Wokai's China Microfinance Series: Development of China Microfinance

Geri Mason & Jason Korsmeyer

Geri lives in Tacoma, Washington, is currently teaching at the University of Puget Sound and is a PhD candidate focusing on the China microfinance sector. Jason now lives in Boston and spent a year researching and writing on China microfinance with Wokai in Beijing.

As microfinance grows rapidly throughout the developing world, one of the largest microfinance markets still remains widely untapped.  Today, approximately five hundred million rural and tens of millions of urban Chinese do not have access to credit. Compared to the rest of the developing world, Chinese microfinance is a recent phenomenon and has developed slowly. This article details the development of poverty alleviation in China, more specifically microfinance, from 1979 through 1996. 

The historical development of China’s financial institutions and development regulations has contributed to China’s current microfinance structure.  In order to implement effective microfinance strategies, it is vital to understand the context in which Chinese microfinance emerged. Modern poverty alleviation programs that led to microfinance’s development in China began in 1979.

The first period, known as the “money-grains-cotton” period, from 1979 to 1986, was a direct subsidy program for rural agriculture. From 1986 through 1994 the Chinese government transitioned to a “Regional Development” strategy.  Finally, in 1994 the 8-7 initiative was introduced.  This latest proposal created the conditional environment for microfinance to emerge in China. 

The first poverty alleviation programs were part of the “money-grains-cotton” strategy, which was to provide relief and direct subsidies to poor areas, particularly rural.  Initially, this strategy delivered necessary resources, in the form of grants and subsidies, to the impoverished farmers who had no access to credit for agricultural inputs.  According to official Chinese statistics, there were 250 million people living in poverty in 1978 and only 125 million in 1985, suggesting the subsidy program was successful in lifting rural residents from poverty.   However, the subsides created an unsustainable cycle of dependence.

Because the “money, grains, cotton” strategy could not be sustained, in 1986, there was a shift in policy.  This shift defined the start of the “Regional Development” period.  Rather than giving direct relief, the Chinese government began to provide regionally-focused, subsidized loans. This program reflects the CPC’s perception that the poor cannot repay loans at market interest rates.   These loans—along with materials, technical personnel, and information—were directed to impoverished areas.   The transition from the direct subsidies of the “money-grains-cotton” strategy to the subsidized loans of the Regional Development strategy illustrates the CPC’s willingness to incorporate impoverished individuals into regional development.

While regionally-focused subsidized loans in practice did alleviate some poverty, they failed to reach the poorest of the poor.  While the loans were distributed in poor areas, they were not distributed directly to poor individuals. Instead, these subsidized funds were captured by enterprises with minimal connection to the poor. Because local governments benefited from the profits of these enterprises, they were willing to allow the enterprises to secure these loans. 

Organizations with a vested interest in the loans’ success—local lending groups, local governments, and the Agriculture Bank of China—also lacked incentives to target the poor. Furthermore, these regional subsidized loans had abysmal repayment rates, further constricting the number of loans targeting the poor.  In some cases these funds not only failed to target the poor, but also flowed out of poor landlocked areas to fund projects in the wealthier costal provinces.  

From 1980 to 1994, under Regional Development programs, the volume of loans to rural areas increased by 12 times,  and regionally subsidized loans became a vital part of regional economies, in spite of their poor performance and lack of impact on the poor.  They largely ignored their intended goal of poverty alleviation. 

During the 1980s, regionally subsidized loans were not the only form of poverty alleviation in China.  Beginning in 1981, the UN conducted a series of programs that laid the first foundations for microfinance.  These programs focused on “women's status and employment opportunities, to promote improved health practices, or to expand choice in reproductive health.”  These projects were generally large loans given to enterprises, rather than micro loans.  The importance of these experiments was to create a precedent and set up a model for international organizations to effectively execute poverty alleviation programs within China while maintaining relationships with the Chinese government. 

One example of the UN approach to poverty alleviation is the pilot program launched in 1989 in collaboration with the Chinese International Center for Economic and Technical Exchange (CICETE).  This program, under the direction of the United Nations Development Fund for Women, sought to increase rabbit production in Shandong Province by giving loans to individual women engaging in this industry.  These loans were distributed through the Agriculture Bank of China (ABC).  The loan period was two years, and payment was due annually with a yearly interest rate of 5%.  This project achieved a 100% repayment rate.  

This and other projects conducted by the UN laid the foundation for international organizations to work with the Chinese government on poverty alleviation.  Unlike the “Regional Development” model, where money that was given to local governments  trickled down to the poor at best, this new model injected funding directly into the hands of the poor in order to alleviate poverty.  The Chinese government took note of the success of these programs and shifted its poverty alleviation approach once again.

