Recent Growth and Institutional Constraints in China’s Consumer Credit Sector*
Bruce L. Reynolds University of Virginia
Tu Yonghong People’s University
Wang Yu People’s Bank of China
For presentation to a panel on China’s Financial System, Annual Meetings of the Southern Economics Association, New Orleans, November 2004
Abstract: This paper reviews the rapid growth of consumer credit in China since 1997, within the context of the United States experience with this sector. We attribute the rapid growth to an initial government policy commitment, facilitating laws and regulations, rapidly rising incomes, and changing attitudes toward consumption and credit. The paper notes a range of impediments to continued expansion of this sector – in particular, lack of good credit information, a weak credit culture, and the absence of secondary markets for consumer debt.
PRELIMINARY: NOT FOR QUOTATION OR ATTRIBUTION WITHOUT PERMISSION. Comments and criticisms are welcomed.
*The authors gratefully acknowledge support for this research from CUNA-Mutual Inc. and the Filene Research Foundation. Useful criticism was received from Wake Epps and from participants in the CCER Conference on Consumer Credit in China, August 2004, Beijing. All remaining errors are our own.
Institutions that foster the intermediation of savings to investors are arguably the most critical part of the infrastructure of any modern economy. They make possible the constant increase in the capital-intensity of the production process. More and more, the capital in question is human capital rather than physical capital. (One recent estimate asserts that human capital accounts for 95% of the U. S. capital stock.) Any sort of capital creation involves investment. Investment cannot proceed without saving. And so the market for loanable funds is arguably the most important market in the economy. It’s also the one most prone to market failure. Financial transactions necessarily extend across time as well as space, involve mathematical computations that can be daunting, and are prey to many other sorts of uncertainty as well – for example, concerning the ability and willingness of the borrower to repay. Faced with such uncertainty, rational households wishing to save may well draw back – the market will fail. Virtually every institutional aspect of financial markets – futures markets, mortgages, securitization mechanisms, etc. etc. – has grown up to avert this failure. If we consider the three main types of borrowers – governments, businesses and households – it’s immediately apparent that the potential for market failure is greatest in the case of household credit. These transactions are on a far smaller scale than others. Consequently, households can more easily engage in opportunistic default, knowing that the expected return to the lender of pursuing the defaulter is unlikely to balance the fixed cost of doing so. The fixed costs of loan evaluation are also harder to spread out when the transaction size is small. Households are more unsophisticated than businesses or governments, and thus may themselves be wary of opportunistic behavior on the other side of the transaction. The largest single expenditure of households – on a child’s education – cannot easily be securitized. In a word, the household credit sector is replete with opportunities for market failure. We should consequently not be surprised to find, there, a lush ecosystem of institutional adaptations designed to overcome these problems, ranging from consumer credit protection laws, to small, non-profit credit unions, to the secondary market (pioneered by FNMA) that enables educational loans to be securitized. The growth of this sector in the U.S. – the steady rise in household credit’s share of total
lending described in Part I of this paper – reflects the impact of these institutions, and of technological innovations as well. Now, a scant two decades after rediscovering the market mechanism, China has opened up the household credit sector. Lending to households is growing very rapidly – far faster than lending to business or government. We can imagine that China will move down the same path the U.S. has followed – an evolution that would be completely consistent with the progressive withdrawal of government from other areas of economic life. The rapid rise in Chinese urban incomes, and China’s openness to new institutions and technologies, presage a major future role for household credit. Still, one can conjecture that the technology – in particular, the infotech that today enables a credit card to reach out across the Internet and buy at will – is more transferable by far than the institutional arrangements that encourage intermediation, and guard against speculation and panics - in industrial economies. This paper explores that conundrum, trying to feel its way towards the institutional future of China’s household credit sector. Part 1 reviews the experience of the United States over the past half century. Part 2 summarizes the growth of China’s household credit sector since 1997, and suggests some policy concerns. Part 3 presents institutional impediments to the development of household credit in China. Part 4 concludes.
1. Long-term Growth: the United States Experience
This section tries to look far into China’s future, by asking: What has been the experience of the United States with consumer credit since World War II? Do we see patterns that might have predictive power for China as consumer credit expands there?
Broadly speaking, over the last fifty years the U.S. experienced steady capital deepening. Business, government and households all made increasing use of credit markets. The share of credit flowing to households steadily rose. Today, households are the primary borrowers in U.S. credit markets, borrowing more than either government or business. Figures 13-17 tell this story in more detail.
Fig. 13: All Outstanding Credit as a % of GDP, 1953 - 2004
2 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1
Source: derived from Federal Reserve Board data at economagic.com. Notes: outstanding credit is measured in January of each year. GDP is first quarter.
