China’ state banks are ridden with debt from ill-judged lending, while up to three quarters of rural households and tens of millions of urban people lack access to credit for productive investment.

In the 1990s, international organisations were keen to introduce microfinance practice to China, and a small community of Chinese microfinanciers developed. But continuing policy and operational constraints have cooled donor interest, while many programmes rolled out by the government of China have paid scant attention to microfinance principles.

Change may be on the way, though, as government seems determined to ‘deepen’ reform of Rural Credit Cooperatives, if not yet to abandon its subsidised ‘poverty alleviation loan’ programme.

Thanks are due to many individuals consulted in the course of researching this article, and particularly to the sector specialists who contributed written responses to an email survey conducted last year.

Communists and bankers are not natural bedfellows. Small wonder, then, that financial sector reform should prove so hard to achieve in China – even after two ‘glorious to be rich’ decades in which the top leadership has appeared ever more firmly committed to capitalist accum-ulation and growth.

At the end of last year, the central government paid out USD 86 billion – well over a year’s public spending on health and education combined – to prop up two of the biggest state-owned banks, the China Construction Bank and the Bank of China. ¹

The bail out is all the more striking for the fact that China is famed as a nation of savers who, each year, deposit around USD 240 billion – fully 20% of GDP – in bank accounts.²Such a high domestic savings rate, one of the highest in the world, is routinely cited as a factor in the country’s robust, economic performance; and it ought to provide plenty of working capital for the banks. So why should they keep needing extra injections of govern-ment cash?

Simply, because so much capital has been squandered on bad loans. Up to a quarter of the money lent out is not paid back, and current ‘non-performing’ loans are thought to amount to USD 500-750 billion. ³

In its dealings with international devel-opment banks the Ministry of Finance is strict about borrowing only for projects that will bring a financial return. The World Bank and Asian Development Bank have so far been unable to persuade the government to borrow at commercial rates of interest for investments in health and education that may have long term economic as well as social benefits. The government insists that international loan projects must generate the cash to repay the loan. But this hardheaded principle is not yet reflected in the domestic banking system.

Bank loans have often been used to stave off bankruptcy of failing state owned enterprises, with little or nothing done to ensure their longer-term competitiveness. Central government may rail against this, but local leaders, who are able to influence the banks’ lending, will use any means at their disposal to avoid more unemploy-ment in their area. They can also use their influence to secure finance for white elephant development projects that may boost their own prestige or temporarily inflate local GDP, but that soon fail economically.

During a previous government bail out, in 2000, debts amounting to CNY 1.3 trillion (USD 157billion) were transferred from the four main state banks to Asset Management Companies charged with recovering whatever they could. Some of these ‘distressed assets’ have since been sold on, at bargain basement prices, to Wall Street banks. (Morgan Stanley, the biggest player so far, bought USD 1.3 billion worth of debt for just USD 65 million. Goldman Sachs, J P Morgan and Citigroup are also acquiring portfolios of Chinese distressed assets.) These foreign investors can negotiate to convert the debt they have bought into equity in the debtor companies, and try to restructure them into viable enterprises. Or they can simply bully and squeeze whatever they can out of the debtors. A recent Wall Street Journal article on Morgan Stanley’s debt-recovery efforts emphasised, and seemed to admire, the latter approach. ⁴

In what may prove a controversial move, the Asian Development Bank is now proposing to finance debt purchases by international or Chinese investors.⁵ Helping merchant bankers buy Chinese debt may seem a rather indirect way of pursuing its ‘poverty alleviation’ mission, but the ADB doubtless sees itself as build-ing the foundations for future growth.

Remedial action of any kind is a very poor substitute for using loan capital productively in the first place. A huge amount of money has been wasted not just because so many loans fail to ‘perform’, but because potentially pro-ductive sectors of the economy are starved of the credit they need to grow and flourish. So acute are the problems that, some international doomsayers warn, China not only faces economic slowdown as capital is deployed unproductively, but may even risk financial collapse. ⁶

Many Chinese economists share these concerns, but they are seldom discussed openly in Chinese mass media, for fear of precipitating a crisis of confidence. The withdrawal of savings could easily trigger financial sector implosion.

Central government is certainly aware of the risks, and pressing the banks to adopt a more commercial approach. The impetus to do so is increased by WTO accession agreements that commit China to opening its financial services market to international competition by 2007.

As in other sectors, government policy has been to open financial services first to Chinese investors and then to inter-national investors. Recent years have thus seen a move towards partial privatisation of the banking sector: notably, in the fully private Minsheng Bank, established in 1996 by a former pig feed salesman. It is now reported to have much better ‘asset quality’ than state competitors, and is planning this year to raise USD 1 billion by offering 20% of its stock on the Hong Kong stock exchange, in order to expand its chain of 126 branches. ⁷

Some of the smaller and more streamlined state owned banks, such as the Pudong Development Bank and Shenzhen Development Bank, have also sold shares on mainland stock exchanges. In Zhejiang, a historic centre of private enterprise, nine private companies were allowed last year to buy stakes in the Wenzhou Commercial Bank.⁸ Two of the ‘big four’ state banks, the Bank of China and China Construction Bank are said to be planning to follow Minsheng’s lead by selling shares abroad within the next two years.

Accountability to private investors may improve the banks’ balance sheets, but the more commercial they become in their operations the more likely they are to look for lending with high returns and loan guarantees. This generally shuts the door on poorer borrowers. Which is where microfinance comes in.

Finance for the little folk

China’s banks now offer personal loans for better-off professional and salaried staff in urban areas to buy homes and cars. Lending of this kind is growing fast, accounting for around 20% of new loans.⁹ But small businesses, farmers, migrants to urban areas and laid-off workers hoping to start new business ventures are at the end of the queue for formal credit. According to the People’s Bank of China (the Central Bank), no more than a quarter of rural households have access to formal sources of credit¹⁰– in the main, through a national network of some 38,000 Rural Credit Cooperatives or through the Agricultural Bank of China. Most must either do without, or borrow from kin, or turn to China’s myriad informal financial institutions. ¹¹

There are, at first sight, commercial reasons for excluding the rural masses from the formal financial sector. Farmers have no land titles that they could use as loan guarantees so the lender’s risks are high, as are the transaction costs of doling out and recovering millions of small loans. But these factors would better justify ‘credit rationing’ if China’s banks had proved a commercial success – which, as the repeated bail-outs show, they have not.

