NEWS WIRE: Financial Predicaments in China’s Rural Areas

Original news wire here.

China, November 20 – CEOCIO China reporter arrived in Jiaxian County, Shaanxi province in July with teachers and students from the “Financial Development in China’s Rural Areas” research team co-launched by HSBC and School of Economics and Management, Tsinghua University, for a 7-day study tour.

Jiaxian County is a state-level poverty-stricken area, which has been on the bottom of Shaanxi Province’s “Fortune” list for 19 consecutive years. Located in the southeastern part of Yulin City, the county has 8 townships with 653 administrative villages under its jurisdiction. Agricultural laborers account for 91.1 percent of the total population, which numbers 271,000. The county spans over a piece of land as large as 2,028 square kilometers. 30 percent of the area is sandy, 48 percent hills and ravines, and 22 percent mountains. Chinese dates are the only crop that can be developed as an industry in the county.

Such a poverty-stricken county has many peers in China. Jiaxian County is an excellent example to learn about the current conditions and future of finance in China’s rural areas.

Unsatisfied Demand for Loans
When the reporter met Ms. Jiang, she was sitting idle beside the table where people played cards. At the entrance to the village were two other grocery stores.

Jiang couldn’t remember clearly when she went to the local branch of Agricultural Bank of China (ABC) or rural credit cooperative. “It was probably when my children were young,” she recalled. Now her two sons have married and her daughter has graduated from college for some years. However, that she didn’t go to apply for loans at the local credit cooperative or ABC branch for years does not mean she is not short of money. Last year, she organized the wedding of her second son, leaving a debt of USD 1,000 (RMB7,000). “We haven’t paid off the debt yet,” she said.

Jiang and her husband borrowed money from their friends and relatives with a monthly interest rate of at least 0.6 percent. When Jiang fell ill last year, she couldn’t wait for the money from her sons. “I would have borrowed money from some of the wealthier villagers,” she said. If she maintains a good relationship with the creditor, she does not need to look for a warrantor. But if someone else introduces her to the creditor, a warrantor is a must. “Normally, we just reach an oral agreement, and I don’t write an IOU,” she said. She also told the reporter that when she was in urgent need, she would even borrow money with monthly interest rates of up to 1.5 percent or 2.0 percent.

Since she married, she has been living in a cave-house with her husband. Her family doesn’t have any savings at present, but a few hundred yuan are usually enough to see them through the month.

Mr. Cao, who runs a grocery at the village entrance, presents a different case. Over the past few years, he sent his four sons to college and had to borrow about USD 10,254-USD 11,719 (RMB70,000-RMB80,000). After squeezing all his friends and relatives, he took out USD 7,324-USD 8,789 (RMB50,000-RMB60,000) of poverty alleviation loans from the local credit cooperative. “I have just paid off most of the loans,” he said. In fact, he couldn’t get such a large amount of loans in his name, because the credit line for each household was just several thousand yuan. Cao had to use nearly eighty people’s names and ID cards to get the loans for his children’s studies.

Currently, in Jiaxian County, farmers need money for education and medical care. Chai Xiaoping, head of the county, called the county a “large depositor” because of its annual fiscal revenues of USD 2.9 million (RMB20 million) and per capita net earnings of around USD 300 (RMB1,900). Although total deposits amount to USD 87 million (RMB600 million), people can hardly secure loans. Approved loans stood at around USD 44 million (RMB300 million), half of which were circulated in other counties.

Therefore, when Mr. Cheng from Chengjiagou Village told the reporter the amount of loans he just received, people were shocked. He borrowed USD 51,270 (RMB350,000), and bought two agricultural vehicles with the loan.

Chengjiagou Village is located at Wangjiabian Town, where the Jiayu Expressway and Jiashen Expressway meet. Shenmu County, which is opposite, is blessed with abundant natural resources: the salt and coal-mining industries are well developed. Freight and transportation services are thus an excellent business choice. However, among the USD 51,270 (RMB350,000), only USD 6,591 (RMB45,000) was borrowed from local credit cooperative. The rest was secured from informal financial institutions.

