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Why did the rural agricultural cooperation funds fail? A look at Changde, Hunan Province.

A modern economy needs financial institutions that facilitate the transfer of funds from people who save to those who have productive investment opportunities. (1) In China, this function is performed overwhelmingly by the banking system. In 1985, a new type of financial institution came into being--the rural cooperative funds (RCFs). They were simple depository institutions that basically took savings deposits from peasant savers and lent them to other peasants and town and village enterprises (TVEs) in the same local area. These institutions filled a gap that was not filled adequately by the existing financial institutions, and they showed great promise. However, many of the RCFs ran into serious problems, primarily with their loan portfolios, and in 1997 they were ordered closed by the central government. Many peasant depositors have never gotten their money back. (2) The RCFs were not able to survive in the Chinese environment, with its heavy-handed government interference, its abuse of power by the privileged and powerful at the expense of the depositors, and its seeming disregard of some basic principles of business and economics. As China strives to develop an efficient, diversified and durable financial system, the short, ill-fated history of the RCFs provides some object lessons.

Setting up the RCFs

Structure and Need (3)

The typical depository financial intermediary borrows at one rate and lends at a higher rate. After allowing for expenses, the difference between the two rates is the profit. Of course, loan losses are an expense, so these must be minimised.

In China, some peasants have idle money, while others need money. A financial intermediary was required to absorb the idle money and then lend it to the peasants who needed it. The RCF was just such a financial intermediary. (4)

Local governments at each level of government set up the RCFs. That is, there were county funds, town funds and village funds. The RCFs at each of the three levels operated independently of each other, so that village funds were not controlled by the town funds, and the town funds were not controlled by the county funds. The RCFs were under the supervision of the Ministry of Agriculture, not the central bank. (5)

The RCFs had important advantages and seemingly could have done a good job, especially in the case of loans to peasants. Fund employees were local people who were familiar with all the peasant families. They knew which peasants were diligent and had the ability to repay loans and which peasants might not pay them back.

A need existed in China for a financial institution such as the RCFs. (6) By providing financing to agriculture, the RCFs helped fill an important gap in the financial system. This was a healthy development. In a modern economy, there is need for a variety of financial institutions and financial instruments, not just banks and bank loans. Given the vast size of China as measured by both area and population, a diverse and decentralised financial system would be especially valuable.

There exist two types of financing in the Chinese economy--financing done by official (or formal or governmental) institutions and financing that is done outside official institutions. As discussed below, the RCFs were nonofficial (or informal) institutions. (7)

Official Financial Institutions

The rural sector in China is served primarily by official institutions: a state bank (Agricultural Bank of China), a policy bank (Agricultural Development Bank of China) and thousands of rural credit cooperatives (RCCs).

RCCs are small savings and lending organisations that are the main source of small-scale financial services at the local level in the countryside. Their main borrowing clients are farmers and TVEs. Almost every township has at least one RCC. Although created at the township level, their presence in villages through branches and Offices makes them the financial institution with the widest outreach among rural populations. (8)

Established in the 1950s, the RCCs belong to the formal (official) financial system. The Agricultural Bank of China (ABC) primarily managed them until 1996, when they were placed under the direct regulation and supervision of the People's Bank of China (PBC). In 2003, the supervisory function of the PBC was transferred to the newly established China Banking Regulatory Commission. The RCCs are nominally independent cooperative banks at the township level, each responsible for its own profits and losses. At the county level, RCCs may be linked through a RCC union (RCCU), which provides clearing facilities and other functions for the RCCs.

Nonofficial Financial Institutions

Nonofficial financial institutions include mutual assistance savings associations (MASAs), rotating savings and credit associations (ROSCAs), private moneylenders, credit middlemen, pawn shops, underground private banks and microcredit projects targeted at poverty relief that have developed in recent years, as well as financing among relatives and friends and direct financing between farmers and rural enterprises. Although they were under the Ministry of Agriculture, the RCFs were nonofficial financial institutions.

