Citigroup joins the debate on Chinese microfinance

Citi sets up China's first national microfinance training centre.
According to a Chinese Academy of Sciences researcher, self-financing microfinance initiatives may only have a limited application in resolving ChinaÆs poverty issues.

ôUltimately, the resources needed to combat ChinaÆs poverty problem need to come from the government exchequer,ö estimates Professor Du Xiaoshan, a development expert from the Rural Development Institute of the Chinese Academy of Social Sciences (CASS).

CASS has its own microfinance institute called the Founding the Poor Co-operative (FDC), overseen by Du.

DuÆs recent comments to FinanceAsia are a reminder of how intractable the problem of poverty alleviation is, despite the hope raised by initiatives such as microfinance.

Microfinance has become increasingly popular as a concept for alleviating poverty because it holds out the promise of a market-friendly, self-sustaining poverty reduction mechanism. In its purest form, microfinance refers to making very small loans (rather than grants) to a countryÆs poorest segment at commercial rates of interest. The hope is that these loans will provide the seed capital for the individuals to begin small businesses, and later enabling them to repay the bank. Micro-credit is a variant whereby the lending makes loans but does not take deposits.

In China, government funding to the countryside has been drastically reversed since the launching of pro-market reforms by premier Deng Xiaoping in the early 1980s. In the past 20-years, education, welfare and health services have all become fee-paying, even, or perhaps especially, when the services are in government hands. This has inevitably made life much more difficult.

Poverty is often viewed as a statistical issue, despite the obvious hardship in both rural and urban parts of China. Chinese government figures estimate that 3% of the population lives on, or less than, Rmb600 per year, or some 30 million people. Around 75 million people live on, or less than, Rmb900 per year, which is the average GDP per capita. The World Bank estimates that 120 million people live on or below the one dollar per day (defined by the bank as absolute poverty), or 10% of the population û equivalent to the population of Japan.

Microfinance institutions will typically target a range of people, for example based on their income as a percentage of per capita GDP. A figure of less than 50% is often seen as a level where microfinancing becomes relevant. However, if the countryÆs GDP per capital is especially low (as in China), that proportion could rise to a 100% of GDP per capita.

The poor are often excluded from the formal bank financing system because they may not have any assets to use as collateral, or they do not have legal title to their assets. Poverty researchers such as Hernando de Soto point out that the æpoorÆ are not as asset-deprived as one might imagine. But they do find it hard to leverage the scant assets they do have, for example by mortgaging a house for collateralising a small business loan. The poor may not even have ID cards or birth certificates, let alone title to their homes.

Microfinance tries to finds way to cope with these problems. Unfortunately, the due diligence necessary for assessing people living outside the legal infrastructure, such as personal visits to loan recipients and setting up systems of group guarantees, adds to the cost of operations. In addition, the cost of processing a micro loan is just as high for as for a large loan. This frequently makes microfinance unpopular to mainstream financial services providers.

As many observers understand, this means that even microfinance needs cash grants or training to be viable.

"Citigroup believes the global benefits of a robust microfinance industry are clear and that it is necessary to help strengthen the industry via a combination of philanthropic and commercial initiatives," says Robert Morse, CEO of corporate and investment banking at Citigroup Asia Pacific.
Citigroup targets microfinance as part of its charitable activity through the Citigroup Foundation, and this year provided a grant of $1.5 million to set up ChinaÆs first national microfinance training centre and microfinance associations.

Microfinance initiatives have grown in popularity in certain parts of the world in proportion to the increasingly poor image of conventional aid. The latter is often seen as being squandered on corruption or white elephant projects.

ôWith microfinance, you can provide a poor person with a fishing rod and he can then feed himself. ThatÆs far better than giving him a one-off gift of a fish,ö notes one observer.

At its best, microfinance can obviate the need for huge subsidies to the poor from the central government and enable the poor to become economically self-sufficient.