The reasons why people don’t like to borrow money from the credit cooperative include complicated procedures and personal connections. Another important reason is that the credit line, which the credit cooperative can extend, far satisfies Cheng’s needs. According to Jiaxian County credit cooperative regulations, ordinary employees can only grant a credit of USD 2,197 (RMB15,000), and loan officers no more than USD 2,929 (RMB20,000). A loan committee should examine any application for a loan exceeding this limit. Cheng is well known locally and was therefore able to secure USD 6,591 (RMB45,000), the upper limit on loans from the credit cooperative. This is by no means enough to buy two agricultural vehicles.

In the Chengjiagou Village field study, we found that all the local families interviewed had borrowed money, all from private lenders. The director of the Jinmingsi Town credit cooperative roughly estimated that locally circulating private funds is around USD 732,440-878,928 (RMB5-6 million). In contrast, the aggregate loan of the cooperative branch was no more than USD 878,928 (RMB6 million). This means local farmers could demand double the credit.

Complicated Supply
Farmers are not unwilling to turn to formal financial institutions. Instead, it is because formal lenders can only provide a limited amount of loans. Among the three financial institutions in Jiaxian, ABC has only one office, and the credit cooperative has 24 branches.

According to Jiang, Vice Director of the local branch of ABC at Jiaxian County, he always wants to help bring up an enterprise that can benefit the bank, but his wish never comes true. The “enterprise that can benefit the bank” is an enterprise that can conduct a genuine commercial operation, manage itself and make a profit. In return, the local ABC branch is willing to lend money to the enterprise because they both win in the end. However, over the past decade, results have been mixed. “Many enterprises died in the end. Occasionally, a few of them went out of Jiaxian and even went nationwide. Eventually they did not need us,” said Jiang.

In fact, another more practical condition is that the local ABC is unable to extend any credit. “Each of our loan applications needs to be signed by the director before they are submitted to the city for examination. Then it will be returned to the county. The director does not have the authority to grant any credit. Nor do the loan officers,” said Jiang.

The picture over the last two years has been even worse. Due to restructuring, ABC needs to pay more attention to risk control and increasing its revenues from intermediate services. More importantly, a set of strict guidelines was put in place to standardize the borrowers’ qualifications. “In the grading system, only those whose score are above 70 points can be granted with loans. Those with a score lower than 70 points will not be eligible for any loans,” said Jiang. For him and his colleagues, these strict metrics resulted in consequently a small number of qualified borrowers.

ABC has only one office in Jiaxian County staffed with 15 loan officers. The bank implements a unified credit policy in both urban and rural areas across the country. “Actually, the credit business in urban and rural areas is different. In a poverty-stricken area like our county, many rules for urban areas are not applicable,” said a local ABC employee.

For instance, large loans are not applicable in the county-what people need here is micro-finance. But the head office does not have any related regulations. “If we extend loans of USD 439,464-732,440 (RMB 3-5 million), as our colleagues do in urban areas, we may not be able to recover the amount because the local economy is less-developed here, which in return, may affect our business development,” said the same employee.

This is why people in Jinmingsi Town jokingly say that Mr. Gao, Director of local credit cooperative, is doing “exclusive” business. Staffed with four employees and no loan officers, the credit cooperative office is responsible for the business in two towns. In addition to granting subsidies, the routine work also includes extending loans to farmers for business purposes. “This does not make much sense to farmers,” said a local government employee.

An important reason why it does not make much sense to local farmers is that the credit cooperative is more inclined to extend loans to farmers who can pay them back. In addition to the instinct of a business institution to pursue its business interests, the direct factor that influences the selection of eligible borrowers is an incentive mechanism. Although at Jinmingsi town, the salary of local credit cooperative employees is around USD 293 (RMB2,000), which is a large sum locally, if the loan that an employee extended cannot be recovered on time, 1 percent of the employee’s salary will be deducted each month until the loan is paid back. The instinct of business institution for benefit is directly transmitted to the work of loan officers, which influences the selection of borrowers.

