Long-expected rural financial reform is in the pipeline. State Council, the Chinese cabinet, has since last November approved plans by eight provinces and municipalities to fully restructure local rural credit cooperatives (RCCs), launching a series of pilot projects.

The pilot areas are Chongqing Municipality and Jilin, Shandong, Zhejiang, Guizhou, Jiangxi, Jiangsu and Shaanxi provinces.

RCCs were initiated in the 1950s to provide financial services to farmers. Although they have made contributions to China's rural economic development, their establishment was based on government directives, not in line with principles of voluntary participation, mutual benefit and cooperation, as well as democratic management.

So far, the RCCs have lost their basic function as cooperative financial institutions after rounds of reshuffles since their establishment. Moreover, the RCCs are already in trouble and becoming the most fragile financial institutions in China due to ambiguous ownership, weak supervision, poor management and inefficient products that fail to fill farmers' needs. Calls to link up RCCs and increase the growth of smaller banks intensified in some developed coastal areas with the rapid economic expansion over the past years.

Back in black

China now has 34,909 RCCs, with a combined 2.23 trillion yuan ($270 billion) in outstanding deposits and 1.61 trillion yuan ($194 billion) in outstanding loans.

Those figures translate into 11.5 percent of the deposits in China, and 10.8 per cent of the loans in the country.

RCCs are saddled with massive bad debts-estimated at 500 billion yuan ($60 billion)-with the non-performing loan (NPL) ratio possibly exceeding 50 percent, analysts say.

But the China Banking Regulatory Commission (CBRC) said recently that RCCs made an aggregate profit of 148 million yuan ($17.8 million) in the first 11 months of 2003, ending a streak of losses that started as early as 1994.

The commission attributed the reversal to a hefty rise in loans, substantial improvement in asset quality as well as progress in a cost-reducing campaign.

In 2002, China's four state-owned commercial banks-the Industrial and Commercial Bank of China (ICBC), the Bank of China (BOC), China Construction Bank (CCB) and the Agricultural Bank of China (ABC) closed their outlets in rural areas successively to focus on more profitable businesses in big cities. This has left the mission of financing agricultural needs with RCCs. Though it is known that private funding, that is banned for the moment, has increased its spread to rural areas, RCCs have served as major lenders in the rural financial market.

To a large agricultural country like China, RCCs play an important role in rural development. Therefore, maintaining their sound operation has become imperative. On June 27 last year, the State Council unveiled the pilot reform program on RCCs, and later called a meeting attended by leadership from eight experimental areas on August 18. Reform was placed high on the agenda.

True financial link

Rural financial reform is vital to rural economic development. According to Wang Hongzhang, Governor of the People's Bank of China Chengdu Branch, RCCs would be rooted in villages and aimed at providing service for farmers, no matter what reforms are going to happen. Currently RCCs are the primary funding channel in China's countryside, distributing some 75 percent of all agricultural loans. The reform is expected to make RCCs the true financial link with farmers through overhaul to RCCs' ownership and management. As China's villages still lag behind urban development, completely market-oriented reform of RCCs is impractical since they still need government policy support.

As the economic lifeline of the rural area, RCCs' reform will compromise the entire financial structure should it fail. Therefore, how to keep RCCs' operation steady during the reform process, as well as where the reform will go, have become hot topics for discussion.

According to the program, the reform is to gradually transform RCCs into shareholding financial institutions. RCCs will be able to establish their equity structures based on local conditions. Farmers, small business owners and other economic organizations based in rural areas could become RCC shareholders, in the form of shareholding entities or partnerships.

The reform will enable some RCCs, especially those in regions where industry is more developed, to upgrade into shareholding commercial banks, analysts say. But it also allows flexibility for those that are not able to grow into commercial banks.

Unlike the banking system, which has a clearer management structure-from headquarters to local branches and outlets-the RCCs have been largely regulated directly by the central banking watchdog and its local offices. Under the pilot scheme, management of the cooperatives will be transferred from the central bank to local governments.

Granting more power to the local governments in RCC management would enable each region to adopt a most feasible mode to suit its own situation, analysts said.

The CBRC will shoulder the financial supervision of the RCCs, which is still part of the overall rural financial system. Experts say the complicated reform is preconditioned on sound cooperation among various government departments.

Reform of RCCs was viewed one of the most pressing concerns for the People's Bank of China, but the work has been transferred to CBRC following a split from the nation's central bank earlier last year.

The move was echoed with repeated calls to establish private banks, as a way to further open the market to private funds, in line with opening the market to foreign competition following the country's WTO (World Trade Organization) entry.

Concrete steps

To ensure the smooth progress of the reform, the government has offered supporting policies: RCCs that are losing money because of conducting inflation-adjusted savings deposits at the government direction will enjoy subsidy from the state; pilot cooperatives in less developed western provinces will be exempt from paying income taxes from January 1, 2003, until the end of 2005, and RCCs in other pilot areas will pay just half the taxes; and, from January 1, 2003, RCCs under the reform scheme need to pay business tax at a rate of only 3 percent, in addition to some fund injection.

The action plans of the eight pilot provinces and municipalities based on the reform program all contain concrete steps in five aspects-management system, equity structure, policy support, operation mechanism and services to farmers.

All the provinces and municipalities will each create a provincial-level credit cooperative union to manage and guide all of their restructured RCCs, the CBRC said. Provincial governments are, under the reform scheme, given the responsibility of administrating and guiding RCCs and handling losses of any RCC failures.

The pilot areas will form about 30 rural commercial banks and rural cooperative banks on the basis of RCCs. The CBRC says it will take two to three years to bring their capital adequacy ratios up to regulatory requirements.

The government will infuse about 38 billion yuan ($4.59 billion) into RCCs in the pilot areas to help them write off NPLs and establish sound operation mechanisms. Meanwhile, local governments will also offer various measures, such as clearing bad loans and asset transfers.

(Beijing Review February 11, 2004)