ôIn the past 25 years, we have seen the emergence of microfinance units which have become genuinely viable financial institutions,ö points out Bob Annibale, CitigroupsÆs global director of microfinance. Some institutions have recently even approached Citi for advice on how to provide cash management, insurance, hedging, foreign borrowing and capital markets services, he adds.

Annibale also points out that some of the repayment rates at microfinance institutions are often as good as triple-A corporate borrowers.

Microfinance institutions come in a combination of three main forms. They may make loans based on commercial lending decisions; and/or grants; and they may take deposits. Annibale says that in the early stages, non-governmental organisations were key in developing the concept. In Bangladesh for example, microfinance institutes reach more people than the formal banking sector.

According to Professor Du, the Chinese authorities are reluctant to allow the creation of deposit taking microfinance institutions, since a business failure (stemming from a borderline legal property deal, for example) could lead to many people losing their savings and creating social unrest.

Yet deposits are crucial, because they provide the liquidity for making loans.

China has tried to get around the problem by a pilot scheme involving the creation of non-deposit taking lending institutions financed by a strictly limited number of private entrepreneurs and with a minimum registered capital of Rmb10 million. They may charge interest of up to 24% (around four times the approved one-year lending rate of 5.8%). Loan contracts with interest rates higher than that are not given legal protection in China, since the government does not to wish to encourage usury.
Another experiment by the ministry of finance revolves around rural credit cooperatives in ChinaÆs poorest 200 counties. The cooperatives can make can make loans with interest rates of up to 10%, but the government takes on half the interest repayments on behalf of the farmers.

But Du points out that the perennial contradiction of microfinance (ie profitability versus pure poverty alleviation) means that within the pilot scheme currently being rolled out across six of ChinaÆs poorest provinces (Inner Mongolia, Shanxi, Shaanxi, Sichuan, Guizhou and Gansu), the very poorest province, Gansu, has attracted very little attention from financial entrepreneurs. On the other hand, Inner Mongolia has attracted a great deal. While Inner Mongolia has a poverty problems related to the high number of poorly-assimilated Mongols, it also contains rich mineral and oil deposits.

In Latin American, says Annibale, microfinance has taken a variety of forms. Most microfinance institutes are classified as consumer finance companies, but increasingly, microfinance institutes are getting banking licenses. In Brazil microfinance institutions services are done through the formal banking system, the post office and even in lottery offices.

Professor Du is sceptical about ChinaÆs formal banking system effectively carrying out microfinance. There are two main reasons, he estimates: firstly, bank staff are poorly trained, and secondly, banks do not see the sector as a moneymaker. ChinaÆs banks are traditionally averse to lending even to large private companies when they can park their funds with state-owned companies, who are seen as having an implicit state guarantee. As ChinaÆs banks get more commercialised following the overseas listings of the state-owned commercial banks, they are becoming impatient with initiatives that donÆt contribute to the bottom line. ItÆs in that spirit that many banks are closing down their rural branches in China.

Another problem in China is that deposit and lending rates (although not money market rates) are fixed by the government. Banks arenÆt accustomed to making credit decisions based on floating rates, and even if they could, the amount of interest they can charge is not commensurate with the risk they feel they are taking on.

ôUnfortunately, we have had seen few success stories in microfinance,ö judges Du.

Matt Perrement, a poverty expert working at one of the leading NGOs in China, China Development Brief in Beijing, says that microfinance only addresses the first step of the problem and cannot be seen as a panacea.

ôEven if the right person got the right amount of money at the right time (quite unlikely right now in China), he still has to find a satisfactory business to make money from,ö he points out.

In PerrementÆs experience touring ChinaÆs poorest regions, farmers who do get the loans often lack the skills (legal, financial, technical, sales and marketing knowledge especially) necessary to make the best use their funds.

ôIÆve seen rice farmers branch out into rearing pigs. But once one does it, they all do it. And they didnÆt know how to look after the pigs, so many of them died,ö says Perrement.

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