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Rural Market Competition

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					  Microcredit Companies and Village Banks – Competition or
                                    Pluralism*


     THORSTEN GIEHLER, SUN YINHONG, REN CHANGQING, GUO PEI




* the article is partly based on a research mission carried out by Ren Changqing and Guo
Pei commissioned by the German Technical Cooperation (GTZ) and the International
Fund for Agricultural Development (IFAD)




                                           1
During January 19-20 of 2007, the Chinese government held a central financial
conference. Rural finance became one of major concerns in the conference, and some
arrangements were determined in terms of rural financial reform and development, with a
goal of establishing a rural financial system natured in multi-level, wide coverage and
sustainability. The new rural financial system should be characterized by reasonable labor
division, diversified investment sources, full-fledged functions and efficient services.
Besides, a more developed rural financial market system should be established to support
and promote rural economic development through providing rich financial products and
services.

Importantly, to promote the innovation of rural financial institutions and to relax the long
standing market barrier in rural areas by lowering the access thresholds should be the
priorities in the way to meet the huge rural finance demand. Microfinance should be
extended to more farmers by setting up more diversified forms of microfinance
organizations.

The Establishment of New Rural Financial Institutions

a. PBC Microcredit Company (MCC) in Five Provinces

In order to change the current situation in which existing formal financial institutions
monopolized the rural financial market and explore the possibility of establishing a
competitive rural financial market, in the first half of the year 2005, the PBOC decided to
carry out a microcredit pilot program in Sha’anxi Province, Shanxi Province, Sichuan
Province, Guizhou Province and Inner Mongolia Autonomous Region, aimed at
establishing microcredit companies predominantly invested by private capital in
competition with RCCs and invigorating the rural financial market. This ushered into the
effort to explore the possibility of rural financial innovation both diversified and
commercially sustainable. The objective of the five-province pilot program is to provide a
normal investment channel for private finance, reverse the monopoly over the rural
financial services sector by RCCs, and then foster a competitive rural financial market.


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The requirements of the PBC in regard to the pilot program include the followings. First,
“credit only” Microcredit companies (MCCs) in such a program only provide lending
services and cannot accept deposits. The equity for loans comes from self-owned equity,
donations or wholesale funds from a single source, and it is composed of private capital
completely. Second, there should be no more than five shareholders in principle. Third,
the lending interest rate is liberalized, but such loans cannot become shark loans and their
interest rates cannot go beyond four times the statutory benchmark interest rate. Fourth,
the clients of microcredit companies are “the rural areas, agriculture and farmers”. It is
stipulated that microcredit can only be extended within the administrative jurisdiction
where a microcredit company is located and in principle cannot be extended to clients
outside of such a jurisdiction. Fifth, the ceiling of a single loan is RMB 100,000 yuan,
and the lending interest rate can be negotiated between the lender and the borrower freely.
By the end of October, 2006, the five provinces have already set up 7 microcredit
companies in compliance with the above-mentioned principles, and these companies have
already started business operations (see table below).

    Table 1: Profiles of PBOC Pilot Microcredit Company in Five Provinces

                                                                                    Registered
                                                                    Inaugurate      Capital
   Province    Institute Name
                                                                    Date            (Million
                                                                                    Yuan)

               Shanxi Pingyao Jinyutai Microcredit Company Ltd.     Dec. 27, 2005   16
   Shanxi
               Shanxi Pingyao Rishenglong Credit Company Ltd.       Dec. 27, 2005   15

               Sichuan Guangyuanzhongqu Quanli Microcredit          Apr. 10, 2006
   Sichuan                                                                          20
               Company Ltd.

   Guizhou     Guizhou Jiangkou Huadi MicrocreditCompany Ltd.       Aug. 15, 2006   30

   Inner       Inner   Mongolia   Erdous   Rongfeng   Microcredit   Oct. 10, 2006
                                                                                    50
   Mongolia    Company Ltd.