If there were enough jobs in big factories and service industries to absorb laid-off workers and underemployed, rural labourers – kicking their heels at home on their tiny farms, with no productive outlet for their energies – then it would not matter so much that credit scarcity constrains their potential for productive self-employment. But there are not enough ready-made jobs. The World Bank now puts effective unemployment at ‘over 10%’ and estimates ‘conservatively’ that, during the current decade, China will need to create at least 8 to 9 million jobs per year to absorb 80 million young people entering the work force; yet recent job-creation rates have lagged at only 5.5 to 6.5 million new jobs per year. ¹²

All the more reason to maximise opp-ortunities for people to create their own work. The dynamism of private initiative was, after all, demonstrated by the de-collectivisation of agriculture in the early 1980s, which proved a critical engine of subsequent growth.

An international movement

At much the same time that the Chinese countryside was de-collectivising, the Grameen Bank in Bangladesh was show-ing the productive potential of people with low incomes, once given access to credit. The bank’s founder, Mohammed Yunus, began in 1976 by lending to women basket weavers who were previously borrowing small sums each morning from private moneylenders, and repaying with 10% interest at night, having made and sold their goods for a tiny profit. In the years since then the bank has supplied loans to more than three million people in Bangladesh, 97% of them women, with repayment rates of 99.16%¹³ It has also developed a national communications subsidiary that works to make new information and communications techno-logies accessible to village people.

Moreover, although the objective was always to provide a service rather than to turn a profit, the bank’s lending has proved to be commercial, showing that it is possible to extend financial services to people who lack collateral without this requiring subsidies or ‘charity’.

The basic ‘Grameen model’ is to make small loans (generally below USD 300 per year) to individual women who form ‘mutual guarantee’ groups. If one woman defaults, the five or so others in her group must repay on her behalf, or they will not be eligible for future loans. This incentive is enough to ensure prompt repayment, in weekly or monthly instalments, at a rate of interest that is high enough to cover the transaction costs. The model thus demon-strates that low-income clients can be creditworthy, and can be served in financially sustainable ways, without the need for hand-outs.

Grameen’s influence has extended a long way beyond Bangladesh. In much the same way that, from the 1970s, China’s experiments with ‘barefoot doctors’ inspired global interest in primary health care (even if the original model was not quite what its overseas admirers imagined), during the 1980s and ’90s the Grameen Bank fired the imaginations of those working in rural development. It has served as something of a flagship for a global microfinance movement committed to extending financial services to the poor in developing countries.

Yet Grameen’s is by no means the only microfinance model to have proved successful. Some programmes lend to in-dividual borrowers, requiring collateral much like a traditional bank, but make a special effort to identify and attract poorer clients, with ‘loan products’ tailored to their needs. Others lend livestock instead of money. Credit and savings cooperatives have also flourished in many places.

The Foundation for International Community Assistance (FINCA), estab-lished in 1985, piloted ‘village banking’ – savings and credit associations managed at village level – in several countries of Central and South America. It has since begun programmes in Africa and Central Asia, with more than USD 40 million per year in working capital worldwide.¹⁴

In Bolivia, BancoSol (Banco Solidario) was established in 1992 as a commercial operation serving micro-entrepreneurs, and by the end of 2001 it had more than 53,000 active borrowers, of whom 63% were women.¹⁵

Bank Rakyat Indonesia provides financial services on an even larger scale for people on low incomes. This is perhaps of especial relevance to China, as the bank was established in its present form in 1983 in response to a crisis in Indonesia’s banking sector which, like China’s today, was struggling with a high ratio of non-performing loans. Bank Rakyat is state-owned bank but now operates through village level branches that aim to serve small entrepreneurs. At the end of 2002 it had more than 3 million active borrowers (although only 18% of them were women), with outstanding loans of USD 1.4 billion.

Microfinance has, then, increasingly been seen as an important tool for pro-poor development, and has in many countries been delivered on a significant scale. This is not to suggest that the idea of providing credit to small entrepreneurs is itself new. From the nineteenth century, credit unions, cooperative banks and mutual societies played an important role in providing financial services for farmers and small businesses in Europe and North America; and informal associations of this kind also evolved in many parts of the world now dubbed as ‘developing’.

But recent interest in microfinance does embody relatively new recognition – arguably first advanced by NGOs – of little folk as important agents of dev-elopment, not just its passive beneficiaries. International donor agencies now also generally espouse this position, as part of a post-Cold War approach to development that emphasises a reduced role for the state.

At the same time, however, promotion of microfinance is not an unqualified vote in favour of market forces. On the contrary, microfinance practitioners often present it as an attempt to ‘correct market failure’. The market, left to its own devices, tends to exclude the poor from credit facilities altogether, or else expose them to the kind of 10%-per-day interest rates demanded by the Bangladeshi loan sharks.

Pro-poor microfinance is therefore intrinsically interventionist, aiming to create, and ideally institutionalise, oppor-tunities for poorer people. This is seen both as a matter of social justice and as a way of building a platform for new, vigorous enterprises to develop: for, with a foot on the ladder, some of today’s micro-enterprises may grow into substantial ventures.

Summarising international experience of microfinance, Martin Holtmann, of the Frankfurt-based consultancy, IPC, has described three intervention strategies. Firstly, encouraging existing banks to reach out and offer services to poorer clients. Secondly, building on existing but informal community based credit insti-tutions. Thirdly, creating new banking institutions from scratch.

National and international agencies have experimented with the first and third of these approaches in China. But, despite an accretion of useful experience and the testing of a plethora of ‘models’, progress has been patchy overall, hindered by policy obstacles and government ambi-valence about the respective role of state and market.

Policy barriers

Banking is tightly controlled in China. The controls may not have succeeded in ensuring sound banking practices, but they have strictly limited the number of lawful players. Central Bank approval is required to operate but, in what is a familiar ‘Catch-22’ for China, there is no recognised process for applying and obtaining that approval and thus for entering the market lawfully. Those who enter without per-mission may be subject to crackdowns and severe penalties.¹⁷ Holtmann’s second strategy for developing microfinance – building up the capacity of existing, informal institutions – has therefore not been a practicable option in China.

