76425 CASE STUDIES IN DONOR GOOD PRACTICES No. 10 March 2004 Nurturing Microfinance in a Challenging Environment: The Ford Foundation In China by Ann Duval, with Ruth Goodwin-Groen This case study describes how the Ford Foundation supported the emergence of microfinance in China by funding research, conferences, training, and an experimental Grameen project, run by an academic team, that developed into a large microfinance program. Overview economic development: more than 30 million private The potential of microfinance to alleviate poverty is businesses were created over the next two decades, gradually being recognized in China. In the context of a bringing unprecedented prosperity to many Chinese tightly regulated financial industry with high barriers to citizens. However, close to 100 million people in rural entry, the Ford Foundation has supported microfinance China still live in poverty. development through a wide range of local capacity- building activities. These initiatives include research and As part of its liberalization effort, the government conferences on poverty, microfinance, and rural financial restructured existing official financial institutions, created reform, as well training tours and an action-research new ones, and allowed unofficial financial institutions to project led by Chinese scholars. Ford’s support of these operate. In repeated attempts to ensure a sound financial activities has contributed to greater experimentation with sector, the government alternated between relaxing and microfinance in China, where a long history of massive tightening financial controls throughout the 1980s and subsidized rural finance programs makes the environment early 1990s. By 1993, however, the financial system especially challenging. Today, Chinese specialists on found itself in crisis. poverty and policy makers are expanding the policy dialogue on microfinance. A number of unofficial financial institutions had failed outright, causing many people to lose their savings. Among the local initiatives supported by Ford is an Politically motivated lending by state-owned banks experimental microfinance project led by a group of (which dominate the banking sector) had dire results: scholars at the Rural Development Institute (RDI) of the close to 25 percent of outstanding loans were non- Chinese Academy of Social Sciences. In 1994, the performing and loan-loss reserves proved to be scholars began a modest action-research initiative based inadequate. The government responded by introducing on the methodology developed by Grameen Bank new, stricter reforms to restore health and fiscal control to (Bangladesh). Funded by the Grameen Trust ($50,000 the financial sector. The new measures included soft loan) and the Ford Foundation ($50,000 grant), restricting small industry financing, closing unsanctioned Funding the Poor Cooperative (FPC) has since grown financial institutions, and establishing artificially low into a large microfinance program. As of August 2003, it interest rate ceilings in an attempt to curb inflation. had approximately 15,300 clients. FPC continues to experiment with adapting microfinance models to the Chinese context, providing valuable lessons, and We must severely attack all actions in the financial arena that disseminating information on good microfinance practice are illegal or in violation of regulations. We must guarantee to a growing Chinese audience of interested policy that financial laws, regulations, and rules are implemented makers, researchers, and practitioners. thoroughly. We must emphasize the prohibitions against banks using high interest rates to monopolize deposits, illegal fund- raising in society, and haphazard financial activities. Setting the stage Renmin ribao (People’s Daily), February 1999, as quoted in The People’s Republic of China initiated sweeping Back-Alley Banking (2002) by Kellee S. Tsai economic reforms in 1978. These reforms led to rapid Page 2 A DIRECT Case Study Concurrently, the government continued to subsidize 2003, one branch had an arrears rate1 of 0.08 percent. The loans in the effort to alleviate poverty. During the 1980s second branch had an arrears rate of 11.95 percent and and early 1990s, the Ford Foundation in China concen- needed to strengthen its management, while the third was trated on capacity building and poverty research. Several struggling to survive. Although not uniformly successful, Ford research grants were extended to Professor Du the experience of the three branches has identified Xiaoshan and his colleagues at RDI. In addition to valuable lessons for creating a sustainable microfinance studying rural poverty in China, RDI scholars studied sector in China. microfinance. In particular, they followed the progress of the Grameen Bank in Bangladesh. By 1992, Professor Du The founders of FPC have recognized that stronger and his team wanted to move beyond research and test management is needed to ensure the program’s long-term whether the Grameen model would work as a poverty success. Accordingly, they have hired professional staff alleviation tool in China. Their idea for a test project, in Beijing in an effort to standardize management across however, coincided