Giant Steps

By Jonathan Haagen

PlaNet Finance
Tian Si Wan may not be the middle of nowhere, but you can see it from there. Surrounded by an ever-encroaching desert, the small village in rural Ningxia has an economy based almost entirely on lamb herding – an occupation that aggravates the already critical problem of desertification. A great number of those living in Tian Si Wan today are recent arrivals, forced to move by the government after their own homes had been swallowed up.

But many of Tian Si Wan’s women have experienced a more positive transformation than the town itself. Jiao Li has been borrowing from the Ningxia Yanchi County Association for the Advancement of Women (Ningxia CEPA) since 2000, when the microfinance organization made her a loan of RMB 1,000 (USD 146).

At the time, Jiao’s annual income was only RMB 1,600 (USD 234), a figure so small that she could not afford to send her children to school. “It was an extremely bitter period in my life,” she recalled.

In the eight years that have followed, micro-loans have offered her upward mobility. Jiao now takes in revenues of RMB 90,000 (USD 13,140) per year from her herd of 240 lambs and her side business – corn she sells as feed to fellow herders rapidly running out of grazing grounds. “I would never have the freedom I do now [without the loans],” Jiao declared. “It is not only my husband that works. I also contribute. My position in society as a woman is much higher.”

Stories like that of Jiao Li, whose current net income of between RMB 10,000-15,000 (USD 1,460-USD 2,190) annually surpasses the local average, have become common anecdotes in describing how microfinance can be used to alleviate poverty. Her story confirms what proponents have long argued; even in poor communities, wealth can be grown as well as redistributed.

However, historically China’s microfinance institutions (MFIs) have not had the same success as their counterparts in places like Bangladesh, where Nobel Peace Prize winner Mohammad Yunus pioneered the industry with the Grameen Bank. While many MFIs in South Asia have clients numbering in the millions, most of China’s organizations remain small, generally servicing in the region of 3,000 clients.

NO LEGAL STATUS

China’s relative underdevelopment in this sector can be largely attributed to an issue of legal status. Since their inception in the mid-90s, traditional MFIs in China have not been officially recognized as legal entities and have thus been unable to take on any sort of debt investments.

While demand for microcredit services is immense — an estimated 228 million people in China have no access to financial services — regulatory and legal hurdles have prevented the sort of growth seen in other countries.

Last year, however, the Chinese government granted official status to microcredit and microfinance companies. This presents tremendous opportunities and daunting challenges for existing NGOs, which must now transform themselves into regulated financial institutions.

The regulatory changes, which allow organizations to take on debt, are already catalyzing rapid growth in the sector, increasing both the number of people with access to financial services and the size of the loans they can receive. Some in the industry, however, fear that increased opportunities for profits in microfinance may compromise the original mission of poverty alleviation.

REGULATORY CHALLENGES

Although there were domestic programs as early as 1989, the origins of microfinance in China can really be traced to the mid-1990s, when the United Nations Development Program (UNDP), along with other large donors like the US Agency for International Development (USAID), founded approximately 300 microfinance projects throughout China.

More than 10 years later, however, around 200 of these original microfinance ventures have failed completely. “They have had to shut down because of inefficient management, lack of technical support and limited funding. However, all of these limitations have been exacerbated by the fact that these projects have had no official legal status,” said Kira Dubas, director of administration and finance at PlaNet Finance, an NGO committed to developing China’s microfinance sector.

While the projects were allowed to operate because of their positive impact on poverty and close relationships with local governments, restrictions on taking on debt investments, along with government-imposed interest rate ceilings, made it impossible for most MFIs to achieve financial sustainability. “Interest rates have traditionally been capped at between 10-12% annually in China, compared with the 20-40% rates for micro loans in other countries,” said Dubas.
The surviving third have done so by relying heavily on donations, but even these have been unable to expand because of legal restrictions barring them from taking on commercial funding. “Without this funding, MFIs have not been able to expand their capital base and thus haven’t been able to access more clients,” explained Dubas.

CENTRAL BANK BACKING

Critical regulatory reform began in 2005, when the People’s Bank of China decided that microfinance was indeed a viable solution for poverty alleviation. The bank instituted the “MCC initiative,” launching seven microcredit companies in five provinces.

