Lately, there has been a few noteworthy news pieces on China’s microfinance development.  Dr. Yunus announced at the Clinton Global Initiative that it will be starting a bank in Sichuan.  Jack Ma’s Alibaba is said to contribute $5 million to kick start lending.  Dr. Yunus has been trying to start a true Grameen Bank in China since 2006.  I am not sure if the small loan company license (小额贷款公司) has been issued yet, but you have to give them credit for trying.  Perhaps the announcement is to increase pressure for the government to hand over licenses quick.

Vikram Akula of SKS recently wrote an Op-Ed in the WSJ about opening up investments in MFIs in China.  He is definitely correct in pointing out that most casual observers who sees China as ‘developed’ and don’t need microfinance is wrong.  He is also correct that the sector needs to open up.  But I would have like to see what his ideas are in terms of liberalizing the sector.  Allowing foreign investment is definitely one option (which he is, of course, interested in), but what else can China do domestically?  Are there different models that he can share given India and SKS’s experience?  As he pointed out, current regulations do not allow MFIs to take deposits.  What then, are the risks of the MFIs?  What should MFIs who do not take deposits be aware of in terms of managing risks?

Lastly, a press release from from HSBC came out yesterday that it has partnered with Women’s World Banking (WWB) in provided microloans through its rural banks in China, specifically in Hebei’s Suizhou branch and Chongqing Dazu branch.  According to a Caijing article, the product is called “Happy Loans” (”贷款乐”).  The product has been piloting for 3 months in Suizhou and is currently being expanded.  What is WWB’s role in this partnership?  Is it providing operational expertise?  If so, does this mean that WWB (and perhaps MFIs in general) is better at assessing credit worthiness of low-income borrowers than a large multinational bank such as HSBC?  Or is HSBC simply outsourcing it’s operation activities to WWB?  From previous research, it seems that HSBC Rural Bank’s branches tend to focus only on export oriented areas (mostly exporting mushrooms actually), specifically for SMEs.  Are they moving away from SME finance and moving towards ‘real’ microfinance?  What are the terms of the loans?

Questions to ponder during my midterms.

1) Small Loan Company (小额贷款公司) is really Microcredit Company version 2 (小额信贷公司).

Apparently the CBRC never intended for the microcredit company to be completely “credit” base. They wanted them to provide loans with collateral / guarantees; hence the rename and new law.

In effect, this has made SME their main clients, as they are the only ones who can provide titles and assets for collateral. This isn’t exactly “microfinance” as most of us understands it. Even though some might translate 小额贷款公司 as “microloan company,” I prefer to call them “small loan company” since they don’t really serve the poor and their loan amounts are 100K+ RMB.

The upside is that with the 1000+ small loan companies being formed currently, some may move in the rural finance / true microfinance direction. The legal status is there, it’s just a matter of having willing, patient, and socially-focused investors step up.

2) There’s a serious lack of sustainable / commercial microfinance expertise in China.
Aside from expansion capital and legislation, there’s a serious lack of sustainable / commercial microfinance expertise in China.  Microfinance in China has largely been an NGO experiment for the past 15 years.  As a result, there lots of NGO people who have microfinance background; however, they haven’t been exposed to managing for financial sustainability at all. On the other hand, there are lots of finance people / bankers in China, but they don’t really understand microfinance or how it really works.  As a result, there’s a gap in expertise.

It would be wonderful if we can either a) send Chinese NGO microfinance managers for training at a financial sustainable MFI to learn how it works and what it takes or b) send finance people who are truly interested in doing microfinance into the fields and bring their expertise into the NGOs.

Option B is probably easiest, but could lead to mission drift.  Option A is probably best, but most costly.  Option A is more effective in nurturing existing dedicated talent and more inline of the philosophy of microfinance and developing from the ground up than option B.

The Uyghur Autonomous Region Government issued a pilot test program guideline for SLCs in February 2009. A total of 11 firms applied to register and 5 were provided the license. The largest is Huachun Small Loan Company (华春小额贷款股份有限公司), the focus of the press release.

A few facts of particular interest from the press release that I noticed were:
1) Huachun has 100 million RMB of registered capital (~14.6 million USD)
2) 90% of the capital came from private investors and 10% came from an investment company
3) Investors include enterprises, individuals, and “society organizations” (I am not sure if this means NGOs? associations? the state poverty alleviation office?)
4) The loans are aimed at small-medium enterprises (SMEs) and can be on credit, on guarantee, or secruitized. Loan amounts are from 10K RMB to 5 million RMB (~$1.5K USD to $731.7mn USD)
5) New customers will need only 4 days for approval; repeat customers only need 4 hours!
6) 60% of the loans will be for rural areas as part of the “Three Agricultural” initiative
7) The people present at the signing ceremony (which tells us what’s needed to get an SLC approved):
a. Urumqi Economic Committee’s Party Secretary
b. Urumqi Economic Committee’s Party Chairman
c. Urumqi Small Loan Company Pilot Working Group’s Chairman
d. Urumqi State Administrative Industry and Commerce’s Bureau Chief

The PR directly referenced that Huachun, if successful, will transform into a village bank within 3 years
9) If successful, Huachun can apply to incorporate an affiliate in Yiwu County

Some Quick Analysis

It is interesting that the PR explicitly stated that Huachun is allowed to expand into another county if they are successful.  Current CBRC and PBoC regulations only allow Small Loan Companies (SLCs) to incorporate at the county levels (县), not at the provincial level.  It seems that the Xinjiang government government is thinking about experimenting on a higher level, which would make SLCs more profitable and sustainable in the long run.

The reference to become a village bank in 3 years is also noteworthy.  There is clearly an “end-game” for Huachun.  They want crack into the banking market and the SLC license is the way to do that.  Having a successful venture with proven credit and risk management records will give them leverage later on as they court a banking institution investor required for a village bank license.

The fact that Xinjiang only issued its pilot guidelines in February and in 5 months they have issued licenses indicate that the model is effective.  It reflects the national build up of these SLCs (now 500+ of them).

However, this is still not a “microfinance” company still.  From the surface Huachun is explicitly targeting SMEs and in fairly wealthy counties in Xinjiang, not poor individuals / micro-enterprises.

I wonder if by “social organizations” they mean NGOS or multilateral organizations.  The World Bank has a significant presence there.  However, it is most likely that it’s a state civil organization like the State Council’s Poverty Alleviation office, which has been active in promoting microfinance with CFPA.

Today, the China Banking and Regulatory Commission (CBRC) released a directive on converting Small Loan Companies (SLCs / 小额贷款公司) 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” (三农).  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.