In January 1994, the CPC announced the 8-7 poverty alleviation plan, bringing an end to the “Regional Development” period. Under this plan the CPC sought to directly reach impoverished individuals, and used microfinance as one of the tools for achieving this.  Funding for the Poor Cooperative (FPC ) was the first organization in China to experiment with microfinance to achieve the goals of this plan.

The Funding for the Poor Cooperative was instigated in 1993. Prior to its inauguration, Du XiaoShan , now known as the “father” of microfinance in China, traveled to Bangladesh with a team of colleagues from The Rural Development Institute of the Chinese Academy of Social Science. They went to examine the Grameen Bank , the institution which was awarded the Nobel Peace Prize in 2005 for its fundamental role in the development of modern microfinance.

Specifically, the Chinese researches went to study Grameen’s group guarantee loan system, the innovative method employed by Grameen Bank to screen borrowers and ensure successful repayment.  Rather than requiring collateral, like a formal bank loan, the group lending model uses joint liability and peer pressure to guarantee repayment.  Groups are typically composed of three to five individuals.  Two individual in the group receive a loan, and to ensure repayment, everyone in the group is jointly liable, or responsible, for repayment of the loans.  If one individual does not repay their loan, then the rest of the group has incentive to help with repayment and/or monitor that individual to make sure repayment is made. Should the loan default, the entire group becomes ineligible for future loans.

After studying the Grameen model, The Rural Development Institute of the Chinese Academy of Social Science initiated the Funding the Poor Cooperative (FPC) with funding support from the Ford Foundation and the Grameen Trust.   In 1993, under the direction of Du XiaoShan and with informal permission of the government, the FPC began its action-research experiment based on the Grameen methodology.

The FPC set up 3 county offices: one in Yixian County of Hebei Province, and one each in Yucheng County and Nanzhao County of Henan Province.  Although the FPC encountered difficulties, by 1996 it had resolved management issues  and improved repayment rates, providing a practical example of tailoring microfinance to China.  The FPC provided practical field experience in achieving sustainability, promoting outreach, balancing portfolio quality, and maintaining efficiency.   Furthermore, it provided a successful model for managing donor funding and maintaining relations with the Chinese government. 

Soon after the FPC project began demonstrating the potential for success in these areas, the UNDP , in collaboration with CICETE , began implementing microfinance projects.  The first project was formally launched in 1996, and expanded to 48 counties in 16 provinces.  Other notable microfinance programs also originated around this time: the China Foundation for Poverty Alleviation (CFPA), in collaboration with the World Bank , Huaxia Bank , and Kadooie Charitable Foundation ; the Qinghai Agricultural Bank, supported by the AUSAID ; and the Sustainable Microfinance to Alleviate Poverty (SMAP), also a project of the UNPD.  In addition to these projects, many smaller microfinance programs originated at this time.

In China, non-financial institutions such as NGOs are prohibited from supplying any type of financial services.  This is a key challenge for NGOs supplying microfinance in China. They are allowed to do so only through informal operating agreements with the local governments. “With the exception of the Funding for the Poor Cooperative (FPC) at the Chinese Academy of Social Sciences and the ‘Rural Development Associations’ funded by UNDP, which have received written approval from the PBC, other NGO’s microfinance activities are, in theory, illegal.”  

Due to the temporary and uncertain legal status of microcredit NGOs in China, achieving high repayment rates and operational efficiency is more difficult. Borrowers may perceive the organization as temporary, or view its quasi-illegal status as justification for late payments and/or default. Additionally, the NGO cannot credibly promise future loans as a reward for repayment performance, since they may not be allowed to operate in future periods. This further decreases the incentives of borrowers to repay their existing loans.

This situation also decreases the incentives of the organization itself to thoroughly screen and monitor its borrowers, and to pursue repayment of late or defaulted loans. The NGO is aware that its permission to operate may not be renewed; therefore extra effort in these areas will be of little or no benefit to the organization. The staff is also aware of the temporary non-legal status of their employer, and will therefore be less concerned with their own performance. Longevity of employment is not a credible reward for the NGO to offer, decreasing the employees’ incentives for efficient and high quality performance.

Another challenge for NGOs providing microfinance was the interest rate ceilings imposed by Chinese government.  Without the ability to charge appropriately high interest rates, microfinance organizations were unable to cover costs. This was an additional impediment to the long term success of these institutions. 

There were great strides in poverty alleviation during the period from 1979 to 1996; according to official Chinese government statistics, the number of rural poor decreased by 170 million. During this period, the foundation for microfinance in China was laid and the initial developments of the sector took place.  The FPC’s action-research project was the first of many of its kind, beginning a trend of internationally funded microfinance projects in China.  These institutions have faced and continue to face many challenges, the largest of which is the regulatory environment of the People’s Republic of China. While outreach continues to increase, millions of rural Chinese still live in poverty. Microfinance institutions will continue to be a significant player in poverty alleviation in rural China.

