75149 Financial Inclusion in the People’s Republic of China An analysis of existing research and public data A joint publication of CGAP and the Working Group on Inclusive Finance in China Pete Sparreboom and Eric Duflos China Papers on Inclusiveness No. 7 August 2012 The Working Group is led by the Executive Committee: Research Team Members of the Executive Committee This paper is a joint publication of CGAP and the Deutsche Gesellschaft für Internationale Zusammenarbeit Working Group on Inclusive Finance in China. Established on 1 January 2011, the Deutsche Gesellschaft für Interna- tionale Zusammenarbeit (GIZ) GmbH is a federally owned enterprise which brings together the long-standing expertise of the Deutscher Co-authors Entwicklungsdienst (DED) gGmbH (German Development Service), the Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH Pete Sparreboom, Consultant, (German Technical Cooperation) and Inwent—Capacity Building Inter- World Microfinance Forum Geneva national, Germany. GIZ supports the German Government in achieving its objectives in the field of international cooperation for sustainable Eric Duflos, Regional Representative development. GIZ is also engaged in international education work for East Asia and the Pacific, CGAP around the globe. GIZ operates in more than 130 countries worldwide and employs approximately 17,000 staff members, and in 2010 had an estimated turnover of EUR 1.9 billion. GTZ has been operating in China About us for almost 30 years focusing on sustainable development, including financial sector reform. www.giz.de/en/home.html World Microfinance Forum Geneva CGAP is an independent policy and research The World Microfinance Forum Geneva (WMFG) is a Swiss not-for-profit center dedicated to advancing financial association established in 2007 that organises Working Groups on access for the world’s poor. It is supported topics of global importance for investors in inclusive finance. It facilitates by over 30 development agencies and private informed discussions between regulators, investors and inclusive finan- foundations who share a common mission to cial service providers based on high quality, practical research. Working alleviate poverty. Housed at the World Bank, Group Partners and Members provide the necessary time, finance and CGAP provides market intelligence, promotes other resources to reach agreed objectives. standards, develops innovative solutions and www.microfinanceforum.org offers advisory services to governments, finan- cial service providers, donors, and investors. www.cgap.org Link to CGAP publications in Chinese: http://www.microfinancegateway.org/chinese Working Group on Inclusive Finance in China The Working Group serves as a research-based discussion platform that advises all market par- ticipants of inclusive finance in China in order to responsibly develop investment into that sector. Market participants include the Chinese Government, the private sector, the media, domestic/foreign investors, all providers of inclusive finance in China and other operating agents. Through fact-based research and open dialogue, the objectives of the Working Group on Inclusive Finance in China are to promote inclusive finance in China, mutual exchange of information and learning, responsible investor behaviour and supportive government policies. Cover photo courtesy of Baoshang Bank. Photographer: Zhang Quanli The following are the current Partners of the Working Group on Inclusive Finance in China: Founding Partners Strategic Development Partner BlueOrchard is the world’s leading commercial microfinance inter- CreditEase is China’s first and now the biggest P2P (person-to-person) mediary. Its mission is to empower the poor worldwide and improve microfinance platform, established in 2006 in Beijing. On the innova- their quality of life by promoting income-generating activities through tive platform, people with surplus funds (lenders) lend to people with private investments in microfinance. BlueOrchard Finance S.A. has funding needs (borrowers) based on trust. With a service network been providing funding to microfinance institutions (MFIs) since 2001. covering more than 30 cities country-wide, the company has enabled Headquartered in Geneva, Switzerland, BlueOrchard has over USD 1 tens of thousands of micro-entrepreneurs, students and parents, billion assets under management and works with over 150 partner salaried workers and extremely poor rural women to gain access microfinance institutions in more than 50 countries. to credit. CreditEase is a board member of the China Association www.blueorchard.com of Microfinance. www.creditease.cn Partners De Pury Pictet Turrettini & Co LTD is a Geneva-based company that offers asset management and estate advisory as well as family office services. It was founded in 1996 by David de Pury, Guillaume Pictet and Henri Turrettini, and has developed leading-edge expertise ACCION International is a private, nonprofit organization with the in asset management for both individual and institutional clients. In mission of giving people the financial tools they need—microen- addition, De Pury Pictet Turrettini & Co LTD has always been very inno- terprise loans, business training and other financial services—to vative; for instance, it was a pioneer in responsible and sustainable help work their way out of poverty. A world pioneer in microfinance, investment. In 2010, PPT had over CHF 2.5 billion under management. ACCION was founded in 1961 and issued its first microloan in 1973 www.ppt.ch in Brazil. Over time, ACCION has helped build 62 microfinance institutions in 31 countries on four continents. Those institutions are currently reaching millions of clients. In the United States, the U.S. ACCION Network is the largest microfinance lending network Ernst & Young is a global leader in assurance, tax, transaction and in the country and has served tens of thousands of clients with over advisory services. Worldwide, its 152,000 people are united by their $300 million in loans since the inception of its pilot program in 1991. shared values and an unwavering commitment to quality. They make www.accion.org a difference by helping their people, their clients and their wider com- munities achieve their potential. Ernst & Young’s Transaction Advisory Services bring together a unique combination of skills, insight and experience which helps clients make better and more informed deci- Since 1979, Fern Software has been delivering banking systems solu- sions about how they strategically manage capital and transactions tions around the world. Customers are supported by professional in a changing world. engineers and technical partners out of offices in Australia, Dubai, www.ey.com Ecuador, Ireland, Kenya, Philippines, South Africa and the UK. Cus- tomers range from small individual organisations up to larger multi- branch national organisations with 500,000 clients. Fern Software also provides central solutions through national networks to their affiliated organisations. Standard Chartered is a British financial services company head- www.fernsoftware.com quartered in London, England with operations in more than seventy countries. It was formed in 1969 through a merger of the Standard Bank of British South Africa and the Chartered Bank of India, Australia and China. From the early 1990s, Standard Chartered has focused on Zhong An Credit was established in 2005, and is dedicated to provid- developing its strong franchises in Asia, Africa and the Middle East, ing unsecured, non-guaranteed small amount loans to micro entre- concentrating on consumer, corporate and institutional banking and preneurs, small businessmen, and lower income individuals, many of on the provision of treasury services. In 2010, Standard Chartered whom are otherwise unable to obtain funding from the banking system, served 52 microfinance institutions with $385 million in credit and to help them grow their businesses and meet their individual funding financial instruments. needs. The IFC invested in Zhong An Credit and has provided the www.standardchartered.com company with funding and technical assistance, while also seconding a senior member of its global microfinance staff to serve on Zhong An Credit’s Board. At the same time, Zhong An Credit has developed long term, strategic partnerships with domestic financial institutions such as China Development Bank, China Construction Bank and Bank of China, to support its microfinance endeavors. This publication is also supported by the following members of the Working Group on Inclusive Finance in China: • Bamboo Finance • PlaNet Finance • China Foundation for Poverty Alleviation • Planet Rating • Incofin IM • Unitus Capital Financial Inclusion in the People’s Republic of China Photographer: Zhou Qing iv Acknowledgments This paper originates from a Master’s thesis by Maria Li for the University of Virginia with the support and supervision of CGAP. Kira Dubas, Peter Situ, David Wu, and Ramkumar Narayanan of the World Microfinance Forum Geneva (WMFG) contributed a wealth of information and made fundamental improvements to the paper. The present version of this paper was written by Pete Sparreboom (WMFG) and Eric Duflos (CGAP). Some members of the Inclusive Finance in China Working Group and CGAP provided comments on the draft. The authors especially thank Gabrielle Harris (Planet Finance), Duncan Frayne (Accion), Vidhi Tambiah (WMFG), Steve Rasmussen (CGAP), Lingjun Wang (CGAP consultant), Jeanette Thomas (CGAP) for the investment of their time and contribution of their expertise, and Anna Nunan (CGAP) for editing the report. The people who have contributed to this study are too numerous to mention. Special thanks go to Jeanine Barthwaite, Jennie Ma, Ming Li, Ruthie Eisenberg, Ashley McCormack, Sarah Pinsky, Peter Swiggert, Bin Wang, Chengcheng Feng, Stephen Michael Baron, Li Ma, Xueting Huang, Xingchen Li, and Jingyi Liu. The authors also thank Baoshang Bank for contributing the photographs featured in this paper. Table of Contents List of Abbreviations______________________________________________________________________________1 Executive Summary_______________________________________________________________________________2 1 Introduction____________________________________________________________________________________4 1.1  Global Context 4 1.2  Background and Objectives 5 1.3  Caveat on Data Quality 5 2 The Origin and Nature of Financial Exclusion_______________________________________________________6 2.1  Historical Background 6 2.1.1 1949–1979: Creation of a State-owned Mono­ banking System 7 2.1.2 1979–1993: Creation of a State-led Multibanking System 7 2.1.3 1993–2005: Market-oriented Banking System Reform 9 2.2  The Unmet Need for Financial Services 10 2.2.1 Situation Before the Policy Changes Initiated in 2005 10 2.2.2 Groups with Difficult Access to Banking Services 10 2.2.3 Financial Services Needed by These Groups 11 3 Policy Changes and the Evolution of Financial Inclusion___________________________________________ 12 3.1  Changes in Policy Goals and Objectives 13 3.1.1 A Stable and Healthy Banking Sector Through Clean-up and Commercialization 13 3.1.2 Social Harmony Through Financial Inclusion 13 3.1.3 Crisis Prevention Through a Temporary Increase in Credit Supply 14 3.2  Effects of Recent Changes on the Health and Stability of the Banking Sector 14 3.2.1 Composition and Nature of the Banking Sector 14 3.2.2 Performance of the Banking Sector 15 3.2.3 Vulnerabilities of the Banking Sector 15 3.3  Effects of Recent Changes on Financial Access to Banks and Nonbank Providers 16 3.3.1 Full Banking Service Coverage 16 3.3.2 Rural Household Bank Credit 17 3.3.3 SME Bank Credit 18 3.3.4 Nonbank Providers of Financial Services 20 4 Gap Assessment_____________________________________________________________________________ 22 4.1  Breadth and Depth of Outreach of Banks and Nonbank Providers 22 4.1.1 Full Banking Service Coverage 22 4.1.2 Rural Household Bank Credit 23 4.1.3 SME Bank Credit 24 4.1.4 Credit from Selected Nonbank Providers 26 4.2  Considerations on the Role of Banks and Nonbanks in Financial Inclusion 27 5 Conclusions_________________________________________________________________________________ 28 Financial Inclusion in the People’s Republic of China Annex A: Important Providers of Financial Services to Rural Households and SMEs_____________________ 32 A1. Rural Credit Cooperatives (RCCs) 33 A2. Agricultural Bank of China (ABC) 34 A3. City Commercial Banks (CCBs) 35 A4. Postal Savings Bank of China (PSBC) 36 A5. Village & Township Banks (VTBs) 37 A6. Rural Mutual Credit Cooperatives (RMCCs) 38 A7. Poverty Alleviation MFIs 39 A8. MicroCredit Companies (MCCs) 40 A9. Peer-to-Peer (P2P) lending platforms 41 Annex B. Productive Loan Supply—an Optimistic Estimate__________________________________________ 42 B1. Rural Household Loans 42 B2. SME Loans 43 Bibliography___________________________________________________________________________________ 44 List of Abbreviations ABC Agricultural Bank of China MSME Micro-, Small- and Medium-sized Enterprise ADB Asian Development Bank NBFI Nonbank Financial Institution ADBC Agricultural Development Bank of China NBS National Bureau of Statistics AFI Alliance for Financial Inclusion NPL Nonperforming Loan ATM Automated Teller Machine NRCMS New Rural Cooperative Medical Scheme CAM China Association of Microfinance NTFI New-type Financial Institution CAR Capital Adequacy Ratio P2P Peer-to-Peer CBRC China Banking Regulatory Commission PA MFI Poverty Alleviation Microfinance Institution CCB City Commercial Bank PB Policy Bank CDB China Development Bank PBC People’s Bank of China CFPA China Foundation for Poverty Alleviation POS Point of Sales CGAP Consultative Group to Assist the Poor PRC People’s Republic of China CPC Communist Party of China PSBC Postal Savings Bank of China FFB Foreign-Funded Bank PSRB Postal Savings and Remittance Bureau G2P Government-to-Person RCC Rural Credit Cooperative GIZ German Agency for International Cooperation RCF Rural Cooperative Foundation GNI Gross National Income RCOMB Rural Commercial Bank GPFI Global Partnership for Financial Inclusion RCOOPB Rural Cooperative Bank ID Identity Document RMB Renminbi IFC International Finance Corporation RMCC Rural Mutual Credit Cooperative IMF International Monetary Fund ROE Return on Equity IPO Initial Public Offering ROSCA Rotating Savings and Credit Association JSCB Joint Stock Commercial Bank SBU Small-Business Unit KYC Know Your Customer SME Small- and Medium-sized Enterprise LC Lending Company SOE State-owned Enterprise LCB Large Commercial Bank TVE Township and Village Enterprise MCC Microcredit Company UCC Urban Credit Cooperative MFI Microfinance Institution VTB Village and Township Bank MIA Microfinance Institution Association WMFG World Microfinance Forum Geneva MIX Microfinance Information Exchange Exchange rate end 2010: 1 US$ = 6.62 RMB and 1 Euro = 8.81 RMB. 1 Financial Inclusion in the People’s Republic of China Executive Summary The beginning of the 21st century represents a watershed in Third, policies to prevent contagion from the international the promotion of financial inclusion in the People’s Republic financial crisis have resulted in the development of new of China (PRC). risks to the stability of the country’s economic and financial system, but have not destroyed its fundamentally stronger The transformation from a centrally planned to a partially mar- nature. Stress tests conducted by the International Monetary ket-oriented economy since the end of the 1970s had made Fund and the China Banking Regulatory Commission (CBRC) access to financial services increasingly difficult for rural indicate that the system could withstand considerable shocks households, low-wage workers, small- and medium-sized and is therefore essentially more sustainable. enterprises (SMEs), and the unemployed. Directed lending and fiscal and interest rate policies had created a banking Experts agree that ownership of bank accounts and bank system that channeled savings from rural, western areas cards has become much more widespread. Unfortunately, toward urban and eastern areas. The system had become this cannot be confirmed from information produced by finan- inefficient and burdened with very high levels of nonperform- cial institutions, which tend not to report their numbers of ing loans. The subsequent commercialization of the country’s accounts and clients. However, a World Bank survey found state-owned banks and the reform of rural credit coopera- 64 percent of adults with a bank account in 2011, and the tives (RCCs) had resulted in the closure of tens of thousands People’s Bank of China reports a bank card penetration rate of rural branches and entities. These reforms had cut off of 35 percent at the end of 2010. people’s access to basic banking products. Subsidized rural poverty lending programs that were intended to compensate There has also been a significant increase in the diversity of the for increasing disparities had not achieved their goals and banking sector and the variety of appropriate, commercially were unsustainable. Calls for more lending to small and pri- viable loan products. A review of a wide range of data sources vate enterprises had contradicted the system’s inherent incen- conducted in 2011 shows that the RCC system probably still tives for banks to serve mostly large state-owned enterprises. serves the largest number of rural clients with credit, but the By the end of the 20th century, rural households, low-wage Agricultural Bank of China, the Postal Savings Bank, and city workers, SMEs, and the unemployed largely depended on commercial banks are starting to become serious competi- nonbank financial service providers. This exposed them to tors. Scores of existing large, medium, and small commercial the risk of losing their deposits, paying very high interest rates, banks have established small business units offering SME and being exposed to informal and occasionally unethical loans, and the newly incorporated Postal Savings Bank has methods of loan recovery. become a market leader in this segment. Policies to support the establishment of new types of financial institutions, such New policies and regulations, particularly those introduced as village and township banks and rural mutual credit coop- since 2005, have reversed this trend. First, policies to clean eratives, are likely to increase their role. up and commercialize the banking sector have resulted in a much stronger system, with financial regulators reporting However, experts also agree that basic banking services healthy levels of bank profitability and capital adequacy, even are not yet accessible to all, and there is still a sizeable gap if some vulnerabilities remain. A more welcoming environment between demand for and supply of loans to rural households has also attracted a large number of foreign banks to invest and SMEs. Many RCCs are not viable and, therefore, do in the country. not constitute a sustainable source of rural household loans. While SME credit is increasing, banks still face a variety of Second, policies to promote social harmony have widely obstacles to increasing their exposure to private entities. increased banking service coverage and sustainable bank lending to rural households and SMEs. Besides, despite the frequent use of the word “microcredit,� banks provide very few loans that are small compared to aver- • A massive increase in government-to-person transfers age income (no greater than 250 percent of gross national has been a major factor in expanding ownership of bank income per capita). According to a recent World Bank report, accounts in rural areas. in 2011, only 39 percent of the poorest quintile of adults owned a bank account in a formal institution compared with • Policies to increase institutional diversity and competition a national average of 64 percent. This is of particular concern have been a major factor in reducing rural households’ given the wide gap between the rich and the poor in China, dependence on the remaining RCCs. and between urban and rural areas. While many banks have developed products for “microenterprises,� in the PRC micro- • Political pressure, incentives, and knowledge transfer have enterprises are defined very widely and include enterprises been major factors in breaking the banks’ habits of lending that would be considered SMEs in many other countries. mostly to large, state-owned enterprises. 2 Photographer: Shi Tian’an The groups that are excluded from banking services rely bureaus, and payment systems, has started to contribute to largely on nonbank sources of finance. The recent monetary the expansion of opportunities. tightening has resulted in strong growth of this so-called shadow banking sector. Morgan Stanley estimates that guar- To take full advantage of this potential, policy makers, financial antee companies, microcredit companies, and pawnshops institutions, and investors need comprehensive, high-quality are the principal providers of nonbank financial services to market information. Currently, stakeholders need to consult a SMEs and rural clients. Poverty alleviation microfinance insti- wide range of sources to get a picture of the financial inclusion tutions have much smaller loan portfolios but are particularly landscape. And information from these sources is not always good at reaching out to the poor. Some peer-to-peer lending comparable, consistent, and complete. There is a great need platforms also manage to achieve considerable depth of out- for better data and more research. Greater financial inclusion reach. While these nonbank providers play an important role can be achieved only when the needs of different market seg- in satisfying the need for financial services, they also expose ments are understood. Stakeholders also need a thorough the most vulnerable to considerable risks. comprehension of the nature, efficiency, and effectiveness of financial service providers that target the previously excluded. There is considerable potential for increasing and improving More in-depth analysis of policies, regulations, and supervi- the commercial provision of financial services to the previ- sion would help to enhance financial inclusion, for example, ously excluded in the PRC. Regular policy statements confirm in the area of branchless banking. the government’s commitment to ensuring sustainable out- reach to the excluded through innovation and investment in Finally, both Chinese stakeholders and the international new technologies. The size of the PRC’s market offers oppor- community would greatly benefit from a more extensive tunities for economies of scale that are not available in many exchange of knowledge on financial inclusion. Global part- countries; its comprehensive and sophisticated identification nerships, such as the Inclusive Finance in China Working system greatly helps banks to meet know-your-customer Group, the Global Partnership for Financial Inclusion, the Alli- requirements. The excellent mobile telephone infrastructure ance for Financial Inclusion, the World Microfinance Forum and wide network of branchless access points offer opportu- Geneva, and CGAP offer opportunities for studying global nities for reaching large numbers of clients at low costs. Work best practices and lessons learned in other countries, and for on financial infrastructure, such as deposit insurance, credit sharing the PRC’s unique experience in improving financial access with the rest of the world. 