Wokai Adventures

Wokai's China Microfinance Series: Chinese Government to Legalize Private Lending & Other Recent Developments

George Scott

The Chinese government has taken positive steps in an attempt to mitigate the effects of widespread unemployment brought on by global economic downturn.

The government has warned that this year would be “the toughest” since the turn of the century. Huge job losses in the heavily labor intensive industries, construction and manufacturing have left 20 million migrant workers without work and home, since, in many cases, their accommodation was provided by their employer, leaving them with little choice but to return back to their towns and villages across the country.

An article published in chinaview read “In a statement on its website posted Feb. 20, the PBOC -- the central bank -- said it would formulate regulations on private lenders and develop the sector into “a significant player” in the country's rural money markets. It hasn't said when the new regulations would take effect.” In effect granting it legal status, allowing private lending to occupy a legitimate place in the countries financial marketplace.

In mid-August last year the government introduced new incentives to encourage microcredit lenders to provide more loans to small companies engaging in labor-intensive manufacturing activities, expanding the credit limit for the first time and making statements encouraging laid-off workers to become entrepreneurs. In addition, the central bank has allowed qualified microcredit lenders to source funds in the inter-bank money market for on-lending to their customers.



This action is important in combating an already chronic capital shortage in rural areas and risks further aggravation d ue to the economic downturn. This capital shortfall, mainly due to an industry reshuffle in the early 90’s which forced most state banks to withdraw from rural areas, leaving behind only the Agricultural Bank of China, rural credit cooperatives and postal savings banks. Many of these institutions limited their rural lending; though fear of bad debt and low profits. This brought about a situation were rural deposits was being used to finance production in larger more affluent cities and not in the towns and villages were the deposits were actually held.

Relaxing regulation on private lending and encouraging the growth of the microcredit business will have a far reaching impact on China's financial markets. Channeling part of the huge deposit base of the banking system to finance the growth of the vibrant private sector, which, unlike the staid State-owned sector, is made up primarily of many highly competitive and adaptable enterprises.

"People are becoming more aware of the fact that private capital is playing an increasingly important role in funding the growth of small enterprises, and more private capital is being pumped into small enterprises in the form of microcredit to help ease their capital shortage," Zhou Dewen, president of Wenzhou's council for the development and promotion of small and medium-sized enterprises, says.

Recent positive steps taken:

By end of 2006:

· China Banking Regulatory Commission (CBRC) relaxed the conditions of entry for banking institutions in rural areas. Which meant investors were able set up new types of rural financial institutions such as township and village banks and rural mutual cooperatives.

· Minimum registered capital for rural institutions was reduced

· For Credit-cooperatives from 20 million RMB to 10 million RMB

· Rural credit unions, from 10 million RMB to 5 million RMB.

· For larger township and village banks, the amount was set at 1 million RMB

· Loan companies 500,000 RMB and

· Rural mutual cooperatives 100,000 RMB, respectively.

 
By end of 2007

· Licenses were granted to 38 new types of rural financial institutions, including 25 township and village banks, four l  oan companies and nine rural mutual cooperatives.

 · The proportion of rural households having access to bank loans reached 33 percent, which benefited more than 300 million farmers.

· CBRC expanded the list of qualified micro-credit lenders to include all banking institutions, as well as broadening target industries from planting and breeding to all agriculture-related business.

 · The size of credit lines was increased from 3,000 RMB - 5,000 RMB, to 10,000 RMB -  3million RMB. And loan terms got longer, rising from less than one year to as long as three years. Floating rates were also allowed.

 · Rural finance was opened to allow participation by private-sector and foreign institutions: In December 2007, the HSBC. opened its first rural bank in  HubeiProvince, marking the first entry by an international bank into a rural area of China.

Source: Chinaview Contact Centre solutions Community

Wokai's China Microfinance Series: China Microfinance Birdseye View

Geri Mason & Jason Korsmeyer

Here's a quick view into the landscape of the China microfinance sector and key stakeholders:

Rural Credit Cooperatives

Rural Credit Cooperatives, referred to as RCCs, were established in the 1950s, and are the major rural lending organizations in China. RCCs account for 85% of all agricultural loans. With the encouragement of the government, RCCs entered the microfinance sector in 1999.  Currently, there are approximately 32,000 RCCs with around 628,000 employees. This provides RCCs with an unmatched level of outreach and the potential to effectively implement large scale microfinance programs. Yet RCCs have been constantly plagued by corruption, misguided management, lack of competition, and non-performing loans.  These problems stem from a host of internal issues, including: unclear ownership, poor corporate governance, inadequate business scope, poor asset quality, a poor administrative framework, staff capacity and quality problems, a heavy historical burden, poor accounting practices, and a lack of internal control.   Externally, they have been protected by regulations constricting financial institutions’ regional movement, thus eliminating competition.  RCCs were restructured in 2004 to improve ownership clarity and business goals, but without competition RCCs will not provide efficient microfinance programs.