In the agricultural sector, nonofficial institutions have flourished, primarily because the official financial system has not been adequate to the task of providing capital to agriculture. (9) When villages wanted to set up local collective companies, it was difficult for them to get a loan from the RCCs or the ABC. Similarly, when peasants needed some money, it was very difficult for them to get loans from these official institutions because of the tedious application procedures, red tape and long waiting times. The lack of adequate financing has constrained the development of China's rural economy.

The RCCs and the ABC mainly provided loans to town companies. They were not interested in the farming and breeding industries in which most of the peasants were involved. A major problem was that many peasants needed only small loans. For some farm households, only a few yuan were needed. Moreover, the households and TVEs were spread widely across the large area of the countryside, so the RCCs and ABC did not have enough staff to screen, monitor and enforce the contracts. It was much easier for them to service the town companies. (10)

Lack of effective collateral was another obstacle for rural households in obtaining loans. The lack of individual ownership of land limits a poor household's ability to offer collateral. This is a serious problem for formal institutions, such as the RCCs. But informal financial institutions such as the RCFs can discover substitutes for collateral, such as a wide array of social relationships among individuals, business ties and other informal relationships. (11)

Some Minor Problems in the Design of the RCFs

No Cross-region Loans and No Central Bank The central government confined RCFs to absorbing money from, and providing loans to, peasants and regional village collective economic organisations in their local areas. (12) As a result, the RCFs lacked geographic diversification in their loan portfolios. However, this is by no means a fatal flaw, as evidenced by the credit unions in the United States.

There was no central bank for the RCFs. As a result, they had no "lender of last resort" and no way to mediate money surpluses and shortages over different counties.

Some Early History of the RCFs

In 1985, the central government issued official orders encouraging local governments to set up RCFs to meet financing needs in the local areas. (13) In 1987, the Changde Government set up three experimental RCFs in Hucheng Town (Dingcheng County), Zengwenmiao Town (Dingcheng County) and Xiumei Town (Linli County). (14)

In 1992, Deng Xiaoping gave a now well-known speech that encouraged the Chinese to be more willing to embrace new things. Perhaps partly as a result of the freer political atmosphere, many more RCFs were set up after 1992. At the end of 1993 there were 128,400 RCFs. Among them, there were 17,800 at the township level accounting for 38 per cent of the total number of townships and 110,600 in the villages accounting for 15 per cent of the total number of villages. In 1997, there were some 150,000 RCFs throughout China. By the end of 1997, the RCFs' total assets amounted to 150 billion RMB estimated by the PBC, or 250 billion RMB estimated by the Ministry of Agriculture. (15) According to the Ministry of Agriculture, in 1997, there were over 100 million households being serviced by the RCFs. (16)

In Changde, the RCFs grew rapidly and steadily (see Table 1). At their peaks, the number of RCFs reached nine at the county level, nearly 200 at the township level and over 250 at the village level. In Changde, at their peaks in 1997, deposits at the RCFs totalled nearly 950 million RMB, and loans totalled nearly 800 million RMB.

RCFs were set up not only to transfer funds from peasant savers to peasant borrowers but for other purposes as well. For example, in 1988, the village government in Zhaojia Village (Xiumei Town, Linli County) decided to set up a paper factory, but there was not enough money. In November 1988, that village set up its own RCF, specifically for the purpose of financing the paper factory.

Some Major Problems Faced by the RCFs

The RCFs faced serious problems that eventually led to their demise. These problems arose largely because of the three primary groups involved, namely, (1) those who had power over the monies in the RCFs, (2) the managers of the RCFs, and (3) those government bodies that should have been supervising and regulating the RCFs.

