Rural Finance in Poverty-Stricken Areas in the People’S Republic of China Balancing Government and Market

RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA BALANCING GOVERNMENT AND MARKET

Zhang Xuechun, Xu Zhong, Shen Minggao, and Cheng Enjiang Ying Qian and Todd A. Manza Editors RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA BALANCING GOVERNMENT AND MARKET

Zhang Xuechun, Xu Zhong, Shen Minggao, and Cheng Enjiang

ISBN 978-971-561-892-2 Publicaon Stock No. BKK090446

Cataloging-In-Publicaon Data

Zhang Xuechun, et al. Rural ﬁnance in poverty-stricken areas in the People’s Republic of China: balancing government and market. Mandaluyong City, Philippines: Asian Development Bank, 2010.

1. Rural ﬁnance. 2. People’s Republic of China. I. Asian Development Bank.

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For orders, please contact: Department of External Relaons Fax +63 2 636 2648 [email protected] ii Contents

Preface vii

About the Authors viii

Foreword: Nurturing Local Financial Strength in Rural Areas ix

Abbreviations xiii

Introduction 1 Ensuring Access to Finance 1 Promong the Domesc Opening of Financial Markets 5

Part I. An Overview of Rural Finance

Chapter 1. Rural Financial Reform 17 History of Rural Finance in the People’s Republic of China 17 Main Issues of the Rural Financial System in the People’s Republic of China 30 Lessons from Rural Finance Reform 33

Chapter 2. Rural Economic Situation 37 General Economic Situaon 38 Industrial Structures 39 Agriculture Loans 39 Fiscal Posion 39 Sources of Farmers’ Income Growth 40

iii Chapter 3. Rural Financial Services for the Poor and for Rural Migrants 43 Local Instuonal Outlets 43 Agriculture and Poverty Reducon Loans 45 Remiances of Rural Migrants 56

Part II. Current Rural Financial Policy

Chapter 4. Capital Flows and Rural Finance 65 Interregional Capital Flows 66 Loans and Deposits 71

Chapter 5. Interest Rate Policy 75 Changes in Rural Deposits and Loans 76 Market Distorons and Eﬃciency of Rural Financial Instuons 77 Instuonal Response to Market Distorons 81

Part III. Financial Models

Chapter 6. Cooperative Finance 87 Principles of Cooperave Finance and Internaonal Experience 88 Lessons of Cooperave Finance in the People’s Republic of China 89 Strengths of Rural Credit Cooperave Reform Policies 93 Rural Credit Cooperave Reform Policy Issues 95 Evaluaon of Rural Credit Cooperave Reform Policy 95

Chapter 7. Microfinance 101 Diversified Microfinance Development Model 102 Lessons of Microfinance 104 Development and Innovaon of Microfinance in the People’s Republic of China 105 Internaonal Microfinance Donor Agencies 107 Reasons for the Slow Development of Microfinance 109 A New Phase of Microfinance Development 111

Chapter 8. Informal Finance 113 Informal Finance in the People’s Republic of China 114 Informal Finance in Poverty-Stricken Areas 115 Informal Financial Instuons 116 Comparison of Formal and Informal Finance 116 Rural Finance Opons in Poverty-Stricken Areas 117

iv Part IV. Surveys, Pilot Studies, and Policy Recommendations

Chapter 9. Surveys and Pilot Projects 121 Poverty Reducon Loans 121 Rural Remiance 123 Cooperave Finance 125 Microﬁnance 143 Informal Finance 148

Chapter 10. Policy Recommendations 151 General Policy Consideraons 151 Poverty Reducon Loans 157 Rural Remiance 159 Cooperave Finance 161 Microﬁnance 168

Chapter 11. Opening the Rural Financial Market and Piloting New Rural Financial Institutions 179 Important Issues in Opening the Rural Financial Market 180 Addional Requirements 183 Cost-Eﬀecve Approach 185

Appendix 187 List of Tables A.1: Number of Banking Outlets, by Region, 2005 189 A.2: Credit Market Concentraon in Sample Counes, 1999–2003 189 A.3: Rural Deposits in Sample Counes, 1999–2003 190 A.4: Rural Loans in Sample Counes, 1999–2003 191 A.5: Rural Credit Cooperaves’ Nonperforming Loans, Bad Debt, and Losses in Sample Counes, 1999–2003 192 A.6: Fiscal Funds for Poverty Alleviaon in Sample Counes, 1999–2003 192 A.7: Interest Collected in Sample Counes by the Agricultural Bank of China, 1999–2003 193 A.8: Agricultural Development Bank of China Nonperforming Loans in Sample Counes, 1999–2003 193 A.9: Agricultural Bank of China Loans Outstanding in Sample Counes, 1999–2003 193 A.10: Agricultural Bank of China Loans in Sample Counes, 1999–2003 194 A.11: Agricultural Bank of China’s Poverty Alleviaon Loans in Sample Counes, 2001–2004 194 A.12: Rao of Medium- and Long-Term Loans to Total Agricultural Bank of China Loans in Sample Counes, 1999–2003 195 A.13: Agricultural Bank of China Deposit–Loan Rao in Sample Counes, 1999–2003 195

v A.14: Agricultural Bank of China Enterprise Loans in Sample Counes, 1996–2003 196 A.15: County Revenues Surrendered and Subsidies, 2000–2004 197 A.16: Number of State-Owned Commercial Bank Outlets per County, by Region, 2000–2004 197 A.17: People’s Bank of China Agriculture Loans per County, by Region, 2000–2004 197 A.18: Funds Deposited with Higher Financial Instuons, by Region, 2004 198 A.19: Rural Migrant Workers’ Annual Remiance per County, by Region, 2000–2004 198 A.20: Foreign Direct Investment per County, by Region, 2000–2004 198 A.21: Domesc Direct Investment per County, by Region, 2000–2004 199 A.22: Rural Deposits, 1989–2005 199 A.23: Amount and Composion of Rural Loans, 1989–2005 200 A.24: Agricultural Bank of China Loans, 1989–2005 201 A.25: Rural Credit Cooperave Loans, 1989–2005 202 A.26: Porolio Balance and Cumulave Loans of the Agricultural Bank of China and Rural Credit Cooperaves, 1989–2001 203 A.27: Rural Deposits and Loans, 1991–2001 204 A.28: Demand for Credit Among Sample Populaon 204 A.29: Fund Inﬂows in Sample Counes, 2003 205 A.30: Rural Credit Cooperave Deposits and Loans Outstanding in Guizhou, 2000–2003 205 A.31: Agricultural Bank of China Deposits and Loans Outstanding in Guizhou, 2000–2003 205

Notes 207

vi Preface

The Asian Development Bank (ADB) is pleased to make this book on rural finance issues in the People’s Republic of China (PRC) available to policy makers, financial instuons, and praconers. The analysis contained in this volume grew out of ADB-financed technical assistance projects for rural and microfinance that focused on expanding sustainable financial services to the rural poor in underdeveloped areas.

The book is a valuable contribuon toward a beer understanding of the issues in the PRC rural finance market, parcularly the reasons for recent reform measures and key market and instuonal changes. The book will hopefully promote further work and innovave approaches toward building a sound rural finance system that allows easy access for the underserved financial segments of market services. There are indeed opportunies for synergy between government and parcipants in the rural financial market to join forces for poverty reducon.

The book highlights the need for a boom-up approach in rural financial market development to meet local demand and adapt to local financial risk profiles. It emphasizes that effecve supervision of rural financial market parcipants requires effecve communicaon between government and the market. The book also argues that opening the rural financial market allows innovave approaches and different types of instuons to compete, thereby ensuring beer services and higher efficiencies.

The contribuons of authors, editors, and the staﬀ of the Financial Sector, Public Manage- ment, and Regional Cooperaon Division as well as the Department of External Relaons were invaluable in producing this knowledge product and are acknowledged with gratude.

Klaus Gerhaeusser Director General East Asia Department Asian Development Bank

vii About the Authors

Zhang Xuechun, PhD in Economics, Research Bureau, People’s Bank of China. Prior to joining the People’s Bank of China, Zhang Xuechun worked for the Asian Development Bank, the Internaonal Monetary Fund, the Federal Deposit Insurance Corporaon, and the Federal Reserve Board in various posions. She has extensive research experience on rural and microﬁnance issues.

Xu Zhong, PhD in Economics, Senior Research Fellow and Deputy Director General, Finan- cial Market Department, People’s Bank of China. Xu Zhong has been engaged in rural and microﬁnance policy making and research for more than 15 years.

Shen Minggao, PhD in Economics, Economist at CiBank, and adjunct professor at the China Center for Economic Research, Peking University. Shen Minggao has a long-term interest in rural ﬁnance research.

Cheng Enjiang, PhD in Economics, Professorial Fellow, Internaonal Poverty Research Cen- ter in the People’s Republic of China. Cheng Enjiang is an adjunct professor at the Zhejiang University, and has been involved in rural ﬁnance research for more than 15 years. He has also worked as an internaonal consultant for various internaonal agencies.

viii Foreword

Nurturing Local Financial Strength in Rural Areas

Exisng finance theory and pracce has demonstrated that local small and medium-sized financial instuons are the best financial system for small and medium-sized enterprises and farming households. Government agencies in the People’s Republic of China (PRC) have proposed policies that would relax market entry criteria and allow the creaon of diversified rural financial instuons, enhancing financial support for small and medium- sized enterprises and farmers. These measures will help improve the PRC’s financial structure, promote beer rural financial services, enable financing of labor-intensive economic acvies, and promote harmonious socioeconomic development.

The development of rural finance, in parcular, necessitates innovaons in percepon and instuons. For this reason, I greatly appreciate the effort of the authors of this book to introduce internaonal experience, to examine the evoluon and relevant lessons of rural finance in the PRC, and to provide valuable suggesons for improvement. Developing rural finance requires the parcipaon of local small and medium-sized banks, microcredit companies, and cooperave financial instuons as well as the development of formal and informal credit, guaranty mechanisms, and a system of investment and financing.

In recent years, the newly opened rural financial market has provided rural economic enes with diverse financing opons and has introduced the concept of small-scale financial instuons. These instuons include village banks, microcredit lending companies, and credit shops. However, such small and localized instuons differ from exisng commercial banks and demand innovave supervision.

The key to developing a new rural financial enty lies in nurturing localized rural financial services through a boom-up approach, which creates the basis for a new rural financial market.

Tradional rural ﬁnancial instuons, such as the Agricultural Bank of China and rural credit cooperaves, are all local branches of larger ﬁnancial instuons. The authories or higher-level branches appoint senior management, set policy or commercial objecves,

ix RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

and help to resolve financial difficules. This kind of top-down setup usually carries high cost and high risk, liming the instuons’ incenve to meet the financial demands of small and medium-sized enterprises and farming households and liming financial supply in rural areas.

In the poorer rural areas in the central and western regions of the PRC, moreover, ﬁnan- cial instuons either are unsustainable because of policy lending or channel funds out of rural areas for commercial purposes. Since the restructuring of the state-owned commercial banks in the 1990s, large banks have been relieved of policy lending tasks. To increase proﬁt, they now target urban areas and medium-sized and large enterprises and have been withdrawing from rural areas.

Improving financial services for small and medium-sized enterprises and farming households requires investment in local financial services. In this regard, the opening of the rural financial market is more about reinvenng incenve systems and promong local financial instuons than about inving the return of state-owned commercial banks or restructuring rural credit cooperaves hindered by large volumes of nonperforming loans.

Localized rural ﬁnancial enes can leverage their informaon advantage for rapid expansion.

The nurturing of localized rural finance should begin by legalizing informal finance. Non- deposit-taking informal finance providers can be transformed into new rural financial organizaons, and deposit-taking informal financial service providers should register as formal financial instuons and be subject to prudenal supervision.

Localized financial enes, likely to be cooperaves, should be developed in a boom-up manner to meet local demands using local money. In this way, new rural financial organizaons can beer meet diverse local demand through flexible services. This kind of financial enty will blend and grow with the local economy. As their scale increases, they may either be transformed into commercial enes or remain as cooperaves.

The core advantage of small and medium-sized rural financial enes is that they can use “so informaon” to ensure lending safety. So informaon is difficult to quanfy. It comprises intangible assets rather than legally binding restraints and includes, among other things, interpersonal kinship and trade relaonships, borrower work capability, borrower experience and reputaon, peer pressure, and compeon among related pares. Such informaon represents an alternave to financial statements, tangible collateral and guaranty, and so forth. The localizaon of new rural financial enes is a prerequisite for using the so informaon inherent in all social and economic acvies. More importantly, such so informaon carries low cost.

Rural credit shops and microcredit enes may present more vitality for future rural ﬁnance development. These enes have close links with exisng agricultural organizaons such as producon cooperaves or specialized farmers’ organizaons, which helps them to beer understand farmers’ ﬁnancial demands, producon capabilies, and systems. Such understanding can serve as a replacement for collateral and is the key to idenfying suitable borrowers and ensuring loan repayment. x FOREWORD

Successful financial models ought to carry disncve local features, but their innovave and broad instuonal arrangements must be capable of replicaon across regions. If small rural financial enes can develop a profitable credit model, then the credit demands of labor-intensive small enterprises and business can be beer met, agricultural producvity can be enhanced, and farmers’ income can be increased. This kind of finance model surely will be trusted by farmers and therefore can be widely replicated.

The development of new rural financial instuons also can help aract commercial banks back to rural areas. Relavely large commercial banks can make wholesale loans to small financial enes with sound performance and credit, and such wholesale lending can be commercially viable and profitable. Moreover, by using small financial enes as agents for credit and asset management, commercial banks can recover part of their lost market share. Meanwhile, with their informaon advantage and support from large commercial banks, small rural financial instuons will develop sustainably.

Effecve supervision of localized rural financial enes requires both innovaon and effecve communicaon between government and market.

New rural financial instuons will require different supervisory measures than commercial banks, and the objecve of supervisory innovaon is to balance financial stability with efficiency. The guidelines for microcredit lending companies—issued jointly by the China Banking Regulatory Commission and the People’s Bank of China—introduced three revoluonary breakthroughs in rural financial supervision.

First, the guidelines introduced layered supervision, which allows provincial authories such as the Microcredit Lending Company Supervision Bureau and the Office of Finance to supervise if they agree to be responsible for lending companies’ risks. This is a major breakthrough in financial supervision in the PRC and it will promote supervisory diversificaon, compeon, and financial innovaon.

Second, the guidelines allow microcredit lending companies to borrow from up to two commercial banks. This not only will present commercial banks with wholesale lending opportunies but also will enable them to parcipate in rural ﬁnance. Moreover, the wholesale banks will join provincial supervisory authories in overseeing microcredit lending companies, which will help to reinforce market discipline among such companies.

Third, the guidelines allow microcredit lending companies with superior credit records to apply to become deposit-taking village banks. This provides incenves and gives lending companies the ability to transform into local, privately owned banks. Equally important, as the wholesaler to the lending companies and, later, as a shareholder in the village banks, wholesale banks can assist in this transformaon. This will support the integraon of rural and urban ﬁnance.

Other changes also are required. For instance, the capital adequacy rao requirement for new rural ﬁnancial enes needs to be upgraded. The major diﬀerence between lending companies and credit shops or village banks lies in their respecve capital adequacy raos. The capital adequacy rao requirement for lending companies is 100%; the rao for credit shops or village banks depends on credit risk. Following the establishment of an enty, a capital adequacy rao of 50% or higher can ensure that part of the founders’ own

xi RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

money is used for lending. If an enty becomes commercially viable, such a requirement can be relaxed to the level of commercial banks. Higher capital adequacy rao requirements, combined with mely bankruptcy mechanisms, can eﬀecvely migate a ﬁnancial enty’s operaonal risks.

Moreover, small financial enes should be allowed a higher deposit rate ceiling to enhance their compeveness. Small financial enes carry higher risks, and the depositors in such enes should receive a risk premium. Only when these small enes offer higher deposit interest rates can they compete against other commercial banks in the deposit market.

Finally, government policy lending targets should be met through commercially sustainable means. If the government intends to provide low-cost support for agricultural producon, it should provide the relevant small ﬁnancial enes or banks with ﬁscal subsidies or reduce lending risks by providing agriculture insurance. Such instuons will survive and be sustainable only when commercial viability is guaranteed.

In all, the ulmate goal in opening the rural financial market is to meet diverse financial demand and to migate financial risk by enhancing compeon and improving the efficiency of the financial system. We genuinely hope that the opening of the rural financial market will be a harbinger of future financial market opening throughout the PRC.

Jusn Yifu Lin Senior Vice President and Chief Economist World Bank

xii Abbreviations

ABC - Agricultural Bank of China ADBC - Agricultural Development Bank of China BRI-UD - Bank Rakyat Indonesia–Unit Desa PRC - China, People’s Republic of CNY - yuan GAO - gross agricultural output GDP - gross domesc product MFI - microﬁnance instuon NABARD - Naonal Bank for Agriculture and Rural Development PBC - People’s Bank of China PKSF - Palli Karma-Sahayak Foundaon PSBC - Postal Savings Bank of China RCC - rural credit cooperave RCFs - rural cooperave foundaons SSCOP - Self-Support Capacity Building Project UNDP - United Naons Development Programme

xiii Introduction

Despite significant progress in the general financial reform of the People’s Republic of China (PRC), rural financial reform has been lagging. It has been 16 years since the establishment of the Agricultural Development Bank of China in 1994, 14 years since the separaon of the Agricultural Bank of China from the rural credit cooperaves (RCCs) in 1996, and 7 years since the current round of RCC reform began in 2003. Nonetheless, rural financial policies, especially those targeng poverty-stricken areas, are sll in the explora- on stage.

Many constraints on reform remain to be addressed. For example, urban finance is used to guide rural finance, and informal finance is simply replaced by formal finance. This has led to the dominaon of RCCs in rural areas and difficulty in enacng rural financial innovaon. In addion, the mission of rural finance to sustainably support sannong— agriculture and agricultural industry, including rural areas and farmers—remains unclearly defined. Rural financial instuons should support sannong in a financially sustainable manner and stop the vicious cycle of placing the heaviest burden of support on the poorest areas, which undermines sustainability. Third, the moral hazard of local government intervenon in rural financial instuons must be reduced. Government intervenon increases the cost of rural finance and creates the percepon that rural finance is not sustainable without government support and direcon. These constraints call for changes in percepon, an improved financial environment, and innovaon.

Ensuring Access to Finance

Economic reform in the PRC is a process of empowering individuals and enterprises and transferring power from government to market. It also is a process of government and market reposioning. The reform that has occurred in rural areas allows tens of millions of farmers to decide what and how much to produce. The reform in distribuon enables suppliers and buyers to sell and purchase, as they desire, at mutually accepted prices. The reform of state-owned enterprises links the performance of managers with enterprises’ revenues, reﬂecng the rights and value of entrepreneurs as the soul of enterprises. The opening of the labor market endows the labor force with the freedom to migrate to other

1 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

places and choose jobs. Farmers, as users effecve interest rate discovery mecha- of collecvely owned land, are granted nism is a more important cause. certain land lease right. Private capital is allowed to enter most industries formerly In addion, an incomplete credit infor- monopolized by state-owned enterprises, maon system may result in individuals including the civil aviaon industry, reflect- infringing upon the state’s credit. Credit ing respect for the rights of investors. informaon is a basis for financial acvies. For a long me, financial instuons Unl now, however, reform has not have based their businesses on state or touched upon the right of individuals and collecve credit. Without a fully developed enterprises to access financing. The only credit informaon system, uncertaines legal financing channel for individuals is brought about by the diversificaon of through financial instuons dominated by financial rights may shi credit risks to state-owned commercial banks, whereas the state. For instance, troubled securies enterprises can get financing only through companies and enterprises are put into bank loans or in the highly regulated capi- state custody. tal market. Modern financial theory holds that finance includes both investment Finally, the inera of the tradional sys- and financing. Thus, the financial rights of tem postpones financial diversificaon. individuals and enterprises are incomplete In the command economy, all economic if they comprise the right to make invest- resources, including financial resources, ment without access to financing. were at the disposal of the state or collecve. Given the unique role of finance The requirements for diversifying finan- in resource allocaon, financial rights are cial rights include culvang the market, an extension of the administrave rights establishing a credit mechanism, and of governments. When it comes to eco- breaking the inera of the tradional nomic planning, industrial policies, project government administraon system. The approval, and microeconomic adjustment, protracted state monopoly of the credit the combinaon of financial rights and market suppresses informal finance, administrave rights reflects the govern- and unsound market mechanisms or the ment’s guarantee. This is why, at a me uncertaines of market operaon are prin- when most economic rights are diversi- cipal reasons for concentraon of financial fied, financial rights, especially the right rights. For instance, financial instuons to financing, remain centralized in govern- have maintained previous interest rates ment-controlled financial instuons. even a er bank loan interest rate liberalizaon. The insensivity of state-owned Overly centralized financial rights con- financial instuons to interest rates is centrate economic risks in the state and partly to blame for this, but the lack of an are very costly. One major characterisc of centralized financial rights is a limit on the right of individuals and enterprises The insensitivity of state-owned to use their own money, forcing them to financial institutions to interest entrust this right to state-designated and state-guaranteed financial instuons. rates is partly to blame for this, but Due to pervasive informaon asymmetry the lack of an effective interest rate in financial markets, the use of others’ money in this way may lead to moral discovery mechanism is a more hazards. On the one hand, financial ins- important cause tuons may suffer from moral hazard in

2 INTRODUCTION selecng clients and monitoring loans. On assets because limited financial resources the other hand, enterprises may be sub- must be used to serve the economic good. ject to moral hazard when they sacrifice According to these provisions, deposit others’ interests in the pursuit of profits. agreements between individuals, between Moreover, the centralizaon of financial enterprises, or between individuals and rights may spread the credit risks gener- enterprises are illegal acvies. Such lending ated by these two types of moral hazard and borrowing acvies are regarded not throughout the enre economy. as legimate compeon for state-owned financial instuons (including RCCs) but as Financial rights centralizaon also infringes illegal acvies, and lending organizaons on the economic rights of individuals and outside of formal finance are illegal financial enterprises. Many business opportuni- organizaons. Beyond a certain threshold, es are transient and cannot be turned taking deposits through private channels into earnings without the right to financ- also is considered a crime. The coarseness ing. In this sense, the right to invest is not of this legislaon results in law enforcement complete without a right to financing. The authories randomly cracking down on lend- difficulty of small and medium-sized enter- ing acvies outside the system and puts a prises in accessing funds reflects the con- damper on financial innovaon. flict between diversified investment rights and centralized financing rights. The only The statutes governing usury are unclear. opon for most such enterprises is infor- According to provisions of the Supreme mal finance. However, informal finance People’s Court, private lending interest is not protected by law and therefore rates can be higher than the bank inter- represents a heavy burden rather than a est rate, to a certain extent, subject to right for individuals and enterprises. In the discreon of local people’s courts and the current system, informal fund-raising in accordance with the local situaon. and solicing deposits from the public are However, the private lending rate may not criminal conduct; there is only one step exceed four mes the bank lending rate in between investment and crime. the same category; interest rates exceeding this threshold are not protected by law Major efforts are needed to guarantee and are deemed usury. In a market econ- the diversified financial rights of individu- omy, however, the lending rate should be als and enterprises, beginning with the linked with lending risks, and the interest repeal of laws and rules that conflict with rate on riskier loans should be higher. In a the establishment of a compeve finan- developing country such as the PRC, there cial market. For example, Arcle 176 of are many uncertaines associated with the criminal law spulates that whoever loans, so annual interest rates of 15% to takes deposits from the public illegally or in disguised form or disrupts financial order shall be sentenced to between 3 Major efforts are needed to and 10 years in prison or criminal deten- guarantee the diversified financial on and fined CNY20,000 to CNY500,000, rights of individuals and enterprises, depending on the severity or monetary amount of the offense. beginning with the repeal of laws and rules that conflict with the The basis for such laws is that financial resources belong to the state and no indi- establishment of a competitive vidual has the right to dispose of financial financial market

3 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

30% are normal. Arficially liming the to eight mes the benchmark bank loan private lending rate to within four mes interest rate or more. the bank loan rate renders illegal a large number of private lending acvies. Third, commercial bank law should be amended and the criteria for the entry of In addion to repealing laws that hinder private banks should be relaxed. Lending the establishment of a compeve finan- shops, private lending agencies, and micro- cial market, laws and regulaons should credit instuons with a long history of encourage such establishment. For exam- operaon, good business records, adequate ple, to facilitate financial innovaon, laws scale, and the desire to establish banks should confirm the integrity of individual should be allowed to upgrade into banks and enterprise capital property rights, according to the requirements for com- guarantee the legimate investment rights mercial banks, and prudenal regulaon of individuals and enterprises, and allow should be applied. The key to a compeve nonfinancial enterprises and individuals financial market is to allow compeve to lend their proprietary funds to other financiers and financial instuons to grow enterprises and individuals according to into intermediaries of that market. This lawful agreements. requires the creaon of opportunies for informal financial instuons to grow into Second, when amending or dra ing laws formal ones, bringing about meritorious on taking deposits from the public, dis- compeon in which superior instuons turbing financial order, or usury, aenon succeed and inferior ones fail. should be paid to disnguishing financial fraud from investment acvies. The Current law spulates that naonal com- primary purpose of financial regulaon is mercial banks must have no less than to avoid the moral hazards brought about CNY1 billion in registered capital, city by financial instuons taking deposits commercial banks must have no less than from the public, such as sacrificing deposi- CNY100 million, and rural commercial tors’ interests to maximize profits. Normal banks must have at least CNY50 million. lending acvies between individuals and These high thresholds have resulted in a enterprises that do not belong to this cat- gap between informal and formal finan- egory should be legalized. The maximum cial instuons, which is not conducive to penalty for the crime of illegally taking the market entry and growth of small and deposits from the public should be relaxed medium-sized banks. Consideraon should according to the type, purpose, and poten- be given to reducing these thresholds and al risk of loans. An–financial fraud laws emphasizing the quality rather than the size should be instuted, but the crime of ille- of financial instuons. Community-based gally disturbing financial order should be financial instuons are not necessarily eliminated. Laws on market-based interest big, but they can operate more efficiently rates should be dra ed, and the threshold than large commercial banks. In the interest rate for usury should be increased United States, for example, credit cooperaves based on enterprises, schools, large organizaons, and communies play an Normal lending activities between important role among financial instuons. individuals and enterprises that do They remain important in several waves of acquision, primarily because they can not belong to this category should take advantage of community informaon be legalized disseminaon and contracts enforcement.

4 INTRODUCTION

Because naonal banks do not have such on in financial systems and instruments, advantages, community-based credit coop- though decisions about which systems eraves are irreplaceable. and instruments are the most effecve should be le to markets rather than to Fourth, laws regarding microcredit instu- governments. Legalizaon of informal ons, cooperave finance, and informal finance is part of opening the market finance should be promulgated. In the to domesc players, because informal early stage of reform, microcredit instu- finance is the means by which enterprises ons should be prohibited from taking and individuals allocate credit resources deposits, cooperave financial instuons based on market price signals. should have their membership and scale restricted, and the size of informal finance Opening to Informal Finance should be controlled. Nonprudenal regulaon should apply to these three types Informal finance covers lending between of instuons. individuals and enterprises, lending through moneylenders (brokers), rotang Fi h, internaonal experience can be savings and credit associaons, pawns, used to formulate laws or regulaons on chambers of commerce, underground community reinvestment in the PRC. For banks, trade financing, and so forth. In example, the United States’ Community some places, Buddhist temples serve as a Reinvestment Act requires a community- plaorm for financing acvity. In the PRC, based financial instuon to meet the these financing modes used to be called lending needs of the community, predi- underground finance or illegal finance; cated on compliance with principles of they are now known as informal finance. operaonal safety and soundness. Other than that, there are no rigid requirements The key to opening financial on loan percentages. In Thailand, on the other hand, all community-based financial markets to domestic players is to instuons must use 20% of their deposits endow enterprises and individuals in agriculture. with lawful financial rights, enabling Finally, anmonopoly laws should be those most effective in capital enacted to protect fair compeon, policy finance laws should be enacted to utilization to lawfully participate enhance the effecveness and transpar- in financing activities ency of policy finance, and the investment acvies of major shareholders in financial Finance is an extension of trade in goods, instuons should be regulated. and credit from transacon is the foundaon of finance. The famous Shanxi Dra Bank was developed based on industrial Promoting the Domestic capital, and other communies have Opening of Financial Markets managed to combine industrial capital with financial capital. However, there The key to opening financial markets to were no banks or specialized banking domesc players is to endow enterprises regulatory authories in the PRC during and individuals with lawful financial the late 19th and early 20th centuries. In rights, enabling those most effecve in Hong Kong, China, there sll is no central capital ulizaon to lawfully parcipate in bank, although a few financial instuons financing acvies. This requires innova- print Hong Kong dollars. So-called formal

5 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

financial instuons grow out of success- business acvies, and social relaonships. ful informal financial instuons, the only Moneylenders, rotang savings and lending difference being whether an instuon is associaons, and the like are financial organi- accepted by regulatory authories. The zaons based on credit plaorms. development of formal finance will not and should not restrict the existence and Second, informal finance addresses infor- development of informal finance, and maon asymmetry by using layered the financial rights of individuals and informaon and various low-cost informal enterprises should be protected, not informaon sources. Community-based constrained. organizaons such as chambers of commerce and guilds, producon organiza- In developed market economies where the ons such as specialized technology criteria for market entry are much lower, associaons for farmers or cooperave there are few informal financial instu- producon associaons, intermediaries ons. Formal financial instuons employ such as reputed celebries in local areas, some informal finance principles, such and other organizaons with abundant as the “church steeple” principle that the access to informaon, such as automobile borrower is much more important than clubs, pigeon-raising clubs, and temples, collateral or the courts. A good financial are used to disnguish borrowers, screen instuon should be able to see its clients lending projects, and reduce credit risks. and know what they are doing, as from the For example, some relavely large enter- steeple of a church. prises can gauge farmers’ credit demand and evaluate credit risks through their long-term supply and markeng relaon- A good financial institution should ship with farmers. More importantly, be able to see its clients and know lenders can reduce repayment risks by linking loan repayment with proceeds. The what they are doing, as from the lending shops emerging in some areas are steeple of a church established on a natural relaonship with producon cooperaves. Such pracces The discriminaon against informal finance also can allow the informal financial mar- in the PRC stems from the protecon of ket to play an important part in interest state-owned financial instuons, but such rate discovery. protecon actually dumps the baby with the bathwater. At present, exisng infor- Third, informal finance can guarantee mal finance is based on individual credit, loan security by using social capital— addresses informaon asymmetry, guaran- forms of informal agreement based on es loans through social capital, comple- social networks, informal organizaons, ments formal finance, and can become and social customs—to replace collateral an important mechanism for interest rate or courts. Social capital represents a kind discovery. of virtual collateral or court, and funcons similarly. The difference is that most First, informal finance is based on indi- social capital is established by usage, thus vidual credit. An individual’s credit record offering a much less expensive way to is established through culture; folk custom; sele lending disputes. geographic, kinship, personal, or business relaonships; and other social networks that In the early stage of economic develop- keep detailed “records” about reputaons, ment, informal finance can dissolve risks

6 INTRODUCTION before, during, and a er loan issuance, before booming under relaxed regulaon making it a cheaper instuonal arrange- and an improved operaonal environment. ment than formal finance. For example, Presently, a friendly policy environment is before a loan is issued, informal finance encouraging the diversificaon of financial can use various informaon sources to organizaons in the PRC, and diversified screen borrowers and lending projects, real economic enes demand increas- thus prevenng reverse selecon of ingly diverse forms of finance and financial riskier borrowers, who are more willing to innovaon. apply for loans even when the interest rate is high. Such screening can help reduce The new rural financial organizaons risk before a loan is made. Moreover, are both familiar and strange for many when a loan is provided, the lender can farmers. Before the reform of the col- prevent moral hazard on the part of the lecvely owned economy in the coun- borrower, because the purpose of the loan tryside, producon cooperaves, supply is clear. Finally, a er a loan is provided, a and markeng cooperaves, and lending lender can prevent a borrower’s strategic shops (or credit cooperaves) were the default by using peer pressure, group three major cooperaves in rural areas. punishment in which all informal financial However, the funcon of these coopera- organizaons respond together to stop ves was to prepare for the transforma- lending to the defaulter, or a boyco of on to a collecvely owned economy. the defaulter’s business. It has become obvious that, a er being stripped of distribuon and/or sales and Fourth, the relaonship between informal credit, producon cooperaves cannot and formal finance is both compeve operate independently and efficiently. This and supplementary. Studies have shown is parcularly true of RCCs, because such that compeon from informal finance segregaon severed the otherwise inher- exerts a posive effect on the governance ent link between producon and capital structure and the performance of formal allocaon, arficially creang informaon financial instuons. On the one hand, barriers between producon cooperaves compeon promotes innovaon by and lending cooperaves and thus making formal financial instuons; on the other it difficult to match capital allocaon with hand, formal financial instuons can producon demand. Emerging producon learn from informal finance. Internaonal cooperaves (also known as rural special experience also indicates that formal technique associaons or the company- finance can ulize the informaon advan- plus-farmer model) successfully link pro- tage of informal finance when lending to ducon and the market, and rural lending start-ups, which can become clients of for- shops represent a model that connects mal financial instuons a er establishing supply, sales, producon, and credit. a credit record. In some localies, formal and informal financial instuons even diversify credit risk by issuing joint loans. Private enterprises in the PRC faced discrimination before booming under Rural Lending Shops relaxed regulation and an improved Any instuonal innovaon, parcularly operational environment an inducve instuonal innovaon, needs an enabling environment. Private Rural lending shops can help address, at enterprises in the PRC faced discriminaon low cost, issues that are costly for formal

7 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

financial instuons such as credit coop- contracts, making them unofficial and eraves. The purpose of merging Baixin informal, as opposed to laws and regula- Rural Lending Shop and Baixin Farmers’ ons. One advantage of informal ins- Cooperave in Jilin Province, for example, tuonal arrangements is their low cost, is to provide funds for the farmers’ coop- which makes it possible to meet even the erave. Though the two cooperaves have smallest demand for credit. In addion, their own names, they are one enty; the informal instuonal arrangements may farmers’ cooperave provides the lend- be exempt from the regulatory and other ing shop with a plaorm to raise funds. types of examinaons required in formal Members of the farmers’ cooperave have instuonal arrangements. Of course, detailed knowledge of members’ funding informal instuonal arrangements also needs, integrity, repayment ability, and are subject to constraints, such as difficulty capital source for loan repayment (e.g., in accessing legal and administrave assis- income from sheep sales). Such knowledge tance in case of disputes. In this sense, helps address informaon asymmetry and lending shops are similar to private lending simplifies loan assessment. organizaons.

In addion, the farmers’ cooperave is an The risks faced by lending shops are simi- instuonal arrangement through which lar to those faced by farmers’ coopera- borrowers may repay loans. If a mem- ves. Lending shops are generally small, ber intenonally defaults, the farmers’ with strong homogeneity, meaning that cooperave may deduct the proceeds similar producve or operaonal risks of a member’s sales to repay the loan or affect a large number of their members. may terminate his or her membership. Baixin Rural Lending Shop, for example, Because all members live in the same would suffer large numbers of defaults or or adjacent communies, peer pressure even go bankrupt in the event of plague subjects the defaulng member to sanc- or other disease, or if market prices fluc- on in every aspect of producon and tuated, and its self-rescue ability is weak. life. Such punishments prevent borrowers from defaulng, and loans are repaid on Thus, instuonal innovaons are needed me even in the absence of collateral, to forestall the risks related to lending ligaon, government intervenon, or shops. In the beginning, government has other means. an important role to play. First, the size of lending shops must be rigorously restricted One advantage of informal to ensure that financing occurs only among members. Second, producve and opera- institutional arrangements is onal risks must be diversified. For exam- their low cost, which makes it ple, farmers’ cooperaves may cooperate with the government, insurance companies, possible to meet even the smallest and disease prevenon and quaranne demand for credit agencies to prevent the spread of plague. Governments can subsidize some insurance Inially, lending shops were an informal premiums and can encourage the insurance instuonal arrangement that relied sector to create insurance products tailored mainly on interpersonal trust, local culture, to local needs. Disease prevenon agencies folk customs, and personal acquaintance. can share paral risks or benefits through Such informal instuonal arrangements holding a stake in the form of technology. are difficult to regulate through word and Third, a risk fund can be established with

8 INTRODUCTION interest income and parally subsidized by agriculture to nonagriculture sectors. The governments. Finally, a loan guaranty fund emergence of township and village enter- can be created to compensate for losses prises in coastal areas enabled farmers to from natural disasters or accidents beyond go from subsistence to prosperity. How- human control. ever, farmers in the central and western parts of the PRC lagged behind. Later, In addion to the adopon of instuonal with the opening of the labor market, innovaons to diversify risks, rural financial many farmers migrated from central and instuons also should put in place inno- western PRC to coastal regions and urban vaons to reduce operaonal and trans- areas. The transformaon of farmers acon costs, especially in far-flung and to migrant workers provided them with sparsely populated areas. Rural financial another opportunity to parcipate in organizaons may reduce transacon costs economic development. by adopng informal financial approaches, creang an all-around operaon that cov- Industrialization: From Farmers to ers rural finance, postal savings offices, Migrant Workers and farming material sales. They can also learn from internaonal experience in Even in the command economy, the introducing technologies such as mobile importance of agriculture made it one phone banking. of the central government’s top priories. However, farmers failed to reap real Developing a New Rural benefits. Price controls were created to Financial System support industrial development, farmers and agriculture were exploited, and finan- The purpose of reforming and developing cial resources were mostly monopolized rural finance is to provide farmers with by the state. In addion, farmers were equal access to investment, financing, and bound to the land and could leave neither development opportunies. The ulmate their land nor their hometown. A series of objecve of establishing a harmonious instuonal arrangements was erected to society is to enable all cizens of the PRC achieve these objecves. to share the benefits of rapid economic development. The proposed new socialist countryside is intended to allow vast rural The emergence of township and areas and farmers to benefit from develop- village enterprises in coastal ment. Thus, rural financial services should engage in and promote industrializaon, areas enabled farmers to go from urbanizaon, and the building of a new subsistence to prosperity socialist countryside. A er over 2 decades of rapid growth, a Since 1978, farmers have parcipated in solid industrial foundaon has created the the PRC’s economic development and capacity to support agriculture. However, have benefited from rapid growth. In fact, the industrial support of agriculture is farmers were the first group to benefit intended not to place farmers back on the from reform. In the early 1980s, the land but to improve their lives with limited launch of the household contract respon- fiscal subsidies. A more important aspect sibility system brought benefits to almost of such support is to create more jobs every rural household. Later, develop- for farmers, enabling them to become ment priories gradually shi ed from migrant workers.

9 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Industry can support agriculture either by Urbanization: From Rural Migrant Workers to transferring funds from industry to agri- Urban Residents culture or by transferring farmers from agriculture to industry. The experience of Transforming farmers into migrant workers township and village enterprises in the is not the ulmate goal, and it is neces- central and western PRC in the late 1980s sary to enable migrant workers to become and early 1990s showed that industrial- new cizens or new residents of urban izaon in these regions resulted in large areas. This is urbanizaon. For a long numbers of nonperforming loans in the me, the PRC’s urbanizaon has lagged finance sector. This mistake should not far behind industrializaon. Less than 40% be repeated. Therefore, farmers must be of the PRC’s labor force has urban hukou transferred from agriculture to industry, (a residenal cerficate), but 60% of the which means transferring farmers from labor force is engaged in nonagriculture rural areas in the central and western PRC sectors. Inadequate urbanizaon impedes to coastal regions and urban areas. Es- the transfer of the labor force from agricul- mates show that about 300 million people ture to industry while also constraining will have been released from agriculture the development of consumer and ser- by 2020. Assuming that one-third of the vice sectors in migrant workers’ places of resulng migrant populaon concentrates origin. This is an important cause of tepid in coastal regions, these regions will aract consumpon. about 100 million new migrant workers in the next 10 years, enabling the PRC to The change of status from migrant worker connue with labor-intensive industries to new urban resident can directly but also posing new challenges. improve farmers’ welfare. Migrant workers with such status can at least join in the The change of status from migrant social security network provided by local governments and share in public resources worker to new urban resident can such as educaon and medical services. directly improve farmersÊ welfare The change of status also can fundamentally change the migratory habits of a This does not mean that rural areas do not populaon on the move, from individual to need more investment, but it does mean family-based migraon. Such a change will that the investment should be focused. have posive effects on consumpon and First, fiscal transfer payments and new the development of the service and real investment should focus on providing pub- estate sectors. lic services, including basic educaon, skills training, a minimum standard of living, and Presently, the PRC’s urbanizaon has three assistance for the destute. The provi- shortcomings. First, the residenal system sion of such public services can help some that has been in place for nearly half a farmers to access jobs and to avoid sliding century was intended to prevent farm- into poverty because of illness or disaster. ers’ free migraon and relieve burdens on Second, farmers engaged in the handicra cies. It is a system that sacrifices farmers’ industry or in peddling should be exempt interests to support industrial development from taxes and fees, to encourage capable in cies. Second, the current land system farmers to start their own businesses. forbids collateralizaon and sales of land, Finally, financial instuons should provide which reduces farmers’ ability to raise funds credit to farmers with a certain acreage of and to migrate. Finally, the reforms of the farmland or parcular animals. residenal and land systems promote the

10 INTRODUCTION development of urban belts in the coastal become new urban dwellers. The build- regions, concentrang economic acvity ing of a new countryside has entered but prevenng concentraon of popula- this final phase in certain mature regions on in urban areas. At present, the Pearl where farmers not dependent on land River Delta, the Yangtze River Delta, and represent a certain percentage of the the Bohai Rim account for one-third of the total populaon. naonal gross domesc product, and with the expansion of urban belts, the propor- In the central regions, the core sannong on will probably increase to around 50% issue is about agriculture. Again, the key to or 60% by 2020. The size is comparable to building a new countryside is to encourage that of urban belts in the United States and more farmers to move out of the agricul- Japan. The development of urban belts ture sector and become migrant workers makes possible large-scale labor transfer or new city dwellers—urbanizaon. At from the agriculture sector to the industrial the same me, land is increasingly con- sector, and from the central and western centrated in the hands of skilled farmers, regions to the coastal regions. which prevents agricultural producon from fluctuang due to the migraon of Building a New Countryside: From labor and also forces industry to nurture Traditional to New Farmers agriculture through subsidized scales of producon, increasing agricultural income. Industrializaon and urbanizaon should This marks the intermediate phase. become an organic part and an important development phase in establishing a new Most coastal regions have gone countryside. Given the PRC’s vast territory and the sharp differences in economic through the industrialization phase, development among different regions, the so they have a high proportion building of a new countryside is bound to start first in more-developed regions. of nonagricultural labor and well- Customarily, we use the word sannong developed small townships to describe countryside-related issues, but such a generalizaon risks blurring In western regions, the issues of sannong the policy focus. Roughly categorized, the center on the issues of farmers. To a large issues of agriculture, rural areas, and farm- extent, subsistence guaranty depends ers occur in three different regions of the on fiscal transfer. At the same me, the PRC, requiring the adopon of individual government can use mandatory educaon strategies suited to the characteriscs of and vocaonal training to help farmers these regions. find jobs in nonagriculture sectors. These regions are in the primary stage of the In most coastal regions, the core sannong building of a new countryside. issue is the transformaon of rural areas. Most coastal regions have gone through A New Rural Financial System: Satisfying the industrializaon phase, so they have Multilayered Financial Needs a high proporon of nonagricultural labor and well-developed small townships. The The new type of rural finance is based on building of a new countryside in these industrializaon, urbanizaon, and the areas should focus on urbanizaon. An building of a new rural countryside. It appropriate mechanism of land turnover serves more than just sannong, and the should be created to encourage farm- financial service providers include both ers to voluntarily leave their land and RCCs and a variety of financial instuons.

11 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

At present, the opening of the rural finan- microfinance instuons, lending com- cial market in poor areas provides new panies, and village and township banks opportunies for the development of rural signifies the paral legalizaon of infor- finance, and a brand-new era is unfold- mal finance and diversifies the available ing. In May 2005, the People’s Bank of financing channels. China launched pilot microfinance lending companies in Guizhou, Inner Mongolia Second, with rapid economic development Autonomous Region, Shaanxi, Shanxi, and and urbanizaon and the resulng decrease Sichuan, signaling a key step forward in in the farming populaon comes the oppor- the opening of rural finance. In December tunity to develop large-scale plantaon 2006, the China Banking Regulatory Com- and animal husbandry enterprises, which mission issued an opinion on reforming may become the most important elements RCCs and encouraging banking financial of producon. At the same me, prices instuons to increase their presence in for agricultural produce have increased rural areas. In addion, permission was in recent years, so such enterprises have granted to form three new types of rural good prospects and have become major banking financial instuons: village and recipients of rural credit. More importantly, township banks, community credit coop- some specialized farmers’ associaons will eraves, and lending companies. Gansu, become carriers of credit, linking borrow- Hubei, Inner Mongolia Autonomous ers with lenders. The combinaon of rural Region, Jilin, Qinghai, and Sichuan pio- lending shops with specialized producon neered the pilot programs, and if these organizaons will become a major form of turn out to be a success, a series of grass- rural finance in the future. roots financial innovaons will promote boom-up rural financial reform. Third, the transformaon of farmers into city dwellers and the steady cash flow of The new rural finance may encompass migrant workers in urban areas during the several rural financial innovaons and process of urbanizaon will generate a services. The first innovaon is in financial heavy demand for consumer credit. Farm- services for microenterprises or individual ers will need funds for their children’s edu- businesses, which encourages entrepre- caon, for homes, for marriage, and for the neurship and represents an important purchase of durable consumables. Financial means of increasing the employment instuons can design relevant financial and income of farmers. To date, such products to provide farmers with consumer financing needs have been met through credit. With migrant workers’ cash flow as informal lending. The emergence of a guaranty, the risks of consumer credit are controllable.

The first innovation is in financial Fourth, sannong must be supported in a services for microenterprises commercially viable manner, guided by or individual businesses, which fiscal policies and based on laws such as the Community Reinvestment Law that encourages entrepreneurship and encourage financial instuons to tap the represents an important means of rural credit market in poor areas. Credit support for sannong should be a goal of increasing the employment and the government rather than of financial income of farmers instuons. For example, the govern-

12 INTRODUCTION ment wishes to expand credit coverage of supporng sannong at the wholesale for low-income populaons and li them or retail levels. out of poverty. However, due to the high credit risks associated with low-income Finally, there is a growing demand for populaons, any financial instuon is wealth management in rural areas. Farm- bound to ask for a relavely high-risk ers’ increased income improves their abil- premium in the form of a high interest ity to accumulate wealth and increases rate, government-subsidized interest, tax their need for wealth management. The reducons, or other preferenal policies. wealth management market in the PRC Only in this way can government objec- will gradually expand from cies to rural ves to support sannong be combined areas. Suitable wealth management prod- with the funcons of financial instu- ucts can improve farmers’ property gains ons. In fact, not only the Agricultural and generate intermediary commissions Bank of China but also other financial for financial instuons, represenng instuons and investors should be an important future component of encouraged to parcipate in the process rural finance.

13 PART I AN OVERVIEW OF RURAL FINANCE

15 CHAPTER 1 Rural Financial Reform

History of Rural Finance in the PeopleÊs Republic of China

Rural financial reform in the People’s Republic of China (PRC) has been slow and has lagged behind general economic reform. The reform process has occurred in five phases, beginning with the monobanking system and then moving through the resumpon of rural financial instuons, the formaon of the rural financial system, exploraons of rural financial reform, and finally, a new round of rural financial system reform. The ulmate objecve of the new round of reform is to build up a modern rural financial system.

Phase 1. The Monobanking System (19491978)

During the period of the planned economy (before 1978), the central government was in charge of resource allocaon, including credit allocaon. Almost all enterprises, including banks, were state owned, and investment decisions were made by the government’s planning department. There was no real market.

The People’s Bank of China (PBC), established in the 1940s under the leadership of the Ministry of Finance, was the supervisory authority and the sole praconer in rural ﬁnance. It was established as a central bank but also funconed as a commercial bank. Deposit and lending outlets were set all over the countryside. The agriculture department of the PBC had branches from provincial to township levels.

Launching the Rural Credit Cooperatives

In 1951, the government promulgated a series of regulaons on cooperaves and a new type of instuon—the rural credit cooperave (RCC)—was launched to oﬀer credit services exclusively to rural households. By 1954, under the slogan “One village, one cooperave,” 124,000 RCCs had been established in the country. In 1955, the number reached 159,000. In 1956, the administrave mergers of districts and townships reduced the number of RCCs to 103,000; these covered close to 100 million rural

17 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

households. By 1957, rural credit coop- Phase 2. Resumption of Rural eraves were firmly established in the Financial Institutions (19791993) country. Subsequently, RCCs gradually deviated from the cooperave system and In the late 1970s, the PRC embarked on were put under the management of the economic reform. The reform started in PBC unl a er the Cultural Revoluon. the rural areas and significantly increased Throughout the 1960s and 1970s, RCCs farmers’ producon incenves by increas- served as implemenng agencies for rural ing prices for agricultural products and by credit and savings plans. RCCs and the instung the land contract responsibility agriculture department of the PBC thus system.1 The reform soon expanded to the formed the rural financial system. agro-industrial sectors. Producon was deregulated, leading to a non-state-owned Establishing the Agricultural Bank of China type of rural enterprise—township and village enterprises—most of which were The Agricultural Bank of China (ABC) was collecvely owned and proliferated during established in 1955 with a mission to raise 1980s. The market opening unleashed funds from rural areas and to support suppressed consumpon demand, and industrializaon and agricultural produc- township and village enterprises flourished on. At that me, the ABC was entrusted because they met the demand well and (by the PBC) with the supervision and kept profitability high. management of the RCCs. In 1957, the ABC merged with the PBC. A few years later, The rise in agricultural output and the the ABC was supervising the distribuon emergence of rural industrializaon sub- of budgetary agriculture funds and central stanally boosted rural household income bank lending to rural areas. in the early stages of reform. From 1978 to 1984, the annual growth of per capita rural Similar to instuons in other sectors, the household income reached 73% (adjusted relaonship between the RCCs and the by the agricultural products purchasing ABC in rural areas is not compeve but index) and industrial producon in rural is more like the relaon between cashiers areas grew by 1,188%, which was much and accountants. In the planned economy, higher than the rate of naonal industrial the industrial system did not need services producon for the same period (227%). from commercially oriented financial ins- Industrial producon in rural areas as a tuons. Likewise, rural financial instu- percentage of total industrial producon ons were designed to provide the rural increased from 13% in 1980 to 40% in credit that would enable producon of 1990, adjusted for inflaon. During this cheap grains and raw materials for capital- phase, rural financial instuons were intensive industrial development. reestablished or newly established, and a diversified and compeve rural financial The rise in agricultural output system started to take shape.

and the emergence of rural Restructuring the Agricultural Bank of China industrialization substantially PBC restructuring represented the core boosted rural household income in of ﬁnancial reform. During the planned the early stages of reform economy period, the PBC was the sole

18 RURAL FINANCIAL REFORM

financing enty, with extensive funcons. onship resulted in lack of independence With economic liberalizaon, however, the and ineffecve compeon in the com- PBC was unable to perform these complex mercializaon of the rural finance sector. dues well. At the same me, the monobanking system was unable to provide Beginning in 1983, joint RCCs were formed financing for dynamic rural areas. To at the county level to strengthen the remedy these problems, four state-owned independence of the RCC system, and the commercial banks—the ABC, the Bank State Council created county rural credit of China, the China Construcon Bank, unions. A two-level legal-person system and the Industrial and Commercial Bank was gradually established at the county, of China—were carved out of the PBC as county-level city, and township levels, and independent financial instuons serving the rural credit unions assumed responsi- different economic sectors. bility for managing, guiding, and funnel- ing funds to the RCCs. In 1984, the State The ABC, dissolved during the Cultural Council requested that the RCCs become Revoluon, resumed operaon in 1979 the cooperave financial organizaons for and established branches and subbranches the majority of rural households and be all over the PRC. In parcular, the ABC took responsible for their own operaons and charge of lending to the agriculture sector performance. and was the only state-owned commercial bank allowed to do business in rural Nevertheless, at this stage, the govern- areas. The main funcon of the ABC was ment sll entrusted the management of to manage agriculture funding, provide the RCCs to the ABC, which ran the RCCs rural credit in a centralized manner, and as banks, effecvely making them ABC manage the operaon of the RCCs. The branches and offices. As a result, RCCs ABC was therefore at the core of the rural were sll characterized as government financial system as it undertook combined owned and failed to follow the direcon funcons of fiscal appropriaon, commer- of cooperave finance. In addion, the cial lending, and RCC management. legal-person status of a township RCC was mostly nominal. Rural credit unions had Reforming the Rural Credit Cooperatives the right to appoint and dismiss RCC senior management and to approve both loans A second reform was the resumpon of and expenditures. RCCs as cooperave financial instuons. In 1979, the management of the RCCs Creation of Postal Savings was transferred from the PBC to the ABC, and the county branches of the ABC were A third reform was the creaon of postal made responsible for regulang local savings, which had been removed from RCCs. However, the relaonship between China Post in 1953. In 1986, upon the the two varied by region and over me. approval of the State Council, the func- For instance, in some regions the RCC and on of postal savings was resumed. The the ABC branches were the same instu- Postal Savings and Remiance Bureau on, whereas in other regions the RCC and the ABC township branches were independently managed but reported to the Rural credit unions had the right same ABC county branch. In many regions, to appoint and dismiss RCC senior the ABC and the RCC shared the same management and to approve both management team, with only the names disnguishing the two. This kind of rela- loans and expenditures

19 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

was set up within the postal system, and from the public. Some of them even paid the postal management bureaus of vari- high interest rates themselves, to aract ous provinces, autonomous regions, and savings. As a result, postal savings offices municipalies established corresponding expanded rapidly. agencies. The Ministry of Posts and Tele- communicaons and the PBC announced However, the high interest rate on postal the agreement on launching postal savings deposits with the central bank savings and outlined their respecve resulted in an oulow of rural funds, capacies as investor and operator. The distorted the interest rate structure, and agreement first took effect in 12 cies, encouraged irregular operaons on the including Beijing and Tianjin, to explore a part of the postal savings offices. The legal framework for developing the busi- shutdown of ABC outlets at the township ness all over the PRC. level and the closure of rural cooperave foundaons le RCCs as the principal A er China Post resumed the postal sav- source of credit in rural areas, but the ings business, it became an important part rapid development of rural postal savings of the financial arena, taking deposits but offices took available savings away from not extending loans. In rural areas, it also RCCs. In extreme cases, farmers in certain facilitated savings and remiance. Inially, townships deposited money with postal the postal savings outlets served as agents savings offices while applying for loans of the PBC, and postal savings deposits with RCCs, weakening the ability of RCCs were redeposited in the PBC at a monthly to provide loans. commission of 0.22%. During the high- inflaon period of the 1980s and early Creation of the Rural Cooperative 1990s, postal savings played a posive role Foundations in absorbing funds and withdrawing cash from circulaon. The PBC paid interest on In a fourth reform, rural cooperave foun- postal savings in addion to its commis- daons came into play. In the late 1980s, sion. Later, the commission was changed Sichuan Province approved the establish- to a savings-interest spread. ment of both rural cooperave foundaons and some rural enterprise finance Due to the high interest rate and the companies. With the development of the family contract responsibility system, risk-free nature of deposits with the rural cooperave foundaons started to central bank, postal savings offices emerge naonwide in 1984. By the end of 1992, various types of rural cooperave were motivated to take deposits from foundaon had been established in 37% of the public townships and 15% of villages all over the country. In the early stage, their funding A er 1990, postal savings branches col- sources were largely collecve funds, and lected savings on their own and transferred loans mainly targeted local village farmers. deposits to the PBC at relavely high interest. The interest rate on deposits of postal Enhanced producvity provided impetus savings in the PBC was 4.13%, whereas the for the commercializaon of previously interest rate on commercial banks’ reserve policy-oriented financial businesses. with the PBC was only 1.89%. Due to the The rural branches of the ABC and RCCs high interest rate and the risk-free nature of began developing commercial credit with deposits with the central bank, postal sav- idle funds. Although credit size and term ings offices were movated to take deposits structure were strictly controlled, the

20 RURAL FINANCIAL REFORM credit target shi ed. From 1980 to 1994, loans accounted for more than 60% of ABC and RCC loans to rural industries grew total agriculture loans. With the promulga- twelvefold, much faster than the growth on of the State Council’s 1996 Decision rate of other loans, and the share of rural on Rural Financial System Reform, a series industry loans rose from 13.8% to 33.2%. of reforms was undertaken. These efforts focused on safeguarding rural financial Phase 3. Formation of the Current stability, improving services, and managing Rural Financial System (19931996) risks. Major changes have taken place in the rural financial system, which is based The PRC’s financial reforms launched in on cooperave finance and encompasses 1993 and 1996 have been characterized by both commercial and policy finance. drasc changes in rural financial instuons and their lending responsibilies. In The Role of the Agricultural Development terms of rural finance, the reforms aimed Bank of China to separate policy operaon from commercial operaon, to commercialize the Prior to the creaon of the Agricultural operaon of the ABC, and to make RCCs Development Bank of China (ADBC), the into real credit cooperaves controlled by ABC and the China Construcon Bank their members. In these ways, the reforms took charge of medium- and large-scale sought to improve the efficiency of finan- infrastructure loans for agriculture, for- cial intermediaries and to reduce the pro- estry, animal husbandry, and irrigaon poron of nonperforming loans. Prior to as well as for technological advancement the reforms, formal finance in rural areas and other policy operaons. The Third of the PRC was dominated by the ABC, Plenum of the Fourteenth Communist which was responsible both for commer- Party of China Congress in November cial and policy lending in agriculture and 1992 spelled out the overall objecves of for managing RCCs. the PRC’s financial system reform.2 The following month, in December 1992, the Commercialization of the Agricultural Bank State Council promulgated the Decision of China on Financial System Reform, charging the ADBC with managing policy loans—which Before 1994, the ABC was a pure policy at that me included loans for agricul- bank; its primary tasks were to support ture procurement, storage, and process- agricultural producon, manage RCCs, and ing—and loans for integrated agriculture develop the rural economy. In 1994, the development and poverty alleviaon. ABC separated its commercial operaons from its policy funcons and began com- Major changes have taken place in mercializing. In September 1996, the ABC divested itself of the RCCs and changed its the rural financial system, which is development focus from the rural financial based on cooperative finance and market to urban commercial financing at the county level and above. encompasses both commercial and policy finance The Role of Rural Credit Cooperatives In line with the spirit of the decision, the The role of RCCs as the major force in the ABC transferred to the ADBC CNY186 billion rural financial system has been enhanced. worth of policy lending, to separate policy By the end of 1995, there were 50,000 and commercial operaons. However, the financially independent RCCs, and RCC management of subsidized poverty loans,

21 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

an important part of agriculture policy lend- has improved, with strengthened enforce- ing in the PRC, was returned to the ABC in ment and an increased supply of valid 1998, following a marked deterioraon in collateral. Finally, the development of the quality of poverty loans. informal credit and the entry of foreign banks have intensified compeon in the Phase 4. Pilot Rural Financial Reform finance sector. (19962002) Agricultural Development Bank of China and In response to problems—especially the Agricultural Bank of China risks—that emerged in rural financial reform during the 1990s, the authories Also since the mid-1990s, a financial sys- stepped up their management efforts. tem featuring the coexistence of coop- Major policy measures included put- erave banks and policy banks has been ng rural finance in order and advancing taking shape in the PRC’s rural areas.3 In reform. In line with the basic strategy 1994, the newly established ADBC took up set by the 1997 Central Financial Work- policy financing funcons such as managing Conference, state-owned commercial ing the fund supply for acquision of agri- banks were required to shrink instuons cultural products; poverty reducon loans; at (and below) county level, and small and and lending for comprehensive agriculture medium-sized financial instuons were development, small-scale rural infrastruc- to be developed to support local economic ture, and technological upgrading. development. State-owned commercial banks, including the ABC, therefore gradu- In August 1996, the State Council pro- ally streamlined their county and sub- mulgated the Decision on Rural Finan- county branches. cial System Reform, further clarifying the guiding principles for rural financial The comprehensive financial reforms system reform to include establishing and improving a rural financial system based launched in 1996 pushed the ABC to on cooperave finance, complemented become profit oriented with commercial and policy finance under a clear division of labor, and further Since the mid-1990s, the operaonal envi- improvement of rural financial services. ronment of rural financial instuons has In line with this decision, the RCCs were undergone significant changes. First, many spun off from the ABC and reformed on a township-owned and state-owned enter- cooperave paern. prises at and below county level have been privazed, and private small and The comprehensive financial reforms medium-sized enterprises have thrived. launched in 1996 pushed the ABC to By 2000, the output share of state-owned become profit oriented. The manage- enterprises declined to below 30% of ment of RCCs was shi ed to the newly total enterprise output. Second, the rural established Interministerial Coordinaon labor market and other factor markets, and Leading Group for Rural Financial excepng the capital and land markets, Reforms in 1996, and then the leading have been largely liberalized. Third, group joined the PBC in 1997. In 1998, the development of informaon technology ADBC assumed exclusive responsibility for has enhanced regulaon and consumer crop procurement loans, and other policy discipline. Fourth, the legal environment operaons were undertaken by the ABC.