Agricultural Bank of China

The Agricultural Bank of China (ABC) is China’s second largest provider of agricultural loans.  Microfinance operations began here in June of 1998 .  The ABC has been burdened by non-performing loans and unclear goals.  So far, its microfinance programs have directed capital to the poor, but remain financially unsustainable.  The bank also lends at below market rates, which makes it difficult for the other participants in the microfinance sector to lend at rates that cover their costs. 

While ABC’s practices will continue in the short-term, change is approaching.  Within the year, ABC is expected to follow the Bank of China and China Construction Bank to become a publicly traded company.  Because it will need to attract investors, ABC will need to focus on sustainable microfinance growth or else exit the market.

NGOs

Beginning with Funding for the Poor Cooperative (FPC), NGOs have been conducting microfinance activities in China since 1994.  After the first action-research projects conducted by the FPC, there was an influx of international attention and dollars into China’s microfinance industry.  This influx came from the United Nations , the World Bank , AusAid , the Ford Foundation , etc., and established a microfinance base in China. Currently, there are approximately 300 microfinance programs of this nature.

Within China’s microfinance sector, NGO programs represent a small portion of the pie.  However, they have functioned effectively as an arena for research and best practices development, resulting in the most successful and sustainable microfinance programs in China to date. 

Microcredit Companies

In December 2005, the People’s Bank of China authorized the launch of seven microcredit companies , the first microfinance programs with legal recognition in China. Of these seven MCCs, one, “Procred ”, is a wholly foreign owned organization.

While this is a major step forward, these MCCs are only able to provide loan services and unable to collect deposits, because they are not formal financial institutions.  Thus, equity for loans comes from private capital, which is a major hindrance to MCCs’ ability to expand.  But legal recognition does give the MCCs potential to become sustainable institutions, which would go a long way to bringing change in the future.

MCCs are also limited geographically; the approval process requires them to designate a particular area where they will conduct their financial activities.  This obstacle hinders the ability of successful organizations to grow and implement their model throughout the country.

Village Banks

On December 22, 2006, the Central Banking Regulatory Commission launched a program to authorize Village Banks.  Before this program was introduced, there were hardly any entrants to the rural financial market.  This program lowered the capital threshold to three million Yuan for a county level bank, and lowered it to one million Yuan for a town or village level bank.  These organizations function like normal banks, providing loans and collecting savings.  While this gives them the ability to expand naturally, they are still limited geographically to the region where they are approved to operate, and by their respective capital thresholds. 

Village Banks face two other limitations, as well. First, an established bank must hold at least a 20% share in the newly formed village bank.  The goal of this regulation is to ensure new village banks have financial experience.  It hinders the ability of these new organizations to prosper, however, by forcing them to be reliant on the established bank.  Second, an individual investor can hold a maximum share of 10%, limiting the freedom for public investment.  Despite these limitations, HSBC has opened the first foreign village banks in China.

Postal Savings Bank of China

In 2007, China Post was authorized to enter the rural financial market and provide retail financial services to rural markets.  With a massive number of branches already established, China Post has the potential to reach millions of clients.  As of March 26, 2007, China Post had launched collateralized loans through 1901 offices and made 228 million dollars worth of loans.  With the permission of the Central Banking Regulatory Commission, certain branches of China Post have also been conducting experiments with uncollateralized loans across the country.

Because the Postal Savings Bank of China is a new player in the microfinance market, with branches established throughout the country and relatively relaxed restrictions, their potential for success is high.  However, the possibility for misdirection and failure is also high because they are new and need to create a regulatory infrastructure with in which to operate.

