VZCZCXRO2984
PP RUEHGH RUEHVC
DE RUEHCN #0276/01 3341719
ZNR UUUUU ZZH
P R 301719Z NOV 09
FM AMCONSUL CHENGDU
TO RUEHC/SECSTATE WASHDC PRIORITY 3569
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHOO/CHINA POSTS COLLECTIVE
RUEHCN/AMCONSUL CHENGDU 4280

UNCLAS SECTION 01 OF 04 CHENGDU 000276 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM 
 
E.O. 12958: N/A 
TAGS: ECON EIND EFIN PGOV CH
SUBJECT: WORLD BANK/IFC'S CHENGDU OFFICIALS ON STRUCTURAL IMPEDIMENTS 
TO SME- AND MICRO-FINANCING 
 
REF: BEIJING 2952 
 
CHENGDU 00000276  001.2 OF 004 
 
 
¶1. (U) This cable contains sensitive but unclassified 
information - not for distribution on the Internet. 
 
¶2. (SBU) Summary: Small business access to credit in China is a 
long-term, structural problem that 'is not going away for the 
next 10-20 years", a Chengdu-based official of the World Bank's 
International Finance Corporation (IFC) told Consul General. 
While official statistics indicate increased small and medium 
enterprise (SME) financing in 2009, this has gone primarily to 
the "medium" end of the spectrum, with true small and micro 
ventures remaining significantly underserved.  The development 
of a healthy, non-deposit taking lending institution (NDTL) 
sector, requiring significant financial sector liberalization, 
is the key long-term solution, he said.  Newly-emerging local 
credit guarantee companies (CGS) could evolve into an important 
component of the sector, if allowed to start legally lending. 
He also advocated increased government support for rural SME 
credit, particularly through "value chain financing," a new 
approach IFC is promoting in China.  End Summary. 
 
IFC on Goals and Activities 
in Southwest China; Optimism About Chongqing 
-------------------------------------------- 
 
¶3. (SBU) In a November 10 meeting with Consul General, Lai 
Jinchang, head of IFC's Chengdu office, discussed: 
 
-- the challenges China faces in providing sufficient credit to 
small and micro-enterprises; 
-- the particular challenges of addressing rural credit access; 
and, 
-- how IFC is working to address these issues. 
 
Also in the meeting were Charlie Cheng, Program Manager for 
Corporate Advice-Sustainability and Lin Huang, Operations 
Officer.  The IFC's Chengdu office was created in 2001, at the 
request of the Chinese Government, following the launching of 
the PRC's "Go West" policy on January 1, 2000.  Although its 
emphasis is on western China, the IFC Chengdu office coordinates 
with the Beijing and Ulaanbaatar offices on IFC's overall 
China/Mongolia programs. 
 
¶4. (U) IFC Chengdu primarily focuses on technical advising 
services, but also has two investment officers and has 
coordinated IFC investment in: 
 
-- Renshou Minfu Rural Bank, a village and township bank (VTB) 
an initiative by the Leshan City Commercial Bank, in Sichuan 
province, to promote micro-finance; and, 
-- the Chengdu Small Enterprise Credit Guarantee Company, which 
guarantees loans to SMEs by local credit cooperatives and 
commercial banks. 
 
The office is working to help create and invest in additional 
microfinance institutions throughout Southwest China, including 
in Guizhou, Yunnan, and Chongqing (as well as Xinjiang).  (Note: 
IFC investments are limited to a maximum of 20 percent of a 
target institution, Lai said.  End Note.) 
 
¶5. (SBU) Lai expressed particular optimism about Chongqing, 
reporting that Mayor Wang Hongju "has been very open-minded" and 
expressed to IFC that he wants a micro-credit company in each of 
its 40 counties and districts. (Note: We understand that about 
four have been established there within the last year.  End 
Note.)  However, the IFC has no activities in the Tibetan 
Autonomous Region (TAR) -- they "can't touch" it, noted Lai, as 
it is "too sensitive."  (Note: According to local TAR officials 
China provides microfinance in the TAR via its "Developing 
Border Areas and Enriching People" (xingbian fumin) initiative, 
which officially covers the entire autonomous region.  They 
cited as an example the state-owned Agricultural Bank of China's 
micro-finance subsidiary (xinyongshe) in the TAR, which provides 
micro-credit to farmers and herders (nongmumin).  End Note.) 
 