3 Photographer: Li Suren 1 Introduction 1.1  Global Context People need reliable access to a broad variety of financial services, such as savings, credit, payments, transfers, and insurance, to manage their lives, take advantage of business opportunities, and prepare themselves for major expenses and difficult times. While financial inclusion1 has been a con- cern of governments for several centuries throughout the world, in the past 20 years or so, financial access for the poor and the unbanked has rapidly evolved with microfi- nance. Thousands of new institutions have emerged to serve those at the bottom of the pyramid and microenterprises, and many of them have become financially sustainable while fulfilling a social mission. Many governments have adopted and continue to adopt national strategies for financial inclusion. The emergence from the G-20 of the Global Partnership for Financial Inclu- sion shows that financial inclusion has become a major con- cern for leading countries worldwide. New technologies have also created hopes that one can expand financial access at lower costs through “branchless banking.�2 And yet there are still 2.7 billion people worldwide who do not have access to formal financial services (CGAP 2010). A recent World Bank survey shows that only 22 percent of adults report that they have saved in a formal financial institution in the past 12 months (Demirgüç-Kunt and Klapper 2012). While policy makers, banks, international donors, investors, and mobile network operators are working to reduce this gap and find new solutions to solve the problem of financial exclusion, there is still a significant task ahead. Part of the solution will come from better understanding each individual country’s financial inclusion landscape, so that possible solutions to close the financial exclusion gap rapidly can be identified. 1. CGAP (2011) defines financial inclusion as “a state in which all working age adults, including those currently excluded or underserved by the financial system have effective access to the following financial services provided by formal institutions: credit, savings, payments and transfers, and insurance.� 2. CGAP defines branchless banking as the delivery of financial services outside conventional bank branches using information and communications technolo- gies and nonbank retail agents, for example, over card-based networks or with mobile phones (McKay and Pickens 2010). 4 Financial Inclusion in the People’s Republic of China 1.2  Background and Objectives Clearly, financial exclusion goes beyond these services and includes products such as consumer credit, payments, With 1.3 billion inhabitants in 2010, the People’s Republic of money transfers, and microinsurance products. Further China (PRC) constitutes the largest single market for finan- research in these areas and others is recommended. cial services (NBSC 2011a). The annual income per capita has increased considerably over the past 30 years (NBSC The analysis in this report is largely based on research con- 2011b), with urban disposable income in 2010 estimated at ducted in 2011, and therefore describes the situation at the RMB 19,109 (US$2,8853) and rural net income estimated at end of 2010. It is important to be aware that the PRC Gov- RMB 5,919 (US$894) per person.4,5 Yet, international inves- ernment and financial authorities are issuing new policies tors and donors who consider funding financial institutions and regulations on an almost monthly basis. At the same that seek to serve this large and growing market often seek time, several types of institutions have been experiencing in vain for information on demand and supply. double digit growth rates in the numbers of their clients. This report should therefore be considered a snapshot of a situ- This paper aims to be a first step in providing a picture of ation that is in a state of considerable flux. the extent and nature of financial inclusion in the PRC and the size and characteristics of the unbanked and under- 1.3  Caveat on Data Quality banked market. It analyzes the effect of policy changes since 2005 on the inclusiveness of the PRC’s formal financial Availability of reliable information is a significant issue in system. The authors hope that it will provide a useful basis the PRC. Not only should one carefully verify every piece for forthcoming research and diagnostics on financial inclu- of data, one should be aware that important information is sion in the PRC. The report describes the overall landscape, often simply not available. For example, data published by while the annexes provide more detail on a number of key NBSC is often not comparable to data from other countries financial retailers. because of methodological discrepancies; recent informa- tion on portfolio quality of financial institutions is not always This paper covers a limited number of financial services. available from CBRC. These and other issues regarding The focus is on the three key aspects of financial inclusion data on financial inclusion in the PRC have been extensively that the China Banking Regulatory Commission (CBRC) has documented. been promoting since 2005: 1. Universal access to basic banking services (i.e., bank Language barriers are another important challenge. Inter- accounts, payment services) national researchers often need to rely on native Manda- rin speakers to locate and interpret important sources of 2. Productive bank credit for rural households information. 3. Bank credit for micro-, small-, and medium-sized enter- prises (MSMEs) The authors recommend that readers use this report to supplement their own research. The authors and contribu- 3. According to the People’s Bank of China’s Annual Report 2010, the end of 2010 exchange rate was 6.62 RMB per US dollar and 8.81 RMB per euro. tors have made every effort to collect data from credible 4. The National Bureau of Statistics of China (NBSC) defines disposable income sources, and where possible to verify these data through of urban residents as the actual income at the disposal of residents that can triangulation. Despite this effort, they cannot guarantee that be used for final consumption, other noncompulsory expenditures, and sav- ings. This equals to the sum of income from wages and salaries, cash income all the information presented here is accurate. from household operations, income from properties, and income from transfers, minus income tax, personal contribution to social security, and subsidy for keep- ing diaries in being a sample household. Currently, disposable income of urban residents includes cash income received only. 5. NBSC defines net income of rural residents as the total income of rural resi- dents from all sources minus all corresponding expenses. It is classified as the sum of income from wages and salaries, income from household operations, income from properties, and income from transfers, minus household operation expenses, depreciation of fixed assets for production, taxes, and fees paid, and gifts to nonrural relatives. 5 2 The Origin and Nature of Financial Exclusion The year 2005 constitutes a turning point in the govern- ment’s approach toward financial inclusion in the PRC. This chapter describes the historical developments between 1949 and 2005 that led to the government’s decision for a much stronger focus on access to banking. Section 2.1 analyses why the transformation from a centrally planned to a more market-oriented economy gradually excluded more and more people from the financial services they needed. Section 2.2 explains that in 2005 it was not just the rural poor who had difficulty accessing formal financial services; the tens of millions of migrant workers and private small- and medium- sized enterprises (SMEs) constituted a significant part of the Photographer: Wu Guoqun unbanked or underbanked. 2.1  Historical Background To understand the evolution in the government’s approach to financial inclusion, it is useful to go back to the creation of the PRC in 1949, and to follow its transformation from a state-controlled society to one in which resource alloca- tion is left partly to the market. Between 1949 and 2005, economic transformation was accompanied by three distinct phases in the development of the banking system, which eventually made it very difficult for certain groups to access the financial services they needed. 6 Financial Inclusion in the People’s Republic of China Figure 1. Development Phases in the PRC’s Financial System 1949 1979 1993 2005 • Centrally planned economy • Marketisation of economy • Partial privatisation of economy • State-owned monobanking system • State-led multibanking system • Market-oriented banking system • State-controlled and managed • Directed and subsidised lending • Directed and subsidised lending resource allocation to priority sectors to weak sectors Economic inclusion, Inclusive growth, Slower growth and but stagnation and poverty but increasing inequality increasing exclusion Figure 1 illustrates the three principal phases in the develop- During this period, the state took responsibility for allo- ment of the PRC’s financial system between 1949 and 2005. cating resources. Surplus income from economic activities These phases are further described below. were deposited in PBC, which then used part of this income to provide investment funds to SOEs directly and to the com- This section draws heavily on a study on rural finance com- munes via RCCs according to the central plan. missioned by the Asian Development Bank (Zhang, Xu, Shen and Cheng 2010) and on two papers by Kellee Tsai (2004 The transformation of the economy led to increased and 2006). equality, but the country remained poor. Intended produc- tion and welfare gains were partly undone by a series of banking 2.1.1 1949–1979: Creation of a State-owned Mono­ political campaigns and natural disasters, and partly by the System well-documented efficiency and incentive issues associated with command economies. Having established the PRC in 1949, the Communist Party of China (CPC) quickly developed a centrally led “com- 2.1.2 1979–1993: Creation of a State-led Multibanking mand� economy. In an attempt to create a unified, prosper- System ous, and nonexploitative society, the government nation- alized all property and outlawed all private enterprise. It The introduction of market pricing and profit incentives created specialized monopolistic state-owned enterprises into the real economy and the opening up of the economy (SOEs) to produce necessary goods and services. The rural resulted in significant growth. Upon Mao’s death in 1976, population was gradually organized into people’s communes, CPC leadership launched a series of changes, including with output targets to achieve. The government ordered the instituting the household land responsibility system, cre- closure of all types of private finance and banned popular ating collectively owned township and village enterprises forms of “informal finance,� including pawn brokerage and (TVEs)6 run by local authorities, and partially commercializing “loan sharking� (Tsai 2004). SOEs. This greatly boosted worker productivity, resulting in a significant rise in both agricultural and industrial production, The People’s Bank of China (PBC) was gradually turned and unprecedented rates of annual growth (Zhang, Xu, Shen, into the sole provider in rural finance. In 1951 it ordered and Cheng 2010). the creation of rural credit cooperatives (RCCs) in every township to provide savings and credit services to the 80 To support economic transformation, the government percent of China’s population living in rural areas. As their created a more diverse banking system of large national numbers grew into the hundreds of thousands, in 1955 the banks with sectoral mandates and smaller banking institu- government created the Agricultural Bank of China (ABC) to tions with local mandates. Four state-owned banks were supervise and manage them. In 1957 PBC took ownership carved out of PBC, and PBC assumed the role of banking of both ABC and RCCs and integrated them into its structure regulator and supervisor. ABC remained in charge of RCCs.7 (Zhang, Xu, Shen, and Cheng 2010). While these RCCs were Although several reforms were implemented to restore the originally set up as independent entities owned and con- trolled by their members, the centralization of management 6. There is controversy over the proportion of TVEs that were truly collective. and ownership made them lose their cooperative nature (Li 7. For the purposes of this paper RCCs are considered to be part of the banking system. Like banks, they are allowed to mobilize deposits, and they are overseen and Xuchu 2011). by the PRC’s banking sector supervisory authority. 7 Financial Inclusion in the People’s Republic of China RCCs’ original cooperative nature, in the end ABC effec- allowed local governments to keep a portion of tax income tively ran the RCCs as its branches and offices (Zhang, Xu, for local investments and expenditures. In addition, whether Shen, and Cheng 2010). In this same period, the government a Communist Party cadre working in a local government started authorizing the establishment of smaller banks, by or SOE was promoted depended on his or her success in first permitting urban governments to set up urban credit increasing fiscal income. Local governments therefore used cooperatives (UCCs) (Girardin and Xie 1997) and later letting their influence in local RCCs to direct credit toward local regional authorities establish joint stock commercial banks government-run TVEs (Ong 2012). (JSCBs) (China Merchants Bank 2012). Priority sector guidance, policy loans, and directed lending In parallel, the government permitted the emergence or resulted in high volumes of nonperforming loans (NPLs). re-emergence of a set of nonbank financial service provid- As in other countries at the time, government’s involvement ers. Most notably, from 1984 it allowed the Ministry of Agri- in managing banks and credit cooperatives resulted in high culture to establish a network of rural cooperative founda- inefficiencies, credit rationing, capture of subsidized loans tions (RCFs), which were effectively mutually owned. It also by state-backed or wealthier clients, and high default rates. allowed various branches of government agencies as well Since fiscal income was insufficient to cover losses, state as state banks to establish “nonexploitative� pawnshops, banks were left severely weakened, and many RCCs became and even allowed some pawnshops to register as ordinary technically insolvent (Zhang, Xu, Shen, and Cheng 2010). private businesses. By the early 1990s RCFs were offering savings and credit services in a third of all townships, and Market pricing, fiscal, and interest rate policies caused over 3,000 documented pawnshops were offering credit. savings from agricultural areas to be converted into loans Other types of nonbank financial service providers, known to industrial areas, thus increasing rural–urban and west– as “underground banks,� remained strongly suppressed east disparities. Policies to pay positive interest rates on sav- (Tsai 2004). ings and charge low interest rates on loans made it impossible for banks to cover the costs of small and risky rural loans The government strongly encouraged deposits in the pru- in resource-constrained, remote inland areas. At the same dentially supervised banks and RCCs. RCCs were expected time, the opening to the outside world offered banks many to deposit part of the savings they collected in the central attractive investment opportunities in the coastal areas. This bank. In 1986 the government also created the Postal Sav- resulted in the “water pump� phenomenon of savings being ings and Remittances Bureau (PSRB). PSRB had to deposit transferred on a large scale from rural to urban areas, and all client funds in the central bank, which paid a high interest from western and central to eastern China. In addition, fiscal rate on these deposits (Zhang, Xu, Shen, and Cheng 2010). decentralization allowed the better endowed coastal prov- In the virtual absence of social security provisions, insur- inces to collect and spend more tax income. Partly as a con- ance, wealth management, and other investment products, sequence of much better access to credit and government the country achieved household savings rates that were very investments, urban and eastern areas grew much faster, and high by international standards. inequality increased. The government started to fear social instability (Ong 2012). During this period, banks were given “priority sector guidance� on where to invest these deposits. Large A strict residential registration system prevented increas- and small institutions were given lending quota or portfo- ing flows of rural–urban migrants from settling in the cities lio growth targets, mostly for infrastructure and industrial and benefiting from services available to urban residents. development projects. Increasing numbers of people grew frustrated by the house- hold registration or “hukou� system in which people with A significant part of fiscal income was distributed to the rural hukou were allowed to go to cities to work but could state-owned banks for on-lending in the form of so-called not take their families and had to return to their rural homes. policy loans. In the more market-based system introduced at the end of the 1970s, the country’s income and savings no A large subsidized lending scheme for poverty alleviation longer flowed to the central government, and it could no longer was not very effective in reducing inequality, repayment fully control the allocation of resources. The government, was poor, and it was unsustainable. Policy lending in the therefore, introduced a system of taxes and fees on enterprise 1980s was targeted at particular sectors and not aimed at and household income and profits. Policy lending consisted of poverty alleviation. The poverty alleviation lending program channeling fiscal income to particular priority projects, sectors, introduced in 1986 targeted TVEs rather than individual or target groups in the form of low-interest loans. households. As is the case with most subsidized credit schemes, many loans were distributed to politically impor- Fiscal decentralization and the Communist Party cadre tant enterprises and higher income households, and repay- evaluation system encouraged local governments to ment rates were only about 50 percent (Tsai 2004). steer bank lending toward state-run companies. From the beginning of the 1980s the central government gradually 8 Financial Inclusion in the People’s Republic of China 2.1.3 1993–2005: Market-oriented Banking System Reform RCCs into cooperative or commercial rural banks, the con- solidation of promising RCCs into county and provincial Inefficiencies in the real economy prompted the cautious cooperatives with shareholders as members, and the elimina- and partial reintroduction of private property into the real tion of the weakest RCCs (Zhang, Xu, Shen, and Cheng 2010). economy. The government decided to sell part of SOE and TVE share capital to private investors, and promote SMEs In an effort to increase its control over monetary flows of combined public and private or fully private ownership. and to protect depositors, the government cracked down on nonbank financial service providers. In 1996 it closed In the regulated banking sector, unsustainable NPL ratios more than half of all pawnshops because of illegal deposit prompted market-oriented bank reform. From 1993 onward mobilization, and reorganized their supervision. In 1999 it the government undertook a series of reforms aimed at announced the closure of rural credit foundations that had improving the efficiency of financial intermediaries. ABC been taking excessive risks with their members’ capital con- was instructed to let its investments be guided by profit- tributions, and the take-over of the better performing ones ability considerations, to transfer its policy loan portfolio to by the newly mutualized RCCs (Tsai 2004). These measures the newly created Agricultural Development Bank of China made it more difficult for people to get access to the financial (ADBC), and to transfer the management of RCCs to PBC services they needed. (Zhang, Xu, Shen, and Cheng 2010). At the same time, UCCs were demutualized, partly privatized, and consolidated into Unfortunately, the market-oriented bank reforms led to so-called city commercial banks (CCBs) (KPMG 2007). the closure of large numbers of rural bank outlets, which greatly reduced access to basic banking services. ABC Accumulated NPLs in RCCs also prompted a series of moved away from agriculture to refocus its business on low- reforms aimed at improving their governance and viability. risk urban and industrial projects. Between 2000 and 2005, In the early 2000s the government