As Chinese commercial banks retreat from the rural market, foreign banks appear ready to jump into a sector with a strong thirst for capital. In July, Rabobank Group, the International Finance Corp. and the United Rural Cooperative Bank of Hangzhou (URCB) in Zhejiang Province signed an agreement for Rabobank and IFC to acquire 10 percent and 5 percent stakes, respectively, in the Chinese financial institution.

Established in 2005, with a registered capital of 500 million yuan, URCB is a joint-stock cooperative financial institution focusing on local communities. It was formerly known as the Hangzhou Rural Cooperative Union.

By the end of June 2006, it had a deposit balance of 24.3 billion yuan, a loan balance of 18.1 billion yuan, and total assets of 39 billion yuan, taking the lead in the rural financial system in Zhejiang Province.

With total assets of 506.2 billion euros, Rabobank has the largest market share in its native country, the Netherlands, and ranks 14th among the world's biggest banks.

This is only an opening for foreign equity participation in rural Chinese financial institutions, according to Rabobank (China) President Wang Yang, who added that Rabobank is looking for other partners in China such as rural credit cooperatives and rural cooperative banks. Rabobank is now negotiating with two rural financial institutions in Tianjin Municipality and Liaoning Province on an equity participation, said Wang.

The 2006 Chinese Government Work Report has made deepening rural financial reform one of the three major tasks of reforming the country's financial system. "The government's policies have made it clear that rural finance is the focal point of the next phase of Chinese financial system reform," Wang said.

The state-owned commercial banks have massively retreated from rural and underdeveloped areas in the hope of maximizing their profits under the country's financial reform program. Loans are not provided any more in these areas and the local branches have become mere deposit collection offices.

Even the Agricultural Bank of China has withdrawn from the rural financial market and is unwilling to invest in long-term agricultural projects that have a high risk, resulting in a weakening of investment in rural areas.

Data from the National Bureau of Statistics show that the proportion of agricultural loans to total loans has seen an annual decline of more than 1 percentage point over the last three years, and only 32 percent of farmers and 30 percent of small and medium-sized companies can receive loans from standard financial institutions.

One of the main reasons why farmers and small and medium-sized companies find it hard to get loans from financial institutions is that too few institutions provide services for the rural areas, explained Han Jun, head of the Rural Economy Research Department of the Development Research Center of the State Council.

Hard times

"Financial services in rural areas are meeting with hard times," said Tang Shuangning, President of the China Banking Regulatory Commission (CBRC). He added that 15 trillion to 20 trillion yuan will be needed to build the "new socialist countryside" by 2020 while the domestic commercial banks are withdrawing from this market. The Agricultural Bank of China is closing its branch offices in the countryside on a large scale, while the Agricultural Development Bank of China is shrinking its service range, for a time only buying grain and cotton. The rural credit cooperatives failed to provide tailored services for different clients because of the masses of non-performing loans and gigantic losses.

At the same time, farmers are in great need of capital. For them the commercial banks are out of reach and the loan threshold of the rural credit cooperatives is too high as well. "I raise chickens and grow vegetables all with my own money and if I need money I would borrow some from my friends or relatives," said Liu Yongjun, a farmer from Qingzhou in Shandong Province. "If only it took fewer procedures to ask the rural credit cooperatives for a loan!"

Experts acknowledge that rural financial institutions find it hard to make a profit because financial institutions in rural areas are too widely dispersed, loans to farmers are small, and their credit status is hard to determine. That is why the commercial banks retreated from the rural market.

"There are 37,000 townships, 653,000 villages, 249 million farmers and 940 million people in the countryside; this is a huge market," said He Guangwen, a professor at the China Agricultural University. "Considerable money is needed to build the new socialist countryside, so…inevitably it will bring opportunities for the development of the rural financial industry."

"It is the market potential of financial services in China's countryside that draws Rabobank," said Wang, the Rabobank (China) President. "It will be about 10 years before a big change takes place in the financial situation in rural areas and before our investment pays us back."

According to Wang Songqi, a researcher with the Finance Center of the Chinese Academy of Social Sciences, last year more than 10 billion yuan in capital was invested in China's state-owned and joint-stock commercial banks. The next step is to enter the rural market through equity participation in rural cooperative banks.

Golden opportunities

According to the central bank, non-government money raised through various financing methods in 2005 stood at 950 billion yuan, making up 6.9 percent of the country's gross domestic product (GDP), while such financing for Zhejiang, Fujian and Hebei provinces amounted to 55 billion yuan, 45 billion yuan and 35 billion yuan, respectively, equivalent to 15-25 percent of new loans in each province that year.

Dai Hui, Chief Representative of Rabobank in Beijing, noted that livestock farmers and fishermen in many regions find it hard to get loans from rural credit cooperatives and they turn to underground money shops, paying interest rates of 20-30 percent.

"Building the rural financial system can help these farmers get loans through regular channels," said Dai. Rabobank itself stems from a rural cooperative financial organization, which resembles the Chinese rural credit cooperatives, according to Dai. It offers farmers loans with relatively low interest rates and enables them to process agricultural products on a large scale, acquire raw materials and become technologically innovative.

Though reform has made rural credit cooperatives function better, some still blindly focus on business expansion and ignore the practical needs of farmers, never mind their development. Besides, some rural credit cooperatives are only enthusiastic about short-term projects that promise high rates of return, paying little attention to actual agricultural needs.

"Many gaps are waiting to be filled in the rural financial service field," said Dai. "Using the advantages in structural trade and bulk commodity financing, Rabobank's cooperation with United Rural Cooperative Bank will make the latter a community bank." He said futures trading will be introduced as one of the financial services offered, adding that, "Weather futures, for example, will reduce the risks of agricultural sectors that are vulnerable to weather."

Meanwhile, the Chinese Government is working on filling the rural financial gaps. Tang of the CBRC called on the Agricultural Bank of China to give more support to agriculture, to help cultivate agricultural production bases and raise the level of services for pivotal enterprises. He also urged the rural cooperative financial institutions to promote microcredit loans and provide mortgages for farmers and small enterprises.