms to the game of interests
Two competing rules emerge after lenders default on their prior agreements: risk-bearing and risk-sharing. Government departments, service centers, and intermediaries will require lenders to bear their risks and insist on legal procedures to deal with disputes. In contrast, lenders will insist that intermediaries, service centers, or government departments share risks and use government mobilization procedures to resolve disputes. The legitimacy of the former is based on legal principles, while the latter’s legitimacy is based on social norms.
The competition of rules is reflected in the game process among lenders, intermediaries, and government departments. Usually, the lender will first ask the intermediary to share the risk, and after being refused by the intermediary, the lender will petition the service center, district financial office, or even the city financial office and the petition bureau. Since the service center is a nonprofit platform for the facilitation of government public services, it has no actual risk-sharing ability, and the key to the game is the government’s response.
The research found that the responses of city and county governments varied in different scenarios. When the government had to intervene in a dispute, it usually first considered letting the intermediary share the risk, and only after the intermediary refused would the government consider sharing the risk directly. Therefore, the actual risk-sharing rules in different lending dispute resolution processes may be different in the same service center, and there are various scenarios such as risk-bearing, government sharing, and intermediary sharing. The risk-sharing rules show uncertainty.
Risk-bearing or risk-sharing?
What determines the mechanism of risk-sharing? The author aims to trace the development of the service center to show the states of risk-sharing rules at different stages and the influential factors behind them. Overall, the six-year development of the service center can be summarized into three phases, namely, the flourishing phase, the wandering phase, and the transition phase. The explicit rule was the risk-bearing rule during this period, but there were differences in the actual operating risk-sharing rules in different phases.
Flourishing phase
The flourishing phase of service center development was from April 2012 to June 2013. During this phase, the main leaders of the municipal party committee attached great importance to the center’s work, with strong support from various government departments, courts, and banks and great social attention. At that time, there were nine intermediaries in the service center, which attracted a large number of borrowers and lenders, and the volume of transactions increased rapidly, with many off-site intermediaries hoping to move in. By the second half of 2012, lending risks began to emerge. Although the financial offices and service centers at district and city levels always emphasized the risk-bearing rule, the rule changed when the risk occurred.
The emergence of risk transformation
Six months after the establishment of the service center, the first batch of lending contracts expired and began to show overdue defaults, and gradually, the lending risks rose. These risks were concentrated in the business of two intermediaries (referred to as Xinxing Loans and Dingsheng Loans).Footnote 19 Taking Xinxing Loans as an example, according to the aggregated information from the financial service office, the scale of risks arising from the lending transactions brokered by this intermediary is described below.
Xinxing Loans Economic Information Consulting Co., Ltd… has received many complaints. The main cause of the complaints is that 30% of the total loan matches made by Xinxing Loans are overdue, resulting in a risk that cannot be resolved. In April 2013, Xinxing Loans applied to the center to withdraw. During the period of operation, Xinxing Loans filed a total of 95 businesses (amounting to 48.22 million yuan), but 64 businesses (amounting to 30.97 million yuan) were to be closed, of which 26 businesses (amounting to 13.22 million yuan) expired without being processed (Documentary information, 2013).
The situation of Dingsheng Loans is similar to that of Xinxing Loans. Many risks emerged in the matchmaking business, mainly due to many loopholes in the risk control in the early stage. When late defaults appeared, the lenders demanded that the intermediaries were responsible. However, the intermediaries insisted on the risk-bearing rule and advocated a legal solution to the problem. The cost of a legal resolution was high, and the lenders petitioned the service center or the government to solve the problem, and some lenders were emotional and persistent, posing a potential political risk to the government. In the face of these lending disputes, the government expected intermediaries to share some of the risks.
Exit of intermediaries
The success of risk transfer from the government to intermediaries depends on the extent of the intermediary’s dependence on government resources. In general, intermediaries are dependent on government resources, especially the legitimacy and market status conferred by service centers on intermediaries; however, the degree of dependence varies across intermediaries and requires a trade-off between costs and benefits. Given the degree of resource dependence, the likelihood of receiving a government risk transfer decreases when the size of the risk increases.
Both Xinxing Loans and Dingsheng Loans were unwilling to accept government risk transfer even when there were obvious vulnerabilities in their businesses, and both consistently adhered to the risk-bearing rule and preferred to withdraw from the service center. Their responses caused the government’s risk transfer strategy to fail. Following is a statement from one of Xinxing Loans’ businesspeople about why they chose to withdraw from the service center.