22 RURAL FINANCIAL REFORM

Between 1998 and 1999, the State Coun- loans for crops, coon, and oil. RCCs thus cil decided to shi from the ADBC to the became the main force in rural finance. ABC the special lending for comprehensive agriculture development; poverty In 1999, to increase rural households’ reducon; enterprises affiliated with crop, access to credit, the PBC began to provide coon, and oil producon; and People’s loans to RCCs to encourage the issuance Bank of China agriculture loans. More- of microcredit through agriculture loans. over, efforts were made to crack down The interest rate was 3.25%, 0.99 per- on illegal and informal financial acvies, centage points lower than the general which included closing down and liquidat- PBC lending rate.4 Meanwhile, RCC reform ing rural cooperave foundaons across was pushed ahead under the principles of the country. In 1999, the rural coop- voluntary share purchasing, democrac erave foundaons were overhauled to management, and member-oriented restore rural financial order. The PBC pro- services, which proved to be beyond the vided funding support to promote RCCs RCCs’ capacity. The reform thus failed to and extend to rural households micro- achieve the expected results and instead credit and collecve-guaranty loans, and magnified the conflict between the pilot RCC reform was iniated in Jiangsu capabilies and the responsibilies of the Province in 2000. rural credit cooperaves.

Rural Credit Cooperatives since 1996 During the third stage (2000–2002), the Pilot on Organizaonal Systems of Rural Since 1996, RCC reform has gone through Credit Cooperaves provided the legal three stages, with the first stage occurring basis for pilot RCC reform in Jiangsu Prov- between 1996 and 1998. Following the ince. Jiangsu examined the possibilies of 1996 Decision on Rural Financial System clarifying the equity rights of members, Reform, the RCCs were separated from improving operaonal mechanisms, mak- the ABC and began a transformaon into ing township RCCs into branches of county cooperave financial instuons with RCCs, establishing rural commercial banks, farmers as shareholders and members and creang provincial rural credit unions as management. RCC reform in various to manage the RCCs. In addion, the regions of the country was implemented microcredit pilot was implemented naon- under the direcon of the State Council, wide, expanding rural household microfi- but the result was unsasfying. RCCs nance to nearly CNY75 billion naonwide were le with heavy historical burdens, by December 2002. poor asset quality, and high potenal risks, and their services fell far short of RCCs were left with heavy historical the needs of rural economic development. Since 1997, the PBC has strength- burdens, poor asset quality, and high ened supervision and has closed over potential risks, and their services 10,000 RCCs. Nevertheless, RCCs sll face many difficules. fell far short of the needs of rural economic development Stage two (1998–2000) comprised the commercializaon and withdrawal of During this stage, reform proceeded amid state-owned commercial banks from rural RCC restructuring. RCCs were gradually areas and the shutdown of rural coop- restructured into cooperaves owned and erave foundaons. The operaons of managed by farmers and providing services the ADBC were confined to acquision to members. RCCs, now separated from the

23 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

ABC, were managed by county rural credit Since 2000, the ABC has closed many unions and regulated by the PBC. outlets, including 8,601 in the central PRC (a decrease of 39.3%) and 4,635 in the Phase 5. Rural Financial Reform and western PRC (a decrease of 31.9%). Under Liberalization its strategic restructuring, the ABC has focused on commercial financing in coun- In recent years, the PRC has been devel- es and cies. oping rapidly and rural income has been growing quickly. From 2001 to 2004, total ADBC has outlets in 1,606 counes, though savings in rural areas increased from nearly none in the poorest regions, and its func- CNY4 trillion to nearly CNY7 trillion, yielding on has shi ed from comprehensive loans a CNY1 trillion yearly increase in rural sav- to crop-acquision loans. With the market- ings. RCC savings accounted for 40% of total oriented reform of the grain and coon rural savings, the ABC accounted for nearly circulaon system, the monopoly of state- 20%, and other banks represented around owned enterprises in this area has been 30%. Postal savings accounted for around broken. This has reduced ADBC business in 10% of total rural savings, with the per- some regions, ending the supply of devel- centage varying from region to region. The opment financial services and leaving the gap between total rural savings and loans RCCs as the major player in rural finance, widened to about CNY2 trillion in 2004, although RCCs can only meet basic finan- accounng for half of total rural loans. cial demand for agricultural producon in most regions. The major functions of the Rural financial instuons’ deposits and RCC union include providing loans are not enrely rural deposits and management, coordination, and loans. As financial instuons based at the township level, however, the operaons of services to the RCCs in the county RCCs have been restricted to rural areas. Therefore, all RCC deposits and loans can The formal finance sector in rural PRC be regarded as rural deposits and lend- currently comprises the ABC, the ADBC, ing.6 ADBC loans, which are used for the RCCs, and rural postal savings.5 Rural procurement, storage, and processing of postal savings financial instuons are important farm goods (mainly grain), have savings-only. The ABC, RCCs, and postal been officially defined as rural lending, savings have outlets at the county level although the benefits brought about by and below. RCCs are the main force in rural such policy loans are far from restricted to finance and township RCCs are categorized rural areas. as independent legal persons and profit centers. Many RCCs have credit and sav- The PRC’s gradual rural financial reform ings staons and agents in the villages. At has been demand-oriented. When the the county level, RCCs are represented by rural economy was dominated by township a union that, with shares from individual and village enterprises, collecve credit RCCs in the county, also is a profit center dominated. At the me, the ABC and RCCs and a legal person. The township RCCs were instrumental in supporng township report to both the RCC union and the and village enterprises. In early 1990s, county branch of the PBC. The major func- when township and village enterprise ons of the RCC union include providing reform began, private enterprises in a few management, coordinaon, and services regions witnessed rapid growth and indi- to the RCCs in the county. vidual credit gradually overtook collecve

24 RURAL FINANCIAL REFORM credit in rural areas. To some extent, the lending requirements, and transferring commercializaon of the ABC, the separa- deposited funds with upper-level enes. on of RCCs from the ABC, the introduc- First, the ABC has made reducons in rural on of collateral and various guaranes, areas. Inially, the ABC enjoyed the advan- and new financial products such as micro- tage of extensive grassroots operaonal finance based on individual creditworthi- offices in every county and township. Since ness and collecve guaranty addressed the 2000, however, the ABC has undertaken contradicon between state-owned and a reform similar to that of other state- collecve financial systems and individual owned commercial banks, focusing on staff credit. Rural finance played a posive role reducon, instuonal adjustment, risk- in supporng the development of private control enhancement, and improvement enterprises and small-scale industrial and of internal management. It also has cut commercial enes. operaonal offices, retreang from rural areas and parts of the rural credit market. However, a number of problems emerged According to a 2006 survey of selected during the course of reform. For instance, counes in 29 provinces, from 2000 to a great number of nonperforming loans mid-2006, the number of operaonal ABC built up during the process of township offices in Shandong Province declined from and village enterprise reform and the tran- 2,173 to 1,228 (a 9% decrease per year) sion from collecve to individual credit. and the number of employees decreased With the gradual exit of state-owned com- from 31,340 to 14,557 (a 12% decrease mercial banks from the rural financial mar- per year). In Changchun, 58% of the ket and the overhaul of rural cooperave ABC’s operaonal offices (in rural areas) foundaons, RCCs became monopolies in and savings offices (in urban areas) were the rural financial market. A large amount dissolved. In Qinghai, the ABC dissolved of money departed rural areas through or merged township operaonal offices, rural financial instuons. RCC reform thus and no other financial instuons provide failed to change the foundaons of rural credit or lending to farmers or herdsmen. financial instuons and parcularly failed to address poor RCC governance. County subbranches are the lowest

Agricultural Bank of China Development management layer, but they have Strategy no authority to appoint or remove

The ABC receives the majority of its depos- staff, to budget independently, or its from rural areas but lends in both rural to approve loans and urban areas and, since 1996, has gradually shi ed its lending operaons more Second, the ABC adopted measures to exclusively to urban areas. All rural postal weaken the funcons of county sub- savings deposits originate in rural areas branches. Thus, due to sharp differences and are redeposited with the PBC. Thus, across regions, policy and management the ABC and rural postal savings have been decisions made by headquarters usu- blamed for channeling funds from rural to ally lag behind or fail to conform to local urban areas. reality. County subbranches are the lowest management layer, but they have Changes in the ABC’s development strat- no authority to appoint or remove staff, egy include reducing rural staff and offices, to budget independently, or to approve weakening the authority of county sub- loans. For example, lower subbranches branches, implemenng more-stringent and enterprises spend me and effort

25 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

rang enterprises applying for loans mainly provide selement, remiance, and then submit the results to provin- and other intermediary services; deposit cial branches, which conduct examina- cerficate guaranty loans are the bank’s on only on an annual basis. Moreover, only credit product. At present, grassroots according to the president of one county operaonal offices take deposits but refrain subbranch, it normally takes 1 to 2 from lending to township enterprises and months for loan distribuon, much longer farmers, except for a few poverty-reducon than loan distribuon from urban and loans. Thus, the ABC has been transformed rural credit cooperaves. Such an over- from a state-owned commercial bank that stretched line of reporng deprives the mainly targets rural areas to a bank that ABC of good development opportunies. gradually reduces its presence in the agriculture sector. Third, the ABC raised the threshold of access to loans, focusing on businesses Finally, the ABC transfers all collected in advantageous industries and enter- deposits to upper-level enes and central- prises in big cies. ABC’s policy is to serve izes capital by raising the interest rate on only clients with credit rangs of 2A and such deposits, resulng in capital oulow above, abandoning clients rated below 2A from rural areas. A PBC survey showed that and subjecng new clients to credit rang the interest rate on capital deposited with by provincial branches. The ABC employs upper-level enes is much higher than the universal criteria for credit rangs, but rate provided by other commercial banks. some enterprises in less-developed For example, in the first half of 2006, the regions have difficulty meeng such 1-year interest rate on capital deposited requirements and therefore cannot get with upper-level enes was 3.33%— loans. Some high-quality county enter- one-half to one percentage point higher prises do not appear to be viable when than the interest rate at other commer- compared with peers at the provincial cial banks. This policy encourages county level, and many enterprises are daunted subbranches to deposit their capital rather by the standards. than lending it, impeding the efficiency of capital ulizaon in the local area. A PBC survey showed that the As a result, the balance sheet of county subbranches is quite unbalanced, with a interest rate on capital deposited declining deposit–loan rao. with upper-level entities is much Following these major policy shi s, the ABC higher than the rate provided by lost its advantages and now competes with other commercial banks a multude of financial instuons in large and medium-sized cies. At the same me, A er 2003, the ABC strengthened control certain agriculture loans are more likely to over credit aggregaon and intensified col- become nonperforming loans. Because it is lecve management of credit, resulng in impossible to get addional loans from the a worsening capital shortage at the county ABC, the bank has become more estranged level. The ABC’s funcon in rural areas has from its former clients, including enter- shi ed from supporng rural development prises and farmers, and many borrowers by providing loans to taking deposits, pro- are less willing to repay exisng loans. This viding selement and intermediary ser- is parcularly true of borrowers in certain vices, and liquidang nonperforming loans. townships where the ABC has closed down Operaonal offices below the county level operaonal offices. As a result, the number

26 RURAL FINANCIAL REFORM of nonperforming loans in county sub- provincial governments should parcipate branches has skyrocketed in recent years. in risk migaon.

Dominance of the Rural Credit Cooperatives In June 2003, the State Council launched the pilot RCC reform in eight provinces Compeon in the PRC’s rural financial and cies, including Chongqing, Guizhou, markets is constrained by state regulaon Jiangsu, Jiangxi, Jilin, Shaanxi, Shandong, of the entry and exit of financial instu- and Zhejiang. In August 2004, the pilots ons. The ABC and the ADBC are govern- were expanded to 21 provinces, regions, ment-owned financial instuons. RCCs, and cies, including Beijing, Hebei, though defined as cooperaves, are sub- and Tianjin. ject to PBC regulaon and management and have a corporate governance structure The 2003 pilot RCC reform was designed to similar to that of state-owned financial solve the supply–demand contradicons instuons. It is virtually impossible for between collecve financial instuons new financial instuons to enter the mar- and individual credit by improving the ket, and there is no defined mechanism for governance of financial instuons. Two individual loss-making RCCs with negave Communist Party of China Central Commit- equity to exit the market. tee documents, in 2004 and 2005, further defined the guiding macroeconomic policy Despite the creaon of the ABC and the principles behind rural financial reform, transfer of RCC management from the laying the overall foundaon for a modern ABC to the PBC, the reforms of 1994 and rural financial system in the PRC. 1996 failed to make rural financial markets more compeve. On the contrary, By the end of 2006, the RCC pilot reform the reforms led to the gradual withdrawal was launched in Hainan Province, mark- of the ABC from rural lending and the ing the naonal coverage of the reform collapse of rural cooperave foundaons (there are no RCCs in Xizang Autonomous and other informal financial instuons, Region7). The China Banking Regulatory and the PRC’s rural instuonal lend- Commission created rules to allow for the ing markets have become dominated establishment of rural financial instu- by RCCs. Nonprice compeon for rural ons such as rural banks and lending deposits has become fierce, especially companies, opening a new chapter in in more-developed areas, as the ABC the PRC’s rural financial development. connues to fight for rural deposits, and Meanwhile, the pilot of new types of the share of deposits held by rural postal rural financial instuons was gradually savings has grown over me. expanded to increase compeon in the rural financial market. Building on the experience of a pilot in Jiangsu Province, the 2002 Naonal Financial Working Conference laid down In June 2003, the State Council the basic principles of RCC reform. The launched the pilot RCC reform in conference decided that one-size-fits-all organizaonal paerns are ineffecve, that eight provinces and cities, including commercializaon should be allowed in Chongqing, Guizhou, Jiangsu, qualified regions, that management should not be vercal across the country, that Jiangxi, Jilin, Shaanxi, Shandong, microcredit should be connued, and that and Zhejiang

27 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

The pilot RCC reform allowed private proposing to the State Council a postal shareholding for ownership restructuring, system reform plan that would enable which drew on the experience of restruc- postal savings offices to ulize their funds turing township and small and medium- independently and promote commercial sized state-owned enterprises. Conducted viability of postal savings. under the leadership of the China Bank- ing Regulatory Commission, the major A er 1 August 2003, the PBC changed the reform measures included giving provincial interest on deposits from postal savings. governments authority for administering According to the new method, the inter- RCCs, issuing special central bank bills and est rate on new deposits with the PBC was loans to support the reform, and granng the same as that on financial instuons’ subsidies and tax exempon for the period reserves (1.89% per year), while the previ- 1994 through 1997. ous interest rate (4.13% per year) remains applicable to deposits before August 2003. The reform of postal savings is an At the same me, postal savings offices were allowed to ulize new savings at their important part of the state postal own discreon. system reform Under such circumstances, postal savings Unfortunately, the implementaon of RCC maintained rapid growth. As of the end reform has yet to address the issue of of 2002, postal savings outstanding stood moral hazard. First, RCCs are not subject at CNY736.9 billion. Two-thirds of these to bankruptcy and can incur losses in the deposits were from rural areas and all name of supporng the rural economy. were deposited with the central bank. As Second, local governments and RCCs might of August 2006, postal savings outstanding ask for unreasonably high compensaon was more than CNY1.5 trillion, an amount from the central government as a means exceeded only by the four state-owned of resolving historical burdens. Third, commercial banks. The Postal Savings Bank by exploing the overlap of policy and of China (PSBC) also boasts the largest commercial operaons, RCCs can request financial network in the naon, connecng central bank support, again in the name of urban and rural areas through more than supporng the rural economy. 37,000 outlets, two-thirds of which are in rural areas. Postal Savings Reform An important part of the central govern- The reform of postal savings is an impor- ment’s postal system reform was to reform tant part of the state postal system the postal savings management system reform. Since 2001, the PBC, the Ministry and standardize the operaons of finan- of Finance, and the Ministry of Posts and cial services provided by postal savings Telecommunicaons have conducted a offices. The general reform plan called for number of studies and proposed a reform a gradual shi from the previous opera- scheme under which different interest onal model, in which all savings were rates apply to deposits before and a er deposited with the PBC, to independent a cutoff date, and postal savings offices ulizaon of savings under the supervision have been encouraged to expand their of the PBC and the China Banking Regula- business scope. In 2003, the Naonal tory Commission. Savings deposited before Development and Reform Commission the cutoff date of 1 August 2003 would played a leading role in coordinang with connue to follow previous policies unl relevant ministries and commissions and 1 August 2005, whereas new savings were

28 RURAL FINANCIAL REFORM ulized at the discreon of postal savings line with market principles. Similar to offices. A er 1 August 2005, postal savings other banks, the instuonal arrange- offices’ deposits with the PBC would be ment, operaons, and senior management transferred out over 5 consecuve years. are subject to banking supervision focused As of 21 March 2006, three such trans- on the bank’s capital adequacy rao. The fers—totaling CNY62.2 billion—were made PSBC is well posioned to rely on its cur- without affecng the operaon of the rent network of outlets to improve finan- postal savings offices. cial services with retail and intermediary businesses in both urban and rural areas. The second element of reform was the gradual diversificaon of the use of postal A er its transformaon from China Post, savings funds. With previous savings grad- the biggest problem now facing the PSBC ually transferred out of the PBC, the ability is inadequate lending capacity. It was of postal savings offices to ulize funds not unl August 2003 that postal savings independently has been improving. They deposits were gradually transferred out have adapted to rural financial reform of the central bank and new savings were and have piloted pledged microcredit to available for ulizaon at the discreon reinforce support for agricultural indus- of the PSBC, which mainly purchased try, rural areas, and farmers (sannong). bonds and deposits under negoated In December 2005, the China Banking terms. Since 2006, the China Banking Regulatory Commission approved micro- Regulatory Commission has allowed China credit lending to rural residents, using me Post to launch pilot programs of micro- deposit cerficates as pledges, in Fujian, credit pledged with deposit cerficates, Hubei, and Shaanxi provinces. interbank deposits, and investment in syndicated loans and bonds issued by As of August 2006, independent fund use internaonal development agencies. As of outstanding exceeded CNY800 billion, most August 2006, the balance of independently of which was in bonds or was deposited ulized funds exceeded CNY800 billion, with banks. The China Development Bank but most of the funds were sll invested in was selected as China Post’s partner in the bonds or deposited with banks. lending business. In June 2006, the two pares signed a comprehensive agreement Market Liberalization and Rural to cooperate in a variety of areas, such as Financial Development asset management, fund use, consulng services, human resources, and selement. Liberalizaon of the PRC’s rural financial market entered a new stage in 2005, and On 31 December 2006, the China Bank- the most notable reforms are the pilots of ing Regulatory Commission approved the microfinance companies and new types of incorporaon of the Postal Savings Bank of financial instuons. Since the second half China, permied China Post to become the of 2005, the PBC has piloted microfinance sole investor in the PSBC, and approved companies in five provinces and regions, the creaon of the fi h-largest commercial bank in the PRC. According to the arcles The PSBC is well positioned to rely of associaon, the PSBC operates through the China Post network, must establish on its current network of outlets to an internal control and risk management improve financial services with retail system in accordance with corporate governance and other requirements for and intermediary businesses in both commercial banks, and must operate in urban and rural areas

29 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

and in May 2008, the pilot was expanded capital (including foreign capital) is now, naonwide (including Guizhou, Inner for the first me, allowed to purchase a Mongolia Autonomous Region, Shaanxi, stake in and control newly established Shanxi, and Sichuan). Presently, nearly financial instuons. Pilot provinces 500 microfinance companies have been have experienced an increase in mutual established. In addion, the China Bank- financial organizaons self-managed by ing Regulatory Commission relaxed market farmers, private microfinance companies, entry requirements for rural financial ins- and village banks represenng partner- tuons and, at the end of 2006, piloted ships between financial instuons and the liberalizaon of rural financial markets private investors. in Gansu, Hubei, Inner Mongolia Autono- mous Region, Jilin, Qinghai, and Sichuan. In addion to microcredit instuons that Main Issues of the Rural provide lending without taking deposits, other new types of financial instuons Financial System in the include village banks, loan companies, and PeopleÊs Republic of China mutual financial organizaons (also called mutual fund associaons). The main challenges to the PRC’s current rural financial reform stem from the old Market opening also has provided financial administrave system, which was designed to support agricultural produc- a base for the legalization of on with cheap money from the ABC informal credit (in the form of poverty reducon loans) and RCCs (in the form of small credit A great number of farmers have gained loans). Such an instuonal design control over their agricultural produc- requires a highly centralized financial on, supply, and sales through the family s ystem, simplified financial instuons, contract responsibility system, and the and administrave management similar to liberalizaon of the rural financial market that of government agencies. allows farmers to legally obtain credit. Producon, supply, sales, and credit can The PRC’s tradional rural financial system work together to help farmers gain a is characterized by lack of compeon, compeve edge in the growing market diverse demand, capital oulows, difficult economy. access to credit, the need for government credit inputs, insider control, and a lack Market opening also has provided a base of an enabling operang environment. for the legalizaon of informal credit. Monotypic instuons reduce compe- Some qualified informal creditors could on in rural financial markets, and demand become legal rural financial instuons for diversified financial services cannot be through registraon. Such instuons, as met. Furthermore, government credit sup- well as loan companies with a 100% capi- plies cannot reverse the large oulows of tal adequacy rao, RCCs with relavely funds from rural areas or relieve farmers’ low capital adequacy raos, and other difficult access to credit. At the same me, commercial banks, including the ABC, the “reform” of rural financial instuons will present a complete spectrum of rural under senior management that makes financial instuons, and such diversity decisions without consulng shareholders of instuons can beer meet diverse has separated loan decision making from financial demands. In addion, private the interests of rural households.

30 RURAL FINANCIAL REFORM

Lack of Competition management, and incenve systems, are unable to meet these diverse demands in Rural financial reform since 1996 has a mely fashion. failed to promote compeon in the rural credit market. Instead, the reform caused Capital Outflows the ABC to gradually remove its lending business from the rural credit market and Since the mid-1990s, the sluggish and vola- close down rural cooperave foundaons le nature of agricultural product prices, and other informal financial instuons. the low producvity of small-scale, self- In addion, the ADBC has decreased its sufficient rural households, and the large lending for acquision of crops, coon, number of closures of township enterprises and edible oil. As a result, RCCs have been have contributed to the lack of investment forced to play the role of primary credit opportunies in rural areas. This has forced providers in rural financial markets, giving many farmers to migrate to other prov- them a virtual monopoly in the rural credit inces. The earnings of these farmers are market and creang the low efficiency that remied back to the rural financial instu- usually accompanies a monopoly. How- ons in their hometowns but then flow to ever, a mismatch between RCCs’ capacity the eastern and more-developed regions and their mandate soon emerged. Due to through instuonal purchases of Treasury the historical burden of a large volume of bonds and deposits in upper-level enes. accumulated nonperforming loans, the As a result, insufficient funds are available administered interest rate, and inefficient for sannong, and rural economic develop- management in some areas, RCCs sll ment enters a vicious cycle. suffer huge losses, despite their monopoly status. The losses are especially heavy for RCCs in the central and western regions Postal savings enjoys very high of the PRC, and such losses make RCCs redeposit interest rates at the PBC, unsustainable as the only service provider which translates into a hemorrhage in the rural financial market. of rural funds into other regions Diverse Demand Rural funds flow out through three chan- One consequence of the lack of com- nels: state-owned commercial banks, peon in rural financial markets is the postal savings, and RCCs. State-owned creaon of a monotypic rural financial commercial banks have shrunk their system that cannot cope with the dif- branch networks and ghtened credit ferent demands for services among the controls, and most county and lower-level eastern, central, and western regions. A offices of the four largest state-owned system with the RCC as the sole player commercial banks are required to rede- cannot meet the demands of farmers posit funds in their upper-level enes. and enterprises in different regions. With Postal savings enjoys very high redeposit the development of local economies and interest rates at the PBC, which trans- urbanizaon, demands for financial ser- lates into a hemorrhage of rural funds vices have been evolving. Moreover, differ- into other regions. Finally, many RCCs ent economic structures in different areas purchase Treasury bonds, deposit funds produce different demands for financial in other financial instuons, and lend to services. RCCs, with their similar opera- urban clients, which translates into addional structures, lending modes, internal onal oulows.

31 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Difficult Access to Credit difficules in accessing credit in rural areas with PBC onlending and poverty alleviaon Most rural households, especially those loans, both of which are fiscal in nature. running small and medium-sized rural The PBC’s relending is uerly inadequate in enterprises, have difficulty accessing dealing with the vast demand in rural areas. credit. With commercializaon, the ABC It was difficult for government-sponsored, has abandoned some branches and interest-subsidized poverty reducon loans merged others. Meanwhile, the mode dispensed through the ABC to truly benefit and means of RCC services cannot meet rural households, and the persistently high the demands of rural households or rural nonperforming loan rao of poverty reduc- economic development. Although RCCs on loans made it difficult to achieve the have increased microfinance lending ancipated poverty reducon. to rural households, loans to small and medium-sized rural enterprises have been Key factors widening the gap between shrinking significantly. In addion, because urban and rural areas are the relave microfinance loans largely depend on PBC access to fiscal funds, naonal and local agriculture onlending, they feature high government investment, and the different transacon costs and loan sizes are small. returns on investment in various regions. With the fixed interest ceiling, RCCs can Although support for sannong is impor- hardly maintain their microfinance opera- tant, finance cannot serve the funcon of ons in the long run. In many central and fiscal policy. In the past, the central and western provinces, loss-making RCCs are local governments have misconstrued unable or unwilling to lend to rural house- finance, making it shoulder too many holds, whereas PBC onlending for agricul- fiscal funcons. This has resulted in huge ture is unequal to the demand for credit, losses, shrinking rural financial services, forcing farmers to depend on borrowing increased oulows of rural funds, and from relaves, friends, or informal sources. serious moral hazards. The government’s poverty alleviaon loans through the ABC can barely accommodate Insider Control rural households. The advantages of local rural financial Government Credit Inputs instuons lie in their access to local informaon, which can reduce monitoring costs If the old rural financial system supported and informaon asymmetry. However, the PRC’s rural economic development, under the current system, RCC manage- the financial support represented a kind ment assumes lile responsibility for RCC of overdra and was therefore unsustain- performance. In the absence of significant able. It is impossible to solve the problem changes in the ownership arrangements of oulow of rural funds and to ease the and governance structures of rural financial instuons, the reforms remain under the control of an RCC management that Key factors widening the gap benefits from the current system. With between urban and rural areas are weak governance, risk control can only the relative access to fiscal funds, be strengthened by administrave measures—that is, by concentrang decision- national and local government making power. At the ABC, this is done by investment, and the different returns depriving lower-level branches of decision- making power over loans; RCCs concen- on investment in various regions trate decision-making power regarding

32 RURAL FINANCIAL REFORM lending and treasury funcons in the rural ability of rural finance to support the rural credit cooperave unions. Nevertheless, economy, and its inefficiency will obstruct concentrated decision-making power rural economic growth. For too long, the can hardly solve the problem of asym- rural financial system has been under- metric informaon or encourage a mely going reform in name, but this reform response to changes in demand. has centered on improving the external administrave system of RCCs rather than Lack of an Enabling Operating pung in place effecve internal incenve Environment and discipline mechanisms. Regardless of nominal changes, therefore, the RCCs have There are insufficient risk-sharing mecha- failed to break away from the general char- nisms for rural loans. Underdeveloped acteriscs typical of state-owned enter- agriculture insurance, the rudimentary prises in the planned economy, including futures market for agricultural products, lack of ownership, so budgetary disci- and various legal and policy constraints pline, and insider control, resulng in more have prevented rural financial instuons government involvement and increased from finding efficient substutes for collat- distance from farmers. Farmers sll must eral and guaranty. At the same me, rural resort to informal financial instuons to financial instuons have few incenves meet their financial needs. to resolve collateral-and-guaranty difficules through financial innovaon. The The traditional rural financial system sustainable development of these instuons also is hampered by tax policies and has contributed to rural economic controlled interest rates. growth, but the „overdraft‰ of financial resources from rural areas Lessons from Rural Finance can hardly be sustained Reform It is fair to say that, so far, the PRC has not Past reform has not fundamentally truly launched market-oriented rural finan- changed the basic structure of rural cial reform. The relaonship between the finance in the PRC. First, the government government and the market has not been sll controls rural finance, and the com- resolved, reform has focused on changing mercializaon of financial instuons has exisng instuons rather than on building been limited by both lending policy and a modern financial system, there remains a low interest rates. Second, the market mismatch between the rural financial and structure has not changed, and RCCs sll nonfinance sectors, and reform has tended dominate rural financial markets. Third, toward a one-size-fits-all approach. the performance of financial instuons has not fundamentally improved. This rep- First, the ends and the means of the gov- resents a sharp contrast with the naon’s ernment’s rural work were confused, and robust economic growth, parcularly rural the relaonship between the government economic growth, in the past 2 decades. and the market was not properly resolved. The objecves of the government’s rural The tradional rural financial system has work are to solve problems related to san- contributed to rural economic growth, nong, to develop the rural economy, and but the “overdra ” of financial resources to raise rural household income. Mulple from rural areas can hardly be sustained. means could be ulized to achieve these The delay in reform has hampered the objecves, and credit support is one

33 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

important channel through which rural it may be said that the secret of successful financial instuons can serve and support reform lies outside the reform itself. the rural economy. However, if rural financial instuons are forced to extend credit The reform of the collecve rural economy support as a major means for the govern- has achieved great breakthroughs, thanks ment to achieve its rural targets, then to instuonal innovaons such as the rural financial instuons are constrained family contract responsibility system and in maximizing their profit. This not only the reform of large state-owned enter- harms the independence and efficiency of prises. Nevertheless, the reform of the financial instuons but also provides a rural financial system has so far been basis for direct government interference in dominated by the monopolisc RCCs. In the business of financial instuons. some regions, informal finance and other innovave financial instuons were Facing a shortage of fiscal resources, rural labeled as illegal fund-raising or disrupt- financial instuons unduly assumed ing the financial order, so that informal some fiscal funcons to promote rural finance was actually killed. If RCCs do not development, which contributed to seri- perform well, rural finance in some regions ous problems in rural finance. Large losses has no backup. on the part of rural financial instuons made farmers’ access to credit increasingly Third, the mismatch between the rural difficult, and rural capital oulows and financial and nonfinance sectors is yet to inadequate credit became major con- be resolved. Historically, the PRC’s financial straints on rural economic development. system was based on collecve credit, or In this context, changes to and evoluon government credit, which was measured of the single rural financial paern previ- by the nature of the enterprises or the ously tailored to a planned economy were administrave level of the government in inevitable. The rural financial system has queson. In the early period of specialized acvely or responsively evolved to meet banks, assessment of a borrower’s repay- the financial needs of sannong. ment ability was based on collecve credit, which took the form of implicit guarantees If RCCs do not perform well, rural by industrial regulators or the government. As long as enterprises within a parcular finance in some regions has jurisdicon made profits on the whole, col- no backup lecve credit was sound. Industrial regulators and local governments controlled the Second, with the excepon of commercial- majority of economic resources, such as ized reform of the ABC in the mid-1990s, appropriaon and pricing of raw mate- rural financial reform has been limited to rials, enterprise licensing, energy, and the reform of the RCCs. No effort has been transport, and were backed by large fiscal made to build a modern rural financial sys- revenues. Thus, the higher the administra- tem. A truly modern rural financial system ve level of a regulator or government, should have the capacity to accommodate the more resources it controlled and the formal and informal finance, direct and beer was its creditworthiness. Collecve indirect finance, and compeon among credit did not depend on collateral; thus, different financial instuons and financ- state-owned or collecve enterprises with ing approaches. One key lesson of the support from industrial regulators or local PRC’s gradual reform is that reform en- governments could easily borrow from es need external impetus. In this sense, banks, which largely explains the pro-

34 RURAL FINANCIAL REFORM tracted and large numbers of nonperform- economic and financial needs, given the ing loans of the PRC’s financial instuons. differences in rural financial demand across the eastern, central, and western Beginning in the mid-1990s, however, inten- regions of the PRC. With the deepening sified compeon worsened the profit- of financial reform, especially since com- making capability of local state-owned and mercialized banking reform was launched collecve enterprises, and collecve credit in the mid-1990s and shareholder banking was on the brink of collapse. To protect reform began in 2003, enormous changes their lending, financial instuons were have taken place in the PRC’s rural financial forced to look for substutes for collecve system. Growing regional disparity in eco- credit. The commercialized reform of banks, nomic structure has created differences in launched in 1994, was intended to replace supply and demand in the rural finance sec- specialized banks with commercial banks tor. In advanced coastal regions, for exam- and to make a disncon between policy ple, the growth of nonagriculture industries lending and commercial lending, at least in has increased the need for financial services terms of the form of the reform. in extra-agriculture rural sectors and has increased both the need for and the actual However, the reform represented a integraon of rural finance with the enre revoluonary shi in the credit basis financial system. In the central region, the of financial instuons, from collecve share of non-crop-growing sectors, includ- credit to individual credit—an inevitable ing animal husbandry and agricultural process in the transion from a planned products processing, has been increasing; economy to a market economy. The basic thus, specialized producon accounts for feature of individual credit is to disregard the bulk of financial needs and financial administrave level or the nature of a supply has been trending toward specializa- borrower’s enterprise and to base bank on. Poverty reducon and streamlining lending on a borrower’s repayment abil- consumpon are the main financial needs ity as measured by a series of indicators, in the western region, which has relavely including adequate collateral or guaranty, few profit-making opportunies, a shortage repayment history, corporate size, infor- of natural resources, and large uncertaines maon disclosure, and so forth. With the related to market and weather condions. emergence of individual credit, enterprise ownership is no longer a key factor in The major demand for financial banks’ lending decisions, as long as an individual meets the lending criteria. services in poverty-stricken rural areas includes the need to make Thus, banks gradually shi ed from lending only to state-owned and collecve deposits, to remit funds, and to enterprises and began to include private access capital for simple production enterprises. This promoted broad reform of small and medium-sized state-owned Despite differing regional needs, however, enterprises and collecve enterprises, each round of rural financial reform since especially township enterprises. However, the 1990s has been carried out uniformly it will take me to resolve the mismatch across the whole country, giving localies between the rural finance sector and the lile discreon in adapng implementa- credit system of the nonfinance sector. on to specific local circumstances. As a result, previous reforms have failed to Finally, the one-size-fits-all reform approach solve praccal problems, and a paern has been unable to keep up with changing that worked in some regions might be

35 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

difficult to implement in other regions. to access capital for simple producon. Thus, new problems connue to emerge in Postal savings agencies and RCCs sasfy the process of reform. these demands well. However, the current financial structure faces great challenges in The major demand for financial services in creang sustainable development that will poverty-stricken rural areas includes the promote a sound cycle of local economic need to make deposits, to remit funds, and and financial performance.

36 CHAPTER 2 Rural Economic Situation

The poverty reducon effort in the People’s Republic of China (PRC) serves as an example for the rest of the world, with the number of poor people (relave to average income in the PRC) sharply reduced, from 200 million in 1980 to 25 million in 2005. However, since the mid-1990s, the PRC has witnessed widening disparies between urban and rural areas and among regions. A large number of poor people are concentrated in the midwestern region, especially in its poverty-stricken rural areas. Despite government efforts to ease the economic development boleneck in these regions through fiscal policy–based poverty alleviaon, poverty alleviaon credit, and the Great Development of the West, there have been no fundamental changes, and the number of poor people has increased in many midwestern rural areas. This has hindered sustainable economic development and social harmony.

Although fiscal transfer has leaned toward less-developed regions in recent years, a large proporon of public service resources actually have been concentrated in urban areas, and funds and other resources constantly flow into cies and developed regions through a variety of channels. Because of the uneven distribuon of public finance investment among urban and rural areas, the flow of funds and labor in the PRC’s rural areas, especially in the midwestern region, has resulted in prolonged sluggishness and volality in agricultural producon; extremely low producvity among small-scale, self- sufficient peasants; and massive shutdowns of township and village enterprises. These factors have forced many farmers to leave their homes to seek employment. However, the money they earn and remit home usually is deposited in rural financial instuons, where it then flows back to big cies and developed regions through instuonal purchases of government bonds, interbank lending, reserve banking, and deposit with the People’s Bank of China.

Many aspects of the PRC’s poverty reducon policies call for further study. For instance, if the rao of nongovernment income (e.g., migrant workers’ remiance) to farmers’ income has been increasing, then where have those government poverty alleviaon subsidies gone, and how eﬀecve are such subsidies? Under the current system, it is diﬃcult for local

37 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

governments to change local industrial projects under the Great Development structures and improve the economic status of the West, some rural financial instu- quo. In this context, what should be the ons connue to serve as public finance direcon of future poverty alleviaon poli- providers, due to the limited rural social cies and rural financial reform in poverty- security system and the unsound grass- stricken areas of the PRC? roots fiscal system.

The number of poor in these core poverty- General Economic Situation stricken counes has not shown a downward trend; instead, it rose from 22.5% in Our data show a severe economic situa- 1999 to 28.4% in 2003. In the core poor on in poverty-stricken areas. The basic counes in Sichuan Province, the number features of these areas include an increased by about 10 percentage points. increasing percentage of the populaon Similarly, there was an upward trend in the living in poverty, a relavely low gross rao of poverty-stricken townships to the domesc product (GDP), and a decreas- core poverty-stricken counes in Gansu and ing area of culvated land per capita. Yunnan, and the figure remained at around Because a major proporon of income 80% in four other western provinces of increase has come from nonagriculture Ghizhou, Ningxia Huizu Autonomous income, especially migrant workers’ Region, Shaanxi, and Sichuan. During the remiance, local economic development 5-year observaon period, the rao of is unlikely to lead to increased income for key poor villages in these places stood at farmers in these regions. around 50%. From 1999 to 2003, the average per capita GDP increased by around A large proportion of the budget is CNY200 per year in the sample counes, rising from CNY1,668 in 1999 to CNY2,391 in earmarked for paying the salaries 2003. This is about one-quarter of the of government functionaries, which naonal average for the same period. has trimmed the local public finance There also is a lack of culvated land in available for medical care and poverty-stricken areas, especially in the poor southwestern regions, where most of education and has reduced local culvated land is in small parcels located farmersÊ access to public services far from farmers’ homes. Gansu and Ningxia reported a larger area of cul- It seems that local governments can do vated land per capita but suffered from lile to improve local industrial structures the lowest irrigaon rate among the six significantly. Meanwhile, the fiscal posi- provinces; only 9.5% of the culvated land on of poverty-stricken areas with agri- in Ningxia’s poverty-stricken counes is culture as their pillar industry does not irrigated. Poverty-stricken counes in the look rosy either. A large proporon of the other four provinces sampled have a rela- budget is earmarked for paying the sala- vely small per capita area of culvated ries of government funconaries, which land—the per capita area of culvated has trimmed the local public finance land in Guizhou, for instance, was only available for medical care and educaon 0.72 mu, or 0.05 hectare—and from 1999 and has reduced local farmers’ access to to 2003 the per capita area of culvated public services. Although recent years land in the poverty-stricken counes of have seen heavy investment in transport, all six provinces decreased. In 2003, the compulsory educaon, and clean water figure in the sample counes was 1.8 mu,

38 RURAL ECONOMIC SITUATION or 0.12 hectare, around half of which was harm the sustainable long-term develop- unirrigated land. Land scarcity and inferior ment of local economies. quality are important reasons for rural household poverty and farmers’ migraon to the nonagriculture sectors. Agriculture Loans

Stascs show that the rao of agricul- Industrial Structures ture to other loans is nearly equivalent to the rao of the agriculture sector to the Agriculture is the main sector in poverty- overall economy, and our survey data con- stricken areas. Although from 1999 to firmed this. During the 5-year period from 2003 the rao of gross agricultural output 1999 to 2003, the GAO–GDP rao dropped (GAO) to GDP decreased, the magnitude by 4.8 percentage points in the western of decrease was small and the GAO–GDP provinces, which are major agricultural rao of all sample counes stood at over provinces. This trend was in line with the 50%. The industrial sector in these areas situaon of the country as a whole, where is underdeveloped. Of the six provinces the GAO–GDP rao decreased by 3.7 per- studied, Shaanxi had the highest rao centage points. During the same period, of gross industrial output to GDP, at agriculture-related loans represented 47.4%, and Gansu had the lowest rao, around 70% of total loans outstanding at 27.9%. During the period from 1999 to and increased by 3.7 percentage points— 2003, the gross industrial output of pov- greater than the increase in the GAO–GDP erty-stricken counes in Gansu, Guizhou, rao. This showed that, on the one hand, Ningxia, and Yunnan even observed a local governments had strengthened their downward trend. efforts to support agriculture-related loans but that, on the other hand, they sll were Despite the efforts of local governments focused on secondary and terary indus- to increase tax revenue and develop raw tries for their economic development. The materials–based industry, all the prov- importance of the secondary and terary inces except Shaanxi have shown limited industries was enhanced, whereas agricul- results. Local industrial output values are ture had not been duly developed. not high, and with the abolishment of the agriculture tax, the rao of tax revenue to expenditure in poverty-stricken areas will Fiscal Position decline further. Currently, local public finance in the In addion, the output value of the PRC, especially public finance below the service industry in these areas is very county and township levels, is mostly low. Many poverty-stricken areas are payroll finance, and a considerable num- in mountainous regions with beauful ber of poverty-stricken areas rely on fiscal scenery, and the idea of developing the subsidies to maintain operaons. In these service industry, especially the tourism poverty-stricken areas, the expenditure industry, has merit. However, this is not in the interest of local governments because the service industry yields lile local tax The importance of the secondary revenue. Currently, industries in poverty- and tertiary industries was stricken areas are mostly energy intensive enhanced, whereas agriculture had and highly pollung, which will affect the development of the service industry and not been duly developed

39 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

for exisng staff accounts for over 60% Typical of the situaon in rural areas, the of the total fiscal expenditures, and this core poverty-stricken counes in Guizhou number is rising. In 2003, the percentage lack not only a sound township fiscal reached 92.9% in Shaanxi. Because local system but also sufficient fiscal resources private economies are underdeveloped for educaon and medical care. In 2000, and employment opportunies are scarce, the per capita spending for public health in people have a strong incenve to get gov- urban areas was 3.8 mes the spending in ernment posts. rural areas. In 2004, this figure increased to 4.2 mes. Many farmers lack basic med- In the current paern of resource allo- ical insurance, and many poverty-stricken caon, the central and provincial gov- households are lost in a vicious cycle of ernments control most public finance poverty and illness. Educaon and medi- resources whereas the county and cal treatment accounted for 29.7% of rural township governments are responsible household borrowing in 2004, and funds for a large proporon of social security used for such purposes are less likely to be and social development expenditure. repaid. Moreover, although investment in Under the current fiscal and investment educaon is very important to families and systems, central and provincial govern- to the country as a whole, the short-term, ments mainly invest in large and medium- direct benefit from educaon investment sized infrastructure projects, and it is remains low. difficult to cover vast rural areas. Thus, county and township governments are Preferenal tax treatment and other gov- responsible for the construcon of small ernment subsidies represent the major- and medium-sized infrastructure in rural ity of fiscal support for rural finance. For areas, but they have difficulty fulfilling instance, RCCs in eight provinces (expanded such responsibility due to their limited to 21 provinces in January 2004) received financial strength. an exempon from a 3% business tax for the period from January 2003 to January 2005, resulng in a total tax exempon of Many farmers lack basic medical CNY1.7 billion, and the business tax on RCCs insurance, and many poverty- in other provinces was halved. In 2003 and stricken households are lost in a 2004, RCCs in the eight provinces also paid CNY1.6 billion less in income tax. In addi- vicious cycle of poverty and illness on, governments subsidized the RCCs for losses resulng from the interest rate rise The deteriorang fiscal posion of pov- on their inflaon-linked deposits for the erty-stricken counes affects the sus- period from 1994 to 1997. tainable development of local financial instuons. Because public finance at the township level is used primarily to Sources of FarmersÊ Income finance payroll, heavy rural debts affect Growth the operaon of rural financial instuons and represent an important factor Farmers’ per capita net income in the pov- constraining their sustainability. There is a erty-stricken counes of the six western relavely serious financializaon of rural provinces increased by over CNY200 per debts in the sample counes, and a large year from 1999 to 2003. In poverty- proporon of these debts are owed to stricken areas of Gansu and Sichuan, the rural credit cooperaves (RCCs). growth of rural households’ per capita

40 RURAL ECONOMIC SITUATION nonagriculture income exceeded the tripled during the 5-year study period. growth of per capita net income, indicang Remiance by migrant workers comprised a decrease in rural households’ agriculture an important part of the local per capita income. In Guizhou, Ningxia, and Yunnan, net income, and farmers’ income growth the growth of rural households’ per capita in these poverty-stricken areas increas- nonagriculture income also accounted for ingly relies on rural labor transfer and the over 50% of their increased income. employment opportunies created through economic growth in more-developed Both the number of migrant workers from regions. The income of rural migrant work- poverty-stricken areas and their income ers has become the most important source have been increasing. Guizhou posted the of income growth in poverty-stricken areas, greatest increase; income of migrant work- indicang that government poverty allevia- ers from its poverty-stricken areas nearly on policies have an insigniﬁcant eﬀect.

41 CHAPTER 3 Rural Financial Services for the Poor and for Rural Migrants

Local Institutional Outlets

The People’s Republic of China (PRC) has established a rural financial system featuring both formal financial instuons, which serve as major providers of financial services in rural areas, and informal financial instuons and nongovernment microcredit organizaons, which serve as valuable supplements. Rural financial products comprise loans and microcredit, remiance services, and in a few regions, agriculture insurance. Rural financial product innovaon has been springing up. However, the rural financial market sll suffers from lack of compeon, weak performance, and inability to meet the demands of agriculture and rural economic development.

As of this wring, formal instuons—including the Agricultural Bank of China (ABC), the Agricultural Development Bank of China (ADBC), the Postal Savings Bank of China (PSBC), and rural credit cooperaves (RCCs)—have outlets at and below the county level, though the ABC has substanally withdrawn since 2000. The ADBC has outlets in 1,606 counes, but not in most poverty-stricken regions. Around 20% of poverty-stricken areas have PSBC outlets. A China Banking Regulatory Commission survey found that financial instuons covered most county areas but fewer and fewer townships and villages. This was parcularly true in the western regions.1 By the end of 2005, there were slightly more than 126,000 depository instuon outlets at or below the county level, down by 24% from approximately 166,000 in 2000. Of these, 49,000 outlets were in counes, 62,200 were in townships, and 9,368 were in villages. On average, there are 25 outlets per county, 2 outlets per township, and 1 outlet for over 50 villages (Table A.1). About 65% of townships have only PSBC and/or RCC outlets; these two types of financial instuons accounted for 87% of total financial outlets in townships and 90% in villages.

43 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Commercial banks (excepng the ADBC, (Table A.2), implying the withdrawal and the PSBC, and RCCs) also have substanally merger of many financial instuons in the reduced staff at or below the county level. rural financial market and reduced compe- From 2000 to 2005, the number of employ- on in general. Relavely speaking, more ees decreased by 14%. By the end of 2005, financial instuons were scrambling for commercial banks had 31,900 outlets and the rural deposit market, which reduced the 431,400 employees at or below the county level of concentraon in this market, but level, a decrease of 26,200 outlets and these instuons were not making loans 179,000 employees from 2000. locally. Guizhou was a counterexample; it posted a declining concentraon in both Distribuon of financial instuon employ- deposit and loan markets, with the level of ees is much higher in the eastern region concentraon in its loan market declining than in the western region. By 2005, there by nearly 12 percentage points. were 1.3 employees per thousand people in the eastern region, as opposed to The market share of the ABC, postal sav- 0.9 employees per thousand people in ings, and the RCCs in the sample coun- the western region. A survey demon- es changed less in the deposit market strated that approximately 64% of rural (Table A.3) than in the loan market households considered the number of (Table A.4). For example, the ABC’s share local financial instuons to be proper, of the loan market dropped by nearly whereas around 24% considered it to be 7 percentage points from 1999 to 2003, on the low side. Moreover, approximately whereas RCCs’ share of the deposit mar- 22% of rural enterprises and 16% of rural ket increased by just under 5 percentage households regarded inadequate cover- points during the same period. The share age of local financial instuons to be the of loans from other state-owned com- major reason for difficult access to credit. mercial banks was close to 20% in 2003. Although these instuons’ share of the deposit market is lower than in 1999, it is Data showed a small increase in the much higher than their share of the loan concentration of the deposit and loan market (12%), meaning that these state- owned commercial banks took funds out markets in 54 counties from 1999 of western rural areas. to 2003 Due to the rapid expansion of the enre Our survey in six western provinces sup- rural deposit market, the total deposit ported previous studies’ conclusions about of postal savings in 2003 was over three the concentraon of rural finance. The mes that in 1999, but its market share concentraon of deposit and loan markets moved up less than 4 percentage points. in the sample counes during the obser- The deposit market share of postal sav- vaon period was measured using the ings in poverty-stricken areas increased Herfindahl-Hirschman Index. The higher the from 7.4% in 1999 to 11.1% in 2003. The index, the higher the market concentraon expansion was parcularly significant in or monopoly, with a score of 1 implying a the sample counes in Shaanxi, where the monopolized market. Data showed a small postal savings market share almost dou- increase in the concentraon of the deposit bled, from 10.6% in 1999 to 20.8% in 2003. and loan markets in 54 counes from 1999 to 2003. The concentraon of the loan mar- Among the 54 counes surveyed, 22% ket (around 39%) was slightly higher than of villages and townships had no RCCs. that of the deposit market (around 36%) Fi y percent of villages and townships in

44 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS

Sichuan had no RCCs. From 1999 to 2004, oriented approaches are needed to the absolute number of RCCs decreased by improve financial support for sannong. 15% and the number of rural households Policy finance includes agriculture loans, per RCC increased from around 3,000 to poverty alleviaon loans, and policy loans. over 3,770. Thus, the workload of each RCC increased by an average of over 20%. The strategic adjustment of the ABC, Each RCC loan officer had to take care of the shi ing funcon of the ADBC, and approximately 1,500 rural households the decreasing share of ADBC loans in on average; in Guizhou, the figure was poverty-stricken areas has made rural 2,278 households. Given a loan coverage credit cooperaves the main force in rate of about 58%, each loan officer was rural finance. However, RCCs are unable thus responsible for issuing and managing to adapt themselves to the diversified loans for over 800 households—a difficult demand for rural finance, and in many task, even without considering the limited regions can only meet simple producon transport and infrastructure in poverty- needs of rural households. High operat- stricken areas. Under such circumstances, ing costs and transacon risks have led it is hard to ask for quality loan issuance to RCC losses in the western region. Total and management. RCC losses in the 54 sample counes exceeded CNY105 million in 1999 and With the reform of the state-owned com- CNY25 million in 2003 (Table A.5). mercial banks, the ABC has posioned its operaon at or above the county level and has been withdrawing or merging its The strategic adjustment of the ABC, outlets below the county level in many the shifting function of the ADBC, of the core poverty-stricken counes. By the end of 2005, the ABC had merged or and the decreasing share of ADBC closed 8,601 outlets in the central region loans in poverty-stricken areas has (about 39% of outlets since 2000) and made rural credit cooperatives the 4,635 outlets in the western region (about 31% since 2000). As a result, the number main force in rural finance of ABC outlets in villages and townships, and the number of ABC employees, has RCC funding sources in 2003 included been decreasing, especially a er 2000. On PBC agriculture loans, deposits, and funds average, 85.4% of villages and townships transferred from the provincial RCC, and had no ABC office by 2005, and the trend the average interest rate was less than is connuing today. 3% per annum. The average interest rate on PBC loans was 2.25% from 1999 to 2003, increasing to 3.24% in 2005. In addion, Agriculture and Poverty the average RCC interest rate was 7.3%, Reduction Loans yielding a spread of 3.5 to 5.5 percentage points. The spread enabled RCCs to provide The central government aaches great necessary financial services in poverty- importance to the issues of agriculture, stricken areas, but it could not make up farmers, and rural areas (sannong), and for the operaonal and transacon costs in turn, to relevant financial policies. In of RCCs. For example, the average salary this regard, the ABC, the ADBC, and the of RCC employees increased by 12% per People’s Bank of China (PBC) have made year, from over CNY10,000 in 1999 to over tremendous efforts to undertake some CNY20,000 in 2003, likely the fastest salary fiscal funcons, although new, market- increase of any financial instuon in the

45 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

world. Although the actual income of RCC this ﬁgure reached 67% in 2002 and employees was not salary only (the actual 124% in 2003, indicang either that the income of some might be several mes RCCs in the sample counes in Ningxia their salary), the salary increases were were unable to absorb the PBC loans not aﬀected by RCCs’ high nonperforming or that these loans were used for loan raos. other projects.