Geri Mason & Jason Korsmeyer

Here's a quick view into the landscape of the China microfinance sector and key stakeholders:

Rural Credit Cooperatives

Rural Credit Cooperatives, referred to as RCCs, were established in the 1950s, and are the major rural lending organizations in China. RCCs account for 85% of all agricultural loans. With the encouragement of the government, RCCs entered the microfinance sector in 1999.  Currently, there are approximately 32,000 RCCs with around 628,000 employees. This provides RCCs with an unmatched level of outreach and the potential to effectively implement large scale microfinance programs. Yet RCCs have been constantly plagued by corruption, misguided management, lack of competition, and non-performing loans.  These problems stem from a host of internal issues, including: unclear ownership, poor corporate governance, inadequate business scope, poor asset quality, a poor administrative framework, staff capacity and quality problems, a heavy historical burden, poor accounting practices, and a lack of internal control.   Externally, they have been protected by regulations constricting financial institutions’ regional movement, thus eliminating competition.  RCCs were restructured in 2004 to improve ownership clarity and business goals, but without competition RCCs will not provide efficient microfinance programs.

Agricultural Bank of China

The Agricultural Bank of China (ABC) is China’s second largest provider of agricultural loans.  Microfinance operations began here in June of 1998 .  The ABC has been burdened by non-performing loans and unclear goals.  So far, its microfinance programs have directed capital to the poor, but remain financially unsustainable.  The bank also lends at below market rates, which makes it difficult for the other participants in the microfinance sector to lend at rates that cover their costs. 

While ABC’s practices will continue in the short-term, change is approaching.  Within the year, ABC is expected to follow the Bank of China and China Construction Bank to become a publicly traded company.  Because it will need to attract investors, ABC will need to focus on sustainable microfinance growth or else exit the market.

NGOs

Beginning with Funding for the Poor Cooperative (FPC), NGOs have been conducting microfinance activities in China since 1994.  After the first action-research projects conducted by the FPC, there was an influx of international attention and dollars into China’s microfinance industry.  This influx came from the United Nations , the World Bank , AusAid , the Ford Foundation , etc., and established a microfinance base in China. Currently, there are approximately 300 microfinance programs of this nature.

Within China’s microfinance sector, NGO programs represent a small portion of the pie.  However, they have functioned effectively as an arena for research and best practices development, resulting in the most successful and sustainable microfinance programs in China to date. 

Microcredit Companies

In December 2005, the People’s Bank of China authorized the launch of seven microcredit companies , the first microfinance programs with legal recognition in China. Of these seven MCCs, one, “Procred ”, is a wholly foreign owned organization.

While this is a major step forward, these MCCs are only able to provide loan services and unable to collect deposits, because they are not formal financial institutions.  Thus, equity for loans comes from private capital, which is a major hindrance to MCCs’ ability to expand.  But legal recognition does give the MCCs potential to become sustainable institutions, which would go a long way to bringing change in the future.

MCCs are also limited geographically; the approval process requires them to designate a particular area where they will conduct their financial activities.  This obstacle hinders the ability of successful organizations to grow and implement their model throughout the country.

Village Banks

On December 22, 2006, the Central Banking Regulatory Commission launched a program to authorize Village Banks.  Before this program was introduced, there were hardly any entrants to the rural financial market.  This program lowered the capital threshold to three million Yuan for a county level bank, and lowered it to one million Yuan for a town or village level bank.  These organizations function like normal banks, providing loans and collecting savings.  While this gives them the ability to expand naturally, they are still limited geographically to the region where they are approved to operate, and by their respective capital thresholds. 

Village Banks face two other limitations, as well. First, an established bank must hold at least a 20% share in the newly formed village bank.  The goal of this regulation is to ensure new village banks have financial experience.  It hinders the ability of these new organizations to prosper, however, by forcing them to be reliant on the established bank.  Second, an individual investor can hold a maximum share of 10%, limiting the freedom for public investment.  Despite these limitations, HSBC has opened the first foreign village banks in China.

Postal Savings Bank of China

In 2007, China Post was authorized to enter the rural financial market and provide retail financial services to rural markets.  With a massive number of branches already established, China Post has the potential to reach millions of clients.  As of March 26, 2007, China Post had launched collateralized loans through 1901 offices and made 228 million dollars worth of loans.  With the permission of the Central Banking Regulatory Commission, certain branches of China Post have also been conducting experiments with uncollateralized loans across the country.

Because the Postal Savings Bank of China is a new player in the microfinance market, with branches established throughout the country and relatively relaxed restrictions, their potential for success is high.  However, the possibility for misdirection and failure is also high because they are new and need to create a regulatory infrastructure with in which to operate.

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.

Wokai's first monitoring trip to Chifeng

Zhang Sheng

Zhang Sheng has been working with Wokai for the past year and a half as Wokai's Director of Field Partnerships.

