the china initiative to kick start rural development and reform, when successful, will be far more weighty in global impact than what has gone on over the past quarter century
check the news per Stratfor, skip their analysis
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Global Market Brief: New Credit to Feed China's Rural Development
The China Development Bank (CDB) and Postal Savings Bank (PSB) signed a formal strategic cooperative agreement Dec. 9. The agreement officially marks China's first step toward setting up a banking system akin to the one it already has, specifically to cater to its rural economy. This is a move toward Beijing's goal of redistributing wealth and economic development between China's urban and rural regions.
The Chinese Banking System and NPLs
The Chinese economy, like Japan's, was built on the concept of state-directed lending -- loans issued not for efficiency but out of consideration for political and social stability. As a result, loans were often given to loss-making enterprises lacking the ability and/or will to repay, especially when such loans were so easy to roll over (rather than bankrupting businesses or writing off loans, banks often rolled over and extended debt to enterprises so old debts could be repaid and the appearance of financial health would be maintained).
Thus, the Chinese banking system existed not to channel money from savings accounts to the most profitable segments of China's economy, but to direct money from savers to the most strategic or politically connected enterprises on behalf of the government. Enterprises most able to turn a profit often could not get bank loans because they lacked political connections, while government officials had credit almost as if on tap to pour into land and equity markets. Nonperforming loans (NPLs) accumulated without limit inside the Chinese system.
The only reason China was not dragged down by the 1997 Asian financial crisis -- as countless other similarly structured Asian economies were -- was China's relative insulation from global capital markets at the time. Other economies' suffering in the aftermath of the crisis served as a catalyst for Beijing to make NPLs one key focus of its financial reform agenda.
This agenda has, to an extent, made notable progress in the last few years. Although China's NPLs have not been repaid or written off, the bulk of the loans no longer sit on state bank balance sheets. Rather, they have been shelved away in the books of multiple state-owned asset management companies -- books that remain covered up and away from public eyes.
So long as Beijing is able to continue servicing these shelved liabilities, there are no obvious pressing concerns. But another problem exists in the proportion of potential NPLs (loans already issued to bad borrowers) that have yet to go bust. As in the U.S. sub-prime crisis, loans were handed out that never would have been given if efficient credit checks were in place. China's next NPL crisis has yet to hit. There is no way of telling when this potential new wave of dubious loans will go bust, or how big it will be. When it does -- depending on the size of the wave and the amount in Beijing's coffers -- a financial implosion cannot be ruled out.
Some of the same state bank lenders are continuing with these poor lending practices. Initial progress has been made in re-educating Chinese lenders in efficient loan risk assessments (for example, revamping national loan risk categorization to conform to international best practice). But until Beijing stops using banks to direct credit to policy priorities, future NPL build-ups are nearly inevitable.
China's Rural Financial Sector
So where do rural banks fit in all this?
China's rural financial sector has been relatively less affected by Beijing's overall financial reform program (and the associated layoffs and bankruptcies) designed to solve the endemic NPL problem that has plagued China's wider banking system for decades. Because a large segment of China's population -- more than 800 million of China's 1.3 billion citizens -- are rural citizens, Beijing has continually hesitated to reform the Agricultural Bank of China even as each of the other Big Four Chinese commercial state banks were cleaned up and listed on stock exchanges around the world.
To put the rural-urban split in context, China's entire banking industry can be broadly split into two categories: banks fed by urban credit and banks fed by rural credit. Urban credit has typically been used to make loans in urban regions, and rural credit in both urban and rural regions -- hence the rural anger over how the fruits of economic growth have concentrated in urban areas.
Farmers' savings sitting in China's financial system have typically gone into China Post, the Agricultural Bank of China, rural credit cooperatives run by local governments, or unofficial rural money operators. About one-tenth of these savings have never been re-used and lent out as new credit inside China. This sum -- more than $206 billion -- currently sits in the PSB, which was spun off from China Post in March.
China's financial reformers engineered that spin-off to expand financing channels for the hundreds of millions of rural residents, assist in financing China's rural construction plans through 2020, quell rising rural discontent and kick-start domestic consumption among the rural populace. Thus, the PSB became a pivotal part of China's social, rural and financial reforms.
PSB's unique appeal as a source of new domestic loans comes from its insulation from the rest of China's fundamentally diseased banking system. Its portion of Chinese savings is not tied into the rest of the sector's maze of distorted NPLs, many of which have been recycled multiple times to roll over past debts. Using postal savings, the Chinese government can redirect real, fresh credit (as opposed to subsidized, rolled-over credit) toward the most underdeveloped sections of society without sucking credit out of -- and potentially toppling -- the asset pool supporting the other Big Four banks.
Since its creation, the PSB has invested heavily in the southwestern province of Sichuan -- home to two key pilot reform cities in Beijing's latest experiment for equalizing China's severely lopsided urban-rural development -- primarily through China's top state policy bank, the CDB.
The CDB is China's version of the World Bank or International Bank for Reconstruction and Development -- banks that offer loans (at slightly below market rates) to fund development projects, typically in low- to middle-income countries. The CDB is different in that it is directly connected to a country's government and channels most of its funds toward development projects only within China. Besides funding its rural development initiative with new PSB credit, Beijing also is using some capital from its new sovereign fund -- the China Investment Corp. -- to fuel the CDB.
Financing China's Rural Development
Ultimately, Beijing wants to shift the issuance of loans for small rural households, firms and self-employed businessmen away from unofficial Chinese lenders and into a formal rural banking system.
Beijing's pilot rural development program aims to use rural credit to generate new loans for rural businesses and entrepreneurs. The involvement of foreign banks such as Citibank and HSBC (which opened its first Chinese rural bank branch in Hubei province Dec. 13) and microfinance service providers like Microcred Nanjing and the Grameen Foundation will instill more efficient lending practices from the start and avoid another buildup of latent NPLs.
Microfinance institutions differ from development banks because they tend to be much smaller and they provide credit, savings, insurance and payment facilities to poor household and small enterprises. Hence, financing for small, medium and large rural projects will be offered in Beijing's vision of rural development. Foreign banks bring credibility and capital capable of financing large-scale infrastructure projects, while foreign microfinance service providers act as an intermediate step for getting rural borrowers more accustomed to personalized, smaller-scale operations, helping to ensure that all segments of rural society are covered.
Right now, CDB only has a formal agreement with PSB in Sichuan. Keeping this rural financial experiment limited to Sichuan is a smart move, as China is still not prepared to implement effective risk-assessment mechanisms across all its banks. And the majority of PSB's 270 million account holders -- who could be exposed to risk if all PSB assets were released at once -- would be from rural areas. This means any failure will induce political volatility (most rural residents have put their life savings into postal savings accounts).
Of all China's financial experiments, its rural development pilot stands a higher chance of success than any before it -- mainly because it is based on new, untarnished credit with no strings attached and because foreign expertise is involved in spearheading this program. The main risk is that CDB (which is used to implement China's overall internal development strategy) could start tapping this new pot of rural credit for agendas outside of rural development, or start overriding efficient lending principles for policy or personal reasons
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