Diverse Demand
One consequence of the lack of competition in rural financial markets is the creation of a monotypic rural financial system that cannot cope with the different demands for services among the eastern, central, and western regions. A system with the RCC as the sole player cannot meet the demands of farmers and enterprises in different regions. With the development of local economies and urbanization, demands for financial services have been evolving. Moreover, different economic structures in different areas produce different demands for financial services. RCCs, with their similar operational structures, lending modes, internal management, and incentive systems, are unable to meet these diverse demands in a timely fashion.
Capital Outflows
Since the mid-1990s, the sluggish and volatile nature of agricultural product prices, the low productivity of small-scale, self-sufficient rural households, and the large number of closures of township enterprises have contributed to the lack of investment opportunities in rural areas. This has forced many farmers to migrate to other provinces. The earnings of these farmers are remitted back to the rural financial institutions in their hometowns but then flow to the eastern and more-developed regions through institutional purchases of Treasury bonds and deposits in upper-level entities. As a result, insufficient funds are available for sannong, and rural economic development enters a vicious cycle.
Postal savings enjoys very high redeposit interest rates at the PBC, which translates into a hemorrhage of rural funds into other regions
Rural funds flow out through three channels: state-owned commercial banks, postal savings, and RCCs. State-owned commercial banks have shrunk their branch networks and tightened credit controls, and most county and lower-level offices of the four largest state-owned commercial banks are required to redeposit funds in their upper-level entities. Postal savings enjoys very high redeposit interest rates at the PBC, which translates into a hemorrhage of rural funds into other regions. Finally, many RCCs purchase Treasury bonds, deposit funds in other financial institutions, and lend to urban clients, which translates into additional outflows.
Difficult Access to Credit
Most rural households, especially those running small and medium-sized rural enterprises, have difficulty accessing credit. With commercialization, the ABC has abandoned some branches and merged others. Meanwhile, the mode and means of RCC services cannot meet the demands of rural households or rural economic development. Although RCCs have increased microfinance lending to rural households, loans to small and medium-sized rural enterprises have been shrinking significantly. In addition, because microfinance loans largely depend on PBC agriculture onlending, they feature high transaction costs and loan sizes are small. With the fixed interest ceiling, RCCs can hardly maintain their microfinance operations in the long run. In many central and western provinces, loss-making RCCs are unable or unwilling to lend to rural households, whereas PBC onlending for agriculture is unequal to the demand for credit, forcing farmers to depend on borrowing from relatives, friends, or informal sources. The government’s poverty alleviation loans through the ABC can barely accommodate rural households.
Government Credit Inputs
If the old rural financial system supported the PRC’s rural economic development, the financial support represented a kind of overdraft and was therefore unsustainable. It is impossible to solve the problem of outflow of rural funds and to ease the difficulties in accessing credit in rural areas with PBC onlending and poverty alleviation loans, both of which are fiscal in nature. The PBC’s relending is utterly inadequate in dealing with the vast demand in rural areas. It was difficult for government-sponsored, interest-subsidized poverty reduction loans dispensed through the ABC to truly benefit rural households, and the persistently high nonperforming loan ratio of poverty reduction loans made it difficult to achieve the anticipated poverty reduction.
Key factors widening the gap between urban and rural areas are the relative access to fiscal funds, national and local government investment, and the different returns on investment in various regions
Key factors widening the gap between urban and rural areas are the relative access to fiscal funds, national and local government investment, and the different returns on investment in various regions. Although support for sannong is important, finance cannot serve the function of fiscal policy. In the past, the central and local governments have misconstrued finance, making it shoulder too many fiscal functions. This has resulted in huge losses, shrinking rural financial services, increased outflows of rural funds, and serious moral hazards.
Insider Control
The advantages of local rural financial institutions lie in their access to local information, which can reduce monitoring costs and information asymmetry. However, under the current system, RCC management assumes little responsibility for RCC performance. In the absence of significant changes in the ownership arrangements and governance structures of rural financial institutions, the reforms remain under the control of an RCC management that benefits from the current system. With weak governance, risk control can only be strengthened by administrative measures—that is, by concentrating decisionmaking power. At the ABC, this is done by depriving lower-level branches of decisionmaking power over loans; RCCs concentrate decision-making power regarding lending and treasury functions in the rural credit cooperative unions. Nevertheless, concentrated decision-making power can hardly solve the problem of asymmetric information or encourage a timely response to changes in demand.
Lack of an Enabling Operating Environment
There are insufficient risk-sharing mechanisms for rural loans. Underdeveloped agriculture insurance, the rudimentary futures market for agricultural products, and various legal and policy constraints have prevented rural financial institutions from finding efficient substitutes for collateral and guaranty. At the same time, rural financial institutions have few incentives to resolve collateral-and-guaranty difficulties through financial innovation. The sustainable development of these institutions also is hampered by tax policies and controlled interest rates.
Lessons from Rural Finance Reform
Past reform has not fundamentally changed the basic structure of rural finance in the PRC. First, the government still controls rural finance, and the commercialization of financial institutions has been limited by both lending policy and low interest rates. Second, the market structure has not changed, and RCCs still dominate rural financial markets. Third, the performance of financial institutions has not fundamentally improved. This represents a sharp contrast with the nation’s robust economic growth, particularly rural economic growth, in the past 2 decades.
The traditional rural financial system has contributed to rural economic growth, but the “overdraft” of financial resources from rural areas can hardly be sustained. The delay in reform has hampered the ability of rural finance to support the rural economy, and its inefficiency will obstruct rural economic growth. For too long, the rural financial system has been undergoing reform in name, but this reform has centered on improving the external administrative system of RCCs rather than putting in place effective internal incentive and discipline mechanisms. Regardless of nominal changes, therefore, the RCCs have failed to