Microfinance in China : An overview

Wednesday, July 28, 2010, 16:26
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By Shaun Chan,

Microfinance Focus, July 28, 2010: Making financial services accessible to all social groups particularly the poor has proven to be an unprecedented success for reducing poverty and inequality for many developing countries in the world. The world’s most populous nation, China is home to 200 million people living in poverty. This figure represents 17% of all the world’s poor. China cannot be ignored in the quest to solve global poverty. However, the existing social organization in China poses steep challenges. Tight government regulations stand in the way for microfinance to flourish. Moreover, microfinance was born entirely from a principle of capitalism: namely that wealth is grown, not distributed. This is at odds with China’s purported socialism.

China has achieved massive development in her economic and social aspects since economic reform started in 1978. However, China’s financial sector is relatively underdeveloped and inefficient compared to other sectors of her burgeoning economy. It is dominated by four state commercial banks, has very high bank deposits and is plagued by misallocation of bank lending. However, China has made substantial progress in recent times through reforming her financial system. Some important reforms include the restoration of a commercial banking system, development of non bank financing, progress in rural financing, special lending priorities to SMEs, microlending and the rise of NGO-MFIs.

Microfinance Development in China

Microfinance is a relative young industry in China given that it was only introduced in 1993. The impact of microfinance in China will be huge given that China has large rural populations, high numbers of unemployed workers, many SMEs and micro enterprises, limited outreach to rural areas and high loan/deposit ratio of formal financial institutions.

Before 1994 the Chinese microfinance sector was in a highly experimental phase. During this period microfinance activities were limited to a myriad of development projects throughout the country that involved international foreign aid projects with some government intervention. Some projects that were being conducted then were the “Women, Population and Development” project implemented by United Nations Population Fund (UNFPA) for revolving capital, and Hong Kong Oxford for providing credit to rural households for livestock farming and veterinary services. The first experiment of Microfinance on the successful Grameen Bank model was replicated by the Chinese Academy of Social Sciences (CASS) in 1993 in China. The clients were poor rural women in four project sites- Yixian County, Hebei; Nanzhao County, Henan; Yucheng County, Henan; and Danfeng County, Shaanxi.

In 1995, the United Nations Development Programme (UNDP) undertook a microfinance experiment project at Yilong County in Sichuan Province and expanded it to 48 counties in 17 provinces, becoming one of the largest microfinance projects assisted by international organizations in China. In 1996, the United Nations Children’s Fund (UNICEF) began microfinance activities as the Social Development Program for Poor Areas. Besides microlending activities, UNICEF provided training on maternal and child health care. The United Nations Population Fund (UNFPA) began microfinance activities in 1998 and first loans were disbursed in 2001. In addition, several other international and national organizations came forward to participate in microlending in China including World Vision.

Similarly, the government has also been providing loans for rural development through the three leading financial institutions since the 1990s- the Agricultural Bank of China (ABC), for larger farming units such as seed companies and marketing co-operatives, the Agricultural Development Bank of China (ADBC), for storing crops, distributing, marketing, or processing agricultural products, or for large-scale agricultural development projects, and lastly the Rural Credit Cooperatives (RCCs) for the township/village enterprises (TVEs), and middle-income farmers.

Hence, RCCs were the first government banks to provide micro loans to the farmers. RCCs have reached almost every township of rural China under the supervision of the People’s Bank of China (PBC). In 1996, the RCCs were detached from the Agricultural Bank of China and converted into a ‘cooperative financial organization’ with rural labourers as share-holding members with the intention of having them democratically manage their interests. Among many tasks are to provide rural households with small loans and to ‘build up a credit rating system and establish a credit file system’. The recent years saw the RCCs promoting small loans to rural household in the form of ‘jointly guaranteed loans’ similar to the Grameen bank lending methodology.

