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.

Happy Fry Tofu Seller in Beijing

China’s State Council just issued a draft ordinance that allows street vendors and other microentrepreneurs to register for permits and recruit employees legally. The draft ordinance, titled “Individual and Household Business Ordinance (Draft)” / “个体工商户条例(征求意见稿)“, will allow micro-enterprises to get access to loans from alternative sources such as small loan companies and village banks.

Previous requirements only allow business to be registered at its place of operation, which is impossible for street vendors and hawkers. Under the draft ordinance, entrepreneurs would be able to register their business under their place of domicile, no matter where they operate. The permission to register will be delegated to the local State Administration of Industry and Commerce (SAIC).

If registered as a “personal business,” the person and his/her personal assets will be liable for the business. If it is registered as a “household business,” then the entire household, including the household’s assets are liable for the business.

According to statistics from China’s State Administration for Industry and Commerce, individual and household business registrations have been raising rapidly. In the first quarter of this year, there were 1.5 million newly registered individual and household businesses, a 28% increase year on year. As of March 2009, there are 29.5 million individual and household businesses registered in China, which employs roughly 58.1 million people in total.

The individual and household businesses will be allowed to engage in various industries, including wholesale, retail, hospitality, food and beverage, manufacturing, transportation, warehousing, post, agriculture, fishery, animal husbandry, construction, mining, and services.

Under the proposed draft ordinance, individual and household business will also be able to recruit employees legally. In the past, these businesses were only allowed to have one to two assistants or three to five apprentices if skilled labor is involved. Such measures would help migrant laborers get employed at small and micro-businesses with some protection.

Along with the proposed ordinance, there is a stipulation that no one can collect “management fees” or “bazaar fees” from individual and household businesses. Associations fees are allowed as long as it is voluntary. I wonder if this clause is included to snub existing extortion that commonly affect street and market vendors.

Yet not all of it is rosy. Along with registration, is responsibilities: taxes. After microentrepreneurs register they must also keep proper books and file for taxes like other businesses. Or else, fines can range from 100 to 1,000 RMB.

More information on the ordinance, in Chinese, can be found here.

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.