combined a massive it closed more than 13,000 outlets in central and western capital investment with the transformation of relatively strong regions (Zhang, Xu, Shen, and Cheng 2010). Photographer: Jian Changjiang 9 Financial Inclusion in the People’s Republic of China RCC reforms not only failed to resolve the problems of Box A. Subsidized Lending Programs and Projects Targeted at the governance and NPLs, but also further reduced rural Financially Excluded access to their services. Reform resulted in the closure of From 1992, the government encouraged and partly funded the develop- more than 10,000 of the weakest RCCs. For the remaining ment of guarantee companies to take on the risk of bank lending to disad- RCCs, the centralized administration by PBC contradicted vantaged groups, in particular SMEs. At the time of the SOE restructuring, the efforts aimed at transforming them back into member-owned government asked banks to cooperate with guarantee companies to offer laid- entities. The withdrawal of the banks turned RCCs into vir- off workers business start-up loans. The project later expanded to cover college students, returning soldiers, landless farmers, and low-income entrepreneurs. tual monopolists in their markets, which made it very difficult Credit guarantee companies have not managed to leverage large volumes of to increase their efficiency. As a consequence, the majority bank loans to disadvantaged groups because banks, faced with a multitude of of the remaining RCCs continued to be weak and ineffec- attractive investment opportunities, were unwilling to assume any risks. tive. However, in the absence of a prudentially supervised Starting in 1993 the government began to allow international donors, alternative for the rural poor it was politically impossible to local governments, and other agencies to co-finance poverty-oriented close them all. Overall, between 2000 and 2005, the number loan programs that were mostly based on the Grameen Bank model. At one point there were over 300 such programs, and they were mostly registered of depository institution outlets at or below the county level as societal organizations, foundations, and privately run nonprofit enterprises fell from 166,000 to 126,000, resulting in a situation where and institutions. Lack of recognition by financial authorities made it difficult for there was only one outlet for every 20 villages (Zhang, Xu, these poverty alleviation microfinance institutions (MFIs) to raise funds locally Shen, and Cheng 2010). after donor funding ended. Programs that bowed for local government pressure to adopt lending rates close to those of RCCs mostly faded, but those that man- The market-oriented reform of the banking sector did not aged to charge interest rates closer to cost-recovery survive until today. Most reach fewer than 2,000 clients. For more information on poverty alleviation significantly increase private companies’ access to bank- MFIs, see Annex A7. ing services. Banks continued to concentrate on lending to A few years later the government introduced poverty-oriented loans that SOEs and government guaranteed infrastructure projects. were distributed through the banking system in collaboration with local This is blamed on a combination of banks’ inability to assess government offices. In 1997 ABC and ADBC were instructed to channel pov- a project’s commercial viability, the absence of clear prop- erty alleviation funds from the 8-7 Poverty Alleviation Plan to poor people in the erty rights, political pressure to focus on state priorities, and form of microloans. In 1999 PBC started extending “agriculture loans� to RCCs for on-lending in the form of microcredit; the program was rolled out nationally a fear of change. In 2005–2006, less than 1 percent of bank in 2002. While both program adopted aspects of the Grameen Bank system, loans went to private enterprises (Tsai 2006). their success was hindered by excessive involvement of local governments in client selection, the imposition of outreach quotas, and interest rates that were In parallel to the banking reform described above, the too low to cover program costs. The subsidized loan programs suffered the national government, local governments, and international usual problems of loan deviation, inefficiencies, high NPL ratios, and lack of sustainability (Tsai 2006). donors developed subsidized loan programs targeted at the several groups that have difficulty accessing banking The subsidized microcredit programs had limited outreach and were services. Box A describes the principal initiatives. largely unsustainable. They failed to compensate for the reduced access to financial services as a result of banking reform. Sources: Situ (2011), Sun (2008), and Du (2008). 2.2 The Unmet Need for Financial Services 2.2.1 Situation Before the Policy Changes Initiated in 2005 over the total volume of credit, and therefore of monetary By the beginning of the 21st century, the banking sector policy, and it also exposed individuals and enterprises to the had largely withdrawn from markets that were considered risk of losing their savings, being charged usurious interest too risky or too costly to be commercially viable. In urban rates, and having to endure inappropriate and occasionally areas, a variety of commercially oriented financial institutions unethical methods of debt collection. focused on services to national and local SOEs and salaried employees. In rural areas, only RCCs and the postal system 2.2.2 Groups with Difficult Access to Banking Services maintained a network of outlets, yet RCCs failed to meet Four groups found it particularly difficult to access banking the credit needs of rural households and the postal system services at the beginning of the 21st century. Of course offered only savings and remittances services. some members of these groups did manage to open bank Households and businesses largely relied on family and accounts and get bank loans, but many faced obstacles friends, informal savings and credit associations, and ranging from problems reaching branches to being offered the suppressed nonbank institutions that provided finan- unattractive or inappropriate products. cial services. A 2001 IFAD study estimates that farmers 1. The largest group was rural households, in particular obtained four times more credit from the informal market those of small-scale farmers, livestock raisers, and than from formal financial institutions, and a 2002 study of fishermen. These rural households had difficulties small-business owners found that nonbanking sources of because they lived at large distances from each other, finance accounted for up to three-quarters of private sector had limited assets and low productivity, and operated in financing during the first two decades of reform (Tsai 2004). a risky environment. This meant that the government did not have full control 10 Financial Inclusion in the People’s Republic of China 2. The second largest group was low-wage workers, 2.2.3 Financial Services Needed by These Groups especially migrant workers. Low-wage workers had dif- The four groups described constitute distinct market seg- ficulties accessing banking services because they had ments for different financial products. Table 1 illustrates the little income and almost no collateral. Migrant workers groups’ multiple financial service needs. in particular could not open a bank account or get a loan because they had no residence status in towns. Since 2005, CBRC has been introducing guidelines and 3. The third group was MSMEs, particularly private enter- regulations affecting the availability of financial services prises. MSMEs found it difficult to access banking ser- to what it calls “the weak sectors.� It has been giving vices because financial institutions preferred lending to priority to: large, state-owned companies with implicit guarantees. • Basic financial services (such as household current and 4. The fourth group was the unemployed, particularly savings accounts) for those who currently have difficult laid-off workers from SOEs and rural job seekers in access (especially rural households and low-wage workers) urban areas. They had difficulties because previously • Credit for enterprise investment purposes for those who there were no unemployed people and because lending currently have difficult access (in particular, rural house- to them to start up a business was very risky. holds and MSMEs) Within these groups, the poorest households and the The remainder of this report is structured around the smallest enterprises had the most difficulties. However, financial authorities’ efforts to improve the availability note that not all poor people and microenterprises were of basic financial services for all, rural household credit, excluded from banking services, and some nonpoor people and MSME credit. and medium-sized enterprises also experienced problems accessing banking services. It should be noted that the PRC government has also made policy changes affecting the availability of other financial Subsidized loan programs failed to substitute for the services for other target groups. Most notably, in 2003 it banking services the groups needed. As indicated in introduced the New Rural Cooperative Medical Scheme, a Box A, a range of government-supported loan programs basic health social security system that combines insurance failed to reach their target groups, depended heavily on fiscal and social assistance, which at the end of 2010 is reported to resources, and were unable to give people and enterprises cover 97 percent of all farmers and rural residents (ILO 2012). permanent access to credit. They also did not offer other These important policy changes and accomplishments are much needed financial services. not covered in the report. Table 1. Important Financial Service Needs of Groups with Difficult Banking Access Credit for Current and Credit for consumption, savings enterprise including Payment accounts, investment education, and transfer Insurance bank cards purposes housing, etc. services services Rural households, especially small-scale farmers, livestock raisers, and fishermen Low-wage workers, especially rural migrant workers Micro-, small-, and medium-sized enterprises, especially private MSMEs Unemployed, including low-income workers from SOEs and rural job seekers in urban areas 11 3 Policy Changes and the Evolution of Financial Inclusion Since the beginning of the 21st century, three changes in the PRC government’s goals have strongly affected financial inclusion: • The desire to clean up the banking system • The aspiration to improve social harmony • The wish to prevent contagion by the global financial crisis Section 3.1 describes these changes in government goals and some of the key policies under each of these goals. Then, Section 3.2 describes how the banking sector has under- gone a considerable transformation and greatly increased its overall health and profitability. Section 3.3 describes how financial access to banks has improved over the past couple of years, thanks in part to the government’s new goals and policies. It also describes how these same policies and eco- nomic developments have contributed to a parallel increase in the use of nonbank financial services. Figure 3 summarizes the PRC government’s parallel goals and objectives since 2005, which are further described below. This chapter does not seek to provide a full diagnostic of prudential and nonprudential financial regulation and super- vision in the PRC. Rather, it offers insight into the effects of recent policies and changes in the economy on finan- cial inclusion. The chapter notes positive achievements but also points to some remaining vulnerabilities that put these achievements at risk. Annex A provides detailed descriptions of some of the most significant providers of financial services to the previously excluded. Photographer: Miao Hualong 12 Financial Inclusion in the People’s Republic of China Figure 2. Parallel Government Goals and Objectives Stable and healthy Social harmony through No contagion with GOALS banking sector �nancial inclusion world �nancial crisis • Partial bank privatization • Promotion of universal • Rein in inflation • Increased foreign investment banking coverage • Manage growth of shadow banks OBJECTIVES • Promotion of rural �nance • Enhanced banking supervision • Avoid property price crash • Partial interest rate liberalization • Promotion of SME �nance • Control bank asset quality 3.1  Changes in Policy Goals and Objectives 3.1.2 Social Harmony Through Financial Inclusion 3.1.1 A Stable and Healthy Banking Sector Through Rising disparities and labor migration policies have caused Clean-up and Commercialization the population considerable frustration, and the risk of social instability pushed the government to change direc- Persistent NPLs and the impossibility of covering all the tion. In early 2005 PRC President Hu Jintao instructed the banks’ losses forced the government to pursue a thorough country’s leading officials and Party cadres to move away clean-up of the banking sector. In 2001, when NPLs were from gross domestic product growth as the central policy estimated to compose 27–44 percent of the financial sector’s goal, by placing “building a harmonious society� on the top portfolio (Pistor 2009), the government created asset manage- of their work agenda (People’s Daily 2005). Subsequent ment companies to buy NPLs. In 2003 it created the CBRC to policy documents issued by the State Council required the take over PBC’s task of banking regulation and supervision, banking sector to find ways to support the drive toward and make it more modern, professional, and efficient. CBRC social harmony by enhancing social and economic inclusion was charged with creating and maintaining a healthy banking through increased access to finance. sector that focuses on protecting the interests of depositors and consumers. PBC was to focus on monetary policy.8 Based on an analysis of the gaps in the market, the State Council instructed CBRC to put particular emphasis on CBRC was to ensure that the banking system met the stan- what it calls “the weak sectors� through the following: dards set by the Basel Committee and the World Trade Organization. To achieve this, CBRC’s steps included the • Achievement of full banking service coverage10 following, among others:9 • Promotion of san nong, the three rural issues (rural areas, • Partial privatization of most banks, to bring in a certain agriculture, and farmers)11 level of market discipline • Promotion of SMEs (which under government definitions • Increased admission of foreign investors, to increase com- included microenterprises)12 petition and obtain knowledge • Increased and enhanced supervision of the banking sector, to ensure its stability • Partial liberalization of lending rates, to allow banks a degree of risk pricing 10. In July 2007 CBRC launched the China Banking Services Distribution Map on its Web site. The map contains detailed information about the banking service coverage and competition status in rural areas and serves as a reference when 8. Although the supervisory functions of financial institutions have been transferred licensing new-type rural financial institutions. to CBRC, PBC remains a very influential institution with considerable regulatory 11. “During the 11th five-year period from 2006 to 2010, CBRC has, in line with power. In theory, PBC will concentrate on regulations concerning monetary con- the instructions and arrangements of the State Council, earnestly performed its ditions and financial system liquidity with the objective of promoting economic supervisory duties and attached great importance to strengthening and improv- growth and price stability. CBRC, on the other hand, will focus on the strength ing the provision of financial services to agriculture, farmers and rural areas� of financial institutions, capital adequacy issues, and the restructuring of the (CBRC 2011a). banking sector. In practice, however, there is no clear division between the 12. “CBRC has always attached great importance to the promotion of small enter- functions of PBC and those of CBRC. It is not uncommon for their functions to prise finance. As early as 2005 CBRC made it clear that alleviation of the funding overlap in some areas (China Knowledge 2012). difficulty of small enterprises was a long-term strategic task for banking institu- 9. Based on CBRC’s annual reports from 2006 to 2009 (http://www.cbrc.gov. tions, who should regard it as a part of their social responsibility as well as an cn/showannual.do). Because annual reports before 2006 are not available on effective means of contributing to economic development and social harmony� CBRC’s Web site, it is not always clear when each of these steps was initiated. (CBRC 2011b). 13 Financial Inclusion in the People’s Republic of China Table 2. Banking Institutions by Total Assets (Trillion RMBs) Assets 2009 Percentage Assets 2010 Percentage Large commercial banks (LCBs) 40.8 51% 46.9 49% Joint-stock commercial banks (JSCBs) 11.8 15% 14.9 16% CDB and policy banks (PBs) 6.9 9% 7.6 8% City commercial banks (CCBs) 5.7 7% 7.9 8% Rural credit cooperatives (RCCs) 5.5 7% 6.4 7% Postal savings bank (PSBC) and new-type financial institutions 2.7 3% 3.5 4% Rural commercial banks (RCOMBs) 1.9 2% 2.8 3% Nonbank financial institutions (NBFIs) 1.6 2% 2.1 2% Rural cooperative banks (RCOOPBs) 1.3 2% 1.5 2% Foreign-funded banks (FFBs) 1.3 2% 1.7 2% Total 79.5 100% 95.3 100% Source: CBRC Annual Report 2010. 3.1.3 Crisis Prevention Through a Temporary Increase in 3.2  Effects of Recent Changes on the Health Credit Supply and Stability of the Banking Sector Fearing that the financial crisis that originated in the United 3.2.1 Composition and Nature of the Banking Sector States would lead to global contagion and an ensuing decline in China’s robust export-led economy, the coun- Commercially oriented banks now make up the brunt of try’s leaders decided on drastic interventions. In November the banking sector in terms of assets. According to CBRC 2008 the government announced a 4 trillion RMB stimulus (2011b), at the end of 2010 the formal banking system com- program. Local governments were to provide 70 percent of prised 3,769 banking institutions with assets totaling 95.3 the funds (Wong 2012). Since local governments could not trillion RMB. More than 80 percent of these assets belonged directly issue bonds, they created local investment com- to institutions classified as commercial banks. Table 2 shows panies that could borrow from banks. In addition to being that 49 percent of total banking sector assets13 were held by expected to lend indirectly to local governments, banks China’s “big five�: Bank of China, Industrial and Commercial received instructions to increase their lending to companies Bank of China, China Construction Bank, Agricultural Bank and households. of China (ABC), and Communication Bank of China. They were followed by JSCBs, policy banks (PBs), and CCBs. The economy was unable to effectively absorb the national stimulus program. In 2009 commercial bank loans grew by A large majority of commercial banks have been “equitized.� 32.5 percent in real terms (Monus 2012). Local governments All large, state-owned commercial banks have sold part and banks invested part of the funds in unviable undertak- of their capital to nonstate investors through initial public ings, resulting in NPLs. A significant part of the funds was offerings (IPOs), although the government has maintained used by local companies to purchase stocks at the stock control in four out of five. Private ownership in JSCBs and exchange and make real estate investments, resulting in a CCBs has increased, with local government holdings now sharp rise in the prices of these assets. The stimulus package a minority. Besides, the country has made great progress in also resulted in a sharp increase in inflation, which caused transforming viable urban and rural cooperatives into small returns on deposits to become negative. This encouraged and medium-sized commercial banks, also partly privately people and companies with excess funds to look for alterna- owned. This has increased the chances of the banking sec- tive ways to place or invest their money. tor’s continued commercial orientation. Financial regulators needed to bring the risks arising Foreign investment in the banking sector has increased from the stimulus program back under control, by doing considerably. At the end of 2010, 37 wholly foreign-owned the following: banks had incorporated in the PRC, with a combined total of • Minimizing the effect of local government debt and specu- 260 branches or subsidiaries. In addition, 90 foreign banks had chosen to open branches of their home bank in China lation on banks’ asset quality (Martin 2012). • Avoiding a sudden crash in the prices of property and stocks • Reining in inflation 13. While CBRC uses “banking institutions� in the title of the table on which Table 2 is based, it actually also includes information on some nonbank financial institu- • Managing the growth of nonbank financial services tions that are under its supervision. These include insurance companies, trust companies, financial leasing companies, and consumer finance companies. 