Informal Lending Amongst Friends and Relatives: Can Microcredit Compete in Rural China?

2 Since 2006 China's central government has opened up its financial markets to foreign Microfinance Institutions (MFI). The idea is that by allowing MFI's to operate, Agricultural Banks would lead to increase access to credit, economic efficiencies and growth in rural agriculture, and efficiency within the financial system in underserved markets. Microfinance as it is understood today refers to a broad range of services-loans, savings, insurance, remittance transfers, and pensions offered to rural and urban poor through a variety of commercial banks, cooperatives, credit unions, specialized banks, post offices and retail chains (Meyer and Nagarajan 2006; Zeller 2006 provides a summary of the characteristics of different types of microfinance institutions). It is towards this broader definition that Chinese policy in the past few years has been directed. The formalization of microcredit in China started in 1994 when the Chinese Academy of Social Sciences piloted a Grameen-style NGO (Park and Ren, 2000; Tsai 2004). This quickly led to numerous new initiatives by at least 17 MFI reportedly making micro loans of 1,000 Yuan or less and with none exceeding 4,200 Yuan. The interest rates on these early models was about 12% when poverty alleviation loans could be obtained through RCC for about 2.88%., although the bulk of poverty loans did not reach the poor. The pilots were targeted to the poor, designed to maximize repayment rates through group liability, dynamic incentives, and regular repayment, and directed to bring net benefits to the poor while not crowding out other (formal) sources. Early models such as the Yucheng 'Funding the Poor' Cooperative obtained funds from international donors, including Grameen. By 1996 the Chinese Government established government run MFIs making micro-loans to 50,000 households, and by 1998 22 provinces had microfinance programs with about 600 million Yuan lent (cooperative financial institutes in China were 1,226,000 million Yuan and amongst them, micro credit loans outstanding for farm households was 203,800 million Yuan, group lending outstanding was 135,100 million Yuan, and 7.742 million farm households were provided microloans loans(China Agriculture Department, 2009). 3 Whether or not current reforms will work as intended is an open question (Guo and Jia, 2009). Several problems prevail. First as described in Meyer and Nagarajan (2006) there is a long history of microfinance and microcredit to which China is a late entry and may not have the necessary institutions to support large scale microcredit initiatives beyond what currently exists with RCCs. …