How much can microfinance really help people? This is a question I used to ask myself before I first attended a meeting of individuals who have actually received micro-loans. Most recipients are women who arrive at micro-loan meetings on the back of their husbands’ motorcycles. Theoretically, many of these individuals come from the same village, but in reality these loan recipients are spread widely throughout the surrounding countryside. Despite the distance, most micro-loan recipients regularly attend this kind of meeting. They attend not only because they need to repay their loans and sign new loan contracts, but also to get together and catch up on the latest local gossip about whose kids are getting married and whose cow had another calf. To be honest, attending this kind of meeting sometimes makes my head hurt. Even though they understand what I am saying in Mandarin, they all speak Mongolian and I cannot understand a single word. It is as if I am in a foreign country.

 Meetings like these are always filled with laughter as the women joke with one another. And, even though I have no idea what they are saying, their laughter is contagious. The expressions on their faces leave no doubt that they enjoy getting together for these meetings. At this particular meeting there was a loan recipient among them who caught my attention, not only because she was pregnant, but also because her hesitant gaze was so out of place amidst the bustle and excitement of her surroundings. After asking a loan recipient next to me, I learned that this mother-to-be had just joined their micro-credit union. Looking at this insecure newcomer and then at the hopeful and determined individuals around her who had already benefited from microfinance, I guess I had evidence of the difference microfinance can make.

I have interviewed many Wokai micro-loan recipients in order to check if their loan information and website profiles match. This provides very useful information for Wokai and important feedback for improvement. I am also moved by the hope for the future and the gratitude for microfinance in the eyes of every single person I interview. The phrase I heard most often was this: “Thank you for your micro-loan that let us continue running our business; we can’t imagine what our lives would be like without you.” With typical financial institutions providing little relief amidst economic hardship, access to these microcredit unions is their only resource to escape poverty.

The Deputy General Secretary of CZWSDA told me in an interview that many of the MFI employees do two things everyday: first, they check their e-mail and, secondly, they log on to Wokai’s website. After hearing that Wokai and ARDY are going to be cooperating, a loan officer based out of Youqi, a branch office of CZWDA, is already directing more energy to making clients’ files more attractive and diversifying their opportunities. Considering their organization’s standardized client files, I think this is also a more efficient method of controlling client risk. Even as I write this, CZWSDA is already networking with another potential partner of Wokai.

 

During the meeting, members of one group wait outside the door to sign their micro-loan agreement. Their husbands are also chatting together.

That day I hurried to the house of Wei Xiuxia (back row, middle) for an interview and was just in time to eat lunch with the whole family. She said that in the village, the New Year holiday did not end until February 26. Two of her grandsons joined us for the group photo.

Front row, left to right: Cao Budungerile, Si Qin, Zhao Xiuqin

Back row, left to right: Qiqige’s husband, me, Siqinjiruhe, Director of Center 29

Qiqige’s child was sick, so her husband came to payback the loan. Originally he didn’t want to be in the group photo, but I pulled him into the picture. Other than the Director of Center 29, the other five are all clients of Wokai (or close friends of Wokai clients).

 

Zheng Xianfang took a brief break from her tailoring to take this photo with me. When we took it, she was actually still holding a pair of scissors in her hand. She said that business was particularly good right before students went back to school. After previous failure, her micro-loan enabled her to start a new business and restored her confidence. She has even been able to employ her daughter, indirectly resolving her employment difficulties as well.

 

 

China Microfinance Series: Introduction to 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.

The popular definition for microfinance is small loans given to low-income entrepreneurs who lack the ability to receive loans from a formal bank.  However, this definition is incomplete and only refers to a part of the microfinance industry known as microcredit. Microcredit was the first aspect of microfinance to develop, but as microfinance grew, it became clear that the poor needed more financial services, so microsavings, microinsurance, and remittances where introduced.  Today, the most succinct and complete definition of microfinance is as follows: a variety of financial services, such as credit, savings, insurance, and remittances that are provided to poor entrepreneurs.  To wholly understand this definition, we must explain microfinance’s origin and growth.

Modern microcredit originated in war-ravaged Bangladesh in the early 1970s. In 1971, Bangladesh won its independence from Pakistan, but the damaged inflicted from war, along with the subsequent floods and famine, pushed Bangladesh into extreme poverty.   In 1976, a professor named Muhammad Yunus, in response to the poverty engulfing the country, began to give small loans to the poor. Due to the lack of available resources, Muhammad Yunus provided loans using his own money, with the conviction that they would be repaid.  To the surprise of others, the loans were repaid, and by 1983, the government registered the Grameen Foundation, Muhammad Yunus’s organization, as a formal bank. 