Fig. 13 shows the steady rise in the ratio of outstanding credit to GDP over this half century (broken only by the abrupt rise during the Reagan-Bush era and the compensating decline in the Clinton years). This long-term upward trend reflects the increasing capital-intensity of the technology with which all sectors of the economy – government, businesses and households – produce goods and services. The underlying stock of government infrastructure, of business capital stock, and of households’ productive capital, is many times larger than the stock of credit outstanding. Only a portion is financed through borrowing. But Fig. 13 suggests that the financed share is a constant or rising portion of the whole. Within this stream of borrowing, the role of consumer credit – borrowing by households – is increasingly important, as Fig. 14 shows. In the early 1950s, government accounted for more than half of all borrowing, followed by business and household borrowing. (Farms, a minor part of the economy even then, essentially disappear from the picture by the end of the century.)
Over time, the role of government in credit markets diminished dramatically. Even in the Reagan era of heavy government borrowing, the business and household sectors held their own. By the end of the century, households had emerged as the dominant borrowers in the marketplace, accounting for more than 40% of all credit outstanding.
Fig. 14: Sectoral Distribution of Credit, 1952 - 2003
60 50 40
Household Sector Government Business Farm
30 20 10 0
Source: all data are from Federal Reserve Board at economagic.com. Notes: Business includes only domestic non-financial sectors.
What accounts for this trend? Did household demand for credit rise quickly over time – more quickly than demand in other sectors? Or did credit markets over time become increasingly willing and able to lend to households? The second reason – increased credit supply to households - seems the most likely. We know that during this period, the ability of lenders to obtain information on the prior borrowing and repayment behavior of households increased dramatically, as did their ability to track households and enforce repayment of debt. Households, in turn, became increasingly aware that prompt, regular repayment of debt would ensure a strong credit rating, lowering borrowing costs.
Another important change was the development of secondary markets in securitized debt. Even before World War II, home mortgages were resold, through FNMA, as securitized debt. Today, the same approach – the creation of pools of securitized assets - has dramatically increased lending for automobile, educational and credit card debt. This pooling and bundling approach helped to overcome a fundamental obstacle to household borrowing: the fact that millions of small households are intrinsically more risky (and hence less appealing) borrowers than thousands of large businesses, or hundreds of municipal, state and federal governments. (As Part 2 notes, in China these markets are still absent.)
More generally, this half century tells a dramatic story of the shift between the state sector and the private sector. The state began the period borrowing more than half the available credit. By the end of the century, private sector borrowing was more than three quarters of the total, perhaps because private households and businesses were increasingly credit-worthy. We might imagine that China could experience a similar sort of evolution over the next fifty years, or even sooner.
Figure 15 shows consumer credit as a percentage of disposable income. This statistic is sometimes used to assert that households are “sinking deeply into debt” – that they are borrowing “too much”. Figure 15 reveals that indeed, U.S. households borrowed more and more over time, relative to their incomes. This trend persists despite the fact that Fig. 15 excludes home mortgages; including mortgages would accentuate the trend. Does this indicate that U.S. households in 2002 faced a debt crisis?
Fig. 15: Consumer Credit as a % of Disposible Income, 1948 - 2002
15 10 5 0
Source: data are from Federal Reserve Board at economagic.com.
It seems implausible that a trend which persists for more than a half century is a sign of impending crisis. To gauge that question, the more useful statistics are default rates, measures of household net worth, and household attitude surveys. Rather, the rising trend in Fig. 15 simply tells us that as incomes rose, as new technologies emerged and as credit markets were increasingly open to household borrowers, a rising proportion of what U.S. consumption came to be produced within the household, in the form of a flow of productive services from a growing stock of housing, automobiles, TVs, VCRs, and human capital. And increasingly this household capital is financed by borrowing.
Fig. 16 subdivides consumer credit, looking at the flows that finance the purchase of these separate forms of household capital. While home mortgages are still nearly 80% of the total, that share is steadily declining. (To give a clearer view of the other three components, Fig. 17 omits home mortgages.)
Fig. 16: Components of Household borrowing, 1968 - 2004
90 75 60
45 30 15 0
Educational Loan Residential Mortgage Credit Card
Source: residential mortgages from gpoaccess.gov/usbudget/fy02/sheets/b75.xls Auto and credit card loans: Federal Reserve Board data at economagic.com. Educational loans from U.S. Department of Education at ed.gov/finaid/prof/resources/data/fslpdata97-01/table5.xls Notes: Educational loans for 1960-89 interpolated from incomplete data. Auto loans for 2000 estimated based on 1997-1999. Credit card loans equals non-revolving credit of major commercial banks.
