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More fizz than bang? More fizz than bang? To help the 800 million Chinese farmers left out of China's economic miracle, China's government has lowered the entry requirements of new rural financial institutions to increase farmers' access to microfinance. As a result, China's smallest bank - Yilong Huimin Village Bank - commenced operations on March 1 2007, followed quickly by four other 'grassroots lenders'. Insiders tell us that three more will be established in April, with a dozen more already in the pipeline. While this is not totally unexpected, CBRC's decision to grant banking licenses to institutions like Huimin, which has only ten staff and two million yuan ($0.26 million) registered capital, seems more a matter of politics than economics. Interestingly, though, the existing microfinance institutions in the country: the 300 underground MFIs that have been around since the 1990s seem to have been left out in the cold. Some of them are survivors of international financial-aid projects, others emulators of Nobel Prize winner Mohammad Yunus, and the rest local farmers who have have come up with their own microfinance model. Micro loans have undergone rapid growth to over 700 billion yuan ($91 billion) by end-2005, covering nearly 50 percent of the rural households. 'But the financial needs of the other 50 percent households remain unmet, not to mention that loans granted by credit cooperatives are not real microfinance: in most cases they need collateral and only high-end customers of the market could afford it,' Bai Chengyu, secretary-general of the China Association of Microfinance (CAM) says. Further, though Chinese banks' branch network in the countryside is massive, they act only as a one-way financial institution by channelling deposits out to the big cities. 'One key reason why they don't do microfinance is lack of the know-how, but the deeper reason is rooted in the system: because of the system, they don't have the motivation to develop the know-how,' Bai explains, referring to the majority government ownership of these institutions and the government-stipulated loan pricing limit that encourages them to stay away from innovating and risk-taking. Against this backdrop, some of the underground MFIs seem to offer a ray of hope. The Association for Rural Development of Yilong (ARDY) led by Gao Xiangjun is one of them. In operation for 12 years, ARDY had opened six branches and developed 17 village-specific development cooperatives by 2006. It had originated over 50 million yuan ($6.5 million) non-guaranteed loans in the past 10 years with a striking repayment rate of 98.8 percent, helping more than 80,000 people exit from poverty. Due to its success, many international non-government organisations (NGOs) have been consistent funders. Despite these, however, Gao's application for a 'village banking' license was rejected in favour of Huimin Village Bank: a new comer into microfinance established by the region's Nanchong City Commercial Bank and six other local enterprises. 'We prefer a brand new institution,' claims Zang Jingfan, director general of CBRC's Cooperative Finance Supervision Department (CFSD) that engineers the financial reforms in the rural sector. 'A new bank is much easier for us to experiment new ideas. But for established MFIs, we have to run due diligence to check their balance sheet back to a few years' time, and we have to figure out the business models and people behind the numbers: that could take way much time,' More importantly, 'it's not easy to make them licensed from something underground, something without a firm legal foundation'. Still, they are 'not ruling out the possibility' of doing so. Emerging from the cave But whether underground MFIs will rush to be transformed into village banks to legitimately originate loans, especially to take deposits, is another question. According to the Provisional Rules Governing the Management of Village Banks, collateral-free lending to 'guan xi ren' - individuals or small businesses with personal connections to the shareholder or the staff - is an offence. But since the rules have not defined the scope of 'guan xi ren', compliance will be tough. Given the information asymmetry, microfinance officers rely heavily on personal judgment in originating loans and in many cases, they will choose someone they are familiar with; he or she could be a friend, a relative or a partner. Even Yunus's Grameen Bank will find it difficulty to continue business if it was in China. 90 percent of Grameen Bank is owned by its borrowers, which means most borrowers are 'guan xi ren' to the bank. Moreover, village banks have to maintain an above eight percent capital adequacy ratio and above 100 percent bad loan coverage ratio: understandable, but may be too unrealistic. Only half of China's 131 commercial banks have fulfilled Basel I requirements and less than ten have maintained a full bad loan coverage. Is CBRC expecting the grassroots lenders to be more serious about compliance? What is missing in the new rules is the loan pricing ceiling of village banks. According to the international Consultative Group to Assist the Poor, 'Interest rate ceilings hurt poor people by making it harder for them to get credit.' China liberalised risk-based pricing in 2006 by removing the lending rate upper-limit that commercial banks can charge, but has kept the lending rate ceiling of credit cooperatives at 2.3 times of benchmark rate. Since the new village banks are much smaller than credit cooperatives, we believe that at least the credit cooperatives' lending rate ceiling will be applicable for village banks. Given the current 5.85 percent benchmark rate in China, village banks should not be able to charge more than 13.5 percent interest: this is even lower than what commercial banks normally charge on the credit card revolving balances. On the other hand, underground MFIs may charge as much as four times the benchmark rate without violating the law, which means that it is easier for them to sustain their business and stay afloat. It also remains to be seen how the new village banks will grow with so many constraints and underground MFIs will fare in the new competitive environment. It took Yunus eight years before his Grameen Bank was officially recognised by the Bangladeshi government. How long would it take for China's Yunuses? - Benny Zhang
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