Microfinance: The Untapped Chinese Market

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By Sophie Cerny and Jessica Tou

May 13 – Microfinance in China has the potential to be one of the leading, innovative approaches to alleviating poverty and boosting rural and regional economic development. This report will take a closer look at how the current Chinese microfinance model came about, the current outcomes of the model, and lastly the problems and solutions of the potential market, which has yet to be tapped by foreign investors.

The current market
Despite the rapid economic growth in China, much of the country’s development and wealth are inequitably partitioned across the country. According to PlaNet Finance China, a non-profit organization aimed to promote and support the microfinance sector, “an estimated one third of [China]’s people do not enjoy access to any kinds of financial services.” Most traditional banks in rural areas view the offering of financial services to those who lack individual ownership of land as an unattractive business opportunity. An individual without land ownership is unable to offer proper collateral, providing him financial services is seen as a high risk, unmanageable asset.

This barrier to financial services has lead to a shortage of working capital loans for single-owner business proprietors, farmers, and small agri-business (i.e. lower links of the supply chain). Speculative financing is needed to run and expand business, and its absence has led to a slowdown in rural and regional growth by diminishing the capability of small businesses to compete with more modern companies.

Microfinance has yet to reach its potential. Not because of a lack of demand, but because of the incomplete regulatory environment and a misconception of the industry.

China’s microfinance institutional models
Currently, China hosts a wide range of microfinance institutions: the informal ones, such as borrowing and lending among relatives and moneylenders with low rate of interest or interest free; and the official ones, intended by the government to be conducting microfinance-related transactions. There are two types of them in China:

Micro-credit Companies (MCCs)

  • Began in the mid-2000s;
  • Local government plays the role of MCC in some counties;
  • Operate in more remote, local regions, limited to one county;
  • Composed of 100 percent  private equity;
  • Only provide lending services, cannot accept deposits;
  • Offers loans under RMB5,000.

Village and Township Banks (VTBs)

  • Began in 2006;
  • Operate in small towns, limited to one county;
  • Composed by one or more financial institutions with no lower than 20 percent equity each and other non-bank shareholders with a maximum of 10 percent equity;
  • Provides lending services, can accept deposits as it is a financial institution;
  • Offers loans as high as RMB500,000 and as low as RMB5,000, in practice.

By the end of 2006, the China Banking Regulatory Commission and the People’s Bank of China jointly released guidelines allowing the transformation of MCCs into VTBs, in order to provide incentives for more public financial institutions to take part in developing the rural economy. The new guidelines require licensed domestic banks to have a 20 percent minimum ownership of VTBs, and further states that the remaining shares cannot be more than 10 percent for individual non-financial institution investors.

In addition to qualifying restrictions, MCCs and VTBs are also subject to a number of other limitations, including remaining within a single, administrative jurisdiction and charging under the capped interest rate level of four times the statutory benchmark rate. Such restrictions were created to force MCCs to go down-market and continue to serve the poorest clients of a district. However, placing a cap on interest rates has actually deterred potential investors who view providing small loans too expensive and fruitless, ultimately hurting the lower links of the supply chain. In truth, to make MCC’s sustainable, interest rates should be liberalized. Only after liberalization of the interest rates can MCCs find a profit, target new down-market clients, begin to operate sustainably, and eventually entice more external investment.

Just this February, Director-General of the Regulatory Department of the People’s Bank of China Zhou Xuedong announced that two current restrictions will be revised. According to Zhou, the central bank will not only liberalize interest rates, but will also ease the restrictions on debt financing, lowering the cost for MCC’s to borrow.

Untouched massive rural market
As of 2007, more than 128 million Chinese, many of whom are located in the remote western interior regions, are living in poverty and isolated by the general market. Gabrielle Harris, executive director of PlaNet Finance China, stated that with a growing number of low-income borrowers, commercial banks have the opportunity to reach a large number of new clients who may later be in a position to buy other products from the bank. In her presentation on the evolving Chinese microfinance industry at the Lafferty Global Retail Financial Services Summit in late March, Harris argued that “financial inclusivity can be a driver for growth, but it requires re-thinking how the business is done.” Harris advised that by borrowing a few microfinancing techniques from conventional banking systems, retail banks that are willing to adapt their operations to maximize staff efficiency and do proactive marketing could easily be the first to reach the millions of potential clients currently neglected – thereby establishing a strong, loyal relationship. Financial inclusivity can help an institution diversify its group of clients and widen its product offerings. Local banks and investors must take advantage of this window of opportunity and grab the substantial number of rural households that have yet to be acknowledged by large commercial banks.

With climbing operation costs and labor costs in eastern China, foreign investment is starting to head towards the less developed western regions where costs are lower and potential is higher. With the world’s eyes on the East as China continues to dominate the global economy, investors should start glancing further inland where the market potential is only beginning to be recognized for its real worth.

PlaNet Finance China’s strategy is to extend the reach of the microfinance concept by helping MCCs and VTBs better understand the potential of their credit-hungry local markets and enable them to efficiently deliver low value loans using high-level risk management skills.

For more details, go the planetfinancechina.org.

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