Fig. 17: Components of Household Borrowing, 1968 - 2004
Educational Loan Credit Card 10
19 65 19 70 19 75 19 80 19 85 19 90 19 95 20 00 20 05
Source: See Fig. 16
The story of consumer credit in the United States, then, is a story of changes in technology, in attitudes, in the nature of U.S. household production, and in institutional and regulatory practices, all of which have had the effect of dramatically shifting the flow of credit away from government and toward the private sector. To label the household portion of this flow “consumer credit” risks missing the fact that investment decisions – to purchase a house, a car, a VCR, or an education – are being made here. The decisionmakers are individual households, rather than government or business. To the extent that those decisions are based on particular, widely dispersed information that is unavailable to government, we might even speculate that investment funds are being allocated more efficiently today as a result of the swing toward consumer credit.
2. Development of consumer credit in China after 1997
Before the Asian Financial Crisis broke out in 1997, consumer credit in China was experimental: slow growing, small scale, with few product types (only mortgage loans, auto loans and student loans). The crisis generated big external shocks for China. Exports sharply decreased, consumption and investment demand declined, and unemployment increased. In response, the Chinese government carried out macroeconomic policies targeted at increasing domestic demand, including supporting and encouraging commercial banks in the consumer credit business. Since then, consumer credit has been on the agenda of the commercial banks. Its development has had the following characteristics:
The balance of consumer credit in China increased from RMB 17.2 billion in 1998 to RMB 1,573 billion up to the end of 2003(Figure 1), increasing by 90 times in five years. The average annual rate of growth was 112%. The growth rate was 326% in the
first year, 1998. As the total balance grew, these growth rates gradually slowed down, decreasing to only 47% in 2003.1 With such rapid growth, the share of consumer credit in banks’ loan portfolios rose steadily, from only 0.85% in 1998 to 9.9% in 2003.2 (Figure 2) The Construction Bank of China, the first one to develop consumer credit, had the highest share, 17.1%. In the Industrial and Commercial Bank of China, whose absolute balance of consumer credit was the largest, the share in the bank’s portfolio was 12.2%. Consumer credit has now become an important market for Chinese commercial banks. Each bank has subdivided their original credit operations, setting up retail divisions, individual financing divisions, mortgage loan divisions, and bank card centers especially for consumer credit.
18000 16000 14000 12000 10000 8000 6000 4000 2000 0 1997 1998 1999 2000 2001 2002 2003
Fi gure 1 Bal ance of Consum Credi t i n Chi na er
Cheng Jiansheng and Liu Xiangyun, Developing consumer credit and promoting consumption , 2003.7, Research Bureau of People’s Bank of China 2 Data in 1997-2002 have the same source as 1; data in 2003 come from “A report on the trend of consumable good market in 2004”, Commercial Ministry, www.xinhuanet.com, 2004.3
B RM 0. 1 bi l l i on
0.23% 0.85% 1.50% 9.90% 4.31% 1997 1998 1999 2000 2001 2002 2003
Fi gure 2 R i o of Consum Credi t Bal ance t o Tot al at er Loan i n Chi na
Growing Range of Product Types
New types of consumer credit have emerged, and now include mortgage, education, large durable goods，home improvement, autos, travels, healthcare, real estate deposits and composite consumer loans, as well as loans for agricultural machinery in the countryside. Some details follow. (1) Individual mortgage loan occupy the biggest share of consumer credit, averaging 75% of the total over these six years. The total mortgage loans, RMB 1,178 billion at the end of 2003, had increased 42% over 2002 and 28-fold over 1998. Because the term of mortgage loans is long, and also because individual willingness to repay is stronger than for firms, the non-performing loan (NPL) ratio is very low, only 0.5%. There is no doubt that this delights the state-owned commercial banks, which are heavily burdened with NPLs.3 Indeed, individual mortgage loans have become their most important and most hotly contested product. Of the four SOCB’s RMB 1,236 billion balance of consumer credit in 2003, the share occupied by mortgage loans has now risen to 79%. 4
Data source: Statistical report of People’s Bank of China People’s Bank of China: A investigation report on individual consumer credit market
8. 70% 0. 50%
m t gage l oan or aut o l oan com posi t e per sonal l oan st udent l oan
Fi gure 3 Structure of Cunsum Credi t of the Four er State-O ned Banks i n 2003 w
