The notion that banks are built to serve those who are relatively well off has been challenged by Muhammad Yunus, the 2006 Nobel Peace Prize winner and founder of Grameen Bank, a microfinance institution. For the past 30 years, the Bangladeshi banker to the world’s poorest citizens has proven that, even in very difficult environments, providing very small loans to poor farmers and other entrepreneurs can be a profitable business.
On March 11, the China State Council’s Poverty Support Office, France’s Danone Group and Grameen Bank announced plans to jointly set up the Danone Microfinance Fund. It will join a list of newly established Chinese microcredit companies that has been growing in the wake of regulatory loosening over the past year.
The fact that rural finance has climbed up the Chinese government’s agenda should come as no surprise. After all, nearly 70% of China’s 1.3 billion people live in rural areas, and a widening wealth gap separates urbanites and rural dwellers. When the Chinese Communist Party’s highest leaders convened last October in a meeting held only once every five years, rural development was the main theme. Immediately afterward, the country’s top financial regulators, the People’s Bank of China (PBOC) and the China Banking Regulatory Commission (CBRC) issued guidelines to facilitate the innovation of financial products and services for rural customers. The guidelines called for experimentation with microcredit and rural group guarantee loans, noting that it is imperative to “innovate … and expand the guarantee scope … to improve the efficiency of credit resource allocation, and to experiment with issuing collective rural enterprise debts” to help develop the rural finance system.
“It’s more than [just] serving the poor,” said ex-banker Liu Ke Gu, who was in charge of microfinance and loans to small and medium enterprises at National Development Bank (NDB) until the end of last year. Liu spoke to the local media in early March at the annual congressional meeting in Beijing, where he serves as a member of the national committee of CPPCC. “In China, 75% of the jobs are provided by small and medium enterprises. Microfinance has made a significant contribution to relieving employment pressures in China, and it’s the most vigorous sector in the whole economy.”
Compared with an average loan value of US$10 to US$18 dollars in Grameen bank’s case, microfinance in China may not be so micro. NDB has issued 4.6 billion yuan (US$676 million) in microloans during the past three years, with an average value of 76,000 yuan (US$11,000).
However, microfinance does have an established history in China. Rural Credit Cooperatives (RCCs), the most extensive finance agencies in rural China, began microfinance operations ten years ago and had total loans of 3.2 trillion yuan (US$471 billion) by the end of 2007. According to a PBOC report on rural finance released last September, microloans to rural families by all RCCs in China stood at 300 billion yuan (US$44 billion), or almost 10% of the total.
In 2003, when Xiao Shan Rural Cooperative Bank (XSRCB) began, most present-day RCCs were in place and reform of their governance systems was under way. Wu Wei Jun, a loan officer in the bank, which is based in Xiao Shan in the relatively prosperous Zhejiang Province, says that total loans as of the end of 2008 were 23.2 billion yuan (US$3.4 billion), with loans to rural families at 3.85 billion yuan (US$570 million). Among these, 660 million yuan (US$97 million) are classified as microcredit (individual loans worth less than 100,000 yuan). “Our bank is profitable every year,” he says. “We are the number-two tax contributor to the local government.”
One potentially tricky issue for microfinance lenders is the business of evaluating the credit risk of individual rural borrowers. Data tends to be short, and the logistical challenges of collecting it can be forbidding. Nevertheless, Wu says that over in 20 years of working in the region, RCCs have built up a degree of knowledge and experience with handling the risks of local families and individuals. Village-level authorities also help to collect data and information for them to judge.
In the case of XSRCB, for single loans of less than 50,000 yuan (US$7,300), loan officers bear the risk themselves. Loans between 50,000 yuan and 500,000 yuan (US$7,300 to US$73,000) require a guarantee, or group guarantee, or a property mortgage. Loan officers will perform background checks on a potential borrower, asking locals about the person’s character and reputation. If this goes well, and provided the purpose of the loan is well-defined and the proper guarantees are in place, the paperwork will be done and credit issued within two weeks. “For a borrower who has a good record in the past, it only takes a few days for him to get a new loan from our bank,” Wu says.
Normally, the loan period will be less than one year, and the interest rate will be no more than 10% above the PBOC benchmark rate. Wu’s bank has total deposits of 40 billion yuan (US$5.88 billion). “The NPL [non-performing loan] rate for microfinance is a little higher than the average NPL rate for all of the bank’s loans,” he says.