with the financial crisis and sub- the branches. sequent tighter government controls. Meeting the Challenge: Funding the Poor Cooperative Start Up. Rather than seek permission to create a microfinance institution, Professor Du and his colleagues sought and received informal government approval in 1994 to test the Grameen model as an action-research experiment—the Funding the Poor Cooperative. Learning through Trial and Error. FPC chose to conduct its experiment in three of the country’s poorest counties. (The photo shows a typical client.) Although the RDI scholars had studied the Grameen methodology, they An FPC client in Hebei Province, August 2001. found putting it into practice to be more difficult than (Photo: Kellee Tsai.) theory. As the research experiment grew, like many MFIs, it experienced ups and downs, including Creative Solutions to Contextual Challenges. FPC occasional instances of corruption and financial mis- overcame two major stumbling blocks—institutional and management. Yet, the project leaders worked diligently financial—to initiate microlending operations. Unable to to continuously improve FPC’s financial performance register as a financial institution, the experiment and promote its institutional development. developed an unusual structure. FPC “headquarters� is a research center within a research institute (RDI), It was the first time we had done a real project. Practice is so comprised of the scholars who founded and continue to much more difficult than theory. The Grameen model is very guide FPC. Each of its three “branches,� however, is easy to understand, but very difficult to make real. registered as a separate association with the Bureau of Du Xiaoshan, Economist, Rural Development Institute, Civil Affairs at the county level. Although the branches and FPC Founder are legally independent of headquarters—the project is essentially four organizations, not one—they are We didn’t really understand what microcredit was. We thought operationally and financially dependent on the central it was just handing out loans and getting the money back. office. Sun Ruomei, Economist, Rural Development Institute, and FPC Co-founder The interest rate ceiling was another hurdle FPC had to overcome. FPC sought and received permission to charge higher interest rates on the basis that all its loan capital Despite occasionally uneven performance, FPC’s three comes from foreign sources. While these creative branches continue to demonstrate that rigorously solutions to institutional and financial obstacles allowed implemented microfinance works in China. In September 1 FPC’s arrears rate: total portfolio in arrears plus loans rescheduled, divided by total loans outstanding. FPC does not calculate portfolio at risk. A DIRECT Case Study Page 3 FPC to proceed and gain practical experience as a Encouraging Microfinance in China: microlender, they also constrain its long-term Good Donor Practice sustainability. Ford’s success in encouraging microfinance in China can be attributed to several factors. Raising Awareness of Microfinance in China Ability to Experiment. Ford was able to support the FPC As FPC evolved, other donors and international project largely due to its willingness to take risks and organizations (including the United Nations Development experiment. Ford did not know if microfinance would Programme, the United Nations Childrens’ Education work in China; in fact, microfinance was not even part of Fund, Oxfam, and Save the Children) initiated their own its program when the scholars of the Rural Development microfinance projects across China. UNDP alone Institute approached the Foundation. The Ford team in sponsored microfinance demonstration projects in 48 China was, however, able to back the project due to an counties. By the end of the 1990s, however, many of established policy of setting aside about a fourth to a third these experiments had failed. of the country portfolio to finance potential opportunities As microfinance projects sprang up around the country, not included in the defined program. Having decided to FPC realized that it had a role to play in disseminating fund FPC, Ford had the flexibility to go on to sponsor information about microfinance to a larger audience. conferences and training on microfinance and rural With support from the Ford Foundation, FPC organized finance reform. several national conferences on microfinance in China, raising the visibility of the sector. At the same time, Ford “We thought microfinance was not a possibility [in the mid-1990s]. It seemed crazy in some ways, and was very sponsored a number of seminars that focused on defining removed from what we were doing. . . [yet] it also microfinance standards in China. Stephen McGurk, seemed like a good idea.� Director of the International Development Research Stephen McGurk, former Ford Foundation Program Center (Singapore) and former Ford Foundation Program Officer in China Officer for Economic and Social Policy in China, remarked, “FPC grew in its ability to influence people, and this became an important role over time. In a way, Banking on Local People. Ford has consistently their work was less about microfinance and more about supported local people and initiatives in China. It has policy reform.