(2) Auto loans were second only to housing credit. These loans began in the 1990s. The financial institutions that extend auto loan include commercial banks, the finance companies of auto conglomerates, and auto finance companies. Since China’s entrance into WTO, automobile sales have risen rapidly, and 20% of that spending is supported by loans. The automobile market has been effectively stimulated.5 The balance of auto loans was RMB 43.6 billion in China in 2001, increasing to RMB 94.5 billion at the end of 2002, and roughly doubled in 2003 to RMB 180 billion. (3) Credit card credit is relatively small, but with growth potential. The total number of bank cards has grown rapidly, from 8.4 million in 1994 to 496 million in 2002, and total transaction volume increased from RMB 520 billion to RMB 11,560 billion in that time.6 But only 1.6% of this transaction volume in 2002 was consumer credit, and virtually none of that was revolving credit.7 Bank cards were being used mainly as electronic currency. Of these bank cards, 95.8% in 2002 were debit cards, capable of transferring funds and making deposits and withdrawals, but with no credit element. Even regarding the remaining 4.2%, or 25.9 million, with which credit purchases could be made, the great majority of these required that a countervailing balance be maintained on deposit in the bank.8 But during 2003, the true credit card business grew rapidly. There were about 4.8 million credit cards in use at the end of that year, an increase of 3.25 million over 2002
Su Qin, Problems and Solutions of auto loan market, Automobile Industry Research, 2004.4 Data source: “The three trends of the development of bank cards in China in 2004”, www.chinaunionpay.com 7 The same as 7 8 Data source: calculated from “A quarterly report on the situation of the development of China UnionPay” of the third quarter in 2003
(or a growth rate of 209%). The average annual transactions amount per card was about RMB 7,400, far more than that of debit card.9 (4) The share of student loans was small and developed slowly. The Chinese government offers two sorts of student loans: a market interest rate loan (introduced in the late 1980s) and a means-tested, interest-subsidized loan (beginning in 1999). From 1999 to 2001, the cumulative amount of subsidized student loans was RMB 1.44 billion, which supported 379 thousand students, with the help of further funding from colleges and universities. Unsubsidized loans added RMB 1.9 billion.10 By February 2004, these numbers had risen to RMB 5.2 billion and RMB 2 billion respectively.11 Thus consumer credit grew rapidly in China after 2000. Mortgage loans dominated. Auto loans and credit card credit grew rapidly. Student loans developed slowly. (Table 1) Table 1 The proportion of each type of consumer credit in 2001-2003(%)12
year type 2001 2002 2003
Mortgage loan 82.95 77.4 74.87
Auto loan 6.23 10.78 11.44
Student loan 0.40 0.50 0. 42
Other composite loan 10.42 11.32 13.27
Unbalanced development among regions and between urban and rural areas (1) Development of consumer credit is uneven among China’s different provinces.
It is growing quickly in the developed coastal areas, and slowly in the central and western areas. Policies restrict mortgage loans to the region where the financial institution is located. Thus the uneven financial development among regions guarantees an imbalance
Data source: “The three trends of the development of bank cards in China in 2004”, www.chinaunionpay.com Monetary Policy Office of People’s Bank of China, A report on the development of consumer credit in China, 2002.3 11 Statistical Data form the headquarters of People’s Bank of China, Financial Market Office of People’s Bank of China 12 Data Source of 2001-2002: Cheng JianSheng and Liu Xiangyun, Developing consumer credit and promoting consumption, 2003.7, Research Bureau of People’s Bank of China; Because of the lack of relative data, education credit of 2003 is calculated by detracting the cumulated education credit in January and February, 2004 from the balance of education credit at the end of February, 2004; At the end of year consumer credit reaches more than RMB 180 billion, but there is no actual data, so RMB 180 billion is used here; Therefore, comprehensive consumer credit is the difference between total consumer credit and others, which is not same as the actual data, but it can still reflect the characteristics of the consumer credit structure in 2003.
of consumer credit. Guangdong, Zhejiang and Fujian, and the cities of Beijing and Shanghai, with 14.7% of China’s population, absorbed 61% of the consumer credit (RMB 192 billion) as of November 2000.13 Some types of credit are simply unavailable in some regions: for example, student lending has still not been launched in some western areas, so students there cannot get student loans. (2) Among financial institutions, consumer credit is monopolized by the four large state-owned commercial banks (SOCBs). Through the end of 2002, they accounted for 85.6% of the total, and 81% of auto loans as of November 2003.14,15 The Bank of China has been particularly successful at expanding its market share, extending RMB 94B in mortgage loans in 2003, 36% growth over 2002.16 (3)The focus is limited to cities, while the markets in the countryside where two thirds of Chinese live) is almost untouched. A 2003 survey in Shandong showed that 70% of the peasants there were eager to access consumer credit.17 A county-based survey showed that more than 90% of consumer credit goes to towns and less than 10% to the countryside.