Those Who had Power Over the Monies in the RCFs

A major problem with the RCFs appears to have been the attitude of those who had power over the funds. To a large extent, those in authority did not think of the money in the RCFs as belonging to the peasant depositors, and they did not think of themselves as having a fiduciary responsibility to act in the interest of the depositors. Instead, they generally viewed the money in the RCFs as their own money, to do with as they saw fit. As a result, the money was far too often lent to unprofitable local businesses and to the politically powerful. Often the money was simply confiscated by local authorities in the guise of taxes and fees.

Pressure to Make Bad Loans

A common feature of the RCFs was that many of them made a large number of bad loans. For example, as shown in Table 2, 42 per cent of the loans made by the RCFs in Changde were overdue by mid-1997, shortly before the central government decided to put an end to all RCFs in the country. Many of these bad loans were made because of pressure from local governments and cadres.

In contrast with the commercial banks, which belonged to a hierarchy headed by the PBC, each RCF was an independent entity, subject to the control of the local government (county, town or village) that set it up. In fact, the RCF in a town or village became almost a de facto government agency of the town or village. Local governments realised that RCFs could be a new financial resource and intervened directly in their loan-making. In effect, the local governments used the RCFs as their own wallets. As mentioned, some governments and government branches set up RCFs explicitly because they needed a new source of money.

The RCFs were often forced to lend to the local governments. For example, when a local government did not have money to pay officials' salaries, it forced the co-op fund to lend money to pay those salaries. Similarly, if a local government such as a town failed to pay enough taxes and fees to the next higher level government (the county), then the leader of the town could lose his job. Under that pressure, the town might have to force the RCF of the town to give it loans. (17) In the same way, a village might force the co-op fund of the village to lend it funds so the village could pay taxes and other fees to the town government.

Local factories and companies often thought of the RCFs as a pool of money that they could tap. So they went to local government leaders and other cadres and asked them to force the RCFs to lend them money, even though they may have had little ability to pay back the money. (18)

Local cadres used their influence to borrow money from the RCFs not only for themselves, but also for their friends and relatives. Usually fund managers did not want to offend the cadres, and so they lent them money. The cadres became co-signers of many bad loans. In practice, the co-signers were often not held responsible for the bad loans. (19)

"Handing in Profit"

The RCFs were set up to be independent from local governments, but local governments extracted money from the RCFs in the name of "handed-in profit". For example, the Qiaonan Co-op Fund was set up in June 1993. In the following three years, the local government extracted 2.3 million RMB from the fund as "handed-in profit". Actually, after "handing in" so much money, the fund did not make any profit at all, but lost 1.8 million RMB.

Mismanagement by Fund Managers

According to Delhaise, "the main reason why the banking systems in Asia as a whole are so weak lies in the quality of financial management". (20) This situation is true of banks in Asia as a whole and of banks in China in particular. It was also true of the RCFs in China.

Managers Did Not Understand Sound Principles of Making Loans

In the West, banks focus on whether the cash flow of a business will be sufficient in the future to allow it to make the payments of interest and principle. In contrast, Asian banks tend to think that collateral is sufficient to make a good loan. In this regard, the RCF managers in China were little different from banking officials throughout Asia. (21)

Managers Used The Funds for Their Own Benefit

RCF managers thought of their power to provide loans as a chance to do favours to others. Some RCF managers provided loans to their relatives and friends. Many were also eager to provide loans to government cadres because the latter could benefit the manager's career or his family in the future. Fund managers and their families lived locally. Their wives may want to get better jobs and their children may want to go to a good primary school or a good high school. They believed that if they had good relationships with government officials in charge of these, they could make themselves and their families better off.

Another problem was that the fund managers were too closely related to local governments. Most who were in charge of the RCFs were officials from the Agriculture Economic Management Division of the government. So they were government officials whose colleagues and friends were government officials. If the managers quit working in the RCFs they would work in the local government again. Thus it was hard for them to say no to local government leaders.

