A New Dawn for Microfinance in China, Part II

By Yan Yong
Published: 2008-08-19

From Nation, issue no.379, August 4, 2008
Translated by Liu Peng
Original article
: [Chinese]

Though community-based financing has long been popular in modern-day China, many such companies have been operating underground or semi-legally. Recent guidelines by the Chinese government on micro-finance companies may open the door for them to be formally accepted into the mainstrean banking and financial system, and hopefully help curb the usury businesses.

In Part I of this two-part series, we check out two pilot regions where micro-financing is being tested - Pingyao, the banking center of ancient China, and Wenzhou, the cradle of private capital following China's economic reforms.

Following is Part II of the series, an interview with Guo Tianyong, director of Chinese banking research center of Central University of Finance and Economics, on the challenges facing micro-financing in Zhejiang province.

The EO: Many refer to the move of setting up micro-credit companies as an official effort to "tame" or regulate those private money shops, which are abundant in Zhejiang, which their bosses are said to be relunctant of...

Guo Tianyong: Lots of private capital in Zhejiang has at one point or another been involved in underground financing. The pilot program for establishing micro-credit companies this time around is of a rather big scale, with over 100 qoutas, and in Wenzhou alone, about six would be approved. This is an attractive opportunity for underground credit companies to be legalized.

In the long run, the micro-credit company would likely stand a chance to be upgraded into township level banks--an incredible opportunity! Even if that didn't come through, micro-credit companies can still fundraise through legal means and acquire up to half of their capital from commercial banks under the existing regulations. This advantage alone is far better than the usury business which is totally dependent on one's own capital.

The EO: Even with the advantages you have mentioned above, such a micro-credit company would still be sidelined as it cannot accept deposits. Why are we hesitant in allowing deposits taken by these companies?

Guo: If the micro-credit company begins providing deposit services, its nature would have changed, and the regulations deployed would need to be changed too. Recently, the China Banking Regulatory Commission (CBRC) has issued a decree to regulate the operation of micro-credit companies, restricting deposit services.

In the past, the rural mutual assistance foundation and underground fund-raising had exposed various problems. Therefore, controlling risk is a top priority. I believe the permission for taking deposits would not be opened to all micro-credit companies immediately, or else, it could possibly turn messy. Screening for more credible companies is necessary, and finally, the regulatory body will select the better ones to launch a pilot program on deposit taking.

For instance, when the municipal government of Nanchong, Sichuan wanted to set up a township level bank, CBRC demanded that Nanchong Bank become a major shareholder in the township level bank, but the local government wanted independent community-based fund raising. That highlighted differences of opinions on risk control between governmental institutions, what more with private credit companies?

The EO: In other words, if a micro-credit company invited a commercial bank to be its major shareholder, that could be a way to get permission to launch deposit services?

Guo: Presently, micro-credit companies are mainly run by private capital without affiliation to the banks. The CBRC's main concern now is to prevent risks from arising.

The EO: In recent years, we have been worrying over risk in the financial sector, does that reflect weakness in supervision, or a lack of mediation mechanisms if a financial institution collapsed?

Guo: If a financial institution went bankrupt, first, the liquidation process would be very tedious; second, the regulatory body would have to assume responsibility.

Once a bank collapses, local government and administrative bodies would have a tainted report card. That's because the collapse would lead to social turbulence, especially when the deposit insurance mechanism has yet to be established. The CBRC's function is separated from the Chinese central bank, therefore, if a financial institution went under, the CBRC would turn to the central bank, asking the latter to foot the bill.

Yet on the other hand, the CBRC has always opposed the central bank's suggestions to set up deposit insurance mechanism for rural, township level, and small scale financial institutions. The reasoning given is that these institutions have low profit margins but bear higher risks. If they wered to pay for insurance, they would likely be forced into bankruptcy.

The EO: In the recent years, however, we do notice that many community-based and private-run financial institutions in Zhejiang, such as the private money shops, have been operating well and demonstrating a high-level of risk management capability. What is your view?

Guo: Well, the underground financial companies have their own tricks in collecting loan repayment; if you fail to pay up, just wait and see what happens. The legal and mainstream banks, however, are reluctant in issuing micro loans, and even if they do, the amount is so small that the motivation for them to chase after bad debts is little.

The EO: The financial environment varies from place to place, yet we always adopt the same policy. Do you think we should experiment with different interest rate policies in more market-oriented regions?

Guo: In fact, the latest pilot program on micro-credit has chosen the more developed coastal region in eastern China, with a more vibrant financial market than in inland areas. Previous round of pilot projects were implemented in poorer provinces like Gansu, Qinghai and Shanxi.

This time around, provinces like Zhejiang and Jiangsu are relatively more affluent, with larger fund raising markets and a better credit repayment capacity. In addition, underground financing has been doing well in Zhejiang previously.

One reason to open the door for micro-credit companies in Zhejiang is to meet the demand there, especially the small and medium enterprises facing tight credit controls from commercial banks.

As for the interest rates, some commercial banks do have room for adjustment yet they cannot publicly announced their interest rates are higher than allowed. Whereas in the underground or community-based financial market, the rate is basically market driven.

The EO: Presently, there are various grassroots levels and rural financial institutions, such as rural credit cooperatives, urban credit cooperatives, township level banks and micro-credit companies. This web of financial institutions seems rather confusing and messy. How can we make multi-level financing more satisfactory?

Guo: Having a diversity of financial institutions is a good thing because it can promote market competition. It is better to sub-divide the rural market demand. Generally speaking, larger banks like the Agricultural Bank of China, and Agricultural Development Bank of China can provide some medium and high grade services; while the smaller loan services should be left to the micro-credit companies, credit cooperatives and other small-scaled banks.

Though we are not lacking in financial institutions, we do lack a strong mechanism that could ensure the sustainability, commercial viability and proper risk management of the rural financial institutions. Private capital does have the interest to support rural financing, but when they enter the market, they realise the return on investment is low and risk high, thus we must think of a way to retain these institutions in the countryside.

Some have suggested the setting up of a bank specially dedicated to the small and medium enterprises. I disagree. Once the bank managed to attract large sums of deposits, it is likely not to channel the money to SMEs because we lack a strong supervision and management mechanism.

The EO: Looking back at the thirty-year history of China's opening up and reform, have there been discriminations against small scale, community-based and private capital?

Guo: China's economic growth was much weaker in the beginning of the reform, so the people had a strong desire to develop the economy, and that shortage of capital was the most urgent problem. When there was excessive demand for capital in the market, the government would squeeze the banks under its control.

In China, the economic reform is state-driven, thus official institutions would have more room for development. The financial sector is basically under state control, while the community and private capital are operating on the margins of supervision, or illegal.

If these unofficial financial institutions could play a role that the larger banks could not fulfil, the official would act in implicit acknowledgement and let them be; but once problem emerged, enforcement would come down hard.

In other words, the present private and underground financial institutions do have their contributions but they are not presentable enough, like a mistress that cannot be seen in public.