14 Financial Inclusion in the People’s Republic of China 3.2.2 Performance of the Banking Sector Figure 3. China: Nonperforming Loans to Total Loans (%) According to official statements, the stability and profit- ability of the banks has improved substantially. Over the 16 last few years, the banking sector has gone through a pro- All commercial banks 14 Major commercial banks cess of significant structural reform. According to CBRC’s Joint-stock banks City commercial banks 2010 Annual Report, at the end of 2010 the NPL ratio of all 12 Rural commercial banks banking institutions registered at 2.44 percent, and that of 10 Foreign banks commercial banks only was down to 1.13 percent.14 The 8 weighted average capital adequacy ratio (CAR) of com- 6 mercial banks reached 12.2 percent at year end, and the weighted average core CAR rose to 10.1 percent. By the 4 end of 2010, CAR of all commercial banks exceeded the 2 minimum requirement of 8 percent. In 2010, China’s bank- 0 ing industry realized a return on equity (ROE) of 17.5 percent, 2005 2006 2007 2008 2009 2010 while the return on assets (ROA) was 1.03 percent during Source: World Bank (2011). the same period. Figure 4. Number and Percentage of Banks Meeting the Figures 4 and 5 show recent developments in the banking CAR Requirement (2003–2010) sector’s NPL and capital adequacy ratios. Number of banks meeting the standard Assets share (%) 3.2.3 Vulnerabilities of the Banking Sector 300 100% While considerable progress has been made in improving 90% the health of the financial sector, vulnerabilities remain 250 80% (IMF 2011 and World Bank 2011). For example, while banks 70% are expected to make decisions based on commercial con- 200 60% siderations, they are still under pressure to allocate resources 150 50% according to “guidelines� issued by the financial authorities, and to favor state-preferred enterprises. Whereas banks 40% 100 are gradually starting to introduce risk pricing for loans, in 30% practice, they appear to have limited ability or willingness 50 20% to differentiate interest rates or to set interest rates much 10% beyond the official benchmark rate. Besides, while banks 0 0% 2003 2004 2005 2006 2007 2008 2009 2010 are in principle free to price loans, they are still limited in their ability to attract deposits because PBC continues to fix Source: CBRC (2010). interest rates banks can pay. These vulnerabilities limit the banking sector’s ability to contribute to financial inclusion. However, there is no doubt that in 2010 the PRC’s banking system was in much better shape than at the beginning of the decade. 14. It should be noted that the reduction in NPLs is largely due to the transfer of NPLs into four state-owned asset management companies. Photographer: Zhou Qing 15 Financial Inclusion in the People’s Republic of China 3.3  Effects of Recent Changes on Financial • The government has also been promoting the ownership Access to Banks and Nonbank Providers and use of bank accounts and bank cards, by requiring bank accounts for government-to-person (G2P) transfers In this section we look in more detail at the government’s and recommending the use of bank cards for person-to- goals of achieving full banking service coverage (Section government (P2G) payments (PBC 2009). 3.3.1), increasing rural household credit (Section 3.3.2), and growing SME credit (Section 3.3.3). In each section Access to basic banking services: Banking outlets and we first describe the way financial authorities have translated service points the goals into concrete guidelines and regulations. We then Since 2005 the number of banking outlets has increased present an overview of the principal banking sector providers significantly. While in 2005 the number of financial institution of financial services in each category that have emerged from outlets had arrived at a historic low (Zhang, Xu, Shen, and the changes in regulations and the overall economy over the Cheng 2010), in 2010 only 2,312 towns and townships had past few years. Section 3.3.4 concludes with an analysis of no physical outlet (CBRC 2011). However, in many townships the effects that recent policies and economic developments and villages banks had found cost-effective ways of creat- have had on the use of nonbank financial service providers. ing branchless access points by setting up mobile units and automated teller machines (ATMs), or placing point-of-sales 3.3.1 Full Banking Service Coverage (POS) devices with retailers and other nonbanking institutions. Policies The number of bank card access points has multiplied. The massive closure of commercial bank outlets and unvi- Table 3 shows PBC’s estimate of the number of establish- able RCCs created a need for alternative ways of reaching ments, POS terminals, and ATMs that had established a con- people in western and central, rural, and remote areas with nection to the Bankcard Interbank Payment System by the basic banking services. Some of the main policies related end of 2010. For clients, the presence of physical outlets and to meeting that need are as follows: branchless access points reduces the costs and increases • Since 2005 financial authorities have been pushing the the convenience of access to basic banking services, such banking sector to ensure the availability of minimal finan- as bank accounts and money transfers. cial services in all townships and villages, by increasing Even though experts believe official reports overstate the number of branches and exploring innovative alterna- access in remote western villages, and point out that the tives to physical facilities (CBRC 2011b). reports say little about the quality of the services on offer, • In 2006 CBRC issued a policy document that lowered the they agree that significant progress has been made in requirements for setting up rural financial institutions, by improving access to service points. encouraging the establishment of three new-type rural financial institutions (Giehler 2012). Village and township Table 3. Number of Bank Card Access Points banks (VTBs) can offer bank accounts and other bank- National Rural ing services to all people and businesses in the county (in thousands) (in thousands) where they are registered; rural mutual credit cooperatives Establishments/merchants 2,183 87 (RMCCs) can offer such services only to members. ATMs 271 11 • In the mean time, the government has continued to con- POS devices 3,334 265 solidate RCCs, to transform viable RCCs into rural com- Source: PBC Annual Report 2010. mercial banks and rural cooperative banks, and to close down highly unviable ones (CBRC 2011b). Photographer: Lu Jia 16 Financial Inclusion in the People’s Republic of China 3.3.2 Rural Household Bank Credit • Also in 2007, it instructed ABC to return to its original mandate of serving rural areas, but this time with the Policies instruction to pursue this mandate on a commercial basis By the beginning of the 21st century it had become clear (Yuk-Shing 2009). that RCC reform was not going to be enough to improve • In 2010, it instructed banks to ensure that the overall tighten- the rural population’s access to bank credit and that it ing of credit did not affect rural lending, by making sure that would be necessary to create competition in the market rural loan growth remained at or above overall loan growth. for rural loans. Following are some of the key policies intro- duced since 2005 that were intended to improve rural access RCCs and all banking institutions mentioned above are to productive bank credit: described in more detail in Annex A. • In 2005 PBC designed and pilot-tested MicroCredit Use of rural household bank credit: Providers and products Companies (MCC), a new type of small, privately funded, credit-only institution to compete with RCCs in rural According to CBRC, the banks’ value outstanding of both areas. In 2006 it issued guidelines for investors to create agro-related loans and loans to farmers doubled between MCCs. However, while in 2008 CBRC accepted MCCs as 2007 and 2010 (CBRC 2010a).16 In 2010, the regulator cate- nondeposit taking companies, it ruled that they were to gorized 2.6 trillion RMB or about 5 percent of banking sector be supervised by the provinces’ financial offices (Giehler RMB loans as farmer loans. Note that overall RMB bank 2012). However, since CBRC does not supervise MCCs credit to the entire economy also doubled over this period, it does not include them in its statistics on banks and thanks largely to the stimulus package introduced in 2008. nonbank financial institutions.15 Data on the breadth and depth of outreach of rural finan- • Two of the new-type finance institutions created in 2006, cial institutions are scarce. Table 4 aims to provide some bank-initiated VTBs and member-owned RMCCs, were insight by showing the main categories of providers of bank encouraged to develop loan products for rural enterprises loan products to rural household-run enterprises.17 and households (Giehler 2012). • In 2007 the government transformed PSRB into the It is important to note the following: Postal Savings Bank of China (PSBC), with the mandate • Table 4 contains information on loans to rural households to develop commercially viable loan products for rural for productive investment in the household’s business. enterprises, migrant workers, and farmers (Giehler 2012). It is not always clear whether the loans are restricted to • In the same year, the government issued a guideline that agricultural investments only or may also be used for non- lifted earlier restrictions on the type of banking institutions agricultural purposes. permitted to provide small rural loans, thus allowing CCBs and other types of banks to enter rural areas (He, Du, Bai, and Li 2009). 16. For CBRC, agro-related loans are all loans issued by banking institutions cat- egorized as rural, whereas loans to farmers are loans to rural households for the 15. PBC collects statistics on MCCs and reports them on its Web site, see purpose of investment in agriculture. http://www.pbc.gov.cn/publish/diaochatongjisi/3172/2012/ 17. It is not always clear whether these loans can be used only for agriculture or 20120510160014154597736/20120510160014154597736_.html. whether investment in nonagricultural enterprises is permitted. Table 4. Principal Types of Banks that Provide Rural Household Productive Loans Average Total volume outstanding Number of of loans out- balance Year Number of Published product borrowers standing (in (in thousands started institutions* name in English Date of data (in thousands)† billions RMB) RMB) Rural Credit Cooperatives 1950s 2,646 Trust loans and group 2005 73,000 314 4 (RCCs)a guarantee loans Large Commercial Banksb various 5 NA Dec 2010 NA NA NA −− Agricultural Bank of China c 1951 1 Ag. loans through Dec 2010 5,800 99 17 rural benefits card Postal Savings Bank of 2007 1 Microloans to farmers Mar 2010 1,310 62 47 Chinad New-Type Rural Financial 2006 395 Rural household loans Dec 2010 237 21 89 Institutions‡b City Commercial Banksb 1995 147 NA Dec 2010 NA NA NA −− Harbin Banke 1997 1 Just for You Dec 2010 226 8 36 Farmer Loans *All numbers of institutions are from CBRC (2011b). † Where no figure on number of borrowers is available, the data in this column represents number of loans. ‡ New-type rural financial institutions consist of village and township banks, rural mutual credit cooperatives, and lending companies. Sources: a. Planet Finance (2008); b. CBRC (2011b); c. ABC (2011a); d. Chen (2011); e. Harbin Bank (2011) 17 RCCs offer innovative products in line with international good practices, the absence of comprehensive informa- tion makes it difficult to judge the overall appropriateness of RCCs’ loan products. Since CBRC does not publish information on RCCs’ financial health, it is unclear to what extent they are a sustainable source of finance for rural households (Zhang, Xu, Shen, and Cheng 2010). • Large commercial banks, such as ABC20 and PSBC, have developed commercially oriented loan products for farm- ers and rural entrepreneurs. Together they serve about 8 million clients. Product design is innovative and based on international good practices. The extensive branch/ branchless networks of these banks mean that these products have great scope for expansion. • An unknown number of small and medium-sized banks have recognized the opportunity at the low end of the rural loan market and invested in the development of appropriate and profitable products. These banks have the advantage of being able to tailor loans to the needs in their area of operation. Harbin Bank—a CCB turned joint stock commercial bank—reports that its credit product for farmers reached 230,000 clients in 2010. The importance of the other 158 JSCBs and CCBs in rural household loans is unknown. • New-type financial institutions have also been develop- ing commercial products targeted at rural households; because they are small and their operations are restricted to a limited geographical area, they are in a good position to tailor products to local needs. However, by the end of 2010 the 395 institutions together served barely more rural households than Harbin Bank on its own.21 Photographer: Liu Yinhua 3.3.3 SME Bank Credit • For some categories of institutions, for example, CCBs, no aggregate information is available. In such cases, the table By the beginning of the 21st century the government real- presents data for a selected institution in that category ized that SMEs were an important engine of growth, and that is widely considered to be a leader with respect to that private SMEs in particular were facing major obstacles rural household loans. So, in the case of CCBs, the table to borrow from banks. It was therefore necessary to remove presents specific data on Harbin Bank. institutional barriers to SME lending and to encourage a • Since MCCs are not banking institutions and, therefore, have market-based approach at the same time. not increased access to bank loans, they are not included in It is important to note that in the PRC the term SME is Table 4. MCCs are discussed further in Section 3.3.4. commonly used to refer to MSMEs, too. For a long time, Table 4 shows that government policies have contributed policy makers and banks did not distinguish between micro to a significant increase in the number and diversity of and small enterprises, and considered all enterprises under banking institutions involved in rural finance. At the end of a certain size to be small (China SME Online 2004). In the 2010 RCCs were probably still the main banking sector lend- middle of 2011 the government issued a new regulation ers in terms of the number of rural households and house- on the classification of SMEs that did include a separate hold-run enterprises they reached.18 However, a diversity of category of “microenterprises� (China Briefing 2011). How- banks was quickly increasing their role: ever, regulations and press statements continue to con- sider the term SME to include microenterprises. In keeping • According to the most recent data available, in 2005 RCCs with this practice, this report uses the term SME to also had “credit loans� (collateral-free loans) and group loans include MSMEs. outstanding to 73 million households.19 Although some 18. In keeping with CBRC’s categorization, in this paper we treat RCCs as part of the banking sector. 19. As far as the authors have been able to ascertain, the government and regula- 20. It is unknown to what extent the ABC figures include poverty alleviation loans tory authorities have not issued any more recent figures on the number of RCC that carry government interest rate subsidies. household loans. Experts concur with Du Xiaoshan (2008) that reliable data on 21. Note that according to Luo Ping from CBRC (2012) the number of approved RCCs are very difficult to obtain, and data from different sources vary greatly. new-type financial institutions had doubled to 786 by the end of 2011. 18 Financial Inclusion in the People’s Republic of China Table 5. Maximum Number of Employees for Different Sizes Policies of Enterprise In recent years, the government has put in place several Micro Small Medium policies to increase SMEs’ access to finance. Agriculture, forestry, livestock, farm- NA NA NA • In 2005 the government issued guidelines encouraging ing, fishing large, medium, and small banks to set up small business Heavy industry 20 300 1000 units. Retail industry 10 50 200 Transportation 20 300 1000 • A number of subsequent guidelines, policies, rules, and Restaurant and catering 10 100 300 opinions issued between 2005 and 2010 encouraged banks to support SMEs. • In 2011, CBRC issued a new regulation designed to pro- Table 6. Maximum Revenue for Different Sizes of Enterprise vide greater incentives to Chinese banks to offer loans to (million RMB) small enterprises. Micro Small Medium • Finally, over the past few years, the government has tol- Agriculture, forestry, livestock, farm- 0.5 5 200 ing, fishing erated the emergence of a range of nonbank financial service providers targeting SMEs, as long as they did not Heavy industry 3 20 400 mobilize deposits or charge usurious interest rates. Retail industry 1 5 200 Transportation 2 30 300 Use of SME bank credit: Providers and products Restaurant and catering 1 20 100 SMEs’ access to bank credit has improved. According to Source: China Briefing (2011) CBRC (2010a) the SME part of banks’ portfolio grew faster than any other part of their portfolio in 2010. At the end Tables 5 and 6 present a selection of current criteria for of the year its value amounted to 7.27 trillion RMB, which classifying SMEs. As can been seen, the criteria for clas- constitutes about 14 percent of banking institutions’ total sification as an MSME differ by sector. The tables show the portfolio of loans and advanced accounts. criteria for five out of 16 sectors. Note that in many coun- As is the case for rural household loans, comprehensive tries, the companies that are classified as microenterprises information on banks’ breadth and depth of outreach with in the PRC would be considered small- or medium-sized. SME loans is difficult to obtain. Table 7 shows the catego- Also, many enterprises considered medium-sized in the PRC ries of financial institutions that are the most significant SME would be considered large elsewhere. loan providers. Where no consolidated information is avail- able the table shows detailed data for one or two examples. Photographer: Zhao Jianming 19 Financial Inclusion in the People’s Republic of China Table 7. Principal Types of Banks that Provide SME Loans (including microenterprise loans) Average Total volume outstanding Number of of loans out- balance Year Number of Published product borrowers standing (in (in thousands started institutions* name in English Date of data (in thousands)† billions RMB) RMB) Large Commercial Banksb various 5 NA Dec 2010 NA NA NA Small loans Dec 2010 40 461 11,525 −− Agricultural Bank of Chinac 1951 1 SME loans Dec 2010 63 1,900 30,159 −− Bank of Chinac 1912 1 SME loans Dec 2010 36 1,000 27,778 Postal Savings Bank 2007 1 Microloans to small Mar 2010 910 43 47 of Chinad enterprises Joint Stock 1987 12 NA Dec 2010 NA NA NA Commercial Banksa −− China Minsheng Banking 1996 1 Shang Dai Tong loans Dec 2010 110 159 1,445 Corp.e City Commercial Banksf 1995 147 Micro and small loans Dec 2009 NA 716 NA −− Baoshang Bankg 2002 1 NA Dec 2010 30 4 147 New-Type Rural Financial 2006 395 SME loans Dec 2010 31 31 1,000 Institutions‡a *All numbers of institutions are from CBRC (2011b). † Where no figure on number of borrowers is available, the data in this column represents number of loans. ‡ New-type rural financial institutions consist of village and township banks, rural mutual credit cooperatives, and lending companies. Sources: a. CBRC (2011b); b. ABC (2011b); c. Bank of China (2011); d. Chen (2011); e. China Minsheng Banking Corp. (2011); f. CBRC (2010); g. CAM (2011). As Table 7 indicates, government policies have contrib- It is generally believed that the growth in nonbank finan- uted to a significant increase in the number and diversity of cial service provision is a consequence of a number of institutions involved in SME finance. At the end of 2010, the developments in the national and international economy, 147 CCBs together had probably become the main providers combined with a set of government policies intended to of what the government considers SME loans, in terms of manage the economy (J.P. Morgan 2011). These include number of clients. However, a large number of other banks a continued cap on bank deposit rates, an increase in the played an important role: minimum lending rate and banks’ reserve requirements, and • By the end of 2010, the Postal Savings Bank, with 500,000 “guidelines� to banks to reduce lending. microloans to small enterprises, was probably the largest Since 2005, financial authorities have issued a large single supplier of SME bank loans in terms of number of number of regulations and guidelines regarding nonbank clients. financial service providers. For example, the regulation and • 109 large, medium, and small commercial banks had supervision of banks’ off-balance sheet activities have been established small business units (SBUs), which were typi- tightened, and leasing and guarantee companies have come cally serving several tens of thousands of clients each.22 under closer scrutiny. Most notable among the new regula- • All 395 new-type financial institutions together were serv- tions have been guidelines for investors to set up MCCs, ing only 31,000 SMEs, i.e., the approximate number of which offer opportunities for private actors to engage in SMEs served by a single bank SBU. legalized microcredit activities. These actors include people and companies formerly engaged in illegal lending. Annex A provides more details on the banking categories with the deepest outreach. Use of nonbank credit: Providers and products Recent estimates of the size of the shadow-banking or 3.3.4 Nonbank Providers of Financial Services nonbank financial sector vary widely—4–18 trillion RMB, Policies depending on which activities are included or excluded (Borst 2011). Table 8 shows Morgan Stanley’s (2012) esti- While CBRC has had some success in helping to increase mate of the volume of outstanding loans in the shadow bank- access to bank services and the availability of bank loans ing market. This volume is the equivalent of 20 percent of for SMEs and rural households, experts agree that the past banking institutions’ total loan portfolio at the end of 2010.23 few years have also seen a significant increase in “shadow It is interesting to compare this to banks’ farmer credit port- banking services� (J.P. Morgan 2011). This term is widely folio (5 percent of the banks’ total loan portfolio) and banks’ used to cover financial services that do not come from banks SME credit portfolio (14 percent of the banks’ total portfolio). or RCCS but from nonbank financial service providers. 