Boundaries of Microfinance: A Case Study of Microfinance Business of CD Finance

Abstract

We will discuss the boundaries of microfinance with the micro loans issued by CD Finance Management Co., Ltd. (hereinafter referred to as CD Finance) in rural areas as an example. Microfinance is fundamentally different from traditional finance in terms of customer positioning, loan limits, credit products, risk control methods, etc., which constitute the upper boundary of microfinance. Microfinance shall determine the loan interest rate that enables its financial self-sufficiency and complies with the social mission and goal, which is the lower boundary that distinguishes it from charity. Adopting the Rosenberg model and the cost-plus pricing method for calculation, we found that the interest rate that should be charged by CD Finance for maintaining a low profit rate (1%) is almost equal to its actual loan interest rate, indicating that CD Finance is basically in the state of financial self-sufficiency.

The author would like to express gratitude to Zhang Haobing’s research work and the help of Duan Hongbo, Gao Wei, Lianan Hexia, Yan Li, Li Zhenni, Luo Shen and Lin Wang in case investigation.

Appendices

Descriptive materials used in this article refer to the information provided by CD Finance headquarters, the annual reports on the official website of CD Finance and CD Finance Microcredit Cases written by Li Jing (included in the book Microfinance in China) etc.

Appendix 1: Microcredit Practices of CD Finance

Descriptive materials used in this article refer to the information provided by CD Finance headquarters, the annual reports on the official website of CD Finance and CD Finance Microcredit Cases written by Li Jing (included in the book Microfinance in China) etc.

CD Finance is a social enterprise dedicated to providing microcredit to middle and low-income groups in rural areas. It aims to support income-generating activities of middle and low-income families in poor areas by means of mortgage-free and door-to-door microcredit. In addition, it also offers various forms of non-financial services, in order to improve customers’ comprehensive ability and achieve sustainable poverty alleviation and prosperity.

1.1 Development History

1.1.1 Pilot Project

The microcredit business of CD Finance can be traced back to the microcredit pilot project of foreign non-governmental organizations in China in the 1990s. In 1996, the World Bank Loans Poverty Alleviation Project in Qinba Mountain Area was initiated, including the microcredit pilot projects of Western China Human Resources Development Center implemented in Langzhong Sichuan and Ankang Shaanxi. In 2000, China Foundation for Poverty Alleviation (CFPA) had fully taken over the microcredit programs of Western China Human Resources Development Center and established the microcredit project department. In 2001, the Poverty Alleviation Office of the State Council accepted CFPA as the pilot unit of microcredit poverty alleviation, suggesting the official approval of the microcredit poverty alleviation pilot project of CFPA. During this period, microcredit of CFPA was co-run and co-managed by local governments. To be specific, local governments (generally led by the Poverty Alleviation Office) established the county service agency, and CFPA signed agreements with local governments, provided fund, product design and technological support and carried out supervision and management etc.

1.1.2 Transformation

CFPA microcredit project department was officially established in January 2005, devoted to the strategic transformation and management of microcredit; and it has been running under CFPA all this time. At the end of 2006, CFPA received a credit line of RMB 100 million yuan from China Development Bank, becoming the first microcredit institution acquiring a wholesale loan from a bank in China. It indicated that microcredit of CFPA started using interest-bearing loans, while, by comparison. special government funds and endowments had been adopted before. In the year of 2007, the total loans released exceeded RMB 100 million for the first time, and the pilot project of personal loans began. In 2008, CFPA obtained a wholesale loan of RMB 20 million from Standard Chartered. On November 18, 2008, CFPA transformed the microcredit project department into CD Finance Project Management Company Limited.