The time-period of 1999-2004 earmarked the participation of formal financial institutions and the institutionalization of various projects. RCCs started to introduce microcredit loan and group loan businesses for rural households in 1999. The experimentation made by the various RCCs have seen much success in provinces like Shaanxi, Sichuan, Yunnan, Hebei, Guangxi, and Guizhou which experienced faster microfinance growth. At present, RCCs are the largest microfinance practitioners in China in terms of formal financial institutions. During this period, the PBC also promulgated the guidance on microcredit loan management of RCCs.

In order to help the unemployed seek reemployment and meet the financial needs of this group of individuals, the PBC, the Ministry of Finance, the State Economic and Trade Commission, and the Ministry of Labor and Social Security encouraged local governments to establish the reemployment guarantee foundation in 2002. Consequently, the unemployed were allowed access to start-up funds and working capital to attain self-employment. This initiative not only fulfilled the required funding needs but also expanded the microfinance market from rural to urban areas in China.

The past few years can be considered to be the normalization and institutionalization phase of microfinance. The phase begins with the issuing of a series of regulations by regulatory bodies in favour of microfinance development. Legalization of microloan companies was a significant event in the course of microfinance development in China as well as rural financial reform.

In the course of microfinance development, China Association of Microfinance (CAM) was set up in 2005. CAM consists of domestic MFIs, relevant administrative departments, and domestic and international organizations as well as experts and scholars which care for and support the undertaking of microfinance. It is a collaborative, service-oriented, and self-disciplinary organization. The main five functions of the CAM includes: policy coordination, self-regulation, technical assistance and training, information exchanges, and fundraising services.

In 2006, the China Banking Regulatory Commission (CBRC) permitted postal saving banks to gradually develop its collateral-based microloan services. At the same time domestic commercial banks and rural cooperative banks were also encouraged to set up fully-owned lending companies specializing in credit business. Since 2007, the CBRC encouraged microloan institutions and all financial institutions to offer microcredit to traditional farming households, households in a variety of business, sole proprietors and rural micro and small enterprises.

Additionally, CBRC permitted individual, corporate legal entities and other social organizations investment towards establishment of microloan companies in 2008. At present microloan companies are allowed to raise their funds from shareholders’ capital, donated funds, and borrow from (not more than two) banking financial institutions.

General overview of China’s microfinance policy

The government considers Microfinance a powerful measure for the alleviation of poverty yet there are strict policies on Microfinance activities in terms of legal status, interest rate and institutional deposits. Unfavourable provisions are also not conducive to the development of the market such as terms on the initiator qualification, shareholding structure, fund sources, and financing proportion of MFIs etc. Moreover, there is no clear policy definition for NGO MFIs. Recently though, the government has announced that there will be no cap on interest rates imposed by MFIs (compared to the previous cap of up to four times the benchmark interest rate).

The microfinance programs that use non-government funds for operation currently stay at the stage of permitted “trials”, without any generally applicable documents or regulations on detailed administrative methods. The present policy environment and management level of operational programs also fail to address the issue which will allow financial institutions and international aid agencies to invest more funds in microfinance. For the time being, China has no ideal credit environment or sound credit reporting system either.

Challenges in China

China’s microcredit organizations face a series of problems, including securing follow up funds, controlling risk, loan monitoring and regulation. Unlike large-scale rural financial institutions, with the influence of factors like small-scale registered capital and lower-level deposits, Village Township Banks (VTB) and RMCCs have difficulties in mobilizing savings so that insufficient sources of funding become initial problems in the pilot phase. New policies have expanded their sources of funding, allowing non-banking financial institutions to borrow from banking financial institutions, but the borrowed amount is not permitted to exceed beyond 50% of their net capital.

The risk control ability of China’s MFIs is also very weak, the evidence of which is their high rates of non-performing loans. Take RCCs as an example, according to statistics, the non-performing loan ratio was about 15.53% in 1999 and increased up to 27.25% in 2000, and since then, it has been increasing year by year and accelerating later on. The indicators present a remarkable gap as compared to those of foreign institutions. The high rates of non-performing loans are mainly attributed to the nature of microcredit and some specific management factors.

