As the Grameen Trust enters China, this article tries to explain why microloans are still relatively underdeveloped – the reasons include: inadequate or overly restrictive government regulations (e.g. requirement that a formal bank must be the controlling shareholder in any village bank and that fact neither organization can operate outside its registered county), complex logistical challenges, poor risk management, a lack of expertise and insufficient funding.

Are there however other solutions to reach China’s rural villagers - around 480 million people – who have no access to formal credit? Past Experience with rural agricultural cooperation funds in the late 1980s showed that loose regulation led to corruption and poor management and failure. A few smaller regional banks - with strong support from the China Development Bank - have begun to offer small and medium-sized enterprise loans to family businesses and individuals. These loans help to create jobs but their average loan size is arguably still too high for the micro loans needed by the rural population. There are however 8,000 State-owned rural credit cooperatives (which are not very professional), and China's postal savings banks have started to make small business and microfinance loans (potentially one of the largest sources of rural credit but they too lack management and financial expertise).

Blocks on the road to Riches

By Dan Chinoy (China Daily)
Updated: 2009-11-13 09:36

Ten years ago, Lu Xuetao's livelihood depended entirely on two pigs and a handful of chickens. A poor farmer in Hebei's Yixian county, just two hours from Beijing, he lived virtually untouched by China's dramatic economic growth, rising standards of living and rapidly expanding opportunities.

That all changed in 1999 when a small organization called Funding the Poor Cooperative (FPC) offered him a loan of 1,000 yuan ($140).

Lu used the money to buy a new pig and paid the loan back easily. It was a vital springboard and, after a decade of help from FPC, his farm has expanded to almost 80 pigs and more chickens than he can count. His annual income has also soared to 30,000 yuan.

"I couldn't have done it without the loans. I just wouldn't have had any other options," said Lu, who in his collared shirt, glasses and faux leather shoes looks more like a computer programmer than a Chinese farmer.

This, advocates say, is the promise of microfinance in China: opportunities for those largely forgotten by the country's economic development.

Pioneered in the late 1970s by Bangladeshi economist Muhammad Yunus and his Grameen Bank, the basic concept is simple: extend small loans to the poor for otherwise unaffordable investments with a long-term payoff, like a pig or a stove for a roadside dumpling stand.

But despite almost 15 years of research, pilot projects, advocacy by non-governmental organizations (NGOs) and the State Council's renewed focus on poverty reduction, stories like Lu's are still rare in China.

As Yunus joined China's microfinance experts in Beijing for a major conference last month, it was clear the sector faced a daunting array of problems that have stymied its development, including inadequate or overly restrictive government regulations, complex logistical challenges, poor risk management, a lack of expertise and insufficient funding.

The numbers tell part of the story. Two-thirds of the nation's rural villagers - around 480 million people - have no access to formal credit, the China Banking Regulatory Commission estimated in 2006. A recent report from the World Microfinance Forum in Geneva, Switzerland, also stated there were only about 100 poverty alleviation-focused microfinance NGOs in China, serving an estimated 150,000 clients. Only about 10 NGOs can independently cover the costs of their loans, the report stated.

In contrast, there are more than 1,000 such microfinance institutions in India, according to Intellecap, an India-based social investment consultancy, and that does not include the millions of informal "self-help groups" of 10 to 15 women who receive and distribute small loans from the country's 500 or so formal banks. Grameen Bank alone has nearly 8 million customers worldwide.

"The development of microfinance in China lags far, far behind the rest of the world," said Bai Chengyu, chairman of the China Association of Microfinance, to which most microfinance organizations in China belong.

When Du Xiaoshan, a poverty alleviation researcher for the Chinese Academy of Social Sciences, founded FPC in 1993, things looked more promising.

Starting as a pilot project in Yixian, then one of China's poorest counties, Du closely followed the Grameen Bank model - loaning mostly to women, requiring borrowers to apply in groups that guaranteed each member's loans - to see if it could be adapted to China.

"Grameen's model trusts poor people, and it has a system that guarantees poor people will pay back the loans. It uses business methods, not charity, but its goal is specifically to help poor people, especially poor women," said Du. Working closely with local and central governments, FPC quickly expanded to four branches in Hebei and Henan provinces. With a loan repayment rate between 95 and 99 percent, it was soon financially sustainable: the money made from the loans covered the cost of making them. China's first microfinance organization was a success.

"What did we learn? We learned that the Grameen model could work here," said Du. Yet the model has proven difficult to replicate in China, mainly because the central government never expanded its support for microfinance beyond a few small pilot projects supported or managed by local authorities, he said.

"Only documents from the central government say China should support the development of all kinds of microfinance models and institutions; but no concrete policy and regulations," he said.

This has left the sector on uncertain ground, without any concrete legal basis for its operations, said Liu Dongwen, director of the microfinance department at the China Foundation for Poverty Alleviation.

