"The CBRC's new policy opens a large door to the rural financial market," said Shen Minggao, a Beijing-based economist with Citigroup.

According to Shen, allowing private capital to establish village and township banks and credit cooperatives has legalized some private loans. The competition between these new banking institutions and the existing rural credit cooperatives will help boom the rural financial market.

Tang Shuangning, Vice Chairman of the CBRC, disclosed that the commission is striving to create a favorable environment for financial service development in rural areas by adopting preferential tax policies and establishing a credit system covering all farming households and rural enterprises.

Although the threshold of registered capital is quite low, risks of village and township banks will not be high, since the CBRC will uphold the principle of "low threshold but strict supervision," requiring that at any time, the capital adequacy ratio shall not be lower than 8 percent and that the asset loss reserve rate shall not be lower than 100 percent.

Moreover, in order to prevent congenital deficiency of newly born village and township banks, the CBRC's policy demands that at least one banking institution should be enrolled as the sponsor. "It is an important measure to ensure that newly established banks have a sound basis from the beginning," Zang said.

Foreign banks and investment companies such as Citibank, the Hong Kong and Shanghai Banking Corp., Actis and Softbank Asia Infrastructure Fund told Beijing Review that they are quite interested in village and township banks but will make further decisions after the rules for implementation are released.

Promising future

In China's rural areas, financing problems are prevalent. According to Liu Mingkang, a major problem in rural financial service is the limited number of financial outlets. Hence, there is a vast market space for village and township banks, and competition in rural areas is less intense than that in cities.

According to Guo Tianyong, a county-level village and township bank may need only three or five managers and 20 to 30 business staff for absorbing deposits and granting loans. If a bank of this kind can absorb 100 million yuan of deposits and grant 40 million yuan in loans a year, it can make an annual profit of 2 million yuan.

Statistics from the People's Bank of China (PBC) show that at present, deposits in China's rural areas stand at 4 trillion yuan. That is to say, by simply absorbing one 40,000th of present rural household deposits, a village and township bank may gain 2 million yuan a year, and it is easy to grant 40 million yuan of loans.

Figures from the PBC show that at present, 120 million rural households need loans, but less than 60 percent of them can be satisfied, with most of the capital coming from small loans provided by rural credit cooperatives. In addition, only 50 percent of small rural enterprises can be granted the loans they need.

Existing rural financial institutions still have great business volumes. The PBC statistics indicate that in the first 10 months of 2006, small loans granted to farming households amounted to 187.3 billion yuan, up 17.42 percent from the same period a year earlier, and loans granted to groups of farming households surged 37.47 percent over the beginning of 2006 to 118.5 billion yuan. By the end of September 2006, the balance of loans granted to small rural enterprises by major commercial banks had reached 2.7 trillion yuan.

Du Xiaoshan, Deputy Director of the Rural Development Institute of the Chinese Academy of Social Sciences, said that thanks to preferential state policies, the agricultural, industrial and service sectors in rural areas have flourished. This provides a good chance for the development of village and township banks.

Credit cooperatives face pressure

Rural credit cooperatives, the major financial institutions in rural areas now, are collectively owned and have many limitations. They contain only credit departments and have no departments of risk control and human resources, which are common in commercial banks. They chiefly operate deposits and loans, and attend to settlement and intermediate businesses as well.

There are over 32,000 rural credit cooperatives throughout the country. They used to bear responsibilities of both commercial and policy banks, since the government has been emphasizing the significance of agriculture and assigned many policy tasks to them. Owing to administrative interference, many cooperatives are not well managed and harbor a high ratio of non-performing loans. Statistics from the CBRC indicate that at the end of June 2005, capital adequacy ratio of the country's rural credit cooperatives stood at 5.89 percent and the non-performing loan ratio was 17.54 percent.

During the trial run of village and township banks, rural credit cooperatives may not feel challenged. Since rural credit cooperatives cannot satisfy the financing demand in rural areas, village and township banks currently just serve as a supplement to them. But once village and township banks spread nationwide, rural credit cooperatives will be directly influenced.

Rural credit cooperatives still have advantages of established networks in rural areas and are playing a greater role in supporting agricultural development. However, their capital adequacy ratio is low, plus a large amount of non-performing loans. Eventually, if they compete with village and township banks in terms of flexible mechanisms and a wider range of business, they are likely to lose.

"It will be unavoidable that some poorly managed rural credit cooperatives will go bankrupt," commented China Business Post, which is sponsored by the Ministry of Finance.

Du Xiaoshan holds that besides rural credit cooperatives, private lending will also be influenced. In recent years, private lending has been active. The fact that legal financial institutions cannot meet the capital demand of rural economic development has resulted in the rapid growth of private lending in rural areas. Usually among family members, acquaintances and friends, private lending does not require mortgages or guarantees. This is more simple and convenient than the complicated procedure of getting banks loans. Private lending is hence favored by farmers and small and medium-sized rural enterprises.

A research report by the National Natural Science Foundation shows that in Zhejiang Province, private lending totaled around 140 billion yuan. But, as it lacks government regulation and guidance, private lending tends to interrupt financial order, trigger economic disputes and increase social instability.

"It is quite possible that this capital, once invested in village and township banks, would allow it to be better regulated and help reduce financial instability," Du said.