Which is more difficult, extending loans or attracting deposits? Gao would choose the latter without hesitation. The local credit cooperative always raises funds through three channels. First, it collects as many funds as possible by itself, i.e. attracting savings. Secondly, it extends its business to the surrounding better-off counties by attracting deposits from wealthy people. Thirdly, it applies to the People’s Bank (China’s central bank) for agriculture-supporting re-loans.

These three measures are not enough to eliminate the problem. For instance, in terms of the re-loan policy of the central bank, due to the change in the policy for the Xi’an Branch of People’s Bank, the agriculture-supporting re-loans granted to Jiaxian are down from USD 16 million (RMB110 million) last year to USD 4.3 million (RMB30 million) this year. The USD 4.3 million (RMB30 million) will be taken back in due time, and will no longer be granted. “Therefore, we are facing huge pressure for funds,” said Gao.

The local credit cooperative in Jiaxian reports that at end of May 2008, savings deposited at local financial institutions amounted to USD 89 million (RMB608 million): USD 41 million (RMB280 million) in the credit cooperative, USD 33,506 (RMB33 million) in the local ABC branch and USD 12.9 million (RMB88.28 million) at the local post office, accounting for 47.84 percent, 38 percent and 14.52 percent respectively. However, among the granted RMB370 million (US$54 million), the credit extended by the credit cooperative, local ABC branch and post office amount to USD 41 million (RMB280 million), USD 12.3 million (RMB84.33 million) and RMB5.1 million (US$747,374), accounting for 75.96 percent, 22.67 percent and 1.37 percent respectively. That is to say, the credit cooperative extends 75 percent of the loans with 47 percent of the deposits. The remaining 1/4 is extracted by the local ABC branch, causing a serious outflow of funds.

There are three financial institutions. The credit cooperative plays a positive role, but fails to meet all demands. The local ABC branch normally only attracts deposits rather than grant loans. The banking operation at the post office has just kicked off, and is still being explored. Moreover, the postal saving service currently can only provide mortgage loans, therefore fails to make a substantial difference.

In addition to the single supply channels and inadequate supply, a more serious problem is that the formal financial institutions in rural areas are providing more and more services for non-agricultural purposes.

Origin of Problems
The demand for funds has increased, but supply channels are still singular. Demands are multi-faceted, but financial institutions are implementing uniform policies. Farmers are in great need of small loans, but formal financial institutions are highly selective when deciding eligible borrowers. The list of problems continues.

Since China adopted reform and opening up policies in the late 1970’s, financial reform experiments in rural areas have frequent. The government has been trying to boost economic development in rural areas by reforming the financial system and improving the allocation of financial resources. However, one unavoidable fact is that formal financial systems fail to solve the long-existing contradictions between the supply and demand of funds in rural areas. And as a result, the imbalance between supply and demand has not been adequately addressed.

Among all the reasons discussed, the most heavily debated is the role the government plays in implementing a transition of the financial system in rural areas. Even today, grassroots credit cooperatives are controlled by a provincial credit cooperative union in terms of loan application approvals and leadership appointments. This leads to inflexibility in decision-making in grassroots credit cooperatives. Some people believe the reforms have only shifted the intervention from the central government to local governments.

Other reasons mentioned include too much attention paid to stock adjustment and ignorance of increment introduction, or overestimating the ability of formal financial institutions to pursue their own interests. A more practical result is that the extension of more credit for non-agricultural purposes increases the gap between the supply and demand of funds in rural areas.

Yet another practical problem is the severe imbalance in economic development in different regions in China. For instance, some scholars place the demand for funds in China’s rural areas into three categories: for living purposes in less-developed areas of western China; for agricultural production in central China, and for further growth in China’s more developed eastern areas.