Pre-communist China had numerous informal mechanisms for supplying credit to small traders and farmers. Family rel-ations were, and remain, the main source of borrowing for ‘consumption expend-iture’ associated with weddings, house building, medical bills and funerals. But lineage associations, revolving loan clubs and even monasteries also loaned funds for productive investment The Mao regime shut down these credit channels; but, during the two decades of post-Mao reform, informal (that is, illegal) finance has reappeared in both old and new forms – ranging from mutual-aid arrangements to private moneylenders who charge interest of 2-4% per month.¹⁸

Informal finance almost certainly played a significant role in the resumption of private faming after the break-up of the rural communes, and again in financing the rural industries that sprang up in the following years. Recognising its import-ance for economic development, some local officials have turned a blind eye to, or even unofficially encouraged, informal credit channels. But central regulators have firmly opposed this, leaving informal financiers in a position that is at best precarious.

Strict control over savings accounts is a major barrier to the emergence of new microfinance institutions. Only registered banks, RCCs and post offices are author-ised to accept deposits from China’s millions of thrifty savers. This means that new institutions or projects that are keen to develop ‘loan products’ for people on low incomes are unable to get the working capital they need by accepting savings deposits. It has also meant that deposits from rural savers tend to flow out of rural areas to investments in urban or industrial projects, which the formal banking sector favours.

The government also sets loan interest rates and these are extremely low – currently around 6% per year. Because of the relatively high costs of making small loans, microfinance depends upon relat-ively high rates of interest – at the very least 12% per year, and in some cases as much as 30%. Practitioners vigorously defend this, arguing firstly that people on low incomes can, if they are making sound productive investments, afford these rates; secondly that for most clients the only alternative source of credit is to pay even higher rates to loan-sharks; thirdly that low-interest loans are likely to be snapped up by better-off clients who already have access to formal sector credit, and fourthly that cost recovery through interest rates is the only way to provide a sustainable service that can serve increasing numbers of people.

Internationally funded projects over the last decade have been able to negotiate permission to charge higher interest rates for experimental purposes. (Some have also been allowed to require borrowers to open savings accounts, in order to encourage the habit of regular saving; but the deposits in these accounts cannot be used for lending to other clients). These projects have claimed significant success and have certainly attracted the attention of government agencies, but there has been little fundamental change in the overall policy environment. Only one or two county-level programmes in China can yet claim to have recovered their costs or achieved financial sustainability; and for these there is no clear path to becoming established as permanent microfinance institutions.

Poverty and ideology

Tight government control of the financial sector may best be understood in terms of enduring communist ideology. Usury was one of the evils, along with exploitation by landlords and capitalists, which the Communist Party set out to eliminate. Officials schooled in Party history – and let us not forget that Party documents still routinely, if speciously, contrast the peasants’ situation before and since Liberation – do not easily accept the startling claim that it benefits the poor to be offered high-interest loans. Officials are more inclined to believe that the poor need special assistance and subsidies, rather than additional burdens.

This welfare mentality is often accompanied by a perception of the rural poor as ‘backward’ or of ‘low quality’: people who need ‘lifting out of poverty’ rather than people who, if they had a ladder, could climb out by themselves. Given this attitude, it becomes natural to see the challenge of poverty in terms of limited resources – land is too scarce, the state is cash-strapped – rather than in terms of policy constraints on the productive capacity of the capable poor.

China’s ongoing anti-poverty drive is certainly in earnest, and has prompted some useful reflection and debate, but it has so far largely reflected a welfare mentality and approach. To many international observers, it is increasingly apparent that economic reform in policy areas such as fiscal decentralisation has proved regressive, hitting the poorest hardest. Yet the government’s war on poverty has largely been conducted through the injection of funds into regional poverty alleviation ‘projects’. This is not a policy response so much as a remedial, compensatory mechanism. ‘Poverty alleviation loans’ have figured prominently in these government projects, – and have, latterly, often been presented as microfinance components. But, true to the welfare orientation of the programmes, these have always been offered at low interest (typically 2-3%).

Who (and what) is microfinance for?

In this context, it is important to ask in exactly what sense microfinance can or should be a tool for poverty alleviation. Whose poverty can it realistically alleviate? Who are the appropriate targets groups?

On these fundamental issues, there are mixed messages from an international microfinance community that in fact embraces a broad range of approaches. Many groups, especially in South Asia, have talked up the ability of microfinance to reach ‘the poorest of the poor’, and compete to find and serve the poorest clients. Others speak instead of serving ‘the poorest of the economically active’. Yet others tend to eschew talk of the poor altogether, describing their services instead as targeting ‘people on low incomes’, ‘small entrepreneurs’, or even ‘small and medium enterprises’. This has been a common tendency in Latin America, where many practitioners are adamant that microfinance programmes must be fully integrated into the formal and commercial banking system.¹⁹

Nearly all internationally sponsored projects in China have adopted a ‘poorest of the economically active’ approach in the sense, at least, of excluding those who are too old, too sick or too incapacitated to work, and who typically comprise the literal ‘poorest of the poor’. For these constituencies, it is often argued, other kinds of assistance are more appropriate. (Although the capacities of elderly and disabled people should not be underest-imated. Some microfinance programmes [eg, those of HelpAge International and the China Disabled Persons Federation] target precisely these constituencies.)

But, beyond the apparent consensus that borrowers should be able to work, internationally funded projects in China have differed widely in the weight they attach to commercial viability and sustain-ability. For some, the whole point is to permanently increase the number of people with access to productive capital. Others have looked on provision of credit as a useful tool for achieving broader goals – poverty alleviation, women’s empower-ment, environmental conservation – and have been more willing to depart from strict criteria of financial sustainability.

An equivocal international triumph

International projects are now dwarfed by programmes run or mandated by Chinese government agencies. These have so far paid little or no attention to sustainability.

The government’s embrace of micro-finance as a poverty alleviation tool may to some extent be seen as a triumph for international cooperation. But it is an equivocal victory, because international models have been distorted in the adoption. Purists would deny that govern-ment loan programmes even qualify as microfinance.

