Restructuring Chinas Rural Credit Cooperatives: Lessons Learned

1
Restructuring Chinas Rural Credit Cooperatives
Lessons Learned

• Wang Jun, Senior Financial Sector Specialist
• EAP Region, the World Bank
• December 5, 2005

2
Main points of the presentation

• A brief history of the RCCs
• Recent attempts at restructuring the RCCs
• Objectives and options

• Objectives
• Financial restructuring
• Diversity in organization formats
• Incentives

• Financial restructuring should be accompanied
  with operations restructuring
• Role of government
• Role of foreign and private investors

3
Main players in Chinas rural financial market
How the RCCs became a virtual monopoly in rural
finance
Established as a specialized agricultural bank,
but a became commercialized state-owned bank and
withdrew from the countryside after 1998
Established in 1994 with the objective to take
over policy lending from the ABC, and became a
funding vehicle for procurement of grain, cotton
and edible oil.
A deposit-only financial institution that has
been regarded as a capital sucking machine on the
rural financial market, with about 80 of its
over one trillion deposits taken from the
countryside.
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But the RCCs were subject to conflicting mandates
Social objectives
Commercial objectives

• To become commercially sustainable over time
• To be transformed into commercial entities with
  all forms of corporate governance in modern
  financial institutions
• To introduce commercial managerial systems and
  controls by mimicking commercial banks

• Support agricultural production
• Poverty reduction
• Rural financial stability
• Support the rural economy
• Support various policy initiatives by the local
  government

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The RCCs were subject to stakeholders with
conflicting objectives

• The government
• Central
• Local

• The regulatory authorities
• CBRC
• PBC

• The market
• ABC
• PSRB
• Money lenders

RCCs

• The owners/clients
• Members
• customers

And they were no different than state-owned banks
in the rural financial market
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Main objectives of the RCC reform pilot
A three-pronged approach to restructuring the RCCs

• Ownership transformation
• Create all forms of corporate governance

• Consolidate ownership at the county level
• Rural commercial banks
• Rural cooperative banks
• RCC union at the provincial level

• Hand over managerial responsibilities to the
  provincial government
• Allow the CBRC to concentrate on regulation and
  supervision of RFIs
• Fund historical losses through monetization and
  fiscal support

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The RCCs were given two options to compensate
historical losses
A re-lending facility
Special CB notes

• Local governments borrow from the PBC to cover
  50 of the historical losses with cut-off date of
  December 31, 2002
• Maturity ranges from 3 to 5 to 8 years depending
  on circumstances of the RCCs
• Interest rates charged were half of the that for
  required reserve
• And insolvency data were calculated according to
  a formula set by the PBC, which specified loss
  ratios to each category of loan classification

• A special note with two-year maturity, issued by
  the PBC to reforming RCCs in exchange of NPLs
• The special notes were not tradable, endorsable
  and could not be used as collateral
• But could be redeemed ahead of maturity with
  conditions attached
• Redemption of the special notes were conditioned
  upon improvements in RCC reforms, and would be
  verified based on performances of individual RCCs
• Criteria for redemption include ownership
  transformation corporate governance capital
  adequacy NPL ratio, etc.

In the end almost all provinces opted for the
special notes
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Capital adequacy of the 8 provinces before and
after financial restructuring, 2002-04, in percent
9
Aggregate capital of RCCs in the 8 provinces
participating in the pilot
Capital Adequacy Ratio Unit
Net Capital Unit RMB100 Million
The aggregate negative capital of all RCCs stood
at 122.74 billion at end 2002.
10
Portfolio quality of RCCs appeared to have
improved in the 8 pilot provinces, but did they
really?
Non-performing loans Unit RMB 100 million
Non-performing loans In percent
And the average NPL ratio of all RCCs combined ws
37 at end 2002
The aggregate NPLs stood at 505.9 billion yuan
at end 2002
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Looks can be deceptive are the RCCs really
making money?Profitability of RCCs in the 8
provinces
Unit RMB100 Million
12
Volume of loan growth maybe, but hard to tell if
agricultural lending also grew
Outstanding Loans Unit RMB100 Million
Outstanding Agricultural Loans Unit RMB100
Million
13
The RCC reform pilot was given little time for
experimentation

• 8 provinces participated in the pilot
• Jilin
• Jiangsu
• Jiangxi
• Shandong
• Shanxi
• Guizhou
• Zhejiang
• Chongqing

• 21 other provinces were brought in, with the
  exception of
• Hainan which opted not to participate in the
  pilot
• Tibet where there are no rural credit cooperatives

The hastiness in pushing the pilot, slightly one
year into it, to the rest of the country
seriously damaged credibility of the pilot scheme.
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Examples of perverse incentives
The option to set up provincial RCCU
The option for PBC special notes

• All provinces chose to set up a RCC union at the
  provincial level, and personnel appointment
  became an obsession
• All eligible RCCs chose to be converted to
  Rural Cooperative Banks

• All provinces chose the PBC special notes as the
  funding option, given the apparent financial
  advantages
• In order to meet the requirements for redemption,
  local government offered guaranteed dividends
  payment to new shareholders
• Some bank regulators ended up being owners of
  RCCs under their regulation and supervision,
  especially in localities where new equity was
  hard to mobilize

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The role of government remains dubious
Under the central government
The option for PBC special notes

• First the PBC, later the CBRC, served as both
  owner and regulator
• RCC managers were appointed by the government
  agencies at various levels
• The CBRC is supposed to limit its role to
  regulation and supervision
• The government protected the RCCs from market
  competition
• The government officials driving the RCC reform
  pilot got promoted or reassigned elsewhere,
  casting uncertainty over the future of RCC reform

• The provincial government assumed managerial
  power and run the RCCs through the provincial RCC
  Union
• RCC managers now appointed by the RCC Union
  representing the provincial government
• The fit and proper test by the CBRC sometimes
  become overbearing
• The government continues to protect the RCCs from
  market competition through entry and exit
  policies

The central bank is preparing another pilot to
introduce credit-only commercial microfinance
institutions in 5 provinces, with the objective
to increase competition in the rural financial
market while bringing in commercially sustainable
microfinance to improve access to finance
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The role of foreign and private investors in RFIs

• Limited experiment in equity participation by
  foreign and private financial institutions in the
  emerging RFIs
• IFC and Rabobank in Hangzhou RCCU
• IFC and Rabobank in Tianjin Rural Cooperative
  Bank
• Equity participation in the PBC sanctioned
  credit-only MFIs in selected provinces, which
  could serve to break the monopoly of RCCs in
  those localities
• Other experiments