22. While the authors have made every effort to include in the table the total number of SME borrowers per featured bank, it is possible that the sources used did not 23. According to CBRC’s 2010 Annual Report, at the end of 2010, banking institu- include information on all loan products used by SMEs. tions had 47.6 trillion RMB outstanding in short-, medium-, and long-term loans. 20 Financial Inclusion in the People’s Republic of China Table 8. Nonbank Providers of Financial Services by Total Loan Volume Outstanding Number of Total volume of loans Date institutions outstanding (billion RMB) Regulators Enterprises: entrusted loans* Sep 11 NA 4,571 CBRC, PBC Trust companies: trust loans Sep 11 65 1,674 CBRC, PBC Credit guarantee companies* Dec 11 6,500 780 CBRC, PBC Noncredit guarantee companies* Dec 11 13,000 840 NA Licensed financial leasing companies Sep 11 17 377 CBRC, PBC Nonlicensed financial leasing companies* Sep 11 242 750 MOFCOM Pawnshops* Dec 11 5,000 55 MOFCOM Microcredit companies (MCCs) Sep 11 3,791 336 Local governments’ financial service department, CBRC, PBC Other private lending* Dec 11 NA 850 NA Total 10,233 *Estimate. Sources: Morgan Stanley (2012). Box B provides a short description of what Morgan Stanley by CBRC and PBC24 over the past few years. The other pro- considers the most significant shadow banking providers viders are not supervised by central financial authorities. and activities, all of which can operate legally. The differ- ent providers pose different risks to clients and the financial Other sources of private lending include a variety of legal system. Off-balance sheet activities, such as trust loans and as well as illegal operators. Illegal practices, such as direct entrusted loans, financial leasing, and credit guarantee com- intercompany lending and informal note discounting, often go panies, have become highly regulated and strictly supervised unregistered and are unsupervised. So-called underground banks, such as private money houses, illegally mobilize Box B. Significant Nonbank Financial Service Providers deposits and pay deposit rates above PBC’s deposit rate ceil- Trust Companies Extend Trust Loans. As they are not authorized to absorb ing. These as well as professional moneylenders often charge deposits, the loans are mainly financed through various financial products, such very high lending interest rates. In fact, MCCs were designed as wealth management products, issued to enterprises and individuals. Banks as a way for underground lenders to legalize their business. and trust companies act as intermediaries only to earn fees, and usually do not undertake risks should borrowers default. Morgan Stanley does not specify what is included in its Enterprises Provide Entrusted Loans. Enterprises that wish to lend significant estimate of other sources of private lending. We do not sums to other enterprises are prohibited from doing so directly; however, they can provide Entrusted Loans with banks or other financial institutions as intermediar- know whether it includes informal but legal practices, such ies. In the same vein as trust loans, banks and other financial institutions play only as interpersonal lending, loans from friends and family, and an intermediary role to earn fees, and it is very rare to assume default risks. rotating savings and credit associations. It is also unclear Licensed Financial Leasing Companies Offer Leasing Services. These are whether the estimate includes two important types of institu- regulated by CBRC and PBC because they can engage in some kind of banking business, such as financing from the interbank market. Many are subsidiaries tions that explicitly target those with difficult access to banks of banks. nonlicensed financial leasing companies are mainly regulated by the and other formal financial institutions: Ministry of Commerce, and they usually conduct traditional leasing business. • Poverty alleviation microfinance institutions (MFIs). Credit Guarantee Companies Offer Bank Loan Guarantees. Since 1992 the government has permitted the establishment of credit guarantee companies. Poverty alleviation MFIs were started in the early 1990s Licensed credit guarantee companies provide guarantees for bank loans, and and tend to target the rural poor. Nowadays they tend their credit volume represents bank lending that would not have taken place to be legally registered as societal organizations, founda- without their involvement. So-called noncredit guarantee companies are illegal. An unknown proportion of credit and noncredit guarantee companies have been tions, privately run nonprofit enterprises, and institutions illegally involved in direct lending and taking deposits from the public. (Sun Tongquan 2008). Pawnshops Offer Collateral-Based Loans. Pawnshops were abolished in 1949 • Peer-to-peer (P2P) platform managers. P2P platforms are but reappeared in the 1980s. After a review in the 1990s, they are now regulated a more recent phenomenon, started in 2006. P2P platform and supervised by the Ministry of Commerce. While not intended for enterprise loans, in a situation of tight bank credit, they have become an important source managers intermediate between individual investors and of short-term business lending, taking real estate and vehicles as collateral. borrowers in urban as well as rural areas. They tend to be Some have also illegally started taking deposits. registered as nonfinancial companies, such as consultan- MicroCredit Companies Offer Cashflow-Based Loans. In 2005 PBC designed cies (Caixin 2011). and pilot-tested the MicroCredit Company (MCC)—a new type of small, rural focused, and privately funded, credit-only—intended to offer nonbank credit providers a vehicle for legalizing their businesses. In 2006 it issued guidelines While these two types of providers constitute less than for investors to create MCCs. The 2008 guidelines for MCCs issued by CBRC 1 percent of the nonbank sector in terms of the volume of in conjunction with PBC marked their official acceptance as nondeposit-taking loans they provide, they may be some of the most relevant companies. MCCs were to be supervised by the provinces’ financial offices. nonbank providers of financial services for microenterprises While MCC lending is technically legal, regulatory support has not been unam- biguous. CBRC is concerned about MCCs illegally taking deposits. and the poor. This is discussed further in Chapter 4. Sources: Morgan Stanley (2012), Situ (2010), Tsai (2004 and 2006), and Giehler (2012). 24. The different roles of CBRC and PBC in banking regulation and supervision were described in Section 3.1.1. 21 4 Gap Assessment Recent government policies to improve financial inclu- sion in the PRC have focused on access to basic banking services and productive bank loans for rural households and SMEs. This chapter analyzes the degree to which banks meet the potential demand from groups that previously found it difficult to access such services. Section 4.1 looks at banks’ breadth of outreach (as measured by the number of clients) Photographer: Li Xiangju and their depth of outreach (as measured by the degree to which the poor are reached); it also analyzes selected nonbank financial service providers. Section 4.2 considers some of the reasons behind banks’ and nonbanks’ current roles in financial inclusion. Based on the limited data that are publicly available, we conclude that while the results of policy changes have largely been positive, considerable work remains to be done before the PRC’s financial system can be considered fully inclusive. 4.1  Breadth and Depth of Outreach of Banks and Nonbank Providers 4.1.1 Full Banking Service Coverage Breadth of outreach: Bank account and card ownership The number of adults with bank accounts has increased significantly. Most banks do not report how many clients they have.25 However, from a recent World Bank study reporting on a survey of more than 4,000 nationally repre- sentative and randomly selected individuals, we know that, in 2011, 64 percent of Chinese adults owned an account with a formal financial institution, compared to a 50 percent global average (Demirgüç-Kunt and Klapper 2012). We also know that PSBC had 475 million individual clients at the end of 2010, which is a third of the population. Many Chinese experts believe that most households (not individuals) now have access to formal banking in China. 25. While some publish the number of accounts, this is not a good proxy for number of clients as many people have more than one account. 22 Financial Inclusion in the People’s Republic of China Bank cards have become widely available. According to 4.1.2 Rural Household Bank Credit PBC (2011), by the end of 2010 banks had issued over 2.4 Breadth of outreach: Number of rural households with billion bank cards—more than 90 percent of which were productive credit debit cards. ABC alone had issued 96 million Kins Farmers Benefit Cards.26 With a national population of more than 1.3 To be able to judge the proportion of rural households billion, this means that the number of bank cards per capita reached with productive credit, it is important to first exceeded 1.8. Even in rural areas, the number of bank cards obtain an estimate of demand for rural household bank per capita was 1.07. However this does not mean that all loans. The latest population census, which was conducted rural people had a debit card. In fact, PBC (2011) reports a in 2010, counted 674 million rural residents living in slightly bank card penetration rate of only 35 percent. Only 8 percent over 200 million rural households. According to the latest of adults hold a credit card according to the recent World national Agricultural Census (NBS 2008), in 2006, 71 per- Bank Findex report (Demirgüç-Kunt and Klapper 2012). cent of the total rural employed population of 478 million (i.e., 373 million) worked in the primary sector.28 Syngenta Even if many of these bank accounts and cards are not Foundation (Yuan 2011) calculated that 190 million of these actively used,27 the ownership of accounts and cards is an were smallholder farmers, with the remainder working in important step in improving financial inclusion. state, local government, and collective enterprises, or being unemployed. Depth of outreach: Use of basic banking services by the poor The number of rural households is not an accurate proxy Bank account ownership among the poor is still low. Banks for demand; rather, the number indicates an order of mag- do not generally have information on the income level of nitude. Only a certain percentage of households want to their clients. The most reliable up-to-date demand side study supplement their own funds with bank loans, and not all that gives insight into depth of outreach is the Findex study. have a viable business and are able to repay a loan. According to this study, 39 percent of the poorest quintile in To obtain an estimate of the supply in the sense of the the sample had a bank account (Demirgüç-Kunt and Klap- number of bank loan clients, we extrapolated the data on per 2012). This is considerably lower than for the total adult financial service providers presented in Table 4 in Chapter 3. population in China of which 64 percent has access. See Annex B1 for the detailed calculations. We estimate that PBC’s recent commitment to ensuring that all social trans- in 2010 all banks and RCCs together had a maximum of 119 fers are made through bank accounts and bank cards is million rural household loans outstanding. This constitutes likely to have a significant impact on the number of poor 58 percent of the number of rural households. with access to basic banking services. It should be noted that these extrapolations constitute an overly optimistic estimate, and in actual fact, the number 26. For more information on ABC see Annex A2. 27. The World Bank’s Findex study (Demirgüç-Kunt and Klapper 2012) found that of bank loan clients is significantly lower. The calcula- only 32 percent of the sample had made savings in their account over the past tions make the very generous assumption that all banks year, compared to 45 percent in high-income countries. It is well known that, in many cases, transactions on accounts and cards are limited to the reception and withdrawal of the G2P transfer, and the accounts are dormant for the remainder 28. This includes individuals belonging to households engaged in farming, forestry, of the time. animal husbandry, and fishery. 23 Financial Inclusion in the People’s Republic of China Table 9. Relative Loan Size of Rural Household Loans Column 1 Column 2 Column 3 Column 4 Column 5 Column 6 Column 7 Average loan Average rural balance/ Average loan Average out- annual net average rural National rural balance/rural Institutions by standing balance income per net income (%) poverty line poverty line average out- per loan (2010) capita (2010) (2011) standing balance Product name (thousand RMB)a (thousand RMB)*b Column 3 ÷ Column 4 (thousand RMB)c Column 3 ÷ Column 6 Trust loans RCCs and group 4 5.9 68% 2.3 174% guarantee loans Ag. loans through ABC 17 5.9 288% 2.3 739% rural benefits card Just for You Harbin Bank 36 5.9 610% 2.3 1,565% Farmer Loans Microloans PSBC 47 5.9 797% 2.3 2,043% to farmers Rural household NTFIs 89 5.9 1,508% 2.3 3,870% loans Sources: a. See Table 4; b. National Bureau of Statistics of China (2011b); c. Xinhuanet (2011). in a particular category have a portfolio comparable to the Compared to other countries, a majority of the PRC’s sample institution in that category.29 This is certainly not the banking institutions do not reach out very deeply with their case. However, in the absence of complete data, it is not loans. This is further explained in Box C. possible to determine the real magnitude of the number of clients. Box C. The PRC’s Banks’ Depth of Outreach Compared to Other Countries Depth of outreach: Relative value of rural household loans The Microfinance Information Exchange (MIX) contains information on about 2,000 MFIs worldwide. For an institution to be included in MIX, its average A frequently used indicator for the depth of outreach of outstanding loan balance has to be less than 250 percent of gross national loan products is the relative value of the average outstand- income (GNI) per capita. Based on this guideline, none of the banking sector institutions in the PRC except RCCs are eligible to be included in MIX. However ing loan balance. Table 8 compares this loan balance first some nonbank providers, such as MCCs and poverty alleviation MFIs, are to average rural annual net income per capita30 (in column included in MIX. 5) and then to the poverty line31 (in column 7). Source: MIX (2011). Table 9 shows that the average rural household loan bal- Note that Table 9 shows only averages. Each institution’s ance of most banks is many multiples of average rural portfolio contains loans with a balance above and below this annual net income per capita.32 Of all the rural household average. For example, a certain proportion of PSBCs’ micro- loans presented in Table 9, only RCCs’ collateral-free loans loans to farmers is certainly reaching people with the aver- and group guarantee loans have an average outstanding bal- age rural net income. In addition, not all institutions within ance that is below rural annual net income per capita (4,000 the same category have the same average loan balance. RMB is 68 percent of 5,900 RMB).33 The average outstand- Since we do not have data on all CCBs, it would be inap- ing balance of agricultural household loans extended by the propriate to draw far reaching conclusions on their depth of institution with the next deepest outreach, ABC, is 17,000 outreach based on the data of Harbin Bank alone. RMB, or 288 percent of rural annual net income per capita. The average loan balance of most banks is also much 4.1.3 SME Bank Credit higher than the rural poverty line. The average outstanding Breadth of outreach: Number of SMEs with credit loan balance of RCCs, the banking sector institutions with To obtain an estimate of demand for SME and rural house- the deepest outreach, is 174 percent of the rural poverty hold bank loans, in the sense of the number of people line, and that of ABC’s agricultural household loans is 739 needing bank loans, we obtained national statistics on the percent of the rural poverty line. number of SMEs. The latest Economic Census (NBS 2009) 29. For example, it assumes that each CCB has the same number of rural loan clients held in 2008 counted 45 million legal units, establishments, as Harbin Bank. and self-employed individuals who were engaged in sec- 30. The definition of rural net income is given in the footnotes to the introduction of ondary and tertiary industries within the territory of China. This this report. 31. Column 6 mentions the new rural poverty line introduced in 2011, which is 80 number includes large, state-owned enterprises, but a large percent higher than the one used previously. majority are public and private SMEs, including microenter- 32. Note that the table contains the average outstanding balance for PSBC’s entire microloan portfolio (which includes both farmer loans and SME loans) because prises. The closest estimate for the number of legal private this is the only figure available. In fact, farmer loans are only half the size of SME SMEs and microenterprises is the number of self-employed loans, so in reality the average outstanding balance for farmer loans is smaller than 47,000 RMB. 33. RCC household loan balance figures are 2005; the income figures are for 2010. 24 Financial Inclusion in the People’s Republic of China Table 10. Relative Loan Size of SME Loans Actual average loan size of different types of institutions Government criteria for defining different types of SMEs Institutions by average Average outstanding Minimum Maximum outstanding loan balance per loan Enterprise average average balance Product name (2010) (thousand RMB)a Sector sizeb revenueb revenueb PSBC Microloans to small 47 Primary Micro 0 500 enterprises Taizhou Bank Micro and SME loans 450 Retail Micro 0 1,000 NTFIs SME loans 1,000 Transportation Micro 0 2,000 China Minsheng Shang Dai Tong loans 1,450 Heavy industry Micro 0 3,000 Banking Corp ABC Small loans 11,500 Heavy industry Small 3,000 20,000 BoC SME loans 28,000 Wholesale trade Small 10,000 50,000 ABC SME loans 30,000 Real estate development Small 20,000 50,000 Sources: a. See Table 7; b. China Briefing (2011). individuals with licenses, at 29 million.34 In general only legal, Note that both SMEs that do and those that do not have registered SMEs are eligible for bank loans. access to bank credit often use a range of nonbank sources of finance. A recent survey of 2,400 SMEs in the It should be noted that the number of SMEs is not an PRC found that on average they had financed only 20 per- accurate proxy for demand; rather, the number indicates cent of new investments with bank loans. For the smaller an order of magnitude. For example, only a certain percent- companies, banks were an even less significant source of age of SMEs want to supplement their own funds with bank finance (Ayyagari, Demirgüç-Kunt and Maksimovic 2010). loans, and not all have a viable business and are able to repay a loan.35 Depth of outreach: Relative value of SME loans Again we use average outstanding loan balance as an indi- To obtain an estimate of the supply in the sense of the cator for the depth of outreach. To see to what extent SME number of bank loan clients, we extrapolated the data lenders reach out to the smallest types of enterprises, Table 10 on financial service providers presented in Table 8 in compares their average loan balance with the government’s Chapter 3. Annex B2 shows the detailed calculations. We newly issued revenue criteria for defining microenterprises. estimate that in 2010 banks had at most 6.6 million SME loans outstanding. This constitutes 16 percent of the Table 10 shows that different categories of banks probably number of all registered SMEs. target different market segments: As was the case for rural household loans, this extrapo- • PSBC and Baoshang Bank, a CCB, have products of lation for SMEs constitutes an overly optimistic estimate, a size comparable with the average revenue for a pri- and in fact, the number of bank loan clients is significantly mary sector or retail microenterprise, as defined by the lower. The calculations make the very generous assumption government. that all banks in a particular category have a portfolio com- • New-type financial institutions and China Minsheng Bank- parable to the sample institution in that category.36 This is ing Corporation, a joint stock commercial bank, offer SME certainly not the case. However, in the absence of complete products of a size that would be suitable for microenter- data it is not possible to determine the real magnitude of the prises in the transportation sector and heavy industries.37 number of clients. • The average size of SME products of ABC and the Bank of China is above the criteria for microenterprises in all 34. NBS defines these as economic units except rural households where the means sectors. of production is owned by individuals, individual work constitutes the basic form of operation, and the results of the operation are owned by or at the disposal of the individuals concerned. Of course, not all institutions within the same category have 35. Many SMEs are not viable and, therefore, cannot pay back a loan. Enterprise the same average loan balance, and each institution’s portfolio survival rates constitute an indication of the percentage of unviable SMEs. For example, in Switzerland where competition is considered to be tough, only 66 contains loans with a balance above and below this average. percent of new SMEs in the secondary and tertiary sector survive after their third year. 36. For example, it assumes that each CCB has the same number of SME loan 37. As far as the authors have been able to discern, there is no separate criteria for clients as Baoshang Bank. manufacturing. It seems plausible that “heavy industries� covers manufacturing. 