International organisations have been sponsoring microfinance experiments in China for twenty years. (See panels on pages 22 to 27). Many of these have used a var-iant of the Grameen Bank model, but other methods have also been piloted with apparent success. When this publication last reviewed the field, five years ago, nearly all donors were claiming effective targeting and high rates of loan repayment, even at interest rates well above the government norm and ranging as high as 20% per year. ²⁰

At the same time that these exp-eriments were taking place in the field, the international donor and NGO community was questioning the targeting and efficacy of China’s own poverty alleviation pro-gramme, overseen by the Leading Group for Poverty Reduction (LGPR).²¹ From 1986 to the end of 2000, CNY 154.6 billion (USD 18.8 billion) of central fund-ing was allocated to poverty alleviation projects in 592 counties officially desig-nated as poor.

These poverty alleviation funds were allocated partly to general budgetary supp-ort for county governments, partly to food-for-work programmes on infrastruct-ure projects such as irrigation systems, terracing and land reclamation, and partly to low interest loans. The loans were usually invested by local officials in projects that they (often mistakenly) believed would bring a financial return, especially those that promised to increase local government revenue. Investment was thus inherently biased towards urban as opposed to agricultural projects, and ranged from support for existing enterprises to building hotels and restaurants in the county seat. At best, these projects had only ‘trickle-down’ benefits for poor families; and the benefits had a long way to trickle, given research findings that ‘the great majority of households in poor counties are not poor.’²²

From the late 1990s, in order to prevent diversion of poverty alleviation funds to non-poor areas within ‘poverty counties’, the LGPR (with the encourage-ment of international agencies) urged that poverty loans should be directed to rural households. The Agricultural Bank of China (ABC) was charged with distrib-uting low-interest household loans.

This was at variance with ongoing efforts to commercialise the ABC’s activities. The financing of grain procure-ment and other ‘policy lending’ was in 1994 transferred to the newly established Agricultural Development Bank, leaving the ABC free to concentrate on using its deposits to make commercially viable loans. Given this mandate, it has preferred to lend to enterprises with assets that can serve as collateral, and as a result only 10% of its general lending is agricultural.²³ Most branches regard the ‘poverty loans’ as an administrative burden and diversion from more profitable investment rather than an opportunity to develop and serve a new client group. In practice, local poverty alleviation officials appear in many cases to have retained responsibility for identifying clients for the poverty loans. ²⁴

Some local officials resisted the move towards household lending, continuing to believe that the poor are not creditworthy. Others distributed poverty loans in return for kickbacks. According to Chinese researcher, Wang Sangui, ‘field interviews in many of China’s poor areas confirm that [this] is often the rule rather than the exception’.²⁵ Jonathan Unger, a veteran international researcher of rural China, also reported last year that during recent fieldwork in southwest China, ‘I came upon several instances where quite pros-perous households had been provided with substantial aid-the-poor credit; and in all of these cases, the households were closely connected to important local officials’.²⁶ In short, wealthier and better-connected households seem to have headed the queue for this new source of subsidised credit.

Nevertheless, targeting of poor house-holds – fupin dao jia – became an official mantra and, according to an ABC official, in the four years from 1998 to the end of 2001 17 million families received poverty loans totalling CNY 25 billion (USD 3 billion).²⁷However, in 1998 fully 60% of the loans were not repaid, and a senior Chinese government researcher has est-imated that, over the period as a whole, the non-repayment rate was high as 67%.²⁸

The poverty loan programme doubt-less works better in some places than others, but these aggregate figures suggest a general picture of poor management, monitoring and evaluation, and a system that remains imbued with the belief that the poor cannot really be expected to repay. The programme’s main emphasis is on boosting people above the official poverty line (an objective whose political importance inevitably introduces pressure to distort reporting) rather than on creating a sustainable supply of rural credit. Nonetheless, some officials within the government poverty alleviation system have come to see microfinance as a valuable instrument for poverty alleviation.

In addition, some provincial govern-ments, and very many Women’s Federation provincial branches have rolled out their own microcredit programmes. In some cases, these have imitated the Grameen model in using group loan guarantees, but set interest rates well below financially sustainable levels.

Ironically, one effect of this Chinese government venture into microfinance was to force the contraction or early closure of several international projects that were attempting to demonstrate the viability and sustainability of high interest rates, but that could not compete when other cheap sources of credit became available.

One of the most devastating critiques of the government’s poverty alleviation programmes has come from a joint study by the Chinese Academy of Sciences’ Centre for Chinese Agricultural Policy and the International Food Policy Research Institute. The findings suggested that the impacts on poverty of poverty alleviation loans are much lower than the impacts of public investment in (in ascending order) rural electrification, roads, agricultural research and development and, above all, education.²⁹ The researchers concluded that ‘Increasing investments in education should have the top priority in . . . Government spending in rural areas’ and that ‘The small impact of the government loans specifically targeted to poverty reduction indicates that the government may have to either reduce this type of loans or target [them] to improve education and infrastructure access of the poor.’

The study was based on provincial data from 1970-1995 – before the govern-ment’s current emphasis on household loans – but the findings are unequivocal in pointing towards more cost-effective public investments for poverty alleviation. This is not necessarily to deny the value of a rural credit system that reaches down to poor households; but it does strongly suggest that government should not itself set out to act as supplier of credit, much less that it should hand out money with little real expectation of getting it back.

That view is strongly echoed by World Bank rural finance specialist, Jacob Yaron, who argues that, internationally, ‘directed, subsidised credit was a poor response to the symptoms without addressing the root cause of poorly performing rural financial institutions’. Government’s role, he says, should not be to intervene directly and administer agricultural credit, but to pro-vide a favourable policy environment for rural financial institutions that operate at a profit, using voluntary deposits from savers to lend at unsubsidised interest rates.

‘Cooperatives’ join the fray

Meanwhile, China’s so-called Rural Credit Cooperatives have also entered the micro-finance market, albeit largely at the government’s bidding, rather than of their own accord. Indeed, they are now much the biggest microfinance player: From 1999 to the end of 2002, nearly half of all RCC branches were said to have offered Grameen-style group guaranteed loans totalling CNY 25.3 billion (USD 3 billion) and reaching 10.27 million familes; while a further 46.57 million families received ‘small loans’ totalling CNY 74.6 billion (USD 9 billion).³⁰ this amounts to around 20% of the RCCs’ total lending.