It has become necessary to break the current pattern of single and monopolized channels of fund supply and build a diversified financial eco-system that is business-oriented and full of competition. The Several Opinions on Relaxing the Access Policy for Banking Financial Institutions in Rural Areas for Better Support to the Construction of New Socialist Countryside issued by China Banking Regulatory Commission on December 20, 2006 is deemed as a significant reform breakthrough. According to the regulation, the financial market in rural areas will be deregulated on principles of “low threshold and strict supervision”. The new types of financial institutions in rural areas like village banks, loan companies and rural loan cooperatives will constitute a valuable supplement to the financial market in rural areas.

Who will Benefit from Financial Reform in Rural Areas?
In 2003 when it began its first term, the new government announced it would address two difficult financial problems, i.e. reform of state-owned commercial banks and the restructuring of the financial system in rural areas.

As commercial banks have been successfully transformed, it is time to reform the financial system in rural areas. The financial system outside major cities has been reformed in two aspects: major fund suppliers in the financial market and pricing mechanisms.

An estimated 120 million farmers in China are now in need of loans. Each year, the grant is around USD 146 billion (RMB1 trillion) less than the demand. Currently, only 60 percent of demand can be satisfied. This figure is merely 50 percent for small enterprises in rural areas. It is difficult for farmers to get loans from formal financial institutions. Therefore, they would often turn to informal financial institutions.

Legalizing trillions of yuan in private funds has become a pilot mechanism to address the short supply of funds. On July 15, the general office of Zhejiang Provincial People’s Government issued the Opinions on Carrying out a Pilot of Micro-finance Companies, starting the countdown for legalizing “private lenders”. In the next two or three months, legal and standardized small loans from private lenders will officially enter the capital market in Wenzhou.

The legalization of private funds will help to improve the fund supply in rural areas. According to some data, funds circulating in several major cities in Zhejiang province are over USD 146 billion(RMB1 trillion), USD 87 bilion (RMB600 billion) of which is in Wenzhou. Regulations prevent small loan lenders from raising funds internally or externally or attracting public deposits in any form. This only encourages lending instead of depositing. Furthermore, this loosens lender qualifications and deregulates the credit market for non-banking lenders.

Wu Xiaoling, former vice governor of the People’s Bank of China, recently indicated in public that the principle of small loan lenders only lending money but not attracting deposits encourages the growth of wholesale business between lenders and financial institutions. According to regulations, small loan lenders can borrow funds at a rate “no higher than 50 percent of their net capital” from banks.

“Actually, this is the ultimate target for which many international financial institutions are developing the financial market in China’s rural areas,” said an industry insider. For instance, HSBC once described their plan to develop the rural financial market in China. “In the second phase, we will study the possibility of launching other services, including directly providing loans to farmers, or indirectly by cooperating with the credit cooperative, rural loan cooperatives and agricultural enterprises.” A source argued that this is a mature business model, i.e. financial wholesale business, in other financial markets. </p.

Coincidentally, on July 18, Citibank also announced that it would enter a 3-year partnership with Peking University. One of the objectives is to finance the students at Peking University for field studies on finance in rural China. Previously, Citibank had begun the exploration of financial markets in rural areas. Citibank also plans to open at least 10 banks and loan institutions in China’s rural areas.

“The disparity in information, exorbitant costs and other factors contribute to the special interest of foreign financial institutions in the wholesale financial business in China’s rural areas,” said Li Qiangsheng, Chief Advisor to the HSBC-Tsinghua project. In many mature markets, foreign financial institutions invest their funds into the wholesale market through wholesale and then return the interest to local financial institutions via cooperation with grassroots village banks and funds for mutual-aid groups.

In addition, with financial reform in rural areas, opportunities arise for third-party guarantees, insurance and other upstream and downstream industries. This presents a fairly good opportunity for foreign financial institutions. For the local financial institutions that are more familiar with the local market, such opportunities should be easier to grasp.

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