1.1.3 Expansion

By the end of 2008, the microcredit project department was transformed to be CD Finance Project Management Company Limited, a specialized microcredit project management company controlled by CFPA. In 2009, CFPA acquired a credit line of RMB 200 million from the Agricultural Bank of China. In 2010, the credit tracking system independently developed by CD Finance was put into operation, marking the new stage of professional chain management. In 2010, the number of active credit customers of CD Finance exceeded 100,000 for the first time; the loans released of the year went beyond RMB 1 billion; and CD Finance was successfully incorporated into the credit information system of the People’s Bank of China and had grown to be the largest public-welfare microcredit organization in China. In 2013, CD Finance had successfully developed Android-based smart phone business system, and transferred the management end of loan business from computers to mobile phones. By December 31, 2014, CD Finance had provided microcredit to 141 counties in 16 provinces nationwide, most of which were poverty-stricken counties at the national or provincial level, had outstanding loans totaling RMB 1.88 billion, attracted 238,000 farmers as active loan customers, achieved a risky loan ratio for loans over 30 days as low as 0.27%, and had more than 1,860 employees. In over a decade, it has released approximately 938,000 small loans to farmers and benefited over 2 million poor people.

1.2 Structure

As a national specialized microcredit organization adopting chain management, CD Finance has gradually established a group-based management method characterized by centralized research and development and unified supervision by the head office and strict implementation of regulations by branch offices. CD Finance has created a credit, finance and human resources management system under the centralized operation by the head office and formulated the uniform operation process and management system. All branches in different regions are incorporated in the management system of the head office; human resources, finance and materials are subject to the unified management of the head office; funds are operated in a closed manner; and front-line managers and credit operators of different levels are cultivated. In addition, CD Finance as constructed an independent internal audit system, which assures at least one internal audit for each branch office a year and controls the operational risk.

CD Finance applies the four-line three-level matrix management system. It sets up the head office in Beijing, which consists of functional departments and is responsible for fund management, credit policy, branding, risk control and technology research and development etc., and establishes regional offices in different areas of China to guide local businesses. The branches directly under the head office are established at the county level, responsible for the release and recovery of loans in accordance with the standards of the head office. At present, it only takes three months of preparation for a new branch of CD Finance to conduct business.

CD finance has been adhering to the principle of “locals serving locals”. Regional branches fully apply local management. They recruit local employees, assign loan officers to each township or town and provide door-to-door services, to make it as convenient as possible for farmers to obtain loans. Loan officers come from local rural areas, who may have not received higher education but know well about rural areas and have strong ability. In particular, the grass-root loan officers are local farmers, mostly married women aged over 30. As these women’s working ability and comprehensive quality will be improved through a series of business and skill trainings, they will gradually grow to be excellent loan officers. In this way, great jobs are offered to these project areas. CD Finance also performs regional distribution of loan officers based on the loan officer’s location and personal ability as well as the population density of the region. Loan officers may manage 20,000 to 40,000 people, and, on average, each loan officer is responsible for the management of over 20,000 people. CD Finance specially designs the examinations for front-line employees, to make sure that they regard micro loans as their long-term careers, assure the security of each loan, and develop businesses and expand the volume of credit.

1.3 Products and Services

1.3.1 Credit Products

CD Finance supplies simple credit products, including the joint-guarantee credit loan, and the personal credit loan that was only launched in recent years. These two products vary in two ways. First, their ways of credit guarantee are different, as group lending is guaranteed jointly by five households, and personal lending is guaranteed by personal credit. Second, they have different limits for each single loan. The maximum amount of group lending is RMB 16,000, while the limit of a personal loan is RMB 50,000.

The credit products of CD Finance show the following characteristics:

• First, mortgage-free design. CD Finance serves those called low-quality customers in traditional financial institutions, who have no collateral and may bring high risks. Considering the features of these customers, the microcredit products are supplied based on customers’ future ability and willingness of repayment instead of their current assets. Breaking through the thinking pattern of traditional financial institutions, CD Finance has developed the mortgage-free five-household-guarantee loan and personal credit loan that adapt to rural areas.

• Second, access to rural women. As CD Finance mainly supports the development of rural families by providing loans, rural women become its major objects of lending. In this way, it improves the family status of women and also lowers the loan risk. At present, 93% of CD Finance customers are women.

