Prosper or Perish: Credit and Fiscal Systems in Rural China

3. The Design of China’s Rural Credit Institutions

51 3 THE DESIGN OF CHINA’S RURAL CREDIT INSTITUTIONS Does the institutional design of rural credit cooperatives (RCCs) explain patterns in their lending? In this chapter I illuminate the factors that shape loan officers’ behavior and affect the loan allocation process by analyzing the findings of my household survey. Though not part of the state bureaucracy, RCCs are subject to a dual accountability system similar to that of any subnational bureau in China. Comparison of RCCs’ line of reporting and supervisory structure with that of state-owned banks further illustrates why credit cooperatives are more susceptible to local-government influence. I begin by reviewing existing explanations for the rural credit sector outcome, particularly bias in lending toward local government-owned enterprises described in chapter 2, and explain why China’s banking regulator cannot supervise RCCs effectively. The problem, I show, stems from the central government’s dual and contradictory objectives with regard to RCCs. I also account for patterns of lending by rural cooperative foundations (RCFs),once the largest informal credit institutions in China. In particular, I account for the fact that, until the central government shut RCFs down in 1999, more than three-quarters of RCFs’ loans went to projects related to local governments. As shown in chapter 2, RCCs have undergone a great deal of institutional restructuring since 1979: from being part of the state-owned Agricultural Bank of China (ABC) between 1979 and 1996, through being managed and supervised by local offices of the central bank between 1996 and 2003, to coming under the management of the provincial unions after the 2003–5 restructuring.This chapter will focus on the earlier periods, for two reasons. First, these two periods are more 52 PROSPER OR PERISH pertinent to the development of the collective township and village enterprises (TVEs) during the 1980s and 1990s, which is the issue under examination. Second , when I conducted my fieldwork in 2005–6, many provincial unions were still being set up, so the implications of the 2003–5 restructuring were not yet clear. Existing Explanations for the Rural Credit Sector Outcome Though RCCs were intended as sources of credit for farmers and other small and medium-sized borrowers, they lend mostly to local government–related enterprises and other big borrowers. The most common explanations for this phenomenon point to two interrelated factors: (a) government regulation of interest rates and (b) long-standing institutional biases against small and/or nongovernment related borrowers. Until the deregulation of banks’ lending rates in 2005,1 formal lenders had shied away from small and medium-sized enterprises and from rural households because these borrowers are more costly to service and are deemed to carry higher default risks. Since interest rate is the cost of capital, if lenders are unable to adjust rates to reflect their cost structure, they will refuse to lend to high-cost borrowers. (This is a common reason that small and rural borrowers fail to obtain formal financing in developing nations where interest rates are controlled.)2 Another impediment to private enterprises’ ability to obtain formal credit prior to 2004 was the communist regime’s ideological bias against private ownership . Until the official recognition of private property rights in 2004,3 private enterprises operated in a gray economy and were forced to adopt various covert strategies to survive. Many private enterprises chose to register as “collectively owned”firms, commonly called“wearing a red hat,”to avoid government harassment .4 Many bank officers I interviewed told me that if a loan they had approved to a private enterprise went sour, it could cost them their jobs. By contrast, loans to state-owned enterprises or government-linked firms did not carry such personal risk since they came with a tacit local-government guarantee.5 Lack of legal recognition for collective lands as collateral also impedes farmers ’and private rural enterprises’ability to obtain formal credit. Rural borrowers’ most valuable assets are the lands on which farmers build their homes and private enterprises set up their factories. However, rural households or enterprises have only user-rights in such land because rural land is collectively owned.6 As a result, farmers and private enterprises cannot use their most valuable assets as collateral for bank borrowing. The absence of a developed legal system in property-value THE DESIGN OF CHINA’S RURAL CREDIT INSTITUTIONS 53 assessment or guaranteeing a minimum livelihood for farmers also makes seizing collateral...