With their extensive reach and their capacity to collect rural savings deposits, the RCCs may indeed be the institutions best able to provide credit to poor, rural families. However, like the state banks RCCs have also been hamstrung by a legacy of non performing loans, and in many cases are technically insolvent, although it was reported at the end of 2003 that, for the first ever time, they generated an aggregate profit.³¹Lack of clarity in their ownership and governance is also widely cited as a constraint on their effectiveness and reach.

Rural credit and savings cooperatives were originally established (along with industrial cooperatives) in Communist-held areas during the Republican and civil war era, and spread nationwide after 1949.³² Following rural collectivisation, the cooperatives were subordinated to People’s Communes and gave minimal services to individual households. Their role changed again in the post-1978 reform period, when they operated under the Agricultural Bank of China, often effectively serving as township and village branches of the bank. But, while the RCCs collected substantial deposits from farmers, mainly in fixed term savings, a large part of these had to be transferred to the ABC or held in reserve accounts. Much of the RCC’s own lending, mean-while, was to rural enterprises rather than to farm households. Thus, in Andrew Watson’s assessment, the RCC system was ‘not rural in orientation, since its funds were routinely siphoned off for urban or industrial use, and not cooperative in operation, because its members had no say in its management.’

In 1996-97 the RCCs were separated from the ABC, and placed under a new bureau within the People’s Bank of China. They were also amalgamated into county level Unions that had some supervisory responsibility (eg, approving major loans made by branches).

Within this new framework, the RCC’s have still had to cope with past non-performing loans (and in some cases also acquired bad debts from township Rural Credit Funds, under the administration of the Ministry of Agriculture, that were closed down in the same round of rural financial reforms). Moreover, the RCCs remain vulnerable to the ‘moral hazard’ of interference from local government, either in directing credit or in rent seeking. Xie Ping, of the People’s Bank of China, has pointed out that these problems are exacerbated by ‘soft budgetary constraints’ – that is, the fact that the People’s Bank of China will if necessary bail out the RCCs because of the social unrest that would certainly follow bankruptcies and loss of farmers’ deposits. Thus ‘local govern-ments tend to follow the strategy of levying high taxes and fees on RCC because they are aware central government will not let RCC [go] bankrupt;’ and ‘RCC management and staff may not concern about their management and profitability and may extend risky loans.’³³ The problems of ‘moral hazard’ are generally thought to be more acute in less developed areas.³⁴

Besides these practical difficulties, the restructuring of the rural financial system in the late 1990s did not clarify a central ambiguity in the role of the RCCs: as Andrew Watson puts it: ‘whether it should become a proper cooperative owned and locally operated by its members or whether it needs to develop an institutional hierarchy and become a cooperative bank.’³⁵

Subsequent policy discussions and initiatives at first perpetuated rather than resolved this question. Xie notes that: ‘By nature RCCs are not real cooperatives although the Central Government and PBC have made repeated efforts to turn them into real ones.’ He recounts cam-paigns since the late ‘90s in which ‘rural households have been persuaded by PBC staff to pay 50-100 renminbi to join the RCCs, in exchange for a free lunch.’

At the same time, however, Xie points out that ‘In practice, RCCs have not been treated as cooperatives’ and ‘the products and services offered [by them] have been almost the same as those of commercial banks’. He suggests that they are better viewed as ‘small-scale and locally based quasi state banks’.

Given this ambivalence in their nature and role, it is not surprising that a People’s Bank of China survey of 22 RCCs in Shanxi should have found, as Xie reports, that ‘The RCCs and their directors are confused about the objectives of RCCs. About 40 percent of RCCs directors inter-viewed took profit seeking as their major objective and half regard their major objective as serving the members.’ It was presumably the latter who were most inclined to venture into microfinance when the People’s Bank of China encour-aged them to move in this direction in the late 90s.

In 1998, Developpment International Desjardins, the international NGO arm of a Quebec credit union, began to provide training and capacity building to RCCs in Hebei’s Luanping County, to help them deliver small loans with group guaranteed. Other donors, most notably the Inter-national Fund for Agricultural Dev-elopment (IFAD), have also worked with RCCs; and IFAD recently approved a USD 14.6 million loan to China that will be largely devoted to RCC reform and capacity building. But, to date most RCC microfinance programmes have been basically home-made, without the benefit of initial training or capacity building.

Compared to the attention that the government’s poverty loans have attracted, there is little published information on the quality of RCC microfinance programmes and asset portfolios. In a 2002 Master’s thesis, Kate Druschel outlined several likely problems: ‘First, the type of client that RCCs traditionally reach are not the rural poor, but rather, the rural middle-income. Second, RCCs traditionally have lent to men instead of women. Third, implementing microfinance using group guarantees and instalment repayments requires a certain amount of staff know-ledge and capacity [and] it is not clear RCCs have attained [this] before rushing into this model. Fourth, RCCs are doing this lending as a state directive, not [in] recognition of a new and untapped market niche. These four points are troubling in that they point to microfinance . . . As state-directed policy lending [the RCCs] do not have the capacity to fulfil. The sustainability of such an initiative is questionable.’³⁶

These concerns are echoed by Professor Cheng Enjiang, of the Centre for Strategic Economic Studies at Victoria University in Australia, who has served as a consultant to many international donor projects in China. He points out that most of the RCC programmes have only begun in earnest over the last two years, so it is too early to tell how well the micro loans have performed, although experience will doubtless vary widely from place to place. He adds that RCCs do not generally dis-aggregate their portfolio data between microfinance and larger, secured loans to households or enterprises. Moreover, data from RCCs is at present often distorted by rescheduling and refinancing arrangements that are not clearly reported. All of which will make it very hard to assess the RCCs’ micro lending.

Many RCCs have established a credit rating system, whereby households are first assessed for creditworthiness and then given a ‘credit card’ entitling them to a certain level of borrowing from the RCC. Professor Cheng reports that ‘In the poor areas I have visited they have done this credit rating for about 70% of the households and, about 50% get a card.’ A significant problem, he says, is that ‘credit rating takes lots of time, especially in poor areas where farmers are scattered in the mountains, and RCCs don’t have enough staff. One person may be responsible for 1000 households, whereas normally for microfinance programmes it would be 200-400.’

