VZCZCXRO3081
RR RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0889/01 2190729
ZNR UUUUU ZZH
R 070729Z AUG 07
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 6353
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC

UNCLAS SECTION 01 OF 02 GUANGZHOU 000889 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV CH
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 
SUMMARY. 
 
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 
harvest. 
 
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. 
 
 
GOLDBERG