IFC Official: SME Credit Access a Long-Term Structural Challenge 
--------------------------------------------- ------------------- 
 
¶6. (SBU) In Lai's assessment, substantive expansion of credit 
access to China's SMEs is fundamentally impeded by long-term 
structural challenges, specifically the lack of a developed 
non-deposit taking lender (NDTL) sector.  This fundamental 
problem, he said, is 'not going away for the next 10-20 years." 
The lack of NDTLs stems from an underdeveloped capital market, 
and cannot be addressed without true, long-term liberalization 
of the financial sector, he said.  Lai estimates that 90-95 
percent of debt financing in China currently comes from 
 
CHENGDU 00000276  002.2 OF 004 
 
 
deposit-taking institutions (banks), in contrast to his estimate 
of bank finance comprising no more than 60 percent of the total 
in the United States.  Chinese banks, he asserted will remain, 
both by regulation and necessity, conservative (policy-lending) 
institutions that will continue to loan primarily to the larger 
end of the business spectrum.  (Comment: Lai's emphasis on the 
financial sector's structure as the primary issue adds to the 
barriers to SME credit that others have told us about, including 
the banks' lack of familiarity with SMEs and a consequent 
inability to properly assess risk; lack of effective rule of law 
to enforce contracts; and corruption and nepotism.  End Comment.) 
 
¶7. (SBU) Acknowledging recent official emphasis on expanding SME 
credit (such as the State Council's September directive to 
bolster SMEs), and recent statistics citing an increase in SME 
lending in 2009 supported by the stimulus package, Lai argued 
that the vast majority of this lending is going to the medium 
end of the SME scale, leaving out most truly small businesses. 
There is widespread misapplication of the "micro," "small," and 
"medium" labels throughout China, he argued.  In his view the 
business lending market should be analytically divided up into 
five categories of enterprises: a) micro, b) micro - small, c) 
small, d) medium, and e) large corporations.  (Note: He did not 
provide a hard definition of each category in regards to either 
number of employees or level of assets.  End Note.)  The real 
challenge to accessing credit falls within the first three 
categories, he noted.  Thus, he said, too often when "SMEs" are 
said to be benefiting from increased access to credit, the funds 
are mostly flowing to medium-sized enterprises, or at best the 
very top end of the small business market.  Almost all micro and 
most small enterprises have seen no genuine expansion in credit 
access, Lai asserted. 
 
Few "Microfinance" Institutions Actually Providing Microfinance 
--------------------------------------------- ------------------ 
 
¶8. (SBU) Lai noted that officially there are three types of 
financial institutions in China that are supposed to be 
providing micro credit, including: 
 
-- banks that are downscaling to provide a "micro" product; 
-- the village and township banks (VTBs), piloted under the 
Banking and Regulatory Commission; and, 
-- micro-credit corporations (MCCs), non-deposit taking 
institutions piloted under the People's Bank of China. 
 
However, of the 1000 MCCs and 110 VTBs he estimates have been 
established nationwide, he believes that most -- "practically 
all" -- do not actually do microfinance.  Typical loans of these 
institutions, he said, rarely fall below 2 - 3 million RMB 
(approximately 295,000 - 440,000 USD).  He cited IFC-supported 
institutions, by contrast, as an exception, asserting that they 
are doing "real" microfinance, although he did not specify the 
loan amounts they were dispersing.  (Note: Some international 
NGOs in Southwest China, such as the Nature Conservancy and the 
Mountain Institute, are also providing microfinance.  End note.) 
 
¶9. (SBU) Lai was generally pessimistic about the ability of 
major Chinese commercial banks to service the lower end of the 
SME spectrum in Southwest China.  Citing the case of Minsheng 
Bank, which established a "small enterprise" financing capacity 
at its Chengdu branch several years ago, he emphasized that they 
will "never do micro-credit," and that "the actual size of 
Minsheng's loans is much larger than the IFC considers to be 
microfinance." 
 
¶10. (SBU) Lai also dismissed the notion that foreign banks might 
establish a significant presence in the microfinance field, 
noting that they in fact have little interest in institutions 
such as the VTBs.  Those that have invested in VTBs (e.g. HSBC, 
Standard Chartered) or established microfinance units (e.g. 
Citibank) have done so in response to government pressure, 
rather than because of a belief in the potential profitability 
of the microfinance sector.  Thus, for example, Citibank's 
microfinance unit is, in reality, a part of their corporate 
social responsibility (CSR) function, rather than a genuine 
business line.  In this vein, he cited misunderstandings 
regarding the nature of microfinance by many government 
officials, who, he said, fail to understand that microfinance is 
normally not the purview of traditional financial institutions. 
Microfinance, he concluded, is overall a "very new concept for 
China." 
 
Where Do Small Businesses in Southwest China Turn for Credit? 
Enter the Credit Guarantee Company 
--------------------------------------------- --------------- 
 
 
CHENGDU 00000276  003.2 OF 004 
 
 
¶11. (SBU) Given Lai's assessment that even banks that are 
downscaling are only reaching the top of the small business 
market, CG asked where the remaining established small 
businesses in Southwest China could turn for credit.  Lai 
responded that most micro-to-small enterprises have very limited 
choices, and generally must pay considerably higher interest 
rates.  Many go to "pawn shops" (diandanghang), which he 
described as serving a very different function than US pawn 
shops.  Rather than serving as a lender of last resort, they 
provide an accessible -- if high interest -- option for small 
business financing upon the provision of tangible collateral 
(ranging from physical property to property deeds or stock 
certificates).  An increasing number of small ventures, however, 
are now obtaining "under the table loans" from the growing 
number of credit guarantee companies (CGCs), he said. 
 