With the support of the PBC’s agriculture Poverty alleviaon funds increased from loans, RCC loans in poverty-stricken areas CNY6.8 billion in 1999 to CNY15.8 billion increased significantly from 1999 to 2003, in 2003. In terms of the funding structure, and average loans outstanding more government bonds projects and fiscal than doubled. In poverty-stricken areas funds for poverty alleviaon increased, in Ningxia, RCCs loans more than quadru- whereas funding for work relief programs pled from 1999 to 2003, and microcredit decreased (Table A.6). Although road loans to rural households accounted for construcon under state bonds projects is 74.8% of total loans in the province in conducive to rural development, the work 2003. In Guizhou and Ningxia, RCCs’ share relief program has more direct impact on of the loan market more than tripled. rural households. Moreover, fiscal funds Overall, the market share of RCC loans has for poverty alleviaon were allocated been increasing, from less than 14% in through different government agencies 1999 to about 25% in 2003, and it conn- and the fiscal fund–supported projects ues to rise. were not coordinated with financial policies, further discounng the loans’ poverty In Guizhou and Ningxia, RCCsÊ share alleviaon effects. of the loan market more than tripled The commercializaon of the ABC, its mergers and withdrawals from poverty- As RCC loans to rural households in the stricken areas, and its transfer of loan deci- sample counes increased, agriculture sion making to upper-level branches did loans in these regions by the PBC also not improve the quality of loans in these increased, from about CNY146 million areas. On the contrary, its loan interest in 1999 to over CNY8 billion in 2002. collecon remained at around 50% from However, in 2003, the PBC adjusted the 1999 to 2003, with a minor decrease in geographic distribuon of its agriculture Ningxia and Sichuan (Table A.7). The loans. As a result, loans for the sample situaon was less opmisc for the ADBC, counes in the six provinces declined whose nonperforming loan rao increased to CNY4.4 billion, whereas Ningxia and from 24.9% in 1999 to 29.4% in 2003 Yunnan showed an increase of over (Table A.8). 50% from the previous year. The PBC’s share of the new loans increased from ABC loans mainly include agriculture loans, just under 27% in 2000 to nearly 52% in poverty alleviaon loans, township and 2002 before dropping back below 30% village enterprise loans, and loans for the in 2003. During the same period, the purchasing and processing of grains, coon, new loans of RCCs in the sample coun- and edible oils. Between 1999 and 2003, es increased from CNY6.7 billion to there was a slight increase in the total CNY15 billion. Approximately half of the size of ABC loans in the sample counes new RCC loans in the sample counes (Table A.9). The increases were mainly in were supported by PBC loans. In Ningxia, agriculture loans and poverty alleviaon

46 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS loans, which accounted for approximately no change in the ABC’s loans outstand- 60% of the ABC’s loans. However, the ABC’s ing, but the rao of deposits to loans was loans for township and village enterprises rising (Table A.13), indicang a declining decreased from 7% in 1999 to 4% in 2003 role for state-owned commercial banks in (Table A.10), and loans for the purchase and poverty-stricken areas. processing of grains, coon, and edible oils decreased from 5% in 1999 to 3% in 2003. In terms of the ABC’s corporate loan struc- This was parcularly true in the sample ture in the sample counes, there was counes in Ningxia and Yunnan, where an increase in loans for family businesses there was a dramac decline in township but a small decrease in loans for collecve and village enterprise loans, from 6% in and state-owned enterprises (Table A.14). 1999 to 2% in 2003. The sample counes in Loans for state-owned enterprises in the Gansu also saw loans decrease by one-half. sample counes in Guizhou and Yunnan This indicates that township and village sll accounted for over 50% of total loans, enterprises in these areas were shrinking reflecng underdeveloped private enter- and generally too inefficient to meet the prises in these areas. ABC loan requirements. Since 2001, the reform of the grain circula- The ABC’s short-term agriculture and on system has trimmed the funcon of township and village enterprise loans also the ADBC to issuing loans for grain pur- have been decreasing, and its loans for chases and has transformed the monopoly rural medium- and long-term state bonds status of the state-owned grains circulaon projects are focused on infrastructure enterprises. Even so, ADBC loans for grain such as transport. In terms of loans out- purchasing and selling have decreased standing, the ABC remains number one, notably, and only short-term grain purchase accounng for over 40% of the market. loans are being issued. Many regional ADBC There was a fast decline in the ABC’s operaons have been suspended, ghten- operaon in Guizhou from 2001 to 2004, ing the supply of policy finance, such as with RCCs taking most of the market medium- and long-term loans, in the rural share in the sample counes, yielding financial market. increased market concentraon. In 2001, the ABC’s poverty alleviaon loans for rural households began declining relave Loans for state-owned enterprises to the total number of similar loans in the in the sample counties in Guizhou sample counes in Guizhou and Yunnan, and in some areas, the ABC ceased pov- and Yunnan still accounted for erty alleviaon loans for rural households over 50% of total loans, reflecting in favor of project loans (Table A.11). This underdeveloped private enterprises created unequal compeon in the rural financial market. in these areas

With the excepon of the sample coun- Moreover, although the ADBC is the only es in Guizhou, the ABC’s medium- and policy bank in poverty-stricken areas, it long-term loans rose to over 55% of the had no outlets in many poverty-stricken total (Table A.12), indicang that new counes in 2003 and declined loans in loans in these poverty-stricken areas sample counes in Guizhou and Shaanxi. were mostly directed toward infrastruc- Moreover, its average share of the loan ture projects such as transport and market dropped from 11.3% in 1999 to hydropower staons. There was almost 9.4% in 2003 (Table A.4). In the sample

47 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

counes in Ningxia, the ADBC’s market naonwide experience with microcredit share was cut nearly in half, indicang a loan operaons. In 2002, all RCCs began weakened role for the ADBC as a policy promong microcredit at full scale. Micro- bank in poverty-stricken rural areas. credit and group loans effecvely solved the problem of loan guaranty and expanded PeopleÊs Bank of China Lending to the coverage of loans for rural households. Support the Agriculture Sector In 2003, the pilot program was expanded to eight provinces, and CNY38 billion in The PBC has provided extensive sup- central bank bills were issued to cover the port to rural financial instuons since RCCs’ historical burdens. A er that, the 1996, including lending to the ADBC in program was expanded to 21 provinces, 1996; wring off CNY345.8 billion worth and central bank bills issued amounted to of non-performing loans, some of which CNY168 billion. were central bank loans, in 1998 and 1999; and lending to RCCs in 1999 to encourage By the end of 2003, microcredit opera- them to provide farmers with microfinance ons were being managed by 31,446 and group loans. RCCs across the country (90% of all RCCs) and 17,195 RCCs had provided group loans. Nearly 53 million rural households Microcredit and group loans had received microcredit or a group loan. effectively solved the problem of loan However, RCCs in many areas sll could meet only the simple producon needs of guaranty and expanded the coverage rural households. The high percentage of of loans for rural households rural household microcredit in poverty- stricken areas reflected the stagnaon A er the separaon of the RCCs from the of local private enterprises and family ABC in 1996, the RCCs’ nonperforming loan businesses. rate soared. Massive bankruptcies of township and village enterprises, coupled with Microcredit in the sample counes problems within the rural cooperave foun- increased from CNY72 million in 1999 daons themselves, le the RCCs weak- to 1.8 billion in 2003, an increase of ened, making it more difficult for farmers to 150% per year. The RCCs allocated exten- access credit. To enable RCCs to strengthen sive resources to promote this business, their support for sannong, the PBC supple- and farmers’ demand for microcredit mented the RCCs with low-interest loans.2 was strong. Microcredit also boosted the In 1999, Jiangsu Province was chosen for percentage of RCC rural household loans a pilot program of rural household micro- to over 70%, except in the sample coun- credit and group loans, for which the PBC es in Yunnan, where the rao dropped provided CNY5 billion worth of interest-free from 71.6% in 2002 to 51.8% in 2003. This loans. Because rural household micro- reflected the underdeveloped industry credit has simple procedures and requests in poverty-stricken areas and the efforts no collateral or guaranty, it has been well of the PBC to boost microcredit through received by most farmers and has evolved agriculture loans. to become the major means by which RCCs can serve sannong. In 2004, the PBC increased the RCC loan quota by CNY5 billion, which was used to In 2002, the PBC promulgated the Guide- boost producvity in the grain-producing lines on the Management of RCC Micro- regions. In addion, the PBC adjusted the credit for Rural Households, based on geographical distribuon of the remaining

48 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS credit line, transferring CNY4 billion in loans over loans to farmers, because the two from eastern coastal and more-advanced types of loans yield different returns, areas to the central, northeastern, and undermining the PBC’s efforts to direct a western regions. By the end of 2004, the required percentage of microfinance loans quota of agriculture loans from the PBC to farmers. Finally, the use of unscienfic had reached CNY128.8 billion, with total methods to determine microfinance loans outstanding of around CNY100 credit lines and credit rangs, as well billion. A er that, the PBC decided not as overreliance on village or township offi- to increase quotas but to lt its policies cers, may add to the risks of microfinance toward the central, northeastern, western, in some localies. and grain-producing regions. In all, though microfinance loans are mov- Issues with PeopleÊs Bank of China ing in the right direcon, the microfinance Lending for Agriculture Support business suffers from high costs and risks. In the absence of a risk compensaon mecha- Although the PBC’s agriculture loans have nism, the PBC is the risk taker of last resort. somewhat improved farmers’ access to credit in poverty-stricken areas, the ever- Another problem is the lack of proper prin- increasing number of outstanding loans ciples to guide the issuance of agriculture also creates problems. For example, RCC loans, which can result in poorly perform- microfinance loans create systemic risks ing RCCs being financially rewarded and with the potenal to endanger the PBC’s high-performing RCCs being punished. The agriculture fund. The only characterisc issuance of agriculture loans is based on that disnguishes microfinance loans from whether the RCC is from a large agricultural enterprise loans is the more diverse credit province or the midwestern region, rather lines of microfinance loans. At present, than on its performance in supporng most RCCs operate at the township level, sannong. As such, agriculture loans may fail with only a few at the county level, making to be used for their designated purposes it difficult to achieve geographic diversifi- and cannot provide RCCs with appropriate caon in the fund. incenves. Instead, agriculture loans o en are allocated to instuons with low effi- Another hazard is the nature of the agri- ciency and poor management. In fact, RCCs culture sector itself. In the absence of incurring greater losses need more capital agriculture insurance, the sector is very and hence are more eligible for PBC agricul- vulnerable to natural disasters. Moreover, ture loans. RCCs in less-developed regions some local governments have conducted suffer from heavy historical burdens, poor so-called agricultural restructuring, inter- management, a high nonperforming loan vening in farmers’ producve acvies and rao, and limited sources of funding. The requesng that all farmers within their combinaon of these factors may endanger respecve jurisdicons produce the same the repayment of agriculture loans and put crops. Microfinance loans to these farmers the fund at risk. are therefore suscepble to both environmental and market risks. RCCs in less-developed regions Third, because microfinance loans feature suffer from heavy historical small sizes, diverse clientele, and high burdens, poor management, a high administrave costs, controlled interest rates cannot cover cost and risks. In addi- nonperforming loan ratio, and on, RCCs prefer loans to enterprises limited sources of funding

49 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Management of agriculture loans also is not recover these funds from RCCs that difficult. RCCs keep accounts of PBC lend- have expended their required reserve ing simply for the sake of bookkeeping, and emergency funds. In all, using central and omissions are common. The issuance, bank funds to improve farmers’ credit ulizaon, and collecon of the PBC’s agri- access might hide exisng problems culture loans are not tracked separately in RCCs and bring about a new series but rather are mixed with the agriculture of risks. loans from an RCC’s self-collected funds. As a result, it is difficult to manage a Furthermore, many borrowers do not microfinance fund independently or to have a clear understanding of the pur- guarantee that the fund is used only for pose of agriculture loans. Some RCCs designated purposes, and effecve regula- regard them as policy loans intended on is impossible to achieve. For instance, to maintain social stability and solidar- some PBC funds may be used to provide ity, whereas others believe that, in case credit to companies or to cover farmers’ of default or farmers’ late payments, an medical expenses. In addion, because the RCC will have to repay the central bank interest rate on agriculture loans is rela- with its own funds. These misunderstand- vely low and stable, some RCCs apply for ings have created passivity among RCCs PBC agriculture loans while invesng most instead of encouraging them toward pro- of their surplus funds in corporate and acve financial innovaon. The various Treasury bonds with higher yields. problems associated with central bank lending cannot be fully addressed unl The most successful rural financial such misunderstandings are corrected. institutions, such as the Bank Rakyat The limited use of agriculture loans is not conducive to the RCCs’ commercial viability, Indonesia, usually start with loans for their cooperave nature, or their objecve nonagriculture activities of becoming financial instuons serving communies. The most successful rural Because of low interest rates and a lack financial instuons, such as the Bank of lending criteria, agriculture loans are Rakyat Indonesia, usually start with loans increasingly likely to generate moral for nonagriculture acvies. Only a er they hazards. RCCs in a short capital posi- develop into mature financial instuons on rely on central bank lending rather can they provide agriculture loans. Even than on taking deposits. In addion, cooperave financial instuons in devel- although the 2002 Guidelines on the oped countries, such as Crédit Agricole in Management of RCC Microcredit for Rural France, must cover cooperave finance Households require mely repayment, losses with profits from other businesses, maturity may be extended from 9 months parcularly commercial operaons. to 12 months, and cross-year ulizaon of an agricultural quota by branches is Despite the huge volume of PBC funds allowed. Thus, the actual term can be as flowing into rural financial instuons, the long as 3 years. Because there is a me outputs are negligible. Due to restricons lag (usually 2 years) between loan issu- on capital sources and systemic loopholes ance and default, many RCCs hide risks in the rural financial market, rural financial and expand loan sizes, which totaled instuons suffer great losses, aggravang more than CNY100 billion in 2004. If the financial risk, and commercial banks agriculture loans become nonperform- are therefore reluctant to enter the rural ing loans in a few years, the PBC may financial market. Such capital oulow from

50 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS the countryside is not a phenomenon three types of poverty reducon funds unique to the PRC; other countries have (e.g., fiscal funding, interest-subsidized the same problem. loans, and work-for-aid) also rose, from 55% in 1986 to 63% in 2002. Development of Poverty Reduction Loans In 2001, the PBC, the Ministry of Finance, and the Leading Group Office of the State The poverty reducon credit fund was Council for Poverty Reducon jointly established in 1986 to support priority issued the Measures on Management of poverty-stricken counes and to provide Poverty Reducon Loans with Discounted an important force for poverty reducon. Interest Rates, which set new require- Following the establishment of the fund, ments for the management of poverty poverty reducon efforts were intensi- reducon credit funds. Such funds come fied. As of 1993, CNY10 billion in loans had mainly from ABC deposits, and the ABC been issued. can apply for central bank lending at the normal interest rate. The PBC prescribed In 1994, the ADBC was given responsibil- that such loans should be issued indepen- ity for the issuance and management of dently by commercial banks and include poverty-reducon loans. However, due to project and household loans. The size of the limited number of ADBC subbranches the credit fund is subject to recommenda- and the high cost of managing loans, the ons rather than direcves. central government decided that the ABC should take over the issuance and man- At this new stage, the poverty reducon agement of poverty reducon loans a er credit fund is less policy oriented and May 1998 and should conduct its com- more commercial. Nonetheless, poverty mercial operaons based on principles of reducon loans are policy loans, a fact lendability and zero default. reflected in the preferenal interest rate, which at 2.88% per annum is lower than In 1994, the 8-7 Naonal Poverty Reduc- the benchmark interest rate. The remain- on Program was adopted, signaling a ing poron of interest is subsidized by the new stage in poverty reducon efforts. central government and is included in the To expand producon and increase the annual fiscal budget. income of poor farmers in poverty- stricken areas, the central government scaled up the size of the poverty reduc- The PBC prescribed that such loans on fund to CNY10 billion in 1998 and should be issued independently CNY15 billion in 1999. by commercial banks and include In 1999, for the sake of standardizaon, project and household loans the State Council decided to fix a unified preferenal interest rate for pov- According to the 8-7 Naonal Poverty erty reducon loans. The credit reached Reducon Program, poverty reducon CNY18.5 billion in 2001 and 2002. As loans with discounted interest rates are of the end of 2002, outstanding pov- designed to help low-income people in erty reducon credit stood at just over poverty-stricken counes increase their CNY90 billion—CNY55 billion more than income and improve their living condi- in 1998, when the ABC resumed manage- ons. To ensure that the loans are truly ment of the loans. Along with the aggre- used to li this group of people from gate increase, its proporon among the poverty, the ABC is required to select

51 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

borrowers from a list provided by grass- and human resources. However, because roots poverty reducon offices. The the ABC has been closing branches, these discounted interest payment is subject to resources o en are not available. confirmaon by local financial bureaus and poverty reducon offices. By the end For example, Guizhou Province has of 2000, outstanding poverty alleviaon 48 state-designated poverty-stricken loans stood at CNY70.5 billion; by 2001, counes comprising 874 townships, but they stood at CNY79.2 billion; and by 2003, only 200 townships have ABC outlets, and they had reached CNY96 billion with inter- the average number of loan officers is est subsidies of CNY620 million. between three and five. This small number of loan officers is responsible for the distri- Issues with Poverty Reduction Loans buon and daily management of poverty reducon loans in four to five townships, Though poverty reducon loans are requiring addional staff from county sub- designed to benefit farmers and rural branches to distribute loans extensively regions, the loans suffer from a high and quickly. The ABC branch in Changshun nonperforming loan rao and poor per- County, for instance, has 13 loan officers formance. This is due to the contradicon covering 23,000 clients, a nearly impos- between the goals of policy lending and sible situaon because it normally takes those of commercial banking, to high capi- several days to visit each client in an aver- tal costs, and to government intervenon age village of 100 households. in loan disbursements. To ensure that poverty alleviaon loans reach rural households, local governments The discounted interest payment and poverty reducon offices require that is subject to confirmation by local 85% of loans be allocated to core poverty-stricken counes and that 85% of the financial bureaus and poverty funds go to poverty-stricken households. In reduction offices addion, the maximum amount per loan is set at CNY50,000; most loans are less Because of the conflict between the objec- than CNY2,000. This small scale, coupled ves of a poverty alleviaon loan and with the large amount of retail lending in those of a commercial bank, ABC loans geographically scaered poverty-stricken to rural households have been decreas- households, has added to already high ing since May 1998. Although the ABC is operang costs. In 2000, for instance, given a subsidy to cover the difference rocky roads shortened the life of a four- between the interest on poverty allevia- wheel-drive vehicle used by the ABC’s Libo on loans and the interest on standard County branch to develop poverty allevia- loans, it manages poverty alleviaon loans on loans. The ABC branch in Guizhou in accordance with commercial standards. Province spent CNY58,500 for every Interest-subsidized poverty alleviaon CNY1 million in microcredit loans, loans are mainly provided to support the CNY39,000 more than the cost of loans to aquaculture and animal husbandry busi- other businesses. In other words, the dis- nesses of poverty-stricken households. tribuon cost of microcredit loans is nearly These loans are subject to seasonal 5.9%, 3.9 percentage points higher than fluctuaon, ght processing schedules, the cost of loans to other businesses. In large numbers of transacons, large pracce, therefore, poverty reducon loans numbers of borrowers, and small loan are retail loans with much higher operang sizes, requiring significant instuonal costs than wholesale loans. As such, the

52 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS goals of policy finance contradict the com- neglect the management and servicing of mercial operang principles of the ABC. the loans or the support and educaon of borrowers. There is a widespread miscon- Funding is another issue. Funds for pov- cepon among local government officials erty alleviaon loans are provided by the and borrowers that poverty alleviaon ABC; the government provides only inter- loans are public funds that do not require est subsidies. Because these loans mainly repayment. Some local governments view target deprived counes where the ABC poverty alleviaon loans as public aid and has more loans than deposits and depends distribute them freely, at mes even to the on interest spread for profit, these ABC deceased. In some places, local govern- offices must request funds from other ABC ments take advantage of the loans and use organs. The ABC’s prevailing intrabank them to collect various taxes and charges. lending rate is 4.32% per annum, whereas the interest rate on poverty alleviaon Thus, loans are likely to be treated like loans is 3%, plus a government subsidy other types of poverty reducon funds, of 5.85% or 5.94% (a er the increase in and this in turn influences borrowers’ the PBC base rate). This implies that if willingness to repay. In the case of the funds are borrowed from higher-level ABC ABC, the policy nature of poverty reduc- branches, the county branch will incur a on loans is reflected only in the Ministry net loss of 5.38% to 5.47% per year for of Finance subsidy covering the difference disbursing poverty alleviaon loans, even between interest rates on poverty reduc- without considering repayment rao.3 on loans and the market interest rate. Otherwise, loan management accords with Local governments and county poverty commercial principles, ulmately leading reducon offices intervene excessively in to losses on the part of the bank. By the the disbursement of poverty alleviaon end of 2001, the ABC’s cumulave nonper- loans, and a large number of household forming poverty alleviaon loans reached loans have been made in some areas CNY32.82 billion, equivalent to 41.4% of all where such loans are not suitable. When poverty alleviaon loans. making poverty alleviaon loans to rural households, the ABC generally uses a Some local governments view client list provided by the local poverty reducon office and has neither the abil- poverty alleviation loans as public ity nor the means to examine whether aid and distribute them freely, at borrowers meet the lending criteria or to manage the loans on a daily basis. Some times even to the deceased local governments even ask the ABC to support uncompeve projects featuring Since 2001, the ABC has stopped its special anquated technologies and poor techni- evaluaon of poverty alleviaon loans cal proficiency. For instance, by the end of and has started to combine such evalua- 2000, the ABC had provided CNY1 billion on with the evaluaon of other types of worth of poverty reducon loans to loans. This has linked employee remunera- processing enterprises in poverty-stricken on to loan performance, strengthened counes in Guizhou, but the nonperform- accountability for nonperforming loans, ing loan rao exceeded 85%. and strengthened the assessment of poverty alleviaon loans. In pracce, however, In addion, many local government because county poverty reducon offices authories emphasize only the disburse- decide on loan borrowers whereas the ment of poverty alleviaon loans but ABC subbranches and loan officers release

53 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

and manage loans, the rights and obliga- third is the efficiency of capital uliza- ons of these two enes are asymmetric. on; that is, how much is paid to achieve There is lile incenve for local ABC offices a set target, or the input–output rao. to process poverty alleviaon loans that The fourth measure is whether the pov- will incur losses, and this has exposed erty reducon effects can be sustained related problems. and fund management instuons can become financially self-sufficient. If mea- Evaluating Poverty Reduction Loans sured against such criteria, the performance of poverty reducon loans in the Conflicts between policy and commercial PRC is unsasfactory. goals are bound to emerge. Although the ABC regards poverty reducon loans as The first challenge of poverty reduc- commercial loans with certain policy loan on loans is to target the correct group features, such loans nonetheless represent of people and to provide loans to the a kind of directed lending. Many countries needy. Poverty reducon loans are mainly cite market failure as a legimate reason granted to leading agriculture companies, for directed lending. However, extensive thereby playing a certain role in driving directed lending cannot compensate for the economic development of agriculture market deficiency and may even impede and increasing farmers’ income. However, the development of the finance sector as a because of the high risks associated with whole. Therefore, it is crically important agriculture and the inefficient manage- to evaluate the effects of such directed ment of such policy loans, poverty reduc- lending, the allocaon of scarce public on loans remain highly risky. capital, and the improvement in poverty reducon loans. Moreover, although poverty reducon loans are designed to target farming households, the ABC prefers to lend to rural Poverty reduction loans are mainly enterprises. The proporon of loans actu- granted to leading agriculture ally granted to farmers is very low, and ABC companies, thereby playing a loans to farmers have been on the decline since May 1998. According to a Poverty certain role in driving the economic Alleviaon and Development Office survey development of agriculture and in 22 provinces and autonomous regions, the ABC provided CNY17.6 billion worth of increasing farmersÊ income poverty reducon loans in 2001. Of this, just under CNY3.8 billion was loaned to Four indicators measure the performance farmers, accounng for slightly more than of single batches of poverty reducon 21% of the total. (The percentage of poor loans or individual poverty reducon proj- farmers among all farmers who received ects. The first is targeng, which refers to loans is not known.) For example, poverty whether the poverty reducon funds go reducon loans to 23 poverty-stricken to the designated poverty-stricken areas counes in Hunan Province amounted to and people. The second is effecveness CNY24 million in 2001, accounng for a in achieving desired results—including, mere 3.5% of the total poverty reducon for example, the extent to which farmers’ loans in these counes. Chifeng, in Inner income increases, how much crop pro- Mongolia Autonomous Region, distributed ducon increases, and how many more CNY88 million worth of poverty reduc- people can access potable water. The on loans, but CNY83 million of this was

54 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS loaned to leading companies and only ing loans. As of 2006, 85% of poverty reduc- CNY5 million—accounng for 5.7% of the on loans were sunk and unreceivable. total—went to farmers. Meishan, in Sichuan Province, released only CNY6 million of Even a discount from the Ministry of loans to farmers in 2006, accounng for 3% Finance is insufficient to cover such loan of poverty reducon loans in Meishan. Such losses. In 2001, the ABC issued a cumulave a low percentage plays only a limited role CNY17 billion worth of poverty reducon in driving the local economy of poverty- loans. In accordance with the 2001 Mea- stricken regions. sures on Management of Poverty Reducon Loans with Discounted Interest Rates, the The second measure of poverty reducon State Council creates an annual interest loan performance is the loans’ effecve- discount budget, which it forwards to the ness. Ironically, the low interest rate on Ministry of Finance. The ABC then uses poverty reducon loans does not benefit the interest discount budget to determine borrowers, because interest payments the size of its poverty reducon loans. represent only a small poron of borrowing cost. Our survey showed that the cost In recent years, the budget has been of loans includes gi s and kickbacks for around CNY520 million to CNY550 million, loan officers, me and transport expenses so loans are projected to be CNY18.5 billion. incurred when applying for loans, compul- Normally, however, the ABC’s poverty sory RCC membership fees, and so forth. It reducon loans are CNY4 billion to is not rare to invite loan officers to dinner CNY5 billion more than the budgeted or to provide kickbacks to loan officers or CNY18.5 billion per annum, and the excess other people in charge. The me-consum- part is subject to the benchmark inter- ing and complicated applicaon procedure est rate. Each year, loan repayment totals scares away many prospecve borrowers more than CNY10 billion. The State Council and somemes costs borrowers opportu- requires poverty reducon loans to grow nies to produce and invest. Thus, farmers yearly and requires loan repayments to be cannot access either market-rate loans or reloaned to leading enterprises and agricul- low-interest poverty reducon loans. ture infrastructure projects at the benchmark interest rate. Normally, the duraon Third, the asset quality of the ABC’s poverty of discounted loans is 1 year and no more reducon loans is poor. Between 1998 than 3 years, but other loans can feature and 2000, CNY1.3 billion worth of pov- 3-year to 5-year terms, and the benchmark erty reducon loans came due, but only interest rate applies to poverty reducon CNY120 million was repaid, a repayment loans a er their discount period. rao of merely 9%. By the end of 2001, nonperforming loans outstanding reached The ABC then uses the interest CNY32.8 billion, up CNY2.8 billion from the previous year, for a nonperforming loan discount budget to determine the size rao of 41.4%—an increase of 1.5 percent- of its poverty reduction loans age points. As of the end of 2002, the total outstanding nonperforming loans of the Supposing that all poverty reducon ABC reached CNY34.4 billion, represenng loans are lendable and repayable, non- 38% of total poverty reducon loans— performing loan losses must be included 10 percentage points higher than the non- with overhead, expenses in securing performing loan rao of other loans. Up to repayment, and funding costs when cal- 60% of loans to farmers were nonperform- culang the total cost of lending.

55 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

The operaonal cost of poverty reducon posion relave to other state-owned microloans is over 10% and, according to commercial banks and invites accusaons the ABC’s calculaon, the average cost that the ABC uses low-cost poverty reduc- of issuing and managing poverty reducon loans to undertake commercial lend- on loans is 7%. Even if the ABC receives ing acvies. As such, low-rate poverty interest payment in full and receives a reducon loans disturb the order of the mely interest discount, poverty reduc- ﬁnancial marketplace. on loans are prone to incur losses.

Such a financial system seems unsustain- Remittances of Rural Migrants able, thus failing the fourth performance test for poverty reducon loans. Accord- The PRC’s dual economic model has ing to the survey in Guizhou Province, for increased agricultural producvity and example, outstanding discounted poverty subsequently created surplus farm labor. reducon loans stood at CNY7.76 billion as It also has increased foreign and domes- of October 2001, including CNY3.26 billion c investment and job opportunies in in nonperforming loans (42% of loans) and the coastal regions while constraining a microloan repayment rao of only 21%. farmland transacons. These factors, in Although the spread between the required addion to the residenal registraon interest rate and the interest rate on pov- system, have led to an increasing number erty reducon loans was narrowed from of domesc migrant workers in the PRC. A 7.2 percentage points in 1989 to 2.3 per- paern of temporary migraon has helped centage points in 2002, the interest dif- to generate a huge inflow of money from ferenal remains, and the spread between migrant workers to their families at home. the ABC’s floang interest rate and the Compared with migrant workers in other interest rate on 1-year poverty reducon countries, migrant workers in the PRC send loans can be as high as 5.6%. Thus, the a higher proporon of their income home. interest rate on poverty reducon loans can be much lower than the ABC’s base Remiances from migrant workers have interest rate, dampening the ABC’s enthu- contributed to an improvement in farm- siasm for such loans and resulng in a ers’ incomes and welfare and have aided plummeng loan collecon rao. rural poverty reducon by decreasing the consumpon of grain and other goods on farms. Returning migrant workers also Since 2001, for example, the ABC has bring in addional income by using new gradually reduced loans to farmers in ideas and skills learned while working in favor of directing poverty reduction the coastal areas. The income of migrant workers, comprising 20% to 50% of total loans to projects family income in the receiving households, is crucial to paying for educaon, family Such a situaon can also disturb the mar- medical expenses, and some other basic ket order. Since 2001, for example, the consumpon expenses. ABC has gradually reduced loans to farmers in favor of direcng poverty reducon The quality of remiance services affects loans to projects. But such project loans, rural migrants’ contribuon to family parcularly when used for infrastructure, income and consumpon. An improve- are actually commercial loans in the ment in remiance services not only name of poverty reducon. This pracce will bring about addional income and puts the ABC in an unfairly compeve w elfare gains for migrant workers and

56 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS their families but also will benefit broader In general, migrant workers in the PRC rural communies by increasing the out- send money home either through a reach of formal financial services to the formal remiance provider or by carry- poor in the PRC. ing money home themselves.4 The survey of 400 migrant workers in Zhejiang found Demand for Remittance Services that about half channeled their remittances through postal savings outlets, a Migrant workers usually are defined as quarter carried money home, and a quar- rural laborers transferred out of their ter employed commercial banks, usually home counes for more than 6 months. the ABC. Rural credit cooperaves were So defined, there were 30 million to used by less than 5% of migrant workers. 40 million migrant workers annually from 1997 to 1999 and an average of 75 mil- These findings were confirmed through lion migrant workers annually from 2002 focus group discussions in Sichuan and to 2004. In 2005, the State Council’s Zhejiang. Of the 15 families interviewed Development Research Center predicted in Anyue, 9 used postal savings outlets, that the PRC must shi at least 10 million 5 carried money home, and 1 used the rural laborers out of farming each year for ABC. Rural credit cooperaves are not a approximately 10 years to cope with an popular channel for remiance. According ever-increasing surplus labor supply and to the farmers interviewed, although RCC improvement in agricultural producvity. branches are located in every township of the county, the RCCs’ remiance service Overall demand for remiance services is slow and inconvenient. Some RCCs do is determined mainly by the number and not offer the service, others discourage allocaon of migrant workers, their income farmers from using the RCC for remit- levels, the proporon of income sent tance, and there is no guarantee on the home, and the rates and services offered ming of delivery. Farmers also do not by the services. Demand for remiance completely trust the RCCs and prefer to services in the PRC derives primarily from deposit large sums of money with banks. migrant workers working outside their Of the 15 migrant workers interviewed in home counes, parcularly those outside Cixi, Zhejiang, 7 used the ABC, 6 used postal their home provinces. savings outlets, 2 used other state banks, and no migrant workers used RCCs for Group interviews indicated that migrant money transfer. workers remit a relavely small amount of money home with each transacon. Demand for remittance services An average migrant worker remits money three to six mes each year, each me in the PRC derives primarily from in amounts of CNY500 to CNY1,000. migrant workers working outside Construcon workers, who are paid CNY300 to CNY400 per month, with all their home counties, particularly payment coming in a large sum at the end those outside their home provinces of a project or the end of the year, tend to remit larger sums. Migrant workers in The high proporon of families using general reported that they do not like to postal savings outlets does not necessar- remit too much money each me, for rea- ily mean that these outlets provide beer sons of security and control over spend- remiance services. Rather, the only avail- ing at home. able service providers in most rural areas

57 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

of Anyue are the postal outlets and the imposed by certain service providers RCCs, and the postal outlets are the beer (mainly postal savings outlets in certain opon. ABC offices are located only at the areas), complicated procedures in sending county seat and in large rural townships. and receiving money, and the me and money spent on collecng remiance. Based on the survey results and market In general, such real costs are higher for projecons, we esmate that formal migrant workers and families originat- financial instuons captured about ing in poverty-stricken and remote areas 75% of a CNY223 billion remiance mar- of the PRC, and for older migrant work- ket in 2004. The remaining funds were ers with low levels of educaon. Service carried home or delivered through other providers tend to charge addional fees channels. Of the CNY162.5 billion market and to provide poor service in poverty- captured by formal service providers in stricken and remote areas where few the PRC, therefore, market share was service providers are available. Logically, around CNY101 billion (62%) for postal therefore, these migrant workers are savings outlets, CNY52.6 billion (32%) for more likely to carry cash home. commercial banks, and CNY8.9 billion (5.5%) for RCCs. Migrant workers’ complaints about service providers in the PRC focused on fees Migrant workersÊ complaints about and quality of the service, parcularly the service provided by postal savings outlets. service providers in the PRC focused Postal savings outlets are the sole service on fees and quality of the service, provider in many remote rural areas and provide remiance services for more than particularly the service provided by 40% of migrant workers. Older migrant postal savings outlets workers with low levels of educaon are more likely to use postal savings outlets The surveys in Sichuan and Zhejiang because they are more likely to come from reveal that migrant workers select their areas where only such outlets are present. remiance channel based mainly on the It also is less complicated to use postal sav- availability of the service provider in their ings outlets than to use a bank, which usu- home or a nearby township, and on the ally requires one to open a bank account fees charged. The county seat, where the and, in many cases, to apply for a bank card. commercial bank branches are located, Many migrant workers’ family members do is regarded by most migrant workers as not know how to use a bank card. too far away from their home villages and thus is not their priority service The survey also found that only limited provider selecon. bank services are available for migrant workers in the PRC because these workers Delivery speed, quality of service, and do not have an official urban residence. safety are secondary determinants. In the The services used by migrant work- end, what maers most to migrant workers have been restricted to remiance, ers and their families are the real costs deposits, withdrawal, and the use of of remiance, rather than the nominal debit cards for deposit and withdrawal. fees charged by service providers. The Migrant workers with no local residence real costs of remiance include both are not eligible for loans from financial nominal fees and addional fees charged instuons; likewise, they are not eligible by service providers, the forced savings for credit cards.

58 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS

Supply of Remittance Services at a higher fee, and discounted real-me money transfer to a bank cardholder. The The PRC’s remiance services market so ABC’s Naonal Roaming, the China Con- far has been dominated by formal financial strucon Bank’s Fast Remiance, and the instuons because informal and micro- Industrial and Commercial Bank of China’s finance instuons are not allowed to Direct Vehicle services are real-me, but provide such services. The major service more expensive, remiance services. providers include postal savings outlets, state-owned commercial banks, and rural According to a survey of financial instu- credit cooperaves. Postal savings outlets ons in three cies of Shandong Province, are the channel of remiance most fre- 60% to 70% of all individual electronic quently used by migrant workers, followed money transfers through commercial by large commercial banks. banks were remied to recipients who had an account with the bank, 5% to 20% As of this wring, China Post has 57,136 were remied to individuals who were service points across the PRC, 41,196 of not bank clients, and 15% to 25% were which are located in rural areas. In addi- remied to a bank cardholder. The pro- on, China Post has 34,540 service points poron of remiance through telegraphic for postal savings, usually housed in the transfer and money order is very small, post office, 24,000 of which are con- generally below 10% of all individual nected electronically. In 2004, China Post money transfers. handled 180 million remiance transacons, with a value of CNY213 billion. Unlike the banks in many other developed CNY140 billion (70%) of these remiances economies, commercial banks in the PRC went to rural areas. It is esmated that charge bank clients a fee to withdraw over 90% of remiance to rural areas money from the same bank in a differ- through postal savings outlets has been ent locaon, whether through an ATM or from migrant workers. Postal savings out- over the counter. The rates are similar to lets offer three major opons for money the banks’ fees for money transfers. This transfers in the PRC: postal money orders, creates a problem for migrant workers: if a electronic express money transfer, and worker opens a bank account at home, he green card services. or she incurs a fee to withdraw money at his or her workplace, and vice versa. Some The express service offered by postal sav- migrant workers, aware of such fees, have ings outlets is more expensive than the opted to open bank accounts at home for one provided by commercial banks in the deposing and receiving money transfers PRC, which usually charge a low fee for but do not withdraw money from the their remiance products and services. account at their workplace. Other migrant The commercial banks’ fee structure on workers are unaware of the charges on money transfers within the PRC has been money withdrawn from a bank branch at subject to regulaons set by the People’s a different locaon. Bank of China and the Naonal Develop- ment and Reform Commission. The products and services of commercial banks The proportion of remittance through fall into three broad categories: regular telegraphic transfer and money order 24-hour money transfer service to a bank customer at a low fee, real-me money is very small, generally below 10% transfer to a bank and/or nonbank client of all individual money transfers

59 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

In principle, the fees for interbank money market liberalizaon, rural economic transfer are the same as the fees for intra- growth has been slower than urban bank money transfers, though intrabank growth, resulng in fewer investment transfer can be conducted only among opportunies and lower per capita income banks that have a formal money transfer in rural areas. Interest rate restricons agreement. Some small banks do not have have prevented financial instuons from such agreements with all the major banks. fully covering operaonal costs and trans- Some bank branches are not keen to con- acon risks in such areas. In addion, there duct interbank money transfer operaons, is no established favorable environment especially with smaller banks, and such for the development of informal financial transfers usually take longer. instuons. Given these factors, formal financial instuons cannot meet rural Recently, commercial banks in the PRC financial demand, especially that of small have introduced account-keeping fees for and medium-sized rural enterprises and small savings account. For example, the farmers in poverty-stricken areas. Many ABC introduced a CNY10 account fee for surveys have found that over 50% of the savings accounts or the issuance of a debit credit demand of small and medium-sized card, and the China Construcon Bank in enterprises and farmers is met through Sichuan introduced an account-keeping informal channels, but informal finance fee of CNY10 for accounts with an average has many problems. Ulmately, the mis- daily balance below CNY300. match of financial supply and demand in rural areas has affected rural economic Issues in Rural Finance development.

Internaonal experience indicates a strong Access to rural financial services for correlaon between the scale of rural sannong is hindered by high operaonal finance, gross domesc product, and risks and high transacon costs related rural per capita income. The higher the to the nature of agricultural producon per capita income, the greater the ben- and rural areas, the lack of physical and efit derived from nonsubsidized financial financial infrastructure in such areas, and services and the larger the transacon rural financial policies. For instance, the volumes, which helps compensate for small-scale producon and low income transacon costs. Rural financial demand of rural households requires microcredit, in developing countries generally depends and the management costs of small-scale, on informal financial instuons, includ- seasonal, and risky loans are inherently ing microcredit agencies, pawnshops, and high. In the absence of agriculture or cooperave associaons. Surveys by the natural calamity insurance in the PRC, World Bank and various internaonal ins- financial instuons are unable to trans- tuons suggest that convenonal financial fer the risks of serious regional natural instuons offer limited loan coverage for disasters and therefore must restrain the rural households. scale of their lending. Rural credit cooperatives offer Second, insufficient rural transport, electric- ity, water, telecommunicaons, and secu- relatively wide coverage in the PRC rity infrastructure has affected agricultural profitability, magnified the volality of rural Rural credit cooperaves offer relavely household incomes, and undermined rural wide coverage in the PRC. Nonetheless, households’ ability to repay loans, thus during the past 3 decades of reform and increasing the costs and risks of extending

60 RURAL FINANCIAL SERVICES FOR THE POOR AND FOR RURAL MIGRANTS loans and managing savings. The absence low efficiency. The central government of informaon infrastructure in rural areas also has interfered with the rural financial also drives up the informaon costs of market through credit raoning and lend- rural financial transacons. The informa- ing subsidies, crowding out and suppress- on-collecng and informaon-processing ing compeon from private commercial methods used in modern, urban, large-scale lenders. Because interest rates are not lending cannot be applied to grassroots fully liberalized, exisng financial instu- rural lending, especially in lending to house- ons are unable to determine lending holds, and centralized lending approval rates, resulng in high operaonal risks. requirements negate the informaon advantage of local branches, weakening the One alternave, informal finance, remains ability to collect and analyze informaon. a legally gray area and is therefore impossible to develop. In accordance with Third, despite reform efforts, rural and relevant rules or official decisions, more agriculture policies are yet to be improved, than 100 pilot projects sponsored by vari- and fiscal policy has failed to play its role ous instuons (including internaonal in rural areas. Public fiscal resources have instuons) have been put in place over been directed toward cies, even while the past 10 years, but these remain at the the countryside lacks necessary public pilot stage. services. Farmers are forced to borrow to cover medical services and their children’s In the quasi-monopoly market, monotypic educaon, and loans of this type add to rural financial instuons o en blame instuonal risk. Moreover, low prices for policy restraints for their own perfor- agricultural products and rising produc- mance weaknesses. Even so, preferenal on costs mean farmers’ income has not financial policies for rural development increased, even in the event of a bumper have created moral hazards related to the harvest. This has reduced the profitability lack of financial discipline, strict moni- of agriculture and further weakened the toring, or educaon of rural borrowers. loan repayment capabilies of rural house- Some rural households consider conces- holds, again increasing lending risks and sionary loans to be subsidies that do not costs. As a result, rural financial services need repayment, and even collude for suffer from weak growth and rural credit repayment exempon or waiver. Weak represents only a small poron of total judicial and enforcement systems in the loans. In turn, the small scale of agricul- countryside have augmented risks and ture loans adds to lending costs and fur- transacon costs and have dampened ther impedes rural financial development, commercial creditors’ incenve to develop forming a vicious cycle. the rural market. Limited eligible collateral in rural areas has restricted loan size and In some ways, therefore, rural financial increased borrowing costs, prevenng policies have actually restrained rural farmers from accessing formal financial financial development. For reasons of instuons, and has increased uncertainty financial security, authories have not and costs on the part of creditors, limit- emphasized variety in rural financial ser- ing lending and precluding rural financial vices, resulng in market monopoly and development.

61 PART II CURRENT RURAL FINANCIAL POLICY

63 CHAPTER 4 Capital Flows and Rural Finance

In a market economy, capital flows to regions and sectors with more investment opportunies and higher returns, and this has been true in the People’s Republic of China (PRC). Interregional capital flows have varying effects on economic growth, investment opportunies, financing costs, household income, living standards, and the structure and performance of local financial instuons in both the source and desnaon regions, due to the various channels of flow, different costs, and different incenve mechanisms.

The PRC is experiencing unbalanced regional economic development. Many studies have used growth theories to analyze the trend and causes of regional imbalance, with parcular focus on labor, human and material capital accumulaon, technology, and the economic system (including management and government policies). Few studies have focused on interregional capital ﬂows and allocaon. However, a region’s capital allocaon mechanism and abundance of capital determine the speed and size of capital accumulaon and profoundly aﬀect economic progress in that region.1

Economic development is reﬂected not only in aggregate expansion but also in the restructuring and transformaon of sectors and industries, both of which carry phased characteriscs. Economic development also is a process of urbanizaon and industrializaon.2 In the early stage of this process (the elementary stage), oulows of producon factors from rural areas are likely to grow along with economic development. In more advanced stages, such oulows will gradually moderate and inﬂows may occur.3

This also holds true for capital flows. In a market economy, return spread determines capital flow across sectors. Return spreads will first widen and then become narrower with the advancement of economic development. In the elementary stage of economic development, industrial sectors are underdeveloped and the capital return is not much different from returns in the agriculture sector; hence, capital oulows from the countryside are relavely moderate. With economic development, industrial structures gradually

65 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

improve and economy of scale and indus- the Gini coefficient rising from 0.19 in try concentraon comes into play. Pro- 1988 to 0.23 in 1995.6 Research found ducvity in industrial sectors will increase that the raos of per capita net income in substanally, leading to a growing gap eastern rural areas to that in central and between the returns of the industrial and western areas were 1.79 to 1.13 to 1 in agriculture sectors, and capital oulows 1990; 1.81 to 1.15 to 1 in 1995; and up to from the countryside will grow. Subse- 2 to 1.09 to 1 in 1999, poinng to growing quently, industrial development will drive disparies. growth in agricultural producvity, the return gap will shrink, and capital oulows Economic growth in different regions of will gradually ease.4 the PRC has shown both condional and club convergence, with growth in the eastern, central, and western regions con- Interregional Capital Flows verging to different equilibrium levels.7 To some extent, this underscores the vast A large body of research shows growing difference in development stages among disparity in the economic development of regions. Economic acvity in the eastern the PRC’s eastern, central, and western regions has developed to a relavely regions.5 These disparies are reflected advanced level and supports a high level both in overall regional economies and in of stable economic growth. The precon- local rural economic development. Dispar- dions for such economic equilibrium ity in per capita net income in rural areas are opmal sector structures (between across provinces has been growing, with industry and agriculture) and a benefi-

Figure 1. Interregional capital ﬂows in the People’s Republic of China

! "

Source: Authors.

66 CAPITAL FLOWS AND RURAL FINANCE cent circle among sectors. With economic Domesc and foreign investment and development, rural capital oulows in remiances also nearly doubled, from the eastern regions are likely to moder- CNY3.2 billion in 1999 to CNY6.6 billion ate, whereas rural capital oulows in the in 2003. Yunnan posted the highest central and western regions will increase. increase, nearly quadrupling this type of Such a contrast in capital flow will favor funding, due to internaonal cooperaon economic growth in the eastern regions, and the tourism industry. Sample counes resulng in growing imbalances in the in both Gansu and Guizhou also experi- rural economy. enced an increase, nearly doubling this type of funding. Interregional capital flows in the PRC have three carriers: fiscal authories, banks, When analyzing fund oulows, we focus and other microenes (Figure 1). First, on financial instuons’ deposit-to-lending the central government makes fiscal trans- gap because poverty-stricken areas make fer payments to poverty-stricken areas. few fiscal payments to higher enes. Within a province, county and/or city gov- Postal savings fund oulows from the ernments transfer revenues to provincial sample counes in the six western prov- governments and the laer provide vari- inces increased from CNY1.3 billion ous subsidies to counes. Second, finan- in 1999 to CNY3.8 billion in 2003. The cial instuons allocate funds within and deposit-to-lending gap of other financial across regions. Third, other microenes, instuons, such as the ABC, rural credit including foreign direct investors, domesc cooperaves (RCCs), and other commercial direct investors, and rural migrant worker banks, differed, but the trend was obvious. remiance services invest and remit funds. In 1999, loans in these sample counes were CNY4.5 billion more than deposits, We compiled data on capital flows through meaning that each province had fund local governments, financial instuons, inflows. However, fund inflows through and other microenes. The inflows of financial instuons rapidly declined. government funds include fiscal poverty By 2002, financial instuons in the alleviaon funds, fiscal revenue, and trans- sample counes in five provinces posted fers. In the sample counes of Gansu, a total net fund oulow of CNY2 billion; Ghizhou, Ningxia Huizu Autonomous only Sichuan had a net inflow, of less Region, Shaanxi, Sichuan, and Yunnan, than CNY30 million. By 2003, the total this kind of funding more than doubled net oulows of funds through financial over 5 years, from CNY2.9 billion in 1999 instuons in the sample counes reached to CNY6.3 billion in 2003. Ningxia posted CNY3.8 billion, nearly matching the out- the highest increase, nearly quadrupling flow of postal savings funds. its capital flow. Such inflows came mostly from fiscal transfer payments, which Overall, the inflow of funds to the increased from CNY670 million in 1999 to CNY2.6 billion in 2003. sample counties was far greater than the outflow The inflow of funds through financial instuons included Agricultural Bank of China Thus, interregional fund inflows totaled (ABC) and People’s Bank of China (PBC) CNY8.4 billion and oulows amounted loans, which more than doubled from to CNY3.2 billion in 1999; in 2003, total CNY2.3 billion in 1999 to approximately inflow was CNY15.8 billion and total out- CNY5 billion in 2003. Sample counes flow was CNY7.6 billion. Overall, the inflow in Ningxia and Sichuan had the highest of funds to the sample counes was far increase, more than tripling. greater than the oulow. However, total

67 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

inflows decreased from CNY11.6 billion in to GDP stood at 15% and the rao of fiscal 1999 to CNY8.2 billion in 2003, adding to capital oulows to GDP was 1.1% in west- the funding scarcity created by the escalat- ern regions, indicang that higher-level ing funding demands of the Great Devel- government enes relied considerably on opment of the West. the western region for fiscal support. The rao of fiscal revenues and spending to Capital Flows: Fiscal Authorities GDP was highest in the western counes and lowest in the eastern counes. Fiscal Local fiscal posion comprises fiscal transfer from higher-level governments revenue, transfer, and spending. Fiscal has increased markedly, and government revenues differ sharply across regions as a disposable revenue has matched spending. result of economic development disparies. During the 5-year period from 2000 Capital Flows: Financial Institutions to 2004, for example, fiscal revenue in the eastern regions averaged more than Comparison of deposit–loan raos, CNY900 million, 4.8 mes that of the outstanding loan and deposit balances, central regions and nearly 7.5 mes that deposits with higher-level instuons, of the western regions. The gap widened central bank relending, and postal sav- from 2000 to 2003 and then shrank to ings help us to analyze capital inflows some extent in 2004 due to increased cen- and oulows through financial instu- tral government transfer to the central and ons. Rural areas have experienced heavy western regions. From 2000 to 2004, fiscal capital oulows over me. From 1994 revenue growth was similar across regions; to 2004, the cumulave deposit-to-lend- all doubled over 5 years. The rao of fiscal ing gap in rural areas amounted to more revenue to gross domesc product (GDP) than CNY4 trillion (excluding deposits in the western regions averaged 18.5%, from township and village enterprises). In much higher than the 7% of the eastern 2005, rural financial instuons channeled and central regions. CNY1.87 trillion away from rural areas. By the end of 2005, outstanding postal sav- The gap widened from 2000 to 2003 ings deposits reached CNY883.9 billion, all of which was deposited with the central and then shrank to some extent bank. The trend of capital flows through in 2004 due to increased central financial instuons also was reflected in government transfer to the central the number of financial instuon outlets and the deposit–loan rao. and western regions The four largest state-owned commercial Revenues surrendered by county govern- banks (the ABC, the China Construcon ments and subsidies to county govern- Bank, the Industrial and Commercial Bank ments were higher in the eastern regions of China, and the PBC) each maintain than in the central and western regions, four deposit-taking and lending outlets but the gap in subsidies was much smaller per county in the eastern regions, but than the gap in revenues surrendered deposit-taking outlets outnumbered (Table A.15). In addion, the rao of lending outlets in both the central regions revenues surrendered to GDP was similar, and, especially, the western regions whereas there was a substanal difference (Table A.16). The central region had an in the rao of subsidies to GDP; the rao average of 3.7 deposit-taking outlets in the eastern regions was the lowest and and 3.6 lending outlets per county, the rao in the western regions was the whereas the western region had an aver- highest. The rao of fiscal capital inflows age of 3.1 deposit-taking outlets and

68 CAPITAL FLOWS AND RURAL FINANCE

2.6 lending outlets per county. This sug- Comparison of financial instuons’ gests that these banks channel deposits regional use of funds also points to a high from the west and lend in the east. From correlaon between loans and economic 2000 to 2004, the number of outlets did acvity. The eastern regions had the most not change in the eastern and central loans outstanding, whereas the west- regions but declined slightly in the western regions had the fewest, and this was ern regions, suggesng that the four larg- closely linked with the regions’ level of est banks reduced their financial services economic development. In the central and in the west. western regions, banks deposited substanal funds with higher-level financial In addion, the loan–deposit raos of instuons (Table A.18). The deposit–loan the four largest banks and the RCCs all rao was much higher in the central and were less than 1, suggesng that deposits western regions, where it was around 1 or surpassed lending in rural areas. Dis- more, than in the eastern regions, where it counng factors such as excessive liquid- averaged about 0.7. ity or minimal lending within the banking system, this means that capital migrated Even in relavely advanced provinces, from rural areas to cies. The loan– county financial instuons deposited con- deposit raos of the ABC and the RCCs siderable amounts of funds with higher- were relavely high and generally equal level instuons. A survey of 29 counes across the eastern regions and, with a in Shandong Province showed that, by the few excepons, even higher in the central end of May 2006, financial instuons regions, probably for different reasons. in the sample counes had deposited In the eastern regions, a good customer CNY57 billion with higher-level instuons, base led to a high level of lending. In the represenng an annual increase of 20.7% western regions, poverty reducon loans from the end of 2000. During the same and PBC relending to support agriculture, period, annual loan growth in the sample farmers, and rural areas contributed counes was 17.5%, 2 percentage points to more lending, and thus to a higher lower than the average loan growth of all loan–deposit rao, even given the same counes in the province. amount of deposits. The ratio of PBC loans to GDP was A comparison of financial instuons’ funding sources in different regions illus- much higher in the western regions trates the correlaon between deposits, than in the eastern and central loans, and economic acvity. The rate of deposits outstanding is highest in the regions, and the ratio in the eastern eastern regions and lowest in the western regions was the lowest regions, and central bank loans purposely favor the central and western regions In general, banks in western regions (Table A.17). In parcular, beginning in extended fewer loans while deposing 2002, the average PBC agriculture loan to more with higher-level branches, and the RCCs was higher per county in the west- deposit–loan raos of the China Construc- ern regions than in the eastern regions on Bank, the Industrial and Commercial in absolute terms. The rao of PBC loans Bank of China, and the PBC were much to GDP was much higher in the western lower in the western regions than in the regions than in the eastern and central eastern regions, though PBC fund transfer regions, and the rao in the eastern has eased funding pressure in the western regions was the lowest. regions to some extent.

69 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Capital Flows: Microentities ment in either the central or the western regions (Table A.21). By 2004, the gap had Other microenes include remiance widened; domesc investment in the east- of rural migrant workers, foreign direct ern regions was nearly 3 mes the invest- investment, and domesc direct investment in the central regions and more than ment, all falling into the category of capital 10 mes the investment in the western inﬂows. In absolute terms, the average regions. However, the rao of domesc annual remiance by rural migrant work- investment to GDP was slightly higher in ers per county was highest in the eastern the central and western regions than in regions and lowest in the western regions the eastern regions, and was increasing (Table A.19). However, the rao of remit- over me. tance to GDP in the western and central regions was much larger than in the east- Ulmately, the remiance of rural migrant ern regions: 0.17 in the western regions, workers is more important for the cen- 0.11 in the central regions, and 0.04 in the tral and western regions than for east- eastern regions. ern regions. The western regions lagged behind the central and eastern regions in aracng foreign direct investment and Foreign direct investment in the also aracted less domesc investment, eastern regions far exceeded though this was in line with the GDP of the investment in the central and western western regions. regions Issues of Capital Flow

Foreign direct investment in the eastern Interregional capital flows in the PRC regions far exceeded investment in the are characterized by severe and increas- central and western regions (Table A.20). ing oulows from rural regions, large In 2000, foreign direct investment per regional differences in capital oulow, county averaged CNY342 million in the and constrained development of commer- eastern regions, just under CNY58 million cial banks in rural areas and the western in central regions (amounng to 17% of regions due to regional differences in the investment in the eastern regions), and operaonal revenue. even less in the western regions, where investment is below 5% of investment in By 2000, county banking instuons’ eastern regions. In 2004, the figure rose to deposits amounted to about CNY3.2 tril- CNY1.2 billion in the eastern regions and lion, and these instuons’ loans out- more than CNY412 million in the central standing stood at about CNY2.4 trillion. regions, while remaining at CNY76 million This yielded a gap of CNY843 billion and a in the western regions. The rao of foreign loan–deposit rao of 74.8%, 5.5 percent- direct investment to GDP was much higher age points lower than that of all banking in the eastern and central regions than in instuons during the same period. By the western regions, indicang that foreign 2005, deposits of banking instuons at or direct investment was concentrated in the below the county level amounted to about eastern and central regions. CNY6.9 trillion and loans outstanding stood at about CNY3.9 trillion. This CNY3 trillion Regional differences in domesc invest- gap was 3.5 mes the gap in 2000. More- ment also were significant and growing. In over, the loan–deposit rao decreased to 2000, domesc investment in the eastern 56.3%, 12.7 percentage points lower than regions was more than twice the invest- that of all banking instuons during the

70 CAPITAL FLOWS AND RURAL FINANCE same period. During the 5-year period ing by other banks, which have neither from 2000 to 2005, bank deposits at or networks nor incenves to lend to rural below the county level grew by 16% per enterprises and households, is negligible, year, close to the 17.7% growth rate of except in a few developed areas where all banks in the PRC, but bank loans at or township and village enterprises are below the county level increased by a mere parcularly strong. Both rural deposits 9.7%, much less than the 15.7% growth (Table A.22) and rural loans (Table A.23) rate in total loans across the country. increased significantly from 1989 to 2005. However, total rural instuonal loans as There are large regional differences in a percentage of deposits fell from 110% in capital oulows, with the heaviest oulow 1989 to around 86% in 2001, an indicaon from the central region. At the end of 2005, of the outward movement of funds that the loan–deposit rao was 63.7% in the rural financial instuons might have used northeastern regions, 57.4% in the eastern for rural lending. regions, and 56% in the western regions, whereas the rao in the central regions was The ABC appears to be the most impor- only 51.8%, 4.5 percentage points lower tant rural financial instuon in the PRC, than the average. accounng for about half of both rural instuonal loans and rural deposits. There also are large per capita operaonal There has been a remarkable increase revenue differences between urban and in postal savings deposits, and the per- rural areas and between eastern and west- centage of postal savings to total rural ern regions, which has constrained the instuonal deposits rose from 0.6% in development of commercial banks in rural 1989 to around 8.6% in 2001. The ABC has areas and the western regions. By 2005, allocated a growing proporon of its loans bank deposits averaged CNY13 million per to urban areas, and the year-end loan bank employee in the PRC as a whole, but porolios (as shown in Table A.23) are very deposits averaged only CNY6.5 million different from the supply of rural credit in per bank employee in rural areas. Rural the PRC. The ABC’s rural loan programs— deposits averaged CNY9.2 million per lending to agriculture and to township and bank employee in the eastern regions and village enterprises—decreased signifi- CNY5.3 million per bank employee in the cantly a er 1998, when the commercial- western regions. Thus, the eastern regions izaon of the ABC started to affect its loan had an average of 22.5 bank outlets per composion (Table A.24). The reducon in county whereas the western regions had ABC rural loans has made RCCs the domi- 9.9 outlets per county. In addion, many nant supplier of credit in the rural PRC western counes were dominated by RCCs (Table A.25), although the rao of annual and therefore lacked effecve compeon. loan disbursement to loans outstanding declined significantly for both the ABC and the RCCs a er 1991 (Table A.26). Loans and Deposits Rural deposits averaged Rural financial instuons in the PRC, with their extensive branch networks and CNY9.2 million per bank employee deposits insured by the central govern- in the eastern regions and ment, have played an important role in rural savings and lending and hence in the CNY5.3 million per bank employee process of rural development. Rural lend- in the western regions

71 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

A bulk of rural financial demand is for on system. This has le a vacuum in credit. In recent years, the total amount of the provision of medium- and long-term agriculture loans has been growing rapidly, development loans. The ABC has substan- from about CNY1.4 trillion in 2001 to about ally downsized outlets and has gradually CNY1.9 trillion in 2004, represenng an shi ed loans to large cies and large proj- annual growth of more than CNY100 billion. ects. Its short-term agriculture loans and In 2004, agriculture loans, including Agri- township and village enterprise loans have cultural Development Bank of China (ADBC) declined, and medium- and long-term loans, accounted for 10.5% of total loans loans have targeted transport infrastruc- and 102.7% of agricultural value-added. ture. Most RCC loans have gone to rural These figures were not low when com- households and enterprises, and RCCs in pared with most developing countries. In many areas can only meet the demand for an agrarian country such as New Zealand, simple agricultural producon. for example, agriculture loans represented 114% of agricultural value-added, which Rural Household Credit Demand was 17.2% of GDP. In Lan American countries, agriculture loans represented 8% of According to the China Banking Regula- total loans in 1980, compared to 12% in tory Commission, the RCC loan coverage 1972, and 21% of agricultural value-added of over 240 million rural households was in 1980, compared to 27% in 1970. 30% in 2005, meeng 60% of demand. Generally, rural financial demand in devel- Most RCC loans have gone to rural oping countries largely relies on informal financial instuons such as microcredit households and enterprises, and agencies, pawnshops, and cooperave RCCs in many areas can only meet associaons; coverage of formal financial instuons is low. By comparison, the the demand for simple agricultural coverage of formal financial instuons in production the rural PRC is fairly high.

With robust growth in other industries, Rural households fall into four catego- the share of rural loans as a proporon of ries: tradional households, households total loans declined. Loans to rural areas engaged in mulple small-scale busi- increased from CNY3.3 trillion in 2001 nesses, households engaged in large-scale to CNY4.7 trillion in 2004, with the share planng and/or aquaculture, and rural in total loans declining from 29.43% to migrant workers or self-employed house- 26.36%. Since 2001, new loans to rural holds. The credit demand of tradional areas have averaged CNY400 billion per rural households can be met in me. annum; 60% to 70% of these loans were Because the producon cost of tradi- made by RCCs. ABC loans to rural areas onal agriculture is relavely low, with have remained largely unchanged, ADBC investment averaging around CNY250 to loans are on the decline, and loans from CNY400 per mu (equivalent to approxi- other banks have increased somewhat, mately 0.16 acre), tradional rural house- mostly going to the eastern regions. holds typically require loans of between CNY1,000 and CNY10,000 for basic pro- In recent years, the ADBC has provided ducon, and microcredit businesses can only short-term crop procurement loans, meet the needs of these households. and its loans for crop transacons have For example, 70% of counes and over declined markedly with the deepening 50% of rural households in Inner Mongolia reform of the grain and coon circula- Autonomous Region have obtained credit.

72 CAPITAL FLOWS AND RURAL FINANCE

The credit demand of rural households bank loans can meet only about 30% of engaged in mulple basic businesses, such the financing demand for rural enter- as small-scale planng and aquaculture, prises. Likewise, the funding demands also can be largely met. Due to limited of large enterprises are generally more scale and inputs, credit demand for this than several hundred thousand renminbi, kind of household was CNY10,000 to which is beyond the capacity of small CNY30,000 per year, above the typical and medium-sized financial instu- CNY5,000 threshold of microcredit. How- ons. The Industrial and Commercial ever, households with good credit records Bank of China and the ABC can meet usually can obtain such loans through col- such demand, but their county branches lecve guaranty. require approval from higher-level branches before doing so. The credit demand of households engaged in large-scale planng and/or aquaculture Rural Government Credit Demand cannot be fully sasfied. Their demand is variable, depending on the size of their Finance demand for rural infrastructure land or ponds and the amount of seed, fer- has been strong, and such demand must lizer, and feed required, and ranges from be beer met. According to the survey in CNY10,000 or CNY50,000 to several million Jilin Province, 55% of county governments renminbi. Demand below CNY50,000 can considered it difficult to procure financing be sasfied through collecve guaranty or for rural road construcon and irrigaon. credit lines, but county rural financial ins- Seventy-two percent of respondents named tuons have difficulty meeng demand for roads as the most needed livelihood facili- loans of more than CNY50,000. es, about 30% named irrigaon, and just over 29% considered improvement of drink- Likewise, the credit demand of rural ing water for both humans and livestock as migrant workers and self-employed house- the most pressing need. Moreover, 97% of holds o en remains unsasfied. Their county governments believed that the demand for working capital and funds for finance sector should gradually increase expanding producon is high, but their lending for infrastructure. A survey on rural demand seldom is met. credit demand in Zhongmou, Sichuan, in 2006, suggested that more than 60% of the Rural Enterprise Credit Demand financing demand of primary sectors such as planng and aquaculture could be met, Demand for rural enterprise funding has whereas only 30% of the secondary and been increasing rapidly, but it is increas- terary sectors such as agricultural prod- ingly difficult to meet these borrowing ucts processing and transport could secure needs. Because state-owned commercial needed loans. banks have shrunk their rural operaons, supply-and-demand tensions are A survey by the China Banking Regula- acute in rural enterprise lending. Some tory Commission found that the credit enterprises experience difficulty access- demand of 55% of rural households and ing credit and must rely on self-funding or informal financing. Only the state-owned grain reserve can borrow from the ADBC The credit demand of households for crop acquision, leaving 60% of other engaged in large-scale planting enterprises and the self-employed to rely on other means of finance. For instance, a and/or aquaculture cannot be fully survey in rural Jilin Province showed that satisfied

73 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

44% of rural enterprises could be fully include high interest rates, tedious proce- met, whereas the demand of 45% of rural dures, and complex loan terms. Just under households and 56% of rural enterprises 22% of rural households and about 15% of could not be fully met. Access to credit on rural enterprises considered the lending the part of rural households and small and procedure simple, whereas 22% of rural medium-sized enterprises is an important households and 26% of rural enterprises driving force behind rural development, deemed the procedure complex and me and inadequate access to credit will con- consuming, indicang that credit access strain rural development and the integra- is a more acute issue to rural enterprises on of urban and rural areas. than to rural households. The rural financial market is essenally a seller’s market, with The China Banking Regulatory Commission nearly 62% of rural enterprises unable to also found that constraints on rural finance select their financial instuon freely.

