Cablegate: World Bank/Ifc's Chengdu Officials On Structural Impediments

VZCZCXRO2973
PP RUEHGH RUEHVC
DE RUEHCN #0271/01 3341719
ZNR UUUUU ZZH
P R 301719Z NOV 09
FM AMCONSUL CHENGDU
TO RUEHC/SECSTATE WASHDC PRIORITY 3549
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHOO/CHINA POSTS COLLECTIVE
RUEHCN/AMCONSUL CHENGDU 4260

UNCLAS SECTION 01 OF 04 CHENGDU 000271
Q
SENSITIVE
SIPDIS

STATE FOR EAP/CM

E.O. 12958: N/A
TAGS: ECON EIND EFIN PGOV CH
SUBJECT: WORLD BANK/IFC'S CHENGDU OFFICIALS ON STRUCTURAL IMPEDIMENTS
TO SME- AND MICRO-FINANCING

REF: BEIJING 2952

CHENGDU 00000271 001.2 OF 004

1. (U) This cable contains sensitive but unclassified
information - not for distribution on the Internet.

2. (SBU) Summary: Small business access to credit in China is a
long-term, structural problem that 'is not going away for the
next 10-20 years", a Chengdu-based official of the World Bank's
International Finance Corporation (IFC) told Consul General.
While official statistics indicate increased small and medium
enterprise (SME) financing in 2009, this has gone primarily to
the "medium" end of the spectrum, with true small and micro
ventures remaining significantly underserved. The development
of a healthy, non-deposit taking lending institution (NDTL)
sector, requiring significant financial sector liberalization,
is the key long-term solution, he said. Newly-emerging local
credit guarantee companies (CGS) could evolve into an important
component of the sector, if allowed to start legally lending.
He also advocated increased government support for rural SME
credit, particularly through "value chain financing," a new
approach IFC is promoting in China. End Summary.

IFC on Goals and Activities
in Southwest China; Optimism About Chongqing
--------------------------------------------

3. (SBU) In a November 10 meeting with Consul General, Lai
Jinchang, head of IFC's Chengdu office, discussed:

-- the challenges China faces in providing sufficient credit to
small and micro-enterprises;
-- the particular challenges of addressing rural credit access;
and,
-- how IFC is working to address these issues.

Also in the meeting were Charlie Cheng, Program Manager for
Corporate Advice-Sustainability and Lin Huang, Operations
Officer. The IFC's Chengdu office was created in 2001, at the
request of the Chinese Government, following the launching of
the PRC's "Go West" policy on January 1, 2000. Although its
emphasis is on western China, the IFC Chengdu office coordinates
with the Beijing and Ulaanbaatar offices on IFC's overall
China/Mongolia programs.

4. (U) IFC Chengdu primarily focuses on technical advising
services, but also has two investment officers and has
coordinated IFC investment in:

-- Renshou Minfu Rural Bank, a village and township bank (VTB)
an initiative by the Leshan City Commercial Bank, in Sichuan
province, to promote micro-finance; and,
-- the Chengdu Small Enterprise Credit Guarantee Company, which
guarantees loans to SMEs by local credit cooperatives and
commercial banks.

The office is working to help create and invest in additional
microfinance institutions throughout Southwest China, including
in Guizhou, Yunnan, and Chongqing (as well as Xinjiang). (Note:
IFC investments are limited to a maximum of 20 percent of a
target institution, Lai said. End Note.)

5. (SBU) Lai expressed particular optimism about Chongqing,
reporting that Mayor Wang Hongju "has been very open-minded" and
expressed to IFC that he wants a micro-credit company in each of
its 40 counties and districts. (Note: We understand that about
four have been established there within the last year. End
Note.) However, the IFC has no activities in the Tibetan
Autonomous Region (TAR) -- they "can't touch" it, noted Lai, as
it is "too sensitive." (Note: According to local TAR officials
China provides microfinance in the TAR via its "Developing
Border Areas and Enriching People" (xingbian fumin) initiative,
which officially covers the entire autonomous region. They
cited as an example the state-owned Agricultural Bank of China's
micro-finance subsidiary (xinyongshe) in the TAR, which provides
micro-credit to farmers and herders (nongmumin). End Note.)