Geri Mason & Jason Korsmeyer

Geri lives in Tacoma, Washington, is currently teaching at the University of Puget Sound and is a PhD candidate focusing on the China microfinance sector. Jason now lives in Boston and spent a year researching and writing on China microfinance with Wokai in Beijing.

As microfinance grows rapidly throughout the developing world, one of the largest microfinance markets still remains widely untapped.  Today, approximately five hundred million rural and tens of millions of urban Chinese do not have access to credit. Compared to the rest of the developing world, Chinese microfinance is a recent phenomenon and has developed slowly. This article details the development of poverty alleviation in China, more specifically microfinance, from 1979 through 1996. 

The historical development of China’s financial institutions and development regulations has contributed to China’s current microfinance structure.  In order to implement effective microfinance strategies, it is vital to understand the context in which Chinese microfinance emerged. Modern poverty alleviation programs that led to microfinance’s development in China began in 1979.

The first period, known as the “money-grains-cotton” period, from 1979 to 1986, was a direct subsidy program for rural agriculture. From 1986 through 1994 the Chinese government transitioned to a “Regional Development” strategy.  Finally, in 1994 the 8-7 initiative was introduced.  This latest proposal created the conditional environment for microfinance to emerge in China. 

The first poverty alleviation programs were part of the “money-grains-cotton” strategy, which was to provide relief and direct subsidies to poor areas, particularly rural.  Initially, this strategy delivered necessary resources, in the form of grants and subsidies, to the impoverished farmers who had no access to credit for agricultural inputs.  According to official Chinese statistics, there were 250 million people living in poverty in 1978 and only 125 million in 1985, suggesting the subsidy program was successful in lifting rural residents from poverty.   However, the subsides created an unsustainable cycle of dependence.

Because the “money, grains, cotton” strategy could not be sustained, in 1986, there was a shift in policy.  This shift defined the start of the “Regional Development” period.  Rather than giving direct relief, the Chinese government began to provide regionally-focused, subsidized loans. This program reflects the CPC’s perception that the poor cannot repay loans at market interest rates.   These loans—along with materials, technical personnel, and information—were directed to impoverished areas.   The transition from the direct subsidies of the “money-grains-cotton” strategy to the subsidized loans of the Regional Development strategy illustrates the CPC’s willingness to incorporate impoverished individuals into regional development.

While regionally-focused subsidized loans in practice did alleviate some poverty, they failed to reach the poorest of the poor.  While the loans were distributed in poor areas, they were not distributed directly to poor individuals. Instead, these subsidized funds were captured by enterprises with minimal connection to the poor. Because local governments benefited from the profits of these enterprises, they were willing to allow the enterprises to secure these loans. 

Organizations with a vested interest in the loans’ success—local lending groups, local governments, and the Agriculture Bank of China—also lacked incentives to target the poor. Furthermore, these regional subsidized loans had abysmal repayment rates, further constricting the number of loans targeting the poor.  In some cases these funds not only failed to target the poor, but also flowed out of poor landlocked areas to fund projects in the wealthier costal provinces.  

From 1980 to 1994, under Regional Development programs, the volume of loans to rural areas increased by 12 times,  and regionally subsidized loans became a vital part of regional economies, in spite of their poor performance and lack of impact on the poor.  They largely ignored their intended goal of poverty alleviation. 

During the 1980s, regionally subsidized loans were not the only form of poverty alleviation in China.  Beginning in 1981, the UN conducted a series of programs that laid the first foundations for microfinance.  These programs focused on “women's status and employment opportunities, to promote improved health practices, or to expand choice in reproductive health.”  These projects were generally large loans given to enterprises, rather than micro loans.  The importance of these experiments was to create a precedent and set up a model for international organizations to effectively execute poverty alleviation programs within China while maintaining relationships with the Chinese government. 

One example of the UN approach to poverty alleviation is the pilot program launched in 1989 in collaboration with the Chinese International Center for Economic and Technical Exchange (CICETE).  This program, under the direction of the United Nations Development Fund for Women, sought to increase rabbit production in Shandong Province by giving loans to individual women engaging in this industry.  These loans were distributed through the Agriculture Bank of China (ABC).  The loan period was two years, and payment was due annually with a yearly interest rate of 5%.  This project achieved a 100% repayment rate.  

This and other projects conducted by the UN laid the foundation for international organizations to work with the Chinese government on poverty alleviation.  Unlike the “Regional Development” model, where money that was given to local governments  trickled down to the poor at best, this new model injected funding directly into the hands of the poor in order to alleviate poverty.  The Chinese government took note of the success of these programs and shifted its poverty alleviation approach once again.

