According to statistics from the China Banking Regulatory Commission (CBRC), the State watchdog for the financial sector, at the end of November 2006 some 70.7 million rural families had access to microcredit and other forms of loans designed for farmers. In other words, nearly two-thirds of the rural population do not have any possibility of getting loans from financial institutions.

Recent moves taken by the government suggest that breakthroughs will probably take place in rural finances this year.

On December 31, the CBRC formally approved the launching of the China Postal Saving Bank, to provide financial services for urban and rural residents.

In late January, the authorities decided at the high-level national financial work conference that a restructuring of the Agricultural Bank of China would start soon and reform of the rural financial system would be furthered.

The People's Bank of China, or central bank, and the CBRC also made major revisions to rural financial system regulations at the end of January.

As a matter of fact, reform of the rural financial system had been started in the 1990s. After several ups and downs, the rural financial system is still troubled by several long-time thorny problems.

A major problem, financial outlets are not extensive enough to satisfy the needs in rural areas.

In recent years, the Industrial and Commercial Bank of China, the Agricultural Bank of China and China Construction Bank dramatically reduced the number of outlets. The more than 30,000 outlets erased from the three banks' business scope were mostly located in rural areas.

Meanwhile, the already limited financial service suppliers usually offer far less diversified products in rural areas than in cities.

Not just a problem of not enough banks, the core difficulty for the reformers of the rural financial system is the issue of microcredit.

The loans needed by rural consumers fall into two categories: small loans needed by rural families and larger loans needed by businesses based in rural areas.

The standard measuring the development of rural finance is whether rural families have convenient access to the small loans they need and how many rural families enjoy such benefits.

Without a proper solution to help needy rural families get small loans, reforming the rural financial system will be far from a success.

Rural financial service suppliers are mostly under a management model of traditional financial institutions. In other words, they have a relatively long process of risk control and decision-making, which leaves them limited room for making profits from loans as small as 10,000 to 20,000 yuan ($1,282 to 2,564).

For the same reasons, these institutions are unable to make flexible and timely decisions for would-be clients across the vast areas of rural China.

Therefore, it is not wise to expect the commercial banks to be the main force in developing rural microcredit since microcredit offers less profit and more risk for them.

At this year's central financial work conference, Premier Wen Jiabao stressed that various forms of organizations supplying microcredit should be nurtured. The central bank and the CBRC have since issued policies to promote rural financial services.

These policies have done quite a lot toward solving rural financial problems: establishing truly localized financial institutions that can make flexible responses to demands from rural families for microcredit.

One of the practical steps is to allow more qualified businesses into the microcredit business.

A deeply entrenched misunderstanding is that microcredit aims at eradicating poverty. Actually, microcredit should be targeted toward business development, enabling businesses to remain in operation and increase profits.

The loans offered by microcredit institutions in Pingyao, Shanxi Province, had an annul interest rate as high as 18 percent. But even though the rate is about three times higher than bank loans, it did not devastate the borrowers. On the contrary, there were no records for default last year.

By contrast, the low-interest microcredit promoted by local governments between 2000 and 2003 had to be suspended because of the huge proportion of bad debts.

The reason for such a dramatic difference is that the microcredit institutions carefully select clients who are able to repay the loans. If the lenders only eyed the loans as a form of eliminating poverty, there would be a much higher rate of default.

Part of the big picture, the legal system needs to lay out specific terms relating to microcredit, including the institutions qualified to deal in microcredit.

The author holds a PhD in economics from the Institute of World Economics and Politics of the Chinese Academy of Social Sciences

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