IFC Official: SME Credit Access a Long-Term Structural Challenge
--------------------------------------------- -------------------

6. (SBU) In Lai's assessment, substantive expansion of credit
access to China's SMEs is fundamentally impeded by long-term
structural challenges, specifically the lack of a developed
non-deposit taking lender (NDTL) sector. This fundamental
problem, he said, is 'not going away for the next 10-20 years."
The lack of NDTLs stems from an underdeveloped capital market,
and cannot be addressed without true, long-term liberalization
of the financial sector, he said. Lai estimates that 90-95
percent of debt financing in China currently comes from

CHENGDU 00000271 002.2 OF 004

deposit-taking institutions (banks), in contrast to his estimate
of bank finance comprising no more than 60 percent of the total
in the United States. Chinese banks, he asserted will remain,
both by regulation and necessity, conservative (policy-lending)
institutions that will continue to loan primarily to the larger
end of the business spectrum. (Comment: Lai's emphasis on the
financial sector's structure as the primary issue adds to the
barriers to SME credit that others have told us about, including
the banks' lack of familiarity with SMEs and a consequent
inability to properly assess risk; lack of effective rule of law
to enforce contrQts; and corruption and nepotism. Q Comment.)

7. (SBU) Acknowledging recent official emphasis on expanding SME
credit (such as the State Council's September directive to
bolster SMEs), and recent statistics citing an increase in SME
lending in 2009 supported by the stimulus package, Lai argued
that the vast majority of this lending is going to the medium
end of the SME scale, leaving out most truly small businesses.
There is widespread misapplication of the "micro," "small," and
"medium" labels throughout China, he argued. In his view the
business lending market should be analytically divided up into
five categories of enterprises: a) micro, b) micro - small, c)
small, d) medium, and e) large corporations. (Note: He did not
provide a hard definition of each category in regards to either
number of employees or level of assets. End Note.) The real
challenge to accessing credit falls within the first three
categories, he noted. Thus, he said, too often when "SMEs" are
said to be benefiting from increased access to credit, the funds
are mostly flowing to medium-sized enterprises, or at best the
very top end of the small business market. Almost all micro and
most small enterprises have seen no genuine expansion in credit
access, Lai asserted.

Few "Microfinance" Institutions Actually Providing Microfinance
--------------------------------------------- ------------------

8. (SBU) Lai noted that officially there are three types of
financial institutions in China that are supposed to be
providing micro credit, including:

-- banks that are downscaling to provide a "micro" product;
-- the village and township banks (VTBs), piloted under the
Banking and Regulatory Commission; and,
-- micro-credit corporations (MCCs), non-deposit taking
institutions piloted under the People's Bank of China.

However, of the 1000 MCCs and 110 VTBs he estimates have been
established nationwide, he believes that most -- "practically
all" -- do not actually do microfinance. Typical loans of these
institutions, he said, rarely fall below 2 - 3 million RMB
(approximately 295,000 - 440,000 USD). He cited IFC-supported
institutions, by contrast, as an exception, asserting that they
are doing "real" microfinance, although he did not specify the
loan amounts they were dispersing. (Note: Some international
NGOs in Southwest China, such as the Nature Conservancy and the
Mountain Institute, are also providing microfinance. End note.)

9. (SBU) Lai was generally pessimistic about the ability of
major Chinese commercial banks to service the lower end of the
SME spectrum in Southwest China. Citing the case of Minsheng
Bank, which established a "small enterprise" financing capacity
at its Chengdu branch several years ago, he emphasized that they
will "never do micro-credit," and that "the actual size of
Minsheng's loans is much larger than the IFC considers to be
microfinance."

10. (SBU) Lai also dismissed the notion that foreign banks might
establish a significant presence in the microfinance field,
noting that they in fact have little interest in institutions
such as the VTBs. Those that have invested in VTBs (e.g. HSBC,
Standard Chartered) or established microfinance units (e.g.
Citibank) have done so in response to government pressure,
rather than because of a belief in the potential profitability
of the microfinance sector. Thus, for example, Citibank's
microfinance unit is, in reality, a part of their corporate
social responsibility (CSR) function, rather than a genuine
business line. In this vein, he cited misunderstandings
regarding the nature of microfinance by many government
officials, who, he said, fail to understand that microfinance is
normally not the purview of traditional financial institutions.
Microfinance, he concluded, is overall a "very new concept for
China."

Where Do Small Businesses in Southwest China Turn for Credit?
Enter the Credit Guarantee Company
--------------------------------------------- ---------------

CHENGDU 00000271 003.2 OF 004

11. (SBU) Given Lai's assessment that even banks that are
downscaling are only reaching the top of the small business
market, CG asked where the remaining established small
businesses in Southwest China could turn for credit. Lai
responded that most micro-to-small enterprises have very limited
choices, and generally must pay considerably higher interest
rates. Many go to "pawn shops" (diandanghang), which he
described as serving a very different function than US pawn
shops. Rather than serving as a lender of last resort, they
provide an accessible -- if high interest -- option for small
business financing upon the provision of tangible collateral
(ranging from physical property to property deeds or stock
certificates). An increasing number of small ventures, however,
are now obtaining "under the table loans" from the growing
number of credit guarantee companies (CGCs), he said.