In January 1994, the CPC announced the 8-7 poverty alleviation plan, bringing an end to the “Regional Development” period. Under this plan the CPC sought to directly reach impoverished individuals, and used microfinance as one of the tools for achieving this.  Funding for the Poor Cooperative (FPC ) was the first organization in China to experiment with microfinance to achieve the goals of this plan.

The Funding for the Poor Cooperative was instigated in 1993. Prior to its inauguration, Du XiaoShan , now known as the “father” of microfinance in China, traveled to Bangladesh with a team of colleagues from The Rural Development Institute of the Chinese Academy of Social Science. They went to examine the Grameen Bank , the institution which was awarded the Nobel Peace Prize in 2005 for its fundamental role in the development of modern microfinance.

Specifically, the Chinese researches went to study Grameen’s group guarantee loan system, the innovative method employed by Grameen Bank to screen borrowers and ensure successful repayment.  Rather than requiring collateral, like a formal bank loan, the group lending model uses joint liability and peer pressure to guarantee repayment.  Groups are typically composed of three to five individuals.  Two individual in the group receive a loan, and to ensure repayment, everyone in the group is jointly liable, or responsible, for repayment of the loans.  If one individual does not repay their loan, then the rest of the group has incentive to help with repayment and/or monitor that individual to make sure repayment is made. Should the loan default, the entire group becomes ineligible for future loans.

After studying the Grameen model, The Rural Development Institute of the Chinese Academy of Social Science initiated the Funding the Poor Cooperative (FPC) with funding support from the Ford Foundation and the Grameen Trust.   In 1993, under the direction of Du XiaoShan and with informal permission of the government, the FPC began its action-research experiment based on the Grameen methodology.

The FPC set up 3 county offices: one in Yixian County of Hebei Province, and one each in Yucheng County and Nanzhao County of Henan Province.  Although the FPC encountered difficulties, by 1996 it had resolved management issues  and improved repayment rates, providing a practical example of tailoring microfinance to China.  The FPC provided practical field experience in achieving sustainability, promoting outreach, balancing portfolio quality, and maintaining efficiency.   Furthermore, it provided a successful model for managing donor funding and maintaining relations with the Chinese government. 

Soon after the FPC project began demonstrating the potential for success in these areas, the UNDP , in collaboration with CICETE , began implementing microfinance projects.  The first project was formally launched in 1996, and expanded to 48 counties in 16 provinces.  Other notable microfinance programs also originated around this time: the China Foundation for Poverty Alleviation (CFPA), in collaboration with the World Bank , Huaxia Bank , and Kadooie Charitable Foundation ; the Qinghai Agricultural Bank, supported by the AUSAID ; and the Sustainable Microfinance to Alleviate Poverty (SMAP), also a project of the UNPD.  In addition to these projects, many smaller microfinance programs originated at this time.

In China, non-financial institutions such as NGOs are prohibited from supplying any type of financial services.  This is a key challenge for NGOs supplying microfinance in China. They are allowed to do so only through informal operating agreements with the local governments. “With the exception of the Funding for the Poor Cooperative (FPC) at the Chinese Academy of Social Sciences and the ‘Rural Development Associations’ funded by UNDP, which have received written approval from the PBC, other NGO’s microfinance activities are, in theory, illegal.”  

Due to the temporary and uncertain legal status of microcredit NGOs in China, achieving high repayment rates and operational efficiency is more difficult. Borrowers may perceive the organization as temporary, or view its quasi-illegal status as justification for late payments and/or default. Additionally, the NGO cannot credibly promise future loans as a reward for repayment performance, since they may not be allowed to operate in future periods. This further decreases the incentives of borrowers to repay their existing loans.

This situation also decreases the incentives of the organization itself to thoroughly screen and monitor its borrowers, and to pursue repayment of late or defaulted loans. The NGO is aware that its permission to operate may not be renewed; therefore extra effort in these areas will be of little or no benefit to the organization. The staff is also aware of the temporary non-legal status of their employer, and will therefore be less concerned with their own performance. Longevity of employment is not a credible reward for the NGO to offer, decreasing the employees’ incentives for efficient and high quality performance.

Another challenge for NGOs providing microfinance was the interest rate ceilings imposed by Chinese government.  Without the ability to charge appropriately high interest rates, microfinance organizations were unable to cover costs. This was an additional impediment to the long term success of these institutions. 

There were great strides in poverty alleviation during the period from 1979 to 1996; according to official Chinese government statistics, the number of rural poor decreased by 170 million. During this period, the foundation for microfinance in China was laid and the initial developments of the sector took place.  The FPC’s action-research project was the first of many of its kind, beginning a trend of internationally funded microfinance projects in China.  These institutions have faced and continue to face many challenges, the largest of which is the regulatory environment of the People’s Republic of China. While outreach continues to increase, millions of rural Chinese still live in poverty. Microfinance institutions will continue to be a significant player in poverty alleviation in rural China.