Cheng also points out that micro-finance programmes usually rely for their success on practices such as ‘regular visits by loan officers and frequent contact with borrowers, centre meetings, group guar-antees and dynamic incentives [in the form of increased loans to those who repay on time].’ Although some RCC lending nominally uses group guarantees, the institutional back-up for this is seldom in place.

Like Druschel, Cheng considers it problematic that RCCs have ventured into microfinance because of government prompting – however understandable gov-ernment anxiety to boost rural growth and incomes may be. The visible hand of government in directing lending always brings problems of accountability and sustainability. For, as Cheng points out, it is not clear where responsibility for recovering the loan really lies: ‘If you tell me to give credit to households, and the households cannot repay, then it is not my responsibility.’ RCC staff may simply go through the motions of doing what they are told, with government ending up having to foot the bill yet again.

Yet more reform

June 2003 saw a State Council policy directive on ‘Deepening the Reform of Rural Credit Cooperatives’ that will press a new round of reforms in eight provinces: Jiangsu (where similar measures have already been piloted), Zhejiang, Shandong, Guizhou, Chongqing, Jilin, Jiangxi, and Shaanxi.³⁷ Professor Du Xiaoshan of the Chinese Academy of Social Sciences points out that this is a broad spread, both geographically and in terms of differing levels of economic development; and he adds that the experiment is likely to spread in July of this year to a further ten provinces. This looks, then, like a reform effort in earnest.

Rather than proposing a ‘one size fits all’ model, the directive requires RCCs to choose between four ownership structures: i) becoming commercially oriented rural banks owned by shareholders; ii) becom-ing shareholder cooperative banks; iii) becoming real cooperatives amalgamated into credit unions, or iv) operating as discrete, township level cooperatives that are ‘legal persons’ in their own right.

Whichever model the provinces choose, the People’s Bank will assume responsibility for repaying 50% of the RCC’s existing bad debt, and the new operations will enjoy tax breaks. More-over, they will be allowed to charge loan interest that is up to double the People’s Bank’s base rate. (Until now, the RCCs have only been allowed to charge up to 50% more than the base rate.) This means that the new institutions could charge up to 12% per year, as opposed to the 6-9% that RCCs have typically charged until now.

Professor Du considers it likely that RCCs in the richer provinces will opt to become commercial banks – around 30, he says, have already applied to do so – whereas the cooperative and credit union model is more likely to be taken up in poorer areas by RCCs that have less capital and fewer local enterprise clients.

Commercial rural banks are less likely to be interested in microfinance, and can be expected to prefer making secured loans to bigger customers. Poor house-holds in the richer areas – and it should not be forgotten that half of China’s poor do not live in officially designated poverty counties³⁸- will therefore probably remain excluded from formal credit.

In less developed areas the creation of genuine credit and savings cooperatives that are well managed and immune from government interference could be a real boost for the rural economy. But this will be a momentous task.

The final group snapshot

In summary, there are now three main, authorised microfinance channels in China.

Firstly, the poverty alleviation loan system, through the Agricultural Bank of China and Poverty Alleviation Bureaus. This has been widely criticised, and creates a very difficult environment for more sustainable initiatives, but it is likely to continue at least in the short term because it is driven by the political imperative to keep down the numbers of poor, and to be seen committing resources to that end.

Secondly, the RCC system, which the central government seems determined to revitalise. Several international donors see this as an increasingly viable credit delivery channel. As well as IFAD, long a cham-pion of RCC potential, AusAid has been working with RCCs in Chongqing, and a World Bank/DFID ‘Poverty IV’ project now being designed may well also opt for this channel. The potential for using the current reform initiative to build enduring capacity among RCCs may encourage some donors, who in recent years have been deterred by the policy obstacles, back into the field of microfinance in China.

Thirdly – smaller, more diffuse, legally tenuous, but often running the most care-fully targeted, successful and sustainable programmes – are a number of proto microfinance institutions that in many cases evolved our of internationally funded projects. Prominent among them are the ‘Funding-the-Poor Cooperative’ established by the Chinese Academy of Social Sciences with support from the Ford Foundation, and Rural Development Associations established in around forty counties in the course of UNDP funded poverty alleviation projects.

Over the last three years, the China Poverty Alleviation Foundation has, in collaboration with the US-based NGO, Mercy Corps, also developed programmes with reportedly sound operational princ-iples in seven counties of Fujian, Sichuan, Guizhou and Shaanxi. By the end of 2003, these had disbursed a total of CNY 63 million (USD 7.6 million) in loans. The Foundation has managed to attract corporate donations to support these programmes, including CNY 1.2 million (USD 140,000) from the Huaxia Bank to cover operational expenses, and USD 100,000 from the Shell Foundation to support research. ³⁹

Programmes of this kind have been important laboratories for learning and grassroots experimentation as well as plat-forms for informed participation in policy debate. Their apparent success suggests an inverse relationship between quality and quantity in Chinese microfinance pro-grammes: – small has so far been most beautiful.

But, while these programmes exhibit many of the classic NGO virtues (‘depth’, innovation, flexibility, thoughtful implem-entation) they also encounter the classic NGO problem of how to scale up – or how, at least, to graduate from being ‘projects’ to become permanent instituti-ons. Here they run up against the central policy barriers: lack of any procedure for acquiring long-term, authorised legal status, and a ban on taking savings deposits.

Nevertheless, CICETE (the Chinese counterpart agency for UNDP) FPC and the China Poverty Alleviation Foundation are now proposing to establish a national association of microfinance institutions, to provide training and support for members and to represent their interests in national policy discussions. An umbrella organ-isation of this kind could draw the community of Chinese microfinanciers closer together and bring on board many other project-based programmes, whether run by international or Chinese organ-isations, that are trying to find the road to permanent existence. Citigroup, the world’s largest financial institution, has already pledged funding support for this initiative, in a move that underlines the potential for microfinance institutions to draw technical and funding support from private sector banks.