               Xian Dayang Huijin Microcredit Company               Sep. 18, 2006   21
   Shaanxi
               Xian Xinchang Microcredit Company                    Sep. 18, 2006   22



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b. CBRC New Rural Financial Institutions in Six Provinces

The CBRC new policy on rural finance market is regarded as an important step to build
commercialized sustainable competitive rural financial market in China. On December 22
2006, CBRC announced a new policy to ease the entry threshold for rural financial
institutions. It was regarded as CBRC new policy. The new policy lowered the registered
capital threshold to three million Yuan for banks in counties and one million Yuan in
villages and towns. This is in some extent a signal that the door of rural market is opened
to public. Before this new policy, there hardly has new rural financial institutions
registered under CBRC. Three types of institutions are encouraged to establish, village
bank, specialized credit-only and full-owned subsidiaries and community credit
cooperative. With this new policy, one important component of the policy is the existing
financial institutions are required to be the initiators of new village banks and hold no
less than 20% of the total shares. CBRC designated 6 provinces, Jinli, Inner Mogolia,
Sichuan, Hubei, Gansu and Qinghai as the pilot provinces. Total 36 institutions of all
three types are schemed in 6 provinces.

According to CBRC, by the end of April 2007,CBRC has received 21 applications for
opening village banks, 15 of them have been approved and 9 of them have been
inaugurated in 6 provinces (see table 2 below).




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Table 2: Profile of Newly Established Village Banks
Name           Location           found   Registered     Initiator               Partners
                                  ed      capital
                                          (in  million
                                          RMB)
Sichuan        Sichuan,           1/3/                   Nanchong                Sichuan     Sichaun          Tibet                 Nanchong      Nanchong
Yilong         Jincheng Town,     2007                   Commercial              Mingyu      Haishan          Zhumulangma           Lianyin Co.   Kangda
Huimin         Yilong County              2              Bank                    Group       International    WeiyeGroup            Ltd.          Accessory
Village                                                                                      Co. Ltd.                                             Group Co.
Bank                                                                                                                                              Ltd
                                          Shares:        1 [50%]                 0.2 [10%] for each partner
Jilin Panshi   Jilin, Rongfeng    1/3/                   Jinlin         City     88 private investors
Rongfeng       Town,    Panshi    2007                   Commercial Bank
Village        County                     20
Bank Co.
Ltd.                                      Shares:        4 [20%]                 16 [80%]
Jilin          Jilin, Chengxin    1/3/                   Lianyuan   Urban        3 enterprises                            6 private investors
Dongfeng       Village, Sanhe     2007                   Credit Cooperative
Chengxin       County,                    20             Co. Ltd.
Village        Dongfeng
Bank Co.       County,                    Shares:        7.5 million             6   [30%]                                6.5 [32.5%]
Ltd.           Liaoyuan City                             [37.5%]
Dunhua         Jilin,  Jiangnan   28/3/                  Yanbian        Rural    19 private investors
Jiangnan       Town, Dunhua       2007                   Cooperative Bank
Village        County, Yanbian            10
Bank Co.       City
Ltd.                                      Shares:        5.1 [51%]               4.9 [49%]
Ruixin         Gansu, Xifeng      15/3/                  Gansu      Qingyang     5 Enterprises and 36 Private Investors
Village        Distrct,           2007                   Xifeng District Rural
Bank Co.       Qingyang City              10.8           Credit Cooperative
Ltd.                                                     Union


                                          Shares:        2.7 million [25%]       8.1 million [75%]