The Grameen Bank employed three specific lending practices that generated its success.  First, the Grameen Bank loaned under joint liability contracts, a system which enables the lender to regulate borrowers without credit histories or collateral. A joint liability contract requires an individual seeking a loan to form a group, consisting of three to eight other individuals from the same community seeking credit. 

Five was the common group size used in the Grameen model. Once the group was formed, loans were dispersed to two people within the group at a time. When the first members of the group take out a loan, each person in the group is responsible for the loan.  So if one individual does not repay his loan on time, or falls into trouble repaying at all, then the rest of the group has incentive to cover that amount.  If the entire loan is not repaid, then no other member of the group is able to take out another loan.  Thus, the joint liability contract effectively replaces credit histories with group guarantees, and collateral with peer pressure and monitoring, using access to future loans as an incentive to monitor and insure fellow group members.

Second, the majority of Grameen Bank loans were, and still are, issued to women.  Professor Yunus was initially drawn to lend to this segment of the population by witnessing the hard working women, with viable business ideas, that were excluded from the formal credit markets of Bangladesh because of their gender. It has since been found that women have statistically higher rates of repayment than men. Familial connections and domestic responsibilities, as well as their close ties to social groups and the importance of societal norms and peer pressures in their daily lives, have been cited as major reasons why their repayment rates have consistently been higher. The combination of these factors makes women less likely to abscond with or misuse loan funds.  The practice of extending credit to women has empowered females in poor households throughout the world.

Third, interest rates charged on loans are higher than they would be at a formal bank. It may seem counterintuitive to charge the poorest borrowers higher interest rates.  From the perspective of the Grameen Bank, however, this practice is necessary because the transaction costs of lending to poor clients, without collateral and in the absence of complete information infrastructures, are much higher.

The screening process of a formal bank would involve a quick credit history check. Informal financing of this kind, however, involves seeking and confirming personal knowledge of the borrower, as there is no formal record of her credit history. Monitoring costs are also higher, involving personal visits with the borrowers and their projects. A third factor increasing the transaction costs of lending to the poor is the lack of legal recourse in the event of default. Even if the legal infrastructure exists to sue for the loan principle, the cost of the legal procedure will be much more than the principle amount of a micro loan.

To visualize this difference, consider the following numerical example. Assume that the absolute transaction costs of a single loan is the same for a formal bank as it is for a microlending institution: $10. Hypothetically, if a formal bank’s average loan size is $10,000, and it costs $10 for them to draw up a contract, complete a credit check and have an agent meet with the borrower, then the percentage cost to complete the transaction on the entire loan would be 0.1%.  But, if the Grameen Bank’s average loan is $100, and its transaction costs are still $10, the total percentage of the transaction cost would be 10%.  Therefore, to combat this relatively higher transaction cost, the Grameen Bank needs to charge higher interest rates.

This only explains one side of the story, however.  The more interesting question is: Why would poor borrowers be willing to accept high interest rates?  Surprisingly, the reason is because poor borrowers can expect large returns on their investments.  The most common example used in economics to explain this phenomenon is to imagine a poor corn farmer.  If this poor farmer doesn’t own a plow, his corn production will be very low.  But if he is able to buy one plow, his production will increase drastically. By buying a second plow his production will increase, but less than when he added the first plow, and for each additional plow the farmer adds, his increase in production will be less and less.  This economic concept is known as decreasing marginal returns to capital, and can be applied to other industries as well. For example, adding the first freezer to restaurant or sewing machine to a tailor shop will be more productive to the business than subsequent additions.  Poor borrowers are willing and able to pay high interest rates on loans because high returns are expected from these initial investments. 

By establishing these three characteristics in lending practices, the Grameen Bank was able to provide loans to the poor and also able to cover operational costs through interest rates and service charges. Poor borrowers lives are improved through access to loans, and microfinance institutions can become financially sustainable through the process of providing these loans.

Many institutions worldwide have adapted the Grameen Bank model and met with success.  One successful example is the Foundation for International Community Assistance (FINCA).  In 1984, FINCA initiated the “village bank” system in Bolivia to provide micro loans.  The success of this program has allowed FINCA to establish itself across Latin America, Eurasia, Africa and the Middle East; and, in February of 2007, FINCA surpassed the 500,000 client milestone. In 1993, the first pilot microfinance institution initiated operations in rural China.