By virtue of their official legal status, these MCCs were able to take out loans, a luxury NGO institutions did not have, as well as receive investments. The following year, the China Banking Regulatory Commission announced a new rural finance model called “village banks.” These institutions are able to not only give microcredit loans, but also provide other microfinance services, ranging from taking savings to offering ATM services.

PlaNet Finance

Additionally, the interest rate ceilings on micro loans also became more flexible, jumping from as low as 8% annually to 28% (four times the commercial rate of 7%). In the following years, these reforms have transformed the sector. From the seven pilot MCCs launched in 2005, an estimated 144 are set to be established by the end of 2008. Numbering only 19 as recently as 2007, there are now over 65 village banks on the Chinese mainland.

While it is too early to assess the consequences for microcredit borrowers, the new reforms appear to address one of their most pressing concerns. Asked by PlaNet Finance analysts what they wanted from MFIs in the future, the response of borrowers in Tian Si Wan was uniform: “bigger loans.” Borrowers wanted loans of at least RMB 20,000 (USD 2,920) with which they could increase their herds by 30 head.

To meet these needs, Ningxia CEPA has itself begun the process of registering as an MCC. Since it was founded in 1998, the organization has had to make do with the initial funding it received from the UNDP. However, the new legal status will mean that Ningxia CEPA is able to take on capital from commercial investors, both domestic and international. Though it is still in the process of finding the RMB 5 million (USD 730,000) in startup capital required to complete registration, managers claim they are just “a few days away.”

Ningxia CEPA’s commitment to expanding its operation has already had a measurable impact on the citizens of Tian Si Wan. Since Ningxia CEPA began granting loans, the village’s per-capita income has increased from just RMB 850 (USD 124) per year in 2000 to more than RMB 2,300 (USD 336) per year today.

BECOMING THE GIANT

Despite quantifiable successes in places like Tian Si Wan, some in the sector fear that growing excitement about microfinance as a business venture will undermine its stated goal of poverty alleviation.

Even in the Ningxia village, where microfinance programs have done wonders for the economic fortunes of many people, some are worried that more rapid development could wreak havoc on the environment. “Nearly all the borrowers want to increase their herds, which makes the already serious desertification problem even worse,” said Dubas. However, she argued that microfinance could itself provide a solution, if used effectively. “The solution is not to reject these programs, but rather to increase education. In Tian Si Wan, loans are increasingly being used on related businesses like growing feed for the lambs. Investment of that sort can alleviate poverty and protect the environment, provided the MFIs can educate the borrowers,” she added.

The greater risk may be changes that come as MFIs seek to become more profitable. Speaking at a fundraiser in Beijing, PlaNet Finance’s regional technical advisor, Cris Lomboy, explained that “the operating cost of giving a loan of RMB 1,000 and RMB 1,000,000 (USD 146,000) is pretty much the same.”

For this reason, microfinance organizations hoping to increase profits have an incentive to give out larger loans, which may leave the poorest would-be borrowers without financial options. “In finance you talk about a bottom line, but in microfinance there is what we call ‘double bottom line,’ which is the point where an MFI is both profitable and relieves poverty,” said Dubas. “One of the greatest challenges is balancing profitability with your original mission.”

Organizations like PlaNet Finance and the Grameen Foundation have helped advise China’s MFIs on international best practices. However, some organizations in the country seem more concerned with earning returns for their investors than providing a meaningful service to their poorest clients. In perhaps the most dramatic example, one microcredit company based in Xi’an gave a presentation to PlaNet Finance where it revealed it was giving loans of up to RMB 2 million (USD 292,000), while servicing only 300 clients. “If that’s your structure, then you have no outreach and you are not serving the poor,” said Dubas.

As Chinese microfinance organizations grow larger and attract more investment, the debate over their mission will only increase. Lomboy closed his remarks at the fundraiser with a fable about a village that was attacked and looted by a giant once a year. Every year, the village sent its greatest warrior to climb the mountain to the giant’s cave and kill him. However, upon completing the task, the warrior would become enamored of the giant’s riches and take his place. “All of us in the microfinance industry have to ask ourselves, are we just going to slay the giant. Or are we going to become the giant, too?” With the new legal structures in place, China’s microfinance sector is certain to become gigantic. What form it will take remains to be seen.

http://www.cibmagazine.com.cn/Features/Economy.asp?id=782&giant_steps.html