                                                                             5
Name        Location          found   Registered     Initiator              Partners
                              ed      capital
                                      (in  million
                                      RMB)
Pingliang   Gansu,            16/3/                  State Development      Jingchuan RCC          Pingliang RCC            Baoziguo Coal Mine
City        Jingchuan         2007                   Bank    of   China,                                                     and 10 private investors
Jingchuan   County,                   18             Gansu Branch
County      Pingliang City
Huitong
Village
Bank Co.
Ltd.
                                                     10 [55.56%]            3 [16.67%]             3 [16.67%]               2 [11.10%]
                                      Shares:
Hubei       Hubei, Xiantao    28/4/                  Beijing       Rural    none
Xiantao     City, Xiangfan    2007    10             Commercial Bank
Beinong
Village
Bank                                  Shares:        10 million [100%]
Guyang      Inner Mongolia,                          Baotou Commercial      Beijing    Zhongxin       Zhiyuan     7 private investors
County      Xiashihao Town,                          Bank                   Technology Co. Ltd.
Xiashihao   Guyang County             3
Town
Baoshang
Huinong
Village
Bank
Co.Ltd.                               Shares:
Kaiyuan     Qinghai, Datong                          State Development      Xinning         Xining         City    Daong    County       Qinghai
Village     County                                   Bank    of    China,   Commercial      Investment             State    Owned        Bridge and
Bank                                  20             Qinghai Branch         Bank            Management Co. Ltd.    Capital               Electricity
                                                                                                                   Management            Company
                                                                                                                   Center
                                      Shares:




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The Challenges of CBRC’s New Policy

The ultimate goal of China’s rural financial reform is to establish a commercialized
competitive rural financial system. To realize this goal, the market entry and quit
mechanism is the core component of the policy. The CBRC new polices on lowering
registered capital and encourage foreign and domestic banking capital, industrial capital
and private capital to invest, acquire and establish different type of banking institutions in
rural area is a positive step toward this goal. The monopolistic rural financial market will
be more competitive with the establishment of more and more new financial institutions.
From this point of view, the new policy still engenders some challenges.

The new policy encourages all kind of investors to entry the rural financial market, but
the initiators should be at least one domestic banking financial institution. The initiators’
shareholding proportion of single domestic banking financial institutions should not be
lower than 20%. This makes the new rural financial institutions dominated by existing
banking financial institutions. The business model will be affected by the initiators. These
requirements in some extent prevent investors who are really interested in the rural
financial market from entering the market.

RCC itself is a local based rural financial institution serving the rural, agricultural and
farmers in the county. If RCC initiates a village bank in the same area, it can be seen a
new branch of RCC. Thus, the new village bank and RCC are not competitors.

Lower registered capital is the important component of the new policy. But with the
initiator requirement, lower the capital requirement won’t bring many new players into
the market. For the domestic banking financial institutions, this low capital requirement is
not an incentive to entry the rural market.

The new policy excludes the NGOs microfinance as the initiators and shareholders. NGO
microfinance has been struggling for the legal statues for a decade since 1990s. It plays
an important role in extending finance to the farmers, especially the rural poor farmers
without collateral. The stagnation of the microfinance movement as a whole is mainly the
product of an inhospitable legal and regulatory environment. It remains difficult for NGO
microfinance to expand and develop a critical business model for the poor. Microfinance


                                              7
will only play a large role in the rural financial system after many key system reforms are
put into place.

The policy encourages the new village banks to use as much as the funds in rural area
with the premise of both local inclusiveness and commercial sustainability. The surplus
funds can be employed to financial bonds issued by Agriculture Development Bank of
China or be used for financing in favor of “agriculture, rural and farmers” through other
legal channels after they do satisfy the local needs. This does not assure the village bank
can use the local funds to satisfy the local need. The village bank can be another financial
intermediate that outflow the funds from rural area.

Due to the local supervisor capacity limitation, this hospitable policy won’t lead a
mushroom increasing of rural financial institutions. The restrict approval procedure will
prevent many potential investors from investing the village banks.

Improving the access to the financial services for the poor relies on a favorable financial
environment that encourages a diversity of financial institutions and financial products to
serve the poor. The CBRC new policy does open a path for existing financial
intermediates to working in the rural area. As we mentioned in above, the new policy still
faces some challenges on promoting competition and attract more investors and variety
institutions. From this point of view, the new policy can only play limited role on
improving the access to financial services for the poor.

The new policy focuses on establishing a competitive rural financial market by
encouraging the domestic banking financial institutions invest in the village banks, but
leave the microfinance outside this policy framework. Isolated microfinance from the
formal financial system may slow down the improvement of scaling up financial services
for the poor.

