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By Chen Daofu, Research Team on "Deeping the Reform of Rural Credit Cooperatives", Research Institute of Finance of DRC

Research Report No 151, 2012

I. The Ambiguous Business Model Is the Major Challenge Facing the Further Development of Rural Credit Cooperatives

Despite the reforms and change of competent authorities, the policy and commercial functions of the rural credit cooperatives have remained unclear. As the most principal financial institution in rural areas, even the one-of-the-kind in some regions, the rural credit cooperatives still assume large amounts of policy functions and services. Aimed at "giving policy support to agriculture, facilitating local development, guarding against risks through supervision and earning profit on their own", the rural credit cooperatives finds itself in a dilemma of attending to sustainable business development while losing policy support to agriculture and vice versa. With the mitigation of the historical burden and the acceleration of commercialization, the rural credit cooperatives are also facing the question of how to set up the sustainable business development model through transformation so as to serve the ever-growing "agriculture, rural areas and farmers" as well as micro and small enterprises (MSEs).

1. Change of economic environment calls for the timely clarifying of business development model for rural credit cooperatives

Finance serves the real economy. The financial straits facing "agriculture, rural areas and farmers" and micro and small enterprises are firstly an economic and social issue and a financial issue in the next place. The rural credit cooperatives have been oriented toward "agriculture, rural areas and farmers" since its establishment. However, the development of the industrial economy and the withering of the sector related to "agriculture, rural areas and farmers" are historically inevitable. Acceleration of urbanization has turned previous rural areas into townships and previous suburbs into urban areas. Fishermen lose seas and farmers lose land and the traditional agriculture is constantly shrinking. Rural populations are unceasingly transferring to urban areas and the number of people engaged in agriculture, fishery and animal husbandry has gradually reduced. Even "empty villages" have emerged in some mountainous regions. Like most Chinese enterprises, some agriculture-based enterprises have begun to develop diversified business varieties after growing steadily and gradually.

To fit in with this situation, great changes have taken place in capital needs of the customers of rural credit cooperatives. Firstly, the amount of money needed has increased. Secondly, the unseasonal use of funds has intensified and the period of fund use has prolonged. Thirdly, use of funds has been all the more diversified. Fourthly, customers have become varied. It suggests that the erstwhile agriculture-friendly credit products have found themselves not in a position to adapt to the need for diversified economic development in rural areas and that the county-level corporate joint cooperatives are unable to adapt to the change in rural capital needs for lack of capital fund and fund capacity (loan ratio for each single customer is restricted) and due to relatively low personnel quality (product development ability is limited).

In terms of the features of the financial performance, there is a world of difference in business model and risk management applicable to services offered to industry and urban large and medium-sized enterprises as well as to the sector of "agriculture, rural areas and farmers" and micro and small enterprises, and the requirements for management structure (governance mechanism) are different. Credit services to large and medium-sized enterprises are complicated and standardized, with each amount being handsome, therefore, the cooperatives pay more attention to pledge, mortgage and one-to-one examination of enterprise financial statement. Credit services to "agriculture, rural areas and farmers" and to micro and small enterprises are relatively simple and less standardized, with each amount being small, therefore, the cooperatives pay more attention to actual services and cash flows and lay emphasis on law of large numbers, information technology and collection and application of disperse credit information. In terms of management, the former calls for complete setup of sections and stresses standardization and interaction, while the latter emphasizes on the flexibility on the premise of strictly implementing technological processes and authorization.

Of course, to serve whichever types of real economies, the economies of scale and economies of scope do exist in the financial sector and the financial institutions are all desirous to become bigger and stronger. Once a financial institution is not in a position to achieve the minimum fund size, then there could appear the tendency of self-shrinkage. An important principle for financial risk management is dispersing risks in industries and among individuals. Confining credit business to some region or industry is vulnerable to systematic risks for a single financial institution that are triggered by regional and sectoral risks. Therefore, different service groups will lead to different business operation and risk management models for financial institutions, yet the sustainable operation should be realized through necessary pluralism and large-scale operation. Experiences of ABN AMRO Bank and Thailand show that pluralism and large-scale operation are not bound to happen and should not completely go against the provision of effective financial services for specific groups, which can be well coordinated through necessary techniques and management.

In brief, change of rural credit cooperatives' service targets has posed a significant challenge to the development and reform of the cooperatives i.e. whether the cooperatives should be built into an open system or remain sealed off as they were? Namely, whether the cooperatives should be allowed to expand their districts of operation to diversify and widen their business scale and change their management models and governance mechanisms along with the change of their service targets.

In fact, it is the change of the economic environment that has posed a question of positioning of the credit cooperatives, that is, whether the cooperatives should change with the growth of the service targets or just concentrate on the service targets in specific fields and at specific stage of development. Even for the latter, there is also a question of what methods are more effective in the end to satisfy the financial service demand arising from "agriculture, rural areas and farmers" and micro and small enterprises that are in specific fields and at specific stage of development. It is time for the rural credit cooperatives to make clear as soon as possible the business development models that conform to the economic development and law of financial operation assumed in various localities and maintain commercial sustainability.

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