• Third, interest rate higher than that of banks. The comprehensive rate of CD Finance micro-loans is 20.64%. The higher interest rate effectively prevents people who have other financing channels from lending from microcredit institutions, and therefore assures that the microcredit funds flow to the groups who cannot acquire loans from other financial institutions. In this way, the mission of microcredit institutions can be fulfilled. Anyone with financing ability will choose the loans of a lower cost rather than microcredit. By now 99% of CD Finance customers are farmers.

• Fourth, convenient lending and lower cost. If farmers want to borrow from commercial banks, they need to go to the banks in the county; but they only need to make a call if they borrow from CD Finance, as the workers of CD Finance will provide door-to-door service. Moreover, housing mortgage and guarantors are needed in most cases for the loan from commercial banks. By comparison, CD Finance offers credit loans, which save farmers’ time cost and economic cost to a great extent.

• Furthermore, in order to satisfy different demands of customers in different regions, CD Finance released such new products as agricultural loans and pastoral loans etc. in 2014.

1.3.2 Services in Addition to Micro-Loans

Free insurance: CD Finance cooperates with China Life. Since 2009, CD Finance started introducing commercial insurance and presenting “term life insurance” to all farmer customers as a gift. If exposed to any accident, the farmer will be exempted from remaining debt, so farmers’ repayment pressure decreases. In 2014, CD Finance had provided free credit life insurance to 253,000 customers, with the total amount insured reaching RMB 2.8 billion and the total insurance premium reaching RMB 4.73 million, 40% higher than that in the previous year. 137 families suffering from death or accidental disability had been exempted from debts in this year.

Agricultural technology training and information technology training: Most farmers borrowing micro loans are engaged in agricultural production. CD Finance provides diversified agricultural technology training for free based on local agricultural characteristics, to equip farmers with confidence and ability to develop income-generating projects. In 2014, CD Finance had offered more than 4,000 agricultural technology trainings of various forms to over 20,000 customers and released more than 60,000 copies of technology materials. Rural financial education: CD Finance updates customers’ financial management concept, increases their incomes, lowers risks, and helps them realize the sustainable development of their families. In August 2011, the information of farmers borrowing micro loans from CD Finance was officially included in the credit information system of the People’s Bank of China, and all transactions of CD Finance were imported to the credit system. More than a hundred thousand customers who had no loan record in formal financial institutions had their own credit records all at once.

1.4 Risk Management

1.4.1 Risk Management of CD Finance

The current risk management system of CD Finance consists of three parts, the risk management department, risk management system and credit tracking system. CD Finance mainly adopts follow rick control measures: small loans, joint guarantee, information transparency among different regions and relatives and moral culture.

Small loans mean that the maximum amount of a loan is RMB 50,000, and the average loan amount per capita is RMB 10,000. The small amount principle assures that a single loss will not exert big influence on CD Finance and the risk is relatively decentralized, lowering the unsystematic risk. 10-month equal repayment of principal and interest is adopted, so farmers’ repayment pressure is amortized in the whole loan period, making the loan more acceptable to farmers. In this way, small loans show no direct impact on farmers’ major investments, and will not induce farmers’ willful default at the cost of credit. Therefore, small loans are safer and more effective for risk control.

Joint guarantee is the most important method of risk control for loans. Group lending fully arouse farmers’ initiative to participate in financial activities and makes full use of the trust and morality formed in interpersonal communication in Chinese local society. It not only relieves information asymmetry, but also increases the reputation cost if the helped breach the contract, thus reducing the adverse selection and moral risks that are commonly seen in borrowings.

Loan officers have better local connections. As they come from the local village or neighboring village, they are more acquainted with the farmers and can better promote credit products and control the risk in real time.

CD Finance mainly runs businesses in poor areas in north China, where the people are simple and honest and moral discipline plays an important role. Therefore, morality constitutes another important risk control measure against loan defaults.