The Challenges of the MCC Model

Although the new CBRC policy is to lower the capital threshold, it is still very difficult
for the investors who do not qualify to be initiators to entry the formal rural financial
market. This policy also excludes the PBC’s microcredit pilot. Different from the CBRC
village bank pilot program, PBC’s credit only pilot program does not need the domestic


                                             8
banking financial institutions as the initiators. Any individual and enterprises can initiate
and invest in the credit-only microcredit company. Unfortunately, the credit-only
microcredit company can not get license from CBRC under the current policy.



Therefore the promoters of the MCC pilot still have to define the regulatory context in
which MCCs can operate. Current uncertainty regarding the future status of the MCCs
limits their ability to develop long-term strategic plans. Rules defined vary depending on
the location where the MCC operates and make it difficult to take important decisions
regarding their operations.


Since the adoption of a MCC regulation on national level may still take some time, it is
therefore recommended to draft for each pilot province a provincial MCC regulation or
decree which creates transparency for existing and future MCCs. This would also better
allow comparing different approaches and features of MCCs in the five provinces.


The current strict observation of MCCs by provincial governments and PBC might be
necessary to prohibit illegal or unsound activities. However this also conflicts with the
idea of piloting new things, which requires a certain level of flexibility. Without clear
regulatory framework it is understandable why the MCCs are both risk-averse in their
lending policies, and unable (or unwilling) to plan too far out into the future. After the
creation of the village bank model, the MCC promoters should also try to relax the
regime of the MCCs. Consultant input and donor support can partly substitute strict
supervision with on-site advice and training.


However the introduction of the village bank model causes concern among the MCCs
who worry that they will have to face new competitors before they have had the chance to
establish themselves, especially if these competitors will have the advantage of being
able to attract deposits. In general the guidelines for the establishment of village banks
are welcome, because this shows the willingness not only of PBC but also of CBRC to
allow specialized rural financial and microfinance institutions. This is a breakthrough
bearing in mind the high entry barriers to open new financial institutions defined by the


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banking law of China.


The two models compared
Comparing the two models (MCC and the village bank model) helps to identify the
advantages and disadvantages of both models.



Table 3: Pro and cons of MCC versus village banks

          MCCs                                    Village Banks
 + high investment upfront creates a stable
                                                  + Deposit mobilization is allowed
 basis
 + clear ownership structure and attractive for
 many private Chinese investors (see number       + Full banking license
 of applicants e.g. in IMAR)
 + four times base rate as maximum interest      - operation only in one county: this limits the
 rate                                            ability to reach scale and to lower operational costs
                                                 - 20% compulsory share of existing banks is not
                                                 attractive for private investors and not very
 + more attractive for foreign investors (not realistic bearing in mind the current strategic
 restricted to only 10% of the shares)           orientation of most Chinese banks; creates the
                                                 danger of including pro-forma bank shareholders
                                                 what affects the governance structure
                                                 - 8% Capital Adequacy Rate is too low to buffer
 + high amount of equity
                                                 specific risks of rural areas
 + credit-only limits risks and supervisory - 10 % maximum of non-bank shareholders is not
 burden                                          attractive for private investors
 - facing refunding problems cause of the - only 2.3 of central bank base rate will not be
 unclear status                                  sufficient to cover cost for microcredit
 - operation only in one county: this limits the
                                                 - limited supervisory capacity on county level may
 ability to reach scale and to lower
                                                 create danger for depositors
 operational costs
 - too high lending quotas for agriculture
 (75-80%)



The objective of offering the informal financial sector in China a viable organizational
type can most probably be much better achieved with the MCC model than with the
village bank model. Second, the MCCs approach is more attractive for national and
international investors, because the shareholder structure allows more flexibility.



With regard to the further development of the rural financial market two approaches can



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be followed in the future: first, a variety of possible institutional types for microfinance
are allowed and encouraged by the Chinese Government, including MCCs and village
banks. Second, a new legislation tries to combine the advantages of both, the MCC and
the village bank model and defines a new type of microfinance bank. However this would
require a better coordination between the two major agencies involved.




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