Meanwhile, UNDP and AusAid recently funded a People’s Bank of China policy study of ‘non-financial institutions’ (that is, those without official status) providing microfinance. Some observers are sanguine that the findings will persuade the recently established China Banking Regulatory Commission to recognise the value of the microfinance institutions, and that this will result in policy breakthroughs. Others, however, point out that the CBRC has plenty on its hands with the ongoing RCC reform, not to mention cleaning up the ‘big four’ state banks, and do not expect to see major change for microfinanciers in the near future.

Model diversity and ‘credit plus’

On scaling up, Du Xiaoshan, who first led the CASS Funding-the-Poor Cooperative and can fairly be regarded as China’s fore-most microfinance practitioner, says that: ‘For small-scale micro-finance projects (2-3 thousand households in a county), as long as you run them properly, they will be able to succeed regardless of the particular model you use . . . But as they grow larger, the difference between good and bad projects becomes more marked.’⁴⁰

This is not a critique of diversity as such, for it is unlikely that any single model could do justice to China’s own diversity. Many have pointed out that conditions in the remote and mountainous areas of Western China are a far cry from those of densely populated Bangladesh, where the Grameen model first took root. Virtually all microfinance practitioners in China adapt their ‘loan products’ to local conditions, and flexibility has been a particular keynote of groups like the Tibet Poverty Alleviation Fund, which has piloted several different approaches within the Tibet Autonomous Region. The most recent RCC reform proposals also imp-licitly recognise, or at least allow room for, local Cooperatives to tailor programmes to local conditions and the needs of their members.

Yet Du’s note of caution does address the need for diligent pursuit of sound operational principles to make scaling up a real possibility. This is perhaps especially pertinent for the many programmes that use small loans as a means to achieve other ends – such as nature conservation – and that may pay relatively little attention to longer-term viability of the credit component.

Even among organisations that see delivery of microfinance as an end in itself, there is a vigorous debate about the extent to which micro bankers should add other components to the supply of credit. Some adopt a complementary approach (often called ‘credit plus’) that offers, eg, literacy and technical skills training, and/or help with business planning and identifying markets. Others believe business decisions should be left strictly to the clients, and restrict training to the minimum needed to keep the credit flowing (eg, explaining the model and basic accounting procedures). Credit plus advocates argue that the ‘plus’ can produce more profound transform-ations in the lives and communities of clients, but this is inevitably more expensive to scale up than the leaner model; and so once again we encounter an argument about depth versus breadth.

A parallel discussion concerns the kind of skills and capacity building that micro-finance institutions themselves need to operate effectively.

These debates will not end soon, (esp-ecially given the relatively new frontier of urban microfinance in China), and nor perhaps should they. For while it is true that much experimentation has already taken place, and some older hands are understandably impatient to go to scale, this has all occurred in a difficult policy and operational environment. If that env-ironment does become more enabling, renewed experiments may be needed to see what works best after the thaw.

Keeping women centrestage

As RCC reform proceeds, and if a policy thaw enables microfinance institutions to grow in number and size, a major chall-enge will be to ensure that women are not marginalised by the expansion of pro-grammes.

Globally, microfinance is strongly ass-ociated with lending to women – who, as well as being over-represented among the world’s poor, have proved to be more reliable borrowers than men.

More than twenty years ago, UNIFEM and UNFPA were among the first inter-national agencies to bring the concept of microfinance to China (although, at the time, ‘microfinance’ had not yet secured a place in development discourse: ‘women’s income generation’ was the usual term). For UNFPA, working in China at the invitation of the government, women’s income generation projects offered a way of delivering the advocacy message that improvements in women’s educational, health and economic status result in a natural and voluntary decrease in family size. It was a way, moreover, that reduced the messenger’s risk of being shot down by international critics, especially in the United States, who accused the agency of endorsing China’s birth control policies.

The All-China Women’s Federation, evolving from a Leninist ‘organisation of the masses’ to a role that blended service provision with political management, warmed to these experiments. It has since partnered in many internationally funded small loan projects, and developed its own in many provinces and cities. From 1995, the China Family Planning Association and China Population Welfare Fund also worked together on a multi-million dollar, nationwide programme, known as the ‘Happiness Project’. These projects have not, generally paid sufficient attention to sustainability, but they were always clear about targeting.

Smaller projects included one run by the Yunnan Reproductive Health Research Association (with Ford Foundation fund-ing) that combined credit with health checks for rural women. Ford also spon-sored a programme administered by Rural Women Konwing All magazine. Oxfam Hong Kong and several other internat-ional NGOs have also supported projects implemented by local women’s groups.

Most internationally funded projects have lent mainly to women, and so too do the proto micro-finance institutions that grew out of these projects. But, while there is a general assumption that women clients have prospered as a result, there appears to have been relatively little detailed evaluation of how investment decisions are made, how borrowing has impacted on women’s labour and time, and how much control women have over income that is generated from investments. Although hard to measure, these are important questions in light of the widely-reported feminisation of agriculture as a result of male out-migration.

The government poverty loans system and the RCCs, meanwhile, generally have little or no gender focus. According to Guo Ruixiang, who has extensive exper-ience managing UNDP and AusAid projects ‘The majority of women felt that there was no possibility that such instit-utions would ever lend to people of their income level and gender.’ Government backing of lending to ‘household’ level leaves gender out of the picture. Even when directed to households, RCC loans generally to the male ‘head of household’.

International donors partnering with RCCs have encouraged lending to women, but it is by no means clear how ingrained this will be in the new forms that these institutions take. If RCCs are restructured as ‘real cooperatives’ will their member-ship comprise individuals or male heads of households? What will be the lending pattern of rural commercial or cooperative banks? Much remains to be seen: but the opportunities for constructive engagement in these institutions may now be greater than ever before.

Written by Nick Young

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¹ New York Times, January 14 2004: China to Give up $41 Billion Stake in 2 Big Banks.

² China: Promoting Growth with Equity World Bank, 2003 Country Economic Memorandum No. 24169-CHA, September 2003

³ Wall Street Journal, October 3, 2003: Surge in Lending In China Stokes Economic Worries; Spending, Investment Sprees Point To Overheating; Bad Debts Rise

⁴ Wall Street Journal Jan 13, 2004: In China, Foreign FirmsChip Away at Mountain Of Bad, Overdue Debt Investors Buy Up Dud Loans, Use Hardball Tactics to Collect.