74 CHAPTER 5 Interest Rate Policy

Following the connuous decline in the growth rate of farmers’ incomes, the widening income gap between the rich and the poor, and growing disparies between urban and rural areas since the early 1990s, there has been renewed interest in and policy debate about agriculture and rural development in the People’s Republic of China (PRC). The government inaugurated in March 2003 vowed to give policy priority to supporng agriculture, farmers, and rural areas (sannong), to improving rural incomes, and to narrowing the income gap among regions and between the rich and the poor.

The oulow of funds from rural areas and the lack of rural credit have been idenfied as major obstacles to the PRC’s rural development.1 Large amounts of rural funds have flowed from rural to urban areas, creang a conflict between the demand for and the supply of rural credit. The shortage of rural credit, in turn, has been blamed for the slow pace of rural development because it jeopardizes investment opportunies in high-value-added agriculture (such as large-scale producon of vegetables), in agriculture processing, and in rural off-farm producon. Since the PRC’s entry into the World Trade Organizaon, there has been increasing awareness that development in these areas is essenal to the naon’s rural economic growth and to employment in its wealthier areas, given the extremely small size of farms and the low labor producvity in the tradional agriculture sector.

The central government and the People’s Bank of China (PBC) have outlined various policies intended to raise the supply of rural credit and improve rural output and incomes. In 2002, the Ministry of Agriculture proposed increasing agriculture lending by seng a minimum amount of agriculture loans to be disbursed by ﬁnancial instuons and by increasing the variety and quanty of policy loans for agriculture. It also proposed to extend loan terms and to reduce loan rates for rural lending as a means of reducing borrowers’ costs. These policy suggesons are very similar to the credit policies once implemented in other less-developed naons. For example, the reserve bank in Thailand spulated that the proporon of agriculture loans to the total loan porolio for any commercial bank must be greater than 5% and that the proporon of agriculture loans to total deposits must be greater than 11%.

75 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

The so-called tradional approach to rural ment economics.2 Selecve credit policies finance has proved unsuccessful in reduc- have been blamed for the misallocaon ing rural poverty and promong rural of scarce resources and low efficiency in development. However, the polical pres- financial intermediaon.3 However, as sure to increase inexpensive rural loans far as we are aware, there have been no has been so great that, in 1999, the PBC systemac studies of the effect of finan- introduced the agriculture onlending pro- cial policies and interest rate structure gram, which provided inexpensive loans on the allocaon of resources or on the to rural credit cooperaves (RCCs), and efficiency of financial intermediaon in the value of these loans has been growing rural areas of the PRC, although similar over me. Moreover, in early 2003, the studies have been undertaken for other PBC set the annual target for growth of less-developed countries.4 the RCC loan porolio at over 15%, with the agriculture loan poron set to grow by Such informaon has important policy 20% or more. implicaons, given the size and importance of the PRC’s rural economy, the currently large instuonal loan porolios, The relationship between financial and the amounts of the loans disbursed policies and economic development each year by rural financial instuons has been a popular topic in the study in the PRC. By the end of 2001, the total loan porolio of rural financial instuons of development economics reached CNY11.2 trillion, dwarfing the porolios of many other less-developed Understanding the shortage of rural credit countries. The lessons drawn from the begins by examining the changes in rural PRC are valuable for other economies in financial instuons’ deposits and loans the process of economic development and the relaonship of these changes to and transion. The materials used in this changes in the structure and real rates of chapter comprise both official sources and interest in the PRC. Change in the struc- informaon collected by the authors dur- ture and real rate of interest is one of the ing field invesgaons. major forces—perhaps the most important force—behind the oulow of loanable rural funds that has followed the commercializa- Changes in Rural Deposits on of rural financial instuons since the and Loans early 1990s. Distoron of the PRC’s rural financial market has serious implicaons Annual loan disbursement (credit flow), for the efficiency of rural financial inter- rather than year-end loans outstand- mediaon, for state budgets, and for the ing (stock), determines the supply of allocaon of scarce resources in rural areas. instuonal credit in rural areas. The Theories of finance and economic develop- declining rao of annual loan disbursement allow us to analyze the market distor- ment to loans outstanding reflects an ons caused by selecve credit policies and increase in the proporon of nonperform- their effect on the allocaon of rural credit ing loans for both the Agricultural Bank and the efficiency of financial intermedia- of China (ABC) and RCCs over me. Due on in rural areas of the PRC. to increased numbers of nonperforming loans and the resulng decreases in loan The relaonship between financial poli- collecon rates, rural financial instu- cies and economic development has been ons have less funding available for loan a popular topic in the study of develop- disbursement.

76 INTEREST RATE POLICY

The supply of rural credit comprises the agriculture procurement and storage (pro- cumulave rural lending of the ABC and vided mainly by the ADBC), poverty loans, the RCCs (Table A.27). Agricultural Devel- and agriculture onlending from the PBC opment Bank of China (ADBC) loans are to the RCCs. Other agriculture policy loans not counted as rural lending because include agriculture development loans such loans are not provided to rural and loans to grain processing enterprises households or enterprises for producve provided by the ABC. ADBC loans represent investment or consumpon. The rao of about 20% to 25% of total instuonal cumulave disbursement to year-end ABC loans. RCC poverty loans and agriculture loans outstanding (Table A.26) reflects onlending relave to total ABC and RCC ABC loans for agriculture and for town- rural loans increased beginning in 1995. By ship and village enterprises. 2001, policy loans made up about 10% of total rural loans provided by the ABC and The rao of instuonal lending to total the RCCs. Clearly, the decrease in the supply instuonal deposits in the rural areas of rural instuonal credit would be more has been reduced by more than half in the drasc a er 1996 had there not been a past decade. The fall was most dramac marked increase in rural poverty loans. from 1996 to 2001—a result of the ABC’s reallocaon of credit to urban areas, an increase in nonperforming loans at the Market Distortions and ABC and the RCCs, and an increase in rural postal savings deposits (Table A.22). For Efficiency of Rural Financial instance, the percentage of ABC loans Institutions fell from 17.2% of total deposits in 1996 to 4.9% of total deposits in 2001. Thus, Since the early 1990s, the PRC has made despite the rising demand for rural credit, progress in removing market distorons as indicated by the rapid increase in rural caused by negave rates of interest. Real instuonal deposits, rural credit remains deposit and lending rates rose significantly in short supply and the role of the ABC and from 1989 to 1998. The increases in real the RCCs in channeling rural savings into interest rates, reflecng a process of finan- rural producve investment has declined cial deepening, should have contributed over the past decade. to the increases in rural savings deposits, benefing rural depositors and improving In addion, the decline in the proporon the allocaon of resources in the rural areas of rural credit to deposits has been fairly of the PRC. However, the rapid increase in consistent over me, and the steeper rural deposits also may have been the result declines in the ABC’s agriculture lending of other factors, including a lack of oppor- since 1997 have been somewhat offset by tunies for farmers to invest in financial increased RCC lending. Eighty-four percent assets such as bonds, shares, or physical of total rural instuonal lending in 2001 capital assets, and the closing down of rural was provided by RCCs, and the ABC became cooperave foundaons. a relavely insignificant player in financing households and enterprises in rural areas. An important aspect of the PRCÊs An important aspect of the PRC’s selecve selective credit policies is the credit policies is the policy loans from rural policy loans from rural financial financial instuons to priority sectors of the economy. Policy loans for rural areas institutions to priority sectors include (but are not limited to) loans for of the economy

77 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Farmers and rural communies also have county level were allowed to float their benefited from improvements in the lending rate by a maximum of 30%, and structure of interest rates. The difference the band for loans to small and medium- between the demand deposit and me sized enterprises also was raised, from deposit rates has narrowed consistently, 20% to 30%. Finally, in 2002, the central and the term structure of deposit rates has government launched pilot programs become less lted over me. Depositors, for interest rate liberalizaon of RCCs in especially those with demand deposits, eight counes. The RCC lending rate band have benefited from such a reducon. In was expanded from 50% to 100% and, addion, the disparity between the base for the first me, RCCs in these counes rate and the subsidized rate for poverty were allowed to float their deposit rates loans has declined from 7.2% in 1989 to by 20%. less than 3% in 2002, and the preferenal rate for agriculture procurement loans was However, distorons in the PRC’s rural removed in 1998. Finally, the rate differ- financial market remain. The capped lend- enal between 1-year lending and 1-year ing rates for instuonal finance are far deposit has increased, leaving a higher from sufficient to cover operaonal and margin for rural financial instuons. funding costs while leaving a margin for the growth of rural financial instuons. Lending Rates Although real rural lending rates have increased over me, they remain low rela- In the early 1990s, the central govern- ve to the market rate of interest, repre- ment began relaxing direct state control sented by rates in the informal financial over interest rates, and rural financial markets (around 20% to 25% nominal). instuons, parcularly RCCs, have been Instuonal rates also have been lower at the forefront of interest rate liberaliza- than the effecve rates charged by micro- on. The centerpiece of the reform is the finance instuons. The microfinance introducon of the bands within which experiments undertaken by Funding the financial instuons adjust their lending Poor Cooperaves in Hebei and Henan rates. In 1992, state banks and financial provinces indicate that, given a nominal instuons were allowed to float their fund cost of around 2% per annum, an on- working capital lending rates around the me loan repayment rate of over 95%, and base rate, with an upper band of 20% and an annual loan loss within 3% of the port- a lower band of 10%. On June 1, 1996, folio, microfinance instuons in these state control over the rates on interbank areas must charge an effecve rate of money markets was removed. Then, approximately 15% to achieve operaonal in 1998, the interest band for loans to viability—that is, to ensure that income small and medium-sized enterprises was covers operaonal costs, loan losses, and increased from 10% to 20% and the band real fund costs (which is usually subsidized for RCC lending increased from 40% to and is not the same as the opportunity 50%. In 1999, all financial instuons cost of capital). This is much higher than and branches operang at and below the the maximum lending rate allowed to RCCs. Moreover, microfinance instuons The centerpiece of the reform is the such as Funding the Poor Cooperaves have no historical burdens (legacy nonper- introduction of the bands within forming loans and financial losses) or tax which financial institutions adjust obligaons, and loan repayment rates tend to be much higher than that of the average their lending rates RCC in the PRC.

78 INTEREST RATE POLICY

Based on surveys of RCCs in Anhui, loans. For example, in Guizhou Province in Jiangsu, and Shanxi provinces in 2001 2000 and 2001, RCC staff received almost and 2002, we esmate lending rates that no subsidies for going to villages to screen will substainably cover the cost of capital, loan applicants or to monitor loans, due operaons, and loan losses for rural finan- to the RCCs’ financial difficules. In the cial instuons and the ABC. These cost remote and mountainous areas of Hunan projecons are for above-average RCCs and Guizhou provinces, RCC staff were with good management and would apply forced to use their own motorbikes for to ABC branches as well. The opportunity work-related travel, and no subsidies were costs of capital (more than 3% per annum) paid on fuel. As a result, RCC staff usually and the historical burdens of RCCs are avoided trips to the villages. assumed away. Financial losses and the ever-increasing On average, rural financial instuons in numbers of nonperforming loans have coastal areas need to charge a minimum of crippled rural financial instuons’ ability 9.5% per annum to survive. A few beer- to provide loan support to rural households off RCCs in these areas would be able to and enterprises. Moreover, low lending charge a lower rate if their major custom- rates have discouraged rural financial ins- ers were large enterprises and they could tuons from lending in rural areas, given invest part of their funds in the financial the higher transacon costs and higher market. An average RCC needs to charge risks of rural lending, and have exacerbated a nominal lending rate of at least 11.5%, the RCCs’ already serious moral hazard whereas rural financial instuons in poor problems, a result of unclear ownership and remote areas of the country need to structures and poor corporate governance. charge more than 16% to survive. These For instance, RCCs can easily mix losses results are more or less consistent with from nonperforming loans and bad man- Funding the Poor Cooperaves’ operaon- agement with those caused by the low ally sustainable rate of 15%, consider- lending rates.5 ing that its programs are located in poor counes and the scale of its operaons is smaller than that of RCCs. The actual Financial losses and the ever- required lending rates would be much increasing numbers of nonperforming higher than these projecons, assuming that RCCs need to generate profits to pay loans have crippled rural financial dividends to their members, to grow, and institutionsÊ ability to provide loan to cover accumulated financial losses and historical bad loans. support to rural households and enterprises These findings have important implicaons for the operaon of rural financial instu- Ironically, rural borrowers in the PRC have ons in the PRC. First, low lending rates not necessarily benefited from low lending have contributed to the growing financial rates because interest expense comprises losses of rural financial instuons, given only a part of the overall borrowing costs the high operaonal costs and high risks of for rural borrowers.6 Surveys indicated that rural lending in the PRC. Second, the low the borrowing costs for farmers mainly lending rates have given rise to a lack of include gi s and kickbacks to loan officials, operaonal funds for rural financial instu- me spent on traveling and on loan applicaons and their staffs, which in turn has ons, and membership fees for joining an contributed to increases in nonperforming RCC. To ensure loan access, for instance,

79 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

it is common for loan applicants to invite interest rates likely helped push the ABC loan officials to banquets and/or to give and other state banks away from the rural kickbacks directly to loan officials or RCC lending market. directors. The long and complicated loan applicaon procedures o en place the poor More importantly, rural financial instu- at a disadvantage and jeopardize producve ons are unable to charge a risk premium investment opportunies when quick credit for riskier projects, riskier borrowers, or is required. A PBC survey in Shanxi Province loans disbursed in different regions of also found that it is common for RCCs to the PRC. This inflexibility has efficiency require loan applicants to pay CNY50 to and equity implicaons. The ABC has CNY200 to join the RCC before their loans effecvely closed its lending operaons are processed and approved, which adds to in poor counes, with the excepon of farmers’ borrowing costs. making subsidized poverty loans for state- designated poor counes. Loan disburse- The high cost of instuonal loans is one ments from RCCs in these areas have of the major reasons that farmers switch declined as well, owing to a higher propor- to informal sources of finance. Thus, on of nonperforming loans and the RCCs’ farmers generally would benefit from a accumulated financial losses. The reduced more sustainable interest rate, in com- supply of instuonal credit has pushed binaon with the provision of financial up the interest rates on the informal finan- services and products tailored to their cial markets and more poor have become needs, or from an overall reducon in trapped in the cycle of debt. borrowing costs. Finally, although the gap between the Dual Pricing base lending rate and the rate for poverty loans was reduced from 7.2% per annum Instuonal rates of interest in the PRC in 1989 to 2.3% per annum in 2002, the are distorted in other ways. First, creat- gap remains. The gap between the poverty ing lending rate bands for rural financial rate and the maximum rate that RCC can instuons—an important step toward charge for a 12-month loan is 5.65% per relaxaon of direct state control of inter- annum. Obviously, the poverty loan rate is est—has its own limitaons. The bands far below the sustainable lending rate for have created dual prices for the same loan rural lending in the PRC, and subsidized products offered by different financial rates for poverty loans o en give rise to instuons. For example, RCCs are able low rates of loan repayment and problems to adjust their lending rate by a maximum with targeng.7 of 50%, whereas the ABC can only adjust its base rate by a maximum of 20% to Rate distorons apply not only to borrow- 30%. In conjuncon with high operaonal ers but also to lenders. When special PBC costs, high risk, and low lending rates, dual onlending was iniated, the onlending rate to RCCs was 1% lower than the rate available to other financial instuons The high cost of institutional loans in the PRC. The gap remained unl 2004. is one of the major reasons that The subsidized onlending rate for RCCs, farmers switch to informal sources in combinaon with a 50% band for RCCs’ rural lending, helped push other formal of finance financial instuons further away from

80 INTEREST RATE POLICY the rural lending market. Even so, the rural areas and in the western and central subsidies provided by the lower onlend- regions of the PRC. ing rate are insufficient for RCCs to cover their full costs. Institutional Response to Market Likewise, the rate for rural postal savings Distortions redeposit has been much higher than the rate available to other financial instu- The Agricultural Bank of China ons—even higher than the base me- deposit rate. The higher rate has fueled Following the financial reforms of the large increases in postal savings redepos- mid-1990s, the ABC was required to com- its and has contributed to the oulow of mercialize its operaons and to become loanable funds from rural areas. By the financially viable, which made the bank end of 2001, agriculture onlending to more responsive to interest rate signals. RCCs (CNY65 billion by the end of 2001) The ABC’s head office and the provincial was no match for the oulow of funds divisions not only have raoned credit sup- channeled through rural postal savings ply in rural areas but also have transferred (CNY355 billion). funds from relavely poor to wealthier areas. The ABC has raoned the supply of Barriers to Interest Rate credit by adjusng interest rates, transfer- Liberalization ring lending authority from local branches, cung back on local offices and staff, and Several factors have contributed to the introducing the life responsibility system. formaon and adjustment of official interest rates since the early 1990s: the belief First, the ABC set a relavely high rate of that posive real deposit rates work to interest on redeposits from ABC branches in protect depositors; the interest payment less-developed areas to the provincial ABC burdens of state-owned enterprises, many and to headquarters, so branches in poor of which are highly leveraged; government areas benefit financially by redeposing tax revenue and the profits of financial with the ABC rather than increasing their instuons; the state’s economic develop- lending. For example, in Inner Mongolia ment policies and strategies; and the sup- Autonomous Region in 1999, headquarters ply of and demand for loanable funds, as and the provincial division of the ABC paid well as loan terms and risks. Thus, interest an interest rate of about 4.5% for redeposit rate liberalizaon in the PRC must over- from the prefecture level, which was close come a variety of barriers. For instance, to the rate paid by the PBC for redeposit the low profitability of state-owned from rural postal savings. enterprises and the vastly different natural and economic condions and returns on investment under current market condi- The ABC has rationed the supply ons have prevented capital from flowing of credit by adjusting interest rates, to the poorer areas of the country. More- transferring lending authority from over, owing to low agriculture prices and low profitability, there has been polical local branches, cutting back on local pressure for the central government and offices and staff, and introducing the the PBC to balance growth by providing a greater number of inexpensive loans in life responsibility system

81 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Second, the ABC moved lending authority ons. According to the president of the ABC, from county to provincial branches and consumer loans—including mortgage loans, set direct targets on the total quanty automobile loans, and loans for house of loans by county branches in poor and renovaons—have increased substanally major agricultural areas. In Guizhou, for since 1997. By the end of 2001, the bal- example, some county branches were ance of ABC’s consumer loans reached allowed to make up to CNY200,000 in CNY121.7 billion, represenng around 9% of commercial loans each year but were only the bank’s total loan porolio. However, given authority to lend CNY50,000 to any in 2001, the increases in consumer loans rural enterprise. The lending authority of accounted for only 35% of the increases in state-owned commercial banks resides total loans disbursed by the ABC.8 mainly with the provincial divisions; county branches usually have authority The major losers in the ABC’s credit raon- only for loans under CNY100,000 and for ing are township and village enterprises loans collateralized by borrower deposits, and rural households engaging in off-farm which can be regarded as risk free. producon and investment. The slowing growth of township and village enter- The major losers in the ABCÊs credit prises, which has contributed to slower growth in the PRC since 1996, has been rationing are township and village closely related to the operaon of the enterprises and rural households rural financial system.9 The reducon in ABC rural lending has negavely affected engaging in off-farm production the employment opportunies provided and investment by township and village enterprises and large off-farm households. The withdrawal Third, the ABC cut back on township busi- of the ABC from the rural lending market ness offices and staff and mainly trans- also has reduced the already very limited formed the remaining township business compeon in the PRC’s formal rural offices into savings staons. From 1995 financial markets. to 2001, the ABC cut its staff by around 13% and its branches and business offices The costs of the ABC’s commercializaon by 34%. Many of these closed branches could have been reduced if the finan- and business offices were located in rural cial reforms of the mid-1990s had been townships. broader and beer coordinated. Direct state control over interest rates could have Finally, the ABC ghtened the credit supply been relaxed to encourage the ABC to by introducing the life responsibility sys- connue its rural lending programs, and tem, which makes loan officers responsible compeon in the PRC’s rural financial for loans they disburse. Officers held per- markets could have been enhanced by sonally responsible for delinquent loans encouraging market entry of new ins- are less likely to disburse loans. tuons. The costs also could have been reduced if changes had been introduced By reducing its rural lending, the ABC has gradually and had been accompanied by diversified its porolio, shi ed its lend- government assistance to rural enterprises ing focus to urban and coastal areas, and and rural off-farm producon, especially in developed its off-balance-sheet transac- poverty-stricken areas.

82 INTEREST RATE POLICY

Rural Credit Cooperatives profitable operaons (or declining losses) over the previous 2 years. In addion, Given the current lending rates, RCCs interbanking lending must not exceed should have reduced rural lending and 2% of all the deposits organized by the channeled funds out of rural areas, as the RCC in queson. ABC did. Indeed, RCCs in poverty-stricken and remote areas have a strong incenve Restricons on the uses of RCC funds to do so. However, PBC regulaons control have caused further distoron in the RCC funds. First, RCCs are allowed to lend rural financial markets. For instance, ter- to households and enterprises only within ritorial restricons have contributed to their geographic boundaries. Second, increased geographic and industrial risks, more than 50% of RCC loans must be pro- resulng in a high proporon of non- vided to their members, and over 70% of performing loans. Such risks could have new loans must be agriculture loans, been migated by the small-scale opera- including loans to individual households or on of RCCs and the RCCs’ enhanced agricultural collecves. understanding of their clients. However, moral hazards and the lack of funds Moreover, the PBC set restricons on have prevented RCCs from obtaining the interbank lending by RCCs. RCCs can necessary informaon about their loan transfer funds to other RCCs in the same applicants and borrowers. Thus, the low county through the county RCC union, but lending rate and restricons on the use of intercounty transfers must go through the RCC funds have contributed to the RCCs’ PBC. In order to lend funds to other RCCs low profitability and high proporon of or financial instuons, RCCs must dem- nonperforming loans and have impaired onstrate good capital quality, effecve their capacity to provide more credit to management and internal control, and rural households and enterprises.

83 PART III FINANCIAL MODELS

85 CHAPTER 6 Cooperative Finance

With the deepening reform of the state-owned commercial banks and the transformaon of the rural credit cooperaves (RCCs), a great deal of rural financial instuonal funding has gone to townships, cies, and large projects. Cooperave finance can serve local communies and aract rural funds, which helps to remedy the insufficient funding of commercial banks and to meet diversified microfinance demand. Developing a cooperave credit system with local characteriscs is a major rural finance challenge in the People’s Republic of China (PRC), and relevant internaonal experience and lessons from exisng informal domesc finance may provide important parts of the soluon.

Cooperave ﬁnancing has unique advantages, including democrac management and informaon advantage. Democrac management means that RCC members make the most important decisions and pracce their right to supervise RCC management. How- ever, none of the exisng cooperave ﬁnancing organizaons has pracced a democrac management system. A er true cooperaves are established, democrac management will help protect and beer serve members.

In addion, the structure of RCCs confers an informaon advantage, resolving the difficules of informaon collecon and analysis in microfinance. The high cost of selecng and monitoring borrowers has kept tradional banks away from the informal microfinance sector, but RCC members can supervise each other, reducing informaon asymmetry between banks and borrowers and therefore significantly reducing this kind of cost. Moreover, whereas banks suffer from conflicts between shareholders and depositors, RCC members are most concerned about deposit safety and quality of service. RCCs are nonprofit organizaons, and depositors are RCC members who are highly movated to preserve the safety of RCCs’ assets. This is opposite to the pracce of commercial banks, which are primarily concerned with profit margins.

True RCCs may be useful within the binary structure of the urban and rural economies and in addressing the circumstances under which commercial banks are unable to meet the ﬁnancial demands of agriculture, farmers, and rural areas (sannong). However, RCCs may

87 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

not be superior to commercial banks in all Like a company that wants to maximize cases. In fact, with the coming of economic profits of the owners, a credit coopera- development, many RCCs share some ve wants to provide members with the characteriscs with commercial banks such best service. The community cooperave as Crédit Agricole in France. In the long bank is a financial instuon self-managed term, RCCs may survive the disappearance by its members. This type of nonprofit of the binary economy, when serving san- financial instuon is organized through nong is no longer the government’s main a democrac process and is owned and policy goal. The credit unions in many managed by all members, each of whom developed naons serve as examples of has equal rights in elecng the director this transformaon. of the cooperave. According to the core principle, development of a credit cooperave is boom-up and thus requires me. Principles of Cooperative In the preliminary stage, the operaon of the credit cooperave is characterized Finance and International mainly by member deposits. During the Experience slow course of development, volunteers do most of the work. Cooperave finance originated in Europe in the 19th century and later emerged in In many developing countries, the gov- North America. In this kind of organizaon, ernment has tried to circumvent the all owners (farmers and other small-scale development process by launching credit producers) agreed to take limited returns cooperaves, promong them externally, and to retain the rest of their funds with and developing them rapidly. However, the organizaon, which would use such without sufficient me to explore, learn, funds for the development of local com- and improve the system, the development munies. In other words, the ownership of the credit cooperave is constrained, used the credit cooperave both as a increasing the possibility of failure. In vehicle for investment and as an agency parcular, excess government intervenon for credit. The basic characteriscs of this destroys the core principle of coopera- type of credit cooperave include member- ve finance and increases moral hazard. ship based on willingness and openness; The failure of many credit cooperaves democrac member control; financial has demonstrated that the development parcipaon of members; operaonal of cooperave finance is a step-by-step independence and autonomy; provision of process in which the core principles of inde- educaon, training, and informaon; coop- pendent operaon, voluntary parcipaon, eraon among cooperaves; and commu- and savings orientaon must be observed. nity service. As a credit cooperave develops, individual member shares will shrink. Fewer mem- The core principle of a credit bers will know each other, weakening their cooperative is voluntary supervisory movaon and increasing participation, democratic member difficules in accessing loans. Free riding will become more frequent. This situ- management, and equal membership aon will be aggravated when a cooperave begins to seek external funds—especially The core principle of a credit coopera- when the government tries to use the ve is voluntary parcipaon, democrac cooperave as a channel for implement- management, and equal membership. ing a rural loan strategy. In such a case,

88 COOPERATIVE FINANCE the previous incenve for self-supervision loan is normally around CNY350 for a term will become a moral hazard. Members and of 4 months. Successive loans are linked management are likely to try to use exter- to members’ deposits, which should equal nal funds to maximize profit for themselves at least 20% of the loan amount. Mem- rather than for the cooperave. ber savings are deposited into an internal account and are available for withdrawal Ulmately, the credit cooperave system at any me. The ulmate goal is to estab- will face a new challenge: regional and lish an internal account that will enable naonal credit cooperaves must be united the complete withdrawal of funds from into one organizaon to provide a plaorm the external account within 3 years. for informaon sharing, legal consultaon, banking, and other services. In this way, a A village bank makes use of local informa- mullevel cooperave finance system will on and is supervised by village residents. be established and its rapid development In addion, the operaonal goal of the will aract government aenon. village bank is financial sustainability. To achieve this, the loan rate is set at 4% per Rural finance has played an acve role in month. However, because many village poverty-stricken regions, and one good banks are located in remote areas where example is the village bank. In the 1980s, service is not easily accessible, the average John Hatch and his partners at the Founda- village bank’s revenues cover only 70% of on for Internaonal Community Assis- its total cost and most sll require a consid- tance iniated village banks to provide erable subsidy. Such organizaons must pay microfinance in Lan America. This kind more aenon to coverage than to scale. of organizaon operates in a democrac manner and its main business is to provide loans at market interest rates. (The major Lessons of Cooperative Finance difference between a village bank and a in the PeopleÊs Republic of China community bank is that individual village bank members may have several votes Rural Credit Cooperatives whereas each community bank member has only one vote.) The village bank RCCs in the People’s Republic of China is a self-sufficient organizaon of 10 to have gone through several rounds of trans- 50 people who meet weekly or bimonthly. formaon. In 1952, there were more than The group provides itself with three basic 2,000 RCCs serving farmers. Before the services: microcredit loans to start or Cultural Revoluon, RCCs were the finan- expand businesses, deposit incenves and cial instuons of the people’s commune measures to aract savings, and commu- and were true collecves; a er the Cul- nity support. The members of village banks tural Revoluon, the RCCs became a part provide guaranes for each other and of the people’s commune rather than inde- adopt integrated democrac principles. pendent financial instuons. From 1958 to 1979, RCC operaon was stagnant, but Like other rural financial instuons, in the 1980s, the People’s Bank of China village banks tend to serve poor people, (PBC) resumed collecve ownership of the especially women. More o en than not, the village bank gets an inial loan from a funding organizaon, deposits these funds RCCs in the PeopleÊs Republic of into an external account, and then uses the funds to cover operaonal costs and China have gone through several make member loans. The inial member rounds of transformation

89 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

RCCs. Since then, the RCCs have become a cies. Moreover, incenve, supervision, and supplementary administrave instuon exit mechanisms were largely missing. In of the Agricultural Bank of China. 2003, provincial governments were given management rights, provincial rural credit RCC reform, which began in 1983, brought unions were established, and RCC pilot about rapid RCC expansion, unl member- reform improved governance structure. ship covered 80% of farmers. The board Even so, RCCs have not been transformed of directors was established, as were the into true cooperaves and sll suffer from training system and guidelines for financial weak governance and poor sustainability. safety. However, with the rapid growth and overheang of the economy, local Second, the separaon of RCC supervision governments forced the RCCs to grant and management was ignored, and some large numbers of loans to township and management funcons were replaced village enterprises, which ulmately led to by government supervision, thus weak- massive losses when many of these enter- ening the RCCs’ effecve management prises went bankrupt. mechanism. In legal terms, supervision and management are closely associated The history of RCCs shows that excessive and are referred to as supervision and government intervenon has twisted the regulaon. In the general sense, supervi- nature of the RCC by ignoring the coopera- sion and regulaon oversee market entry ves’ internal governance, blurring the and exit; gather mely informaon about lines between supervision and manage- the supervised organizaon; undertake ment, and ignoring RCC autonomy and discovery and punishment of misconduct shareholder rights, ulmately generang according to laws, regulaons, and other serious moral hazards. spulaons; and administer correcve measures. Regulaon covers the appoint- In 2003, provincial governments were ment of personnel and decisions about development strategy. In the PRC, the given management rights, provincial government also is involved in formulang rural credit unions were established, management objecves and strategy and in appoinng an organizaon’s regulators. and RCC pilot reform improved As a result, there is no clear disncon governance structure between supervision and management, but supervision in place of regulaon has a First, the RCCs’ established internal gov- long history. ernance was ignored. In 1996, when the State Council commercialized the state- Third, the autonomy of RCCs as legal owned commercial banks and separated enterprises was ignored, removing inde- the RCCs from the Agricultural Bank of pendent management and RCCs’ responsi- China, the central bank implemented bility for their own risks and performance. many measures to transform rural credit During the period of planned economy, cooperaves into truly cooperave finance the central and local governments shared instuons. A erward, external supervi- the same goals. However, during the sion was emphasized while the governance transion from the planned to the market and internal control system was ignored. economy, especially a er the tax system Shareholders’ meengs, the board of reform of 1994, the interests of the central directors, and the board of supervisors and local governments began to diverge. played no effecve role, and senior officers Because the central government is respon- were sll appointed by government agen- sible for financial stability, it has to bear

90 COOPERATIVE FINANCE all losses resulng from local government paper RCCs were owned by members, intervenon in financial instuons. On each member’s shares were trivial and the other hand, local governments are scaered, making it very difficult for mem- largely responsible for developing their bers to exercise their ownership. local economies, and they are highly movated to intervene in the opera- It is even more difficult for members to ons of local financial instuons. It was exercise their democrac management not uncommon for local governments to rights because they have almost no say in direct the lending of finance instuons decision making. For instance, the govern- while ignoring debt evasion, resulng in ment and senior RCC management sll increased numbers of bad loans. make all decisions about development goals, business strategy, and operang Since the reform of the state-owned com- mechanisms without reference to the mercial banks and the 2003 amendment of RCC members or organizaons elected commercial bank law, local governments by members. RCCs are effecvely govern- have reduced their intervenon in com- ment-owned and government-managed mercial banking. Nonetheless, interven- organizaons. Given this, it is impossible on in RCC operaons sll exists in some to guarantee the rights of shareholders to regions. By influencing the selecon of make independent decisions about direc- borrowers and the scale of loans, local tors, large investments, profit distribuon, governments have asked RCCs to provide and so forth. loans to clients who are unable to repay the loans. This has put many RCCs into a The RCC director is appointed by difficult, unsustainable posion. the director of the county RCC For example, in the 1990s, local govern- union, and other senior officials ments required RCCs to provide numerous loans to township and village enterprises; are appointed by higher-level many of these loans later became bad loans government offices and brought about heavy RCC losses. Some local governments collected high taxes and Moreover, the board of directors, the fees from RCCs. Moreover, under the weak board of supervisors, and the members’ supervisory system, the management of conference lack supervision over senior some RCCs colluded with a few local gov- management. At present, the RCCs’ can- ernment officials, which enabled some bor- didate directors are not elected by RCC rowers to garner illegal profits. All of these members but are appointed by higher problems cost RCCs dearly, and the central government authories before member government later absorbed these losses. vong. The RCC director is appointed by the director of the county RCC union, and Finally, the legal status of RCCs as inde- other senior officials are appointed by pendent financial instuons has been higher-level government offices. In the ignored, and the democrac management end, the qualificaon of potenal man- right of members and shareholders has agers is inspected by the PBC and their been weakened. RCCs require voluntary elecon is a government appointment; the parcipaon, self-assistance, and demo- members’ elecon is only a final endorse- crac management. However, from the ment. As a result, these managers are not very beginning, the PRC’s rural credit movated to answer to the board of direc- cooperaves were established by govern- tors, the shareholders, or the RCC mem- ment administrave bodies. Although on bers. Instead, they are accountable to the

91 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

officials who appoint them. Managers can From 1992 to 1995, RCFs expanded allocate funds without bearing in mind the rapidly. According to a 1994 report, there risk to the RCC, and some of them do not were 17,800 RCFs with deposits totaling even consider asset quality. Ulmately, the CNY80 billion, accounng for 10% of total interests of RCC members are vulnerable RCC savings. In some provinces, such as and RCC operaons are unsustainable. Sichuan, RCFs accounted for nearly 40% of the market share in savings, somemes Rural Cooperative Foundations even dominang the local savings market. By the end of 1996, 21,000 townships and In the mid-1980s, local governments 24,000 villages had RCFs, with total financ- established rural cooperave foundaons ing of CNY150 billion. (RCFs), without PBC supervision. Origi- nally, RCFs were established to manage The RCFs expanded rapidly in the early the funds of the dissolved people’s com- stages because of their innovave fea- mune and the producon group, but they tures, including an aracve interest rate, soon developed into a sort of “financial public percepon of a government guar- instuon” that collected deposits and antee, and their commercial orientaon. provided loans. The development of the Because RCFs were not subject to PBC RCFs reflected the great demand for diver- regulaons, they could offer high interest sified financial services in rural areas. With rates and aract large amounts of rural the commercializaon of banks, formal savings. In addion, farmers believed that financial instuons in rural areas have RCFs were public financial instuons with transferred to urban areas a large amount an implicit government guarantee. Finally, of savings and the local government has the commercial orientaon of the RCFs lile say in the use of funds. was not set by the Agricultural Bank of China or the RCCs. To a large extent, RCFs served only those who were not accepted The establishment and registration by formal financial instuons. To accom- of RCFs required township plish this, RCFs applied elements of the credit techniques used by RCCs and micro- government approval, but there finance instuons, including linking loans were few entry criteria with savings, serving only local members, collecng informaon via intermediar- To promote local economy, local govern- ies, charging high lending rates, and using ments naturally wish to establish local appropriate guaranty measures and peer financial instuons. A rural cooperave pressure to ensure loan repayment. foundaon is both a nonprofit organizaon of mutual assistance and a tool of local Unfortunately, weak governance structure government. To differenate themselves and a lack of supervision ruined the RCFs’ from financial instuons, RCFs sell shares acve and innovave elements. RCFs instead of collecng deposits, pay dividends were controlled by township governments instead of interest, and lend only to mem- that intended to accumulate rural sav- bers instead of providing loans to the pub- ings for the development of township and lic. For some me, the central government village enterprises, which represented a encouraged and approved of this pracce. tremendous conflict of interest. The establishment and registraon of RCFs required RCFs originated in 1984 in Heilongjiang township government approval, but there and Jiangsu provinces, followed by a were few entry criteria. RCFs were out- 5-year reform period that began in 1987. side of financial laws and regulaons, and

92 COOPERATIVE FINANCE beyond supervision. According to an audit- CNY2.54 trillion in loans, CNY3.97 trillion ing report, for instance, loans to township in liabilies (including CNY3.65 trillion in and village enterprises in Hebei Province deposits), and CNY180.9 billion in share- accounted for 38% of total RCF capital by holders’ rights (including CNY189.8 billion the end of 1998, and 90% of these loans in paid-up capital). At the me, rural were directed by local government. Most of financial instuons’ outstanding these loans could not be repaid. In addion, agriculture loans naonwide totaled RCF funds were used for local government CNY1.22 trillion—91.4% of total agricul- infrastructure projects such as highways, ture loans. While promong effecve ser- schools, and hospitals. In some places, the vices such as group loans and microcredit local government even used RCF funds to loans to rural households, RCCs under the cover budget deficits. Lack of owner super- guidance of the China Banking Regulatory vision and commercial orientaon eventu- Commission also introduced syndicaon ally created serious risks. loans and community loans to strengthen funding support for rural micro- and small- The central government was aware of scale enterprises. These products meet the these problems and was concerned about funding demands of various rural enes the future of RCFs. In the mid-1990s, the and promote the full-scale coordinated State Council prohibited RCFs from taking development of the rural economy. deposits and asked the PBC to intervene. In the late 1990s, the first run on RCFs occurred, because some RCFs were unable Reforms include pilots of to return shareholders’ funds. The State shareholding and stock cooperative Council ordered the closure of all RCFs by systems as well as establishment the end of 1999 and an audit of all RCF accounts. The audit revealed large num- of rural commercial banks, rural bers of nonperforming loans and serious cooperative banks, and the county/ fund abuse by local governments. The closure of RCFs has increased township gov- citybased legal person entities ernment debt, and because RCF savings and loans were in many cases transferred Second, reform has established rural finan- to RCCs, the nonperforming loan rate of cial instuons through merger and pilot RCCs also increased. programs and has improved organizaonal structure and operaonal mechanisms. Reforms include pilots of shareholding Strengths of Rural Credit and stock cooperave systems as well as Cooperative Reform Policies establishment of rural commercial banks, rural cooperave banks, and the county/ With central and local government policy city–based legal person enes. By March support, reform has improved RCC opera- 2009, 25 rural banks had been established, ons, development, and organizaon; 172 rural cooperave banks had been li ed their historical burdens; enhanced approved, and 2,001 county/city–based asset quality and profitability; and legal person enes had been approved improved management. for establishment.

First, RCCs have experienced rapid Third, reform has made progress in operaonal development and improved resolving historical burdens and contain- performance. By June 2006, RCCs’ total ing risks through policy support. At the asset reached CNY4.15 trillion, including end of 2005, for instance, inﬂaon-linked

93 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

fiscal subsidies and discounts totaled rural credit unions had been successfully CNY6.9 billion, and business and income established in 25 provinces, regions, and tax reducons and exempons reached cies across the country. CNY13.4 billion. In 2006, the reducon and exempon for RCCs was extended The improved financial posion of RCCs in for another 3 years, indicang the central recent years is mainly aributable to gov- government’s upgraded support for RCCs. ernment policy support. The pilot program Moreover, by the end of 2007, the central called for historical burdens to be shared bank had issued to rural credit coopera- among the central government, local gov- ves CNY165.4 billion in special central ernments, and RCCs. The central govern- bank notes, accounng for 99% of the ment provided fiscal, tax revenue, and quota. The acceptance of special notes central bank funds, and local governments was iniated as of the second quarter of helped the RCCs recover nonperform- 2006, with a cumulave CNY4.6 billion ing loans, in addion to providing funds, honored. Local governments supported swapping quality assets, and providing RCCs through fiscal subsidies, asset dona- subsidies. Overall, these supporng poli- ons, nonperforming asset swaps, and the cies have been successfully implemented, like. Through policy support and their own although the improvement in the RCCs’ efforts, RCCs have to a certain extent man- financial posion has been short-lived due aged to reduce various risks and historical to RCC governance structure and risk-con- burdens. trol mechanisms. Local governments supported RCCs Even so, this round of reform has improved the RCCs’ financial performance by resolv- through fiscal subsidies, asset ing many historical burdens and pung donations, nonperforming asset RCCs on an equal foong with other financial instuons. This enables evaluaon swaps, and the like of the market value of RCCs. In addion, shareholding reform added investment Fourth, reform has resulted in major shares to strengthen the capital base of enhancement of RCC asset quality and RCCs. This has enhanced the RCCs’ risk profitability. By the end of June 2006, the management capability, defined share- rao of RCCs’ nonperforming loans to holders’ rights, and laid a foundaon for total loans was lowered by 24.6 percent- RCCs to take independent civic responsibil- age points from the rao during the inial ity. Finally, the establishment of provincial period of reform. The capital adequacy rural credit unions was important in clari- rao was 7.72%, an increase of 16.17 per- fying RCC supervision and management, centage points from its formerly negave improving regulaon, and enhancing the number; the capital adequacy rao of rural operaons of grassroots RCCs. cooperave banks, based on the standards for RCCs, reached 12.28%; and the capital The pilot reform of RCCs in eight prov- adequacy rao of rural commercial banks, inces, which began in the second half based on the standards for commercial of 2003, was a milestone in finance banks, reached 8.7%. sector reform and an important experiment in amending the serious mismatch Fi h, RCC reform has transferred opera- between finance sector and nonfinance ons and risk management to provincial sector reform over the past 2 decades. governments, resulng in improved man- It incorporated a lesson from enterprise agement. By the end of 2005, provincial reform, which is to let local governments

94 COOPERATIVE FINANCE and financial instuons, rather than the loan obtainment, and through govern- central government, take the iniave. ment promises of dividends and subsidies. This innovave approach has significant Increasing shares by such means sepa- implicaons for future rural financial rates equity reform from the governance reform and development in the PRC. structure. In addion, high shareholder returns came from the interest of depositors, and in essence, deposits were used to Rural Credit Cooperative Reform pay dividends. In the end, such loopholes Policy Issues became larger and larger, systemic risks emerged, and the central bank was forced Like the progressive reform in other sectors, to intervene once again. this round of RCC reform needs improvement. First, decision makers intended to Fourth, the lack of an exit mechanism use one successful model during the pilot for RCCs means that regulatory authori- reform process, neglecng the need for es must focus on breaches of rules and diversificaon. That is, the success of RCCs regulaons but not on closure or liquida- means the success of the reform. Second, on. Moreover, provincial rural credit although RCC pilot reform followed enter- unions can interfere with RCC operaons prise reform in leng local governments by using management appointment rights. and financial instuons lead the way, it As a result, RCCs are not forced to bear the failed to heed the main lesson: first open consequences of any improper operaons, the market, then establish private firms and and large numbers of nonperforming loans introduce foreign funds to increase com- will have to be borne by the state. peon. The key to the successful reform of state-owned enterprises in the PRC, for The key to the successful reform of example, was to maintain control of large enterprises while releasing small ones. state-owned enterprises in the PRC, Successful township and village enter- for example, was to maintain control prise reform was accomplished through systemic restructuring that let managers of large enterprises while releasing own relavely large numbers of shares. In small ones contrast, the current ownership of RCCs is overly diverse, with a high cost proxy and Fi h, RCC market discipline is yet to be low shareholder control over operaons established. In the course of this round and management. This resembles the situ- of RCC reform, the formaon of uniform aon during the early stages of the reform legal persons at the county level and the of state-owned and township and village compulsory membership in the provincial enterprises, which emphasized employee rural credit unions have reinforced the ownership; these enterprises subsequently RCCs’ monopolisc status in rural financial underwent a second and even a third round markets. RCC reform iniated by the gov- of restructuring. ernment rather than by RCCs themselves is doomed to fail. Third, although the RCCs have increased their capital adequacy rao and many have turned a profit, this has hidden some RCC Evaluation of Rural Credit problems. For instance, the enhanced capi- Cooperative Reform Policy tal adequacy rao was garnered mainly by transforming deposits into shares, by The RCC pilot programs of the past compulsory withholding of shares upon 2 decades were important experiments in

95 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

correcng the serious mismatch between reform introduces compeon and estab- rural realies and finance sector reform lishes a diversified, effecve, and sustain- and development. The main objecves of able rural financial system. However, RCCs the reforms were to encourage financial sll suffer from moral hazards, high costs, innovaons that suit local economic condi- naonalized risk, lack of efficient mecha- ons and to establish a modern rural finan- nisms to acvate idle capital and aract cial system capable of meeng the finan- investors, diverse financial demand in cial demands of localies, industries, and rural areas, and lack of shareholder con- households of varying income levels. Differ- trol over reforms. ent economic and market structures across regions of the PRC have resulted in a variety In the present system, the relaon of demands for financial services. In the between RCC managers and shareholders eastern regions, demand for rural finance creates moral hazards. County RCC unions comes mainly from the nonagriculture sec- (the managers) need to expand their tor, whereas in the central regions it comes capital bases to meet capital adequacy from aquaculture. In the western regions, requirements but they do not need to most financial demand is to protect liveli- report to their shareholders. In addion, hoods, a need generated by uncertaines in each provincial RCC union has the right agricultural producon. The sannong issues to appoint the director of a county RCC also vary from region to region. In the east, union (one director per county) but is not the focus is on the issue of integrang rural responsible for the county RCC union’s with urban areas, whereas the central performance. Finally, the shareholders, region has more agricultural issues and the deprived of their rights as principals, want western region focuses on farmers. to pursue high short-term returns with minimal risk. County RCC unions (the managers) Although some RCCs have expanded their need to expand their capital bases to capital bases and have introduced mem- meet capital adequacy requirements bership and investment shares, the directors of RCCs and county RCC unions sll but they do not need to report to their are appointed by the regulatory authori- shareholders es. The shareholders do not have the right to appoint senior management, and One of the keys to successful RCC reform the shareholders’ meeng and the super- lies in eliminang the RCC monopoly in visory board remain rubber stamps. The rural financial markets. Monopolies, a asymmetry between shareholders’ rights by-product of the planned economy, are and responsibilies has created stocks of by nature rigid in the face of changing me deposits with high interest rates, and demand and must be abolished to estab- the main objecves of the shareholders lish an efficient and sustainable market are convenient borrowing and preferenal with a variety of useful products. Rural interest rates. credit cooperaves must use different approaches in different provinces, and The RCC pilot programs seem to have financial instuons or service providers emphasized the merging and renaming should be suited to local socioeconomic of instuons but have ignored much- and geographical condions. needed systemic reforms. When one RCC director was asked to describe the Therefore, in a sense, one key indicator differences before and a er reform, for for evaluang RCC reform is whether the example, he replied that the two-level

96 COOPERATIVE FINANCE legal enty system had become a unified high average costs per employee, a high legal enty at the county level, and that nonperforming loan rao, and low rural the regulator had changed from the PBC household coverage, making RCC opera- to the provincial RCC union, changes that ons too costly for poverty-stricken areas. are more cosmec than substanve. The Many nonperforming loans are the result pilot programs have not addressed opera- of moral hazards, government interven- onal issues such as incenves, supervi- on, or the risks inherent in agricultural sion, or RCC exit mechanisms. The moral producon. Due to lack of informaon, hazard problem has not been resolved moreover, it is difficult to discern whether and RCCs sll use credit support for san- nonperforming loans are the result of nong as an excuse for their losses. This operaonal or human factors. In fact, deviates from the stated objecves of the loans intended to support agriculture pilot programs. have become an excuse for moral hazard. Although RCCs cannot avoid losses caused An addional moral hazard is that much by natural calamies, loan officers do not of the PBC’s lending is used to benefit RCC take responsibility for rural household employees before it benefits sannong, but loans, and RCCs are not responsible for rural financial reform cannot be limited to risks associated with natural disasters. safeguarding the interests of RCC employ- More importantly, no one seems to be ees. In many areas of Guizhou, for exam- concerned about the RCCs’ huge number ple, the average annual expense for an of nonperforming loans. Credit support for RCC employee is CNY60,000 to CNY80,000, sannong requires a new approach based higher than the expenses of employees in on efficiency and market-based support. the eastern region, indicang that preferenal policies and PBC onlending have failed to achieve their intended objecves The pilot programs followed a top- of assisng sannong. Without a proper down approach that is not in line with governance structure, RCC development cannot go hand in hand with support the guiding principles advocated by for sannong. the State Council, and this round of reform is therefore no different from Ulmately, the RCC model is sll the only model in operaon, RCCs maintain previous ones a monopoly in the market, and their operaonal environments remain the A third issue is that RCC losses ulmately same. The pilot programs followed a top- are borne by the central government and down approach that is not in line with become public debt. The rural areas of the guiding principles advocated by the Guizhou, for example, suffer from inade- State Council, and this round of reform is quate social security or cooperave medical therefore no different from previous ones. systems. As a result, many RCC loans are The RCC system and staff are the same, used for medical treatment, which should there has been no change in mechanisms have been a fiscal expenditure, and losses or human resources, and moral hazards are inevitable when RCC funds are used remain unaddressed. as public finance. In addion, the government is under heavy pressure to develop An addional issue is that support for the local economy, but a large poron of agriculture is costly and unsustainable. government finance goes to civil servants’ RCCs’ organizaonal structure and weak salaries. Because RCCs are the only financial corporate governance have resulted in instuons under its influence, the local

97 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

government will naturally instruct RCCs to nisms to become sustainable. This round use their funds at the government’s dis- of pilot programs should have priorized creon. When the local supply of funds is the establishment of an efficient mecha- insufficient, PBC onlending becomes the nism to aract capital and a sustainable sole funding source and the central govern- mechanism to retain capital. ment must bear the subsequent naonalized risks. A fi h problem is that the arrangement of provincial RCC unions can barely meet Fourth, the major problem of many RCCs diversified rural demand. The uniform is not a shortage of funds but a lack of approach to establishing county and efficient mechanisms to acvate idle capi- provincial RCC unions may be convenient tal and aract investors. The focus of RCC for RCC management, but it concentrates pilot programs is funding, and all efforts risks on the RCC unions and sfles compe- are centered on the special 2-year PBC on. If the central government required notes. However, outstanding PBC onlend- provincial governments to shoulder the ing to RCCs in Guizhou, for example, was risks inherent in reforms, a relavely poor CNY2.4 billion at the end of July 2004, province such as Guizhou might be unable whereas funding for the pilot programs to do so. was less than CNY800 million. If the vast amount of PBC onlending cannot resolve The provincial RCC union system includes RCC issues, it is difficult to believe that a numerous weaknesses. First, the sys- PBC contribuon of one-third that amount tem mixes supervision with regulaon. can make much difference. Regulators bear no risk and managers have no one to blame. Second, provincial RCC unions may be suitable for some The uniform approach to establishing provinces but not for others. Areas may county and provincial RCC unions differ in their level of economic develop- may be convenient for RCC ment and their financial demands, and one provincial RCC union policy may not management, but it concentrates be suitable for all. Third, the provincial risks on the RCC unions and stifles RCC union arrangement is likely to inhibit financial innovaon because county RCC competition union operaons must follow the direcves of the provincial RCC union but In our field interviews with RCC directors, some such direcves may neglect local we asked two quesons. First, we asked financial demands. Moreover, all RCCs whether the directors would operate their have to become members of the provin- RCC in the same way if they owned it. We cial RCC union, which constutes a de also asked whether the directors believed facto monopoly and precludes any out- they could make money as the owner of side compeon. Monopoly is the natural an RCC. The answers to the first queson enemy of financial innovaon. were all negave; directors would not operate an RCC in the present fashion. On A final hindrance to RCC reform is that the other hand, directors responded posi- shareholders currently do not select the vely to the second queson, believing reform mechanisms. The pilot program that they could make money as the owner and local innovaon are restricted if deci- of an RCC. This indicates that, in the view sions about the pilot model are delegated of RCC directors, many RCCs are not short to provincial governments. Such a deci- of funds but simply lack effecve mecha- sion-making structure makes it difficult to

98 COOPERATIVE FINANCE avoid retracing the path followed during vate on a market basis according to local previous reform aempts. situaons. All types of RCCs and investors should be allowed to make decisions about Resolving the issue of who determines a merging and restructuring. RCCs should new mechanism requires transforming decide for themselves whether to join the role of government. Instead of county RCC unions, to be independent, to direcng RCC reform models, provincial form another alliance, or even to form a governments should design a new rural commercial bank. Potenal investors mechanism that is adapve, flexible, and also should be allowed to form new finan- self-correcng according to laws and cial instuons. This will enable effecve regulaons. In other words, the dues of compeon among financial instuons the government are to set the principles and will enable farmers to find reliable that will allow RCCs to operate and inno- instuons for financial services.

99 CHAPTER 7 Microfinance

Microfinance—a type of sustainable financing for low-income and vulnerable populaons—originated in Bangladesh in the 1970s. It began with small loans made to farmers with no collateral and in the 1980s began to serve small enterprises. Later microfinance has aimed at sustainability and coverage, incorporang diversified models that integrate microfinance into the financial system, and has expanded over the past 30 years to become an effecve means of poverty alleviaon in many developing countries of Africa, Asia, and Lan America.

The rapid development of microfinance is a reflecon of the finance-for-the-poor approach. The impoverished once were regarded as unworthy of credit and were not served by commercial banks because of high operaonal costs and risks. To remedy this situaon, governments in developing countries and internaonal development instuons have supported the creaon of specialized policy financial instuons that provide low-interest agriculture and poverty reducon loans. However, most of these instuons have not achieved the desired poverty alleviaon due to problems with guiding principles, policy design, and execung agencies as well as a lack of aenon to deposit taking.

The emergence of microfinance introduced a market mechanism and overturned the tradional model of government-subsidized loans to impoverished households. Microfinance has demonstrated tremendous advantages over the tradional approach, including a high loan repayment rate—successful microfinance projects boast a repayment rate of over 90%. In addion, 100% of microfinance loans reach rural households and target vulnerable groups such as poor women, supplemenng and improving the exisng financial service system. As an effecve poverty alleviaon measure, microfinance projects world- wide are striving to deliver financial services to poor populaons that used to be deprived of such services.

There are many microfinance instuons (MFIs). Among them, Bank Rakyat Indonesia– Unit Desa (BRI-UD), BancoSol in Bolivia, and Grameen Bank in Bangladesh are well known. In addion to financial instuons, microfinance agencies include nongovernment

101 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

organizaons, community organizaons, ized, market-oriented microfinance arms. government agencies, and internaonal Some examples of this are the Agricultural organizaons. Bank of Mongolia, BRI-UD, and the European Bank for Reconstrucon and The history of financial markets has dem- Development. Recently created specialized onstrated the tremendous market poten- MFIs have performed well and covered al of low-income populaons and small 92 million clients as of 2005. enterprises. If operaonal cost and financial risk can be reduced, MFIs can extend Diversified microfinance models address services to the poor while maintaining different economic development stages in operaons and returns. Microfinance can different countries and serve clients with support the start-up of small enterprises diverse social and cultural backgrounds. and provide them with long-term services. Models include the nongovernment orga- Moreover, deposit services can help the nizaon model, the financial instuon poor to increase their savings, and loan model, or some combinaon of the two; services can help low-income borrowers the cooperave or village bank model; or a improve producon and incomes. Micro- state-funded model. Despite their different finance mainly targets the poor with work approaches, however, microfinance mod- abilies, who will invest in a small busi- els share similar targets and offer similar ness, small-scale trade, or producon, services. The aim is to provide sustainable smoothing consumpon. MFIs may pro- services to low-income populaons and to vide long-term agriculture loans to diver- help alleviate poverty. sify their porolios, but the proporon of such loans should be small. Moreover, Grameen Bank is a good example of the the destute and handicapped, who lack nongoverment organizaon model. Estab- repayment ability, should receive public lished in 1976, Grameen Bank was converted aid rather than microfinance loans. into an independent bank with government support in the 1980s. By the end of 2007, Grameen Bank had 2,481 offices and a staff Diversified Microfinance of 12,000. The bank covered 7.41 million Development Model members, with a cumulave loan distribuon of about CNY45.7 million. The annual Microfinance originated from informal loan interest rate was 8.5% to 12%, the financial service providers, and microfi- loan repayment rao stood at 99%, and the nance projects are linked to banks in two declared dividend rate stood at 20%. ways. First, small-scale credit projects To shake off the negave image of depen- gradually grow into independent ins- dence on subsidy, Grameen Bank stopped tuons and then into formal financial receiving government and internaonal instuons such as BancoSol or Grameen funding support in 1998. Bank. Alternately, naonal commercial banks may introduce microfinance proj- To meet increased client demand and to ects, expand services to low- and middle- remain compeve, the bank began lend- income clients, and then set up special- ing to small and medium-sized enterprises. Grameen Bank emphasizes the develop- Microfinance can support the start- ment of group-based farmers’ organizaons, requesng that poor people with up of small enterprises and provide similar social and economic status in the them with long-term services same community form loan groups on a

102 MICROFINANCE voluntary basis. In this way, the poor can Bank Rakyat Indonesia–Unit Desa is help each other to choose projects, moni- an example of the financial instuon tor project implementaon, and assume model. BRI-UD has regional subsidiaries repayment dues for each other. Building that funcon as independent operaonal on the loan groups, centers for financial units to determine loan scale, term, col- and skills training were established. The lateral, issuance, and repayment. Each centers also offer small short-term loans unit has an incenve system, with 10% without collateral; clients are required to of annual profits distributed among make installment payments and to aend employees during the following year. center acvies regularly. Grameen Bank BRI-UD uses high interest rates to achieve provides ongoing loans to disciplined farm- financial sustainability, and the com- ers who make mely payments. mercial lending rate of 32% per annum is applied to cover costs. If borrowers repay South Africa’s Khula Enterprise Finance, on me for 6 months, 5% of the principal founded in 1996, is a microfinance instu- is returned each month as a bonus. The on for small and medium-sized enter- interest rate on savings varies by amount prises. Khula is a public limited liability deposited, with larger deposits paying company, established and registered with higher interest. This policy helps BRI-UD the Government of South Africa, and has to aract idle funds from around 3.3 mil- its own council. Its inial capital was from lion farmers in the rural areas of Indo- a local government and its follow-up capi- nesia, making savings the instuon’s tal comes from the Government of South main funding source. In addion, BRI-UD Africa, the Ford Foundaon, the United clearly separates social from commer- Naons Development Programme (UNDP), cial funcons. For example, it does not and internaonal organizaons from involve itself with farmers’ training and Canada and Europe. educaon.

Khula, which accounts for 90% of financial instuons’ microfinance loans in South Khula is a public limited liability Africa, does not lend directly to small company, established and registered enterprises but rather operates through a with the Government of South Africa, network of nearly 20 retail financial intermediaries. Retail financial intermediaries and has its own council issue loans ranging from approximately CNY140 to approximately CNY8,200 at an A community cooperave bank, or credit annual interest rate of 40% to 60%. Retail- union, is a democrac, nonprofit finan- ers must have more than 50 acve clients cial cooperave administered by specific and about 25 clients per loan officer, must groups, instuons, or organizaons and be financially independent, must have a owned and run by all community mem- loan repayment rate of at least 50%, must bers. Each member is entled to one vote be able to borrow and to aract new in selecng the head of the cooperave. clients, must reach financial sustainability within 5 years, and must make loans The idea of the village bank was estab- under CNY8,200. Retailers meeng these lished by the Foundaon for Internaonal requirements can obtain CNY68,000 to Community Assistance. Village banks are CNY13.7 million at an annual interest democracally managed and their main rate of 14%. product is market-interest-rate loans.

