China's Biggest Ponzi Scheme Shows Rot in Internet Financing

Updated on
China's Crackdown on Peer-to-Peer Lending
  • Regulator: 1,000 of China's 3,600 P2P sites are "problematic"
  • Loans quadruple to $149 billion amid plans to clean up P2P

Almost overnight, Ding Ning and Zhang Min struck it rich with the hot new thing in Chinese finance. In 18 short months, they transformed an old-line industrial company into an Internet phenomenon through the seeming magic of peer-to-peer lending.

It was all a lie -- a vast Ponzi scheme that appears to have been orchestrated by the Bernie Madoffs of China.

Zhang Min
Zhang Min
Source: Imaginechina via AP Images

The story thus far is a tangled tale that stretches from China’s fertile heartland in Anhui province to the war-torn reaches of northern Myanmar to the palm-fringed streets of Beverly Hills.

Just where it will end is still anyone’s guess. But already China’s regulator has warned that the explosive growth of so-called P2P lending -- not only in China, but around the world -- means other problems could be lurking out there, too.

“It was just a matter of time before we saw something this big keel over,” said Zennon Kapron, managing director of Kapronasia, a consulting firm based in Shanghai.

The alleged scheme involving Ding, Zhang and their assorted associates unraveled this week after a months-long investigation into their Yucheng Group and its P2P platform, Ezubo, which had been celebrated as a new model for financial services.

Ding Ning
Ding Ning
Source: Imaginechina via AP Images

The numbers are staggering: Authorities say Ezubo defrauded more than 900,000 people out of the equivalent of $7.6 billion by promising them returns as much as 10 times higher than the official deposit rate. That would make it the largest Ponzi scheme in Chinese history.

Ezubo’s model, allowing the online public to invest in underlying assets in leasing contracts and get returns from the cash flow paid by lessors, made it one of the country’s more than 3,600 peer-to-peer lenders. The industry has drawn unlikely companies, such as nail and screw maker Yucheng Group, to an exploding frenzy of lending totaling 982 billion yuan ($149 billion) in 2015, almost quadruple the amount in 2014. More than 1,000 of these so-called P2P firms are “problematic,” the China Banking Regulatory Commission said in December when it announced draft rules to restrict such lenders and pledged to “cleanse the market.”

China’s plan in allowing online lenders to flourish was to allow additional ways for small business to get financing rather than turn to back-alley shadow bankers -- a shady world that was flourishing outside of government control when P2P lending began taking off in China in 2012 and only 3 percent of China’s 42 million small business owners could get bank loans. Online lending was a way for the government to encourage further economic stimulus in an economy growing at the slowest rate in a quarter century, and in theory it should be more transparent to regulators because it uses a real-time digital ledger of accounts.

Rough Patch

"I think the government allowed this all to happen because it was desperate to pump money into the private economy as all the other slowdowns started to happen," Steve Dickinson, a Qingdao-based lawyer for Seattle firm Harris Moure PLLC, said by e-mail. "It is likely that the regulators at the top simply turned a blind eye to the risks in the desperate hope that this kind of lending vehicle would get them through a rough patch."

Lufax, one of the largest P2P lenders whose official name is Shanghai Lujiazui International Financial Asset Exchange Co., has announced plans to raise as much as $5 billion in an initial public offering in Hong Kong later this year. A Shanghai-based press officer declined to comment on the industry.

“This does taint the industry a little bit, but in the longer run investors have a short memory, and this solidifies the position of the industry leaders,” said Kapronasia’s Kapron.

Invented Projects

For Ezubo, which translates as "easy-to-lease," almost 95 percent of investment projects listed on the website touting annual returns from 8 percent to 14.6 percent don’t exist, and among the 207 lessors it claimed to work with, only one had done business with it, according to the official Xinhua News Agency. 

Ding said in a confession broadcast Monday on state-run China Central Television that he had embezzled about 1.5 billion yuan from company accounts, and most of the money was from Ezubo. He also gave 550 million yuan raised on Ezubo to Zhang, Yucheng’s president and his girlfriend, citing "personal reasons," on top of a 130 million-yuan villa in Singapore, a 12 million-yuan pink diamond ring, an emerald necklace and several luxury cars, he said.

Just a few months before the blowup of Ezubo, state media was still giving the lender glossy coverage. At an industry conference hosted by Ezubo in June, government officials, corporate leaders, and legal experts discussed the development of Internet finance and risk prevention, and lauded Ezubo’s business model. The company promoted itself with campaigns including TV commercials and logos on seat covers of the Shanghai-Beijing high-speed train. Its message conveyed a company that sought to advance Chinese President Xi Jinping’s vision of raising the contribution of direct financing to support the economy.

International Ambitions

The State Council, China’s cabinet, will accelerate legislation and rules-making regarding P2P lending and crowd-funding, the body said in guidelines released Thursday to crack down on illegal fund-raising. The government also urged local authorities to watch risks in online lending and wealth-management products.

Ding, the 34-year-old chairman of Yucheng Group and its related companies, also had international ambitions. In November, Chinese entertainment executive Bruno Wu unveiled a new, $1.6 billion fund to finance Hollywood movies in cooperation with Yucheng Group at an exclusive dinner with Los Angeles producers at the W Hotel in Beverly Hills, according to the Hollywood Reporter. In an e-mailed response to questions, Wu said he dropped the deal before it was finalized and expressed “shock” at the confession. Yucheng Group’s telephone number is no longer working.

Yucheng Group had also obtained permission to open a bank in Myanmar’s unrecognized Wa state, an area along China’s border and disputed in a long-running civil war, China’s Caixin magazine reported.

Excavated Documents

In early December, when Ding and Zhang realized that new investment inflow could no longer meet interest payments for the old investors, they started to move assets, destroy evidence and prepare to run away, according to their confessions. On Dec. 8, local police from various areas coordinated an operation to arrest 21 employees of Yucheng Group including Ding Ning. Police used two excavators and dug for 20 hours to unearth 80 bags of documents that Ezubo executives had buried six meters (20 feet) underground on the outskirts of Hefei, a city in the eastern province of Anhui, Xinhua reported.

The police investigation found the company had spent as much as 800 million yuan to buy corporate details from brokers and used the information to fabricate investment projects. Among Yucheng Group’s numerous units, only three -- including one making nails and screws -- brought in profits totaling less than 100 million yuan in an unspecified period, far from enough to cover Ezubo’s massive expenditures, according to Xinhua.

Premier Li Keqiang and President Xi have been seeking to remodel China’s economy, urging development of new industries such as Internet finance to ensure easy flow of credit without inflating financial-system risks. They can ill afford more high-profile blowups in the P2P industry.

"The Chinese government is supposed to be seeking stability," said Dickinson, the lawyer. "This type of wide-spread financial disaster is obviously not supportive of stability."

— With assistance by Jun Luo

Before it's here, it's on the Bloomberg Terminal. LEARN MORE