¶12. (SBU) Lai described the CGCs as a relatively new/emerging 
financial institution, still facing considerable controversy 
regarding their appropriate role and structure.  Noting that the 
national regulatory framework governing CGCs was only 
established in February of 2009 with creation of the 
Inter-Ministerial Committee on CGCs within the CBRC, he assessed 
it as "not a strong system," remaining basically a locally run 
initiative.  Though relatively lightly regulated, CGCs are 
supposed to limit their activities to guaranteeing other 
institutions' loans and are statutorily barred from making loans 
themselves.  However, despite their lack of lending license, 
many in Southwest China have money to lend, he said, and are 
finding ways to lend to small businesses.  (Lai estimates 
Chengdu to be home to about 100, out of a total of about 4,000 
nationwide.)  Their investors are often wealthy entrepreneurs 
with plenty of spare cash seeking an alternative to either 
volatile stock investments, or low-interest bank accounts.  They 
see CGCs as a way to both diversify investments and get their 
foot in the door of the financial market, he said, which they 
hope will be highly profitable after future liberalization. 
 
The Long-Term Solution: 
Liberalize the Financial Sector, Let CGCs operate as NDTLs 
--------------------------------------------- ------------- 
 
¶13. (SBU) Despite some positive evolutions in institutional 
arrangements and the expansion of under the table CGC loans, Lai 
concluded that the current regulatory system will simply not 
allow sufficient flexibility to ensure that credit can reach far 
enough into the small enterprise world.  Much greater 
liberalization of the market is necessary, he insisted, 
otherwise the regulatory environment will continue to constrain 
the vast majority of would-be entrants to the SME financing 
market.  A key goal of liberalization, he emphasized, should be 
the large-scale expansion of the NDTL sector, which he described 
as currently "rudimentary," comprising only the MCCs, CGCs, and 
pawn shops discussed above.  What is lacking in this picture, he 
said, is the wide range of NDTLs recognized worldwide by the 
IFC, such as university endowments, foundations, pension funds, 
student loan corporations, etc., all of which could step into 
the riskier credit provision arenas. 
 
¶14. (SBU) CGCs in particular have the potential to take on a 
significant role as NDTLs if they are allowed to start loaning 
legally.  However, many CGC investors are expecting to be able 
to turn them into deposit-taking banks, reflecting a fundamental 
misunderstanding of the role and function of banks, Lai 
asserted.  "They will not be allowed to become banks for very 
good reasons," he said, noting the need to shield depositors 
from riskier use of their funds (e.g. through fiduciary rules 
and capital adequacy ratios).  He said that most officials and 
regulators lack understanding of the distinct roles of banks 
versus NDTLs, something he says IFC is attempting to remedy. 
 
Rural Financing: The Value Chain Approach 
----------------------------------------- 
 
¶15. (SBU) In contrast to his case for decreased regulation in 
the financial sector overall, Lai argued that expanding rural 
credit access requires significantly greater government 
intervention due to the inherent risks involved (e.g., weather, 
commodity prices, land title issues), and stressed that China is 
far behind both the U.S. and Europe in terms of government 
involvement in rural financing.  Beyond the expansion of micro 
and SME finance, he said the IFC is now promoting a "value 
chain" approach to rural credit expansion, aiming to structure 
financial services to simultaneously address the needs of 
small-scale farmer/producers, suppliers (e.g. of agricultural 
inputs), and other agribusinesses (processors and distributors 
of agricultural production). 
 
 
CHENGDU 00000276  004.2 OF 004 
 
 
¶16. (SBU) A key example he cited for this model is the 
Chengdu-based New Hope Group which, he reported, is creating a 
number of CGCs solely for the purpose of providing loan 
guarantees for banks and rural credit cooperatives to loan to 
SMEs within the New Hope supply chain.  Lai noted that this 
allows new SME start ups in rural areas, while enabling New Hope 
to develop markets for their own products and stabilizing their 
supply.  For example, in Mianyang (Sichuan's second largest 
city, north of Chengdu), a New Hope CGC is guaranteeing the 
loans made by banks to pig farmers, who in turn purchase New 
Hope's pig feed, and then sell their wholesale pork products to 
New Hope.  New Hope is also providing some additional services 
through the CGC structure, such as free veterinary services to 
pig farmers in their supply chain.  Lai said that these types of 
CGCs are increasingly able to obtain a range of government 
subsidies when registering.  That said, the value-chain 
financing model remains a new concept within the IFC, globally 
as well as within China. 
BROWN