Banking on an Exit for Small Loan Companies

CBRC

Today, the China Banking and Regulatory Commission (CBRC) released a directive on converting Small Loan Companies (SLCs / 额贷公司) to Village Banks (VBs / 村镇银行).  It seems that the explosion of SLC and related credit over the past year is making the CBRC a little nervous.  According to the press release for the directive, as of March 2009, there are already 583 SLCs opened and another 573 in preparation.

Institutionalized in May of 2008, the SLCs were People’s Bank of China (PBoC) and CBRC’s attempt to reinvigorate the much needed rural credit system as part of the “Three Agricultural Initiatives” ().  However, most of the SLCs are registered on the eastern and southern coasts and makes loans to small and medium enterprises (SME), far from the clients whom the regulators intended to target.  In Shenzhen alone, the local government has registered 13 SLCs.  In Zhejiang province, the hotbed of China’s entrepreneurial activity, there are over 40 registered SLCs.  One SLC company in Zhejiang has handed out over 1.6 billion RMB worth of loans already.  The explosion of SLCs reflects the enormous demand for credit within China for micro, small, and medium enterprises.  The larger state banks haven’t been able to develop proper credit assessment models and discipline for the MSME market leaving underground and small loan companies to fill in the gap.

Village Bank, on the other hand, is a different animal.   Unlike SLCs who are non-financial banking institutions, which can’t take deposits, VBs are are fully licensed financial banking institutions, which can accept deposits.  Through deposits, VBs have another source of funds and a lower cost of funds, a significant advantage over SLCs whose funds must reach the investor’s high hurdle rate.  In addition, VBs must be 20% owned by an existing banking institution, exposing them to a shareholder with direct banking background.  However, this requirement also limits the VBs.  The 20% banking shareholder exerts considerable influence over the VB and usually directs the VB towards more profitable clients (read larger loans) driving the VB far from its intended rural clients.

CBRC’s new directive reflects the growing risks of these SLCs.  Many of these SLCs were formed from individuals and companies with excess cash on hand that might not have proper banking and risk assessment experience.  Last Spring, when the global economy was still doing okay, it seemed unlikely that these loans would default.  With the global economy in dire shape, however, the cracks are filtering through to the SMEs and into the SLC loan system.

Converting from a SLC to a VB is not easy.  Below is a list of requirements for the SLCs before allowing them to convert.

The SLC:
1) must have been in operation for over 3 years,
2) must have been profitable for the last two years,
3) its portfolio / asset ratio must be greater than 75%,
4) agricultural-related loans must make up at least 60% of the total portfolio,
5) no single loans can exceed 5% of net capital and no single group of client loans can exceed 10% of net capital, and
6) it debt / asset ratio cannot exceed 10%.

Since many of these SLCs  only started operation in the last year, it is unlikely that any will convert soon.   But essentially, the CBRC is signaling to the SLCs that if they behalf and manage their risks appropriately, they will be reward with a banking license for expansion.  I am encouraged by the agricultural related loan requirement, as it is more directed toward rural financing.  Whether it’s the “real” microfinance, however, will depend on the types of client and loan size.

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