Chinese police have arrested more than 20 people associated with “a complete Ponzi scheme” that allegedly took more than Rmb50bn ($7.6bn) from investors, according to the official Xinhua news agency.

It is the biggest scam yet to emerge from China’s unruly and largely unregulated peer-to-peer lending sector, part of the country’s shadow banking sector. Police had to use two excavators to uncover some 1,200 account books that had been buried deep below ground, according to Xinhua.

Established in 2014, Ezubao was one of China’s highest-profile P2P lending sites, promising investors annual returns of up to 15 per cent. Ding Ning, its 34-year-old founder, allegedly ploughed new investors’ capital into its own real estate projects and also used it to pay off existing investors.

P2P lenders, which grew out of investor hunger for wealth management products, are supposed to invest the money they raise into financial products issued by third parties such as property developers. According to industry estimates, as many as a third of China’s 3,800 registered P2P lenders have run into financial difficulties as economic growth slows.

Such products offer much higher returns than bank deposits. They are often marketed, but not guaranteed, by state banks, leading to disputes between investors and the banks when end-users default.

At its annual Central Economic Work Conference last month, the ruling Chinese Communist party identified “excesses” in online lending as a threat to financial system stability.

According to Xinhua, Ezubao raised more than Rmb50bn from almost 1m investors, some of whom travelled to Beijing to protest outside government offices as the company began to founder. In December, at least four provincial police bureaux announced they had frozen Ezubao assets.

Mr Ding, who is under arrest, could not be reached for comment. The P2P lender’s risk controller, who is also under detention, was quoted by Xinhua as admitting that “95 per cent of [our] projects are fake”.

“It was known for a long time that Ezubao was heading for trouble because it was so aggressive,” said Joe Zhang, a veteran P2P business owner and executive.

“The majority of P2P firms are trying to do the right thing,” added Mr Zhang, who has entrusted his own savings to P2P lenders. “Whether they have a good business model is another matter.”

According to Xinhua, Mr Ding spent some of his firm’s capital on lavish “gifts”, including a Rmb130m villa in Singapore and a pink diamond worth Rmb12m, while his younger brother was paid more than Rmb1m a month as a salaried executive.

Last month Chinese police also reportedly arrested the founder of the Fanya Metal Exchange, a trading platform based in the southwestern city of Kunming that reportedly raised Rmb40bn from investors.

Fanya’s cheated investors had previously travelled to Shanghai in pursuit of Shan Jiuliang, the exchange’s founder, and protested outside government offices in Beijing.