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The difference between a village bank surveys, audits, and review of financial and a community cooperave bank is in statements, and it helps agencies set up the vong; village banks allow individual long-term development programs. members more than one vote, generally determined by the number of shares held. The village bank is a self-administered Lessons of Microfinance group of 10 to 50 members, with group meengs every week or every 2 weeks. Commercially viable MFIs require sus- The group provides its members with small tainable projects and a useful degree of self-employment loans to establish or coverage of the project’s target clientele. enlarge businesses, in addion to savings Sustainability means that project earn- iniaves and a system to provide mutual ings can cover operaonal costs, funding support and promote independence. costs, loan losses, inflaon-related asset Members of the village bank can vouch for value reducons, and project expan- each other and the group employs demo- sion. Moreover, only services that meet crac decision making. the needs of clients can be considered sustainable, and sustainability can only The Palli Karma-Sahayak Foundaon (PKSF) be achieved through financial innova- is a well-regarded state-run wholesale on. That is, a mechanism is needed to microfinance instuon. It was founded reduce financial risk and operang cost, by the Government of Bangladesh to to ensure high loan repayment rates, collecvely manage donor agency and and to cover costs and risks through government funds and to promote MFI loan interest. sustainability. Established in 1990, the PKSF was registered as a nonprofit shareholding Successful MFIs adopt various finan- company with CNY1.16 billion in capital cial innovaons to sustain expansion of raised from domesc and foreign grants the financial market for the poor. Many and internaonal financial organizaons. Its MFIs reduce loan risk through a set of board of directors comprises seven inde- risk management instruments, including pendent social elites; the chairperson and loan amounts as low as CNY340; short two of the members are recommended by loan terms of around 3 to 12 months; the government. The PKSF provides capac- increased loan quotas for those with ity-building support and wholesale micro- a record of mely repayment; security finance loans to qualified agencies. By the deposits proporonal to the amount of end of 2003, the PKSF had 189 cooperang the loan; periodic group meengs; delin- agencies and had issued CNY1.13 billion quency penales, such as fees or refusal in microfinance loans, covering more than of a higher credit line; borrower educa- 2 million poor farmers. The PKSF supervises on; and risk-based interest rates. Loan its cooperang agencies through on-site evaluaon considers factors such as the applicant’s assets and credit rang and the projected cash flow of the proposed proj- The group provides its members ect. Loans may be issued to individuals, with small self-employment loans groups, village agents, or subsidiary credit to establish or enlarge businesses, instuons. Financial products are usually flexible enough to meet the needs of both in addition to savings initiatives and borrowers and depositors. a system to provide mutual support The main constraint on poor clients’ access and promote independence to credit from financial instuons is a

104 MICROFINANCE lack of collateral such as land or houses. profitable operaon and a proven ability Microfinance loans deal with these issues to meet future commercial funding costs in a nontradional way. MFIs rely on alter- before nongovernment MFIs can make use naves to collateral, the most common of of commercial funds to carry out microfi- which is social guaranty. This pracce is nance loans. widely used for group guaranty loans, in which the group assumes the repayment responsibilies of group members. Groups Development and Innovation normally comprise five to eight members of Microfinance in the PeopleÊs who supervise and guaranty loans for each other. The gradual increase of loan Republic of China quotas is another substute for collateral. Timely repayment is encouraged through In 1993, the Instute of Rural Develop- the promise of a larger loan during the ment of the Chinese Academy of Social next loan period. In addion, microfinance Sciences introduced the Grameen Bank loans aimed at low-income clients o en model to the PRC and iniated poverty adopt direct guaranty or a combinaon of alleviaon cooperaves in Danfeng direct and group guaranty. Some MFIs also County, Shaanxi; Yi County, Hebei; and accept movable assets as collateral. Yucheng and Nanzhao counes, Henan. In 1995, the United Naons Development MFIs employ several supervisory models, Programme (UNDP) and the Internaonal including supervision by bank regula- Economic Technology Exchange Center in tory authories, stand-alone instuons, the PRC began developing poverty alle- industry associaons, apex instuons, viaon microfinance projects in 48 coun- or rang agencies; or management by es across 17 provinces. Later, UNDP organizers. There sll is no common established urban microfinance projects understanding about whether supervision targeng laid-off employees in Tianjin and is needed, at which stage MFIs should be several cies in Henan Province. supervised, or how to supervise them. In fact, no bank supervision instuon in any country has enough staff, funds, It is generally believed that if MFIs and skill to supervise all MFIs, and some do not absorb deposits, they cannot even have no interest in carrying out such supervision. It is generally believed that if cause systemic risks and do not MFIs do not absorb deposits, they can- need prudential supervision not cause systemic risks and do not need prudenal supervision. Early microfinance parcipants in the PRC included mullateral donor agencies under Authories should not establish a supervi- the supervision of the European Union, sory mechanism that might fail to funcon the Internaonal Fund for Agricultural due to lack of resources, skill, or polical Development, the United Naons, and or other will. In parcular, when MFIs the World Bank; bilateral instuons such have both financial and social missions, as the Australian Agency for Internaonal there o en is a conflict between the two Development, the Canadian Internaonal that prevents supervisors from seng Development Agency, and the Holland appropriate standards or taking prompt Development Fund; and internaonal and correcve acon. Due to concerns about domesc nongovernment organizaons systemic risk, some countries have set up such as the poverty alleviaon funds and basic criteria requiring a certain period of county poverty alleviaon cooperaves set

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up by the Chinese Academy of Social Sci- instuonal sustainability targets are clari- ences, which also receive internaonal and ﬁed a er the transformaon of projects domesc donor support. into instuons.

The most important donor agencies are Microfinance projects and instuons in the Australian Agency for Internaonal the PRC mainly target poverty alleviaon Development, the Internaonal Fund for and assistance for women and children. Agricultural Development, UNDP, and the More than 80% of projects are in poor United Naons Populaon Fund. More- counes, with many in the mountain- over, Internaonal Fund for Agricultural ous areas. In a survey of 44 counes, Development projects in the PRC usually 21 projects were located in the poorest are regarded as agriculture development townships, 16 were located in less-devel- projects because they are implemented by oped townships, and 7 were in townships county government agencies, which are of average development. This implies that responsible for loan repayment. Loans are almost all projects were for poverty reduc- issued and repaid through county, village, on rather than for development, and it is and rural autonomous agencies, and they unknown how long such projects will last. feature low interest rates and long terms, which differs from microfinance in general. The small loan amounts also reflect an emphasis on poverty alleviaon. In the Loan conditions include joining early stages, 42 of the 44 project counes required that borrowers be poor. By 2005, groups, attending center meetings, the number of counes without such and participating in group guaranty requirements had increased to eight, and among these, six counes clearly spu- Over more than 10 years, the main non- lated that borrowers should not be poor. government microfinance instuons in With the excepon of a few counes, the PRC have included those sponsored most projects required that borrowers by UNDP and managed by the Commu- be employable. nicaon Center of the Ministry of Com- merce; the poverty alleviaon associaons Well-run nongovernment microfinance and poverty alleviaon funds; and the instuons in the PRC generally adopt a Rural Development Associaon, Sichuan similar approach to loan condions, loan Province. Most microfinance projects in issuance, deposit requirements, loan the PRC are sponsored by internaonal terms and amounts, and interest rates. instuons such as UNDP and the United The basic borrowing unit is the group Naons Children’s Fund (UNICEF) rather and community center, with around five than by domesc agencies. people voluntarily forming one group and five to six groups located in one cen- Most microfinance instuons in the ter. Group leaders and center heads are PRC are located in the southwestern elected by vote. Loan condions include regions (52%), followed by the northeast- joining groups, aending center meengs, ern regions (25.4%), the central regions and parcipang in group guaranty. No (10.4%), and the northern regions (6%). collateral or other guaranty is required. Such distribuon reflects the MFIs’ poverty reducon objecves and projects. The Loan issuance is provided first to two MFIs’ supporng instuons, whether reg- members, then to two other group mem- istered as communies or as affiliaons, bers (2 weeks later), and finally to the are nonprofit. In general, financial and group leaders. Half of the loan interest is

106 MICROFINANCE deducted when the loan is issued. When International Microfinance receiving a loan, farmers put 5% of the principal into the group fund. In addion, bor- Donor Agencies rowers deposit CNY1 every week. A er the loan is repaid, group funds can be returned. Microfinance in the PRC is supported and promoted by internaonal donor The loan term usually is 1 year, with repay- agencies, especially mullateral and ment made every week or every 2 weeks. bilateral instuons, which employ vari- The ceiling of the first loan is CNY1,000. ous approaches and instruments. Donor A er repayment of the first loan, bor- agency supports include instuonal rowers can borrow up to CNY1,500 or setup and project upgrading, such as CNY2,000. The nominal interest rate is 8%, microfinance projects, nongovernment although the actual interest rate can be MFI projects, village and community around 16%. funds, and commercial microcredit companies. Agencies also provide support in These approaches differ somewhat from the form of MFI transformaon, decen- those of Grameen Bank in Bangladesh. tralizaon of financial products and ser- For example, Grameen Bank provides vices, and market and service expansion. only group loans whereas microfinance Supporng instruments include low-inter- instuons in the PRC provide loans to est loans, provision of loan capital, equity individual farmers in the group. In addi- investment, and technical support. on, Grameen Bank does not return group funds to members whereas PRC Agencies also provide support in microfinance instuons do so a er the loan is paid off. Finally, Grameen Bank the form of MFI transformation, holds center meengs once a week decentralization of financial products whereas meengs are held once every 10 days or even every 2 weeks in some and services, and market and PRC projects, and some projects hold no service expansion center meeng at all. In addion, some internaonal donor Group guaranty plays a major role in credit agencies are preparing to support the PRC’s risk controls and poverty alleviaon tar- new microfinance instuons and projects gets, because the group members’ mutual in new ways and with different instru- guaranty forms an internal control mecha- ments. In 2005, the PBC began to promote nism. An addional control is the incen- commercially oriented pilot microcredit ve mechanism, which enables connu- companies in five provinces. These have ous loan provision and applicaons. If all garnered equity and technical support from members repay their loans on me, they the Internaonal Finance Corporaon and receive a larger credit quota. Compulsory KfW Bankengruppe as well as technical deposit in the group fund enables MFIs to support from Germany’s GTZ. The Asian deduct funds if a borrower cannot repay Development Bank supported the prepara- the loan. Installments also can offer an on of bidding documents and invitaons efficient method of risk management. in Guizhou Province and Inner Mongolia The main role of the center meeng is Autonomous Region. KfW Bankengruppe to ensure transparent loan issuance provided low-interest loans and technical and repayment, so that borrowers and assistance to support the transformaon loan officers can effecvely monitor the of nongovernment MFIs in Chifeng, Inner loan process. Mongolia Autonomous Region. UNDP also

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is considering support for the transforma- and products. Internaonal donor agen- on of microfinance instuons in Chifeng cies—especially mullateral and bilateral City, Inner Mongolia Autonomous Region, aid instuons—o en cannot decide on and in Xingren County, Guizhou Province. project locaons or partner agencies. For example, they must implement projects Donor focus is shi ing from poverty alle- with local governments but governments viaon and social targets to sustainability. may have different objecves. In the 1980s As a result, donors are more focused on and early 1990s, the concept popular in microcredit companies than on nongov- the PRC was that poverty alleviaon micro- ernment MFIs, and on grassroots services credit must carry a low interest rate—at and financial products. The means of least lower than the RCCs’ interest rate. support also have changed—from funding This approach, combined with a lack of and refinancing to equity investment or techniques and technical staff, has nega- simple technical assistance. Donors such vely affected the sustainability of micro- as the Asian Development Bank, GTZ, the credit instuons. Internaonal Finance Corporaon, KfW Bankengruppe, and the World Bank have Internaonal donor agencies and micro- become the main sponsoring instuons. credit projects and instuons, especially In terms of microcredit for poverty allevia- those aimed at both poverty alleviaon on, the focus is on community funds. For and sustainability, have contributed sig- example, the World Bank recently spon- nificantly to microfinance development in sored village projects iniated by the Min- the PRC. They have assisted in the cre- istry of Finance and the Poverty Reducon aon of nongovernment MFIs, transform- Office. Finally, commercializaon has led ing projects into instuons independent to diversified microcredit products such as of local government, which has formed microinsurance and microremiance. Vari- the basis for future development. The ous supporng measures, including MFI actual interest rate on poverty allevia- credit rangs, credit scoring, and computer on microcredit has been raised from systems, also have augmented market between 3% and 5% to between 16% and diversificaon. 17%, transforming the tradional concept of microcredit interest rates. The projects International donor agencies· have pioneered poverty alleviaon microcredit, proving that farmers and other especially multilateral and bilateral poor clients can repay loans and that with aid institutions·often cannot decide proper management, credit, projects, and instuonal design, MFIs can be sus- on project locations or partner tained in even the most poverty-stricken agencies regions. Projects also have integrated microfinance with social development Internaonal donor contribuons to goals, such as enhancing women’s sta- microfinance in the PRC depend greatly on tus, improving farmers’ health, train- external factors such as the polical envi- ing farmers, and promong agricultural ronment. Compared with other countries, technologies. Finally, internaonal donor the environment in the PRC includes more assistance has provided experiences and constraints, such as the vague legal status lessons applicable to PBC pilots in five of MFIs, limitaons on their scope of provinces and to other commercially ori- services, and restricons on interest rates ented microcredit projects.

108 MICROFINANCE

Reasons for the Slow passed since the inial pilots, nongovernment MFIs remain pilot programs without Development of Microfinance explicit evaluaon standards. Moreover, the requirement that MFIs’ lending rate As of this wring, there are around remain within four mes of the benchmark 300 nongovernment microfinance ins- interest rate has impeded the commercial- tuons and projects in the PRC. Larger izaon of MFI lending. instuons and projects have covered about 5,000 households whereas smaller A second constraint on MFI development ones cover fewer than 1,000 households. lies in their structure and staffing. Other Of the 300 MFIs and projects, fewer than countries have some successful nongov- 20% can operate properly and few are ernment MFIs, such as the Associaon for financially sustainable. Many MFIs face Social Advancement in Bangladesh, and serious challenges caused by shrinking not all nongovernment MFIs need to be equity. Without addional external fund- transformed into commercial microcredit ing and fundamental reform of the micro- or microcredit banks. In contrast, of the finance instuons themselves, most of 67 PRC microfinance projects and instu- the exisng nongovernment MFIs would ons surveyed, 41 are independent instu- face difficules and would perhaps close ons. Among the independent instuons, down within 3 to 4 years. only 31 are civil enes, independent of local governments; the others are project There are many reasons for the slow offices, which are difficult to sustain. development of nongovernment MFIs, beginning with the lack of an enabling policy environment for microcredit in the Only the poverty alleviation PRC. All countries with well-developed associations and the UNDP pilot microfinance have long-term programs program have obtained approval from that include clear legal status for MFIs, which allows these instuons to expand the PBC and the Poverty Reduction even into deposit taking, and a supervisory Office framework of nonprudenal supervision or registraon (for MFIs that do not take However, even the independent nongov- deposits) and prudenal regulaon (for ernment MFIs are vastly different from MFIs that do). In addion, these govern- MFIs in other countries. Most of the ments support MFIs with credits such as a microfinance instuons in the PRC are wholesale fund. dependent on local governments—mainly county and district government agencies In the PRC, by contrast, the legal status of such as the Agricultural Department, the microfinance instuons remains unclear. General Office, the Poverty Reducon Nongovernment MFIs are registered as Office, or the Women’s Union—because social groups or non-enterprises, legally nongovernment organizaons are unable to provide loans or engage in required to be affiliated with a local gov- other financial acvies or to transform ernment department or have some other themselves into microcredit companies affiliaon. More importantly, the manage- or financial instuons. Only the poverty ment staff of county and district non- alleviaon associaons and the UNDP government organizaons must be civil pilot program have obtained approval servants in local government, appointed from the PBC and the Poverty Reducon and paid by local government agencies. Office. Although more than 15 years have Such employees generally are unwilling to

109 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

give up such posts for microcredit posi- drascally different, and one model cannot ons, and in the case of a microcredit suit them all. In addion, many pilot MFIs instuon failure, managerial staff can and projects do not take financial sustain- simply go back to their original govern- ability into account, and a er the instu- ment agency. In addion, the council on or project is designed, lile further directors o en are local government mag- change is made. istrates, leaders of the Women’s Union, or other government officers, even though Under the village bank model, offices are the council is the nominal decision maker set up in counes, branches are set up in for the MFI. Thus, MFI leadership answers townships, and credit officers are located to governments rather than to the ins- in villages. This three-level operaonal tuon. Under such circumstances, it is approach increases the loan cost of MFIs impossible to set up an incenve mecha- relave to their funding scale, which nism for managerial staff, which is crical weakens their financial sustainability. In to the development of MFIs. addion, microfinance instuons in the PRC transform group loans into group- The dependence of MFIs on local govern- guaraned individual loans, but this does ment is closely related to the ownership not transfer costs from MFIs to borrowers of the microcredit funds. In the PRC, the and is therefore unsuccessful. Lowering major funding source for nongovernment the salaries of credit officer could reduce MFIs has been internaonal grants to the costs but would also reduce incenve. government or to the local poor, but local governments can control MFIs by control- Fourth, microfinance is growing slowly ling their managerial staff, their councils, because the main sources of nongov- and their funding. ernment funding for poverty alleviaon are donaons, especially internaonal The difficulties of nongovernment donaons. Donor organizaons, in turn, determine MFI management, operaons, MFIs also are related to issues with models, and projects. Since the mid-1990s, formal finance in the PRC donor agencies have aimed mainly at poverty alleviaon and social development Nongovernment MFIs also rely on govern- and have spread projects across the poor- ment because most are not sustainable. est regions without considering sustain- Salaries and expenditures mostly depend ability. Furthermore, most projects have on government funding, and MFI per- no subsequent capital arrangements and formance is linked to local government find it difficult to obtain addional invest- agencies, though their goals are not neces- ment in case of financial difficulty. sarily the same. Changes in government officials and management can affect MFIs, The difficules of nongovernment MFIs and local government agencies somemes also are related to issues with formal interfere with MFI loans. finance in the PRC. Exisng rural financial instuons are difficult to sustain because Third, development of nongovernment loan interest rates cannot cover funding MFIs is hindered because MFI loans mainly costs, operaonal expenditures, bad loans, follow the Grameen Bank model, without and development. The low interest rate on considering local and instuonal differ- poverty alleviaon loans in poor regions ences. The PRC is not Bangladesh. The and on RCC microcredit also affects the geography, economic development, reli- survival and sustainability of MFIs. Mean- gion, and culture of its various regions are while, supervisory agencies are unwilling

110 MICROFINANCE to open rural financial markets due to the is to shi the focus away from poverty lack of exit mechanisms. alleviaon and social development and to focus on the integraon of poverty allevia- Finally, the microfinance industry suffers on with development of microenterprises from a lack of intermediaries. At present, and sustainable MFIs. the PRC has no rang agencies to increase MFI transparency, no microfinance con- The new phase has several milestones, the sulng or training companies, and no reg- most important of which is support from istered microfinance industry associaons the central government and promoon by or wholesale instuons such as the Palli the PBC. The second milestone is the aen- Karma-Sahayak Foundaon in Bangladesh. on of relevant ministries and internaonal The lack of MFI intermediaries is closely donors to extending the financial products related to the lack of explicit legal status and services of exisng financial instu- for microcredit and the lack of sustainable ons, especially urban commercial banks, retail MFIs. to microenterprises, mini-enterprises, and the low-income populaon. The third mile- Managers, credit officers, and other non- stone is the emphasis on rural and com- government MFI staff have made great munity funds, mainly the village funds, and efforts to develop microfinance in the PRC. on integrang financial services with other Many constraints are beyond their control services to poor farmers. The fourth mile- and they, too, are vicms of unsound MFIs stone was the China Banking Regulatory and projects. Indeed, many staff members Commission’s December 2006 Provisional and credit officers have lost other oppor- Regulaon on Lending Companies and Pro- tunies because they went to work in the visional Regulaon on Village Banks, which microfinance industry. When we recon- approved pilot lending companies and sider microfinance in the PRC, therefore, village banks in four provinces and cies. we should not repeat the same mistakes. Although no implementaon rules were put in place, these measures are important for clarifying the legal status of MFIs and A New Phase of Microfinance enabling their development in the PRC. Development In recent years, the central government has gradually realized that opening the The new phase has several rural financial market is the key to rural milestones, the most important of finance. Because financial instuons which is support from the central lend mostly to large cies, enterprises, and projects, there has been less financial government and promotion by service for agriculture, farmers, and rural the PBC areas (sannong). Microfinance can play an important role in increasing credit access Since 2004, the PBC has acvely promoted for farmers and rural enterprises. All three pilot non-deposit-taking microcredit com- of the central government’s number one panies. Wu Xiaoling, the PBC’s former circulars from 2004 to 2006 emphasized deputy governor, pointed out that the the program for deepening rural finance PRC has a large amount of private funds reform and supporng microcredit, and waing to enter the financial market. central government support has opened Microcredit companies fit both the a new phase of microfinance in the PRC. demands of private funders and the During this phase, the guiding principle requirements of prudent regulators.

111 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Yi Gang, the PBC’s deputy governor, or farmers. Second, most microcredit acknowledged that commercial MFIs companies adopt tradional instruments are an integral part of the rural financial and measures, such as collateralized and framework because this type of instu- guaraned loans, with few credit loans. on represents an innovaon in the social These restricons have kept their services objecves and commercial sustainability from microenterprises and the poor, who requirements of rural financial instuons. have no eligible collateral and are unable to provide a guaranty. Third, microcredit This is a prudent me to open the PRC’s company staffs are drawn mainly from for- rural financial market to private capital. mal or informal financial instuons and With the support of the China Banking have lile experience with loans to micro- Regulatory Commission and the PBC, enterprises or low-income farmers. Finally, such pilots started in five provinces microcredit companies have limited trans- and autonomous regions: Erdos, Inner parency and lack informaon management Mongolia Autonomous Region; systems. These issues are inevitable in the Guangyuan, Sichuan; Hu County, Shaanxi; inial stage of microcredit company devel- Pingyao County, Shanxi; and Tongren opment, but they call for the aenon of District, Guizhou. In May 2008, the pilot supervisors and founders so that they can program was expanded naonwide, and be resolved during the pilot period. by the end of 2008, there were close to 500 microcredit companies. The GTZ and To encourage exisng financial instuons other internaonal organizaons acvely to deliver services and products to micro- support these pilots with technical assis- enterprises, low-income farmers, and rural tance, policy consultaon, and capacity residents, the China Banking Regulatory building. The Internaonal Finance Cor- Commission has encouraged commercial poraon, KfW Bankengruppe, and other bank lending to small and medium-sized donor agencies also acvely seek inves- enterprises. In addion, the relevant tors, helping internaonal MFIs join the ministries have paid great aenon to PRC’s microcredit pilots. the development of rural and community funds, including village funds. For example, Microcredit pilots have drawn on the the Ministry of Finance has conducted lessons of nongovernment microcredit pilots in 100 villages and has coordinated and other projects. In contrast to nongov- with the Poverty Reducon Office to ernment MFIs, commercially sustainable conduct a new round of pilots using World microcredit companies have explicit inves- Bank funding. The difficulty is in figuring tors and owners, which creates a solid out how to establish an independent com- basis for sound governance and prevents munity fund outside of the exisng admin- moral hazard. As a result, such microcredit istrave system, because the funds come companies are in a beer posion to mi- through government channels. The key to gate any local government interference. the smooth operaon of the village funds is whether farmers are willing to deposit Although the microcredit companies are their money, not the amount of money fairly new, some issues are noteworthy. coming from the government. Urgent First, the loan amounts are relavely large issues also include the organizaon of the because some microcredit companies village funds and the need for registraon are not interested in microenterprises and supervision.

112 CHAPTER 8 Informal Finance

Informal finance refers to all for-profit financing acvies that are not lawfully provided by financial instuons. Such transacons may occur among individuals, between individuals and enterprises, or among enterprises. Informal finance is widely distributed in developing countries and regions in Africa, Asia, and Lan America as well as in a number of developed countries, especially in immigrant areas. Informal finance arrangements take many forms, but all are integrated with local economies and communies.

Informal financial instuons in developing countries typically include private lenders (including usurers), pawnbrokers, and borrowing and lending among relaves and friends. There also are rotang savings and credit associaons, or mutual aid unions, which require that members regularly submit funds, labor, or various kinds of producon or assets. Funds gathered in this way are used for special purposes such as tax payments, investment, or holiday expenses. Underground or indigenous banks are for-profit banking instuons that accept deposits and make loans without government authorizaon. Finally, trade credit is a kind of financing by which loans are made to enterprises that are unable to provide sufficient guaranes to obtain loans from formal financial instuons.

The borrower in informal finance is usually an agricultural products processing enterprise with strong seasonal demands. Such enterprises usually need small loans to purchase agricultural goods during the purchasing season, especially during the autumn, but have difficulty meeng rural credit cooperave (RCC) loan requirements and are considered high risk by formal financial instuons. Informal finance can help these borrowers and thus represents an important supplement to formal finance. At the same me, informal finance can support profitable projects, the success of which can help rural households to become quality clients of RCCs.

In some places, informal finance has even become a major player in rural finance. For example, India has experience in combining formal and informal finance. An average of 10 to 20 rural households form self-organized groups that engage in lending acvies

113 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

through accounts with formal financial Informal Finance in the PeopleÊs instuons. Financial instuons provide loans to the groups according to their Republic of China credit record, and disbursements are based on a posive incenve principle: the Informal finance in China dates back to inial amount is small but increases with the 11th century, and informal financial mely repayments. instuons appeared during the Ming Dynasty. Informal finance a er 1949 In most cases, informal finance is an infor- decreased but never ceased enrely. mal agreement subject to human relaon- A er 1978, the tremendous increase ships, convenons, and customs within in funding demands boosted informal a region or an organizaon. Such agree- finance, and by the mid-1980s several ments are not recognized or protected by regions had experienced serious crises in laws, yet the low informaon cost, sharp their informal financial markets.1 In the market orientaon, and unique systemic 1990s, financial system reform revived arrangements channel funds and enhance informal finance, but 1998 regulaons efficiency. Regardless of the kind of sent informal finance underground.2 informal finance operaon, loan costs are lower than formal financial instuonal The characteriscs of modern informal costs, and informal finance has informa- finance in the People’s Republic of China on advantages and lower collateral (PRC) vary by region. In developed regions, requirements. Informal finance can iden- it can be a commercial financing organiza- fy the effecve financial demand of rural on whereas in less-developed regions households, employing informal informa- it is more of a cooperave. Regardless, on gained through local networks. In informal finance in the PRC presently addion, informal finance can discover occupies a legal gray area and its develop- substutes for collateral, including a wide ment is restricted. Moreover, because it array of social relaonships, business es, is not regulated by laws and regulaons, and other informal connecons, to ensure its scale can only be surmised through mely loan repayment. surveys. According to a 2002 report by the Internaonal Fund for Agricultural Devel- Informal finance can identify the opment, for instance, the rate of informal borrowing among farmers in the PRC was effective financial demand of rural over four mes the rate of formal borrow- households, employing informal ing, and thus carried far more importance for the farmers.3 Similarly, in 2004, the information gained through rural survey team of the Naonal Bureau local networks of Stascs found that most rural households had difficulty obtaining loans from Despite these strengths, however, informal banks and RCCs. From 2000 to 2003, the finance is normally not recognized by the average farmer’s bank loan was CNY65 tradional financial management system. per year, represenng about 25% of their Some financial instuons treat informal total annual borrowing, whereas the finance providers as competors and average borrowed from informal sources brand them as usurers. In fact, the scarcer was CNY190 per year, accounng for the the RCC funds and the higher the nonper- remaining 75% of total annual borrowing. forming loan raos in a given area, the more insistent are the efforts to discour- A Ministry of Agriculture survey of over age informal financiers. 20,000 rural households in 31 provinces,

114 INFORMAL FINANCE cies, and autonomous regions confirmed financing channels accounted for 2.9%. that rural households in the eastern, This indicates that nongovernment enter- central, and western regions of the PRC prises, especially small and medium-sized borrowed more through informal sources enterprises, rely on informal finance. than through banks or RCCs. In 2003, the rate of informal borrowing was as high as 72% naonwide, and the main purposes Informal Finance in Poverty- of borrowing were for daily subsistence Stricken Areas (48%) and producon (38%). Informal finance has an informaon In the beginning of 2005, the Central advantage both in screening a borrower’s University of Finance and Economics repayment ability and in monitoring a loan. conducted a naonwide survey of 20 prov- Whether for geographic, occupaonal, or inces, 82 cies and counes, 206 villages, kinship reasons, all pares in informal credit 110 small and medium-sized enterprises, markets can keep in frequent touch, or the and 1,203 family businesses. The survey lender can easily obtain informaon about revealed that around one-third of financ- the borrower. This enables the lender to ing for small and medium-sized enterprises gauge the possibility of loan repayment and in the PRC came from informal finan- to take mely acon if needed. cial sources and less than 50% of rural household loans came from formal financial instuons such as banks or RCCs. The average annual interest rate on Loans from informal financial sources informal lending was about 12% but accounted for over 55% of total borrowing and amounted to CNY741 billion to differed significantly from region to CNY816 billion. Moreover, the underde- region and in different periods veloped regions relied more heavily on informal lending sources.4 Moreover, informal finance’s collateral arrangements are suited to local condi- According to the People’s Bank of China, ons, and items unacceptable as collateral informal lending in 2004 amounted to in formal financial markets can be used in CNY950 billion—approximately 7% of the informal financial markets. For instance, gross domesc product—and represented real estate cannot be used as collateral about 6% of total loans.5 The average in formal markets, due to regulaons, annual interest rate on informal lending high management and disposal costs, or was about 12% but differed significantly the low actual value of the real estate to from region to region and in different formal financial instuons. However, periods. In the more advanced Zhejiang pares in informal financial markets are Province, for example, interest rates were able to circumvent the regulaons and somemes as high as 2% per month, and minimum value requirements of financial this has remained stable in recent years. instuons. In addion, frequent contact between the borrowing and lending par- According to a 2005 report by the es keeps the cost of collateral manage- All-China Federaon of Industry and ment and disposal relavely low. Commerce, 90.5% of nongovernment enterprise funding came through self- In addion to their credit relaonship, financing. Bank loans accounted for 4% informal borrowers and lenders share of funding, financing from nonfinancial relaonships in other markets, such as instuons accounted for 2.6%, and other the commodity market, and both pares

115 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

may access informaon about transacons financial instuons are small and flexible, in these other markets before signing a and their various localized innovaons credit contract. Such external relaonships reduce transacon costs. Although the not only provide the lender with informa- organizaon and operaon of informal on about the borrower’s credenals and financial instuons can be me con- repayment ability but also serve as a de suming, the opportunity cost in poverty- facto guaranty. It adds to the borrower’s stricken regions also is relavely low, cost of breaching contract, enabling the further reducing transacon cost. lender to maintain some control over the borrower and strengthening the borrow- Despite these advantages, informal er’s movaon to use the loan correctly financial instuons remain constrained and fulfill the repayment obligaons. by informaon and transacon costs, and this has confined their scale and scope. There also is a kind of social guaranty mech- First, there is an inverse relaonship anism in informal markets. The borrowing between the informaon advantage of and lending pares in informal financial informal finance and its scope of acv- markets have not only a credit relaon- ity. If informal finance wants to realize ship but also social connecons. These its informaon advantage, it must limit social connecons represent an intangible its acvity and its borrowing and lending resource that can provide material and must target a limited group of people. other benefits to the pares involved. Expanding the scope of financial acv- Moreover, once these connecons are ity weakens the informaon advantage, linked with the repayment behavior of the which in turn requires informal financial borrower, they will become an intangible instuons to employ more standardized guaranty. If the borrower repays his loan in management techniques and operaon full in a mely fashion, these social con- mechanisms and beer-trained manag- necons will be maintained; otherwise, ers and staff, which means higher costs. these connecons will be destroyed, a loss Because some informal financial acvies which may offset any benefit of default. The are restricted or banned, the operaonal existence of the social guaranty mechanism risks also are high. gives the lender addional possible sancons, thus constraining the behavior of the borrower. Comparison of Formal and Informal Finance Informal Financial Institutions The state-owned financial system is an expensive form of financial organizaon The operaon of informal financial ins- and a luxurious arrangement in the early tuons is simple. Contracts are straight- stage of economic development. The state forward and praccal, without many financial system deprives individuals and requirements for the parcipants. Informal nonfinancial instuons of fund ownership and blocks their channels of direct financ- The existence of the social guaranty ing; money used by the enterprise does not belong to the enterprise. In addion, mechanism gives the lender state financial instuons have no control additional possible sanctions, thus over enterprise behavior, to ensure they make good use of loans, or over potenal constraining the behavior of the moral hazards—the fundamental causes of borrower many nonperforming loans.

116 INFORMAL FINANCE

The core of formal finance is impersonal lack of informaon transparency, and borrowing and lending. Without an effec- insufficient collateral. The characteriscs ve market system, formal finance must of rural areas, especially poverty-stricken rely on expensive systems and tools, such rural areas, require organizaonal forms as government support and collateral, to conducive to reduced transacon cost ensure the quality of loans. In comparison, and risk. informal finance is relaonship based. It ulizes geopolics and informal arrange- Grassroots informal finance fits the diverse ments, such as cultural and commercial requirements of rural finance. It will not relaons, as well as peer pressure to crowd out the formal financial market but prevent borrowers from defaulng. This instead will enhance compeon by pro- social capital represents a precious finan- viding financial products. Moreover, some cial resource in the course of economic microlevel arrangements and innovaons development. The exclusive formal finan- of informal finance can benefit the reform cial system, on the other hand, wastes of the PRC’s current financial system. these financial resources and represents a very expensive financial arrangement for First, the growth of informal financial mar- small and medium-sized enterprises and kets is raonal. Treang informal financial individuals. organizaons as illegal ignores the boun- ful financial resources of rural tradions and financial intermediaries, and regard- Rural Finance Options in ing expensive formal financial systems as Poverty-Stricken Areas superior to passive and inexpensive informal financial organizaons has resulted in Small rural household operaons are the lopsided supply and demand. Examining foundaon of poverty-stricken areas, and the effect of the planned economy on the their financial demands usually are char- finance sector and discussing the reasons acterized by scaered inhabitancy, low for inefficiency in rural finance will pave income, seasonality, small deposits, heavy the way for legalized informal finance in environmental and market risks, and lack the PRC, thus enabling complementar- of necessary guaranty and collateral. These ity and compeon between formal and factors represent high risk for rural finan- informal finance and establishing a com- cial services. The long terms, high risk, and plete spectrum of financial instuons. low profit of agricultural investment are contradictory to the safety, liquidity, and The characteristics of rural areas, profitability requirements of commercial funds. The environmental dependence of especially poverty-stricken rural agriculture also leads to relavely great areas, require organizational forms regional risks for rural finance, and the unique features of the rural economy cre- conducive to reduced transaction ates much higher transacon costs than is cost and risk present in urban finance. Second, the compeon of financial A number of regional risks also are not organizaons will promote rural financial in line with standardized commercial reform. Economic reform in the PRC has credit service requirements. Large for- shown that the key to successful reform profit formal financial instuons usually lies outside of the reform itself. The rural are unwilling to provide credit to rural family contract responsibility system enterprises with small operaonal scale, originated with farmers. The success of

117 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

state-owned enterprise reform resulted compeve; in fact, because each type of from compeon among township and vil- finance has its own comparave advan- lage enterprises, and township and village tage, the two can parally complement enterprise reform was an inevitable result each other. Formal financial instuons of the rapid development of private enter- have financial strength, comprehensive prises. It is likely that compeon from organizaonal systems, well-trained mana- informal financial organizaons will play gerial staff, and rigorous internal control the same role in rural financial reform. procedures. Therefore, they have an advantage in providing large amounts of Finally, understanding the microscale basis long-term loans. On the other hand, infor- and mechanisms of informal financial mal finance, characterized by flexibility, organizaons, especially the pracce and promptness, convenience, small size, and innovaon of informal financial organiza- informaon advantage, is more adept at ons in resolving informaon asymmetry providing residents with sundry and small and moral hazard, may prove useful for loans. Given their respecve comparave rural financial reform. advantages, it is possible for each to serve different types of customers in the credit Because the credit acvity of the informal market and to form a reasonable division finance sector is relavely simple, informal of labor. In addion, if formal and informal and formal financial instuons can subs- financial instuons can be integrated, it tute for and compete with each other. The will be possible to bring informal finance relaon between the two is not merely further into play.

118 PART IV SURVEYS, PILOT STUDIES, AND POLICY RECOMMENDATIONS

119 CHAPTER 9 Surveys and Pilot Projects

Poverty Reduction Loans

Loans by the Poverty Reduction Office

To increase the role of discounted credit funds and improve efficiency, the Poverty Reduc- on Office of the State Council conducted pilot programs in 33 counes, beginning in 2004. In the pilot programs, the Ministry of Finance allocates part of the central government’s discounted credit fund to local governments, which then give the funds directly to borrowers or to loan-issuing financial instuons to subsidize interest on loans to poor borrowers. Local government also provides borrowers with support services.

Loan-issuing ﬁnancial instuons, which are selected through an open bidding process, extend loans to farmers at normal commercial lending rates, based on market supply and demand, and retain the right to select candidate borrowers from a list provided by county poverty reducon oﬃces. The Ministry of Finance provides an interest subsidy for 1 year (interest subsidy on loans of less than 1 year is calculated according to actual maturity). Poverty reducon loans are distributed only to eligible poor farmers approved in village poverty reducon plans, and the issuance and ulizaon of these loans are regularly pub- licized and are subject to villagers’ supervision.

Risk compensaon is based on principles of openness and fairness, and loan-issuing ﬁnan- cial instuons are selected through market-oriented approaches. Financial instuons have the right to select candidate borrowers independently, but loans to farmers must account for a certain poron of the instuons’ total poverty reducon loans. In addion, the preferenal interest rate for poverty reducon loans has been brought in line with commercial lending rates, and loan maturity is set at the discreon of loan-issuing ﬁnan- cial instuons, according to the actual producon cycle.

121 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

The pilot program offers two opons for Funding for the pilot programs increased fiscal interest discount. The first opon is from CNY16.5 million in 2004 to CNY100 direct subsidies to loan-issuing financial million in 2005, and the interest discount instuons. In other words, financial ins- increased from 4% to 5% per annum. Pro- tuons issue poverty reducon loans to gram coverage in the central and western borrowers a er deducng the subsidized People’s Republic of China (PRC) expanded interest rate from the normal commercial from 33 counes in 11 provinces in 2004 lending rate. Finance bureaus allocate to 200 counes in 21 provinces in 2005. subsidies to financial instuons follow- A er evaluang the program in 2006, the ing joint approval by the bureau and the Ministry of Finance increased loans to county poverty reducon offices. Because farmers to CNY296 million and expanded the financial instuons assume risks inde- the program to 592 priority counes. The pendently, they are beer able to balance pilot program raised the rao of loans to compensaon with risks. This can create farmers and mobilized the rural credit addional incenves for financial instu- cooperaves (RCCs). ons and can make poverty reducon loans viable and sustainable. Jiangsu Model

In 1998, Jiangsu Province began a pilot Eligibility criteria and subsidy program to gradually transfer to RCCs amounts are announced in the responsibility for distribung poverty reducon loans, and the handover was borrowersÊ home villages and completed in 2001. In 16 high-priority, townships, to enhance policy poverty-stricken counes, county poverty transparency and engage the public reducon offices provide RCCs with a list of prospecve borrowers. The RCCs then in supervision choose their prospecve clients from among this list of law-abiding farmers who The other alternave is direct subsidies are capable of working, have good cred- to poor borrowers, a er poverty reduc- itworthiness, and have suitable proposed on offices and bureaus of finance verify producve acvies. the issuance of loans to poor borrowers at the normal commercial lending rate. The bureau of finance in Jiangsu Prov- However, the loan principal comes from ince provides guaraned funds totaling the financial instuons themselves, and CNY63 million and deposits these funds in the instuons have no incenve to issue RCCs. The RCCs then issue poverty reduc- poverty reducon loans if they cannot on microloans equal to up to twice the break even. amount of the guaraned funds. The government-guaraned funds are intended Each county in the pilot program deter- to offer an interest discount, to reward mines which discount method is appro- successful RCCs, and to migate losses, priate for them, but poverty reducon but use of such funds must meet specific loans to the pilot projects remain the requirements. First, poverty reducon responsibility of the Agricultural Bank of loans are subject to the benchmark inter- China (ABC). Eligibility criteria and subsidy est rate, but farmers who repay on me amounts are announced in borrowers’ are eligible for an interest discount of 50%. home villages and townships, to enhance Second, local governments require the policy transparency and engage the public collecon rao of poverty reducon loans in supervision. to reach 50%. If the local rao exceeds

122 SURVEYS AND PILOT PROJECTS

50%, RCCs and county poverty reducon Among those interviewed in Cixi, 1 had offices split the remainder equally. Finally, a credit card and 14 out of 15 had bank if the loan collecon rao is less than 90%, cards—1 had four cards, 2 had three RCCs and the guaranty fund each cover cards, and 5 had two cards. Twelve of 50% of the losses. The provincial bureau the cards were issued by the ABC, seven of finance conducts an annual audit of the were issued by the Bank of China, and guaranty fund and supplements the fund five were issued by postal savings outlets. if it is found to be insufficient. A er such Cards issued by banks other than the ABC measures were put in place, 16 counes in were provided by employers in coopera- northern Jiangsu Province issued micro- on with a bank and were used for paying loans of nearly CNY88 million, with a col- wages directly onto the cards. Migrant lecon rao of 99.7%. Governments, poor workers remied money home by trans- farmers, and RCCs are all sasfied with ferring their wages to the ABC or a postal the results. savings outlet.

Jiangsu’s experience shows that such a Migrant workers in the PRC generally guaranty system can ensure poor farmers’ send a relavely high proporon of their access to poverty reducon loans, can help incomes home, and remiance incomes distribute financial instuons’ risks, and are crucial for family consumpon. Accord- can provide incenves to provide loans. ing to the groups interviewed, each Jiangsu’s pracce also reveals that market- migrant worker in Zhejiang remits an oriented approaches can magnify the func- average of CNY3,000 to CNY4,000 home, ons of government fiscal support. represenng 35% to 40% of his or her total income. The major determinants of the amount of remiance include a Rural Remittance worker’s income, whether the worker’s family is living with him or her, and the In December 2004, we conducted a survey family’s need for money at home. For of migrant workers in Hangzhou, Zhejiang example, a migrant worker will send home Province. The parcipants, 72% of whom around 20% of his or her income if he or were male, included 400 migrant workers, she is single and/or his or her partner and mostly from the central and the western children are with him or her, although regions; only 10% were from the eastern under such circumstances some migrant regions. The largest group in the sample workers will simply bring the money with (28%) was from Henan Province, the most them when vising their home village, populated central province, followed by rather than using remiance services. A Sichuan and Guizhou provinces. worker will send home 20% to 35% of his or her income if the children are le at the The use of financial services by migrant workers in Zhejiang is related to their educaonal level, which is highly The major determinants of the c orrelated with income. The migrant amount of remittance include a workers interviewed in Cixi had a higher- than-average level of educaon. All had workerÊs income, whether the mobile phones, two regularly sent and workerÊs family is living with him or received e-mails, and six had used internet services, whereas no one in the other her, and the familyÊs need for money three groups had used internet services. at home

123 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

home village, and 60% to 70% of his or her without a local residence are ineligible income if both partner and children are for loans from financial instuons, le at the home village. The money remit- and migrant workers generally are ineli- ted home comprises 40% to 80% of the gible for credit cards. The single migrant family income. Major uses of remiance worker from Cixi with a credit card income include educaonal expenses, received it because her friend worked household consumpon, house building, for a bank. and weddings. The major determinants in selecng The group interviews also revealed that remiance channels are the availability of migrant workers remit a relavely small the service at the worker’s home town- amount of money home with each remit- ship and the cost of remiance. Migrant tance—CNY500 to CNY1,000. The amount workers tend to select a service provider was higher among construcon work- located near their home. If an ABC busi- ers, with the most remied at the end of ness office is located in a nearby township, construcon. Migrant workers in Zhejiang for example, the recipient can travel to were paid monthly, except for workers in get the money because bus transport is the construcon industry, who were paid a inexpensive. The county seat, where the living allowance of CNY300 to CNY400 per commercial bank branches are located, month and a lump payment at the end of is regarded by most migrant workers as the project or when the worker returned too far away from their home villages and home. Interviewees indicated they do thus is not their priority selecon. Delivery not like to remit too much money at one speed, quality of service, and safety are me, usually reming less than CNY1,000, secondary determinants. for reasons of security and to maintain control over spending at home. Three to The ABC charged 0.5% for card-to-card six mes each year, therefore, an aver- services. Other commercial banks charge age migrant worker will remit CNY500 to 1% of remiance, with a surcharge of CNY1,000. Remiance occurs at the me 30% for express service, which is inconsis- of major fesvals, such as the Spring tent with standard bank charges. Money Fesval (usually in February) or the Mid- can be received within 1 day if channeled Autumn Fesval (September or October), through a state-owned commercial bank; or when there are pressing family needs, however, transfer takes 5 to 7 days if such as school fees, a birthday, or building remied through a postal savings outlet. a house. Migrant workers with a partner and children at home sent money more The field invesgaon revealed that bank regularly, every 2 or 3 months. branch service personnel and tellers usually do not advise potenal customers about all available remiance products Bank services for migrant workers and their fees. Instead, they tend to quote are limited to remittance, deposit and the clients a fee, usually for real-me withdrawal, and issuance of debit services at the high end of the scale, according to the quanty of money to cards for deposit and withdrawal be transferred and the transfer desnaon. The various remiance products and Bank services for migrant workers are fees also are not posted or available on limited to remiance, deposit and with- request. As a result, most migrant workers drawal, and issuance of debit cards for have lile idea about the standard rates deposit and withdrawal. Migrant workers for electronic transfers.

124 SURVEYS AND PILOT PROJECTS

Moreover, the addional fees charged and Commercial Bank of China is present for express money transfer vary from one in 2 of the 22 townships of Xiangtang. In place to another, although the People’s Sichuan Province, the ABC is present in Bank of China (PBC) and the Naonal 13 of the 110 townships of Renshou and Development and Reform Commission 10 of the 69 townships of Anyue, and no have set them at a 30% surcharge over commercial bank branches are present in the regular fee. Electronic transfer service any rural townships of Shimei. does not guarantee that the money will be received within 24 hours; therefore, cli- The small, remote townships of the west- ents pay an extra fee for 24-hour service. ern provinces contain almost no formal The varying mes required for express financial instuons at the township service—ranging from instant to 2, 4, or level. In Renshou, Sichuan Province, 24 hours—and the complex fee structure 96 of the 110 townships do not have are designed to encourage both bank staff RCCs, and 35 townships have no RCC or and clients to use the express services. postal savings outlet. In Shimei County, However, charges can be around 1% of 4 out of 12 townships have no RCC and the total remiance, which can be costly 9 have no postal savings outlet. In other for clients. words, four townships in the county have no formal financial instuons or services All four state-owned commercial banks are of any kind. There are no nongovernment present in the three counes of Zhejiang; microfinance instuons in any of the three are present in Wangcheng and sample counes. Xiangtang, Hunan; two are present in Lixian, Hunan; three are present in Renshou and Anyue, Sichuan; and two Cooperative Finance are present in Shimei County, Sichuan. The ABC is found in all of these counes. Ganzi: Perspectives on Unwithdrawable and Unsustainable The state-owned commercial banks are Rural Credit Cooperatives well represented in rural townships in the coastal areas of the PRC, but in general In many poor areas, there is only one RCC, only the ABC has business offices in the and the absence of this RCC would create central and western counes, and that a financial vacuum. On the other hand, presence is limited to less than one- the operaon of many of these RCCs is quarter of the townships. No commercial unsustainable. To examine rural financial bank has offices in the poor and remote reform in ethnic minority areas, a local townships, leaving RCCs and postal PBC branch conducted an in-depth study savings outlets as the only instuons of some so-called unwithdrawable and available for remiance services. The four unsustainable RCCs in Sichuan’s Ganzi largest state-owned commercial banks Ethnic Minority Autonomous Prefecture (the ABC, the China Construcon Bank, in 2006. the Industrial and Commercial Bank of China, and the PBC) all are present in No commercial bank has offices rural townships of the three counes of Zhejiang Province, though the PBC has no in the poor and remote townships, office in Ninghai. In Hunan Province, only leaving RCCs and postal savings the ABC is present in 6 of the 32 townships of Lixian and 2 of the 19 townships outlets as the only institutions of Wangcheng, and only the Industrial available for remittance services

125 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

By 2005, the RCCs in Ganzi Prefecture suf- ments. Employees were pessimisc about fered from insufficient capital, insolvency, their future and morale was low. and connuous losses. Their operaons were in distress, and a number of village The lack of economies of scale also con- RCCs had no business for several years. strained RCC development. In 2005, the In Litang County, for instance, six grass- agriculture sector in Ganzi Prefecture roots RCCs had become dormant, with amounted to CNY1.1 billion, placing it no employees and no business, only the last among the 21 cies and prefectures signage. Most RCCs were unsustainable; in Sichuan Province. The prefecture’s more business only meant heavier losses. populaon was 900,000, and 84% lived To meet deposit payments and operang in rural areas. The per capita net income costs, many RCCs operated on debt such of farmers and herdsmen was CNY1,309, as interbank lending and agriculture loans. which was 45% of the provincial average and 40% of the naonal average. The rao The internal control system in these grass- of urban to rural per capita income was roots RCCs could not funcon with limited 5.3 to 1, the lowest among the 30 ethnic managerial, risk management, and devel- minority autonomous prefectures in the opment capability. RCCs’ loss of credit had country and the 21 cies and prefectures deteriorated the local financial environ- in the province. The Engel coefficient was ment. RCCs’ accounng books were a mess 60.5%. Of the farmers and herdsmen in and asset records were unclear. Some the prefecture, 340,000 (45%) lived in grassroots RCCs kept “pocket books,” in absolute poverty, with a per capita net which they issued only IOUs for receiv- income of below CNY668. In addion, ing deposits and making loans, and some 160,000 farmers and herdsmen (20%) lived even had no entry records. False entries in relave poverty, with a per capita net and fake expenditures were used to line income of CNY668 to CNY924. employees’ pockets, and unauthorized loans to relaves or to fake names pro- Constrained by the rural economy and duced huge numbers of nonperforming low income, RCC deposits outstanding in loans. Moreover, the excessively low salary the prefecture totaled CNY57.8 million of employees resulted in frequent illegal at the end of 2005. This yielded an aver- acvity by some RCC staff. age deposit of CNY1.3 million per RCC employee. Twelve counes had less than The internal control system in CNY1 million in deposits per employee, and seven had less than CNY500,000. In these grassroots RCCs could not addion, 73 legal person RCCs (65% of function with limited managerial, the total) had less than CNY1 million in deposits, and 51 RCCs (46%) had deposits risk management, and development of less than CNY500,000. The county rural capability credit union with the least deposits had only CNY3.2 million, or CNY167,400 per The incenve system of the RCCs in Ganzi employee. The legal person RCC with the Prefecture had separated income from least deposits had less than CNY150,000. performance, and thus most employees Five counes in the prefecture had less had no incenve to raise deposits or man- than CNY5 million in loans. age loans. In addion, these RCCs were unable to provide social security such Our survey showed that, of various RCC as medical insurance, and were nearly deposits, 75.73% were savings deposits CNY10 million in arrears on pension pay- and 19.43% were agriculture deposits.

126 SURVEYS AND PILOT PROJECTS

Corporate deposits outstanding were only generally have only three to five manage- CNY15.61 million. The deposits of village rial staff. and township RCCs came mainly from savings, but they could raise few depos- The herdsmen live scaered across the its. In fact, only half of the RCC deposits prefecture, with inadequate transport came from the county or township. The and communicaon facilies. Highways deposits of two counes with many county are inaccessible in 42 townships and and township outlets—Kangding and 1,307 villages, and telephone service is not Luding—accounted for 52.61% of the total available in 80 townships, adding to the in the prefecture. Excluding deposits raised difficules of rural financial service. by rural credit unions within the county or township, the deposits of farmers and High cost is another problem facing the herdsmen totaled only around CNY250 RCCs in the prefecture. In 2005, operang million—less than CNY350 per farmer. expenses were as high as CNY21 million, or CNY45,900 per employee. Of the operang RCC services also are lagging. At the me expenses, more than CNY13 million was of the survey, only 13 RCC outlets in the used to maintain the operaon of 133 out- prefecture had an electronic transfer busi- lets, with the depreciaon of fixed assets ness and 26 outlets were pilong comput- reaching CNY6.8 million. RCC revenues erized bookkeeping. The RCCs had no bank totaled CNY27 million, while interest card business and their selement and expense and the expense from transac- cash supply were dependent on the ABC. ons with financial instuons totaled The lack of compeveness, weak finan- CNY15.7 million. Employee salaries and cial strength, and high risk have added to benefits amounted to CNY8.7 million. public concern and increased RCCs’ difficulty in aracng deposits. The RCCs in Ganzi Prefecture were At the same me, the operaonal cost of established under the organizational the RCCs is excessively high. The pre- framework of one RCC per township, fecture is 153,700 square kilometers, accounng for one-third of the prov- paralleling the administrative ince and equivalent in size to Shandong structure Province. With a populaon density of 5.8 people per square kilometer, the pre- The RCCs in Ganzi Prefecture were estab- fecture has 18 counes, 325 villages and lished under the organizaonal frame- townships, and 2,345 administrave vil- work of one RCC per township, paralleling lages under its jurisdicon. The RCCs had the administrave structure. More than fewer than 500 employees and 133 out- 90% of these RCCs are not commercially lets, for an average of 3.8 employees sustainable, although they sll must fulfill per RCC. On average, one RCC provided their financial service obligaons. Because rural financial service for approximately 70% of RCCs in Ganzi have fewer than 6,000 people in 1,153 households, or four employees, and some are one-person 16 administrave villages in three town- offices, they lack the basic requirements ships covering 1,000 square kilometers. for a legal person governance structure. Of the RCCs in the prefecture, 79 (60.8% of the total) had fewer than four employ- In addion, it is difficult to establish and ees; 32 had two employees and 12 had improve RCCs’ governance structure one employee. No RCC had more than and incenve mechanisms. Almost all 10 employees. County rural credit unions RCC equity is in membership shares, but

127 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

because the members know lile about regulaons issued by the China Banking finance, they are more concerned with Regulatory Commission. preempve rights to loans than with the RCCs’ operaon and management. This The primary issue in the Baixin Rural has preempted external control. Lending Shop’s restructuring was the shortage of registered capital. According Finally, supervision is ineffecve. Many to the provisional regulaons, it needed RCCs cannot maintain even a basic dual- registered, paid in capital of less than person system, let alone an effecve inter- CNY100,000. In addion, the chairperson nal control system. One county rural credit of the board of directors and the manager union had three to five staff to administer of the lending shop must have at least an average of six RCCs, making it difficult to a high school or technical school educa- conduct inspecons. Only 2 of the 18 coun- on and should have passed relevant es had China Banking Regulatory Commis- qualificaon examinaons before taking sion offices, making it difficult to effecvely office. Baixin Rural Lending Shop had no supervise the rural credit unions. offices or security measures, as required; the office was located in the home of the Pracces in Ganzi showed that RCCs carry chairperson. high operaonal costs and risks and are unfit for poverty-stricken areas. It also Baixin Rural Lending Shop needed fiscal shows that in small, underdeveloped support to raise CNY100,000, but those areas, the market, rather than the govern- funds merely covered office space, secu- ment, should decide the types of financial rity facilies, registraon, and salary for service suppliers. accountants and cashiers, leaving noth- ing to help members. At the me, Baixin Baixin Rural Lending Shop: New Pilot Rural Lending Shop only provided loans Cooperatives for members. The provisional regulaons have since expanded the business scope The Yushutai Township Baixin Rural Lend- of lending shops to include deposit taking, ing Shop of Lishu County, Siping City, Jilin loan provision, selement services, and Province, was established in July 2004 other agent services in accordance with with registered capital of CNY60,000 and relevant regulaons. more than 10 founding households. In 2 years, Baixin Rural Lending Shop devel- Before rural collecvizaon, the three oped a charter that specified member- largest cooperaves in the rural PRC were ship, dividend distribuon, lending rates, credit cooperaves, producon coopera- and the management of the lending shop. ves, and supply and sales cooperaves. In 2006, this lending shop was included However, the classificaon of these three in the China Banking Regulatory Commis- cooperaves was meant as preparaon for sion’s 36 rural finance pilots across six a collecve economy. Producon coopera- provinces and autonomous regions. As ves cannot operate effecvely without the pioneer of lending shops in the PRC, supply and sales and credit cooperaves. Baixin Rural Lending Shop was restruc- From the perspecve of credit coopera- tured in accordance with provisional ves, the separaon of producon and fund allocaon created arficial informa- The primary issue in the Baixin Rural on barriers between producon and credit cooperaves and hindered the Lending ShopÊs restructuring was integraon of fund allocaon and demand the shortage of registered capital with producon.

128 SURVEYS AND PILOT PROJECTS

The emerging producon cooperaves penalty mechanisms ensure mely repay- (rural technical associaons or those ment without collateral, lawsuits, govern- formed by a company and farmers) sup- ment intervenon, or other mechanisms. port household-based producon using supply and sales as a connecon. This has In the beginning, the lending shop was proven to be a successful model in linking an informal system. It mainly depends on small farmers with the market. However, trust, local culture, customs, and long- due to financial controls, these emerging term relaonships among people. These producon cooperaves can only com- informal systems can hardly be regulated bine supply sales and producon, keeping by words or contracts; therefore, they credit cooperaves at arm’s length. Baixin are unofficial and informal compared Rural Lending Shop provided a model for with regulaons and laws. The advantage integraon of supply, sales, producon, of the informal system is the low loan and credit. cost, which results from reduced supervision and examinaon requirements and A rural lending shop is an inexpensive enables the meeng of even the smallest arrangement; it can provide a low-cost res- credit demand. However, the lending shop oluon to issues that formal financial ins- system also has constraints. In cases of dis- tuons can only handle at high cost. The putes, for example, it is difficult to obtain movaon to merge Baixin Rural Lending legal and official support. In this sense, Shop with the Baixin Farmers’ Cooperave lending shops are similar to informal lend- was to raise funds. Although the two coop- ing agencies. eraves have different names, they are essenally one body. The farmers’ cooper- More institutional innovations are ave provides a financing plaorm for the lending shop. On one hand, members of required to manage the risks of rural the farmers’ cooperave know the funding lending shops, and the government demands and purpose of each member, are clear about the moral and repayment plays a very important role in the capacity of borrowers, and even know the initial stage source of repayment (e.g., livestock sales). This resolves the issue of informaon The risks of lending shops are closely asymmetry in loan disbursement and related to the operaon of the farmers’ the difficules encountered by formal cooperave. Cooperave funds are gener- financial instuons. ally small, and the members share similar risks in producon or business. In the case On the other hand, the farmers’ coopera- of Baixin Rural Lending Shop, for example, ve is an arrangement for loan repayment. widespread disease or a large fluctuaon If a member intenonally delays loan in market prices will cause extensive loan repayment, the farmers’ cooperave can delinquency, even bankruptcy. repay the loan by deducng funds from the sales income of that member. The More instuonal innovaons are required member also can be deprived of mem- to manage the risks of rural lending shops, bership in the cooperave. Because all and the government plays a very impor- cooperave members live in the same or tant role in the inial stage. Apart from the in neighboring communies, peer pressure reform in supervision, risk-reducon mea- helps ensure that members repay their sures have been adopted in many places. loans; failure to do so will lead to sancons First, the size of the lending shop is strictly in daily life and producon. These informal controlled to confine financing among

129 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

members. Second, the risk of producon fund with rural producon, technology, and operaon is diversified. Lending shops and sales, boosng the integraon of all can cooperate with government agen- producon factors in poor villages while cies, insurance companies, and epidemic effecvely reducing the funding short- prevenon bodies to prevent risks such as age of poor rural households, leading to widespread disease. The government may enhanced producon and compeve- subsidize premiums so that insurance com- ness of poor villages. Third, the pilot panies can provide adequate insurance aimed to improve the self-management, products; epidemic prevenon bodies can self-organizing, and development abilies bear part of the risk through technical of poor people in managing the coopera- shareholding. Third, a risk prevenon fund ve fund; to nurture special cooperave can be established and drawn from loan organizaons and modern farmers; and to interest, and the government may match enhance rural development in poor areas. subsidies. Finally, a loan guaranty fund can be set up to compensate for losses caused To join the project, pilot villages were by natural disasters or accidents. required to implement a village poverty alleviaon plan and to have available Village Cooperative Funds resources, leading industries, strong leaders, and virtuous customs and tradions. In 2006, the Ministry of Finance, together Funding for the cooperaves came from with the Poverty Reducon Office of the central government poverty alleviaon State Council, developed the pilot pro- funds, paid-in shares from farmers in poor gram of cooperave funds in 14 provinces, villages, and other sources. autonomous regions, and cies. The aim was to manage poverty alleviaon funds, The management of the cooperave capi- resolve poor farmers’ funding shortage, tal was regulated. Village meengs were and boost the self-development capacity convened, and a management commiee of poor villages and households. The pilot of imparal, decent, and conscienous was designed to use some poverty allevia- members was elected. The responsibilies on funds to establish cooperave funds of the management commiee were to in poor villages, enabling village residents formulate the management procedures of to purchase shares of the cooperave fund the cooperave fund; to implement those and borrow for producon purposes. procedures; and to approve, disperse, and collect loans. The management commiee was guided, supervised, and inspected Funds were required to be repaid by upper-level poverty alleviaon and and revolved and to be used for the fiscal authories and was overseen by development of poor householdsÊ all the villagers. production The pilot funds were used for the mutual support of the village. Funds were The pilot project had four main objec- required to be repaid and revolved and ves. First, the project was intended to to be used for the development of poor help poor villages to develop a coopera- households’ producon. Loans were not to ve fund to leverage poverty alleviaon be issued outside of the villages, to be sent funds and innovate a poverty alleviaon to underground money shops, to be used model. Second, the project explored effec- by the management commiee, or to be ve means of integrang the cooperave divided privately.