1.4.2 Operation Process of CD Finance Loans

Distinguished from formal financial institutions that mostly control risks depending on the scoring model or loan officers’ experience and judgment, CD Finance cannot grade customers’ credit based on customers’ previous transaction records since most customers have no credit record at all. Loan officers, except those from the front line, cannot timely acquire information on customers’ repayment ability or rapidly develop risk response measures. Moreover, considering the small amount of loan and dispersed customers of CD Finance, it would take a higher time and economic cost to control risks in a traditional way. Hence CD Finance applies a special procedure of loan for risk control.

CD Finance has established a whole set of operation process of providing a loan, by which all farmers’ self-supporting service communities and microcredit companies must strictly comply when releasing and recovering loans. In addition to few types of products, CD Finance also adopts uniform operation process nationwide. The regulations on the processes of farmer selection, information transfer, loan release, loan recovery and risk monitoring etc. are expressly provided and are incorporated in the information system of CD Finance. This special credit model also improves risk control.

• 1. New loan application. To apply for a loan, the new customer shall first organize a joint-guarantee group and then call the loan officer for loan application. The loan officer will review the information on site, provide loan knowledge training, record necessary information such as the identity card, family status and loan purpose etc. on the same day and check with the information system, and then submit the application to the service community. In this period, the customer does not need to offer any official application material, as all agreements are formalized. Joint guarantee plays an important part in the selection of customers. Since neighbors often communicate with each, have rich and high-quality information about each other and know each other’s background and moral quality well and deeply, some bad customers are directly screened out by joint guarantee. In most cases, the five households of joint guarantee are neighbors, friends or relatives. Joint guarantee is an invisible process of credit investigation and reduces information asymmetry. However, vigilance shall be maintained against the credit group completely made up by people of bad reputation.

• 2. Identification of customers’ credit rating. The maximum amount of loan varies for different grades of customers. The customer applying for a loan for the first time is identified as Grade 1; the customer who had applied for a loan and made repayment on time will be identified as Grade 2 if he/she applies for a loan again; and the customer will be automatically ascended to Grade 3 if no default in two loans. The maximum amount of loan for Grade 1 is RMB 10,000, compared to RMB 12,000 for Grade 2 and RMB 16,000 for Grade 3. In the meantime, the comprehensive rate for Grade 3 customers decreases from 20.64 to 19.2%. CD Finance restricts the borrowing amount for the sake of risk control.

• 3. Loan review. This process includes office review and field investigation. Office review mainly examines whether the age, amount and risk of member groups comply with requirements and generally takes 2–3 days. Field investigation mainly aims to check the results of the training performed by the loan officer on the customer, including whether the customer is fully aware of the loan liability and repayment requirements etc. before the release of loan. After field review, the customer will sign and put his/her thumb print on the documents and fulfill the loan formalities. The loan officer’s control of loan risks constitutes a major part of risk control. The whole review process from the establishment of the joint-guarantee group to loan release lasts up to 10 days.

• 4. Loan release. The county service community is responsible for the release of loans. In general, loans are released jointly by the accountant, cashier and supervisor on site, when a group photo of the customer, loan officer and the supervisor of the service community shall be taken. The loan officer shall record the customer’s repayment information and the group photo in the CD Finance credit management system on the same day.

• 5. Loan recovery. The loan is recovered by the loan officer. The customers shall first give the repayment to the group leader, from which the loan officer will collect the repayments. The loan officer shall communicate with customers on the phone, make an appointment 2 or 3 day ahead, visit the customers to recover the loan and deposit the cash received in the bank (or credit cooperative) nearby on the same day. Each loan officer has one basic account exclusive for loan recovery, where no withdrawal can be made. After the loan officer deposits the repayment, the money will be automatically transferred to the account of the service community. In order not to affect the group’s reputation, the members of the credit group will help each other out in repayment, so the repayment risk in the joint guarantee method is born by three to five people rather than only one person. The unsystematic risk borne by the company has been evidently lowered.