As these new institutions emerged, it became clear that loans were only one financial service that poor individuals could benefit from. Access to formal savings increases household stability and allows safe holding liquid capital in poor households and communities.  Insurance protects low-income farmers from floods, droughts, and other unexpected disasters. Remittances give individuals who have relocated the ability to pursue economic opportunities and send earnings home to family members. As the microlending industry has developed and evolved, lending institutions have put together a collection of financial products in the aforementioned areas to better serve the needs of their clients as microfinance institutions offering a complete set of financial services.

With these developments, the current outlook for the microfinance sector is positive.  Not only has the industry received worldwide recognition—the UN declared 2005 the year of Microfinance and in 2006 Muhammad Yunus received the Noble peace prize—but also, the sector’s potential is bright.  In 2004, the Social Enterprise Associates estimated the market demand for microfinance at 300 billion, of which only 30 billion has been met.  There is no doubt that an industry which will increase by 270 billion dollars, or 1000%, will only grow in significance. And while the financial potential for microfinance is impressive, more importantly, microfinance has provided 750 million poor individuals with the tools to increase their income, create businesses, and improve the stability of their household.

Wokai's China Microfinance Series

Casey

The last two months have been a very exciting period for the China microfinance sector. As the global economic crises proceeds to unravel, over 20 million migrant workers in China are now jobless and returning to their homes in the countryside. At the same time, to sustain growth, create jobs and reduce inventories, China needs to boost consumer spending. And this includes consumption in the countryside, where some 700 million plus people live. The trouble is, the majority of farmers have little spare cash - and any savings are saved away in case family members take ill. One solution could be microcredit - lending to expand livestock or start a small business. China sees the need for microcredit loud and clear and the government is quickly implementing new policies to push forward the development of the microfinance sector.

In lue of these recent developments, we will be featuring a series of posts on the past and present of China's microfinance sector, with an article series written in collaboration between Geri Mason & Jason Korsmeyer, and blog posts from our team on the latest news in China microfinance.

Gumballs, $27, and Wokai

Liz Blase & Jessica Lee

Liz is the Fundraising Associate at Wokai's San Francisco Chapter and worked on business development with Wokai during the Fall of 2008 in Beijing. Jessica is the Business Strategy Associate at Wokai's San Francisco Chapter. 

Riddle me this:

If someone gave you a kit with 27 gumballs and $27, how would you turn that into $500 in just one week?

Our answer: 

Ask the next college team to win the Gumball Challenge sponsored by our newest supporter: Gumball Capital.

In their words:

“Gumball Capital is a nonprofit that gets college students inspired, educated, and involved in fighting poverty through entrepreneurship. Every year, we sponsor a one-week microfinance-benefit competition, the Gumball Challenge where students create value from kits of $27 and 27 gumballs.”

The money that students raise through these competitions fund microloans to low-income entrepreneurs through Gumball Capital’s trusted partner organizations.

What does Gumball Capital look for in a partner organization? 

•    Commitment to microfinance;
•    Effectiveness in reaching driven and deserving entrepreneurs; and
•    Transparency in its use of Gumball Capital funds

Previously, only one organization (Kiva.org) met Gumball Capital’s transparency requirements for a strategic partnership.  Gumball Capital has contributed over $7000 in microloan capital through Kiva since its inception in 2007. 

Today, however, Wokai has risen to such a level of effectiveness and transparency to provide Gumball Capital with a new partnership opportunity.  Similar to Kiva, Wokai’s web platform offers its users a menu of micro-entrepreneurs in rural China (and their projects) whom users can support for as low as $10.  Wokai’s rigorous diligence process, conducted on all of Wokai’s Field Partners, who administer the microloans, ensures that every dollar of user contributions support the chosen projects.  Wokai’s thorough monitoring of its Field Partners and close connection to its users enable Wokai to provide frequent updates to users about the progress and repayment of their generous contributions.

Wokai is very pleased about the new Gumball Capital-Wokai partnership.  The partnership will allow Wokai to reach more micro-entrepreneurs throughout Sichuan and Inner Mongolia.  Additionally Wokai hopes to further the mission of Gumball Capital: “to engage students in entrepreneurship for social change through microfinance.”

Wokai would like to thank the Gates Scholars Society for facilitating the connection between Gumball Capital and Wokai.