"If you want to get more capital, go to a bank for a loan, they'll say your business has no legal basis, so we can't give you a loan, so you can't get much money," said Liu. "And the officials and tax departments also ask us: what kind of organization are you? What kind of business are you? Are you a legal business? Under what laws and regulations should we supervise you? This presents all sorts of challenges."

Casey Wilson, co-founder of Wokai, a small China-focused NGO that helps channel donations made through its website to local Chinese microfinance lenders, agreed.

"The government is pretty ambivalent about how to approach microfinance. On the one hand, it seems pretty positive about it in terms of poverty alleviation and helping the poor. On the other, it worries if it liberalizes financial regulations too much there could be a few bad apples that undermine the financial sector as a whole," she said. One explanation for this is the government's experience with rural agricultural cooperation funds in the late 1980s, said Liu.

Originally established as loan and banking institutions to serve ordinary villagers in the countryside, the funds were very loosely regulated and, as a result, quickly overwhelmed by corruption and poor management. By the mid-1990s, Beijing branded the project a failure and ordered all to be closed. Many villagers never got their money back.

"Because of this - you could call it a lesson - the government is very nervous about opening up rural finance," said Liu.

He argues that the lack of large-scale NGO microfinance schemes in China has made it difficult to convince the government microfinance can be successful here, despite the fact its own regulations are a major reason the sector has not developed quickly.

For all its success, even FPC remains a small-scale program with no plans to expand across the country, said Liu.

"It's a chicken and egg situation. The performance of NGOs in China has not been sufficient to convince the government microfinance can be done in a sustainable way in China, that it can be expanded here," he said.

The nature of microfinance itself also presents other business and logistical challenges.

Most microcredit loans are usually between 1,000 and 5,000 yuan in the countryside and 3,000 to 20,000 yuan in the cities. The payoff on such loans is relatively low, especially compared to the cost, effort and expertise required to make and recover them - a fact that has kept most major banks away from microfinance in China, even though they face far fewer regulatory hurdles than NGOs.

"The problem is three words: cost to serve," said Joe Horn, a private business consultant and founder of a small charity in Yunnan province that offers microfinance loans.

Rather than focus on providing the poor with credit, a few smaller regional banks - with strong support from the China Development Bank - have begun to offer small and medium-sized enterprise loans to family businesses and individuals. Taizhou Commercial Bank, for example, one of the most successful small business-focused institutions, has an average loan size of 446,000 yuan, and even its micro loan section hits an average of 91,000 yuan - sums well out of reach for someone like Lu Xuetao.

"It is a very good thing from a moral and economic point of view. It is not direct aid to the poor, but it helps to create jobs so people can earn an income," said Jorn Helms, senior advisor at the Taizhou Commercial Bank.

However, the situation has left China's rural poor with few places to go for loans and, in the absence of NGOs and banks, most villagers must rely on loan sharks, friends, and a loose patchwork of pilot programs and State-run financial institutions for credit.

The most important of these are China's 8,000 State-owned rural credit cooperatives, which operate like small banks. Many provide good services and make good loans, but others suffer from inadequate financial and management skills, which all lead to non-performing loans - loans close to or already in default - and a lack of focus on China's poorest villagers.

In the worst ones, Helms said, "it is like how I would imagine a scene from the 1980s: people sitting in rundown offices, not very professional".

To supplement and compete with the cooperatives, China's postal savings banks have started to make small business and microfinance loans. With 37,000 branches nationwide, two-thirds of which are in the countryside, they are potentially one of the largest sources of rural credit. But they too lack management and financial expertise.

"Not all branches are well-equipped to give loans," said Du. "Their biggest problem is that because they used to only take deposits and didn't give loans, their human resources are not so strong for lending. But they are slowly training their staff and learning through experience."

To further test the waters, in 2005 and 2006 Beijing created two new types of microfinance organizations: microcredit companies and village banks. While both were intended to improve access to credit in rural areas, they remain constrained by government regulations, such as the requirement a formal bank must be the controlling shareholder in any village bank and that fact neither organization can operate outside its registered county.

The programs have had an impact, though. Grameen Trust, the bank's non-profit arm, announced in September it plans to open two microcredit companies in Sichuan province and the Inner Mongolia autonomous region. The venture will be partly funded by Chinese online business-to-business networking company Alibaba, with an initial goal of serving 8,000 borrowers.

"These last few years have seen a lot of development and progress. But coverage is still very low and credit bureaus are often non-existent in rural areas," said Du.

Still, the market for rural credit is too big to ignore, said Bai Chengyu, who argued that someday China will develop a thriving microfinance sector.

"The demand for micro loans is about 5 trillion yuan but the supply is maybe 1 trillion yuan. That is a huge gap," he said. "The market space is huge and that is very attractive to international investors. Right now, they can't invest because of the government's regulations."