Managers were Under Great Pressure and Did Not Have Enough Incentive to Protect Depositors' Money

At times it was necessary for the fund managers to keep their positions in the fund by providing loans to nearly bankrupt companies, local governments and cadres. Sometimes local government leaders forced the fund managers to provide loans by threatening to take away their jobs. After the loans were due, the fund managers did not try their best to collect them because even if they were collected, the managers had little to gain.

Supervision and Regulation

A third problem area was lack of effective regulation by higher levels of government to prevent abuses by local authorities.

Lack of a Regulator and Adequate Regulations

When depositors put their money into a depository financial institution, it is important that there be a strong regulator to make sure that the institution uses the money wisely and well. (22) If loans cannot be collected, ultimately the depositors bear the loss by failing to get their money back. Managers of a depository institution, on the other hand, do not have the same incentives as depositors to make safe and sound loans. (23) On the contrary, the managers have incentives to gamble with the depositors' money. This situation creates the need for a strong, effective regulator.

The need for a strong regulator is a principle that has been learned the hard way by many countries around the world, including the US. As the savings and loan (S&L) debacle in US in the 1980s revealed, even if there is a regulator, there can be catastrophe if it does not do the job adequately.

A strong regulator was necessary to assure the healthy development of the RCFs. In the case of the S&Ls in the US, incompetent regulators and politicians led to disaster. By comparison, the RCFs were in an even worse situation because they had almost no regulator at all.

Although it was written in Operation Regulations of Rural Co-operative Funds that the Rural Economic Management (REM) branch of government was the regulator, it had little actual power to regulate the RCFs. When the RCFs were providing loans to non-promising companies because of local government intervention, the REM branch had no right to fine or close the RCFs. In fact, it could do little more than just criticise the RCFs. The PBC was the nominal supervisor of the RCFs. However, it essentially supervised only the deposit and loan interest rates.

Because the RCFs had no real regulator, they had a fundamental, fatal flaw. A strong regulator was needed to counter the incentive of fund managers to misuse depositors' funds. A strong regulator was also needed to provide backup to the honest, conscientious fund managers who were willing to resist the pressure of local governments and cadres who pushed for unsound loans.

Lack of Openness and Transparency

The RCFs did not publish their financial statements. As a result, there was little opportunity for depositors and other outsiders to monitor their behaviour and financial conditions.

Hostility of the Official Banking System Towards the RCFs

From the beginning, the official Chinese banking system as a whole--both the PBC and the commercial banks--was hostile towards the RCFs. The banking system treated RCFs as enemies because they competed with the banking system for both deposits and loans. They were basically illegal in the eyes of the PBC. When the RCFs were first set up, the PBC reported to the central government that they upset the financial order and asked it to ban them. (24)

The PBC did not try to help run the RCFs or give professional advice to the REM branch of local governments. It did not fight for the creation of a strong regulator for the RCFs, nor did it help train fund employees. Instead, its main concern was to make sure that the RCFs did not adopt significantly higher deposit interest rates than the banks, in order to prevent them from competing fiercely against the banks for deposits. The RCFs filled an important gap in the financial system. By opposing the RCFs, the PBC seemed to have worked in the narrow interest of the banking system, not the financial system as a whole.

Closing the RCFs

After 1997, especially after the Asian Financial Crisis which began in August that year, China's central government thoroughly investigated the RCFs and found many problems. As a result, it decided to close all RCFs, including the competent ones. They were closed over a period of time. By 2001, in Changde, about two-thirds of all the RCFs had been closed.

Following the closure of the RCFs by the central government, depositors went to the sites of the RCFs and local governments, trying to get their money back. The companies and people who had borrowed money from the RCFs thought they had no obligation to repay the money. The central government and local governments were afraid that the co-op fund issue would harm social stability, so the central government lent the government of Hunan Province 3.7 billion RMB to pay back the depositors. This was a loan to the local governments which they had to pay back in eight years.