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Ulmately, all the poverty alleviaon and other provinces, especially poor provinces, fiscal authories of the pilot provinces, and will advance overall financial reform in autonomous regions, and cies were the PRC. required to cooperate closely and to strive for a beer pilot, and diversificaon of Demographic Information the pilot was encouraged. Currently, the pilot has been fully implemented in all the Guizhou Province is one of the poorest in pilot provinces, districts, and cies, and the PRC, and 81% of the populaon lives response by officials and poor people has in rural areas. The average annual income been posive. per rural resident was CNY1,490 in 2002, the lowest in the country. One-third of Guizhou Province: Demand for and fiscal expenditures result from central Supply of Rural Finance government transfer.

In July 2004, the PBC organized a field sur- A sample of 1,032 households was vey on the demand for and supply of rural selected from six counes in the province. financial services in six counes of Guizhou Two of the six counes in the sample, Province. The main purpose of the survey Fenggang and Meitan, are located in Zunyi was to understand the behavior of rural Prefecture, which is well off. Danzhai and households and rural financial instuons. Taijiang counes, in the Qiandongnan Such knowledge is crical for the design of Miao and Dong Autonomous Prefecture, future RCC pilot programs in the province are of average income. The remaining two and is useful for future improvement of counes, Dafang and Zhijin, are located in the rural financial system as a whole. The Bijie, the poorest prefecture in Guizhou. surveys targeted rural financial instuons Parcipants were selected randomly and and households. County PBC branches sur- a random distribuon of households was veyed the ABC, the Agricultural Develop- assumed within each county. ment Bank of China (ADBC), and the RCCs; local county stascal bureaus surveyed The households have the following fea- the households. tures. First, the average family size is relavely small (4.1 people per house- Guizhou Province shares many similari- hold), which is contrary to many people’s es with other western provinces in the percepons that poor rural households in PRC. However, because it was one of the PRC comprise large families. Second, the provinces to undertake an RCC pilot off-farm employment and income are program, RCC reform in Guizhou is in many becoming more important for rural house- ways ahead of that of other provinces. holds in Guizhou; over one-third of rural The pilot program will have an enormous labors are engaged in off-farm produc- effect on the future rural financial frame- on. More importantly, 45% of off-farm work in Guizhou as well as on the ability laborers have worked as migrant workers of rural financial instuons to provide in other provinces, and over 40% work at efficient, sustainable support for agriculture, farmers, and rural areas (sannong). This, in turn, will assist in developing local Participants were selected randomly economies, enhancing the incomes of and a random distribution of farmers, and establishing a prosperous households was assumed within society. Moreover, these pilot programs will affect future rural finance reform in each county

131 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

home. This suggests a considerable lack of rural household in the province holds employment opportunies in the counes about one-third of its assets in the form and large cies of Guizhou and is rather of financial assets. This rao is not low, different from the rural labor transfer that given household income and wealth. Of occurs in more-developed areas of the total financial assets, about one-third PRC, where there has been a much higher is held in cash and two-thirds in bank proporon of migraon from rural to deposits. Interesngly, rural households urban areas within a province. hold a high proporon of their physical assets (nearly 50%) in animals. Many Third, the heads of households are predom- households have used animals (mainly inately male (94.7%), indicang the lower pigs, cale, and poultry) as stores of social and economic status of women. wealth; whenever needed, animals can Moreover, the level of educaon among be converted into cash at a relavely low household heads is very low; about 10% of cost. This also implies that there are few the survey parcipants were illiterate and suitable financial instruments for rural another 35% had only a primary school households. educaon. In other words, about half of heads of households had received fewer Relave to rural households’ assets, than 6 years of formal educaon. In addi- income levels are not low. In 2002, the on, some went to school around 20 years average net income per household was ago or more, when educaonal quality is CNY6,709, of which CNY5,842 was held considered to have been low. in cash. It is possible that much of this income growth is from migrant workers Older houses mean poorer housing and off-farm acvies—each accounted for more than 20% of net cash income— conditions, an important indicator of whereas farming acvies generated only poverty in the province one-third of net cash income. Income growth from migrant workers and off-farm In rural areas of the PRC, family houses are acvies is quite recent, and it takes me usually the most important asset because for cash earnings to be transformed into families do not own the land. Many in physical assets. Guizhou sll live in very old houses, over 20% of which were built 25 years ago or There is limited growth potenal for rural more, and some of which were built dur- household savings deposits. For those ing the Qing Dynasty. The average cost of without any savings, about half had no building a house in the sample area a er extra cash because their incomes cover only 2000 was CNY17,320. Older houses mean basic living expenses, and over 20% used poorer housing condions, an important their incomes for important items of con- indicator of poverty in the province. sumpon and investment. Another 15% of wealth was held in the form of livestock We classified household assets as physical rather than bank or RCC deposits. and financial, producve and nonproducve. On average, financial assets (cash Only a few households complained that and deposits) accounted for about 40% of the deposit interest rates were low the sample populaon’s nonhouse assets or that the services were too far from and physical assets accounted for the home. Even so, distance to providers is an remainder. Assuming an average fam- important factor in financial services for ily house is worth CNY5,000, an average rural households in remote, mountainous

132 SURVEYS AND PILOT PROJECTS areas. This has become a significant issue loans. The outstanding loans of the ADBC because the ABC has been closing loss- are decreasing, illustrang its dwindling making branches and offices in poor rural role as a policy bank in less-developed areas. Likewise, RCCs are closing some areas such as Guizhou. Remiances from branches in poor and remote areas of migrant workers accounted for around the country or withdrawing their power 33% to 60% of the outstanding deposits of to authorize loans. The average distance RCCs, several mes the amount of deposit from rural households to an RCC is 6 to increases. In fact, remiances have been 30 kilometers; the average distance to a the major source of income growth for postal savings office is 10 to 54 kilome- rural households in poor areas. ters. These distances are not great, but it may take up to an hour to cover in moun- In recent years, postal savings in Gui- tainous areas, even longer if they must zhou has accelerated the oulow of be covered on foot. For example, many funds, many RCC operaons have had villages in Danzhai County do not have to rely on PBC onlending, and the ADBC access to roads. RCCs there must cover has been reducing the amount of its large areas with limited staffing, which loans. Although the ABC’s outstanding hinders service provision and increases loans exceed outstanding deposits, the operaonal costs. increase in loans is less than the increase in deposits and its loans are made mainly Rural Financial Services: Demand for infrastructure. Since 2001, even most poverty reducon loans have been Rural households’ demand for credit directed to project lending. Without con- arises from farm and off-farm producon sidering government transfer and remit- and investment. The major household tances from migrant workers, therefore, farm expense is the purchase of ferlizer, Guizhou suffers from a large oulow of followed by seeds, pescides, and plasc funds, heavy losses on the part of rural film. Accordingly, credit purchasing and financial instuons, and government- borrowing are more o en used to buy supported microfinance and poverty ferlizer than other farming supplies, and reducon onlending programs that have approximately 20% of households may become the major sources of funding. In need to borrow to buy ferlizer. We also other words, the rural financial system asked members of rural households what has entered a vicious cycle. they would do with an extra CNY10,000. A er deposits, the next three priories Households borrowed most from their were children’s educaon, housing, and relaves, friends, and neighbors (64.1% in farm producon (Table A.28). terms of frequency and 45.7% in terms of total value). Rural credit cooperaves Rural Financial Services: Supply were the second most important source of funds (31.2% in terms of frequency and The six counes surveyed mostly depend 41.5% in terms of total value), whereas on outside funding through four channels: state-owned commercial banks were the fiscal transfers, PBC agriculture onlend- least acve lenders (less than 5% in fre- ing, loans from the ADBC, and remiances quency and less than 13% in value). from migrant workers (Table A.29). Fiscal transfers are around one to five mes fis- Postal savings deposits in Guizhou cal revenue and make up for expenditure shoralls. PBC onlending normally rep- have increased rapidly in recent resents 20% to 30% of outstanding RCC years

133 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Rural Financial Institutions not meet the demands of households with large aquaculture businesses. At the same Postal Savings Outlets me, many poor households have small Postal savings deposits in Guizhou have funding demands but the transacon costs increased rapidly in recent years. Total for small loans are high. This suggests that deposits increased from CNY4.5 billion in RCCs cannot meet diverse rural finance 2000 to more than CNY8.8 billion in 2003. demands. These households, which should Deposits from townships and villages be the target clients of RCC microfinance increased from CNY846 million to around loans, also demand simplified loan applica- CNY2.2 billion. In the PRC as a whole, on procedures. postal savings accounts for around 60% of total deposits below the county level. With 85 RCC branches and around With 548 branches, the network of postal 2,000 outlets, RCC deposits and loans savings outlets in Guizhou is relavely in Guizhou have more than doubled small compared to the network in more- during the period 2000 to 2003. Depos- developed provinces, and the farmers its increased from CNY9.2 billion to have a lower relave income, resulng in CNY21.7 billion, for a net increase of a postal savings rate of around 20% below CNY12.5 billion, and rural loans grew the county level. However, the rate of from CNY4.4 billion to CNY9.8 billion, increase is high, with added savings rang- for a net increase of CNY5.4 billion ing from CNY371 billion to CNY571 billion (Table A.30). Loans to township and vil- per year. The increase in postal savings lage enterprises increased moderately, deposits is roughly equivalent to the from CNY764 million to about CNY1 bil- increase in RCC deposits. lion, yielding a net increase of more than CNY236 million, indicang that township Rural Credit Cooperatives and village enterprises in Guizhou are less Most loans provided by donor-supported developed and have low levels of indus- microfinance instuons in the PRC aver- trializaon. Forty percent of the increase age around CNY1,000 to CNY2,000. By in loans was funded by PBC onlending, contrast, of the 245 recorded RCC loans which increased from CNY531 million to to farmers a er 2001, the average loan CNY2.5 billion. Although the importance size was above CNY6,000. Most RCC loans of PBC onlending varied, some districts required collateral and guaranty, which were almost completely dependent on it mostly were provided by relaves and for funding. friends. Moreover, loan rescheduling was common. Fewer than 50% of the loans Medium-term and long-term RCC loans were paid on me, which is consistent represented less than 10% of total loans, with the survey of RCCs in the province. at CNY433 million in 2000 and nearly CNY1.1 billion in 2003. In fact, Guizhou Although the average loan size for RCCs lacks financial instuons that offer in Guizhou is not small, many sample medium-term and long-term loans for households needed even larger loans of agriculture and agriculture projects. The extended tenure. Unfortunately, RCCs can- ADBC provides all grain procurement loans, which are short-term, and only the Most RCC loans required collateral ABC and the China Construcon Bank are willing to provide medium-term and long- and guaranty, which mostly were term loans for government-guaraned provided by relatives and friends state projects.

134 SURVEYS AND PILOT PROJECTS

Agricultural Development Bank of China cial banks, flow through RCCs, and flow The ADBC’s total amount of loans out- through postal savings outlets. The size standing has been decreasing, although of ABC loans, for instance, has become the total number of branches remains smaller in all counes except Taijiang, steady at 56. In 2000, loans outstand- where a matching fund for an expressway ing totaled CNY6.6 billion; 3 years later, drascally increased the amount. More- this figure had decreased to around over, new loans totaled less than new CNY5.9 billion. Medium-term and long- deposits, meaning that the new deposits term loans accounted for a small but dwin- were not used for loans during the obser- dling poron of this number, falling from vaon period, resulng in a net oulow of CNY68.2 million in 2000 to CNY50.3 million funds. It is impossible to break down the in 2003. ABC data by urban and rural areas, and some ABC loans are for urban infrastruc- Agricultural Bank of China ture projects. With the acceleraon of commercializaon in recent years, the ABC’s operaons have Data from the Naonal Stascs Bureau been moving toward big cies and focus- show that, in 2003, total fiscal expendi- ing on large projects. This is evident in tures in Guizhou were CNY33.2 billion, the reduced number of outlets, increased 2.7 mes the total fiscal revenues of lending for medium-term and long-term CNY12.5 billion that year, indicang a state projects, and reduced lending for net fund inflow of nearly CNY21 billion agriculture and township and village through fiscal transfers. Even if all fiscal enterprises in rural areas (Table A.31). transfers were used at or above the county Even poverty reducon funds have been level, that leaves a huge inflow of funds directed to project loans. This, in addi- below the county level. The major chan- on to the lending structure of the RCCs, nels of flow include loans from the ADBC results in low total lending to township and agriculture onlending from the PBC. and village enterprises and is reflected In terms of flow, loans from the ADBC are in the economic structure of Guizhou. decreasing, whereas PBC onlending is With the reducon in ABC lending (except increasing. The total amount of outstand- for projects financed by state debt), the ing ADBC loans stood at CNY5.9 billion repayment rao (calculated as the rao of in 2003; this is all net inflow, because total amount of payment on me to the the ADBC does not take deposits. In total amount of payment due) dropped the same year, total PBC onlending was from 90.26% in 2000 to 78.18% in 2002. CNY2.5 billion, which yields a total inflow In 2003, the ABC’s repayment rao of of CNY8.4 billion when added to the 69.84% in Guizhou was the third lowest ADBC figure. among all provinces in the PRC. The major channels of flow include In general, there are large oulows of funds from rural areas, especially poverty- loans from the ADBC and agriculture stricken rural areas. However, this is not onlending from the PBC the case in Guizhou, where the inflow of funds is far larger than the oulow, a er In Fenggang and Meitan of the more- accounng for government transfer and developed Zunyi District, the growth migrant worker remiances. There are of RCC deposits was three mes the three typical channels for such oulow: growth of postal savings deposits; in the gap between deposits and loans by Dafang and Zhijin in the poorest Bijie the ABC and other state-owned commer- District, however, RCC deposits decreased.

135 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Government-supported loans were unable instuons should be larger. However, to meet expected targets and only RCCs the direcon of the flow could reverse showed increased lending, indicang that a er taking into account migrant worker new demand for funds in these coun- remiances. Remiances from migrant es was met mostly by RCCs. Migrant workers to Guizhou were esmated at worker remiances are the main reason around CNY8 billion per annum, indicang for farmers’ increased income and for the that the total inflow of funds should be increase in deposits in RCCs and postal greater than the oulow, even with large savings outlets. Although the inflow of oulows from financial instuons. Fund- funds through government transfers and ing shortages in the rural areas of Guizhou, remiances far exceeded the oulow, the therefore, result from a lack of profitable demand for credit sll could not be met. investment opportunies and from inef- Rural finance in Guizhou needs an efficient ficient credit allocaon mechanisms. credit mechanism more urgently than it needs addional funds. Government-Supported Rural Financial Services Oulows through postal savings outlets vary; the more-developed counes Rural Credit Cooperative have higher increases in both absolute Microfinance Loans amounts and rates. Postal savings offices The PBC iniated microfinance loans in do not make loans, so deposits are simply 1999, supporng RCC operaons through net oulow. From December 2000 to onlending for agriculture. Between 1999 September 2004, the total amount of and 2003, the deposits and savings of RCCs postal savings outstanding more than in Guizhou increased rapidly, and microfi- doubled in the province, as did incremen- nance loans to rural households without tal savings below the county level. Even collateral increased at an even faster pace. so, total postal savings outstanding The rao of microfinance loans to out- below the county level was CNY2.2 bil- standing RCC loans increased from 22.5% lion as of the end of 2003, and the gap in 1999 to nearly 40% in 2003. Because between RCC deposits and loans was it takes a year or longer for nonperform- 6.8 billion, given total outstanding loans ing loans to emerge, no provisions were of CNY14.8 billion. made for future nonperforming loans; thus, financial indicators do not accurately Without taking into account the gaps reflect actual financial performance. between deposits and loans in other state-owned commercial banks, the total RCC microfinance loans without collateral oulow of funds from the ABC, RCCs, differ from microfinance loans piloted and postal savings outlets was around in the PRC under the Grameen model in CNY9 billion. Thus, the total inflow of terms of interest rates, client gender, and funds in this period was more or less repayment mechanisms. First, the interest equivalent to the oulow of funds. Consid- rates on RCC microfinance loans are lower ering that state-owned commercial banks than the interest rates charged by RCCs other than the ABC have net oulows on other loans, which are also much lower of funds, the oulow from all financial than the interest rates charged by other grant-supported microfinance projects. The PBC initiated microfinance loans The interest rate on microfinance loans under the Grameen model, which is not in 1999, supporting RCC operations subject to PBC regulaons, is normally through onlending for agriculture 15% to 20% whereas the interest rate on

136 SURVEYS AND PILOT PROJECTS

RCC microfinance loans is below 10%. culture onlending, microfinance loans are Second, the Grameen model prefers to unlikely to be commercially sustainable. In extend loans to women whereas RCC comparison, guaraned or collateralized microfinance loans, extended on the basis loans are perceived to be more sustain- of creditworthiness, mainly target heads able. Many RCC credit officers think that of households, more than 95% of whom their microfinance operaons incur high are men. Finally, the Grameen model operaonal risks because of the small scale ensures high repayment with frequent of lending and the geographic distribuon installments and group guaranes, of clients, in addion to risks related to the whereas RCC loans require a single repay- agriculture sector as a whole. ment on the due date. Moreover, because of the interest rate Among the 148 credit lines and loan difference between enterprise and micro- cerficates in 2003, the average loan size finance loans, RCCs prefer to make enter- was CNY4,756 and the maximum loan was prise loans. As of this wring, the effecve CNY20,000, far exceeding the typical inial interest rate on RCC loans to rural house- credit line of CNY1,000 under the Grameen holds has reached its ceiling of 10.28%, model pilot projects. More importantly, the doubling the base rate of 5.14% per rao between rural household credit and annum. In other words, even if the maxi- its expected annual cash income was 107%. mum interest rate is charged, it is sll dif- With excessively high credit lines and with- ficult for commercial financial instuons out a loan repayment incenve system, the to recover their costs, though our survey default rate for microfinance loans without also found that the effecve interest rate any collateral will inevitably be high. on microfinance loans to rural households has reached 15% per annum through the There are three qualitave requirements imposion of interest penales, advance for RCC microfinance loans in Guizhou: deducon of interest, and compulsory loans should go to rural households, shareholding requirements. the amounts should be small, and loan qualificaon should be based on credit- Poverty Alleviation Loans worthiness. By their very nature, these More than half of the PRC’s poverty alle- criteria can help migate risks. Nonethe- viaon funds were used for poverty alle- less, experience in microfinance opera- viaon loans during the survey period, and ons shows that risks sll exist. Inaccurate processing CNY1 million worth of poverty credit rangs for borrowers, neglect of the alleviaon loans cost the ABC’s Guizhou rural credit system, lax loan management, branch CNY58,500, which was CNY39,000 excessive pursuit of speed in operaons, (nearly 60%) higher than the cost of other and oversupply of a single microfinance types of loans. In other words, the cost of product will lead to a large volume of nonperforming loans in circumstances where Many RCC credit officers think that there is no agriculture insurance. their microfinance operations incur Our survey showed that the RCC loan high operational risks because of officers regard microfinance loans as unworthy because of their small scale and the small scale of lending and the because they carry no collateral or guar- geographic distribution of clients, anty. Even though PBC directs RCC lending and sets a percentage of microfinance in addition to risks related to the loans as a requirement for providing agri- agriculture sector as a whole

137 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

disbursing poverty alleviaon loans was and is delegang to provincial governments 5.85%, or 3.9 percentage points higher the power to implement reforms. This than the cost for other products. The ABC boom-up approach marks a fundamental has esmated that the average cost of pro- change from the top-down approach of cessing and managing poverty alleviaon previous finance sector reforms. The objec- loans is 7% of the loan amount. Thus, even ve is to reform the RCCs while searching if interest is paid in full and the interest for financial innovaons, and to provide subsidy is received on me, this business is credit support to rural areas while ensuring unsustainable. financial sustainability.

By the end of 2000, over 85% of ABC loans Guizhou Province is one of the eight to processing enterprises in impoverished pilot provinces. By the end of 2002, counes in Guizhou were nonperform- total RCC assets in Guizhou reached ing. Outstanding interest-subsidized pov- CNY24.1 billion, including outstanding erty alleviaon loans in Guizhou totaled loans of CNY12.6 billion, total liabilies of CNY7.76 billion by October 2001, and CNY24.1 billion, and CNY14.4 billion in out- CNY3.26 billion (42%) of these loans were standing deposits. In addion, cumulave nonperforming. The repayment rao of aggregate loss reached CNY910 million, household loans was a mere 21%. Since with a loss of CNY4 million in 2002. Non- 2001, therefore, the ABC has focused on performing loans totaled CNY3.5 billion, using poverty alleviaon funds to make accounng for 27.8% of total loans out- commercial loans for infrastructure con- standing. Of all nonperforming loans out- strucon. Of the nearly CNY10 billion standing, CNY2.8 billion (80.23%) were idle allocated for poverty alleviaon loans (loans overdue for more than 6 months) in Guizhou, for instance, the ABC has and CNY150 million (4.29%) were bad extended only CNY400 million to rural loans. With an overall capital adequacy households. Some local governments and rao of –0.9%, 969 RCCs (17.2%) had other state-owned commercial banks have negave equity. expressed serious concerns about this. In this round of reform, the central bank Evaluation of the Rural Credit Cooperative granted Guizhou CNY719 million in cen- Pilot Program tral bank notes. According to central government regulaons, the RCCs’ busi- The eight-province RCC pilot program ini- ness tax rate was only 3% and they were ated in the laer half of 2003 is a mile- exempt from income taxes as of 1 January stone in the ﬁnancial reform of the PRC. 2003. The Ministry of Finance approved Compared with previous reforms, the pilot CNY38.67 million in interest subsidies program has suﬃcient funding for robust to RCCs, which paid interest on indexed mechanisms and gives power to the provin- deposits for the period 1994 to 1997. cial governments. The government is paying to eliminate the RCCs’ historical burdens Under the pilot program, 84 county RCC unions in Guizhou (39 of them insolvent) The Ministry of Finance approved were consolidated into new legal enes in accordance with the State Council’s 2003 CNY38.67 million in interest Program on Deepening Pilot RCC Reform. subsidies to RCCs, which paid Three RCC unions—Yunye District Credit Cooperave Union in suburban Guiyang, interest on indexed deposits for the Huaxi District Credit Cooperave Union period 1994 to 1997 in the outskirts of Guiyang, and Meitan

138 SURVEYS AND PILOT PROJECTS

County RCC union of Zhunyi City (a naonal The provincial RCC union was established commodity grain producon base)—were on 30 December 2003, and its affiliates selected to pilot rural cooperave banks. were set up and began operaons upon By the end of June 2004, member share- approval by the provincial government. holders’ paid-in capital from all RCCs in This signified the compleon of the inial the province reached CNY1.12 billion—an phase of RCC administrave reform in increase of CNY754 million over 2002. The Guizhou. Rural cooperave banks have capital adequacy rao was 3%, up from been chartered in three counes or cies, –0.9% (excluding PBC notes) before the and RCC unions in the other 84 counes structural reform. have merged into county cooperave unions, one for each county. The total Even under ght budget constraints, all paid-in capital of the provincial RCC unions levels of government in Guizhou strength- reached CNY972 million, with CNY327 mil- ened their support for RCCs, employing lion in new capital added in 2004 through a number of measures. For instance, the fund-raising and share issuance. provincial finance department allocated CNY8 million per year from 2003 to 2007 One key component of this round of the to support RCC development and risk RCC pilot program is the transfer of admin- management. Such funds have been estab- istraon to the provincial government. lished in 20 counes, cies, and districts, However, because the provincial RCC union and also provide land, buildings, and bud- is inclined to protect its own interests, the getary support to supplement RCC capital. hidden danger is that it will emphasize Governments in some areas also subsidize its own operaons while neglecng RCC RCC business, real estate, and tenure sector management. Thus, acon must be taxes, and stamp dues. taken to minimize the role of the provincial RCC union and to limit its management In addion, the provincial government responsibilies while improving RCCs at entrusted qualified RCCs with the manage- the grassroots level. The key to resolving ment of microfinance poverty alleviaon conflicts between respecng shareholders’ loans formerly managed by the ABC. To rights and strengthening self-regulaon implement State Council provisions and is the power of senior management: the provincial government measures, the shareholder should extend a helping hand, provincial RCC union and agriculture and not a controlling hand. finance departments issued a circular authorizing RCCs to handle agriculture tax exempons for farmers in addion to One key component of this round of reducons and direct subsidies for hybrid the RCC pilot program is the transfer fine rice producon. of administration to the provincial To strengthen the RCCs’ deposit base, government most counes have deposited agriculture- related funds, educaon funds, off-budget In line with central government policies, government agency funds, and special the provincial authories emphasized that central government agriculture funds into rural financial instuons must provide RCCs. Moreover, in coordinaon with rel- beer services for sannong, regardless of evant government authories, such as the ownership and organizaonal structure. Industry and Commerce Administraon The provincial government also guided the Bureau, RCCs are exempt from certain fees provincial RCC union in dra ing and imple- or charges. menng over 40 sector-specific rules and

139 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

regulatory documents, defining the gov- culture businesses in Guizhou have huge ernment’s risk prevenon and migaon market potenal, thanks to the province’s responsibilies at all levels. Government unique natural condions, disncve authories are required to take effecve seasons, and low polluon levels. Turning legal, economic, and administrave mea- these potenal benefits into material gains sures to recover nonperforming loans and for rural households requires a supporve to punish debt evasion and abrogaon. credit environment. However, huge risks Through the government’s efforts, the beyond the scope of credit, such as natural RCCs collected up to CNY350 million worth calamies, disease, and the adopon of of nonperforming loans by the end of new technology, need to be addressed. June 2004. Under the fixed interest rate regime, such risks are beyond RCCs’ means. Without a Finally, the pilot program normalized proper risk-sharing mechanism, an RCC the relaonship among city and county can only avoid risks through credit raon- governments and the RCCs. RCC adminis- ing, which means that even farmers with traon has been vested in the provincial profitable projects are unable to obtain government, which must movate city credit and may miss opportunies. and county governments to support RCCs, without delegang power to them. To In some areas in Guizhou (for example, in accomplish this, the provincial govern- Danzhai County), the risk-sharing mecha- ment has clearly defined the dues of nism established by local governments, the county and city governments, which insurance companies, rural households, include taking praccal measures to sup- and financial instuons has contributed to port the RCCs, create a credit culture, and the reducon of excessive agriculture loan prevent and migate risks in a mely fash- risk. This also has reduced the risks of RCC ion; avoiding intervenon in RCC opera- loans, which has enabled their relavely ons and human resource management; low interest rates to cover their costs. More and avoiding the use of RCCs for direct importantly, this mechanism has facilitated lending. This will support development of agricultural specializaon and has helped RCCs within their respecve administrave form a reliable credit clientele. Under this areas and effecvely prevent excessive win-win arrangement, farmers’ incomes intervenon. have increased and RCCs have culvated a high-quality customer base. Financial Innovations The operaon of the mechanism is simple. Some Guizhou RCCs have experimented First, local governments allocate part of with low-cost financial innovaons, which their budget or poverty alleviaon funds may be important for the success of RCC to subsidize rural households’ insurance reform. One such innovaon is the estab- premiums. Next, insurance companies lishment of a market-based risk disposal introduce special agriculture insurance system, which enables risk sharing among products. RCCs can then lend to insured various stakeholders. For example, aqua- borrowers without collateral or by using the insured products, such as livestock, Under this win-win arrangement, as collateral. farmersÊ incomes have increased and Local instuonal resources such as farmers’ professional associaons and produc- RCCs have cultivated a high-quality on cooperaves also can increase lending customer base quality and improve client relaonships.

140 SURVEYS AND PILOT PROJECTS

In the days of the collecve economy, RCCs issues of credit raoning caused by asym- made loans backed by the goodwill of the metric informaon and can expand credit village or by collecvely owned enter- coverage. The boleneck in rural finance prises. The adopon of the family contract is the asymmetry between RCCs’ returns responsibility system, with remuneraon and their costs and risks. If the costs and linked to outputs, has forced RCCs to deal risks of RCC loans can be reduced by group with individual households based on their guaranes or credit rangs, the RCC model own creditworthiness. This has increased can become commercially sustainable credit risk and the cost of collecng credit even with a relavely low interest rate. Of informaon. With some farmers leaving course, feasibility depends on local tradi- their land and with increased agricultural on, culture, and individual relaonships. specializaon, scaered farmers have In Fenggang County, for instance, group begun to organize themselves, and it guaranes among hog farmers have been will be important for RCCs to deal with a frequent because of the close cooperaon variety of farmers’ organizaons in order among farmers, quaranne authories, to gather useful, accurate informaon and RCCs. about farmers. Fourth, some RCCs are working to create Some RCCs in Guizhou already have coor- collateral substutes. Lack of effecve dinated with local farmers’ professional collateral is the prime obstacle prevenng associaons or producon cooperaves rural households from obtaining loans. and have successfully used this informa- Property such as land and houses cannot on to improve loan quality. For example, be used for collateral, and agricultural pro- in some townships in Meitan County, ducon is seasonal. Both of these factors RCCs have taken advantage of the pres- have increased RCCs’ risks when lending to ence of local aquaculture businesses to rural households, exacerbang the house- sign feed procurement and sales con- holds’ difficules in accessing credit. More- tracts with suppliers on behalf of farmers. over, group guaranes and microfinance This links rural household loans directly are applicable only to rural households with feed supply, ensuring that the loans with small credit demands. are put to good use and enabling the collecon of valuable informaon. To overcome such difficules, some RCCs have begun to introduce effecve col- At the same me, RCCs have established lateral substutes such as bills of lading, lending risk funds that use wholesale and harvest rights, and livestock. Though these retail price differences to enable sharing of are not legally recognized, they can serve credit risks. RCCs also have established a as collateral. Other RCCs gather informa- risk-sharing mechanism with local quar- on on clients through direct involvement anne authories. In some places, RCCs, in the producon and sales acvies of local quaranne authories, and village local quaranne staons and leading officials have established an accountability enterprises, which is another substute mechanism. Under this mechanism, if live- for collateral. It is possible that, when stock die of disease, the local quaranne contractually directed farming emerges in authority will bear 50% of the loss, village the future, agriculture orders can serve as officials will bear 10%, and rural households will bear the remainder. Lack of effective collateral is the

A third innovaon, group guaranty and prime obstacle preventing rural microﬁnance lending, can help resolve households from obtaining loans

141 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

a form of collateral. Furthermore, loans Prospects for Cooperative Finance can be made against the credit rang of in the PeopleÊs Republic of China individual guarantors. It should be noted that, due to the lack of a legal basis, the With the opening of rural financial market development of these types of operaon in the PRC, various forms of rural financial is limited. instuon will emerge, and cooperave finance is one of the opons. Various farm- Fi h, government interest-subsidized loans ers’ technical associaons can effecvely can migate rural households’ credit risks. resolve the conflict between scaered small In Guizhou, some local governments have producon and the concentrated big mar- introduced a variety of special interest- ket, without affecng the incenve system subsidized loans for raw silk producon, based on household operaon. At pres- hog farming, tea producon, and the like. ent, farmers’ technical associaons have Some local governments cover 50% of the integrated the advantages of producon loan interest; others discount the inter- cooperaves with those of supply and sales est rate to the level of ordinary RCC loans, cooperaves, and the growth of coopera- which makes the effecve interest rate for ve finance will further boost the develop- rural households 2.4% per month. These ment of these technical associaons. special interest-subsidized loans have reduced rural household defaults without Urbanizaon will proceed in the PRC over affecng resource distribuon and have the next 20 to 30 years. In the process, turned the implicit demand of rural house- the rural populaon will decrease but holds into effecve demand. agriculture will expand, creang potenal for cooperave finance. More importantly, Rural finance in the PRC has with connuous currency appreciaon, the price of agricultural products will tremendous potential if it can grasp increase together with farmers’ income the opportunities inherent in the and demand for rural financial services. This will go hand in hand with rapid expan- rapid economic development sion of the rural consumer credit market. Meanwhile, the vast distances, scaered Finally, RCCs can innovate in targeng populaon, high cost of informaon col- moderately poor rural households. Rural lecon, and shortage of collateral in rural households require both commercial areas will reduce the compeve advan- funding and social welfare funding. Com- tage of commercial finance and solidify the mercial demand may be met by formal monopoly status of cooperave finance in or informal financial service providers; many areas. Rural finance in the PRC has social welfare demand may be met by tremendous potenal if it can grasp the government agencies. Some local gov- opportunies inherent in the rapid eco- ernments, such as the government of nomic development. Taijiang County, have realized that they should provide loan support mainly to Cooperave finance disnguishes itself in moderately poor rural households that many ways. First, it has a community back- are capable of repaying the funds. These ground and clear boundaries, resulng in households will then be able to help informaon advantage and peer pressure, relieve destute farmers by offering which is one of the key reasons behind its employment opportunies. This, in turn, existence. This community background can parally reduce the pressure on RCCs helps to keep funds in and for the rural to provide loans to the agriculture sector. areas. Second, cooperave finance stresses

142 SURVEYS AND PILOT PROJECTS the principle of equality, one basic element ritory and scaered households. Instead of its corporate governance. An effecvely of requiring repayment installments at organized cooperave financial instu- an interval of every week or every 10 on does not need prudenal supervision. days as in other provinces and autono- Third, cooperave financial instuons are mous regions, installments in Guangxi nonprofit, with only a mission to pro- are due once a month, with repayment vide financing for members. This enables in 10 installments, beginning in the third cooperave financial instuons to aract month from the date of loan issuance. This deposits with higher interest rates and issue change maintains the push for repayment, loans at lower interest rates. keeps the pressure on farmers to work hard, and reduces the me that farmers spend in loan repayment. Microfinance Award and Subsidy Fund Guangxi Learns from Grameen Bank In 2005, the China Banking Regulatory The pilot microcredit program in Guangxi Commission, the Ministry of Finance, the Zhuang Autonomous Region started in PBC, and the Poverty Reducon Office August 1997 by the Guangxi Women’s Fed- of the State Council conducted a pilot eraon. In February 1998, the Government program to promote microloans to farm- of Guangxi issued the Provisions on the ers through an award and subsidy fund Microcredit Poverty Reducon Program in eight counes of Guizhou, Jiangxi, and in Guangxi Zhuang Autonomous Region, Shaanxi provinces, and in Chongqing. The which specifies three principles of micro- program uses part of the central govern- credit: joint guaranty, freedom in forming ment’s poverty reducon fund to subsi- groups, and installaon repayment. In dize interest and loss or as an award. The addion, microcredit borrowers are strictly purpose of the pilot program is to invent separated from commercial loan borrow- a new operaonal mechanism to evalu- ers to exclude applicants not conforming ate loans to poor farmers; to explore the to the three basic principles. possibility of seng aside an award and subsidy fund, creang a precedent for In recent years, Guangxi has followed the operang loans to farmers naonwide; to Grameen Bank model, which includes a accommodate the interests of the poor risk-sharing joint guaranty system featur- populaon; and to create sustainable and ing mutual assistance, monitoring, and financially viable loan-issuing financial guaranty among groups of 5 to 10 house- instuons. The pilot program is based holds. The model also features a center on voluntary parcipaon, and financial conference system in which three to five instuons are selected through open groups form a center and communicate tendering, bidding by invitaon, and bid with one another through conferences. negoaon. Such conferences are designed to fully demonstrate the leadership role of center and group heads and to train members in The program uses part of the central managerial and producve skills. governmentÊs poverty reduction fund

Finally, repayment requirements cater to to subsidize interest and loss or as Guangxi’s reality of vast mountainous ter- an award

143 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Loan-issuing financial instuons raise The pilot program proves that an award credit funds for the pilot program and and subsidy fund can guide financial determine the lending rate in accordance capital to support poor farmers in their with relevant regulaons, with the ceiling producve acvies, and displays the not exceeding 80% of the PBC-regulated leveraging capability of the fiscal poverty rate of loans of the same maturity and the reducon fund. In 2006, the pilot program same type. Loan maturity is subject to the was expanded to eight provinces. actual producon cycle but is no longer than 1 year. Candidate borrowers must be Dezhou: Microcredit and Postal poor, law-abiding, employable, creditwor- Savings Offices thy farmers; beer-off self-employed people, model farmers, and farmers capable We surveyed pledged microcredit busi- of generang above-average income are nesses operated through four postal sav- excluded. Farmers who repay on me can ings offices in Decheng, Leling, Pingyuan, enjoy a 50% interest subsidy. and Wucheng, Dezhou. As of October 2006, 105 loans had been issued, amount- The award and subsidy fund comprises ing to nearly CNY2.7 million. poverty reducon funds transferred from the central government to provincial In Leling County, the average credit line governments. If the loan collecon rao is was between CNY10,000 and CNY50,000; above 90%, principal and interest loss will the largest loan was CNY100,000 and the be fully covered by the award and subsidy smallest was CNY1,000. Most loans were fund. When the collecon rao is less bridge loans for the self-employed. Out than 90% and it is proved that loans are of 16 loans, 10 were used for inventory uncollecble, loan losses are split equally turnover, accounng for 63.6% of the between the loan-issuing financial ins- total. One transacon was for a vehicle tuons and the award and subsidy fund, purchase, two were for house purchases, a er approval from provincial poverty and two were for animal feed purchases. reducon offices and bureaus of finance. The lending rate and maturies were rela- Performance assessment is conducted at vely fixed. In 2006, pledged microcredit the county level, using a loan collecon had only two maturies—6 months at rao of 92% as the benchmark. Principal 5.58% and 1 year at 6.12%. on loans in excess of the 92% loan collecon rao is awarded and split between In general, the microcredit lending proce- loan-issuing financial instuons, which dure is more convenient than at commer- receive 60%, and poverty reducon offices, cial banks. When applying for microcredit which receive 40%. The enre award fund pledged with a deposit cerficate, the is used for operaonal expenses and staff applicant can contact the savings secon bonuses. Eligibility criteria, methods, and of the post office, which will invesgate subsidy amounts determined by pilot the applicant’s eligibility and sign a con- counes are announced in target town- tract with the applicant. Then the savings ships and villages. secon submits the applicaon materials to provincial and municipal savings man- Eligibility criteria, methods, and agement bureaus. Upon approval, borrowers can go to a deposit cerficate–issuing subsidy amounts determined by pilot instuon to terminate the payment of counties are announced in target accrued interest on deposits used as a pledge. A er that, borrowers can receive townships and villages loans. If the deposit cerficate of a third

144 SURVEYS AND PILOT PROJECTS party is pledged, a statement of the third for 60% of total savings, guaranteeing party’s willingness to provide the pledge a stable source of capital. Intermediary should be provided. Generally, loans can services include agency fee collecon, be granted on the day of applicaon, if agency insurance business, and agency borrowers meet lending criteria. salary payment, with commissions steadily increasing. The postal savings Post offices at the county level and below card business has made great headway, in Leling conduct postal savings and handle with 33,735 debit cards issued. The devel- mail. Staff members include one office opment of intermediary businesses and head, two clerks in charge of savings, two the increased issuance of cards further mail carriers, and two clerks in charge of promote the development of the postal postal business. Savings clerks also can savings business. perform postal services. Post offices above the county level conduct postal savings and Taking into account the professional quali- postal business while county post offices ficaons of the staff and management of undertake the mailing business. Postal sav- postal savings outlets, the Postal Savings ings outlets are managed by the savings and Bank of China (PSBC), established in 2007 transfer secon of the county post office. on the foundaon of these outlets, is not equipped to undertake a microcredit There were 26 postal savings outlets in business. First, the vast area to be served Leling County in 2006. Twenty of the out- contrasts with a shortage of personnel. lets, in rural areas, cover all townships and Because most outlets are understaffed, residenal areas in the county. There are most staff members are employed on 109 people employed in the postal savings a temporary basis, and staff also must business, including 90 clerks and 19 staff provide postal services, supervisory members in the savings and transfer sec- mechanisms cannot be fully implemented, on. Seventeen are college graduates, resulng in risk. The current number of accounng for 16% of the total; 40 have employees cannot sasfy business devel- a secondary school educaon or less, opment needs if outlets are conducng accounng for 37% of the total. Generally, microcredit business. therefore, the staff’s educaonal background is quite weak. Post offices above the county level The survey also showed that 74% of staff conduct postal savings and postal members are temporary workers. Out business while county post offices of 26 office heads, only 9 were formal employees; the remaining 17 were con- undertake the mailing business tract employees. All clerks were temporary workers. From 2001 to 2006, all office Second, most staff members are not profes- heads remained in office but were rotated sionals and cannot adapt to business devel- geographically. At the me of the survey, opment needs. When the PSBC began its over 90% of the clerks had been hired lending operaon, the staff did not receive within the previous 2 years, so the turn- any formal or systemac financial training. over was high. Most current staff have only limited knowledge about savings, the credit business, or The postal savings business in Leling bank accounng. They cannot adapt to the County has been developing steadily development needs of a microcredit busi- since 2001, and me deposit accounts ness in such a short period.

145 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Third, presently, there is no internal con- Case 1: Operational Model in Tongjiang trol system on microcredit. The internal County, Bazhong control system of postal savings is limited to overseeing postal savings and transfer, The Farmers Self-Support Capacity Build- cash and safety management, and the ing Project (SSCOP), an independent civil like. In addion, if no interest subsidy is society legal person project managed by provided, the PSBC will have to earn prof- the China Foundaon for Poverty Alle- its from its pledged microcredit business viaon and the Foreign Capital Project and intermediary services. Postal savings Management Center of Sichuan Province, began as an exclusively savings business is a World Bank subproject in Tongjiang and has no history of credit provision or County, under the Qinba Poverty Reduc- fund management, meaning that staff will on Project. Project implementaon began have a great deal to learn to conduct a in April 2000, and by the end of 2004, it microcredit business. had provided CNY27.94 million in loans to 18,824 farming households. SSCOP fund- Microfinance Case Studies ing came from the World Bank, with the central government assuming responsi- We surveyed three microfinance projects bility for repayment and then onlending in Sichuan Province in 2005 to get a sense the funds to the county Farmers Self-Sup- of naonwide pilots. The main focus port Capacity Service Center through the of the survey was microfinance project county finance bureau. operaon and interest rate structure, both of which are key to project sustain- SSCOP service centers in each project ability. The factors determining the inter- village and township supervise several est rate include operaonal cost, fund township and village mentors, issue and supply and demand, risk, and projects’ collect loans, organize meengs and train- sustainability requirements. In pracce, ings, and so forth. The project adopted there are two rate systems: the low-rate the operaonal principles and methods of system with a government subsidy, and Bangladesh’s Grameen Bank, employing the high-rate commercialized system to the farmers’ center as the central admin- cover at least project operaonal cost. istrave unit of organizaon. One center The esmated effecve annual rate of the usually comprises 30 to 40 farmers who United Naons Development Programme meet at the center every month. The ser- (UNDP) project in Tongjiang, Sichuan, vice center examines and approves farm- was 15.09%. The rate of the Caohai Vil- ers’ loan applicaons through the center lage Fund was 24% to 60%, compared to meengs, and provides farmers with tech- the 20% to 40% rates of the Bank Rakyat nical training and project management, Indonesia–Unit Desa. support services, and market informaon.

The SSCOP focuses on the repayment The project adopted the operational capacity of farmers and targets middle- principles and methods of income and low-income farmers with family annual incomes above CNY5,000. BangladeshÊs Grameen Bank, The loans are mainly for aquaculture, pro- employing the farmersÊ center as cessing, transport, and small businesses. the central administrative unit of A parcipatory approach was adopted in idenfying clients, with boom-up farm- organization ers’ autonomous organizaons selecng

146 SURVEYS AND PILOT PROJECTS potenal borrowers. The project only The branch targets middle-income and grants loans with a 1-year term. When low-income farmers, paying aenon not applying for a loan, borrowers are required only to the profitability of the supporng to deduct 50% of the interest to cover projects but also to whether the farmer management costs and service fees, and has a house, vehicle, or livestock as a loans are repaid in installments. The secondary repayment source. Branch loans remaining 50% of interest is paid off with are made mainly for individual rural indus- the final repayment. In 2005, the nominal trial and commercial producon; relavely interest rate was 7% per annum, although few loans are made for aquaculture. the effecve interest rate was about 15%. Groups and centers idenfy potenal The SSCOP was in the red. By the end of clients. The term is normally 1 year, with 2004, the project had a cumulave loss of repayment and interest rate arrange- CNY619,200 and its earnings covered only ments similar to those of the SSCOP. 72% of its cost. The effecve interest rate per year is about 15%, and the loan amounts are Case 2: Economic Promotion Association, normally CNY1,000 per household for Guangna Branch, Bazhong the first year, CNY2,000 for the second year, CNY3,000 for the third year, and The Guangna branch of the Poor Village CNY4,000 for the fourth year, with a Economic Development Promoon Asso- CNY5,000 ceiling. ciaon in Sichuan Province began to provide loans in July 2004. By the end of May In 2005, Guangna branch was making 2005, its cumulave loans are esmated to ends meet. have totaled CNY870,000, made to approximately 750 farming households. Case 3: Association for Rural Development Operational Mode in Yilong County The relaonship between the Guangna branch and the Poor Village Economic In June 1995, UNDP assisted the Yilong Development Promoon Associaon is Poverty Alleviaon and Sustainable similar to the relaon between a loan Development Project in Sichuan Province retailer and a wholesaler. The associaon in seng up the Associaon for Rural provides a wholesale loan to the branch Development in Yilong. Project setup was at a certain interest rate and the branch completed in 1998, but the ownership grants microcredit to farmers at a higher of the project funds was unclear. From rate, with the rate gap represenng its 1996 to 2005, the associaon issued own earnings. The branch’s loan applica- CNY28.27 million in loans, with loans out- on, issuance, and repayment procedures standing of CNY4.25 million, represenng are similar to those of the SSCOP. The 68.7% of available funds. Within 10 years branch submits loan applicaons to the of project implementaon, the project had Poor Village Economic Development Pro- covered 100 villages in nine townships, moon Associaon, which approves the applicaons and then transfers a lump- sum fund to the branch. The branch then Branch loans are made mainly releases the funds to farmers, monitors for individual rural industrial and monthly repayments, and returns the commercial production; relatively few funds to the associaon when the loan is repaid. loans are made for aquaculture

147 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

yielding a coverage rao of around 12%. risk rao exceeds 5%, the associaon will Later, the associaon closed some outlets; stop lending and put all its eﬀorts into ﬁve branches remained in 2005. recovering nonperforming loans.

In 2005, the associaon had a total fund of The expenditures and operang costs CNY6.19 million, including CNY3.93 million of each branch include salaries, inter- in debt from the UNDP revolving fund, est on capital, office expenses, and loan the Madame Saider Trust Fund, and the loss provision. The costs of the county Grameen Bank Trust Fund, and equity of associaon also include funding costs, CNY2.26 million from the United Naons management fees, and training fees. Populaon Fund and donaons from the Since September 2004, each branch asso- Germany Philanthropy and the Ministry of ciaon has made ends meet; however, Commerce. the county associaon is sll in the red because of funding costs and training and The microcredit project is implemented management expenditures. mainly through township branches. The loans target poor households headed by These case studies demonstrate that women, individual industrial and commer- microcredit as an innovaon introduced by cial business operators, service industries, nongovernment organizaons is different agricultural producon, and small-scale from tradional credit provision in terms household processing. The ceiling for indi- of management, funding, market posi- vidual industrial and commercial loans is on, client idenficaon, loan products, CNY10,000, combining credit and collateral loan issuance and repayment, risk control, loans. The ceiling for agriculture loans is and returns. The differences result from CNY3,000 and is based on credit rather innovave mechanisms and this, in turn, than collateral. In 2005, the interest rate, promotes rural financial innovaon. The which is keyed to the PBC base lending PRC has done substanal work in explor- rate, was 8% per annum, yielding a real ing microcredit operaons, accumulang interest rate of 10% to 14%. The inter- experience and laying the foundaon for est on loans repaid in less than 3 months future development. is calculated as 3 months; loans repaid between 3 months and 6 months are On the other hand, although microcredit calculated as 1 year, with interest payment has over 10 years of history in the PRC, made in installments. Interest is repaid there have been no soluons to some along with the principal repayment. fundamental issues. These issues include choosing the appropriate type of microfinance instuons and their ownership, The differences result from idenfying long-term funding sources, innovative mechanisms and this, ensuring sustainability, and establishing low-cost, high-efficiency rural financing in turn, promotes rural financial services that fit local demands. innovation

In 2004, the average repayment rate for Informal Finance new loans was 98.3%, with a loan risk rao of 0.83%. By the end of September 2005, Guizhou and Shaanxi the loan repayment rate stood at 96.8% and the delay rao of new loans was only Comparison of the ﬁnancing structure 1.6%, yielding a risk rao of 3.99%. If the of Guizhou in the southwestern PRC

148 SURVEYS AND PILOT PROJECTS with that of Shaanxi in the northwest formal financial instuons, it is impossible will assist our understanding of informal for informal financial instuons to raise finance in poverty-stricken areas. Among sufficient funds. On the other hand, with- the sample rural households in Guizhou, out informal financial instuons, formal rural families tended to borrow the financial instuons are unwilling to engage most from their relaves, friends, and in this type of business, due to the risks neighbors, which accounted for 64.1% involved, and an automobile loan market of of total borrowing. Borrowing from RCCs this kind would shrink. accounted for 31.2% of the total, and borrowing from state-owned commercial Another example is India’s Naonal banks accounted for 4.7%. Bank for Agriculture and Rural Develop- ment (NABARD), which in 1991 began According to a survey of approximately to integrate the small credit operaons 400 rural households in Shaanxi Province, of self-help groups with formal financial 20% of rural households obtained RCC businesses. Through its employees and loans, 54% had no borrowing, and oth- partners, NABARD conducts the social ers indicated they would borrow money mobilizaon and group-based training of from informal channels such as relaves or rural self-help groups of 15 to 20 women. friends. Of the rural households with loans, At first, savings and loan acvies are 43% prefer to borrow funds from RCCs and conducted within the self-help groups. 40% would consider borrowing from rela- A er approval by NABARD, loans to the ves or friends; in the laer case, interest self-help group are issued either directly usually is not charged. In addion, 17% of or through grassroots commercial banks. rural households obtained loans from infor- NABARD also provides capacity building mal sources that charged interest. and staff training for partners that offer social and financial intermediary ser- Thus, the main compeon for RCCs in vices, as well as onlending for grassroots Shaanxi was interest-free loans among commercial banks that offer small loans. relaves and friends, and the RCCs main- During the 2002–2003 fiscal year, NABARD tained monopolisc market power in rural provided a total of CNY1.1 billion in new commercial credit markets because com- loans to 26,000 newly established rural mercial informal lending was sll under- self-help groups. By March 2003, NABARD developed. Unlike informal finance, which had provided loans for 11.6 million poor aends to creditworthiness and future households in India, covering about 20% of cash flow and carries unlimited liability, the poor households of the country. RCCs pay more aenon to both the quanty and the quality of collateral. The complementary relationship Combining Formal with Informal between formal and informal finance Finance can be realized through conscious The complementary relaonship between cooperation formal and informal finance can be realized through conscious cooperaon. In The pracce in Taipei,China also can serve Argenna, for instance, local banks and as a reference. Major forms of informal automobile dealers employ the informaon finance in Taipei,China include trade advantage of rotang savings and credit financing with long-term contract arrange- associaons to develop automobile loans ments and commodity transacons, and expand automobile sales. Without usually between those familiar with each

149 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

other; private enterprises, such as rotang eligible for parcipaon in the formal savings and credit associaons formed by financial market can onlend its funds to relaves and friends; underground banks the informal financial market, even in charging high interest; and employee cases where formal financial instuons deposits of enterprise working capital, are unwilling to make loans. In addion, which are essenally loans of individual big enterprises can charge a higher inter- employees to an enterprise. Although est rate because the lender has busi- the Government of Taipei,China does not ness connecons with the borrower and recognize informal finance, these forms therefore understands the credenals and of financial transacons are not isolated. repayment ability of the borrower. There are standardized pracces among parcipants, and their effecve implemen- This example demonstrates the comple- taon has reduced problems in customer mentary relaonship between the two mar- selecon, transacons, and incenve kets. The informal financial market provides mechanisms. Thus, the relaonship higher returns, without which a loan will between formal and informal finance in not be made. On the other hand, without Taipei,China is complementary rather than formal financial market, big enterprises will compeve. Taipei,China’s experience is not have sufficient idle funds to invest in a useful reference for countries where the informal financial market. Formal finan- underdeveloped formal finance hinders cial instuons also may adhere to a lend- economic development. ing quota that encourages them to locate quality enterprises and exploit the higher South Africa’s pracce of encouraging returns of the informal financial market. compeon and complementary acvies between commercial banks and informal Some informaon intermediaries, such as finance also is noteworthy. A number of chambers of commerce, also may connect large commercial banks in South Africa formal and informal financial instuons. have iniated a savings business designed The experience of the Leqing Chamber for stokvels—a kind of informal savings of Commerce in Tongxiang, Zhejiang, is and loan project—and have opened a a good example. This chamber of com- bank account for every stokvel. Several merce currently has 160 dues-paying designated group members are autho- members, 50 to 60 of which are enter- rized to sign on the account and to issue prises. The members of the chamber loans based on accumulated deposits. This are required to submit membership fees pracce has benefited both customers and before becoming eligible. The chamber of the bank; stokvel members’ money is safer commerce, in turn, has set up a guaranty and enjoys higher returns, and the bank’s fund of CNY1 million at a local bank. The ability to make loans to stokvel members guaranty has a leverage rao of 10, mean- increases a bank’s profit. ing that it can help the members access to up to CNY10 million in loanable funds. The complementary relaonship between In addion, a joint guaranty group of formal and informal finance does not three people is formed among volunteer require conscious cooperaon. Because members, creang a joint guaranty of they lack relevant informaon, formal CNY500,000. As the ulmate guarantor, financial instuons are unwilling to lend the chamber charges a 1% guaranty ser- funds to “ineligible” enterprises and indi- vice fee. This pracce has produced sas- viduals; instead, they lend at relavely low fying results, bringing enterprises into the interest to big enterprises with sufficient formal financial market and somewhat collateral. However, a qualified enterprise reducing informal lending.

150 CHAPTER 10 Policy Recommendations

General Policy Considerations

The Role of Government and Market Building a moderately prosperous society in a comprehensive manner requires coordinated urban and rural economic and social development, growth of agriculture and the rural economy, and a boost in rural household income. In recent years, county economies have suﬀered from inadequate ﬁnancial services, especially those targeted at agriculture, farmers, and rural areas (sannong), which has restrained the strategic adjustment of rural economic structures.

Finance plays a crucial role in the modern economy; thus, the new socialist countryside cannot be developed without support from the rural finance sector. However, some factors in the current rural financial system are constraining rural economic development. Major tasks in current rural financial reform, and an important element in building a harmonious society, include giving financial instuons an effecve role in resource allocaon, promong county economic development, and guiding rural economic and agricultural restructuring.

The Government of the People’s Republic of China (PRC) aaches high importance to rural ﬁnancial reform, and some progress has been made since the State Council iniated the 2003 Program on Deepening Pilot RCC Reform. Pilot reform has been extended to rural areas across the PRC. The postal savings interest rate mechanism has been reformed, contribung to a drop in rural capital oulows, and the Postal Savings Bank of China (PSBC) has begun operaons. The Agricultural Development Bank of China (ADBC) has acvely expanded funding sources by issuing policy bonds, conducng interbank borrowing, aracng corporate deposits, and conducng negoable deposits with postal savings outlets. The ADBC also has launched new lending businesses, serving ﬂagship enterprises in agricultural industrializaon, coon and oil seed, technological advancement, and agricultural technologies. Breakthrough has been made in the pilot agriculture insurance

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scheme, with three specialized agricul- spending in rural areas. The great challenge ture insurance companies established now is to discover how rural finance should in Heilongjiang, Jilin, and Shanghai, and adapt to serve the rural economy, prevent a pilot scheme of commercial insurance risks, and realize sound, rapid, and sustain- companies offering agriculture insurance able development. on their own, jointly with the government, or on behalf of the government has been The key to an improved rural financial established in Hunan, Jiangsu, Liaoning, system is to properly deal with the rela- Sichuan, and Xinjiang Uygur Autonomous onship between government and market. Region. Addional liberalizaon of the First, the coverage of public spending in rural financial market also has moved rural areas should be increased and the steadily forward. market environment should be strengthened to lay the foundaon for sustain- Communist Party of China Central Com- able development of rural finance. In miee Document No. 1 made it clear that poverty-stricken regions, central and local there should be increased efforts to foster governments should increase spending microfinance instuons (MFIs) launched on infrastructure, including transport, by natural persons, legal persons, or communicaons, water conservaon, j uridical associaons and that relevant gov- educaon, and sanitaon. The rural social ernment agencies should work on admin- security system should be improved to istrave rules with a sense of urgency. To create condions for commercialized rural this end, the People’s Bank of China (PBC) financial instuons. Fiscalizaon of finan- has acvely advocated a pilot program to cial services and the use of rural credit establish microfinance companies that offer cooperave (RCC) funds as fiscal relief lending without taking deposits. To date, funds should be avoided. this program has been implemented in five provinces and regions, including Guizhou, Meanwhile, local fiscal instuons must Inner Mongolia Autonomous Region, be improved; this is a key to improving the Shaanxi, Shanxi, and Sichuan, with the rural financial system and a precondion for acve support of provincial governments. prevenng local government interference in rural finance. In addion, local govern- The great challenge now is to ments should create a sound operaonal and credit environment for rural financial discover how rural finance should instuons by nurturing creditworthy town- adapt to serve the rural economy, ships, villages, and households and cracking down on debt default. Doing so can prevent risks, and realize sound, promote a sound pool of rural funds and rapid, and sustainable development prevent large oulows of rural capital.

