The industry, which had been expanding steadily, has stalled due to a series of scandals involving major social lending firms. Stricter screening procedures for new registrations have made it difficult to enter the market, while existing firms have been forced to deal with tighter supervision.
In the past few years, issues with the use of funds by lenders have been discovered in two major social lending companies in succession, posing a significant problem for investor protection. Particularly notable are the recent scandals which reveal that the current regulatory environment, despite earlier attempts to enhance the transparency of loan-type funds through Q&A sessions, still falls short in preventing such issues. These situations have inadvertently exposed the limitations of the current regulations.
Scandals and Industry Trends
In response to these scandals, regulators have significantly tightened the regulatory review for new registrations of Type II financial instruments business operators seeking to offer loan-type funds. This change has been achieved by interpreting existing laws and regulations more strictly, rather than by revising them. According to statistics from the Type 2 Financial Instruments Business Association, the lending fund industry appears to have reached its peak. The future of social lending, once seen as highly promising, has now been cast into doubt due to the missteps of these two major companies.
Although the number of newcomers is rapidly increasing, many reportedly struggle with profitability. Additionally, the structure of the industry in Japan, particularly the scarcity of high-yield lending projects, makes it challenging for late entrants to establish successful models.
Nevertheless, a certain leading securities company in the lending funds sector has managed to redeem high-yield investment products without any significant incidents. Despite multiple on-site inspections, there have been no major issues identified with their business model. This company appears to be the last stronghold of the social lending business.
Points when setting up a loan fund
To register as a Type 2 Financial Instruments Business for loan-type funds, it is crucial to have a robust examination and monitoring system in place. To undergo a new registration examination, it’s necessary to establish a comprehensive system for both fund and loan examinations. This involves detailing the examination process through internal rules and manuals, and setting specific examination items
Moreover, for any existing companies that do not have such a system in place, it’s necessary to enhance the system by meticulously building a new business. Additionally, while not relevant for existing firms, in the registration examination for new financial instruments businesses, the firm must specify the specific project for which it actually plans to provide financing. The firm should conduct the examination in accordance with internal rules and submit the detailed examination results along with the corresponding evidence to the Finance Bureau
Thus, the absence of specific screening know-how among loan examiners is a significant drawback, which can be challenging to address both during the screening process and in the business operation. It would be preferable to appoint a loan reviewer from a bank or non-bank institution with many years of actual financing experience. In many cases, securing registration as a Type 2 financial instruments business operator for loan-type funds is proving to be more difficult than for Type 1 operators or investment management operators, depending on the business type. Particularly, it’s almost certain to be several times harder than Type 1 financial instruments business and investment management business for institutional investors.
Social lending is no longer a simple business that can be started with a budget of tens of millions of yen and a few financial professionals. It’s important to understand that you will generally need more than 100 million yen and you will also need to establish a more detailed and robust internal structure. This includes having a larger team and a more intricate organizational structure than what you would need for opening a new securities firm.