25 Financial Inclusion in the People’s Republic of China We already saw that most rural loan products in the PRC Box D. Microcredit versus SME and Rural Loans: Confusion in Terminology do not meet the informal international standard for being considered “microcredit�; the same is the case for SME The PRC’s English-speaking press and official English translations of Chinese documents often describe banks offering rural and SME loans as providing loans. Institutions are generally considered to be providing “microcredit.� However, banks do not strictly disburse many microloans as microcredit only if their loans are under MIX’s cut-off rate. defined internationally. The average balance outstanding of rural and microen- Official English translations of Chinese documents on rural terprise loans tends to exceed the informal international norm of less than 250 household and SME loans and the English-speaking press percent of GNI per capita. frequently refer to these loans as “microcredit.� This practice Occasional miscommunication on this issue between the government and the is cause for much international miscommunication. Box D international community arises from two sources: explains this in more detail. 1. Translation—The Chinese word for “MicroCredit Company� can be trans- lated into English as “microcredit company� or as “small credit company.� 4.1.4 Credit from Selected Nonbank Providers Chinese Pinyin English 微型�业 Weixing qiye Microenterprise Breadth and depth of outreach ��业 Xiao qiye Small enterprise Information on the outreach of nonbanks is rather scarce. ��贷款公� Xiao edaikuan gongsi Micro/small credit company As a consequence, it is difficult to estimate the degree to which they meet demand, and the extent to which they 2. Distinction—For a long time, Chinese regulations have not distinguished reach out to the poor. Table 11 provides information on between micro and small enterprises. Although a new regulation is now in place, the government and banks continue to consider microenterprises simply some types of nonbank financial services providers for which to be very small SMEs. data on outreach are available. The international community believes it is important to distinguish between MCCs are starting to become a significant group of actors SMEs and microenterprises for two main reasons: in terms of breadth of outreach, but despite their name 1. Products—Microenterprises require products that explicitly recognize their they do not tend to reach out to the poor. In 2010, the 2,614 unregistered, asset-poor, and informal nature. MCCs38 altogether served almost 500,000 clients. However, 2. Models—Microcredit requires a business model that involves different at 400,000 RMB, average outstanding loan balances were mechanisms for risk control and cost recovery. 65 times rural net income per capita. Experts believe that the Sources: China Working Group on Inclusive Finance (2011b) and IFC (2009). majority of MCC loans do not go to farmers but to rural and peri-urban entrepreneurs in the secondary and tertiary sector. P2P platforms are a new type of nonbank with a lot of Poverty alleviation MFIs have average outstanding loan potential for breadth and depth of outreach. Very little is balances around rural net income per capita; however, known about P2P platform managers as they do not publish with the exception of the China Foundation for Poverty their results. According to press reports (Shen 2011), Cred- Alleviation, their outreach is very low. The 42 MFIs that itEase is the largest of approximately 30 P2P platform man- report to the China Association of Microfinance (CAM) have agers. It has developed relatively low-value commercial loan fewer than 2,000 clients each. Of those that do not report to products, with which it reaches 70,000 clients. According to CAM, the China Foundation for Poverty Alleviation with over personal communications, CreditEase’s rural clients typically 100,000 clients is by far the largest. The majority operates borrow 6,000 RMB and urban clients borrow 60,000 RMB. in an incomplete legal framework, and it is unclear whether It is likely that most P2P platform managers mainly provide the government is going to support their continuation in their loans for rural and urban nonagricultural microenterprises. It current form. is unclear whether the government will accept P2P providers as an alternative model and provide a regulatory framework for their operation and expansion. 38. The number of MCCs is growing extremely fast. In 2011, the total number of MCCs increased by 64 percent, according to data released by PBC (Zhang 2012). Table 11. Outreach of Selected Nonbank Providers of Financial Services Average Total volume outstanding Number of of loans out- balance Year Number of Published product borrowers standing (in (in thousands started institutions name in English Date of data (in thousands) billions RMB) RMB) Microcredit Companies a 2005 2,614 Loans Dec 2010 493 197 400 Poverty Alleviation MFIsb 1993 100 NA 2008 NA NA NA −− Members of China Asso- 1993 42 Loans 2009, 2010 73 0.36 5 ciation of Microfinancec −− China Foundation for 1996 1 Loans Dec 2011 106 0.66 6 Poverty Alleviationd P2P Providerse 2006 30 NA Nov 2011 NA NA NA −− CreditEasee 2006 1 Loans Nov 2011 70 1 14 Sources: a. Giehler (2012); b. Du (2008); c. He, Du, Bai, and Li (2009); d. CFPA Microfinance (2010); e. Lanhee Lee (2011). 26 Financial Inclusion in the People’s Republic of China 4.2  Considerations on the Role of Banks and • It takes time for banks to change their way of doing busi- Nonbanks in Financial Inclusion ness. We saw in the section on the history of the PRC’s financial sector that, for a long time, banks based their While considerable progress has been made in expanding decisions on sectoral quotas and focused their lending access to basic banking services, such as bank accounts on large, state-owned companies that carried an implicit and bank cards, bank loans appear to reach only a part of government guarantee; loans to rural households carried a rural households and SMEs, and they do not reach out very low interest rate and were subsidized. Unsubsidized lend- deeply. This apparently limited breadth and depth of loan ing to smaller private companies or households requires outreach to previously excluded market segments is due to banks to not only build the capacity to assess companies a complex set of issues on both the demand and the supply on the basis of their cash flow and to develop the ability side, combined with some issues on the macro level. The to work with a variety of collateral. It also requires them following are some examples. to change their internal culture and break habits long ingrained during the time of the command economy. In On the demand side: particular, after many years of being told that rural inhabit- • Not all people in the selected sectors and occupations ants can pay only very low interest rates, banks find it hard need or want a loan. For example, many of the PRC’s to accept the idea that the costs of many rural household poor operate unviable smallholdings or enterprises and loans can actually be covered from interest income. do not need productive loans but they need government income support or jobs. A considerable number of rural Box E. Examples of Challenges Faced by Banks in Increasing Outreach households receive domestic transfers from relatives who are working in towns. Others who do have a viable piece • Size and structure make it difficult for large regulated financial institu- tions to adapt products to local circumstances and changes in the of land or a promising enterprise prefer to draw on their market. For example, as Giehler (2012) notes, in large institutions, product own savings. Past policies have ensured that Chinese development, management, and marketing decisions are centralized. This households hold relatively high bank savings balances. means they can apply only an industrialized approach and offer standard- ized products. A multi-layer hierarchical structure makes management and • Of those who do need or want a loan, many prefer to use supervision more complicated. Product features also lack flexibility as a nonbanking sources. The one-child policy means that a result of long decision-making chains. young couple can often borrow some money from their • Regulations governing small financial institutions, such as VTBs, parents as well as from up to four sets of grandparents. discourage them from serving large numbers of the poor and microen- Informal loans from family and friends are usually interest terprises. For example, funding source and leverage restrictions on different free. In addition, a large variety of nonbanks offer loans types of institutions severely limit growth. Geographical restrictions mean that economies of scale from expansion are limited. While they are officially against terms and conditions that compete with those free to price loans according to risk (within bands), many are reluctant to do offered by banks. Easier access often outweighs the so for fear of prosecution (IMF 2011). higher interest rates charged. • However, in poverty-stricken areas people often do not have access to sufficient nonbanking sources of loans. On the macro level: In these areas, extended families and nonbank financial • The government needs to balance its wish to increase service providers often cannot offer the amount of money lending to those who previously had difficulty access- that people need at the time that they need it. ing banking services with the need to conduct monetary On the supply side: policy. Growth in rural and SME lending is necessarily limited by PBC’s measures to reduce the growth in overall • Different types of banking institutions face different credit supply. challenges. Annex A provides a detailed description of the principal categories of financial institutions that offer • The role of the government and the various financial small rural and SME loans, and describes some of the authorities is not always clear. The IMF (2011) mentions bottlenecks for achieving higher growth and deeper pen- contradictions between CBRC’s safety and soundness etration into the market. Box E summarizes some of the mandate and the government’s continued effort to use the issues they face. financial system to attain development goals. While banks are expected to operate on commercial principles, they continue to be “encouraged� to allocate their resources to priority sectors. 27 5 Conclusions Major policy changes have taken place in recent years The beginning of the 21st century represents a watershed in the promotion of financial inclusion in the PRC. During the previous two decades government policies had favored large, industrial, government-owned companies located in urban areas and on the coast, at the expense of rural house- holds, low-wage workers, SMEs, and the unemployed. Rising social inequalities prompted the realization that new policies were required. With social harmony and sustainable develop- ment as its new central policy goals, the central government embarked on a concerted effort to ensure more widespread access to banking services. Furthermore, while thus far the government had tried to increase access through lending quotas and subsidized loan programs, limited success moti- vated a push toward commercially viable, investable institu- tions offering products to clients perceived as too costly or too risky to serve. These changes in goals and emphasis have had a major impact on the PRC’s financial landscape. New policies and regulations, particularly those introduced since 2005, have reversed the previous trend by increasing the accessibility of banking services. There has been an increase in the number of banks with a mandate to provide banking services to the hitherto excluded—in particular, rural people and SMEs. Banks have expanded their outreach by establishing large numbers of virtual access points, such as mobile units, ATMs, banking agents, and POS devices. CBRC reports that banks’ branch and branchless networks now cover all townships and villages. Photographer: Liao Guowei 28 Financial Inclusion in the People’s Republic of China The policies have also increased the sustainability of Some banking institutions do serve what the PRC govern- access to financial services. The overall health and, there- ment defines as microenterprises. For example, PSBC and fore, the stability of the banking sector have greatly improved. some CCBs have developed appropriate products for micro- Banks and legal credit-only financial service providers are enterprises. It should be noted, however, that enterprises experimenting widely with methods for serving account and that are considered micro in the PRC would be considered card holders in a more efficient manner by using the latest SMEs in many other countries. developments in mobile technology. They have expanded their loan portfolios more cost-effectively by building on The groups that have difficulties accessing banks and international and national experience with lending method- RCCs rely largely on nonbank providers. Guarantee compa- ologies. As a result, many of the previously excluded can be nies, pawnshops, and MCCs play an important role in serv- served without the need for long-term subsidies. ing those who have no access to banks. Nonbank providers of financial services that have a deeper reach than most In addition, a more welcoming policy environment has banks include poverty alleviation MFIs and P2P platforms. attracted a diverse base of investors. There has been an Unfortunately, with a couple of exceptions, the outreach of increase in private and foreign investment in banking and these two types of institutions is limited. credit-only institutions, with a mandate to serve the previ- ously excluded. New regulations have enabled domestic Most nonbank financial service providers are less strictly investors to turn the underground banks they supported regulated and supervised than banks, and can therefore into formal institutions. They have also allowed international expose people to considerable costs and risks. Some ille- microfinance investors, such as IFC, Standard Chartered, gal providers charge loan interest rates that are higher than Accion International, and Planet Finance, to enter the market. those of formal institutions. Others use inappropriate loan collection methods or run away with people’s savings; in Financial inclusion has improved, but not sufficiently these cases, people have no recourse to the legal system. While ownership of bank accounts and bank cards is Conditions are right for accelerating progress toward a now much more widespread, work remains to be done to fully inclusive banking sector give the poorest access to these basic banking services. Increased G2P social transfers have had the important There is considerable potential for increasing the com- side effect of significantly increasing the number of people mercial provision of financial services to the previously with a bank account and access to basic banking services. excluded. Regular policy statements confirm the central According to the 2012 World Bank Findex study, 64 percent government’s commitment to ensuring commercial and of adults have a bank account, and PBC reports a bank card sustainable outreach to the excluded, and the promotion of penetration rate of 35 percent. Savings services are widely innovation (see Box F). The size of the PRC’s market offers developed. However, the same Findex study shows that opportunities for economies of scale that are not available only 39 percent of the poorest quintile has a bank account. in many countries; its comprehensive identification system greatly helps banks to meet know-your-customer (KYC) Also, despite the growth in rural household and SME loans requirements39 and to recover loans. The excellent mobile in recent years, the market is still far from satisfied. A lack telephone infrastructure and wide network of branchless of aggregate and consistent data makes it difficult to esti- access points offers opportunities for reaching large num- mate the exact size of the gap between demand and supply. bers of clients at low costs. Work on financial infrastructure, If all banks offered the same number of loans as the market such as deposit insurance, credit bureaus, and payment leaders in their category, 58 percent of rural households systems, has started to contribute to the expansion of and 16 percent of SMEs would currently have a bank loan. opportunities (IMF 2011). However, experts agree that this is an overly optimistic estimate of supply. Frequent reports in the press about the Box F. Government Commitment volume and growth in illegal lending point to large numbers During the 11th 5-year period, the CBRC has, in line with the instructions and of households and enterprises that cannot or do not want arrangements of the State Council, earnestly performed its supervisory duties to use banking services. and attached great importance to strengthening and improving the provision of financial services to Agriculture, Farmers and Rural Areas. Efforts have been In addition, very few types of banking institutions serve made to...encourage and facilitate the innovation of rural financial products and the rural poor with loans. An analysis of average outstanding service…The CBRC has urged banking institutions to increase the extension of loan balances shows that despite frequent use of the word agro-loans according to market principles. “microcredit� to designate their products, all categories of During the 12th 5-year period the CBRC will continue to work hard to advance banks tend to provide loans above 250 percent of GNI per the development of a modern rural financial regime, actively press ahead with the reform of the rural financial system and ensure effective financial support capita, which is often used internationally to define micro- for the development of a new countryside. credit. RCCs are the only banking sector institutions that offer Excerpts from CBRC (2011a). a product whose average outstanding loan balance approxi- mates average rural net income and that are affordable to the poor. This is of particular concern given the wide gap between 39. For more information on KYC requirements and their link to financial inclusion, rich and poor in China, and between urban and rural areas. see CGAP (2011). 29 Financial Inclusion in the People’s Republic of China There is a need for more research and exchange −−What is the extent of the supply of financial services through branchless banking? What are the conditions To take full advantage of this potential, the government, to make it a viable business model in China? What financial institutions, and investors need comprehensive, are clients’ specific needs? What is the level of client high-quality information on the market. Currently, obtain- acceptance of such innovative models? ing a picture of the landscape requires these stakeholders to consult a wide range of sources; information from these More research is needed on the 4. Financial infrastructure.  sources is not always comparable and complete. This paper role and effectiveness of a variety of other meso-level has highlighted the need for better data and more research actors that influence financial inclusion. Stakeholders in the following areas: who wish to advance financial inclusion in China would 1. Demand. Greater financial inclusion can be achieved benefit from a series of studies that provide a systematic only when the needs of different market segments are overview and in-depth analysis of different categories understood. In the past, PBC and the China Bureau of of meso-level service providers and financial partners. Statistics have conducted surveys on the use of formal These include actors such as existing microfinance and informal financial services by rural people and SMEs. networks, consultancy companies, research organiza- The 2012 World Bank Findex study (Demirgüç-Kunt and tions, rating agencies, payment system actors, deposit Klapper 2012) provides up-to-date figures on use of insurance providers, credit reference centers and credit formal financial services and barriers to use of formal bureaus, wholesale lenders, and guarantee companies. accounts. The regular execution of surveys on use and 5. Government and financial authorities. More in-depth needs among groups that have difficulty accessing finan- analysis of policies, regulations, and supervision would cial services, based on the latest insights in demand help to enhance financial inclusion. Questions that merit survey methodologies, would be very useful. more research include the following: 2. Supply. Stakeholders need a thorough comprehension −−How do national and provincial policies and regulations of the nature, efficiency, and effectiveness of formal governing banks and nonbanks compare with interna- financial service providers that target the previously tional standards? excluded. It would save a lot of time and effort if a single −−How well do regulations support branchless banking? agency were to take responsibility for the systematic col- −−To what extent does improved access to banks and lection and national compilation of data from all types of institutions that claim to be engaged in financial inclusion. legal credit-only financial service providers result in This should include the numbers of savings accounts improved client protection? and outstanding loans, as well as their average balances. −−How are regulations implemented on the ground, Information on the volume and number of domestic and and what can be done to enhance supervisory international transfers would also be useful. MIX Market40 effectiveness? offers an interesting international model, although data −−How have government policies on social transfers (G2P should include all kind of institutions providing financial payments) contributed to the rapid expansion of finan- access, such as RCCs, PSBC, MCCs, etc. cial inclusion? 