⁵ Financial Times February 5 2004: ADB to join rescue efforts for Chinese banks The ADB’s own report on this, PRC Fund To Rescue Distressed Assets, is available on the ADB website, www.adb.org

⁶ A notable doomsayer is Gordon Chang: The Coming Collapse of China Arrow, 2002

⁷ Building a Transparent Private Bank in China chinagate.com.cn, n.d.

⁸ People’s Daily online English edition, July 30, 2003 State-dominated Bank in East China Sees Greater Privatization

⁹ Wall Street Journal, as n. 3

¹⁰ As reported by Han Jun, Senior Researcher at the State Council’s Development Research Centre, and Director General of its Department of Rural Economy, at an Asian Development Bank Institute Microfinance Workshop held in Tokyo on December 5, 2003.

¹¹ On informal finance, see Kellee Tsai’s Back Alley Banking Cornell University Press, 2002 and the interview with Tsia in our October 2003 issue. Also, Ma Zhongfu’s Rural Informal Finance in Findlay, Watson, Cheng, Zhu (eds).Rural Financial Markets in China, ANU Asia Pacific Press 2003.

¹² Carl J. Dahlkman and Jean-Eric Aubert China and the Knowledge Economy: Seizing the 21^st Century World Bank/World Bank Institute, Washington, October 2001.

¹³ Grameen Bank Monthly Update, Issue 287, December 23, 2003

¹⁴ As reported on the FINCA website, www.villagebanking.org

¹⁵ Portfolio data for BancaSol and Bank Rakyat Indonesia is taken from ‘Mix Market’ (www.mixmarket.org), a web-based platform for global microfinance information exchange that was originally established by UNCTAD and Consultative Group to Assist the Poorest.

¹⁶ Key Elements for Successful Microfinance: International Experience from Latin America and Eastern Europe; Lessons Learned from Successful Microfinance Institutions Lending to Small Enterprises. Paper delivered to a symposium on Mircrofinance and Urban Unemployment in China, March 1999, Guangzhou.

¹⁷ In a recent example, Hebei entrepreneur Sun Dawu was arrested and charged with ‘illegal fund raising’ in July 2003, because he had been borrowing privately.

¹⁸ The monthly interest rate figure is given by Han Jun [n.10]; For informal finance generally see Tsai and Ma [n.11] Financial services offered by monasteries are discucssed in Jacques Gernet's Buddhism in Chinese Society: An Economic History from the Fifth to the Tenth Centuries (translated by Franciscus Verellen), Columbia University Press, New York, 1995

¹⁹ Sharma, M. et al. Assessing the relative poverty level of MFI clients: synthesis report based on four case studies. CGAP - IFPRI. 2000;. Commercialization and Mission Drift: The Transformation of Microfinance in Latin America CGAP Occasional Paper No. 5, November 2001

²⁰ Volume II, No. 2, May 1999; especially table on pages 14-15.

²¹ See, notably, China: Overcoming Rural Poverty, a joint report of the World Bank, UNDP and LGPR, February 23 2000.

²² Albert Park, Sangui Wang, Guobao Wu, Regional Poverty Targeting in China in Journal of Public Economics, Vol. 86 No. 1, October 2002.

²³ Han Jun (n. 10)

²⁴ Albert Park with Loren Brandt and Sangui Wang, Are China’s Financial Reforms Leaving the Poor Behind in Y. Huang, A. Saich and E. Steinfield (eds.) Financial Sector Reform in China, Harvard East Asian Press, 2004.

²⁵ Wang Sangui China’s Experiences on Poverty Reduction, paper to Ethiopian Social Rehabilitation and Development Fund conference, 2002.

²⁶ Jonathan Unger Entrenching Poverty: The drawbacks of the Chinese government’s policy programmes in Development Bulletin No 61, May 2003, Development Studies Network, Australian National University

²⁷ Wu Jianping, in a presentation to a ‘Microfinance and Poverty Alleviation’ forum, Beijing, February 2003

²⁸ The figure of 60% for 1998 was given by Wu Jianping (n.27); the figure of 67% for the four year period was given by Han Jun (n. 10) during an interview with PlanetFinance, July 2003.

²⁹ Zhang Linxiu, of the Centre for Chinese Agricultural Policy, in a presentation (Growth, Inequality and Poverty in Rural China: The Role of Public Investments) to an international workshop on rural finance hosted by the State Council Development Research Centre and the World Bank in Beijing, September 18-19 2002

³⁰ Dai Genyou, Director of Policy Department, People’s Bank of China, in a speech to From an address to a ‘Microfinance and Poverty Alleviation’ forum, Beijing, February 2003

³¹ There are conflicting claims about the current solvency or otherwise of RCCs. Dow Jones reported (March 9, 2004) that: China Credit Coops Technically Insolvent by End 03 -- CBRC However, a Chinese report on China’s ‘development gateway’ website, www.chinagate.com.cn (December 16 2003), claimed that: Rural Banks Into the Black: CBRC

³² For a more detailed overview of RCC development and operations, see Andrew Watson’s Financing Farmers: the Reform of the Rural Credit Cooperatives and the Provision of Financial Services to Farmers in Findlay, Watson, Cheng, Zhu (eds).Rural Financial Markets in China, ANU Asia Pacific Press 2003.

³³ Xie Ping Reforms of China’s Rural Credit Cooperatives and Policy Options paper presented to workshop on rural financial reform in China hosted by the State Council Development Research Centre and the World Bank, September 2002, Beijing. Later quotations from Xie are also derived from this source.

³⁴ See Park et al, n.24

³⁵ Watson (n. 32)

³⁶ Kathleen Druschel Microfinance in China: Building Sustainable Institutions And A Strong Industry Fall 2002, submitted to the School of International Service, American University

³⁷ Guowuyuan guanyu yinfa shenhua nongcun xinyongshe gaige shidian fang’an de tongzhi State Council, June 27 2003, can be viewed (in Chinese) on:
www.e521.com/cfg/jinrong/1015085853

³⁸ This was one of the main findings of China: Overcoming Rural Poverty (n. 21)

³⁹ China Foundation for Poverty Alleviation Annual Report for 2003

⁴⁰ Address to a ‘Microfinance and Poverty Alleviation’ forum, Beijing, February 2003