12. (SBU) Lai described the CGCs as a relatively new/emerging
financial institution, still facing considerable controversy
regarding their appropriate role and structure. Noting that the
national regulatory framework governing CGCs was only
established in February of 2009 with creation of the
Inter-Ministerial Committee on CGCs within the CBRC, he assessed
it as "not a strong system," remaining basically a locally run
initiative. Though relatively lightly regulated, CGCs are
supposed to limit their activities to guaranteeing other
institutions' loans and are statutorily barred from making loans
themselves. However, despite their lack of lending license,
many in Southwest China have money to lend, he said, and are
finding ways to lend to small businesses. (Lai estimates
Chengdu to be home to about 100, out of a total of about 4,000
nationwide.) Their investors are often wealthy entrepreneurs
with plenty of spare cash seeking an alternative to either
volatile stock investments, or low-interest bank accounts. They
see CGCs as a way to both diversify investments and get their
foot in the door of the financial market, he said, which they
hope will be highly profitable after future liberalization.

The Long-Term Solution:
Liberalize the Financial Sector, Let CGCs operate as NDTLs
--------------------------------------------- -------------

13. (SBU) Despite some positive evolutions in institutional
arrangements and the expansion of under the table CGC loans, Lai
concluded that the current regulatory system will simply not
allow sufficient flexibility to ensure that credit can reach far
enough into the small enterprise world. Much greater
liberalization of the market is necessary, he insisted,
otherwise the regulatory environment will continue to constrain
the vast majority of would-be entrants to the SME financing
market. A key goal of liberalization, he emphasized, should be
the large-scale expansion of the NDTL sector, which he described
as currently "rudimentary," comprising only the MCCs, CGCs, and
pawn shops discussed above. What is lacking in this picture, he
said, is the wide range of NDTLs recognized worldwide by the
IFC, such as university endowments, foundations, pension funds,
student loan corporations, etc., all of which could step into
the riskier credit provision arenas.

14. (SBU) CGCs in particular have the potential to take on a
significant role as NDTLs if they are allowed to start loaning
legally. However, many CGC investors are expecting to be able
to turn them into deposit-taking banks, reflecting a fundamental
misunderstanding of the role and function of banks, Lai
asserted. "They will not be allowed to become banks for very
good reasons," he said, noting the need to shield depositors
from riskier use of their funds (e.g. through fiduciary rules
and capital adequacy ratios). He said that most officials and
regulators lack understanding of the distinct roles of banks
versus NDTLs, something he says IFC is attempting to remedy.

Rural Financing: The Value Chain Approach
-----------------------------------------

15. (SBU) In contrast to his case for decreased regulation in
the financial sector overall, Lai argued that expanding rural
credit access requires significantly greater government
intervention due to the inherent risks involved (e.g., weather,
commodity prices, land title issues), and stressed that China is
far behind both the U.S. and Europe in terms of government
involvement in rural financing. Beyond the expansion of micro
and SME finance, he said the IFC is now promoting a "value
chain" approach to rural credit expansion, aiming to structure
financial services to simultaneously address the needs of
small-scale farmer/producers, suppliers (e.g. of agricultural
inputs), and other agribusinesses (processors and distributors
of agricultural production).

CHENGDU 00000271 004.2 OF 004

16. (SBU) A key example he cited for this model is the
Chengdu-based New Hope Group which, he reported, is creating a
number of CGCs solely for the purpose of providing loan
guarantees for banks and rural credit cooperatives to loan to
SMEs within the New Hope supply chain. Lai noted that this
allows new SME start ups in rural areas, while enabling New Hope
to develop markets for their own products and stabilizing their
supply. For example, in Mianyang (Sichuan's second largest
city, north of Chengdu), a New Hope CGC is guaranteeing the
loans made by banks to pig farmers, who in turn purchase New
Hope's pig feed, and then sell their wholesale pork products to
New Hope. New Hope is also providing some additional services
through the CGC structure, such as free veterinary services to
pig farmers in their supply chain. Lai said that these types of
CGCs are increasingly able to obtain a range of government
subsidies when registering. That said, the value-chain
financing model remains a new concept within the IFC, globally
as well as within China.
BROWN

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