Xinxing Loans adhered to the law while the center took the negotiating route … what happens after a problem arises? The center called us intermediaries over to see if there was a fraud. The district financial office hosted a coordination meeting and said they would coordinate, but there was no further action. Then, they called back and let us intermediaries pay in advance. Our boss quit because of this. Why did we have to pay? The financial office let us pay; in fact, the financial office aimed to maintain stability in fear of greater chaos. Letting us pad the full amount of losses was too unreasonable. We were furious right away. We would rather not pay and see them in court … later, we withdrew. (Interview information: 20140804)
Of course, it is the choice of both the intermediary and the government that Xinxing Loans and Dingsheng Loans left the service center. Such intermediaries will create a large number of problems for the government and may also create more risks in the future. With the withdrawal of the two intermediaries, many outstanding businesses and risks are left to the service center and the government, and the government’s risk-sharing ability becomes critical.
Bureaucratic mobilization
At this stage, the main leaders of the municipal party committee hosted multiple special coordination meetings at the service center, and the heads of the relevant municipal departments attended the meetings. The municipal party secretary asked for a study on how to vitalize transactions and hoped that the courts, banks, housing management, car management, notary, and other departments would actively cooperate with the risk management.Footnote 20 It was under the attention of the municipal party secretary that the mobilization capacity of the financial service office was greatly improved.Footnote 21
Due to the greater bureaucratic mobilization efforts, some lending disputes were resolved through expedited court procedures when intermediaries such as Xinxing Loans refused to share the risk. However, not all lending disputes can be resolved by the government, and many disputes are still at the lender’s own risk. The government’s response strategy to lenders’ claims is influenced by the degree of risk transformation. In the first stage of service center development, the risk-bearing rules are not defined, and risk-bearing and risk-sharing (shared by the government) situations coexist.
Wandering phase
The period from June 2013 to the end of 2015 was a wandering phase in the development of the service center. During this phase, the main leaders of the municipal party committee were changed, the new leaders did not quite approve the service center, and support from government departments, courts, and banks rapidly weakened. There were entries and withdrawals of intermediaries in the field, and there was a wait-and-see attitude toward the service center. At the same time, when loan defaults came one after another, the intermediaries insisted on risk-bearing, and lenders often petitioned. Under heavy pressure, the finance service office and the service center hesitated to change the mode of operation. The service center believed that the intermediary is an important source of risk and that the exit cost is low, leaving too much pressure on the service center and the government, so there is an urgent need to change the established risk-bearing rules.
The frequent occurrence of risk transformation
The outlying problems of Xinxing Loans and Dingsheng Loans had not yet been solved, other overdue defaults emerged one after another, and most lenders asked the service center or financial office to solve the problem. Many of these defaults were related to the intermediary’s risk control failures. However, the intermediary was unwilling to take responsibility afterward and even suggested the lenders petition the service center and the finance service office. It is exerted strong pressure of risk transformation on the government. The head of the service center recounted this dilemma.
Lenders are supposed to bear their own risk. Rules are never changed. Only now there are petitioners every day, and I have no way to restrain them. Moreover, the intermediary has a kind of trouble … do you know what extent the intermediary staff gets to? … the most dramatic ones personally bring customers to my side to make trouble … if I have no way to restrain them, I would rather die. Come to us, come several times, then the manager slammed his hand on the table and said, “you can go to sue us if you think we have a responsibility” … many people want to get the money back. If they don’t get it back on the petition, they will come here. The manager said to them, if they don’t approve, then they should go to the finance office (Interview information: 20140812).
The many problems of intermediaries are an important reason why service centers seek to change the risk-sharing rule. The interconnectedness among the government, service centers, and intermediaries induces a continuous risk transformation, causing the risk to constantly shift between the three, which is a key element that gives rise to rule changes.
Weakening of government mobilization
Another important factor that gave rise to the change in risk-sharing rules was the change in leadership in the municipal party committee and the many changes within the government system that came with it. The person in charge of the finance office described the following:
The new secretary came to the service center and took a look at it, and said, “You are a product of transition.” At that time, the finance office and the manager, they understood as soon as they heard it. Various departments want to withdraw, and even the Human Bank credit system almost withdrew … now the biggest problem [is] not what you say but the focus of the government. The secretary used to come to the special meeting four times … now the top leaders do not approve us, what else [can we] do, we are now mainly busy with the stock market reform (Interview information: 20140728).
The changing attitudes of government departments and others reflected the mobilization mechanism. The change in leadership attention, which affects the shift in government focus, causes the finance service office to be less concerned about the service center and the cooperation of other related departments to be much weaker. This affects the public resources of the service center and the willingness and ability of the government to share the risk.
Resource dependence of intermediaries
In September 2013, the service center explicitly changed its risk-sharing rules. First, the intermediaries were required to leave a deposit for the service center; second, they were required to sign a commitment letter, which mainly addressed prior risk control and post-risk-sharing.
Business risk management and resolution, to ensure that the operation follows industry rules, in the face of the operation, such as unqualified lending or mishandling the negative impact of the center or causing lenders’ losses, the company is willing to bear 10% of the losses as compensation. In principle, this account should be paid by the company. If the company cannot pay with this commitment letter, the center will pay in advance. The company will pay back within three business days. The deposit amount is determined according to the volume of business and the number of nonperforming loans … if the company violates the provisions, it is willing to use the deposit as payment (Article 6 of the Letter of Commitment, 2013).