In Changde, only 70 per cent of the deposit money had been given back to the depositors by 2001. At the time of writing, local governments are still trying to collect the RCF loans from the delinquent borrowers. (25)

A Comparison between the RCFs and the Official Financial Institutions

RCFs and the Commercial Banks

Like the RCFs, the banks in China also had many bad loans. In many cases, these were "policy loans" that the central government required the banks to make. To a large extent, these loans were simply a disguised subsidy by the central government to state-owned enterprises (SOEs) and other favoured companies. That is, instead of giving subsidies directly to the companies, the government required the banks to make loans to them. It then reimbursed the banks to cover the losses on those loans when, as often happened, the companies did not repay the loans.

There are some seeming similarities between the policy loans made by the banks to SOEs and the loans made by the RCFs to local industries. However, there is at least one major difference. In the case of the banks, the central government felt responsible for making sure that the depositors got their money back, so, as noted, it covered the banks' losses that resulted from these policy loans. In contrast, neither the central government nor the local governments insured deposits in the RCFs, and no one felt ultimately responsible to cover the losses and make sure that the depositors got their money back.

RCFs and the Rural Credit Cooperatives (RCCs)

Like the RCFs, the RCCs have also had severe problems with non-performing loans (NPLs). Some analysts estimate the combined NPL ratio of RCCs tops the combined ratio of the Big Four commercial lenders--possibly exceeding 50 per cent, on average, and reaching 80 per cent in some ill-managed institutions. (26)

The problems of the RCCs were very similar to those suffered by the RCFs, especially poor management and pressure by those who had power over the funds. For example, for both RCCs and RCFs, the local governments and cadres had considerable power over loan-making decisions.

On the other hand, the RCCs had two major advantages over the RCFs. First, the RCCs had more direct supervision and regulation than did the RCFs, first by the ABC, then by the PBC after 1996 and by the China Banking Regulatory Commission after 2003. (27) Nevertheless, the RCCs suffered massive loan losses even though clearly specified central government regulators supervised them.

The RCCs had another important advantage over the RCFs, that is, like the commercial banks, the RCCs were official financial institutions. As a result, whereas the central government closed the RCFs, it felt obliged to keep the RCCs open and to Protect their depositors even though the RCCs were in no better financial condition than the RCFs.

Some Conclusions

The story of the RCFs is a simple one to tell. However, it may not be entirely easy to understand. The RCFs were the simplest type of depository institution. Their balance sheets consisted almost entirely of loans and deposits. On the surface, it appears that the RCFs should have succeeded. For example, in the US, the credit unions are similar to the RCFs in that the savings of the employees of a company are pooled and lent to other employees of the company. Everyone knows everyone, so it is relatively easy to make safe and sound loans. The credit unions have been very successful for many years. Seemingly, the principle should have worked in the case of the RCFs. Why not?

The answers to this question should be of interest to the official banking system in China, especially the commercial banks and RCCs, which are facing many of the same problems that killed the RCFs. These problems stand out more clearly in the case of the RCFs because the RCFs' problems were so much simpler than those of the banks. Unlike the banks, the RCFs did not involve foreign exchange, foreign investors, foreign investment funds, attacks by foreign speculators, central government policy in allocating funds, and so forth. Almost everything was at the local level.

The environment in China is challenging, to say the least. To a great extent, the difficulties of the RCFs suggest that there is still a general lack of understanding in China about how a modern financial system should work. In China, as in Asia in general, there is not enough appreciation of the need for realistic evaluation of loans, especially the ability of the borrowers to repay the loans. Also, the RCFs provided little incentive for fund managers to make safe and sound loans. Instead, there were many incentives for fund managers to make loans based on the power and prestige of the borrower. Moreover, the central government, PBC, and rural branch of government did very little to establish effective government regulation of the RCFs.

