China's Shifting Microfinance Landscape: New Players, Old Problems

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China's microcredit scene is beginning to stir interest among foreign investors. HSBC HBC, for example, opened its first rural bank in Hubei on Dec. 13, and international private-equity firms are rumored to be looking at the sector.

At the International Workshop on Rural Finance Reform and Establishing a New Socialist Countryside in China, which took place on Dec. 8-9 in Beijing, academics, policymakers, microfinance practitioners and banking officials provided a useful primer on the microfinance industry in China while revisiting some old problems: How should China reform a microfinance system rooted in inefficient, state-directed lending? How can it create commercially viable institutions while meeting the needs of the poor?

The annual conference, sponsored by the Ford Foundation, the research department of the People's Bank of China and Central SAFE Investment Ltd. (an investment outfit owned by Central Investment Corporation), also highlighted significant new developments in rural finance, and what they might mean for China's credit-starved country dwellers.

Policy vs. Sustainable Finance

Chinese policymakers have been late converts to the cause of microfinance. Much of the discussion at the conference revolved around the problems that China has faced in establishing an effective microcredit infrastructure for the countryside, which many critics blame on state-directed lending that has led to market inefficiencies and has caused lending institutions to run up massive volumes of bad debt . This issue remains at the heart of the policy debate over future microfinance reform in China.

According to Wang Jun, senior research fellow at the China Center of Economic Research, Qinghua University, there is still no clear demarcation between commercially oriented and policy-driven finance. Even in today's policy environment, explained Wang, who is also on the staff of the World Bank , it remains politically problematic for banks to place commercial objectives ahead of supporting poverty-relief policy objectives.

"Nobody wants to stand up and say, 'My strategy is based at the county level and below, but I must make a profit ,'" he said. "'I will provide financial services and products. But I'm sorry, I will not provide services for every farmer, or take every farmer as my customer. I have to select those who are willing to pay me back.'" Since banks then will be forced to fund rural schemes out of their own budgets, he added, they may be tempted to try to recoup cost from the government. A clear demarcation between policy and commercial finance is called for, Wang argued.

Liberalization of interest rates is one of the main battlegrounds in the debate over policy-oriented vs. commercially led lending, Wang noted. Consensus is elusive. "We've been talking about this for years," he said. "But the problem is still there." The rate has been liberalized as an incentive for recently launched pilot schemes designed to bring in private investment: Village banks, which may charge twice the central bank base rate, and fledgling microcredit companies (MCCs) may charge up to four times the base rate. However, those arguing for further liberalization believe that added incentives are required to bring in private investors and make lending commercially viable.