3. Institutional Impediments to the Growth of Consumer Credit in China
A. Information is asymmetric The greatest risk of consumer credit is credit risk. The unsoundness of the credit system in China, especially the lack of a uniform nationwide consumer credit rating system, is an institutional restriction on the development of the sector. Information on residential and automobile sales is unreliable or completely unavailable. Residential developers and automobile dealers regularly engage in fraud, causing disorder in credit markets. Information in the hands of employers and vendors on individuals’ payment
People’s Bank of China: A report on the development of consumer credit, 2001 Cheng Jiansheng and Liu Xiangyun, Developing consumer credit and promoting consumption, Monetary Policy Bureau of People’s Bank of China, 2003.7 15 Commercial banks will fade out from automobile sector, Shanghai Securities News, 2004.1.5 16 He Ping: Bank of China has extended nearly 100 billion loans, Beijing Xianzai Commercial News 17 Data source: Project team of the subbranch of People’s Bank of China in Yishui County, Shandong province, A simple anal ysis of the development space of rural consumer credit market, China Rural Credit Cooperatives,
behavior cannot be shared with banks. Consumers’ very understanding of the nature and importance of credit is itself weak. Loan applicants regularly falsify their income levels. Some borrowers, although perfectly able to repay, deliberately default. There is severe information asymmetry and consequent risk among banks, consumers and products providers.
Consumer credit products lack diversity, and transaction costs are high
Consumer credit in China consists mainly of residential and auto loans. Within these two categories, almost all lenders adopt a common installment structure, without the variations that might accommodate differing income levels or preferences. China’s banking sector traditionally engaged in wholesale loans to enterprises. The consumer credit business is still a novelty to them. Banks thus lack management experience and specialists in this area, which deals with thousands upon thousands of families. This makes banks hypersensitive to risks when extending consumer loans. They become strict about qualifications and procedures, requiring collateral, assessments and insurance for each and every loan, making loan application procedures complex and burdensome. For example, to get durable goods credit, banks now require applicants to provide a residence as collateral, or deposit receipts or T-bonds as collateral security, or a firm acceptable to the bank that will act as guarantor. The”Regulation on Individual Mortgage Loans” prescribes that when used as collateral, a house must carry additional insurance. In addition, mortgage loans face numerous taxes: 3-6% of the purchase price as a credit investigation fee; 11% as a house assessment and registration fee; 2-9% as a comprehensive security fee (for borrowers without a third party guarantor); a loan contract notarization fee; and so on and on.18
The secondary market is absent
Consumer credit is characterized by small scale, high costs and great risk. Credit risk is especially high for residential and auto loans in China. The fluctuation and
An in-depth analysis of the costs of mortgage loan, People’s Daily, 2001.11.28
instability of personal incomes in some sectors and regions is severe, increasing default risk for mortgage loans. In some developed countries, commercial banks sell consumer credit packaged or securitized to cash high-risk and low-liquidity assets in a secondary market, which properly matches assets with debts and risks with returns. But thus far there is no secondary market for consumer credit instruments. Banks can control risks only by collateral or through third party guarantee. These two methods both have obvious defects. First, the liquidity of collateral is low. Provision 53 in the “Assurance Act of the People’s Republic of China” says that if a creditor is not repaid when the obligation becomes due, he can negotiate with the mortgager to liquidate the collateral through sale or auction it to repay, and that if negotiation fails, the creditor can appeal to the courts. But in practice, because of this and that reason, banks find it hard to reach agreement with mortgage holders, and the courts always give priority to the problem of social stability when passing judgment. Regulations on consumer credit are few, and vague. For example, when borrowers default, regulations offer little guidance on how to deal with particular problems such as converting collateral and collateral security to compensation for interest and principal. It is difficult for banks to even begin the process with no legal support. Even when banks get permission to dispose of collateral, it is difficult to liquidate it collateral for the full value when collateral trading is still not marketized, regulated and institutionalized. Banks management costs are high. Secondly, third party guarantees cannot fully compensate for consumer credit losses. Banks usually require an insurance company to provide coverage when the banks extend residential or auto loans. But there are some circumstances under which the insurance companies will not compensate for losses caused by borrowers’ default, and in any event they seldom compensate at full value. Particularly because of the severe moral hazard to policy-holders, and the widespread fraud in automobile insurance claims in recent years, insurance companies are mostly unwilling to offer automobile insurance.