In early 2007, the China Banking Regula- Second, policy finance coverage should be tory Commission enacted rules to develop expanded in rural areas. The naon should mulple types of rural financial instuons. consolidate funding to the countryside Subsequently, the PRC’s rural financial and should disnguish indispensable fiscal reform has entered a new stage of urban- spending from fiscal spending for compen- izaon and industrializaon that, in turn, saon purposes. Such acon will create a promotes agriculture. Building a new social- sound market environment. Fiscal authori- ist countryside is an important task during es at various administrave levels can the period of the Tenth Five-Year Plan, and fund road construcon in rural areas. The thus the government will increase fiscal central and local governments can provide

152 POLICY RECOMMENDATIONS funding for significant construcon projects of remiance services. An efficient remit- and research on fundamental subjects. tance service can help migrant laborers send money back home in a safe and mely Some other projects that usually have high manner, increasing their welfare by saving social benefits but low economic benefits them me and effort in remiance, and include projects related to agriculture beer serving the urgent producon and development, technology, and infrastruc- consumpon needs of their family mem- ture. Because these projects have large bers back at home. Efficient remiance funding demands, long project periods, service also encourages rural migrant labor- slow investment recovery, and high risks, ers to send more money back home and commercial banks are reluctant to step encourages their family members to use rel- in, and such projects are forced to rely on evant financial services, thus aracng new policy finance. Thus, in addion to regu- users of financial products and services. lar fiscal spending, the central and local governments should set aside a poron of spending for compensatory expenditures, Efficient remittance service also such as providing interest subsidies and encourages rural migrant laborers loan loss compensaon to instuons to send more money back home and engaged in policy finance. A small amount of public subsidy could guide funds into encourages their family members agriculture and the rural economy, meet to use relevant financial services, the funding needs of economic restructuring, and fund infrastructure and environ- thus attracting new users of financial mental projects. products and services

Third, rural financial services must adapt Fourth, rural finance must adapt to rural to changes in rural households’ producve industrial restructuring. Rural industrial paerns. An increasing number of farmers instuons have changed with the adjust- are leaving the countryside to find jobs in ment and upgrading of rural industrial the manufacturing and service sectors of structures, including the emergence of coastal provinces, producing large capital a great number of crop-growing, live- flows between rural laborers and their stock-rearing, and combined agricultural families. In contrast to migrant laborers producon enes. Flagship agricultural in other countries, rural migrant laborers industrializaon enterprises and special- in the PRC remit the bulk of their income ized agriculture associaons connect back home. Such remiances contribute rural households with the market. The to an increase in rural household income government should bring rural financial and welfare and alleviate poverty because instuons into full play, rely on market farmers are less dependent on crops and means to solve development financing other agricultural producon. In addion problems, guide farmers toward decreas- to the extra income, migrant workers ben- ing blind producon, and help thousands efit from new ideas and skills learned by of rural households hedge market risk by working in coastal regions. promong agriculture based on orders, documentary insurance, and agriculture Remiance of rural laborers accounted commodity futures. for 20% to 50% of their total household incomes, helping them meet tuion, medi- Fi h, building a new socialist countryside cal, and daily expenses. Such contribuons requires an efficient and compeve rural depend to a large extent on the quality financial system based on improved market

153 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

exit mechanisms, faster implementaon of tem that features financial instuons with deposit insurance, and the steady open- complementary funcons and disnct posi- ing of the rural financial market. Regula- ons, sound risk control, beer services, on and supervision of dispersed RCCs is and commercialized operaons assisted by very challenging, and informaon is not fiscal subsidies. always reliable. It is imperave to develop and improve the corporate governance of An efficient rural financial system serves rural financial instuons and to increase the rural economy by keeping funds within transparency so that an effecve regulatory the rural area for the benefit of sannong. mechanism can provide posive incenves Therefore, this round of rural financial and prompt correcve measures. reform should uphold the principles of rural financial market liberalizaon, Given specific circumstances in the PRC, encouraging innovaon and relying on the a mely and effecve market exit mecha- market to determine the best financial nism also is required. The key to such a instuons based on fair compeon. The mechanism is to protect and compensate pursuit of such goals disnguishes this small and medium-sized depositors; thus, round of reform from previous rounds. deposit insurance must be put into place promptly. In addion, a sound rural finan- Market-Based Rural Finance Reform cial system should be very dynamic, rather than a rigid combinaon of instuons, A er years of study and debate about the allowing the entry of new financial ins- objecve of rural financial reform, consen- tuons and the exit of problem financial sus has gradually emerged that the goal instuons. Because only diversified finan- is to develop market-oriented and com- cial instuons can meet rural financial mercially sustainable financial instuons needs, rural financial reform requires the and financial service providers and to offer creaon of a truly compeve rural finan- sufficient and reasonably priced financial cial system. services for sannong. This overall objecve applies to rural areas across the PRC, Regulation and supervision of though the specific targets and the methods of reaching those targets should vary dispersed RCCs is very challenging, according to the economic and market and information is not always reliable structures of different regions.

When liberalizing the rural financial market, At present, there exist acute problems regulators should take prompt correcve with county financial services in remote measures in line with the development and border areas, in minority regions, of rural financial instuons, strengthen and in poverty-stricken areas. First, policy supervision, build a deposit insurance financial instuons are based in cies system, and ensure safe and effecve and have limited funcons and coverage. market operaon. Rural financial reform is For example, the ADBC serves mainly as a a systemac project covering a wide range cashier for market crop enterprises in poor of areas, and improving the rural financial areas and performs few tasks related to system requires improving the operaonal agricultural product acquision. mechanism of policy finance, guiding funds flowing back to rural areas, and steadily lib- Second, state-owned commercial bank eralizing the rural financial market. Careful branches and postal savings outlets actu- study and mulpronged efforts are required ally serve as channels of capital oulow. to create a sustainable rural financial sys- The Agricultural Bank of China (ABC)

154 POLICY RECOMMENDATIONS already has closed many branches below In underdeveloped rural areas, scaered the county level and channels large depos- small-scale business, low producve effi- its to other regions. ciency, low accumulaon and investment rates, and high informaon and manage- Third, with their limited capital and ment costs all limit the scope of large-scale funcons, the RCCs are very vulnerable commercial financial instuons and and difficult to expand. As legal enes provide a natural seng for small-scale that should be responsible for their own informal finance. A rural financial system performance and risks, RCCs confront an that can adapt to and promote social adverse environment in poverty-stricken and economic developments in poverty- areas. They must connue to fulfill policy stricken rural areas must be based on funcons and maintain social stability even specific circumstances in these areas. The in the face of persistent losses, and most benefits of informal mutual finance should of them are already insolvent due to legal be recognized, and efforts should be made constraints, transacon costs, clearing and to promote its legal operaon so that it selement condions, and coverage. may contribute to economic development in these areas. Fourth, in the near term, the funcons and effects of informal credit in povery- stricken areas are irreplaceable. Policy Most rural financial reform over the finance outlets play a limited role, due past decade has followed a uniform, to their funcon and business limitaons. Commercial financial instuons top-down pattern, with little regard have narrowed their business scope to to specific regional circumstances deposit taking and remiance for capital transfer, owing to profit consideraons Most rural financial reform over the past and stringent credit authorizaon condi- decade has followed a uniform, top-down ons. Postal saving outlets are channels paern, with lile regard to specific of capital oulow, and although RCCs play regional circumstances. Fortunately, even an important role in offering lending, they in the face of many restricons, some remain in a difficult situaon. financial innovaons have emerged, including government-sponsored rural The government uses various subsidies and insurance, local agriculture technology interest rate policies, such as poverty reduc- associaons, or partnerships between on loans and interest rate controls, to corporaons and farmers. Such innova- meet the capital needs of poverty-stricken ons are disncvely local and have rural areas and to promote financial ser- performed soundly, but mechanisms and vices, but this pracce has proved a failure measures to evaluate and extend them because of high cost and because the bulk are not yet in place. of capital does not go to farmers. Mean- while, in areas such as educaon, medical Operang financial instuons in high- services, and social security, the govern- risk, high-cost, poverty-stricken rural ment has not played its role or has played areas requires ensuring their commercial an inadequate role. This has forced financial sustainability. Thus, profit-oriented finan- instuons to take up some fiscal funcons cial instuons in these regions must offer and has led to severe moral hazard, low services to instuons and individuals at efficiency in capital ulizaon, and adverse risk-matching prices. The government can effects on the commercial sustainability of encourage this by improving the legal and the financial instuons themselves. regulatory operang environment for rural

155 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

financial instuons. In addion, policy mote coordinated development between should allow coexistence and compeon poor and developed areas, and advance a among mulple types of financial instu- harmonious socialist society. ons and should promote market interest rate reform. Rural Finance in Poverty-Stricken Areas To promote rural financial development and meet rural financial demand, the Because the PRC’s present rural financial government and market must work to system was formed during the period of reduce the risks and costs of rural finan- the planned economy, a large propor- cial services. In this regard, the funcons on of financial service in rural areas is of government include establishing an neither market oriented nor sustainable. enabling environment, reducing opera- Interest rates have not been liberalized, onal risks, and channeling funds to rural and low interest rates may generate false areas. Given an enabling environment, demand. In addion, part of the supply of financial instuons and other financial rural financial services is policy based. This service providers will be able to strengthen includes ADBC policy loans, microcredit corporate governance and instrument supported by the central bank’s agriculture innovaon, reduce operaonal costs and loans, and excessively low fees on remit- nonperforming loans, improve efficiency, tances. These services are not commercial and increase returns. products and would be unsustainable without government subsidy.

The role of government is particularly Despite the economic and financial important in poverty-stricken areas reform of the past 2 decades, the rural and direct government action to financial system has maintained its original structure with minor changes. Under reduce poverty is a priority this structure, rural finance remains the major tool by which governments support The role of government is parcularly rural economic development (through important in poverty-stricken areas and low interest rates and fund support). The direct government acon to reduce less-developed regions depend more on poverty is a priority. To accomplish this, this tool, which features a higher degree government should assess poverty and of financial fiscalizaon. In many pov- its causes in these areas and idenfy the erty-stricken rural areas, for example, scope of the market in addion to fis- credit from rural financial instuons cal and other government funcons. The is commonly used to pay for medical government must take comprehensive and treatment, educaon, or the salaries of systemac acon to develop the financial village cadres. Moreover, the high degree market, social security, employment, and of financial control has reduced market public aid and to enhance infrastructure compeon and the financial instuons’ and increase human capital investment. elascity and movaon to innovate. This will create an enabling, compeve Thus, the commercializaon of financial environment among rural financial ser- instuons has reduced loan availability vice providers, augment sector efficiency, in poverty-stricken areas.1 enhance product quality, and promote innovaon. Concerted effort on the part The shortage of rural credit cannot be of government and the market will help to resolved simply by increasing agricul- meet growing rural financial demand, pro- ture onlending and other policy loans to

156 POLICY RECOMMENDATIONS rural financial instuons or by ordering Successful market liberalizaon also financial instuons to allocate a higher depends on other condions, mainly proporon of loans to rural areas. Rather, macroeconomic stability, adequate pru- the process of determining interest rates denal supervision, and bank regulaon.2 in rural areas of the PRC must be funda- Simply raising the interest rate may result mentally changed. Instuonal lending in adverse selecon problems and moral rates should be increased to cover opera- hazard, increasing rural financial instuonal costs and loan losses and should be ons’ nonperforming loan rate.3 Careful based on internaonal financial accounng research is required to quanfy returns on standards for rural financial instuons. investment and the repayment capacity of At the same me, the noninterest costs of rural enterprises and households in differ- borrowing should be cut to reduce overall ent regions of the PRC. Following improve- borrowing costs, and rural financial instu- ments in bank supervision and monitoring, ons should be allowed to charge a pre- the restricons on new entry into rural mium for riskier projects and borrowers. financial markets should be gradually relaxed to create more compeon in the In the poor and remote areas of the PRC, PRC’s rural financial markets. where transacon costs are higher and returns on producve investment are usually lower, the government should focus Poverty Reduction Loans on policy measures to reduce the credit risks and transacon costs of rural financial Tradional opinion holds that government instuons. The government can enhance can play a posive role in the rural finan- the repayment capacity of rural communi- cial market and favors direct interference es and farmers by increasing investment such as mandang interest rates on loans in educaon, health, and infrastructure in and deposits and establishing state-owned rural areas, and by improving agriculture rural financial instuons that priori- extension services and introducing new ze agriculture. However, this approach agriculture technologies. Government neglects the growth of nonagricultural money would be more effecve if it were enterprises in rural areas and the resulng invested directly in rural areas rather than opportunity to diversify risks. Rather than being used to subsidize poverty and agricul- increasing farmers’ income or eliminang ture loans. The government also can reduce poverty, therefore, this approach aggre- rural financial instuons’ risk by introduc- gates poverty. ing agriculture and medical microinsurance for farmers and farming communies. Government money would be Finally, there are two ways for the central more effective if it were invested and local governments to reduce transac- directly in rural areas rather than on costs in poverty-stricken, remote, and mountainous communies in the PRC: by being used to subsidize poverty encouraging voluntary reselement and and agriculture loans by allowing and encouraging the establishment of community-based real savings and Since the 1980s, many countries have credit cooperaves, under proper state adopted a new understanding of rural regulaon and supervision. finance that priorizes income growth and poverty reducon and emphasizes market Interest rate liberalizaon alone will not efficiency in the belief that government resolve the problems in rural finance. interference should be limited and market

157 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

oriented. This new understanding does laon in most developing countries sll cannot deviate from tradional goals, but it not access loans through normal channels. ulizes more market-oriented, efficient Tradional methods lean toward loan issu- methods of achieving them. ance but neglect loan quality and banks are treated as loan dispensers rather than as Poverty reducon loans are guidance commercial financial instuons. Moreover, funds intended to increase social welfare subsidized loans create excessive demand by providing loans to priority sectors and for credit, but beer-off, privileged custom- to those who normally cannot access ers intercept many of the limited number of loans. Typically, countries subsidize agricul- loans. In addion, directed loans focus on ture loans through government financing financing primary agricultural acvies but arrangements, including discount instru- neglect nonagricultural economic acvies, ments, loan quotas, and the agriculture even though the laer usually create higher financing system. The intenon may be returns, resulng in a high number of non- to promote rural welfare, guarantee food performing loans. safety, popularize modern technologies, or compensate for deficient economic Directed loans are not in alignment with and financial policies in favor of urban commercial viability indicators, such as development. Such a financing system sufficient asset return and effecve loan features a managed interest rate, subsidies collecon. The agriculture credit model to borrowers, and directed credit plans. usually aggravates the problems of already However, pracces in many countries have poorly performing financial instuons in shown that the agriculture credit model rural areas. Problemac financial instu- rarely succeeds in improving income. ons pay lile aenon to loan collecon, Directed loans are inexpensive, thanks to client needs, or financial sustainability. As low interest rates, and mask obvious prob- a result, such financial instuons usually lems such as a rural credit crunch, but they need a government bailout, but bailout are prone to disappearance when fiscal consumes scarce public funds that should departments terminate capital support or be used to provide future relief, and finan- to remain in place even a er they are no cial discipline is further weakened. Ul- longer needed. mately, poorly performing financial instuons in rural areas will rely on government Directed loans are inexpensive, relief indefinitely. thanks to low interest rates, and The problems of rural financial instuons also might adversely affect over- mask obvious problems such as all economic stability. In the 1980s, a rural credit crunch, but they are for instance, agriculture credit subsidy prone to disappearance when fiscal accounted for 2% of the gross domesc product (GDP) in Brazil and Mexico, and departments terminate capital many countries were ignorant of the fiscal support or to remain in place even cost of maintaining inexpensive directed agriculture credit projects. One study of after they are no longer needed 18 countries showed that direct agriculture credit subsidies accounted for 2% of During the past decades, various countries the countries’ GDP from 1960 to 1984 but and internaonal development agencies that negave transfer brought about by have made huge investments in developing indirect intervenon consumed 15% of rural financial markets, but the rural popu- their GDP.4

158 POLICY RECOMMENDATIONS

Tradional financial indicators are insuf- use of interest subsidy funds should be ficient to evaluate directed loans because revised. Some subsidy funds should be directed loans and the subsequent return used to set up a poverty reducon guar- on assets and equity rely on the cost anty fund to compensate loan-issuing of borrowed funds. If the value of loan financial instuons for their risks. The subsidies is not properly understood, remainder can be used to directly subsi- tradional indicators become meaning- dize farmers. less or even misleading. First, there is a gap between expense and income as it is reflected on the loan’s income state- Rural Remittance ment and financial instuon’s income statement. Second, tradional account- Migrant and Nongovernment ing methods cannot reflect or accurately Organizations record various directed loan subsidies, and because the size of subsidies is a To improve remiance services for migrant determining factor in determining workers in the PRC, it is important to pro- return on assets and return on equity, vide consumers with informaon about the the return on asset and return on equity major products, services, and fees avail- raos are dependent rather than inde- able from different service providers. This pendent variables.5 informaon should be updated frequently and service providers should be required to Internaonal experience indicates that fully disclose informaon about products governments can create a favorable envi- and charges. Government programs, non- ronment for financial intermediaries by government organizaons, and associaons formulang and implemenng effecve working with migrants can disseminate this macroeconomic and monetary policies; informaon through various outlets. Some by seng up full-fledged management, of the informaon should be illustrated, supervisory, judicial, and law enforce- given that more than one-third of migrant ment systems; and by pung in place workers have fewer than 7 years of formal efficient instuonal arrangements, educaon and 15% have fewer than 4 years such as encouraging private sector loans of formal schooling. to the agriculture sector and the rural populaon. Direct intervenon should Some subsidy funds should be be avoided. used to set up a poverty reduction Ulmately, the PRC must establish a guaranty fund to compensate loan- diversified and sustainable rural financial system. Unl then, poverty reducon issuing financial institutions for loans, even if used as an interim poverty their risks reducon method, should be market oriented and reinforced through instuonal Workers also need to be informed about arrangements to ensure that loan-issu- using bank services, applying for and using ing financial instuons have incenve bank card, and locang informaon about schemes in place, that poor farmers get remiance services and charges. A toll-free benefits, and that the cost is acceptable to hotline can be set up for making inquiries or fiscal agencies at various levels. Achieving complaints, and the PBC’s current number this goal requires a compeve market. for reporng card losses should be made Financial instuons should be selected public. Such an educaonal campaign through market mechanisms, and the should focus on migrant workers from

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remote and poverty-stricken areas. Pos- PSBC also should study remiance fees in sible agencies for promong such consumer sending and receiving offices and provide educaon include nongovernment organi- more incenves for receiving offices in the zaons working with migrant workers, or remote rural areas. A permit for the PSBC the All-China Women’s Federaon. to provide other financial services also could increase financial compeon in Policy Makers and Regulators rural areas.

Given the problems with exisng service Increasing the commercial banks’ share providers, it is important to enhance of the remiance market will benefit both compeon among remiance services in banks and migrant workers. Commercial rural areas of the PRC parcularly in the banks with broad branch coverage are western provinces. Market compeon encouraged to consider using this capabil- can be enhanced by encouraging state- ity for remiance services. Funds could owned commercial banks, parcularly the be remied via ATMs or point-of-sale ABC, to remain in the large rural town- devices, and more card-based products, ships. Improving the payment and sele- including credit cards, will reduce work- ment system for RCCs and other small ers’ remiance costs. Migrant workers banks also will provide alternate channels and their families should be able to use of remiance. Lending-only microcredit mobile phones, text messaging, and the instuons and other microfinance ins- internet to make inquiries about their tuons can be linked directly to the pay- bank card balances and about their remit- ment and selement system of the PBC, tance transacons. or indirectly via other commercial banks, to provide remiance services. Other An increase in remiance market share possible alliances between state-owned could benefit commercial banks not only commercial banks and MFIs will create by generang remiance income but also compeon for the Postal Savings Bank by increasing deposits and by facilitang of China (PSBC) in remote rural areas, and consumer loans or other profitable ser- internaonal service providers such as vices. Remiance service providers should MoneyGram, Western Union, and others be encouraged to explore opportunies for may be linked with domesc providers of cross-selling other financial products, such remiance services. as savings accounts, loans, insurance, and mortgages. Commercial banks and RCCs Financial Service Providers should use remiance income, or a record of remiance income, as loan guaranes As the service provider with the larg- for remiers and payees. Migrant work- est market share in the PRC’s domesc ers might be allowed to to use remiance remiance market, it is important for the to buy insurance for family members, and PSBC to improve its services across the workers with stable incomes should be country. In addion to improving access to able to take out mortgages in their home informaon about services and fees, the counes and townships. A permit for the PSBC to provide More remiance partnerships should be formed between RCC township offices other financial services also could and other commercial banks, parcularly increase financial competition in the ABC. Following the establishment of the provincial RCC federaon in rural areas many provinces, the RCCs should be in

160 POLICY RECOMMENDATIONS a stronger posion to negoate with infrastructure, and the upgrading of public commercial banks. Commercial banks finance in support of agriculture and also should be reminded not to withdraw other fields. These measures will create a from the rural markets, given the close sustainable foundaon for rural financial bond between migrant workers and their instuons and will reinforce the role of families in the villages, and the potenal the government. Careful aenon should for developing new financial products be given to the separaon of fiscal and and services. financial services, to the role of government in RCC operaons, and to the effecve supervision of RCCs. Cooperative Finance Serving sannong is a government priority, The key to sustainable financial instu- and of all agriculture supports, funding ons is low transacon and operang support is one of the easiest and most wel- costs. For example, while RCCs in Ganzi comed by farmers. Funding for sannong were making huge losses, local loans by may take the form of fiscal transfer, PBC Buddhist temples were performing quite credit transfer, or loans from rural financial well. To save costs, financial services instuons, but fiscal and financial service in rural areas might be combined with funcons must remain separate. Fiscal postal and telecommunicaons services, transfer can be used to meet poor families’ or with the sale of agriculture materi- nonproducve needs whereas loans from als and other commodies. In addion, the PBC and financial instuons should internaonal experience indicates that be used for producve purposes and must the government should encourage invest- include repayment capacity. Fiscal transfer ment in telecommunicaons networks is a government funcon whereas financial so that farmers and herdsmen can services are acons of enterprises. access financial services electronically. In remote agricultural areas, the Indian Unfortunately, RCCs o en have been used model can be introduced to establish to provide not only financial services but informal self-help groups, which then also fiscal services, including public aid. establish business relaonships with RCCs are told to provide finance for infra- RCCs. In short, rural financial instuons structure development and agriculture in poverty-stricken areas must adapt technology promoon. This happens o en themselves to the local economic, social, in areas with severe fiscal situaons, and religious, cultural, and geographic situa- local governments simply transfer to finan- on. Furthermore, to reduce the risks of cial instuons the funcon of fiscal sup- rural household loans, it is necessary to port. For instance, the PBC provides loans develop agriculture insurance and futures to RCCs for agriculture lending and microfi- and to bring public finance into play. nance, but some areas require that 85% of this type of lending go to the agriculture In addion to reform, the sustainable sector. Thus, 85% goes to farming house- development of financial instuons holds, and a large poron of such lending requires an enabling environment. The supports poor households’ basic living, construcon of the new socialist coun- medical, or educaon expenses, which are tryside will expand public finance in rural areas to include the establishment and Fiscal transfer is a government improvement of a rural social security system suitable to local economic develop- function whereas financial services ment, the strengthening of rural financial are actions of enterprises

161 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

more properly supported through pub- Banking Regulatory Commission, the PBC, lic aid from the fiscal budget. Moreover, and the People’s Commune. Currently, because agricultural producon is subject provincial governments supervise the RCC to high risks and because lending to poor sector through the provincial RCC unions, households for nonproducon purposes which subjects RCC operaons and person- will not generate returns to be used for nel policy to government influence. The repayment, the financial sustainability of dual identy of the provincial RCC union RCCs is compromised. This, in turn, damp- prevents it from acng as a real supervisor ens RCCs’ ability to support sannong and or closing RCCs for violang regulaons. forces the government to connue providing fiscal subsidies. In the pilot program begun in 2003, the provincial RCC union transferred only part The asymmetry in responsibilies and of its funcons to county RCC unions, rights of the central and local govern- and it sll supervises the county unions ments adds to the moral hazard of rural through management. The China Bank- financial instuons. Local governments, ing Regulatory Commission has insuf- especially those with budget difficules, ficient staff and capacity to monitor and tend to direct RCC lending toward local supervise the large number of RCCs, and economic growth, parcularly because the situaon is more severe for commis- commercial bank operaon in rural areas sion offices in remote areas. For historical is o en scarce. Local governments benefit reasons, many commission staff oversee- from the intervenon of RCC operaons ing RCCs are former RCC staff themselves, but transfer the cost to the RCCs, and ul- which may affect their judgment, and both mately, to the central government. the China Banking Regulatory Commis- sion and the provincial RCC union charges supervision and management fees, adding The dual identity of the provincial to RCCs’ financial burdens. RCC union prevents it from acting as a real supervisor or closing RCCs for Efficiency is one of the most important criteria for any rural financial model, whether violating regulations the model is cooperave, commercial, or informal. For example, if the govern- A systemic framework should be estab- ment insists on the so-called cooperave lished to enable local government to system and requires RCCs to make all loans ulize its advantages, provide preferenal locally, as much as two-thirds of the loan policies, and create a sound environ- amount may end up as nonperforming ment for RCC operaon. Meanwhile, local loans. On the other hand, if the govern- governments ought to provide a certain ment requires that only 50% of RCC loans amount of emergency support when be allocated locally, then the RCCs may be local RCCs encounter payment risks. Local able to sustain themselves commercially. government also can use its administra- If commercial operaon is allowed, 50% ve authority and resources to help RCCs of the deposits from rural areas can be resolve nonperforming loans. used locally, support for sannong will be much stronger, and local governments can The Government of the PRC typically has be freed from responsibility for nonper- been involved in the operaon of enter- forming loans. The guiding principles of prises, and the government has always rural finance reform, therefore, should supervised the RCCs. The RCCs have been be to open the rural financial market variously managed by the ABC, the China and encourage various forms of financial

162 POLICY RECOMMENDATIONS instuons to compete on an equitable achieve economies of scale while also sat- basis. This would mark a major difference isfying local demand for financial services. between this round of reform and the It is not desirable to sustain RCCs without previous rounds. sasfying local needs; this only creates a vicious cycle of poor economic develop- Rural financial markets in Guizhou Prov- ment, low per capita income, low savings ince, for instance, have tremendous rates, low investment levels, and a lack of potenal. First, the province has a large incenve for development. number of migrant workers, and their remiances are an inexhausble source Financial instuons in poverty-stricken of funds for financial instuons. Second, areas require preferenal policy and capi- with appropriate mechanisms, reforms in tal support, but more importantly, they the near future can enable retenon of need efficient mechanisms. Rural financial part or all postal savings deposits. Third, reform requires a large, systemic effort; Guizhou has become an integral part of concentrang only on RCC reform cannot the naonal economic system over the succeed. One such reform, for example, is past 20 years. If it can take the iniave, to introduce market-based interest rates the province will be able to create and that will induce flows of funds to poverty- capitalize on opportunies. stricken areas. With large numbers of clients spread over extensive areas, small Financial instuons have tremendous loan sizes, and high transacon costs and potenal for innovaon. Various credit risks, rural financial instuons can survive guaranty and risk-sharing arrangements, only with an adequate interest spread. Lib- such as microfinance and group guaran- eralizaon of interest rates on loans is one es, will greatly enhance credit quality. prerequisite for sustainable rural financial Financial instuons can be profitable if instuons and for the flow of funds into the financial markets are opened, if fair rural areas. When rural households must compeon is allowed, and if under- choose between low interest rates and performing instuons are given an exit loan accessibility, they prefer access. mechanism. The withdrawal of state- owned commercial banks from rural areas has provided a large opportunity for the New mechanisms must be designed development of grassroots financial ins- to curb the present outflow of human tuons, and the PBC is adjusng onlend- and financial resources from poverty- ing to the central and western regions. Finally, some RCCs and local governments stricken areas are cooperang to reduce credit risks and some RCCs are making efforts to meet Given RCCs’ monopoly status in the cur- the credit demands of specialized agricul- rent rural financial market, interest rate ture, because the income of households liberalizaon on loans may enable RCCs engaged in agriculture industrializaon to transfer their low efficiency to farm- is much higher than the income of other ers. In addion, liberalizing interest rates rural households. on deposits may cause fierce compeon among financial instuons, if those New mechanisms must be designed to curb with high risks increase their rates to hide the present oulow of human and financial operaonal losses. Nevertheless, liberal- resources from poverty-stricken areas. Such izing interest rates is a necessity, and it mechanisms should enable RCCs to make must be done in tandem with the opening profits on loans to rural households and to of markets. Suppliers will not enter the

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market without adequate interest rates, early stages, provincial pilots of regulated and compeon among market players microfinance agencies that do not accept will decrease rates only if interest rates deposits might be considered. Such are sufficient to cover costs and risk. This instuons can avoid the potenal moral is what happened in Bolivia, for example. hazard of taking public deposits without When interest rates were first liberalized, prudenal financial supervision. This the rates climbed rapidly, but they soon differs from accepng deposits backed were pushed down to a reasonable level by implicit state guarantees against loan by compeon in the microfinance mar- losses, which can lead to moral hazard. ket. This compeve equilibrium of inter- Such instuons can inially use their est rates cannot be achieved in the PRC, own funds and funds donated by inter- where many counes have only one RCC. naonal organizaons. At a later stage, funds from wholesale instuons such Along with interest rate liberalizaon, rural as the Postal Savings Bank of China can financial reform must introduce new types serve as a major revenue source. Ul- of financial instuons and explore new mately, the development of regulated forms of financial organizaon. The PRC MFIs not only can introduce compeon should consider regulated and commer- in the rural financial market but also can cially oriented MFIs (engaging in lending play an important role in legalizing infor- only and inially prohibited from taking mal finance. deposits), village-based cooperave associaons, privately owned banks, and informal Reform also should implement market- finance providers. Opons for organizing based RCC pilot programs. According to RCCs should not be restricted to the types the theory of financial hierarchy, financial spulated in the State Council’s 2003 Pro- instuons have various advantages and gram on Deepening Pilot RCC Reform. The disadvantages, and the market should key to the success of an RCC is its suitability select the survivors. In the PRC, coop- to the local market and its ability to create erave finance is not truly cooperave financial innovaons. Community-based because it has to address policy, but nei- financial instuons with good governance ther cooperave nor commercial finance structures will help serve the local econ- can be sustained if government intervenes. omy, including sannong. Therefore, each The government should not preempvely area should be permied to develop new prohibit any form of financial instuon; forms of financial instuon and to let the the market and investors should have the markets decide the winners. final say. To achieve this, policy makers must decide whether it is possible to allow Community-based financial some RCCs to remain independent of a county RCC union, whether it is possible institutions with good governance to allow two RCC unions in one county, structures will help serve the local and whether it is possible to allow some county RCC unions to stay out of a provin- economy, including sannong cial RCC union.

In the near term, possibilies for promot- Establishment of interregional RCCs also ing compeon in rural financial markets should be allowed. Intervenon in RCC (in addion to reform of exisng RCCs) operaons mostly comes from local gov- include pilot tesng of regulated micro- ernments, especially county and township finance and cooperave finance and the governments. Establishing interregional legalizaon of informal finance. In the RCCs would avoid the current overlap of

164 POLICY RECOMMENDATIONS administrave and business regions. One covered by central government funds; RCC could cover several townships and, the rest must be covered by RCCs and if needed, an RCC union could cover a local governments. In addion, policy and number of counes. The number of town- system changes and polical intervenons ships and counes covered by each local resulted in about CNY2 billion worth of RCC or RCC union may not be large, but nonperforming loans. For instance, when there should be no fewer than three. It is RCC management was transferred from highly possible for two county and town- the ABC in 1999, a large volume of non- ship governments to collaborate in seek- performing loans also was transferred. The ing rent from RCCs, for instance, but the RCCs also suffered huge losses when the possibilies for collusion are much lower central government forced the closure of if three or more townships and counes five types of small enterprises and when are involved. This is in line with the PBC’s the central bank required indexed loans as strategy of establishing interprovincial a guard against inflaon. regional centers to prevent local government interference. It is impossible to resolve all of the RCCs’ historical problems in the short term, and Moreover, profitable RCCs should be RCC development must therefore follow allowed discreon about whether to join a progressive, long-term course. Many an RCC union or to remain independent. RCCs are unable to make ends meet but Under the present pilot program, RCCs cannot be closed, and they are unable to have no choice but to join the RCC union resolve these issues by themselves. Among system, which prevents any external 959 grassroots RCCs in Guizhou, 514 have compeon. This has essenally led to deposits of less than CNY2 million per monopolies, the natural enemy of innova- RCC employee and 234 have deposits of on. Allowing profitable RCCs to decide less than CNY1 million per RCC employee. on this queson will enable a compeve Most of these RCCs are in remote areas environment, resolve the problem of and must cover extensive service areas exit mechanisms, and subject RCCs to despite difficult transport condions and market discipline. poor operang environments. Although current policies permit mergers and clo- Reform should seek to create an enabling sures, such acon would create a vacuum environment for the sustainable develop- in financial services for sannong that is ment of RCCs. Most areas in Guizhou, for unimaginable for both the farmers and instance, are underdeveloped. Although the government. Party commiees and reforms and the central government governments at all levels have made great policies that support them have helped efforts to boost RCC development in to enhance agriculture support, RCCs in Guizhou and to smooth the implemen- the province sll face a parcular set of taon of pilot programs. However, the difficules due to weak agriculture infra- provincial government cannot solve the structure and a large, poverty-stricken fundamental problems faced by RCCs. populaon. Other difficules include heavy historical burdens and the lack of RCCs in the western regions differ exit mechanisms. from their eastern counterparts By the end of 2003, the cumulave in size, nonperforming loan rates, losses of all RCCs in Guizhou Province had reached CNY1.45 billion. About 50% operating environment, and of the amount, or CNY719 million, was sustainability

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RCCs in the western regions differ from infrastructure, educaon, and health their eastern counterparts in size, nonper- care. Regulaons are needed to enable forming loan rates, operang environment, RCCs to conduct commercial operaons, and sustainability. Although pilot program to penalize debt evasion, and to estab- policy takes into account local economic, lish standards for the creditworthiness geographic, and social condions, actual of households, villages, and townships. implementaon shows that RCCs in the For example, if the repayment rate of a western regions have not benefited much. village as a whole is more than 95%, the In addion, with the excepon of some village can be qualified as a creditworthy insignificant preferenal tax rates and village, eligible for lower interest rates policy fund selecons, most support poli- on PBC-supported microfinance loans. cies are uniform. Or an RCC may choose to let the village rate the households of the village, which In the end, the resoluon of RCC issues will enable those households to get loans in Guizhou depends on development of more easily. In pracce, RCC lending limits the local economy and the deepening of are determined by the limit of their own reform efforts, parcularly the transfor- deposits and by PBC onlending, and only maon of operang mechanisms and the a good credit environment can aract improvement of RCC instuonal capacity. more external funds. In the short term, however, the central government must introduce addional In addion, instead of using poverty supporng policies and measures. These alleviaon funds for interest-subsidized can include, among other things, prolong- loans, the government should distribute ing the corporate income tax exempon subsidies directly to households or create period, suspending business taxes, and a risk-sharing fund to migate some establishing an RCC development fund RCC financial risks. This would leverage to build an electronic network and train fiscal funds and strengthen financial employees. Other elements of an enabling and risk awareness in rural households. environment include agriculture insurance Many rural households regard inter- and an agriculture futures market, innova- est-subsidized poverty loans as aid that on in rural financial instuons, and does not need to be repaid, and this has collateral and guaranty substutes for distorted the market. Financial aware- rural households and small and medium- ness can only be strengthened when the sized enterprises. poverty alleviaon loan is renamed, when there are no preferenal interest rates, The central government also can encour- and when premiums are based on credit- age reform by creang an environment worthiness. Rural households will acquire that will aract external funds to poverty- risk awareness when families with high stricken areas. This requires improved credit rangs are able to borrow at low interest rates whereas families with poor The establishment of a risk-sharing rangs pay more and have lile bargain- ing power. This does not mean that subsi- fund also can help maintain order dies will be completely abolished; direct in financial markets by enabling fiscal subsidies sll can be provided to destute rural households. The only dif- financial institutions to assess ference is that support comes in the form market-based interest rates in a of government fiscal aid rather than loans safe manner from financial instuons.

166 POLICY RECOMMENDATIONS

The establishment of a risk-sharing fund direcves. Nevertheless, in the near also can help maintain order in financial future, postal savings can be pumped back markets by enabling financial instuons into rural areas, and rural financial inputs to assess market-based interest rates in a through the Agricultural Development safe manner. This will prevent potenally Bank of China (ADBC) can be increased. destrucve compeon among financial In the absense of an open rural financial instuons that use interest-subsidized market, however, keeping postal savings funds to invest in commercial projects. For where it originates will only strengthen the example, ABC branches in some areas have monopoly status of RCCs and will present a used poverty alleviaon loans to compete significant moral dilemma. with other commercial banks on small hydropower and road construcon projects, In addion, in the absence of a deposit thus distorng the markets. In the future, insurance system, the inflow of postal therefore, interest-subsidized loans should savings to rural areas through RCCs sll be abolished and loans should carry only presents an asymmetric risk: the borrower normal interest rates aligned with risk and is the provincial RCC union but the actual creditworthiness. Such measures will help user is the county RCC union. Therefore, keep the financial markets in order. More- liberalizaon of the rural financial markets over, preferenal tax rates can reduce the must be integrated with a market-based operang costs of financial instuons and mechanism to aract addional postal encourage them to set up more outlets in savings back to rural areas. Moreover, poverty-stricken areas. internal ADBC control mechanisms should be improved and operaonal transparency As has been noted, rural areas suffer should be enhanced so that the opera- from large fund oulows. Many state- onal scope of ADBC can be expanded owned financial instuons take deposits according to its capability. without making loans in these areas, and postal savings outlets have extracted More research is needed to large volumes of funds from rural areas by redeposing those funds in the PBC. determine the appropriate community Such oulows over a long period inevi- reinvestment model for the PRC, and tably hamper the growth of the rural economy. The PRC should learn from more time is needed to formulate internaonal experience and promul- regulations or directives gate laws and regulaons on community reinvestment. For instance, community Sustainable reform also will require sepa- reinvestment law in the United States raon of regulaon from management requires financial instuons to meet the and the implementaon of minimum credit demands of their communies if regulatory requirements. The current those demands are based on sound and financial supervision system in the PRC is prudenal criteria, though no compulsory an integral part of the tradional govern- rao is specified. Thailand requires all ment administraon system, and adminis- financial instuons to lend to the agri- trave intervenon or micromanagement culture sector 20% of all deposits. is the main means of supervision. Fina ncial supervisors uphold market entry More research is needed to determine criteria through administrave approval, the appropriate community reinvest- especially for private financial instu- ment model for the PRC, and more me ons, and thus direct the lending of finan- is needed to formulate regulaons or cial instuons. Their supervisory goal

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is to reduce nonperforming loans, not to other performance indicators are beyond safeguard the soundness of the financial certain predetermined thresholds. These system, and they apply uniform supervi- acons may prevent managers from tak- sory standards to all financial instuons. ing more operaonal risks or engaging in These pracces, combined with limited other acvies that endanger shareholder supervisory capacity, have limited the interests. If performance indicators reach diversificaon of financial instuons. a second predetermined threshold, the regulator may request an acquision or Therefore, the success of RCC pilot pro- merger of the financial instuon to maxi- grams also depends on the reform of the mize its value and protect the interest of means and focus of supervision. First, shareholders. If performance connues a firewall should be erected between to deteriorate, the regulator should have regulaon and management. This can the authority to close the instuon while prevent both excessive supervision and its assets sll are at least equivalent to moral hazard in RCC operaons. Second, its liabilies. minimum regulatory requirements should be implemented, although a rigid super- It also is necessary to establish a mely visory framework may suffocate financial and effecve exit mechanism under which innovaons, parcularly in transional small and medium-sized depositors can economies. The main objecve of super- be properly protected and compensated visory authories is to prevent financial in case of instuonal failure. Therefore, risks while avoiding rigidity in supervision. the PRC should establish a deposit insur- Minimum regulatory requirements can ance system as soon as possible. While ensure basic financial safety while leaving opening rural financial markets, regula- room for financial innovaon. tors should take measures to strengthen regulaons in accordance with the devel- An effective supervisory mechanism opment of rural financial instuons. Meanwhile, a deposit insurance system should comprise a positive incentive can help ensure the effecve operaon of mechanism that enables prompt the rural financial markets. corrective actions The results of any reform will vary according to region and the external environ- Supervision of RCCs is relavely difficult ment; this is parcularly true of finance because RCCs normally are geographically sector reform. An evaluaon system scaered, making informaon collec- can alleviate risks in reform, summarize on more expensive. To ensure effecve experience, and improve future reforms. supervision, it is imperave to strengthen Among other things, the evaluaon of the governance structures of rural finan- RCC reform should address the sustain- cial instuons and to improve their ability of RCCs, the compability of the operaonal transparency. An effecve rural financial system with the local supervisory mechanism should comprise a economy, and the post-reform capacity posive incenve mechanism that enables for financial innovaon. prompt correcve acons. Under such a system, the regulator should have authority to take acons such as restricng a Microfinance financial instuon’s business scope and dividend distribuon if the instuon’s Microcredit is an important means capital adequacy rao, leverage rao, or of poverty reducon. It can improve

168 POLICY RECOMMENDATIONS

financial services for low-income popula- to donor agencies, thereby mobilizing ons and microenterprises and promote more resources to serve the poor. the low-end financial market. Sustainable microcredit can contribute to sustain- At present, it is unlikely that nongovern- able poverty alleviaon by helping more ment MFIs can be transformed into com- poor people and small enterprises act pletely independent instuons, mainly on their investment opportunies. This because of unclear fund ownership. These will create more employment opportuni- instuons actually are controlled by local es, increase incomes, improve income governments—their staff is government distribuon among different regions, and staff and the board is unable to play its promote the establishment of a harmoni- role. Though local government can be ous socialist society. integral to improved supervision of nongovernment MFIs, it should provide more Microfinance development in the PRC support and less interference and should calls for a holisc development plan. Cur- facilitate the instuons’ independent rently, the most important requirement operaon. Moreover, local governments is innovaon, not imitaon. The PRC should assist these instuons in clarifying needs innovave instuons, microcredit their fund ownership. loans and other financial instruments, microcredit service systems, and related Microfinance development in the policies. Material progress in financial sustainability requires supporng and PRC calls for a holistic develop- improving exisng nongovernment MFIs. ment plan More private capital must be legally invested in financial services for low- The associaons, networks, and other income populaons, small enterprises, intermediaries of nongovernment MFIs and microenterprises, to create more targeng poverty alleviaon also can play employment opportunies. In addion, a bigger role. They can help MFIs develop more commercial banks, especially urban informaon management systems, achieve commercial banks and RCCs, must decen- accounng transparency, promote microfi- tralize their financial services and acvely nance loans and other financial products, develop financially sustainable microfi- contact domesc and internaonal donor nance products and services. agencies, and obtain funding and other support. Moreover, they can help govern- Nongovernment Microfinance ment agencies and donors establish a Institutions wholesale fund for MFIs and strive for legal status for MFIs. The central government Exisng nongovernment MFIs target- might consider changing the legal status ing poverty alleviaon should first res- of nongovernment MFIs targeng poverty cue themselves by improving corporate alleviaon so that they can provide loans governance and management, upgrading and other financial services to the poor informaon management systems, and and to microenterprises. increasing the transparency of financial statements, loans, and business develop- Pilot Microcredit Companies ment. In addion, MFIs should connue to improve their microcredit products Commercialized microcredit companies and services to adapt to changing circum- are important for the sustainable devel- stances. Nongovernment MFIs also need opment of microcredit in the PRC. Estab- to promote themselves to the public and lishing and developing commercialized

169 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

microcredit companies can increase loans macroeconomic management polices may and other financial services to low-income lead to ght credit, which turns some ins- populaons and enterprises, promote tuons away from microcredit. This can be compeon in rural financial markets, remedied by providing necessary technical facilitate the reform of RCCs and commer- assistance and training, helping micro- cial banks, and pave the way for entry of credit companies realize that there is profit private funds into the financial market. potenal in issuing microloans to sannong and microenterprises. Microcredit According to circulars issued by the central companies also can be encouraged to government, one important need of micro- target some urban enterprises and microcredit companies is to fend off finan- enterprises as well as diverse industries cial risk. Rural cooperave foundaons to migate financial risks. Finally, helping have demonstrated the need to prevent well-run microcredit companies access deposit-taking or implicit deposit-taking addional funds through wholesale fund and illegal fund-raising. Presently, there and onlending will encourage microcredit is no systemic risk if microcredit com- and agriculture loans and can serve as an panies do not raise public funds or take example for MFIs. deposits. Therefore, non-deposit-taking microcredit companies may require only a Microcredit companies also should be supervisory authority and uniform report- required to meet certain expectaons. For ing requirements for monitoring purposes. example, support of sannong and micro- Companies involved in illegal fund-raising enterprises and the fulfillment of certain and deposit taking should be banned to condions might make them eligible to pro- maintain financial stability, safeguard the vide other financial products and services, interests of other microcredit companies, including deposit taking. Ulmately, they and ensure the success of microcredit might be transformed into banks for the pilot programs. In addion to strengthen- poor, serving mainly low-income borrowers, ing supervision, supporng microcredit microenterprises, and small enterprises. companies with wholesale and subsequent funding also helps to prevent illegal fund- Restricng a pilot project to a single raising and deposit taking. Well-run micro- county does not encourage sustainable credit companies should be given access to development of microcredit. Instead, this wholesale funding with which to provide may push privately owned microcredit credit services to microenterprises, small companies to provide only large loans. enterprises, and low-income populaons. Moreover, the one-province, one-county, one-pilot model does not encourage com- Microcredit companies also can be peon and comparison among different instuons, prevenng the gathering of encouraged to target some urban valuable lessons from the pilots. Thus, enterprises and microenterprises as pilot projects should be expanded to larger well as diverse industries to mitigate geographic areas. financial risks The other noteworthy issue is MFI financing. At the early stage of development, Microenterprises, small enterprises, and equity investment is the main form of some medium-sized enterprises have MFI financing. With the development of difficulty accessing loans because private microfinance, commercial loans and other funds are profit driven and may be myopic financing instruments can be adopted as at mes, and because the government’s complements to equity financing, and

170 POLICY RECOMMENDATIONS eventually deposits might become an structure and should be encouraged to important source of funding. This, however, experiment with financial innovaon. requires interest rate liberalizaon and pru- The Postal Savings Bank of China should denal regulaon of deposit-taking MFIs. promote microcredit products and develop collateralized guaranty and credit ser- At present, there are two main kinds vices for the low-income populaon and of investors in commercial microcredit microenterprises. The queson is whether instuons: commercially oriented local postal savings outlets can be transformed investors, who treat microfinance as a into a financial instuon capable of issu- profitable opportunity, and internaonal ing microcredit loans. investors specializing in microfinance. These may be donors, foundaons, or During the process of shi ing products and social investment funds of the type that services to rural areas, aenon should be played an important role in the develop- paid to avoiding past mistakes in the PRC ment of microfinance in the former Soviet and other developing countries. Encour- Union and other Eastern European coun- aging low-interest subsidized loans to tries. So far, these two kinds of investors farmers o en has failed to reach targeted have invested a total of nearly CNY7 billion clients, creang unsustainable MFIs. in microcredit, and they are looking for new investment opportunies. Non-Deposit-Taking Microcredit Companies and a Supervisory To help MFIs access bank loans, the Legal System government may consider requiring commercial banks to dedicate a certain level The following policy recommendaons of their loan porolios to MFI financing. are based on internaonal experience and This has been done in Brazil, India, Nepal, the principles guiding the development of Thailand, and the United States. Neverthe- microcredit companies in the PBC. Briefly less, if MFIs show poor profitability, such stated, microcredit companies are non- requirements cannot help either. In any deposit-taking and microcredit lending– case, refinancing should be based on effi- only nonbanking financial instuons, the ciency, and rangs can be used to enhance supervision of which is intended mainly to MFIs’ financial transparency. prevent illegal deposit taking. Microcredit companies should engage in market-based Shifting Financial Products and commercial operaons, increase their Services to Rural Areas presence in the rural financial market, and improve microcredit coverage. Moving the financial products and services of exisng financial instuons New Microcredit Companies and the Market may be a shortcut to creang large-scale, sustainable microcredit in rural areas. At Microcredit companies do not take present, urban commercial banks, espe- deposits but only grant loans and may cially those with a sound governance and target either rural or urban areas. Their management structure, should focus on most suitable legal form is the limited cies. The key is to provide incenves liability company, which can ensure clear for urban commercial banks to conduct microcredit operaons. The key is to provide incentives for Postal savings outlets should improve urban commercial banks to conduct their instuonal capacity and governance microcredit operations

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ownership and sound governance. Micro- nance market is training, and instuons credit techniques are effecve poverty should be set up to provide standardized alleviaon tools for farmers and micro- external training. At the same me, MFIs enterprises, and experience shows that should be encouraged to set up networks. if microcredit procedures are simple and Formal microcredit associaons should be speedy, and the loans can be repeated, established only when there are a sub- the poor are willing and able to pay a stanal number of sustainable MFIs, and market interest rate. wholesale funds should be provided by banks instead of by microfinance associa- The main funding source of microcredit ons. There should be further discussion companies should be direct invest- about the establishment of new whole- ment, including donaons. To aract sale banks, the possibility of using exist- more donor agencies and private inves- ing banks to provide wholesale funds for tors, 100% foreign ownership should be microcredit companies, and the possibil- allowed. The other capital source is third- ity of establishing microfinance guaranty party debt (except that of microcredit agencies. companies and their borrowers). Govern- ment and PBC funds, including postal sav- There are two possible ways to estab- ings funds, can be onlent through profes- lish a microfinance supervisory agency. sional wholesale financial instuons; The first is to let the present supervisory meanwhile, direct lending to microcredit authority assume the duty. Although the companies should be avoided. China Banking Regulatory Commission supervises commercial banks, it is not Supervisory and Microfinance-Supporting clear whether it is suitable for supervis- Institutions ing microcredit companies. Moreover, deposit-taking financial instuons that Although microcredit companies are need prudenal supervision should be lending-only nonbank financial instu- treated differently from MFIs. The sec- ons, registraon and supervision sll are ond opon is to establish a new supervi- required to prevent illegal deposit tak- sory agency for microcredit companies. ing and fund-raising and to ensure that For instance, the Government of South the instuons are meeng their social Africa created the Microfinance Supervi- objecves and management standards. sion Bureau, and its board of directors New instuons comprising representa- includes representaves from the govern- ves from the China Banking Regulatory ment, clients, and credit agencies. Commission and the PBC can conduct such registraon and supervision. The legal framework of microcredit companies is one of the key microcredit Similarly, microfinance-supporng ins- issues in the PRC, and a certain number tuons can play an important role in the of supporng instuons should play a development of the microfinance indus- large role in the whole strategy. The most try. The key to developing the microfi- important supporng instuons include training instuons, microfinance associaons (established a er microfinance The main funding source of reaches a certain stage of development), microcredit companies should wholesale banks targeng microcredit, be direct investment, including credit bureaus, rang agencies, and consulng firms providing service for business donations development.

172 POLICY RECOMMENDATIONS

There are three important kinds of Policy Environment microcredit-supporng agencies. First, training agencies with well-trained staff The PRC must establish a new nonpru- are a precondion for improving micro- denal supervision mechanism and must finance industry in any country. Such parally liberalize the lending rate (to agencies can realize economies of scale eight mes the PBC’s base rate). The new through dense and low-cost courses, on- laws should be consistent with exisng site surveys, and so ware development. In laws and regulaons but should clarify addion, they can undertake to cerfy the whether microcredit is a financial product qualificaons of microcredit companies’ as specified in the commercial banking managerial staff as part of the process of laws. If so, exisng regulaons should be microcredit development. amended or explanatory notes should be issued to account for microcredit compa- Second, microcredit associaons can play nies. Such laws need not contain detailed several roles. Under exisng condions, specificaons for microcredit supervision their main roles are to regulate the con- but they do need to elucidate supervisory duct of microcredit companies, promote means. Detailed implementaon regu- successful microcredit companies, and laons must include entry criteria and collect and analyze loan coverage raos details about MFI operaons and exisng and other member financial informaon. mechanisms. At the same me, microcredit associaons can study the supply and demand At present, the PRC is more concerned of the microcredit market, contact the with the nonprudenal than the pruden- main equity investors within the industry, al supervision of microcredit companies. including government, and lobby relevant The main goal of reform is to encourage individuals and organizaons. Such asso- microcredit companies to provide loans ciaons have performed well in Benin, to low-income populaons at market Bolivia, Ethiopia, and Uganda. To prevent interest rates while protecng clients’ conflicts of interest, wholesale instuons interests. Only registered microcredit should not play roles in associaons. companies should be allowed to charge higher lending rates, and this will push Finally, wholesale instuons can direct MFIs to register as formal microcredit funds into microcredit. Banks are the companies. Market-rate lending by unreg- best candidates for such fund direcon istered microcredit companies should because they not only can channel funds be banned, a pracce which has shown to microcredit companies but also can good results in South Africa. Microcredit fend off local government intervenon. loans are not subsidized or subject to Meanwhile, they can help microcredit companies create procedures to access donaons. The PSBC should not use postal Banks are the best candidates savings funds to provide microcredit for such fund direction because loans directly; instead, wholesale funds should be established to provide MFIs with they not only can channel funds performance-based funding, although the to microcredit companies but also establishment of such wholesale instu- can fend off local government ons is excessive when there are relavely few MFIs. intervention

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outside intervenon, and RCCs with low- Interest rate liberalizaon for microcredit cost funding and the potenal for moral companies will promote microcredit but hazard should not charge the liberalized will also create a large spread between lending rate. Commercial banks and RCCs banks’ low deposit rate and microcredit should be allowed to conduct market- companies’ lending rate. Therefore, MFIs based microcredit operaons only when will have a strong incenve to take illegal microcredit companies are in fair shape deposits. The promulgaon of bylaws, and external condions are mature. random audits, free hotlines, informaon disseminaon, and the like can be Risks and Other Issues employed to prevent this. One effecve mechanism is to cancel all loan contracts Tradional microfinance is not suitable if a microcredit company is found to for long-term agriculture loans or serving be taking deposits, which would elimi- the poorest populaons. Though it is an nate the incenve of MFIs to take illegal effecve instrument for microenterprises deposits. and poor farmers, it is not a panacea. Long-term agriculture loans support Order and Steps in Opening the Market policy lending, insurance, and rural infrastructure construcon, and support A er 16 years of uncoordinated micro- for the destute should follow the same credit pilot projects, the PRC needs a raonale. Destute people need aid that guided and ordered market opening, is not affected by high interest rates, which requires coordinaon among all rather than credit, and microfinance government agencies, clear midterm does not need much public aenon policy targets, and a legal framework to or public funding. Microcredit is usually ensure investor confidence in microcredit used for short-term loans with high companies. A proper operang model returns, and internaonal experience should be led by a powerful government proves that compeon and economies agency with the close cooperaon of of scale will reduce the interest rate. financial supervisory authories, relevant However, the development of long-term ministries, operaonal instuons, and agriculture loans requires a comprehen- donors, which will enable the clarificaon sive agriculture-supporng system, not of regulatory frameworks and market simply low-interest microcredit. Micro- entry criteria. Moreover, priority should be credit companies can be allowed to grant given to the formaon of necessary micro- agriculture loans, but this is not the main credit-supporng instuons, business of microcredit companies. especially training agencies, which may take a relavely long me.

A proper operating model should To obtain ﬁrsthand informaon and be led by a powerful government necessary experience, inial pilots should include minimal restricons. Microcredit agency with the close cooperation pilots can be created in several provinces, of financial supervisory authorities, including at least one province each from the eastern, middle, and western regions. relevant ministries, operational In the past, hundreds of pilots have been institutions, and donors, which will supported, but given limited funding and enable the clarification of regulatory thus limited scale, they have been unsuccessful. Small-scale pilots also can lead frameworks and market entry criteria to the mispercepon that the central

174 POLICY RECOMMENDATIONS government does not strongly support Postal Service Bank of ChinaÊs the microcredit industry, which discour- Microcredit Project ages internaonal donor agencies. Only relavely large-scale pilots can keep the Since the transformaon from China Post cost of a new supervisory framework to the PSBC, the biggest problem facing relavely low. Moreover, large-scale the PSBC has been inadequate lending pilots must adhere to a market orienta- capacity. A key issue is the safety of the on and microcredit companies should microcredit funds, which requires sound not be arficially selected. All applicants instuonal arrangements and experse that meet the registraon requirements in microcredit. Therefore, the first step should be allowed to become microcredit in any microcredit pilot is staff training. companies. Moreover, success requires strong leaders with a full understanding of the signifi- Pilots must include me-limited evalua- cance of microcredit programs, and pilot on indicators and systems. Nongovern- counes should evaluate potenal lead- ment microcredit company pilots have ers’ understanding of microcredit been underway for more than 10 years, and primary implementaon plans. yet no conclusions have been drawn Ulmately, the experience gained from because there were no clear targets and pilot programs should be popularized in no common evaluaon indicators. Taking other areas. a cue from internaonal best pracces, the PRC should form clear evaluaon The PSBC could make wholesale standards, regulate intermediaries, and establish a corresponding evaluaon loans to the ABC, the RCCs, or system in a mely manner. Only then can through the money market pilot programs be evaluated fairly and expanded properly. Regulatory authories should allow the PSBC to expand the scope of its capital Moreover, microcredit companies must ulizaon, gradually and according to its be integrated into the financial system risk-control capacity, while maintaining and the transformaon of microcredit appropriate restricons on the selecon of companies into banking instuons fund recipients. The PSBC also should put should adhere to some basic principles. in place a risk-prevenon mechanism to Before taking deposits, for instance, strengthen internal control. microcredit companies should have a clear ownership structure, a proper Feasibility of the Postal Savings Bank of match between ownership and rights, China as a Wholesale Lender and private capital parcipaon, bearing in mind that only industries and instu- There are many ways by which the PSBC ons with compeve returns aract may transform itself from a pure savings private capital. Moreover, regulatory bank into a bank with a comprehensive agencies can establish a microcredit business line. One opon is to become a registraon system and informaon can wholesale lending instuon. This opon be shared among microcredit companies. is not without risks, and the key is the This will enable lower-income borrowers selecon of loan recipients. The PSBC to enter the credit system and establish a could make wholesale loans to the ABC, credit record, which will help microcredit the RCCs, or through the money mar- companies manage risks and nurture ket. For instance, as the ABC’s funding credit awareness among borrowers. source shi s from central bank lending to

175 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

market financing, the PSBC might provide to them. The PRC has no rang agencies a certain percentage of these fund at an evaluang and publicizing the perfor- interest rate determined by the bond mance of MFIs, nor do any companies interest rate. Because there is excess specialize in offering consulng or training liquidity at the current stage, however, it to MFIs. Moreover, no registered MFI asso- is unlikely that the PSBC can make a profit ciaons or agencies lend funds to MFIs on by lending to the ABC at such a rate. To a wholesale basis. succeed in RCC lending, the PSBC must effecvely control risks and determine The PSBC might engage in wholesale loans an appropriate lending rate by rang the to microcredit companies iniated by the performance of RCCs in different regions. PBC, which has acvely advocated micro- Finally, the PSBC might offer wholesale credit and has promoted the establishment loans through the money market, though of lending-only microcredit companies. Pilot the demand for capital is o en tempo- microcredit companies build on nongov- rary, unstable, and prone to trigger capi- ernment MFIs and other projects, though tal oulow from rural areas. this iniave has only just begun and few companies have been founded. When pro- The PSBC will face substantial risk viding wholesale loans to such instuons, therefore, the PSBC must exercise careful in the wholesale loan business until risk control. The PSBC also may consider there is a stock of healthy small and making wholesale loans to village banks.

medium-sized financial institutions Because the rural financial market must be and competent rating agencies opened up gradually, it will take some me to establish a large number of sustainable PSBC wholesale lending to nongovernment rural financial instuons. The PSBC will organizaons registered as microfinance face substanal risk in the wholesale loan instuons also is a possibility. To date, business unl there is a stock of healthy there are around 300 MFIs in the PRC, small and medium-sized financial instu- with the large ones covering 5,000 house- ons and competent rang agencies. holds and the small ones covering about 1,000 households. Fewer than one-fi h of Feasibility of Direct Postal Savings Bank of these MFIs break even, and only a small China Microloans fracon achieve operaonal sustainability in which interest and other income covers At present, the two outstanding problems operaonal costs, even excluding nonper- in the rural financial market are monopoly forming loan losses and accounng for the and the oulow of large quanes of rural subsidized cost of assets. The number of capital. In recent years, the major channel MFIs that can achieve financial sustainabil- of capital oulow has been postal savings ity is even more marginal. Without external offices at the county level and below. PSBC capital support or radical reform, therefore, microcredit loans in rural areas not only most nongovernment MFIs and projects will would be conducive to the creaon of a be in serious trouble or even face bank- compeve rural financial market but also ruptcy within the next 3 to 4 years. would help address the issue of capital oulow and make loans accessible to indi- Unfortunately, because intermediaries vidual farmers and microenterprises. are less developed, it is difficult for the PSBC to assess the performance of non- The PSBC has unique and huge potenal government MFIs in order to lend money advantages that could help it become a

176 POLICY RECOMMENDATIONS major player in the direct lending busi- there is a shortage of credit officers and ness in rural areas of the PRC, espe- managers, and proper risk-control mecha- cially in providing microloans to micro- nisms are not in place. enterprises, individual farmers, and h ouseholds. These advantages include Selection of Postal Savings Bank of China a massive database of savings accounts Business Models from which historical savings trends can be traced. A broad postal informaon The transformaon of the PSBC will be an system and wide service coverage give arduous task, and a long-term develop- the PSBC a good public image and strong ment plan is needed. Most importantly, reputaon, and mail carriers can access the PSBC should fully capitalize on its potenal microcredit clients at a very low networking advantage. The PSBC has cost. In addion, the PSBC has a broad- been providing savings services through based sales network, an effecve opera- 35,000 outlets and payment and remit- onal plaorm, and an interconnected tance services through 48,000 outlets. It informaon management system. has a market share of 10% of residenal savings and 25% of agency insurance sales The PSBC must effecvely ulize such by banks. Nearly 25% of pension payments comparave advantages to create a com- and 10% of salary payments are made mercially viable and financially sustainable through the PSBC’s remiance system. instuon capable of successfully providing direct loans. Through full use of historical In the short term, the PSBC can diversify savings account informaon, daily access to risks and improve efficiency by diversify- tens of thousands of rural residents, a thor- ing its products. One possible opon is to ough understanding of condions in rural become a wholesale lender. The key issues areas, and other advantages, the PSBC can in this approach include the selecon of tailor loan products to client demand. appropriate borrowers and the purchase of bonds, which may lead to fund oulow. At the same me, the PSBC has some dis- The second opon is to disburse loans advantages. First, the PSBC’s clients include directly through postal savings offices, salaried workers, rerees, students, which will have a posive long-term effect journalists, frequent travelers, and small on rural finance. This opon carries the enterprise owners. Of these, however, lowest risk, but in order to accomplish it, only small enterprise owners can become the PSBC must upgrade its training and microloan clients. Second, the PSBC’s improve its client management system. informaon management and account- Moreover, the PSBC should establish a risk- ing systems are centralized in provincial control mechanism and develop products centers, but client informaon in these sys- based on local condions. Such tasks can- tems is not interoperable and informaon not be achieved quickly, and thus long- management needs improvement. Finally, term plans are needed.