The difficulties of the RCFs also seemed to grow out of some social and attitudinal problems in China which may cause difficulties on a continuing basis in the future. As noted, those in power held a belief that the monies in the RCFs were virtually "up for grabs", i.e., that the monies belonged to them rather than to the depositors. Also, mismanagement, inefficiency and even outright bribery and corruption played a role. In short, the RCFs were overwhelmed by mismanagement and the flagrant abuse of power and influence by governments, cadres, local companies, fund managers and others at the expense of the depositors.

(1) This article is based primarily on government records and interviews with officials familiar with the RCFs in Changde.

(2) Not all of the depositors were individuals, but most of them were. For example, at the end of 1996, 81 per cent of the deposits in Changde belonged to individuals, while the rest belonged to collectives and others. Source: Investigation Report by the People's Bank of China, Changde Branch, Mar. 1997. Changde is an area in northwest Hunan Province consisting of nine counties: Anxiang, Dingcheng, Hanshou, Jinshi, Linli, Lixian, Shimen, Taoyuan and Wulin. Each one contains towns, and each town contains villages. For example, Zhaojia village is in Xiumei Town, which is in Linli County, which is in Changde.

(3) "People's Republic of China: Thematic Study on Rural Financial Services in China: Executive Summary", International Fund for Agricultural Development (IFAD), Dec. 2001 at <http://www.ifad.org/evaluation/ public_html/eksyst/doc/thematic/pi/cn/cn_1.htm> [15 Aug. 2005].

(4) The fiction was maintained that RCFs were not financial institutions. For example, RCFs were not allowed to take deposits but got around this by selling "shares". Instead of receiving interest on their deposits at the RCFs, depositors received "dividends" at the end of each year. Similarly, instead of paying interest to the RCFs, those who borrowed from the RCFs paid a "capital usage fee". Source: Document from the Agricultural Ministry and People's Bank of China, Nov. 1994.

(5) "In August 1992, to further strengthen the management of RCFs, the Ministry of Agriculture set up the Administrative Office of Rural Credit Cooperatives to be in charge of guiding, managing, monitoring, coordinating and serving the development of rural credit cooperatives." Source: Du Zhixiong, "The Dynamics and Impact of the Development of Rural Cooperative Funds in China", Working Paper, Chinese Economies Research Centre, 1998, no. 2 at <http://www.adelaide.edu.au/cies/papers/CERCwp/98_2.pdf> [15 Aug. 2005].

(6) Cheng Enjiang, C. Findlay and A. Watson, "Institutional Innovation without Regulation: The Collapse of Rural Credit Foundations and Lessons for Further Financial Reforms", in Rural Financial Markets in China, ed. Christopher Findlay, Andrew Watson, Cheng Enjiang and Zhu Gang (Canberra: Asia Pacific Press, 2003), pp. 63-88.

(7) Ma Zhongfu, "Rural Informal Finance", in Rural Financial Markets in China, ed. Christopher Findlay, Andrew Watson, Cheng Enjiang and Zhu Gang (Canberra: Asia Pacific Press, 2003), pp. 105-119.

(8) In 1998, there were some 42,000 independent RCCs at township level, 2,400 RCC unions at county level and some 280,000 village credit outlets. In total, the network employed around a million employees and accounted for 12.7 per cent of deposits of all financial institutions. See John D. Conroy, "The Role of Central Banks in Microfinance in Asia and the Pacific", vol. 2, Country Studies, Peoples' Republic of China, Asian Development Bank, 2000, vol. 2, p. 45.

(9) According to Professor Kong Xiangzhi from the Peoples University of China, no more than 20 per cent of the funds borrowed by Chinese rural households are provided through regular channels such as loans from RCCs. Source: "Over Half of Chinese Rural Households Need Financing", from Ta Kung Pao and re-published on People's Daily Online, 20 Feb. 2004 at <http://english.people.com.cn/200402/20/eng20040220_135364.shtml> [15 Aug. 2005].

(10) Source: Interview with a former RCF official in the Agricultural Branch of the Changde Government.