Intermediaries initially opposed the change in attitude of service centers regarding risk-sharing rules. However, in the subsequent games, different intermediaries made different choices. An intermediary businessperson who exited the service center provided the following account.
Previously, the center blocked the application of an intermediary for some time. In the face of 10% of the risk, the intermediaries signed a commitment letter. This reinforced our determination to expand … intermediaries are opposed to 10%, but the center stopped the backend, [and] the previous information is still on the backend. They must pay, they cannot avoid the payment, [and] each intermediary must pay 400,000 into the center, [which is] called the deposit … [in the case of an] exit, all cases have to end safely … if we pay, we can stay as well. We cannot accept this 10%, and we don’t think it is reasonable because there is no particular impact on our business volume (Interview information: 20140803).
Although most intermediaries did not approve the 10% risk-sharing requirement, they chose differently because of their different resource dependencies. The intermediary above was a local agency in City Y with a long-standing market base and other resources, so it was able to exit; the intermediaries that did not exit were either branches of foreign intermediaries in Y or had just been established and were relatively more influenced by government resources.
Although the service center developed risk-sharing rules at this stage, they were rarely implemented and were used more as a constraint on intermediaries. The subtleties are reflected in the following: First, the service center only signed bilateral contracts with intermediaries and did not disclose this rule to both lenders and borrowers to avoid inducing more risk transformation; second, after the occurrence of risks, the service center rarely enforced compensation but required intermediaries to cooperate with risk resolution. The person in charge of the service center spoke of the reduction of risk transmitted to the service center and the government after the intermediary signed a commitment letter and posted a deposit. That person also dealt with the problem by facilitating negotiations between the lending and borrowing parties, facilitating acquaintances in the court, and even directly paying the principal and interest in advance. In short, the risk-sharing rules in practice are closely related to the extent to which lenders initiate risk transformation, and situations exist where lenders share their own risk or intermediaries share the risk.
Transformation phase
The transition phase in the development of the service center was from the end of 2015 to the present. In this phase, the City Y government further reduced the importance of the service center, especially by 2017. The service center was no longer listed as an annual assessment task of the district financial office, and the support of other government departments and banks to the service center further waned. The service center began a transformation mode, that is, to focus on the registration and filing services of private lending in City Y. The center gradually retired the intermediaries in the service center, retaining only a very small number of intermediaries, and the volume of transactions in the field shrunk to almost zero. Although there were few new lending risks at this stage, there were many leftover disputes, and the situation of lenders petitioning the service center and the finance service office still existed. The willingness and ability of financial service offices and service centers to expedite the dispute resolution by mobilizing public resources such as the courts were greatly reduced. Therefore, service centers require intermediaries to cooperate with lenders to solve lending disputes before retrieving deposits. Some intermediaries chose to cooperate with the process and wait until the dispute was finalized before retrieving the deposit; others chose to use the deposit to share part of the lender’s risk but no longer cooperated with the subsequent resolution. Following is the relevant narrative from the head of the service center.
We also have an online business here … In 2015, the Supreme Court issued a judicial interpretation. This type of business was called buying a house, but actually private lending was (overturned) … we included the Rongsu loan (intermediary name) and did a lot of this type of business. The business finally formed a tide of defaults … at that time, only Rongsu loan underwriting; other agents are not underwriting … if you are not underwriting, we can only ask you to leave the service center … when these intermediaries moved in, they have hundreds of thousands of deposits here. Then we told them … [be] sure to resolve your things before I can return the deposit to you … they slowly resolved but [was] unwilling to pay, then surely the customer (lender) will have a reaction, so that service center held seven to eight coordination meetings… there was an intermediary who said, you (service center) simply (ask) me to share the deposit to everyone, after that, I do not care about this matter, you resolve it by yourself, the others (lenders) agree, they resolve by themselves, all signed. If you do not agree, he (intermediary) said I take care of the aftermath, but I also do not stay in the service center … when you (intermediary) all finished taking care of the defaults, the deposit will go back to you, this you must be able to resolve, or he (lender) will also come as well (Interview information: 20180111).
As shown above, risk-sharing rules remain uncertain during the service center’s transition phase. The changes in risk-sharing rules in this phase are mainly influenced by the risk transformation mechanism and resource dependency mechanism, and the role of mobilization is minimal, so there are rare situations where the government shares the risk. Specifically, although the service center had developed a deposit system in the previous stage, it did not force the intermediaries to compensate under the pressure of lenders but used it to motivate the intermediaries to make every effort to participate in risk management; the different reliance of the intermediaries on the service center in terms of the deposit caused them to participate in the risk-sharing of lenders in different ways and to various degrees.