� funded study tours, training sessions, translation of technical materials, research grants, and conferences. FPC conferences brought many actors to the policy table These actions allowed Chinese experts on poverty to and were instrumental in attracting the attention of the become conversant in microfinance good practice, gain Chinese government to microfinance. As a result, several first-hand experience, and articulate the problems and high-ranking officials looked at what FPC was doing and possible solutions needed for microfinance to succeed in publicly voiced their favorable impressions. In 1999, FPC the country. The China Microfinance Training Center has received official approval of its “experiment� from both been an important part of these initiatives. the People’s Bank of China and the State Council. The losses of other experimental programs (often run by the Fostering Policy Dialogue through Research. Ford government) served to highlight the positive experiences recognized that credible local research was needed for of FPC. Chinese practitioners and policy makers to elaborate an enabling policy environment for microfinance. In the late At the same time, the many failed experiments raised 1990s, it began to support research on key policy issues questions about the viability of microfinance in China. such as rural financial reform. Andrew Watson, Resident National policy makers increasingly recognized that Representative of the Ford Foundation in China, points microfinance could be a key poverty alleviation tool, but out that “the rural financial reform work [seeks] to help the model for building microfinance in the China was still people think about creating a more flexible rural financial being developed. Although interested in microfinance, environment within which microfinance could play a the government continued to use highly subsidized rural role.� credit programs as a means of poverty alleviation in the late 1990s. A Vice President of the People’s Bank of China attended the most recent Ford conference on rural financial reform Page 4 A DIRECT Case Study in August 2003, as did officials from the Rural Credit References Cooperative and staff from the Agricultural Bank of China. The conference took place at the same time a new CGAP. CGAP Phase III Strategy, 2003–2008. Washington, experimental policy for Rural Credit Cooperative reform D.C.: CGAP, 2003. was being launched in the country. Ford Foundation. Funding the Poor Cooperative. Briefing document. Unpublished, 2003. An understanding of the overall Chinese rural financial Helms, Brigit, and Peggy McInerny. Water, Water Everywhere sector, its problems and reform prospects, is crucial for But Not a Drop to Drink, CGAP Donor Brief No. 3. the continued, sustainable operations of microfinance in Washington, D.C.: CGAP, May 2002. Based on Doug Pearce, China and its wider adoption. “Water, Water� Viewpoint, 18 Nov 2003. Minquan Liu, Professor of Economics, Nanjing- http://www.microfinancegateway.org/...t/article/detail/13569 Hopkins Center, Nanjing University Tsai, Kellee S. Back-Alley Banking: Private Entrepreneurs in China. Ithaca, New York: Cornell University Press, 2002. Conclusion Tsien, Sarah. “In China, Emerging Microfinance Institutions Set the Bar.� Draft article written for PlaNet Finance China. Ford’s support of research and capacity building in China Unpublished, 2003. has promoted greater professional and practical knowledge of microfinance. Scholars, practitioners, and Contacts and Websites government officials are now engaged in policy discussions about the sector. As a local project initiated Ford Foundation web site: www.fordfound.org by a prestigious Chinese research institution, FPC has Ford Foundation in China: ford-beijing@fordfound.org given microfinance credibility and visibility in the country, while illuminating some of the concrete legal Professor Du Xiaoshan, Funding the Poor Cooperative: and financial constraints to sustainable microlending in duxiaoshan@163.com China. Photograph on page 2 reproduced with the permission of What does the future hold? The Chinese environment Kellee S. Tsai. continues to be extremely fluid, making it difficult to Ann Duval is an independent microfinance consultant. This predict. More fundamental financial system reform is case study is based on a review of the documents cited above, needed before microfinance can find its true place in as well as input from Stephen McGurk, Andrew Watson, Kellee China. Sarah Tsien of PlaNet Finance China, says that in Tsai, Tony Sheldon, Jennifer Isern, Sara Tsien, Minquan Liu, addition to FPC, two other strong programs show and Enjiang Cheng. promise of becoming sustainable institutions: the China Foundation for Poverty Alleviation (CFPA, which is closely linked to the State Council’s Poverty Alleviation Office), and the Sustainable Microfinance to Alleviate Poverty project (SMAP, which was spun off from the UNDP initiatives). Tsien contends, “Together, if FPC, CFPA, and the SMAP project can make the next step to officially institutionalize, the bar for the formalization of . microfinance in China will be both set and met.