(11) Xie Ping, Xu Zhong, Cheng Enjiang and Shen Minggao, "Rural Credit Cooperative Pilot Programs and Evaluation", in Establishing a Framework for Sustainable Rural Finance: Demand and Supply Analysis in Guizhou Province of the Peoples' Republic of China, Ch. 4, (Manila: Asian Development Bank, Apr. 2005), p. 31 at <http://www.adb.org/Documents/Books/Establishing-Framework/chap3.pdf> [15 Aug. 2005].

(12) Provisional Regulations on the Management of Rural Co-op Funds in Changde, 25 Sept. 1993.

(13) Document of Agricultural Branch of Changde Government, Aug. 1993.

(14) Speech by a former RCF official in the Agricultural Branch of the Changde Government in the Peoples' Representative Meeting, Standing Committee, Oct. 1993.

(15) Zhu Dan-tao and Henk van Gemert, "Financing Rural Economic Development", World Economy and China, no. 3, 2001, section IV.4 at <http://www.iwep.org.cn/wec/ English/articles/2001_03/zhudantao.htm> [5 Aug. 2005].

(16) Henry Jackelen and Mi Xianfeng, UNDP Microfinance Assessment Report for China, Prepared as a Component of the MicroStart Feasibility Mission, Oct. 1997, p. 2 at <http://www.uncdf.org/english/microfinance/ documents_and_reports/country_feasibility/chinadb3.pdf> [15 Aug. 2005].

(17) For example, in the towns of Ganxi, Dongshi and Liyang (Linli County, Changde), RCFs were forced to lend a total of 0.6 million RMB to local government units in order that they could pay agricultural taxes and other fees to the county government. Source: An Investigation Report by Peoples' Bank of China, Changde Branch, Mar. 1997.

(18) As just one example, in Jiangjiazui Town (Hanshou County, Changde), the RCF was forced by the leader of the Communist Party of that town to lend 0.2 million RMB to Jinwei Company--an individual business company--even though that company had a debt of 3 million RMB already, with no ability to pay back the loan. (Speech by an official in a Changde RCF Management Meeting, Aug. 1997.)

(19) For example, in Lixian County (Changde), there were 231 government cadres who borrowed a total of 3.0 million RMB from RCFs. More specifically, 25 section chiefs borrowed 0.25 million RMB, 90 vice section chiefs borrowed 1.6 million RMB, and 116 cadres with lower rank borrowed 1.1 million RMB. (Document from the Agricultural Co-op Economic Management Bureau, July 1997.)

(20) Source: Philippe F. Delhaise, Asia in Crisis [Singapore: John Wiley and Sons (Asia), 1998], p. 2.

(21) "[In Asia], lending on the basis of reasoned credit and cash flow analysis is minimal. Instead, collateral is the primary factor in the lending decision. Another reason is the relationship between bank and customer. At best, the focus on relationship results in 'name lending', or making credit decisions primarily on the basis of the bank Officer's assumed knowledge of the customer in question. Such knowledge may involve a real understanding of the customer's business. At its worst, name lending deteriorates into related party lending and crony capitalism. Under such circumstances, depositors tend to get short shrift. Bank managers milk deposits, friends of friends of the well-connected get loans, and creative accounting becomes an art form." Source: Philippe F. Delhaise, Asia in Crisis, p. 2.

(22) "Small depositors should never suffer. They are ordinary people who are in no position to judge whether a depository institution is safe. If this is a difficult judgment for educated creditors, it is an impossible task for ordinary depositors. They must rely on the regulatory authorities that license financial institutions and are supposed to monitor their health constantly. Such depositors should not suffer from mistakes made by regulators." Source: Philippe F. Delhaise, Asia in Crisis, p. 38.

(23) RCFs are a good example of the principal-agent problem. The principal-agent problem occurs because the agents (fund managers) do not have the same incentive to make safe and sound loans as do the principals (the depositors).