177 CHAPTER 11 Opening the Rural Financial Market and Piloting New Rural Financial Institutions

It has been over a decade since the promulgaon of the State Council’s 1996 Decision on Rural Financial System Reform. The reform of rural finance has included the separaon of commercial banking from policy banking since 1996 and a new round of pilot rural credit cooperave (RCC) programs, beginning in 2003. In that me, the objecve of rural financial reform has become beer defined: to create a modern, commercially viable rural financial system that meets the needs of agriculture, rural areas, and farmers (sannong) as well as small and medium-sized enterprises.

Rural financial reform is a systemic program, and it cannot succeed if it depends only on RCC reform. Rather, achieving commercial sustainability and effecvely sasfying rural financial demand requires diversificaon. Market compeon is necessary not only to improve the governance structure of RCCs but also to enable effecve supervision. More- over, diversified rural financial demand requires various types of rural financial instuon, which makes it urgent to open the rural financial market.

The guiding principles of rural finance reform were established in several central government documents. The pilot microcredit companies guided by the People’s Bank of China (PBC) in 2005 and the 2007 China Banking Regulatory Commission regulaons governing the opening of the rural financial market were new iniaves. Recently, the China Bank- ing Regulatory Commission announced the naonwide expansion of the pilot programs. However, although the opening of the rural financial market can enhance the efficiency of financial instuons, it also can increase the possibility of their failure. The People’s Republic of China (PRC) learned bier lessons from the performance of rural cooperave foundaons, and the potenal risks of new types of rural financial instuons cannot be underesmated. The opening of the rural financial market is inevitable, but further

179 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

research is needed to discover the best salary apparently fails to provide senior way to establish a market that is eﬃcient, management with suﬃcient incenve to compeve, and sustainable. maintain good governance.

Second, reform efforts must refrain from Important Issues in Opening the mixing policy objecves with the means Rural Financial Market of achieving those objecves. The government’s objecves are to address the Opening the rural financial market is an issues of sannong and to increase farm- important part of opening the finance sec- ers’ incomes, and there are various ways tor to the domesc market, and it is just as to obtain these objecves, one of which important as the opening of the banking is to provide credit to farmers. However, sector a er 2001. Establishing an efficient requiring rural financial instuons to and compeve rural financial market issue credit to farmers as the major means requires the creaon of sound governance of obtaining policy objecves would con- structures, separaon of policy objec- strain rural financial instuons’ ability ves from reform methods, integraon of to maximize profits, would impair their informal finance, clarificaon of the rela- independence and efficiency, and would onship between new and exisng ins- provide an excuse for local governments to tuons, development of nondepository intervene directly in their operaons. lending instuons, and diverse methods of reform. Third, the rural financial system should integrate exisng informal financial systems. To Formal financial institutions carry some extent, formal and informal finance can substute for and supplement each strong fund capacity, sophisticated other, given their respecve comparave organizational structure, highly advantages. Formal financial instuons carry strong fund capacity, sophiscated qualified professionals, and strict organizaonal structure, highly qualified internal control procedures professionals, and strict internal control procedures. They have advantages in issu- First, opening the rural financial market ing large and long-term loans. Informal requires sound governance. Rural finan- financial instuons, on the other hand, cial operaons feature high cost, lack of benefit from their simple procedures, collateral, and high risks, and therefore flexibility, convenience, small scale, and differ from urban finance. Innovaon is informaon access and therefore are beer required to create sustainable rural finan- posioned to provide short-term and small cial instuons, and a sound governance loans. The two types of financial instuons structure is the basis of capacity for have different target clients and a reason- innovaon. At present, the weak gover- able division of labor. Thus, it is important nance of rural financial instuons is the to develop informal finance to meet diverse most fundamental reason for their losses. rural demands. The senior managers of newly established village and township banks are not The advantages of informal finance are on the payroll of these banks; instead, many. One advantage is in informaon they receive their salary from the parent access, which is reflected in the ability banks, and thus the new banks represent of informal finance to assess borrowers’ de facto branches of their parent banks. capacity to manage and repay loans. Due The decoupling of performance from to geographic, occupaonal, and kinship

180 OPENIING THE RURAL FINANCIAL MARKET AND PILOTING NEW RURAL FINANCIAL INSTITUTIONS connecons, lenders and borrowers in informaon advantage, requires more the informal credit market can maintain standardized management techniques frequent contact. This enables lenders to and operaonal mechanisms, and thus measure the probability of mely loan requires more qualified managers and repayment and to take acon accordingly. staff, all of which pushes up cost. More- over, because some informal financial Such localized guaranty arrangements also acvies are legally restricted or prohib- reduce the constraints on farmers and ited, operators must take regulatory risks small and medium-sized enterprises. Many into account. Finally, certain informal guaranes considered unacceptable in the financial acvies and forms are par- formal financial market, such as real estate cularly adaptable to some cultures and and livestock, can be accepted as collateral hence are more popular in some commu- in the informal financial market. Moreover, nies than in others. in addion to their creditor-debtor relaonship, lenders and borrowers conduct It is unwise to formalize informal finance. business together in other markets, such Rural lending shops, as a type of informal as the commodies market, a relaonship finance, used to be limited to members of which in turn can be included in lending a village or to producon and distribuon agreements. Such relaonships serve as cooperave organizaons, and credit risks an addional guaranty that borrowers will were reduced through informaon advan- correctly ulize the loans and repay them tage. Under the current system, however, on me, because delinquency may dam- market risks cannot be reduced and the age relaonships and incur losses that operaonal and supervision cost of formal offset the benefits of default. financial instuons is bound to outstrip the capabilies of grassroots finance. Another advantage of informal finance is Internaonally, therefore, small formal low transacon cost. The operaons are financial instuons such as rural lending simple, contracts are praccal, and parci- shops are rare. On the other hand, there pant qualificaon requirements are low. are quite a few successful internaonal Although the organizaon and operaon examples of cooperaon between formal of informal financial instuons consumes and informal finance. For instance, India’s me and energy, the opportunity cost in Naonal Bank for Agriculture and Rural less developed regions is low, which fur- Development established a microfinance ther reduces transacon cost. In addion, model that combines self-help groups with informal financial instuons are small formal finance. and apt to innovate based on actual situaons, which also reduces transacon cost. Rural lending shops, as a type We should note that these advantages are of informal finance, used to be relave and that the efficacy of informal limited to members of a village finance is limited to small-scale operaons, leading to disadvantages in economies or to production and distribution of scale. For instance, there is a trade-off cooperative organizations, and between the informaon advantage of informal finance and its acvies. In order credit risks were reduced through to access unique informaon, informal information advantage financial services must be limited to a certain scope and to a few people. The Fourth, an efficient and effecve rural expansion of financial acvies weakens financial market requires clarificaon

181 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

of the relaonship between new and holder rights, and ineffecve control of exisng instuons. Since 2003, the management. This is similar to state- reformed RCCs have been cooperaves in owned and township enterprises during legal form and operaonal approach but the early stage of their reform, when are oriented toward government policy. employee ownership was excessively County RCCs are managed by provin- emphasized. This situaon ulmately cial rural credit unions, and although required a second or even a third round RCC general managers decide on capital of reform. replenishment and investment, they are appointed by their administrave organs One trend in the reform of RCCs is to allow without shareholder input. Shareholder some shareholders to own controlling and supervisory board meengs have shares and to centralize responsibilies, become rubber stamps. Due to asymme- rights, and interests during management try between the rights and obligaons of selecon. Prevenng big shareholders from shareholders, shares have become me hollowing out RCCs, however, requires deposits and the primary goal of share- legislave oversight. In all, opening the rural holders is to obtain convenient borrowing financial market and restructuring RCCs and preferenal interest rates. Microlevel with private capital are crical for both rural RCC mechanisms such as incenves, financial reform and RCC reform. supervision, and market exit are much ignored. RCCs use their credit support of A fi h requirement for an efficient and sannong as an excuse, and moral hazard effecve rural financial market is the issues are not addressed. development of nondepository lending instuons. The PRC has many depository One trend in the reform of RCCs is rural financial instuons, including the RCCs, the Postal Savings Bank of China, to allow some shareholders to own the Agricultural Bank of China, and other controlling shares and to centralize state-owned commercial banks. At present, the Agricultural Bank of China, the responsibilities, rights, and interests Postal Savings Bank of China, and the during management selection RCCs have outlets at the county level or below. However, lending instuons are It is impossible to resolve rural financial not enough. Regulaons on lenders should service issues simply by establishing be promulgated, with emphasis given to new types of rural financial instuons nondepository lending instuons. without aending to the reform of RCCs. The ongoing RCC reform fails to draw on Internaonal experience clearly shows the experience gained from enterprise that equity financing is the major channel reform. The success of state-owned through which nondepository instuons enterprise reform is due to the close can be provided with sufficient funding dur- oversight of large state-owned enter- ing the early development of microfinance prises and the subjecng of smaller ones instuons. As microfinance instuons to market compeon; the success of grow, commercial lending and other debt township enterprises is due to reform of financing instruments can supplement the ownership structure, which allows equity financing. To help microfinance management to own a relave majority instuons access bank loans, commercial of shares. RCCs’ ownership structure, on banks can be required to dedicate a certain the other hand, is overly diversified and percentage of their lending to refinancing features high agency cost, weak share- microfinance instuons. However, this

182 OPENIING THE RURAL FINANCIAL MARKET AND PILOTING NEW RURAL FINANCIAL INSTITUTIONS method does not work in the case of a financial instuons and diversify risks, and weak microfinance instuon. Refinancing a compeve regulatory system should should be based on efficiency, and credit provide naonal and local supervision. rangs can be used to enhance the transparency of instuons’ performance. It is important to establish a layered supervisory system. Following the reform Ulmately, an efficient and compe- of state-owned enterprises, regulatory ve rural financial market depends on authories have become naonal supervi- diverse reform methods. Unl now, rural sors covering all types of financial instu- financial reform has employed monopo- ons in all regions. Centralized supervision lisc approaches and structures. Such is conducive to financial regulaon and an approach enables reforms to proceed is convenient when implemenng the with ease, but this convenience comes macroeconomic and financial policies of with a cost. For instance, in the absence of the central government, but it is difficult compeon it is difficult to evaluate the to adapt such supervision to the vary- advantages and disadvantages of various ing financial supply and demand across forms of financial instuon. The PRC is a regions. This is parcularly true when country with sharp regional differences, financial reform is sll in process and and without compeon we cannot be financial innovaons are sll emerging. sure which instuonal form is suitable to Centralized financial supervision does not any specific region—though dominaon lend itself to boom-up financial innova- by RCCs or village banks certainly is not an ons, and informaon asymmetry drives opmal arrangement. up the cost of supervision.

Regulatory authories prefer to distribute Additional Requirements supervisory funcons by seng up intermediary layers, such as provincial RCC The overall objecve of rural financial unions, and by constraining the scope of reform is to fundamentally change the way small and medium-sized financial ins- finance supports economic development tuons. However, this undermines the and to establish an independent, modern establishment of a comprehensive, com- rural financial system aligned with the peve financial market. In addion, the needs of the market economy and able primary objecve of financial supervision to grow with the rural economy. The new is to forestall systemic financial risks, but system should encourage the coexistence monopolized supervision may concentrate of various forms of financial instuon, the risks arising from certain regions or including informal and formal finance and certain financial instuons. privately owned and state-owned financial instuons of all sizes. The market should enable fair compeon among financial The market should enable fair instuons, and the market, rather than competition among financial government or supervisory authories, institutions, and the market, rather should decide which forms of financial instuons are suitable for which areas. Orderly than government or supervisory financial regulaon should enable various authorities, should decide which financial instuons to display their respecve advantages and instuonal innova- forms of financial institutions are ons. Financial intermediaries should serve suitable for which areas

183 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

It is necessary to explore a new super- The current financial supervisory system is visory approach, dividing supervision part of the tradional government system, among central and provincial authories in which the major means of supervision is to establish a diversified and mullayered administrave intervenon. Financial regu- financial system. Layered supervision is latory authories set arficially high crite- conducive to compeon among differ- ria for the market entry of private financial ent supervisors and thus creates a rela- instuons, consider nonperforming loan vely favorable supervisory environment. reducon rather than financial security Financial innovaons suitable for local to be the supervisory objecve, direct development also will diversify financial loans in the name of supervision, and risks and reduce systemic risks. For exam- apply uniform rather than differenated ple, state supervisory authories might criteria to different financial instuons. focus on large banks that operate naon- This supervisory capacity and approach wide whereas small and medium-sized largely affects the diversificaon of finan- banks might be subject to provincial level cial instuons, and the success of rural supervisors who can tailor regulaons to financial pilot programs therefore depends local condions. This approach takes into on supervisory reform. account regional differences while mobilizing the incenves and creavity of local To prevent moral hazard in RCC operaons governments and maintaining economies while also discouraging excessive supervi- of scale. Ulmately, this will create a sion, there must be a clear line between benign environment for the develop- supervision and market parcipaon and ment of small and medium-sized financial a firewall between supervision and man- instuons. agement. However, only minimal regulaon should be implemented; overly strict legislaon may stymie financial innovaon, Financial innovations suitable parcularly in transional economies. for local development also will Thus, the main objecve of regulatory authories should be to reduce financial diversify financial risks and reduce risks but to refrain from being too heavy- systemic risks handed. Financial innovaon must be given room to prosper. Moreover, it is important to disnguish supervision from management. The Finally, it is important to set up a market approval system for the establishment of exit mechanism. Given the difficules of financial instuons should be replaced regulang scaered rural financial instu- by a registraon system, and market exit ons and ascertaining the authencity of mechanisms should be reinforced. Inves- informaon, effecve supervision is only tors should be allowed to select appropri- feasible with an improved governance ate forms of financial instuons, whether structure and operaonal transparency this comprises informal, cooperave, among rural financial instuons, and an nondepository microcredit organizaons effecve regulatory mechanism must be or small and medium-sized banks. More- compable with incenves. For instance, over, different financial instuons should when an RCC’s capital adequacy rao or be subject to different supervisory require- other performance indicator exceeds a ments to avoid financial risk and to cre- specified threshold, supervisory authori- ate equilibrium between supervision and es should take prompt correcve acon diverse financial instuons. to restrict business development and

184 OPENIING THE RURAL FINANCIAL MARKET AND PILOTING NEW RURAL FINANCIAL INSTITUTIONS dividend payout, thereby constraining the when it breaks from provincial boundaries instuon. If performance deteriorates, and divides the country into several areas supervisory authories should call for covered by central branches. acquision or close down problem instuons while they are sll solvent. Such RCCs also should be given autonomy to authority requires an effecve market exit choose whether to join RCC unions. The mechanism, and the key to such a mecha- current reform scheme requires manda- nism is the protecon and compensaon tory associaon membership, removing of small depositors, which also necessi- compeon from outside the system and tates a deposit insurance system. forming a de facto monopoly, which is the natural enemy of innovaon. Giving RCCs the right to decide on RCC union member- Cost-Effective Approach ship can nurture a compeve environment, address the issue of market exit, Diversified financial organizaons should and help impose market discipline. be allowed to compete fairly, with the market selecng the fiest. Experience Opening the rural financial market is dif- has shown that government-led coopera- ficult but represents an irreversible trend. ve finance is not cooperave in essence However, although some regions and and is required to undertake the addi- departments have made efforts to estab- onal policy task of supporng sannong. lish new types of rural financial instu- Although cooperave finance grudgingly ons, problems remain and potenal risks provides credit for the agriculture sector, cannot be underesmated. More study is the cost is high, and the key issue is who required to determine how to establish will pay the bill. an effecve, compeve, and sustainable rural financial market. In this round of financial reform, reform- ers have two choices: to implement truly What is clear is that rural finance in the cooperave finance or to give up coopera- PRC requires long-term planning. At the ve finance enrely and resort to “less current stage, sound governance and expensive” financial arrangements. Either performance of any naonal rural financial way, the market and investors should instuon (e.g., the Agricultural Bank of select arrangements suitable to their local China, the Agricultural Development Bank needs and RCCs should be allowed to of China, or the RCCs), coupled with com- operate across jurisdicons. Because local peon from smaller, diversified formal governments, especially county or town- and informal financial instuons, will lead ship governments, presently intervene in to benign compeon in the rural finan- RCC operaons, administrave jurisdicon cial market. We suggest that future pilot should be amended to allow one grass- programs adhere to the principle that new roots RCC to serve several townships and rural financial instuons must be boom- one county RCC union to cover a number up organizaons iniated by farmers and of counes, if necessary. This, in fact, is an capable of delivering financial services to extension of the strategy that the PBC uses sannong at minimal cost.

185 APPENDIX

187 APPENDIX

Table A.1: Number of Banking Outlets, by Region, 2005 Northeastern Eastern Central Western region region region region Average Per county 38.95 32.94 25.32 18.96 25.04 Per township 2.70 2.85 2.47 1.58 2.40 Per village 0.01 0.14 0.02 0.02 0.05

Source: China Banking Regulatory Commission.

Table A.2: Credit Market Concentration in Sample Counties, 19992003 (%) Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Loans 1999 41.31 45.63 42.62 31.12 31.86 35.70 38.04 2000 49.91 41.75 42.61 33.38 34.02 45.94 41.27 2001 49.17 39.40 46.02 35.87 34.13 42.69 41.21 2002 48.65 36.26 44.70 36.98 34.08 38.43 39.85 2003 45.81 34.09 44.01 40.78 34.79 35.06 39.09 Deposits 1999 36.09 35.13 40.76 29.99 31.88 31.15 34.17 2000 45.65 35.93 39.73 29.46 31.70 30.53 35.50 2001 43.67 35.58 41.65 30.03 32.88 30.95 35.79 2002 43.51 35.41 39.62 29.93 34.21 30.20 35.48 2003 43.22 34.38 40.74 33.25 34.29 29.18 35.84

Source: Authors’ calculaon.

189 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.3: Rural Deposits in Sample Counties, 19992003 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Total Agricultural Bank of China deposits outstanding (CNY billion) 1999 0.88 0.68 1.04 0.93 1.03 0.55 5.11 2000 1.12 0.89 1.22 1.02 1.29 0.65 6.19 2001 1.20 1.06 1.37 1.11 1.42 0.77 6.95 2002 1.39 1.25 1.53 1.38 1.69 0.91 8.15 2003 1.62 1.60 1.69 1.79 2.01 1.08 9.80 Agricultural Bank of China market share (%) 1999 45.4 36.9 42.2 26.8 32.0 32.0 35.9 2000 55.2 42.1 43.1 26.5 32.8 31.3 38.5 2001 53.9 40.7 44.8 27.1 35.7 32.0 39.0 2002 54.4 40.8 44.3 29.6 35.5 30.6 39.2 2003 53.8 38.5 45.9 32.4 36.3 29.9 39.5 Rural credit cooperave deposits outstanding (CNY billion) 1999 0.45 0.41 1.44 1.25 0.93 0.35 4.83 2000 0.57 0.47 1.58 2.09 0.92 0.42 6.06 2001 0.65 0.62 1.94 1.71 1.33 0.55 6.79 2002 0.73 0.81 2.13 1.93 1.61 0.66 7.87 2003 0.88 0.95 2.59 2.37 1.95 0.92 9.64 Rural credit cooperave market share (%) 1999 20.0 18.4 41.2 28.4 22.9 16.3 24.5 2000 23.2 18.4 38.4 31.7 25.4 21.2 26.4 2001 23.2 19.8 37.5 32.6 25.8 22.9 27.0 2002 23.8 21.8 36.4 32.8 28.9 23.5 27.9 2003 24.6 21.8 36.5 36.3 29.6 26.3 29.2 Postal savings deposits outstanding (CNY billion) 1999 0.12 0.14 0.19 0.39 0.23 0.18 1.25 2000 0.13 0.18 0.29 0.63 0.32 0.23 1.77 2001 0.19 0.22 0.39 0.90 0.46 0.25 2.42 2002 0.21 0.26 0.51 1.22 0.56 0.30 3.06 2003 0.24 0.34 0.61 1.51 0.71 0.43 3.83 Postal savings market share (%) 1999 5.8 6.0 7.6 10.6 7.1 7.4 7.4 2000 5.9 6.0 9.3 14.3 8.9 9.3 8.9 2001 7.4 6.4 9.5 17.4 11.0 9.0 10.1 2002 8.2 6.1 10.4 19.4 11.0 9.2 10.7 2003 7.4 6.2 10.4 20.8 11.7 9.9 11.1 Note: Total market comprises these instuons as well as other state-owned commercial banks and insurance companies. Source: China Banking Regulatory Commission’s local oﬃces.

190 APPENDIX

Table A.4: Rural Loans in Sample Counties, 19992003 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Total Agricultural Bank of China loans outstanding (CNY billion) 1999 1.10 2.10 1.74 1.61 1.68 1.14 9.37 2000 1.19 1.86 1.73 1.59 1.57 1.42 9.36 2001 1.26 1.73 1.81 1.64 1.59 1.42 9.45 2002 1.40 1.63 1.88 1.72 1.67 1.45 9.74 2003 1.63 1.56 1.50 1.99 2.01 1.51 10.21 Agricultural Bank of China market share (%) 1999 58.5 61.8 44.6 44.0 46.1 48.4 50.6 2000 65.0 59.3 46.0 44.4 45.8 60.6 53.5 2001 63.5 54.0 47.4 43.8 43.5 56.2 51.4 2002 61.9 48.9 45.5 42.5 39.9 48.8 47.9 2003 58.7 37.6 42.0 42.7 39.6 41.7 43.7 Rural credit cooperave loans outstanding (CNY billion) 1999 0.36 0.34 1.00 0.89 0.72 0.22 3.53 2000 0.45 0.44 1.13 1.03 0.90 0.24 4.20 2001 0.57 0.59 1.44 1.28 1.13 0.42 5.42 2002 0.52 0.84 1.79 1.61 1.41 0.72 6.89 2003 0.66 0.96 2.12 2.01 1.68 0.97 8.39 Rural credit cooperave market share (%) 1999 13.8 12.2 31.2 21.4 17.0 12.3 18.0 2000 17.1 14.1 34.1 27.3 21.9 12.2 21.1 2001 19.3 18.4 37.7 32.4 26.2 19.7 25.6 2002 21.7 25.4 39.1 37.3 31.2 27.3 30.3 2003 24.2 34.9 43.0 41.7 34.5 31.3 34.9 Agricultural Development Bank of China loans outstanding (CNY billion) 1999 0.15 0.37 0.29 0.45 0.60 0.34 2.20 2000 0.15 0.37 0.62 0.48 0.63 0.41 2.66 2001 0.15 0.36 0.64 0.45 0.63 0.36 2.60 2002 0.15 0.33 0.66 0.67 0.70 0.35 2.86 Source: 2003 0.18 0.30 0.70 0.43 0.71 0.50 2.81 Agricultural Development Bank of China market share (%) 1999 6.5 11.8 9.9 11.7 14.4 13.7 11.3 2000 7.2 11.7 10.6 12.8 15.5 10.3 11.4 2001 6.1 11.2 9.9 11.2 15.5 9.1 10.5 2002 6.1 9.8 9.4 9.4 14.8 6.9 9.4 2003 6.3 10.6 9.1 8.5 14.3 7.6 9.4 Note: Total market comprises these instuons as well as other state-owned commercial banks and insurance companies. Source: China Banking Regulatory Commission’s local oﬃces.

191 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.5: Rural Credit CooperativesÊ Nonperforming Loans, Bad Debt, and Losses in Sample Counties, 19992003

Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Rao of nonperforming loans 1999 0.276 0.533 0.385 0.373 0.402 0.363 0.389 2000 0.262 0.481 0.487 0.438 0.410 0.471 0.425 2001 0.229 0.465 0.437 0.407 0.416 0.417 0.395 2002 0.247 0.269 0.323 0.329 0.476 0.305 0.325 2003 0.309 0.254 0.333 0.262 0.397 0.329 0.314 Rao of bad debt 1999 0.049 0.033 0.043 0.063 0.038 0.046 0.045 2000 0.058 0.038 0.033 0.043 0.040 0.043 0.043 2001 0.063 0.036 0.037 0.039 0.033 0.082 0.048 2002 0.091 0.056 0.061 0.044 0.030 0.096 0.063 2003 0.078 0.060 0.056 0.052 0.034 0.070 0.058 Loss (CNY million) Total 1999 (7.66) (8.00) (53.14) (27.54) (4.43) (4.66) (105.42) 2000 (7.82) (6.50) (24.06) (17.22) (4.32) (1.30) (61.22) 2001 (3.37) (9.97) (16.48) (3.55) 0.74 (8.18) (40.81) 2002 (2.48) (7.64) (4.81) 13.05 3.04 0.54 1.71 2003 (5.76) (48.78) 1.61 22.45 3.73 1.45 (25.30) ( ) = negave. Source: China Banking Regulatory Commission’s local oﬃces.

Table A.6: Fiscal Funds for Poverty Alleviation in Sample Counties, 19992003

Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Rao of work-for-relief subsidies 1999 0.248 0.533 0.340 0.376 0.579 0.274 0.391 2000 0.222 0.401 0.246 0.302 0.455 0.248 0.312 2001 0.154 0.254 0.172 0.271 0.286 0.135 0.212 2002 0.149 0.185 0.210 0.353 0.242 0.093 0.205 2003 0.111 0.163 0.176 0.322 0.236 0.081 0.182 Rao of government bonds 1999 0.243 0.117 0.154 0.205 0.125 0.166 0.168 2000 0.079 0.163 0.162 0.272 0.267 0.305 0.208 2001 0.248 0.293 0.251 0.231 0.301 0.403 0.288 2002 0.394 0.423 0.238 0.225 0.324 0.591 0.366 2003 0.354 0.392 0.258 0.311 0.335 0.558 0.368 Rao of ﬁscal poverty alleviaon 1999 0.508 0.310 0.440 0.419 0.179 0.249 0.351 2000 0.698 0.413 0.478 0.426 0.219 0.188 0.404 2001 0.595 0.444 0.470 0.459 0.368 0.390 0.454 2002 0.448 0.387 0.490 0.389 0.365 0.256 0.389 2003 0.534 0.434 0.500 0.336 0.383 0.322 0.418 Source: China Banking Regulatory Commission’s local oﬃces.

192 APPENDIX

Table A.7: Interest Collected in Sample Counties by the Agricultural Bank of China, 19992003 (%) Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average 1999 63.8 45.5 65.0 63.6 33.7 44.3 52.7 2000 70.8 46.3 69.2 59.4 35.1 44.4 54.2 2001 74.4 46.7 67.4 62.1 33.3 43.5 54.6 2002 73.7 49.3 59.4 62.9 32.5 46.5 54.1 2003 74.5 50.1 60.4 64.2 33.7 44.0 54.5 Source: China Banking Regulatory Commission’s local oﬃces.

Table A.8: Agricultural Development Bank of China Nonperforming Loans in Sample Counties, 19992003 (%) Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average 1999 24.8 19.7 20.3 28.9 36.2 19.6 24.9 2000 30.5 23.6 32.4 34.5 43.9 17.5 30.4 2001 32.1 28.9 44.6 32.7 36.2 20.9 32.6 2002 34.1 34.5 32.0 31.7 33.4 18.4 30.7 2003 27.1 46.5 29.9 28.2 29.0 16.0 29.4 Source: China Banking Regulatory Commission’s local oﬃces.

Table A.9: Agricultural Bank of China Loans Outstanding in Sample Counties, 19992003 (CNY billion) Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Total 1999 1.10 2.10 1.74 1.61 1.68 1.14 9.37 2000 1.19 1.86 1.73 1.59 1.57 1.42 9.36 2001 1.26 1.73 1.81 1.64 1.59 1.42 9.45 2002 1.40 1.63 1.88 1.72 1.67 1.45 9.75 2003 1.63 1.56 1.50 1.99 2.00 1.51 10.19 Source: China Banking Regulatory Commission’s local oﬃces.

193 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.10: Agricultural Bank of China Loans in Sample Counties, 19992003 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Rao of agriculture loans 1999 0.24 0.22 0.12 0.13 0.54 0.17 0.24 2000 0.23 0.21 0.08 0.14 0.52 0.18 0.23 2001 0.23 0.22 0.10 0.12 0.58 0.18 0.24 2002 0.22 0.21 0.11 0.12 0.57 0.16 0.23 2003 0.25 0.27 0.11 0.24 0.64 0.16 0.28 Rao of poverty alleviaon loans 1999 0.21 0.48 0.27 0.39 0.12 0.34 0.30 2000 0.26 0.49 0.30 0.50 0.15 0.39 0.35 2001 0.28 0.57 0.30 0.49 0.15 0.40 0.37 2002 0.28 0.57 0.30 0.48 0.16 0.38 0.36 2003 0.27 0.32 0.32 0.38 0.14 0.37 0.30 Rao of township and village enterprise loans 1999 0.06 0.06 0.07 0.06 0.11 0.06 0.07 2000 0.05 0.05 0.05 0.05 0.08 0.04 0.05 2001 0.04 0.05 0.05 0.05 0.06 0.03 0.05 2002 0.02 0.05 0.04 0.05 0.05 0.02 0.04 2003 0.02 0.04 0.05 0.07 0.05 0.02 0.04 Source: China Banking Regulatory Commission’s local oﬃces.

Table A.11: Agricultural Bank of ChinaÊs Poverty Alleviation Loans in Sample Counties, 20012004 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Rao of rural household loans 2001 0.160 0.344 0.238 0.574 0.600 0.422 0.390 2002 0.143 0.241 0.255 0.610 0.651 0.443 0.390 2003 0.131 0.164 0.291 0.616 0.649 0.454 0.384 2004 0.129 0.219 0.317 0.631 0.652 0.472 0.403 Rao of enterprise and project loans 2001 0.740 0.649 0.762 0.362 0.396 0.575 0.581 2002 0.757 0.752 0.745 0.326 0.344 0.553 0.580 2003 0.763 0.777 0.709 0.318 0.345 0.543 0.576 2004 0.833 0.656 0.683 0.327 0.348 0.517 0.561

Source: China Banking Regulatory Commission’s local oﬃces.

194 APPENDIX

Table A.12: Ratio of Medium- and Long-Term Loans to Total Agricultural Bank of China Loans in Sample Counties, 19992003 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average 1999 0.499 0.638 0.504 0.366 0.417 0.467 0.490 2000 0.583 0.628 0.492 0.433 0.525 0.547 0.534 2001 0.639 0.543 0.527 0.458 0.520 0.511 0.529 2002 0.669 0.582 0.486 0.484 0.524 0.510 0.538 2003 0.695 0.487 0.572 0.557 0.513 0.483 0.551 Source: China Banking Regulatory Commission’s local oﬃces and authors’ calculaon.

Table A.13: Agricultural Bank of China DepositLoan Ratio in Sample Counties, 19992003 Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average 1999 1.17 2.75 1.01 0.94 1.24 1.71 1.47 2000 1.03 1.81 1.27 0.92 1.09 1.88 1.33 2001 0.92 1.43 1.21 0.95 1.00 1.60 1.19 2002 0.92 1.16 1.09 0.97 0.90 1.52 1.09 2003 0.95 0.92 0.71 1.07 0.84 1.46 0.99 Source: China Banking Regulatory Commission’s local oﬃces and authors’ calculaon.

195 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.14: Agricultural Bank of China Enterprise Loans in Sample Counties, 19962003 (%) Year Yunnan Guizhou Sichuan Shaanxi Gansu Ningxia Average Private enterprises 1996 9.1 15.2 8.5 18.1 55.1 36.2 23.7 1997 13.3 13.5 8.3 19.0 28.3 35.8 19.7 1998 14.0 15.1 12.1 19.2 29.2 38.9 21.4 1999 14.8 20.4 15.0 21.6 32.5 39.6 24.0 2000 17.3 21.6 16.9 21.8 35.8 38.1 25.2 2001 18.4 24.3 17.7 22.6 38.3 38.0 26.5 2002 20.8 24.2 19.7 23.5 42.0 37.6 27.9 2003 26.3 18.6 24.2 25.3 41.6 38.2 29.0 Collecve enterprises 1996 23.0 28.9 34.6 21.3 22.8 37.5 28.0 1997 19.9 29.0 35.9 28.4 23.0 36.8 28.8 1998 25.7 29.0 35.9 27.3 22.9 37.1 29.6 1999 26.2 28.0 35.1 27.0 21.9 34.0 28.7 2000 24.0 28.6 33.4 25.9 22.8 30.5 27.5 2001 22.5 26.7 34.7 25.8 22.1 30.1 27.0 2002 19.3 25.7 35.2 22.3 22.0 30.4 25.8 2003 17.9 25.3 34.1 22.7 22.0 30.2 25.4 State-owned enterprises 1996 63.3 56.0 56.9 52.4 67.0 26.3 53.6 1997 62.1 57.5 55.9 43.8 36.8 28.0 47.3 1998 60.4 56.1 52.0 45.3 35.3 24.9 45.7 1999 59.1 51.6 49.9 43.4 32.5 26.5 43.8 2000 58.8 49.8 49.7 44.2 30.2 31.4 44.0 2001 58.7 49.0 47.6 43.5 28.6 31.9 43.2 2002 60.0 50.1 45.1 45.0 24.8 32.0 42.8 2003 55.9 56.1 41.8 44.2 25.6 31.6 42.5 Source: China Banking Regulatory Commission’s local oﬃces.

196 APPENDIX

Table A.15: County Revenues Surrendered and Subsidies, 20002004 Region 2000 2001 2002 2003 2004 Average Revenues surrendered by county governments to higher governments (CNY million) Eastern 294.14 342.25 439.32 724.58 490.26 457.84 Central 25.85 24.82 35.65 42.32 48.53 35.19 Western 59.76 65.40 79.01 93.20 82.74 76.08 Subsidies to county governments by higher governments (CNY million) Eastern 188.65 146.04 217.76 285.64 325.65 233.59 Central 59.64 92.96 120.92 135.70 160.82 114.01 Western 83.96 120.29 174.60 254.10 243.53 176.27 Rao of revenues surrendered to gross domesc product Eastern 0.032 0.030 0.033 0.042 0.028 0.033 Central 0.022 0.021 0.035 0.034 0.030 0.028 Western 0.076 0.024 0.032 0.037 0.032 0.040 Rao of subsidies to gross domesc product Eastern 0.024 0.017 0.023 0.023 0.024 0.022 Central 0.067 0.091 0.121 0.125 0.132 0.107 Western 0.314 0.135 0.156 0.177 0.173 0.191 Source: Department of Finance, various provinces.

Table A.16: Number of State-Owned Commercial Bank Outlets per County, by Region, 20002004 Region Type 2000 2001 2002 2003 2004 Average Eastern Deposit-taking outlets 4.0 4.0 3.9 4.0 4.0 4.0 Lending outlets 4.0 4.0 4.0 4.0 4.0 4.0 Central Deposit-taking outlets 3.7 3.7 3.8 3.7 3.7 3.7 Lending outlets 3.6 3.6 3.6 3.6 3.6 3.6 Western Deposit-taking outlets 3.3 3.2 3.1 3.1 2.9 3.1 Lending outlets 2.8 2.6 2.6 2.6 2.4 2.6 Source: People’s Bank of China. Table A.17: PeopleÊs Bank of China Agriculture Loans per County, by Region, 20002004 Region 2000 2001 2002 2003 2004 Average People’s Bank of China agriculture loans per county (CNY million) Eastern 30.64 28.59 43.14 48.43 59.06 42.57 Central 17.38 21.61 35.54 46.06 46.27 35.19 Western 7.00 31.15 52.09 56.04 58.17 42.85 Rao of People’s Bank of China agriculture loans to deposits Eastern 0.027 0.030 0.037 0.061 0.065 0.045 Central 0.068 0.068 0.088 0.114 0.087 0.087 Western 0.064 0.240 0.296 0.256 0.178 0.213 Source: People’s Bank of China.

197 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.18: Funds Deposited with Higher Financial Institutions, by Region, 2004 Industrial and China Agricultural Commercial Construcon Rural credit Region Bank of China Bank of China Bank Bank of China cooperaves Funds deposited with higher ﬁnancial instuons (CNY million) Eastern 414.04 462.86 552.28 608.89 510.33 Central 74.07 162.20 109.39 151.12 124.35 Western 142.66 184.31 255.76 307.77 222.76 Rao of deposited funds to loans outstanding Eastern 0.746 0.646 0.603 0.699 0.673 Central 1.085 1.098 1.218 1.225 1.157 Western 1.095 1.160 0.819 0.809 0.960 Source: China Banking Regulatory Commission.

Table A.19: Rural Migrant WorkersÊ Annual Remittance per County, by Region, 20002004 Region 2000 2001 2002 2003 2004 Average Annual remiance (CNY million) Eastern 339.75 423.41 419.99 485.67 538.69 441.50 Central 257.86 282.69 451.04 348.09 427.85 356.89 Western 42.92 81.74 55.89 130.27 75.72 77.31 Rao of remiance to gross domesc product Eastern 0.049 0.046 0.042 0.042 0.041 0.044 Central 0.104 0.111 0.129 0.115 0.106 0.113 Western 0.317 0.177 0.086 0.189 0.091 0.172 Source: China Banking Regulatory Commission.

Table A.20: Foreign Direct Investment per County, by Region, 20002004 Region 2000 2001 2002 2003 2004 Average Foreign direct investment (CNY million) Eastern 342.21 358.57 594.24 1,004.64 1,209.12 701.76 Central 57.89 76.24 122.25 202.89 412.23 186.17 Western 14.50 8.33 11.87 22.00 76.00 24.94 Rao of foreign direct investment to gross domesc product Eastern 0.035 0.025 0.035 0.048 0.052 0.039 Central 0.017 0.010 0.010 0.017 0.047 0.019 Western 0.022 0.028 0.046 0.055 0.079 0.048 Source: CEIC and authors’ calculaon.

198 APPENDIX

Table A.21: Domestic Direct Investment per County, by Region, 20002004 Region 2000 2001 2002 2003 2004 Average Domesc direct investment per county (CNY million) Eastern 414.81 555.02 859.11 1,269.78 2,317.27 1,096.76 Central 203.27 301.90 400.37 647.40 798.21 490.61 Western 161.17 143.06 246.84 132.66 227.70 182.36 Rao of domesc direct investment to gross domesc product Eastern 0.065 0.067 0.089 0.118 0.164 0.101 Central 0.089 0.119 0.140 0.173 0.174 0.142 Western 0.138 0.118 0.167 0.131 0.178 0.146 Source: CEIC and authors’ calculaon.

Table A.22: Rural Deposits, 19892005 (CNY billion) Agricultural Bank Rural credit Postal Total rural Year of China % of total cooperaves % of total savings % of total depositsa 1989 206 54.9 167 44.6 2 0.6 375 1990 264 54.6 215 44.4 5 1.0 483 1991 332 54.3 270 44.3 9 1.4 611 1992 314 46.6 348 51.6 13 1.9 674 1993 450 50.0 429 47.6 22 2.4 901 1994 517 46.3 567 50.7 34 3.0 1,118 1995 694 47.3 717 48.9 55 3.7 1,466 1996 895 48.4 879 47.6 74 4.0 1,848 1997 1,132 49.6 1,062 46.5 88 3.9 2,282 1998 1,333 50.1 1,219 45.8 108 4.1 2,660 1999 1,549 51.4 1,336 44.4 126 4.2 3,011 2000 1,752 51.1 1,513 44.1 163 4.8 3,428 2001 2,025 49.3 1,726 42.0 355 8.6 4,106 2002 2,480 52.6 1,988 42.1 2,512 5.3 4,718 2003 2,998 52.8 2,371 41.8 3,066 5.4 5,675 2004 3,492 47.8 2,729 37.4 1,079 14.8 7,299 2005 4,037 49.5 2,761 33.8 1,360 16.7 8,157 a Excluding rural deposits by the Agricultural Development Bank of China, which are insigniﬁcant. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

199 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.23: Amount and Composition of Rural Loans, 19892005 (CNY billion) Agricultural Agricultural Bank of Development Rural credit Total rural Year China % of total Bank of China % of total cooperaves % of total loans 1989 305.8 73.6 — — 109.5 26.4 415 1990 377.4 72.8 — — 141 27.2 518 1991 457.8 71.7 — — 180.8 28.3 639 1992 546.8 69.0 — — 245.4 31.0 792 1993 656.5 66.8 — — 326.2 33.2 983 1994 552.5 57.1 — — 415.9 42.9 968 1995 655 39.8 469 28.5 523 31.8 1,647 1996 771 37.9 625 30.8 636 31.3 2,032 1997 981 38.1 864 33.5 733 28.4 2,578 1998 1,367 47.0 709 24.4 834 28.7 2,910 1999 1,553 48.5 727 22.7 923 28.8 3,203 2000 1,450 44.8 740 22.8 1,049 32.4 3,239 2001 1,605 45.3 743 21.0 1,197 33.8 3,545 2002 1,858 46.6 737 18.5 1,394 34.9 3,989 2003 2,212 48.1 690 15.0 1,698 36.9 4,600 2004 2,590 49.5 719 13.7 1,924 36.8 5,233 2005 2,829 51.6 787 14.4 1,868 34.1 5,484

— = data not available. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

200 APPENDIX

Table A.24: Agricultural Bank of China Loans, 19892005 (CNY billion) Township Agriculture % of loan and village % of loan Total loan Year loansa porolio enterprise loans porolio porolio 1989 46.4 15.2 39.3 12.9 306 1990 56.3 14.9 43.4 11.5 377 1991 69.5 15.2 49.8 10.9 458 1992 84.7 15.5 58.3 10.7 547 1993 85.8 13.1 77.5 11.8 657 1994 87.7 15.9 93.8 17.0 552 1995 95.5 14.6 95.9 14.6 655 1996 120.2 15.6 115.8 15.0 771 1997 153.2 15.6 151.9 15.5 981 1998 178.0 13.0 174.9 12.8 1,367 1999 174.3 11.2 190.0 12.2 1,553 2000 128.8 8.9 141.3 9.7 1,450 2001 125.5 7.8 145.0 9.0 1,605 2002 441.7 23.1 — — 1,913 2003 456.9 20.1 — — 2,268 2004 574.6 22.2 — — 2,590 2005 450.9 15.9 — — 2,829

— = data not available. a Agriculture loans mainly comprise loans to rural households for farm or oﬀ-farm producon and consumpon. Other uses of agriculture loans include loans to agricultural instuons and to rural buying-and-selling cooperaves. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

201 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.25: Rural Credit Cooperative Loans, 19892005 (CNY billion) Township Agriculture % of loan and village % of loan Total loan Year loansa porolio enterprise loans porolio porolio 1989 52.3 47.8 57.2 52.2 109.5 1990 65.2 46.2 76.1 53.8 141.3 1991 80.1 44.3 100.7 55.7 180.9 1992 98.2 40.0 129.4 52.7 245.4 1993 65.7 20.1 178.3 54.7 326.2 1994 80.5 19.4 227.7 54.7 415.9 1995 109.5 20.9 277.9 53.1 523.4 1996 148.7 23.4 326.4 51.3 636.5 1997 177.4 24.2 346.8 47.3 732.6 1998 265.9 31.9 376.1 45.1 834.0 1999 304.0 32.9 418.7 45.4 922.6 2000 358.8 34.2 456.9 43.6 1,048.9 2001 441.8 36.9 484.3 40.5 1,197.1 2002 557.9 40.0 514.1 36.9 1,393.8 2003 705.6 41.6 569.6 33.5 1,697.9 2004 845.6 44.0 598.9 31.1 1,923.8 2005 933.1 50.0 455.5 24.4 1,868.0 a Agriculture loans mainly comprise loans to rural households for farm or oﬀ-farm producon and consumpon. Other uses of agriculture loans include loans to agricultural instuons and to rural buying-and-selling cooperaves. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

202 APPENDIX

Table A.26: Portfolio Balance and Cumulative Loans of the Agricultural Bank of China and Rural Credit Cooperatives, 19892001 (CNY billion) Agricultural Bank of China Rural credit cooperaves Year PBa ADb AD/PB (%) PBa ADb AD/PB (%) 1989 306 — — 109.5 — — 1990 377 — — 141.3 — — 1991 458 654.2 142.9 180.9 259.3 143.4 1992 547 716.2 131.0 245.4 342.9 139.7 1993 657 743.7 113.3 326.2 434.4 133.2 1994 552 744.2 134.7 415.9 525.7 126.4 1995 655 796.7 121.6 523.4 606.4 115.8 1996 771 1,036.5 134.4 636.5 794.1 124.8 1997 981 1,106.9 112.8 732.6 880.2 120.1 1998 1,367 1,048.1 76.7 834.0 796.2 95.5 1999 1,553 1,000.4 64.4 922.6 872.1 94.5 2000 1,450 961.2 66.3 1,048.9 952.7 90.8 2001 1,605 1,195.4 74.5 1,198.7 1,153.9 96.3 2002 1,968 1,392.6 70.8 1,393.8 1,425.1 102.2 2003 2,212 1,936.0 87.5 1,697.9 1,909.6 112.4 2004 2,590 2,082.7 80.4 1,923.8 2,283.5 118.7 2005 2,829 2,507.4 88.6 1,868.0 2,434.0 130.3

— = data not available. a Porolio balance at the end of the year. b Annual cumulave loan disbursement. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

203 RURAL FINANCE IN POVERTY-STRICKEN AREAS IN THE PEOPLE’S REPUBLIC OF CHINA: BALANCING GOVERNMENT AND MARKET

Table A.27: Rural Deposits and Loans, 19912001 (CNY billion) Agricultural Rural credit Cumulave Total rural Bank of China % of total cooperave % of total loan–deposit Year deposits disbursementsa deposits disbursements deposits rao (%)b 1991 611 170.6 27.9 259.4 42.5 70.4 1992 674 187.3 27.8 342.8 50.9 78.6 1993 901 184.9 20.5 434.4 48.2 68.8 1994 1,118 244.5 21.9 525.8 47.0 68.9 1995 1,466 232.8 15.9 606.1 41.4 57.2 1996 1,848 317.2 17.2 794.3 43.0 60.1 1997 2,282 344.1 15.1 879.9 38.6 53.6 1998 2,660 270.7 10.2 796.5 29.9 40.1 1999 3,011 234.6 7.8 871.8 29.0 36.7 2000 3,428 179.0 5.2 952.4 27.8 33.0 2001 4,106 201.5 4.9 1,087.0 26.5 31.4 a Includes agriculture loans and loans to township and village enterprises, including poverty loans. b Includes both Agricultural Bank of China and rural credit cooperave disbursements and deposits. Source: People’s Bank of China. 2006. Stascal Yearbook of China’s Banking and Finance. Beijing: China Finance Publishing House.

Table A.28: Demand for Credit Among Sample Population (N = 833) Respondents ranking Item as highest priority % of respondents Deposits 255 30.6 Educaon 120 14.4 House 116 13.9 Farm producon 78 9.4 Oﬀ-farm producon 60 7.2 Weddings and funerals 55 6.6 Debt repayment 37 4.4 Food 32 3.8 Cash 25 3.0 Medical 14 1.7 Vehicle 12 1.4 Daily necessies 12 1.4 Borrowing for proﬁt 0 0.0 Other 17 2.0 Source: Authors’ calculaon.

204 APPENDIX

Table A.29: Fund Inflows in Sample Counties, 2003 (CNY million) Dafang Danzhai Fenggang Meitan Taijiang Zhijin Total Fiscal revenue 150 21 40 82 22 150 464 Fiscal expenditure 296 70 150 196 100 325 1,137 People’s Bank of China 43 19 30 6 18 32 148 onlending Migrant worker 171 27 90 152 30 136 606 remiancesa Agricultural 63 17 114 69 15 52 330 Development Bank of China loans a Esmated remiances through postal savings outlets. Source: Bureau of Finance, various counes; People’s Bank of China, various provinces. Table A.30: Rural Credit Cooperative Deposits and Loans Outstanding in Guizhou, 20002003 (CNY billion) 2000 2001 2002 2003 Total deposits 9.2 11.5 17.8 21.7 Total loans 7.1 9.2 12.5 14.9

Short-term loans to rural households 4.4 5.8 8.4 9.8 Short-term loans to township and village 0.8 0.9 0.9 1.0 enterprises Total short-term loans 6.7 8.6 11.6 13.8

Total medium- and long-term loans 0.4 0.6 0.9 1.1

People’s Bank of China onlending 0.6 1.1 2.4 2.5 Source: China Banking Regulatory Commission’s Guizhou oﬃce. Table A.31: Agricultural Bank of China Deposits and Loans Outstanding in Guizhou, 20002003 (CNY billion) 2000 2001 2002 2003 Total deposits 21.0 24.4 30.2 36.3 Total loans 31.4 34.1 36.6 42.5

Short-term loans to industry 0.9 1.0 1.7 2.8 Short-term loans to agriculture 0.8 0.7 0.6 0.6 Short-term loans to township and village 0.7 0.7 0.6 0.6 enterprises Total short-term loans 14.7 12.7 13.1 13.5

Medium- and long-term loans for 2.9 4.2 4.8 7.3 infrastructure Medium- and long-term loans for 1.0 1.4 1.3 1.2 technology improvements Other medium- and long-term loans 11.7 14.4 16.7 17.4 Total medium- and long-term loans 15.6 20.0 22.8 25.9 Source: Agricultural Bank of China, Guizhou Branch.

205 Notes

Chapter 1. Rural Financial Reform 1. Under the land contract responsibility system, farming households lease producon tools, including land, from villages or townships. The agreement is a 30-year term contract with zero leasing cost. Farming households determine what to produce a er fulfilling the tasks assigned by the village or township. 2. The stated objecves of financial system reform were to establish a central banking system for independent monetary policy implementaon; to establish a financial system with separate policy and commercial finance operaons, in coexistence with state-owned commercial banks and various types of financial instuons; and to establish an open financial market featuring orderly compeon and strict management. 3. Although cooperave finance in the PRC is not truly cooperave, this book uses the official term, for convenience. 4. The quota of PBC loans to support the rural economy increased each year and reached approximately CNY129 billion in 2004. Therea er, the PBC decided not to increase the quota but to allow for regional adjustment and bias toward the central, western, and northeastern regions and crop-producing areas. Outstanding PBC loans of this type presently stand at over CNY80 billion. 5. Officially, informal financial instuons in the PRC are not counted as rural financial instuons because they are neither regulated nor supervised by the PBC and because deposits with these instuons are not protected by the state. 6. The county RCC union usually has its own business office, offering deposit and lending services to urban residents at the county seat. RCC deposits from urban residents, and lending in the urban areas of the county seat, represent an insignificant poron of overall RCC deposits. Moreover, the county seat itself should be regarded as a rural area. 7. Also known as Tibet Autonomous Region.

Chapter 3. Rural Financial Services for the Poor and for Rural Migrants

1. The northeastern region comprises Heilongjiang, Jilin, and Liaoning; the eastern region comprises Beijing, Fujian, Guangdong, Hainan, Hebei, Jiangsu, Shandong, Shanghai, Tianjin, and Zhejiang; the central region comprises Anhui, Henan, Hubei, Hunan, Jiangxi, and Shanxi; and the western region comprises Chongqing, Gansu, Guangxi, Guizhou, Inner Mongolia Autonomous Region, Ningxia, Qinghai, Shaanxi, Sichuan, Xinjiang Uygur Autonomous Region, and Yunnan. 2. The inial annual interest rate on agricultural loans was set at 2.25%, 0.99 percentage points lower than the benchmark deposit interest rate. On 1 January 2005, the interest rate was adjusted to 3.24%, the same as the benchmark deposit rate. 3. Calculated as fund opportunity cost (4.32%) plus loan processing and management costs (7%), minus the government subsidy rate (5.85% or 5.94%). 4. Although internaonal and naonal media have reported many cases of illegal providers of currency exchange and internaonal remiance services, our invesgaons so far have not found informal providers of remiance services for migrant workers inside the PRC.

207 Chapter 4. Capital Flows and Rural Finance

1. R. I. McKinnon, Money and Capital in Economic Development (Washington, DC: The Brookings Instuon, 1973). 2. S. Kuznets, “Economic Growth and the Contribuon of Agriculture,” in Agriculture in Economic Develop- ment, ed. C. K. Eicher and L. W. Wi (New York: McGraw-Hill, 1964). 3. Economic development stage, a core concept of our analysis, refers to a certain period in the course of economic development, during which economic development demonstrates a stable and consistent trend in aggregaon and structure and differs significantly from other periods. 4. Tan Chongtai, Development Economies: On Development of Industrial and Agricultural Sectors (Shanghai: People’s Publishing House, 1989). 5. See Cai Fang and Du Yang, “China’s Regional Economic Growth: On the Great West Development Strat- egy,” Journal of Economic Research 10 (2000); Lin Yifu, Cai Fang, and Li Zhou, “Regional Differences in the Transional Chinese Economy,” Journal of Economic Research 6 (1998); Shen Kunrong and Ma Jun, “Club Conversion of China’s Economic Growth,” Journal of Economic Research 1 (2002). 6. Zhang Ping, “Regional Income Gap in Rural China and Nonagricultural Employment,” Journal of Economic Research 8 (1999). See also B. Gustafsson and Shi Li, “Income Inequality within and across Counes in Rural China: 1988 and 1995,” Journal of Development Economics 69 (2002): 179–204. 7. See Cai Fang and Du Yang, “China’s Regional Economic Growth: On the Great West Development Strat- egy,” Journal of Economic Research 10 (2000); Shen Kunrong and Ma Jun, “Club Conversion of China’s Economic Growth,” Journal of Economic Research 1 (2002). Absolute convergence means that, in the absence of differences in technology, savings rate, populaon growth, or capital depreciaon, per capita capital and output of different countries tend to reach the same stable level, or converge. Condional convergence means that, if countries share similar characteriscs except for technology, they will converge at different, stable levels. If a number of countries or regions converge at the same level, they can be idenfied as clubs; this is usually called club convergence. See R. Barro and X. Sala-I-Marn, Economic Growth (New York: McGraw-Hill, 1995).

Chapter 5. Interest Rate Policy

1. Zhang Xiaoshan, Some Theorecal Thoughts on Agricultural, Rural, and Farmers’ Issues (Beijing: Social Science Documentaon Publishing House, 2003). 2. For studies on financial deepening and economic development, see R. I. McKinnon, Money and Capital in Economic Development (Washington, DC: The Brookings Instuon, 1973); on financial restricons, see M. J. Fry, Money, Interest, and Banking in Economic Development, 2nd ed. (Balmore, MD: The Johns Hopkins University Press, 1995); on theories of financial restraint, see T. Hellman, K. Murdock, and J. E. Sglitz, “Savings Mobilizaon under Financial Repression,” in Financial Development and Economic Growth: Theory and Experiences from Developing Countries, ed. N. Hermes and R. Lensink (New York: Routledge, 1996). 3. D. Adams, D. Graham, and J. D von Pischke, Undermining Rural Development with Cheap Credit (Boulder, CO: Westview Press, 1984). 4. M. J. Fry, Money, Interest, and Banking in Economic Development, 2nd ed. (Balmore, MD: The Johns Hopkins University Press, 1995). 5. For further descripon of the moral hazards faced by rural credit cooperaves, see Xie Ping, “Disputes on China’s Rural Credit Cooperave System,” Journal of Finance Research 1 (2001). 6. D. W. Adams and G. I. Nehman, “Borrowing Costs and the Demand for Rural Credit,” The Journal of Devel- opment Studies 5 (1979). 7. D. Adams, D. Graham, and J. D von Pischke, Undermining Rural Development with Cheap Credit, (Boulder, CO: Westview Press, 1984).

208 8. Almanac of China’s Banking and Finance (Beijing: Finance Publishing House, 2002). 9. W. T. Woo, “China’s Rural Enterprises in Crisis: The Role of Inadequate Financial Intermediaon” (Davis, CA: University of California Economics Department, 2003).

Chapter 8. Informal Finance

1. See Zhang Zhenyu and Mao Chunhua, Analysis of Wenzhou Finances under Socialist Market Economic Condions (Hangzhou: Zhejiang University, 1993); Jiang Xuchao, A Study of Chinese Nongovernmental Finance (Jinan: Shandong People’s Press, 1995). 2. See Regulaon on Disposing of Illegal Financial Instuons and Acvies (State Council, June 1998); Noce on Regulang Fund Raising, Entry of Financial Instuons, and Financial Operaons (State Council, August 1998). 3. Int ernaonal Fund for Agricultural Development, “Double-edged sword? Efficiency versus Equity in Lend- ing to the Poor: IFAD’s Themac Study on Rural Finance in China,” Evaluaon Profile 3 (2002). 4. Zhao Jie, Equity Markets: Underground Finance of RMB800 Billion to be Brought under the Broad Daylight Regulaon, January 6, 2006, www.finance.sina.com.cn 5. Han Xuemeng, “Wu Xiaoling: Enterprises Should Gradually Reduce Their Dependence on Banks and Increase Direct Financing,” Financial Times (July 25, 2005).

Chapter 10. Policy Recommendations

1. E. Cheng and Z. Xu, “Rates of Interest, Credit Supply, and China’s Rural Development,” Savings and Devel- opment 2 (2004). 2. M. J. Fry, Money, Interest, and Banking in Economic Development, 2nd ed. (Balmore, MD: The Johns Hopkins University Press, 1995). 3. K. Hoff and J. Sglitz, 1993: “Consequences of Limited Risk Markets and Imperfect Informaon for the Design of Taxes and Transfers: An Overview,” in The Economics of Rural Organizaon, ed. K. Hoff, A. Braverman, and J. E. Sglitz (New York: Oxford University Press, 1993). 4. Maurice Schiff and Alberto Valdes, “The Plundering of Agriculture in Developing Countries,” World Bank Lan America and Caribbean Region Department Reports 13 (1994). 5. J. Yaron, “Assessing Development Finance Instuons: A Public Interest Analysis,” World Bank Discussion Paper 174 (1992).

209