Cablegate: Microfinance Poised to Fill Gaps Ignored by Banking Sector

DE RUEHGZ #0889/01 2190729
R 070729Z AUG 07




E.O. 12958: N/A
SUBJECT: Microfinance Poised to Fill Gaps Ignored By Banking Sector
-- Maybe

1. (U) SUMMARY: Extending financial services to China's rural poor
continues to be an uphill battle with seemingly distant rewards.
While foreign banks hope that WTO-driven reforms will allow greater
access to China's "nouveau riche," there is no great clamor to
extend services to the countryside where the returns are not as
great and loans could charitably be described as problematic. This
represents a gap that microfinance could fill, yet in practice
microfinance in China has been lagging and the banking and credit
needs of China's poor are largely unmet. Even so -- and despite the
past use of inappropriate models, poor training, and cultural,
demographic, and regulatory barriers -- the government and the
microfinance community are optimistic about the future. END

Why Can't The Poor Get Loans?

2. (SBU) China has made unprecedented strides to reduce national
poverty in recent years, but barriers exist that still make it
unattractive for banks -- both foreign and domestic -- to invest in
the harder-to-reach rural provinces, according to Director of the
China Foundation for Poverty Alleviation's (CFPA) Microfinance
Department Liu Dongwen. It is still very expensive for banks to
open branches in rural areas and there is little incentive to invest
in technologies that have proved successful in other countries, such
as cell-phone banking. The Postal Savings system is widely used by
those who have enough to save, but it is difficult for the poor to
receive loans there. Even the Rural Credit Cooperatives (RCC), set
up to serve the financial needs of the rural poor with its network
of 38,000 branches, are absent in 22 counties. Moreover, the RCC
often requires collateral, excluding the poorest of the poor. A
recent study by the People's Bank of China (PBC) found that fifty
percent of farmers relied on informal money lending schemes to meet
their credit needs.

3. (SBU) Liu cited low overall levels of available capital, better
investment opportunities elsewhere, and high reserve requirements as
the biggest disincentives for banks to loan to the poor. Many banks
prefer to invest money in large projects in the country's developed
eastern cities, where return on investment is particularly high.
Additionally, he says that Chinese banking regulations prohibit
loans from exceeding 75 percent of a bank's assets. (China recently
raised its banking reserve requirement to 12 percent.) According to
a paper by Liu's colleague, in 2006, China's banks took in about RMB
300 billion in rural savings but only distributed about ten percent
of that amount back to rural areas in the form of loans and grants.
Liu believes that the opening of a banking branch in a rural city
could spur other banks to expand their presence, creating healthy
competition and improving services for the poor there.

Turning a Blind Eye

4. (SBU) Institutional factors also contribute to the lack of
success of microfinance organizations in China. While the
government is committed to encouraging the practice, China lacks a
clear regulatory framework for microfinance institutions (MFIs).
Chinese financial law prohibits non-financial institutions from
providing financial services. Most microfinance institutions are
registered as non-governmental organizations (NGOs) and must
negotiate some temporary legal status in order to practice. PlaNet
Finance China, an NGO operating in China, asserts that not only is
the process less than transparent, but the lack of clear legal
standing precludes them from some regulation and monitoring that
could improve the industry. The government recently lowered
requirements for rural financial institutions to gain village
banking licenses, but prefers to grant them to new institutions.

5. (SBU) Another barrier which microfinance organizations face is
that, without a banking license, they are legally prohibited from
taking deposits in China. Many MFI models used in other countries
incorporate the savings component as an integral part of the
organization's business model; in the model, potential borrowers are
educated through a savings program before ever receiving loan funds.
Similarly, another model of self-help groups, where people
contribute small sums to save together and take turns borrowing a
larger sum, is forbidden in China due to government discouragement
of citizen-formed groups. Many MFIs are, however, able to utilize
group guarantees as part of their lending model.

Not India, nor Bangladesh

6. (SBU) The Grameen microfinance concept pioneered by Nobel Prize
winner Muhammad Yunus found less-than-fertile soil when first
introduced to China's agricultural population in the mid 1990s. The
credit models that were adopted with little-to-no country specific
modifications by organizations like the Women's Federation of
Shanxi, the Rural Development Institute, and China's Ministry of

GUANGZHOU 00000889 002 OF 002

Finance, delivered less than dramatic results. A contributing factor
that makes the Grameen model more difficult to apply here is that
China's population density distribution is different from that of
places like India and Bangladesh. In those places, even in rural
areas, the populations are large and somewhat concentrated. In
China, the rural populations are more spread out, with much smaller
townships, making it difficult and costly to reach the
sustainability required for efficient microfinance.

Collectively Individualistic

7. (SBU) MFI models have also had to adapt to traditional Chinese
social factors. Chinese clients reportedly differ from their
Bangladeshi neighbors, who have close ties and a sense of
responsibility to the community. Ironically, according to Liu,
Chinese prefer individual loans to group loans, and if they must
engage in group lending they prefer to form groups with their own
immediate relatives. Liu cited a lack of trust among neighbors,
perhaps a legacy of corruption in both farming collectives and the
village leadership system, as a defining quality of rural Chinese
borrowers. Unfortunately, this mistrust erodes many of the
advantages of the group-based lending that makes microfinance loan
schemes so cost-efficient.

Creative Solutions Ease the Repayment Burden

8. (SBU) About 90 percent of China's rural population are farmers
with cyclical income flow. Their cash needs are greatest during
planting time, when they require money to buy seed and supplies.
When they sell their crops after harvest, they are better able to
repay their debts, but must budget in order to make ends meet all
year round. This proves to be a difficult task for most and does
not leave much room for unexpected expenses, a bad crop, or loss of
livestock. As a result, the monthly repayment system used in many
of China's early microfinance programs was unrealistic and met with
failure. What works best? Flexibility and innovation, like the
use of loans with a balloon payment -- where the farmer pays only
the interest on the loan monthly and repays the principal after the

Education and Financial Literacy Still a Problem
--------------------------------------------- ----

9. (SBU) One of the greatest challenges for microfinance lenders is
to educate rural borrowers about the concept of credit. In a country
where previous poverty abatement projects amounted to little more
that government handouts, basic financial literacy is still
relatively undeveloped. One new concept for many rural borrowers is
that they have to assume the risk of how the loan money is invested,
even if the investment proves unsound. For example, farmers might
not feel obligated to repay loan funds lost for reasons beyond their
own control -- such as crop failures or livestock dying
unexpectedly. Microfinance organizations must invest considerable
time and energy to ensure that their loans are eventually repaid.


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