Rural Finance Heats Up
The sum of single microloans on Xiao Shan Rural Cooperative Bank’s books might be huge by Grameen standards, but in less developed rural areas in China, the sums involved are smaller, with many farmers receiving sums of just a few hundred yuan. Cao Feng Lin, an official at Tong Zhou Rural Credit Cooperatives (TZRCC), a bank based in Tongzhou in Jiangsu province, says that his RCC lends 500 to 600 yuan (around US$80) to local farmers to enable them to buy seeds or fertilizer.
Even so, it is necessary to find one or two people in the neighborhood willing to act as guarantors, says Cao. “We have deposits of around 11.7 billion yuan (US$1.7 billion) and loans of 8 billion yuan (US$1.1 billion). Among them, around 100 million yuan (US$14.7 million) is microcredit for local farmers.” The bank charges 20% to 30% above the benchmark rate on non-mortgage microloans. “We definitely will [continue to] do micro lending to local farmers,” says Cao. “On top of the policy guidance, that’s also how our bank is positioned in the local area.”
Competition in rural finance service is getting hot, says Wu of XSRCB. “Now, the big four commercial banks are all setting up branches in the area. But they don’t do microfinance, which is too small for them,” he says. “In terms of microfinance, we are definitely the local people’s number-one creditor. We have 90% of the market”. However, Wu notes that the big four enjoy the advantage of an extensive network around the country, while their rural branches have absorbed high levels of deposits and provide more diversified financial services. Young people in the villages are more attracted by their innovative consumption products like credit cards or online banking, says Wu. “But Agricultural Bank of China (ABC) is a rival in terms of microfinance at the village level.”
ABC, the last big commercial bank in China not to have been listed, is set to go to public in the near future. By the end of June 2008, according to the PBOC, loans to rural enterprises and individuals had reached 1.36 trillion yuan (US$200 billion). Meanwhile, concerns over whether its focus will shift away from servicing the rural population have been allayed by the central government last year. Regulators have stated that ABC will continue to target rural dwellers and the agricultural sector.
The list of organizations extending small loans includes the newly established village banks, village capital cooperative agencies and microcredit companies.
Emerging Microcredit Companies
Following trials over the last three years, the PBOC and CBRC issued guidelines in May 2008 on micro credit companies. These were intended to regulate and oversee the thriving underground lending business. Under the new rules, microcredit companies are allowed to be formally incorporated under certain conditions. They can lend, but are not allowed to take deposits, while the permissible interest rate has been set between 0.9 to 4 times the benchmark rate. Interest rates above this will be considered usury.
However, the vast majority of underground loans are as far from “micro” as could be imagined. “The average loan value is nearly one million yuan,” says Wang Zhen Jiang, a business reporter from 21 Business Herald based in Beijing, who surveyed several newly established microfinance companies in inner Mongolia in January and February of this year. “Less than 20% of the loans of the microcredit companies I visited are serving the rural population,” he says. “Most of the loans are given to Livestock breeders and small businessmen with no property to mortgage.” These loans mostly serve the wealthiest of the poor, he says, whom the banks believe have the potential to become better off still.
There are other inconsistencies between the vision of policymakers and how microfinance looks today in China. Following his own on-site research at the end of last year, Jiao Jin Pu, deputy director of the PBOC’s financial research institution, pointed out that some microcredit companies hope to gain banking licenses in the future. This “deviated” from the original intention, he said. The official guidelines state that some well-operated microcredit companies will have the opportunity to receive a banking license in the future, albeit with certain restrictions placed on corporate governance.
The Danone Microfinance Fund is just one of a growing number of new foreign entrants. The competition has heated up, with more companies and banks chasing after the scant resources of the poor, Wang observes. In Inner Mongolia, he notes, foreign microfinance companies from Germany and other countries are also entering the market.
The New Kid on the Block
Guan Da Qing, head of the Shang Tang Road branch office of the Postal Savings Bank of China (PSBC) in Hangzhou, the capital of Zhejiang Province, met with China Knowledge at Wharton in his newly renovated office, which began operations just a few weeks ago.
PSBC, spun off from the China Postal Bureau and formally established in the beginning of 2007, started operations at the provincial and city levels last year. PSBC is believed to have the most extensive depository network in rural China: Its more than 10,000 rural offices make up more than 73% of its total footprint. Moreover, its “deposits only, no lending” business model has been overhauled. Now a bank, the PSBC has started to march into the finance industry.