3. Specific research and case studies could help answer It would also be useful to have a clearer idea of current regu- some of the questions raised in this paper. Examples lations and policies in important areas, such as consumer of these include the following: protection and branchless banking, which are two important −−How do the formal financial institution business models elements for the rapid development of a responsible financial compare with international best practices, in particular inclusion sector in the PRC. in terms of their efficiency, sustainability, and the quality of their products? Finally, Chinese stakeholders and the international com- −−How successful are subsidized loan programs in munity would both greatly benefit from a more extensive increasing financial inclusion? What is the potential exchange of knowledge on financial inclusion. Global part- for substituting their services with commercially viable nerships, such as the Inclusive Finance in China Working products? Group, the World Microfinance Forum Geneva, the Global Partnership for Financial Inclusion, the Alliance for Financial −−To what extent do nonbank financial service providers Inclusion, and CGAP offer opportunities for studying global meet the needs of those with difficult access to banks best practices and lessons learned in other countries and for and RCCs? sharing the PRC’s unique experience in improving financial −−How could more nonbank providers be transformed access with the rest of the world. into formal, regulated financial service providers that serve a large number of people? 40. See http://www.mixmarket.org/mfi/country/China,%20People%27s%20 Republic%20of. 30 Photographer: Wu Shaoping 31 Financial Inclusion in the People’s Republic of China Annex A: Important Providers of Financial Services to Rural Households and SMEs This annex contains detailed descriptions of some of the PRC’s principal providers of financial services to rural households and microenterprises. In the interest of comparability, all figures mentioned refer to 2010, unless otherwise mentioned. Regulated/ Unregulated Type of Institution Short Description Banks Rural Credit Cooperatives (RCCs) Small rural-based providers of multiple financial services including savings, loans, and RCCs and money transfer services; originally mutually owned and managed Agricultural Bank of China (ABC) One of the country’s original five large commercial banks; formerly state-owned and now partly privatized City Commercial Banks (CCBs) Small, urban-based providers of multiple financial services Postal Savings Bank of China (PSBC) New large commercial bank, originally the postal savings and remittances bureau, now also offering credit and insurance products Village and Township Banks (VTBs) One of three “new-type� small rural financial institutions, initiated by commercial banks, offering a wide range of banking products Rural Mutual Credit Cooperatives (RMCCs) One of three “new-type� small rural financial institutions, initiated by rural com- munities, offering savings and credit services* Nonbanks Poverty Alleviation MFIs (PAMs) Credit-only institutions that are mostly registered as social welfare organizations MicroCredit Companies (MCCs) Recent, small, credit-only institutions that are registered as companies Peer-to-Peer (P2P) Platform Managers Financial advisers that link individual investors with individuals needing a loan *The third “new-type� financial institution—lending company—is not presented here because it does not target microenterprises. 32 Financial Inclusion in the People’s Republic of China A1. Rural Credit Cooperatives (RCCs)41 The PRC’s rural cooperative system consists of a large and Questions for further research diverse set of small-scale, locally based rural financial institu- Aggregate up-to-date information on RCCs is extremely tions, including 85 rural commercial banks, 223 rural coop- scarce. Many experts claim that despite all the reforms, erative banks, and 2,646 RCCs (CBRC 2010). Their clients RCCs’ strength and performance continue to vary con- constitute a significant proportion of the rural population, both siderably across the different entities. Local authorities poor and better off. They offer a variety of products, including continue to play an important role in RCCs’ management, savings, loans, and money transfer services. and members do not necessarily have a say. The rural cooperative system originates in the early 1950s, when the state ordered the creation of an RCC in every town- The following are examples of several research questions ship and encouraged the establishment of service outlets or that deserve to be addressed: agents in villages. RCCs were originally independent entities • How strong and how profitable is the rural cooperative owned and controlled by members. However, they were soon finance system? placed under the management of ABC, and then integrated • What share do microloans constitute in RCCs lending into PBC. After the collectivization movement, they were turned into the state’s instruments for funneling credit to the compared with state-owned agribusinesses? communes (Li and Xuchu 2011). In this process they effec- • What will be the effect of the planned further commer- tively lost their cooperative nature. cialization of the rural cooperative system on its incen- tives to serve the needs of the poor? With the dismantling of the communes in the early 1980s and direction to lend to newly established TVEs, RCCs accumu- • What is the potential for RCCs to remain or become a lated high levels of NPLs. Since the government failed to pay significant player in making the PRC’s financial system promised subsidies, many RCCs became insolvent. ABC more inclusive? remained in charge of RCCs. Even though several reforms were implemented to resume their original cooperative nature, in the end ABC effectively ran them as its branches and offices. In 1996 the government launched a series of reforms aimed at, among others, restoring their commercial viability and their cooperative nature. RCCs were separated from ABC in this process. However, these reforms did not resolve the problem of high NPLs and accumulated losses. Besides, the admin- istration of RCCs was taken over by PBC, and from 2003 by CBRC. This not only failed to increase members’ voice in management, but also the combination of administration and supervision in a single institution created a conflict of interest. In the early 2000s, the government launched another round of reforms. Some of the solvability issues were resolved by injecting funds into RCCs with potential and eliminating those that could not be rescued. Corporate governance issues were tackled by consolidating and transforming RCCs into different types of more or less commercial entities, according to their strengths. Some RCCs were merged into rural cooperative unions, others were transformed into rural commercial banks and rural cooperative banks, and unviable RCCS were closed down. Part of the conflict of interest inherent in combining administrative and supervisory functions was handled by transferring RCCs’ administration to provincial authorities. PBC launched a nationwide microcredit program in 2000. Microloans varied between 1,000 and 30,000 RMB and were made available on the basis of a variety of guarantees. In 2002, all RCCs began promoting microcredit at full scale. By the end of 2003, microcredit operations were being managed by 90 percent of RCCs across the country, and half of RCCs had provided group loans. In 2006, Mme Wu Xiaoling stated that the value of RCCs’ collateral-free and group guarantee loans outstanding was 314 billion RMB to 73 million clients (Planet Finance 2008). 41. Unless otherwise mentioned, this Annex draws largely on Zhang, Xu, Shen, and Cheng (2010). 33 Financial Inclusion in the People’s Republic of China A2. Agricultural Bank of China (ABC) ABC is one of China’s big five commercial banks. It has Questions for further research branches and sub-branches in every province and offers a By the end of 2010, ABC had issued 96 million Kins Farm- wide range of services, including savings, loans, and money ers Benefit Cards (ABC 2011a). transfer services. • ABC reports more than 5.8 million rural households with With several older predecessors, ABC was established in small loans outstanding of 99 billion RMB through the 1979 as a policy bank, with the mandate to manage all fiscal benefit card (ABC 2011a), suggesting an average out- funds and bank credits for supporting rural development. As described in Section A1, it used RCCs as its lending extensions standing value of 17,000 RMB. (Zhang, Xu, Shen, and Cheng 2010). • In addition, ABC (2011b) reports 1.9 trillion RMB in small loans outstanding with 40,000 clients, suggest- From 1986, ABC operated the subsidized Poverty Alleviation ing an average loan balance of slightly over 11.5 million program, under which small loans were provided to TVEs. As is often the case with subsidized credit programs, many loans RMB, and 461 billion RMB SME loans outstanding with were diverted to enterprises outside the target group. The pro- 63,000 clients, suggesting an average loan balance of gram incurred heavy losses (Tsai 2004). 30.2 million RMB. • Through the benefit card, in 2010 ABC (2011a) reports With China’s gradual introduction of a competitive banking system in the mid 1990s, ABC was restructured into a state- providing farmers in 484 counties with a new farm- owned commercial bank, operating according to economic ers’ insurance fund and in 313 counties with new rural principles. The restructuring involved transferring its subsidized cooperative medical fund collection, management, and credit portfolio to the newly created ADBC and transferring distribution services. the administration of RCCs to PBC (Zhang, Xu, Shen, and Cheng 2010). Questions for further research include the following: Despite the restructuring, in 1997 the government asked ABC • To what extent do ABC’s products meet the needs of and ADBC to implement the “Eight-seven poverty alleviation specific sectors or locations? project,� another effort at providing subsidized credit to the • How does ABC overcome the problems that a limited poor. Predictably, outreach and performance were poor. Start- local presence poses to the development of appropriate ing from 2000, ABC decidedly phased out of rural lending and microcredit, and reoriented its activities toward the more prof- products? itable industrial and urban market. In this process, it closed • How does ABC overcome the challenges posed by its more than 13,000 branches in the central and western regions size and hierarchical structure in offering flexible and (Zhang, Xu, Shen, and Cheng 2010). efficient products? With China’s realization that the unbalanced development of • Will ABC be able to compete with newly established, urban and rural areas was causing risks to social stability, in small, and agile institutions offering similar products? 2007 the government made an about-turn. It instructed ABC to be the leading financial institution in implementing San Nong, the government’s three-pronged policy of serving agricultural industry, rural communities, and farmers. However, contrary to past efforts, products had to be commercially viable (Yuk-Shing 2009). This required innovation. ABC acted quickly on the call to innovate by introducing a more efficient way of interacting with farmers through the Kins Farmers Benefit Card. Using this debit card, rural households could make cash deposits and withdrawals, conduct transfers, obtain loans, and receive subsidies. It could be accessed via telephone, Internet, and ATMs, as well as through POS devices at local shops and companies. To deepen its penetration into areas where it had no outlets, ABC developed partnerships with companies, cooperatives, service providers, and villages to help select and manage clients and recover loans (Chang 2009). Several personal loan products and overdraft facilities are now available to farmers based on their personal credit scoring and on a wide range of traditional and alternative types of collateral. They include guarantees offered by public servants, leading agricultural enterprise, cooperatives, and guarantee compa- nies, as well as guarantees from fellow farmers. ABC further manages the risks of the loans collaborating with insurance companies and risk compensation funds (Chang 2009). In 2010 ABC was the last of the big five banks to sell part of its shares through an IPO (CBRC 2010). It is unclear what this will mean for its commitment to the rural poor. 34 Financial Inclusion in the People’s Republic of China A3. City Commercial Banks (CCBs) In 2010 there were 147 CCBs in China (CBRC 2010). The first Questions for further research CCB was created in 1995; many followed in the second half of Official figures for 2010 show that CCBs, when taken the 1990s. They were the result of city governments undertak- together, are profitable and financially healthy (CBRC ing the active merger and restructuring of the 5,000 or more 2010). By the end of 2009, CCBs’ balance of loans to UCCs to resolve a number of issues that developed within the sector. At the time most CCBs were wholly or majority state small- and micro-sized businesses reached RMB 715.5 owned (KPMG 2007). The transformation of UCCs into CCBs billion (CBRC 2010), about 13 percent of the total portfolio. is ongoing (CBRC 2010). Unfortunately, very little additional information is avail- In 2005, CCBs started inviting Chinese and international private able on CCBs’ national role in offering inclusive savings companies to take shares, and by the end of 2010, 43 percent accounts, credit, insurance, and money transfer services. of their equity belonged to private nonfinancial institutional • What proportion of CCBs offers dedicated products to investors (CBRC 2010). groups that have found it historically difficult to access CCBs traditionally have been focused on financing local banking services, including rural inhabitants and SMEs? infrastructure and other government projects as well as state- • How many clients do they reach? owned companies (KPMG 2007). In 2002, PBC encouraged CCBs to cooperate with guarantee companies for the provision • To what extent do CCB products meet the needs of of microloans to workers laid off from SOEs in urban areas these groups? (Du Xiaoshan 2008). Since 2005, CBRC has been coming out with guidelines for small enterprise lending every year. This has helped China Development Bank (CDB) take on a catalytic role in the development of commercially viable SME and microfi- nance, by providing banks with technical assistance, loan funds, and where necessary equity (CDB 2012). In 2005, CDB, with funding from KfW and the World Bank, contracted IPC to provide technical assistance to 12 CCBs for developing and pilot testing a microcredit product based on international best practices. The piloted product had a loan value ranging from 100 to 500,000 RMB, according to CDB. In parallel, Harbin Bank contracted Planet Finance for the same purpose.42 The pilots were successful and were soon rolled out. The experience gained in the pilot banks is being used to expand small lending in other CCBs as well as in other types of banks. More recently, IFC, through the China Secured Transactions Project, has worked with the government and PBC to develop a system and reforms that enable financial institutions to increase financing to these businesses by using movable assets (such as equipment, accounts receivable, inventory) as collateral (IFC 2012). There is reason to believe that CCBs play a significant role in small and microenterprise finance. The following are some examples: • In 2010, CDB funds to banks financed an outstanding SME loan balance of 1.2 trillion Yuan to 1.6 million enterprises (CDB 2011), which points to an average outstanding loan value of 750,000 Yuan. A considerable proportion of these funds were lent to CCBs. • By the end of 2010, Baoshang Bank (formerly Baotou Bank), one of the first CCBs supported by CDB, had more than 30,000 active loan clients with an average loan balance of 144,000 RMB (CAM 2011). The proportion of microenterprise loans within this portfolio is not known. • By the end of 2010, Harbin Bank management tells us that it had 226,000 clients for its Just for You group loan product targeted at rural microenterprises with an average loan bal- ance of 36,000 RMB.43 42. The Planet Finance China case study on its support to Harbin Bank is available on World Bank and Finance (2012) blog. 43. Harbin Bank was founded as a CCB in 1997 but converted into a Joint Stock Commercial Bank in 2007. 35 Financial Inclusion in the People’s Republic of China A4. Postal Savings Bank of China (PSBC)44 Postal savings were removed from China Post in 1953. From Questions for further research 1986 China Post resumed the postal savings business by taking When the Postal Savings and Remittance Bureau (PSRB) deposits and placing these in PBC. It facilitated remittances, was converted into a bank, staff from headquarters down but did not extend loans. This resulted in an outflow of funds to those in outlets had little to no lending experience. from rural areas (Zhang, Xu, Shen, and Cheng 2010). • How successful has PSBC been in changing the institu- In 2001, the government started studying the possibility of tion’s culture toward one revolving around the manage- countering the outflow of savings from rural areas through the ment of credit risk? creation of a postal savings bank, with a mandate to provide comprehensive financial services to all. On 31 December 2006, • Has it been able to build sufficient capacity in the credit CBRC approved the incorporation of the PSBC, with China business? Post as its sole investor (Giehler 2012). PSBC’s predecessor, PSRB, was highly hierarchical with At the end of 2010, PSBC had 36,000 service outlets,45 of which a centralized structure and long decision-making chains. two-thirds were are at the county level and below. Approxi- mately 84 percent were run by agents.46 The bank had more • To what extent has PSBC been able to implement the than 893 million accounts, 475 million individual clients (one necessary changes in management and supervision? in three Chinese was a client with PSBC), and over 300,000 • How do PSBC’s relatively standardized products com- corporate accounts. It had issued over 400 million debit cards. pare with those of the new smaller institutions in terms Clients were mostly students, self-employed entrepreneurs, of attractiveness and flexibility? migrant workers, and pension receivers (Cheng 2011). • What future role can PSBC play in reaching the bottom The newly created PSBC was expected to offer microloans to of the pyramid using branchless banking, including farmers and entrepreneurs. It was well-positioned to do this mobile phone technology? because of its extensive branch network, its stable source of funds, and the long-term relationships it had built with local clients through its savings and remittances business. Therefore, in 2007 PSBC launched, with German technical assistance, a microcredit pilot targeted at farmers and microentrepreneurs without collateral. It designed a three-day application process to compete in quick access. In 2008, the bank trained 20,000 credit officers and rolled out the product nationwide. PSBC has since positioned microcredit as a strategic core product (Giehler 2012). By March 2011, microcredit was being offered by 319 city branches, 2,105 county-level sub-branches, and 4,676 outlets; 3,080 were in rural areas. The number of microloans outstand- ing was 2.22 million RMB, and the average balance outstanding was 47,000 RMB. Of the total microloan portfolio, 41 percent was to entrepreneurs (average loan size 86,100 RMB) and 59 percent to farmers (average loan size 42,500 RMB). Seventy- three percent of microloans were disbursed in rural areas. The NPL rate was 1.6 percent. By the end of 2010, the interest income from the retail credit business with microcredit as its core was the branches’ and outlets’ biggest source of income (Chen 2011). PSBC has also developed other products targeted at the poor. In 2008 it launched a banking card service specifically tailored to rural migrant workers in China. With this banking card, migrant workers have greater geographical flexibility in depositing and withdrawing cash and in remittance transac- tions. In 2009 PSBC assumed an important role in promoting the New Rural Cooperative Medical Scheme. Because all of its outlets are connected electronically, it can offer an efficient system for insurance premium payment and medical expense reimbursement. A considerable proportion of local government subsidies and social payments to the rural population also pass through PSBC. 44. Unless otherwise mentioned, this Annex draws on Chen (2011) and Giehler (2012). 45. Whereas the Postal Savings Bank describes these as its outlets, experts say the figure also includes all the post office outlets that do not offer banking services. 46. Agents can offer savings deposit and withdrawal services as well as insurance, mutual fund, and wealth management products. 36 Financial Inclusion in the People’s Republic of China A5. Village and Township Banks (VTBs)47 In 2006, CBRC released its “Opinion regarding easing market Questions for further research access for banking financial institutions in rural areas in order At the end of 2010 there were 349 VTBs (CBRC 2010), to better support the construction of a new socialist coun- considerably fewer than the government’s target. Accord- tryside.