Although China has a large number of MFIs, a complete framework and system has not yet been formed to regulate and supervise those MFIs. There exist the issues of over-regulation as well as lack of supervision, furthermore, lack of flexibility and differentiation is also one problem of regulation and supervision. Regulatory issues increasingly become a major challenge for the future sustainable development of MFIs in China.

As for China’s MFIs, unclear legal status is a major constraint for MFIs to further develop. On April 24, 2008, the CBRC issued the Notice of Relevant Policies about VTBs, Lending Companies, RMCCs and Microloan Companies, enabling pilot microloan companies of the PBC to acquire a legal identity, and stipulating that natural persons, corporate legal entities and other social organizations that meet the registration requirements can invest in the establishment of microloan companies, thus allowing eligible microloan companies to be transformed into VTB or lending companies. Such provisions enable microloan companies to determine the issues such as nature, establishment, funding sources and use, and supervision based on the law, which is conducive to the healthy development of microloan companies.

However, there are still more than 100 NGO MFIs or quasi-governmental MFIs in which their operating funds mostly depend on the donations of external organizations and individuals, thus their funding source is relatively single. Due to lack of funds, only a few MFIs can achieve institutional and financial sustainability.

Way Ahead

A sound legal framework, rules and regulations should be constituted for microfinance. Policies need to be formulated and standardized in favour of the development of various micro loans and for the completion of relevant detailed administrative methods and regulations to enable MFIs easier funding access. Ultimately there is a need to improve the supervision means and monitoring mechanisms, and to ensure the independence and effectiveness of regulation and supervision.

There is a strong need to reinforce the education of credit awareness, constructing a sound credit reporting system and optimizing the credit environment. Credit awareness of end users and investors of microfinance needs to be improved by forging an environment of integrity throughout the sector via the popularization of microfinance knowledge. It is necessary to enhance the financial quality of the population and the prevalence rate of financial knowledge, as well as to improve upon the quality of financial professionals. Both the quality of financial professionals and the education of the majority of investors and consumers of financial services are extremely important for the sound growth of finance and the stable development of the whole society.

The quality of microfinance practitioners should be enhanced and development of microfinance industry as well as the standardization process needs to be promoted. It is also necessary to conduct comprehensive financial education and training activities for urban and rural grass-roots cadres, farmers, urban and rural microentrepreneurs, and undertake microfinance businesses and technical training activities for the credit staff of financial institutions, and to carry out the training activities related to relevant laws and regulations, microfinance and agricultural insurance and the management of microloan companies as well as microfinance methodology.

Meanwhile, the application of microfinance technology needs to be comprehensively facilitated and financial support must be provided for microfinance demanders so as to solve their difficulties in raising start-up funds.

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References

Du Xiaoshan (2006) Development and Policies of Microfinance in China. Retrieved on 23rd July 2010 from http://www2.marshall.usc.edu/…/(Revised)Prof.Du-MF%20DEVELOPMENT%20AND%20POLICY%20IN%20CHINA.pdf
He Guangwen, Du Xiaoshan, Bai Chengyu, and Li Zhanwu (2009) China Microfinance Industry Assessment Report. Retrieved on 23rd July 2010 from http://www.scribd.com/doc/20598261/China-Microfinance-Industry-Assessment-Report
LiLian Lau (2008) Poverty and Sustainability Issues of Microfinance in China: A Case Study in Fu’an, Fujian Province. Retrieved on 23rd July 2010 from www.niaslinc.dk/gateway_to_asia/nordic…/x50605528x.pdf
M. Wakilur Rahman and Jianchao Luo (2010) The Development Perspective of Finance and Microfinance Industry in China: How far is MFIs regulations? Knowledge Globalization Conference, 2010. Retrieved on 23rd July 2010 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1587950
Ruomei Sun (2005) The development of Microfinance in China. Retrieved on 23rd July 2010 from http://www.microfinancegateway.org/gm/document-1.9.26681/22.pd
Sun Tongquan (2008) The Policy and Legal Framework for Microfinance in China. Retrieved on 23rd July 2010 from www.microfinanceforum.org/…/Policy_and_Legal_Framework_for_Microfinance_in_China.pdf

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