“The rural population and small businessmen are definitely our clients,” Guan says. Loans ranging from 1,000 yuan (US$147) to 100,000 yuan (US$15,000) will be issued by group guarantee or as personal credit. Loans with a property-mortgage guarantee can be up to 500,000 yuan (US$73,500). Given the location of Guan’s branch office, his microloans mainly target small business owners in the city. “Yes, it’s costly, and you need to devote more effort to these micro borrowers, but we definitely will need to do it, not only because it’s policy directed, but also because there is profit in doing microloans.” PSBC, unlike RCCs, can enjoy an interest rate of more than 15%.
The other reason why PSBC is now focusing on microfinance has to do its positioning strategy, Guan explains. Since large clients have already been gobbled up by commercial banks, the newly opened PSBC must find its own niche market in both urban and rural areas. As one example of how it is doing this, Guan is now working with the local government of Jian Qiao Town, a rural town near Hangzhou, on a loan project that will provide small business owners with microloans.
The cap set by PSBC on microloans — 100,000 yuan (US$15,000) — is considered too low in an area like Hangzhou, the capital of one of China’s richest coastal provinces, according to Guan. “The working capital a small business owner here would need is more than 100,000 [yuan] to buy his goods at one time.” The quality of banking personnel is another area in which progress is required, says Guan, “but the current economic contraction has provided us with some opportunities to absorb good talent from the marketplace.”
For Profit or Social Responsibility?
As everyone now realizes in the wake of the current financial crisis, risk control is key for finance institutions. In Yunus’s case, he took the risk on himself in the beginning. In an interview by Nightly Business Report a few years ago, Yunus said, “I went to the bank and proposed that they lend money to the poor people. The bankers almost fell over. They couldn’t believe what had been proposed to them. They explained to me that the bank cannot lend money to poor people because these people are not creditworthy. So a long series of debates began with me and the banking system. Finally, I resolved it after about six months by offering myself as a guarantor. I said, ‘I will sign the loan papers. I will take the risk, and you give the money.’ I got the money and gave it to the people. And luckily for me, all the people paid it back. The banks had been saying that I would never get the money back and would ultimately have to pay it back myself. I said, ‘I don’t know anything. Let me try it out.’ And I tried it, and it worked.”
To get deals done with banks, there will have to be some form of guarantee in place. Although group lending is a great innovation, it’s not that easy in practice. “It takes a lot of effort to get group guarantees for loans,” Guan of PSBC says, “because in reality, it’s not as easy as it looks for you to get three couples [six persons in PSBC’s case] to sit together to guarantee each other and sign the deal.”
For Tong Zhou Rural Credit Cooperatives, Cao Feng Lin says that guarantees are relatively flexible, “but you still have to find someone in your neighborhood to be the guarantor.” He acknowledges that the risk control process is now getting much more attention and is much more tightly managed compared with a few years ago.
In some cases, the local government will be the guarantor. Two years ago, Qiong Zhong County, Hai Nan province, China’s most southerly province, set up a microfinance project that is considered to be a notable model of successful cooperation between RCCs, local government and rural families.
In order to support local rural families in chicken breeding or special planting businesses, the local county government has established a county guarantee company which offers insurance for the guarantee. The microloans are thus guaranteed by the local guarantee company, while farmers need to have a group of more than five people to guarantee each other. The county government has taken one million Yuan from its fiscal rural-support spending to reimburse all the interest to lenders who return the money in advance. Lenders who return the money on time will get 80% of their interest back. The county has also established a microfinance officer system to follow up with every rural family with a loan in order to provide support and to monitor their progress.
According to Xiao Siru, council general of Jiang Xi Province Rural Finance Cooperatives, in order to make microloans to farmers a sustainable business, the rural credit system — including evaluation, management and development — has to be established and improved. Addressing this issue, Xiao says, will require a large-scale effort to improve the credit system and credit environment in rural areas.
On the lending rate issue, Wang Jun, senior researcher at China Research Center of Tsinghua University, calls for a relaxation of the cap for the microcredit companies. “As long as the client is willing to accept a higher rate and the bank is aware of the risk, why not allow it to be higher than four times the benchmark?” he asks.
Furthermore, both Xiao Siru and Liu Ke Gu of National Development Bank advocate fiscal and monetary support for rural microfinance institutions. Liu submitted a proposal at the national CPPCC convention last week that called for tax exemptions for these organizations.
However, there is an inherent contradiction between the for-profit banks and the high-cost and high-risk nature of microfinance in some rural cases, acknowledges Xiao of Jiang Xi RCC and others. “Grameen Bank focuses on the clients’ future, instead of the past. If the borrower cannot return the money, we are not angry or punishing [towards] him; we help him to find a solution instead,” said Yunus in a recent interview in China. “We are a bank to help the poor,” he added, calling for microcredit companies in China to shoulder social responsibility before developing further.