(24) In 1984 and 1985, the PBC of Jiangsu Province organised an investigation team which wrote a report to Chen Muhua, the head of the PBC. It said that the RCFs upset the financial order and asked the central government to ban them. However, the Jiangsu Government was angry about the report because it felt that the RCFs actually benefited Jiangsu. The Jiangsu Government organised its own investigation team. Because the Jiangsu Government was more powerful than the local PBC, its investigation team was bigger and its investigation was more thorough. In its report to the central government, the Jiangsu report said that even though there were some flaws in the RCFs, any new organisation was not perfect. Moreover, it said that RCFs had a positive effect on the setting up of a new agricultural financial system and agricultural development. In 1985, in its official orders, the central government said that, in local areas, financial activities outside of the banking system (such as the RCFs) were legal and that the ABC at all levels should support the activities.

(25) Source: Interview with a former RCF official in the Agricultural Branch of the Changde Government.

(26) "Credit Cooperatives Undergo Reform", China Daily Business Weekly, Hong Kong Edition, 19 Oct. 2004.

(27) For example, the PBC established specific rules and regulations for the RCCs, such as "RCCs are subject to PBC reserve deposit requirements, must make at least 50 per cent of loans to members, and must give priority to agriculture. They must maintain an 8 per cent capital adequacy ratio, a loan/deposit ratio not higher than 75 per cent, and observe minimum liquidity and single borrower limits. Provisions for doubtful debts are mandated, and audit requirements set.... Governor Dai Xianglong stated in April 1999 that 60 percent of RCCs had satisfied the current regulations in full." Source: John D. Conroy, The Role of Central Banks in Microfinance in Asia and the Pacific, vol. 2, Country Studies, Peoples' Republic of China (Manila: Asian Development Bank, 2000), p. 50.

W. Leigh Ribble (wlribbl@aol.com) is a retired senior economist from the US Federal Reserve Board. He has been a visiting professor at Lingnan (University) College, Zhongshan University, Shanghai University of Finance and Economics and Central University of Finance and Economics. He earned his PhD in monetary theory from MIT and his main areas of interest are money and banking and macroeconomics.
Table 1. Rural Co-op Funds in Changde

 Number of Funds

 County Town Village Total

 1989 0 85 83 168
 1990 0 85 87 172
 1991 0 86 98 184
 1992 2 109 103 214
 1993 6 143 124 273
 1994 8 165 207 380
 1995 9 170 218 397
 1996 9 175 230 414
 1997 9 179 242 430
 1998 9 182 240 431
 1999 9 199 290 498

 Deposits Loans
 (million (million RMB)

 1989 21.03 16.82
 1990 24.92 21.18
 1991 28.18 22.54
 1992 51.91 44.12
 1993 132.00 112.20
 1994 453.81 385.73
 1995 486.01 413.10
 1996 693.33 589.33
 1997 938.93 798.09
 1998 881.85 665.04
 1999 842.72 754.21

Source: Data provided by an ex-RCF official in the rural branch of
the Changde Government.

Table 2. Overdue Loans in Changde, June 1997 (million RMB).

County Overdue Loans Total Percentage

Linli 52.8 90.1 58.6
Jinshi 7.5 13.6 55.1
Taoyuan 103.0 192.9 53.4
Shimen 30.1 71.1 42.3
Wulin 23.1 61.7 37.4
Anxiang 11.1 31.4 35.3
Hanshou 35.9 102.2 35.1
Lixian 11.0 59.1 18.6
Dingcheng 10.2 61.0 16.7
Total 284.6 683.1 41.7

Source: Speech by Chai Tiejun in Changde RCF Management Meeting,
Aug. 1997.
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Author:Ribble, W. Leigh, Jr.
Publication:China: An International Journal
Geographic Code:9CHIN
Date:Mar 1, 2006
Words:6121
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