Editors Note:  To ensure accuracy, we have updated the information in the text as follows:

1.  As a result,  MicroCred – whose shareholders include the PlaNet Finance, AXA Belgium, and International Finance Corporation (IFC) – have set up operations there.

2.   For example, the private equity firm Sagamore Investments recently committed a $21.9 million equity investment in Accion Microcredit China, up to date 40 renminbi million ( $6.5 million) has already been invested, taking a 40% stake in the second foreign-funded MCC.

In spite of the remarkable economic growth which China has experienced over the past two plus decades, more than 153 million of its 1.3 billion inhabitants still live on less than $1.25 per day. What is more, both its structural economic conditions and its growth policy have resulted in an increasingly marked income gap between inland/coastal areas, and rural/urban areas. Indeed, in spite of its near unprecedented growth, China continues to struggle with poverty.

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Given this reality – and its geographic proximity to the world centers of microfinance – it would seem reasonable to presume that China must boast an impressive microfinance services sector; however this is not the case. Compared with its neighbors in Southeast Asia, (where the leading microfinance institutions were born in the 1970s), the Chinese poor remain quite insulated from MFI capital. In late 2011, The Mix Market reported that there are only 67 MFIs in China with a total loan amount of $13.3 billion — far less than the less populated Asian countries of Bangladesh, India and Vietnam.

Why is this case?
According to both scholars and practitioners alike the reason lies largely in the inherently centralized nature of the Chinese policy framework, which restricts MFIs in terms of their organizational structure, how they can interact with their clients, and their ability to take on leverage. In China, microfinance activities operate under structures called Microcredit Companies (MCCs), Village and Township Banks (VTBs) and Guarantee Companies.  In terms of organization, NGOs are strictly forbidden from engaging the financial marketplace; and domestic financial institutions are by definition 51% owned by the government.

VTBs were established in 2006 to boost rural and agricultural growth (that also included Lending Companies and Rural Mutual Credit Cooperatives).  VTBs are effectively government-owned entities that are regulated and typically controlled by traditional commercial banks. They are permitted to take in deposits, but restricted from lending outside their own localities.

In the absence of NGOs, non-institutional MFIs are the only viable free market players in the microfinance niche in China. MFIs that satisfy these criteria are known as MCCs, which were originally launched by the People’s Bank of China but as yet have no recognized legal status as financial institutions. Unlike some of their international contemporaries MCCs are not allowed to accept deposits of any kind.

MCCs are also required to maintain a debt to equity ratio below 0.5, which is to say they can borrow up to an amount equal to half of their paid-in capital, and this debt can come from no more than two banks.  Finally, there is an interest rate cap posted by the CBRC (China Banking Regulatory Commission), under which MCCs can charge no more than four times the PBOC benchmark rate on their loan portfolios.

Many local MCC owners and social investors say that these regulations are too conservative, dampening their enthusiasm for microfinance and motivating them to turn to other sectors with relatively loose regulations and higher returns such as real estate or even underground lending.

That fact notwithstanding, many foreign investors and western MFIs see the Chinese market as an alluring and untapped market. Perhaps for that reason, several provinces in China have set up regional policies designed to attract potential MFI participants. The province of Sichuan, for example, has loosened its policy restrictions by increasing the maximum debt to equity ratio to 1. As a result, PlaNet FinanceAXA Belgium, and MicroCred – whose shareholders include the International Finance Corporation (IFC) – have all set up operations there. [1]

In order to compensate for the lack of deposits, foreign MFIs rely mainly on global equity partners.  For example, the private equity firm Sagamore Investments recently made a $21.9 million equity investment in Accion Microcredit China, taking a 70% stake in the second foreign-funded MCC.  Besides, foreign MFIs also expand their business lines as a coping plan. For example, PlaNet Finance in China has increased their service line to include advisory and ratings services. [2]

Actions in the city of Wenzhou, (which grew international acclaim at the height of the Chinese shadow banking bubble), also appear to be indicative of a loosening policy environment. In the spring of 2012 the government began a series of experimental reforms which seem to hint at the possibility of eventually allowing MCCs to evolve into rural banks – i.e. increase their service line to include deposits and other similar traditional banking services.

What the future holds for the Chinese MFI sector remains uncertain, however given the continued prevalence of poverty, and the well documented need for a more inclusive pattern of economic growth, it will be interesting to see if this nascent industry continues to make inroads into the Middle Kingdom.   /Chuan Lin