To boost rural incomes, Beijing could ease micro-finance rules

China's leaders talk a lot about lifting incomes for the country's rural poor. Their talk is unconvincing. In many cases the ground-level implementation of government policies hinders rather than helps wealth creation among the 54 per cent of the population who still live in the countryside. Just consider how mainland banking regulations have obstructed the development of China's micro-finance sector. Despite recent criticisms comparing some micro-lenders in India to loan sharks, experience around the world shows that institutions which specialise in making miniature loans to very small businesses can play a big role in creating wealth and reducing poverty, especially in areas where small-scale entrepreneurs have little or no access to conventional financial services. Yet micro-lenders are almost non-existent in China. Although the authorities have approved 1,000 micro-finance licences, the regulatory deck remains stacked against the emergence of the sort of lively small loan markets that have grown up in other developing economies. For a start, would-be micro-lenders are burdened with onerous capital requirements. They must put up 100 million yuan (HK$118.6 million) of capital before they can open their first branch, with a further 50 million yuan required for every additional branch they open. Worse, whereas conventional lenders can gear up their capital eight times over, micro-lenders may only gear up 0.5 times. In other words, a micro-finance company with 100 million yuan in capital may make at most only 150 million yuan of loans. On top of that, micro-lenders in China are extremely constrained in the interest rates they can levy. Under the current regulations, they are not allowed to charge more than four times the benchmark lending rate. At the moment that means they can charge an interest rate of up to 22.4 per cent on a six month loan. That sounds steep - until you consider it is only around half the interest rate currently imposed by credit card issuers in Hong Kong. As a result, micro-lending in China is barely an economic proposition. Even so, some are prepared to try. For example, not-for-profit organisation Accion International opened a pilot branch in Chifeng, Inner Mongolia, in December 2009. Just over 15 months later, Accion has around 900 loans outstanding. Customers are typically small businesses like shops, restaurants, farmers and small-scale hauliers, who borrow an average 30,000 yuan for terms of six to nine months to fund their working capital needs. With no credit data available, Accion's 30 staff are forced to gauge borrowers' ability to service their loans by estimating their likely cash flow. The assessments are time-consuming and labour-intensive. Credit officers will typically sit in a restaurant all day to count the number of customers coming in. As a result, says Accion's US-based managing director Roy Jacobowitz, 'Breaking even on first loans is almost impossible.' Still, with a healthy increase in the number of new borrowers and a high enough level of repeat business, he hopes Accion's Inner Mongolian pilot will be able to break even by the end of its third year in business. That's not an attractive enough prospect for most commercial lenders. As a result, says Jacobowitz, most micro-credit licensees in China have restricted themselves to making larger loans of 500,000 yuan or more to bigger, more established companies to finance stock purchases. And that's a shame, because there is evidence that the sort of small-scale investments Accion is looking to finance can yield big gains in rural income levels. According to a new survey by rural development institute Landesa, since new land tenure laws were passed in 1998 some 22 million farm households in China have invested nearly 950 billion yuan - 43,000 yuan each - in diversifying their income, for example by building greenhouses on their land. Almost all that investment was financed by personal savings together with money borrowed from friends and family. Fewer than 12 per cent of projects involved formal financing, whether from rural credit unions or agricultural banks. Yet these investments have had a huge impact on earnings. According to the Landesa survey, in 2009 income directly attributable to these investment projects came to 454 billion yuan. That's 12 per cent of total rural income for the year and nearly four times the income from the government's much-vaunted rural subsidies. Clearly small investments can generate big increases in rural income. So it is surprising, if not perverse, that the authorities continue to obstruct the development of the sort of micro-lending needed to fund more of these small-scale projects. The most common reason given is that the authorities are anxious to prevent the rural debt boom and bust they fear could follow liberalisation of the micro-lending rules. Such a boom and bust scenario could well be a danger if the authorities were to embark on wholesale deregulation. But weighed against the potential increase in rural incomes that could follow, the authorities' concerns should not be allowed to prevent a partial easing of the current, overly-restrictive regulations. Helping the poor, after all, is supposed to be a key objective of government policy.