� This new policy called for the creation of three dif- ing to a recent study of VTBs commissioned by the China ferent types of rural financial institutions: VTBs, RMCCs, and Working Group on Inclusive Finance (2011a), banks lending companies. According to a CBRC three-year work owned 52 percent of VTB equity and were thus the domi- plan (2008–2011), new-type rural financial institutions should nating investors. preferably be established in the key counties of the national poverty alleviation program in central and western regions (Li • What are banks’ and nonbanks’ incentives to invest and Xuchu 2011). in VTBs? The required registered capital for a new VTB is 3 million VTB regional development was unbalanced, with aver- RMB at the county or municipality level, and 1 million RMB age registered capital, assets, and deposits in western at the town or township level. This is much lower than the and central region VTBs lagging far behind those of the required capital for a rural commercial bank. A Chinese or eastern region (China Inclusive Finance Working Group foreign banking institution must be the controlling or sole 2011a). shareholder, holding at least 20 percent of the VTB’s equity. Chinese natural persons, nonbank financial institutions, and • What are initiators’ incentives to establish VTBs in nonfinancial enterprises can hold no more than 10 percent of remote and poverty-stricken areas? total equity each. In addition, most VTBs offered little support to rural areas, VTBs can provide a wide range of banking services, including agriculture, and farmers (China Inclusive Finance Working current and deposit accounts, loans, money transfer services, Group 2011a). insurance intermediation, and wealth management. However, • What are VTBs’ incentives to serve rural and small they can serve only customers in the county in which they are registered. customers? • What is the role of banking ratios, interest rate restric- In the interest of depositors, CBRC requires VTBs to meet a tions, geographical limitations, and tax policies in large number of banking requirements, such as standards for encouraging an increased role for VTBs in financial the safety of the premises, minimum qualifications for manage- inclusion? ment, and capital and savings ratios. VTBs are subject to the same taxes as commercial banks. For the protection of bor- rowers, they must also respect a maximum loan interest rate. 47. Unless otherwise mentioned, this Annex draws largely on Giehler (2012). 37 Financial Inclusion in the People’s Republic of China A6. Rural Mutual Credit Cooperatives (RMCCs)48 RMCCs, created in conjunction with VTBs and lending com- Questions for further research panies in 2006, are community-based, member-owned bank- There were only 37 RMCCs by the end of 2010—consid- ing institutions. Like VTBs, they must be established within erably fewer than the government’s target for 2011. the scope of a town or village in poor, rural areas. However, • To what extent is the slow growth in the number of unlike VTBs they can offer only deposit, loan, and settlement services, and their business is restricted to members. RMCCs due to the high start-up and operational costs compared to the income of the target group? A minimum of 10 farmers or rural entrepreneurs is needed to establish an RMCC. Ideally they should come from the same At the end of 2010, 98 percent of RMCC capital consisted community and have a strong degree of social connected- of member deposits. It is difficult to increase deposits, ness. Contrary to RCCs, RMCCs are designed to operate like because RMCCs need official approval to enlarge their true cooperatives. Corporate governance is participatory, with membership, and deposit mobilization from nonmembers many RMCCs operating on the basis of “one member, one is prohibited. While in theory RMCCs can obtain bank vote.� Surpluses are partly distributed to members. financing and social donations, in practice this has turned out to be quite difficult. The registered capital is one-tenth of that for a VTB: 300,000 Yuan at the county/town level and 100,000 Yuan at the • What are the obstacles RMCCs face to external administrative village level. Members are the principal source resource mobilization? of share capital, and the biggest shareholder may hold no more than 10 percent of total equity. In addition, RMCCs are allowed to attract bank financing and donations. However, unlike RCCs, they are not entitled to any government sub- sidies. Also, foreign investments are not allowed in RMCCs. Since 2009, the government has encouraged members of farmers’ specialized cooperatives to set up their own RMCCs. This is to overcome the problem that members of these coop- eratives have in accessing loans because they do not indi- vidually own land, buildings, and machinery. Because of their strong community rooting, RMCCs are able to provide loans on the basis of personal creditworthiness. Their design also allows them to develop flexible services and streamlined loan application and approval procedures. RMCCs are fully licensed financial institutions, and fall squarely under the jurisdiction of CBRC. They pay the same taxes as VTBs and have to meet the same savings reserves requirements. Like VTBs, they face stringent regulations on business premises and safety precautions, they must recruit and remunerate qualified directors, and they must pay for the costs of professional accountants. As a result, both start-up and operational costs are high relative to the income of their members. Unlike RCCs, RMCCs do not receive an operating subsidy. 48. This Annex draws largely on Li and Xuchu (2011). 38 Financial Inclusion in the People’s Republic of China A7. Poverty Alleviation MFIs In the beginning of the 1990s, a number of foreign donors Questions for further research started supporting microcredit projects based on the Gra- • How many poverty alleviation MFIs have the poten- meen Bank group lending methodology in the PRC’s rural tial to cover their costs from operational income and areas (Du 2008). The legal basis for their operations was often become sustainable? an agreement between an international donor and a ministry • What can poverty alleviation MFIs learn from organiza- or local government office. At one point, there were 300 such projects in the country. However, many of these projects were tions that have achieved considerable scale, such as unable to cover their costs from income when donor funding CFPA? ended, and they were closed down. Of the approximately 100 • How feasible and desirable is transformation of poverty projects that survived, most are registered as societal organi- alleviation MFIs into MCCs, following Ningxia Humin’s zations, foundations, privately run nonprofit enterprises, and recent example? institutions (Sun 2008). • What has been the result of the recent increase in part- The programs are often referred to collectively as NGO MFIs, nerships between poverty alleviation MFIs and banks, which is a bit of a misnomer: many rely wholly or in part on such as ABC, that wish to gain access to lower market local governments for both funding and management. We segments? prefer to use the term poverty alleviation MFIs. The largest poverty alleviation MFIs include the fast-growing China Foundation for Poverty Alleviation (loans outstanding of 660 million RMB and 106,000 active clients in 2011)49 and the Funding the Poor Cooperative (loans outstanding of 39 million RMB and over 16,000 active clients in 2010) (CAM 2011). Most other poverty alleviation MFIs are quite small. The 42 institutions that reported their loan portfolio and number of clients to CAM in 2011 had an average loan portfolio out- standing of 8.6 million RMB and an average of number of clients of 1,700 clients each (CAM 2011).50 According to Du (2008), in 2008 only about 10 organizations were operationally self-sufficient. Poverty alleviation MFIs are not regulated or supervised by CBRC or PBC. An advantage of this situation is that contrary to VTBs and RMCCs, poverty alleviation MFIs do not neces- sarily face security requirements, restrictions on geographical outreach, etc. A disadvantage is that the organizations are not allowed to mobilize deposits, borrow from banks, or attract commercial investments. In the absence of donor money, this constrains their ability to grow and to become sustainable. Since 2008 poverty alleviation MFIs can convert into MCCs (described in Section A8). In that same year, the first such conversion resulted in the creation of Ningxia Huimin MCC. At the end of 2010, Ningxia Huimin says it had more than 6,000 clients. For many poverty alleviation MFIs conversion is difficult; obstacles include the difficulty of splitting assets as local government supported them with offices and salaries for many years. 49. At the end of 2008, CFPA founded a subsidiary, CFPA Microfinance Manage- ment Co., Ltd., which specialized in the management and implementation of microfinance projects (CFPA 2011). 50. Together, the 42 institutions had 73,000 active loan clients and an outstanding loan portfolio of 360 million RMB. Four of these institutions are local chapters of the Funding the Poor Cooperative (FPC) mentioned earlier; in others words, data for FPC are included in the figures for CAM. 39 Financial Inclusion in the People’s Republic of China A8. MicroCredit Companies (MCCs)51 In 2005, PBC started a pilot of a new type of institution called Questions for further research MCC that was to be predominantly invested by private capital At the end of 2010, there were 2,614 MCCs covering and that was to provide competition for RCCs, whose long- every province of China (Giehler 2012).53 This explosive lasting reform was failing to have the desired effect. An impor- growth may create problems for the financial offices of tant additional goal was the creation of a vehicle that allowed provincial authorities, which have limited, if any, experi- underground lenders, until then difficult to control, to formalize ence or qualified staff to supervise credit institutions. their activities. In 2006, PBC issued guidelines and encour- aged private investors to start MCCs. In 2007 MCCs were • What needs to happen to ensure adequate supervision? recognized and regulated by CBRC (Jiao and Liang 2010), and in that same year the first foreign investments took place. Estimates of average loan size vary from 400,000 to 600,000 RMB. It is likely that the restrictions on the MCCs were designed as credit-only institutions, so as to limit number of equity sources, the level and sources of lever- the risks to the financial system and minimize the supervisory age, and geographical outreach limit MCCs’ ability to burden. They are not banking institutions; they are limited achieve economies of scale and, therefore, discourage liability or joint stock companies. The capital and shareholding outreach to the poor. requirements provide a stable basis and a clear ownership structure. MCCs can also accept donations or bank loans, • How can MCCs play a greater role in serving low- but they cannot leverage their equity by more than 50 percent. income segments? This restricts their growth. Despite the fact that MCCs are allowed to borrow from MCCs have the right to issue loans to anyone they think fit, banks, at the end of 2010, approximately 95 percent of provided that such issuance is in line with the principle to their portfolio was financed by equity. No MCC has con- serve farmers, agriculture, and rural economic development verted into a VTB so far. It is likely that MCCs are not (Jiao and Liang 2010). The balance of loans issued by a MCC interested to do so because private investors would lose to the same customer must not exceed 5 percent of its net their influence by introducing the formal banking partner capital. As is the case for VTBs, microcredit services can be needed to become a VTB. offered to clients only within the administrative jurisdiction in which the institution is registered. • How can MCCs overcome their funding problems? In 2009, CBRC issued procedures for converting MCCs into VTBs. In 2010, PBC issued tax incentives to encourage loans 53. In 2011, the total number of microcredit companies increased by 64 percent, under 50,000 RMB. In 2011, PBC launched the China Micro- according to data released by PBC (Zhang 2012). finance Institutions Association (CMIA), which serves as a national platform for MCCs.52 Based on national guidelines, provincial governments are expected to issue specific regulations. This allows for the adaptation of rules to local circumstances. The provincial financial offices have been tasked with the supervision of MCCs, and most of them have delegated surveillance func- tions to newly created provincial MCC associations. While MCCs have not reached a large number of low-income clients, they have had significant success in SME financing, and they have played an important role in bringing a more commercial approach to the financial inclusion industry in China. 51. Unless otherwise mentioned, this Annex draws largely on Giehler (2012). 52. CMIA should be distinguished from CAM; the former principally unites MCCs, whereas the latter consist mostly of poverty alleviation MFIs. 40 Financial Inclusion in the People’s Republic of China A9. Peer-to-Peer (P2P) Lending Platforms54 P2P lending platforms bring individuals with surplus funds in Questions for further research contact with individuals seeking a loan. While credit interme- P2P platform managers are not required to publish their diation between individuals has existed in China for a long accounts; as a consequence very little information is time, the tight bank credit environment that started in 2010 available. has helped the platforms take off. It is believed that at least 30 P2P platform managers are currently operating in the market, • What is the PRC’s P2P platform managers’ real out- including Credit Ease, Wokai, 51Give, and PPDai. No exact reach and performance? data on number of clients and average loan sizes are avail- able, but it is generally assumed that numbers of clients are Platforms that select borrowers and that promise repay- significant and growing, and a certain proportion of the loans ment are assuming a large responsibility. When they get provided are small or microloans. into difficulties or go bankrupt, as has recently happened to one of them, they cannot deliver on their promise. P2P lending platforms bring clients into contact via the Inter- However, contrary to those who deposit their money in net: Individuals wanting to lend and those who wish to borrow a bank, investors in the platforms cannot appeal or get self-match transactions online. Most P2P companies oper- recourse from the government. ate as investment advisers or e-commerce processors. The companies generally earn their income from a transaction fee, • What needs to happen to ensure P2P platform inves- which because of the lean structure required for the interme- tors are adequately protected? diation is often as low as 2–4 percent. Borrowers pay interest to lenders, and even after taking into account the transaction costs, returns to lenders can be as high as 10–12 percent. This is much higher than the returns offered by most wealth management products at commercial banks. Contrary to traditional individual credit intermediaries most P2P platform managers in the PRC offer investors a guar- antee that their loans will be repaid. They set aside part of the transaction fee they charge to create a reserve against risk. In the event of a default, the platform pays the investor a prearranged amount. A growing number of P2P lending platform managers have been expanding their business to include so-called offline clients. They offer loans to specialized credit providers, such as poverty alleviation MFIs, which then are responsible for selecting and managing borrowers and recovering loans. This is, in fact, the P2P lending model that is most common outside China: while lenders are shown profiles of borrow- ers online, in reality their loans are passed on to specialized MFIs, and the repayments received may not come from the selected borrower. P2P loan providers base their business on the fact that inter- mediation between individual borrowers and lenders is a legal activity. However, they are not covered by any specific regulations, nor are they supervised by financial authorities. In 2011 CBRC issued a notice detailing seven risks tied to P2P lending platforms and ordered banks to watch them carefully. But the notice did not say how P2P platforms might reduce those risks, nor did it mention possible regulations to control their growth. 54. This Annex draws largely on Shen (2011). Information was cross-checked in Lanhee Lee (2011). 41 Financial Inclusion in the People’s Republic of China Annex B: Productive Loan Supply— an Optimistic Estimate An important measure of financial inclusion is the proportion of a population using particular financial services. This annex explains the method used to obtain an optimistic estimate of the proportion of Chinese SMEs and rural households that have a loan for productive purposes. The calculation is based on an extrapolation of the data presented in Chapter 3. B1. Rural Household Loans The rural household loan calculation is shown in Table B1-1. Table B1-1. Optimistic Estimate of the Number of Rural Household Loans Outstanding. Column 1 Column 2 Column 3 Column 4 Column 5 Column 6 Average number of Minimum number of Maximum number of loans outstanding per loans outstanding loans outstanding institution presented in (in thousands) (in thousands) Number of institutions Chapter 3 Total number of presented in Chapter 3 (in thousands) Column 2 × Column 3 institutions in PRC Column 5 × Column 3 Rural Credit 2,646 28 73,000 2,646 73,000 Cooperativesa Agricultural Bank 1 5,800 5,800 1 5,800 of Chinaa* Postal Savings 1 1,310 1,310 1 1,310 Bank of Chinaa New-type rural 395 0.60 237 395 237 financial institutiona City commercial 1 226 226 159 35,934 banksa Total supply 80,573 116,281 (min and max) Number of rural 200,000 200,000 householdsb % of rural house- 40% 58% holds with loans *It is assumed that ABC is the only large commercial bank offering rural household loan. Sources: a. See Table 4; b. National Bureau of Statistics of China (2011a). • Columns 2, 3, 4, and 5 take information from Table 4 in Chapter 3 on the seven institutional categories that offer rural household loans. For the categories where aggregate information was readily available (e.g., RCCs, ABC, PSBC, new-type rural financial institutions), Table 4 presented comprehensive data. For the categories where we did not have aggregate data (CCBs), Table 4 presented data on a market leader—for example, for P2P providers it pre- sented data on CreditEase. • Column 6 constitutes an extrapolation from the data in Chapter 3. It shows how many rural households would have loans if all institutions of a particular category pro- vided the same number of loans as the market leader we presented. So for example, if all 147 CCBs had, like Harbin Bank, a portfolio of 226,000 rural household clients, then together they would be serving more than 36 million cli- ents. Since most institutions that were not individually presented in Chapter 3 are not market leaders in their category, the 119 million figure is clearly an overestimate of the number of rural household loans outstanding. • The bottom section of the table shows a proxy for the demand for rural household loans: the number of rural households SMEs. The optimistic estimate of supply rep- resents 58 percent of the total number of registered SMEs. 42 Financial Inclusion in the People’s Republic of China B2. SME Loans The SME calculation is shown in Table B2-1. Table B2-1. Optimistic Estimate of the Number of SME Loans Outstanding Column 1 Column 2 Column 3 Column 4 Column 5 Column 6 Average number of Minimum number of Maximum number of loans outstanding per loans outstanding loans outstanding institution presented (in thousands) (in thousands) Number of institutions in Chapter 3 Total number of presented in Chapter 3 (in thousands) Column 2 × Column 3 institutions in PRC Column 5 × Column 3 Large Commercial 2 70 140 5 350 Banksa Postal Savings Banka 1 910 910 1 910 Joint Stock 1 110 110 12 1,320 Commercial Banksa City Commercial 1 30 30 147 4,410 Banksa New-Type Rural 395 0.08 31 395 31 Financial Institutionsa Total supply 1,221 7,021 (min and max) Number of 45,000 45,000 registered SMEsb % of registered 3% 16% SMEs with loans Sources: a. See Table 7; b. National Bureau of Statistics of China (2009). Columns 2, 3, 4 and 5 retake information from Table 7 in Chapter 3 on the five institutional categories that offer SME loans. For the categories where aggregate information was readily available (e.g., new-type rural financial institutions), Table 7 presented comprehensive data. For the categories where we did not have aggregate data (large commercial banks, JSCBs, and CCBs), Table 7 presented data on a market leader—for example, for CCBs, it presented data on Baoshang Bank. • Column 6 constitutes an extrapolation from the data in Chapter 3. It shows how many SMEs would have loans if all insti- tutions of a particular category provided the same number of loans as the market leader we presented. So, for example, if all 147 CCBs had, like Baoshang Bank, a portfolio of 30,000 SME clients, then together they would be serving more than 4.4 million clients. Since most institutions that were not individually presented in Chapter 3 are not market leaders in their category, the 6.6 million figure is clearly an overestimate of the number of SME loans outstanding with banks, RCCs, and MCCs. • The bottom section of the table shows a proxy for the demand for SME loans: the number of registered SMEs. 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New York: Columbia University School of Law, 10 August. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1446930. 45 Publications of the Working Group on Inclusive Finance in China China Paper on Inclusiveness 1 China Paper on Inclusiveness 4 Microfinance Wholesale Funds—The The Indian Microfinance Crisis 2010— Case of China Lessons for China Christian Buchmann Pete Sparreboom World Microfinance Forum Geneva/ World Microfinance Forum Geneva, Centre for Microfinance at Zurich April 2011 University, November 2010 China Paper on Inclusiveness 5 China Paper on Inclusiveness 2 Research on the Development of Overview of National Guidelines and Village and Township Banks (VTBs) in Provincial Rules and Regulations China Covering Inclusive Finance in China China Banking Association, Jiao Jiao and Liang Xinxin October 2011 Gesellschaft für Technische China Paper on Inclusiveness 6 Zusammenarbeit, December 2010 The Chinese Regulatory Framework China Paper on Inclusiveness 3 for Inclusive Finance in the Context of Guarantee Funds for Inclusive Finance International Best Practices in China Nikolaus Delius Peter Situ University of Zurich, Department for World Microfinance Forum Geneva, Banking and Finance, Center April 2011 for Microfinance, July 2012 CGAP Publications For English publications visit www.cgap.org For Chinese publications visit www.microfinancegateway.org/chinese Photographer: Wang Xiaohong 47