• 6. Risk monitoring. After the release of the loan, the service community and the loan officer shall call customers back for risk monitoring in the later stage. In this process, the loan officer is considered as the major factor of risk control. The loan officer shall carry out collective trainings on the group, visit customers’ homes, make irregular return visits and inquire about customers when passing by etc.

1.5 Funding Sources

Public-welfare micro-loan companies mainly rely on non-profit capital that stresses social values in the early stage. However, along with scale expansion, these companies have a growing need of for-profit funds from the market. To be specific, funds for CD Finance credit come from following channels.

• 1. Investments. Investments refer to the funds given by the investors of CD Finance, including domestic and foreign contributions collected by CFPA, the donations made by commercial institutions and interest-free loans provided by some non-governmental organizations to CFPA.

• 2. Wholesale loans. CD Finance has cooperated with China Development Bank, Standard Chartered, Agricultural Bank of China and Bank of Beijing successively and acquired wholesale loans from these banks. Considering the wholesale loan interest rate of approximately 6.5% and the guarantee cost, the total cost of capital ranges between 8 and 10%. By now, wholesale loans have become the major funding source of CD Finance.

• 3. Strategic investors. Strategic investors can replenish the capital fund of CD Finance.

• 4. Asset securitization. In 2014, the China Securities Regulatory Commission approved the CD Finance public-welfare micro-loan asset support special plan, totaling RMB 500 million, which opened the channel of capital market financing. In 2015, the product of CD Finance asset special plan of RMB 500 million had been completed, suggesting that the brand new capital market financing model of public-welfare microcredit has become a conventional financing model.

Moreover, CD Finance also enjoys the preferential tax policy exclusive for financial institutions that release agriculture-supporting loans. According to the circular published by the State Administration of Taxation and the Ministry of Finance in 2010, the interest income of agriculture-supporting loans smaller than RMB 50,000 released by CD Finance is exempted from the business tax. CD Finance is the only one among public-welfare microcredit institutions that enjoys the privilege.

1.6 Development Performance

Through years of exploration and efforts, CD Finance has become the largest public-welfare microcredit institution in China and is playing an important role in rural finance. In 2015, Planet Rating, a world-famous microcredit rating agency, evaluated the microcredit programs of CD Finance and concluded that CD Finance ranked Top 20% among global microcredit institutions in terms of its business management and social performance management.

The asset size of CD Finance has been expanding swiftly in recent years. In the year of 2014, CD Finance had released 253,001 loans, totaling RMB 2.9 billion. By the end of 2014, the amount of outstanding loans of CD Finance reached RMB 1.9 billion, having increased by 58.46% compared to the previous year; and the number of active customers attained 237,817. The total assets have gradually grown from RMB 800 million in 2011 to 2.24 billion in 2014 by 1.8 times; and the owner’s equity has increased from RMB 270 million in 2011 to 570 million in 2014 by 1.1 times (See the major data of the balance sheet in Table 4).

Table 4 Assets and liabilities of CD finance 2011–2014 Unit: RMB 10,000

While expanding the scale of assets, CD Finance also maintains favorable asset quality. In 2014, 100% of the loans provided by CD Finance were mortgage-free, 69% had a loan limit lower than RMB 10,000 and 63% were directly applied to the farming and breeding industry. Since 2006, the risky loan ratio (PAR) for loans over 30 days of CD Finance has been stably below 0.5%, and was merely 0.27% in 2014.

CD Finance has realized commercial sustainability and social values at the same time. It has made profits cumulatively since 2008, which demonstrates that releasing loans to poor farmers is a sustainable commercial model but not transfusion-like poverty alleviation. Equal cooperation is established between CD Finance and customers, by which CD Finance provides microcredit to farmers, earns appropriate interests to support its own sustainable operation and further offers customers with credit services, and by which customers apply for and acquire loans for their development, generate new incomes, improve their living standards and get rich. In 2014, CD Finance achieved an operating income of RMB 310 million and a net profit of RMB 19.43 million, reaching a total return on assets (ROA) of 1.04% and a net return on equity (ROE) of 3.48%. In regard to the service area and object, in 2014, 81% of the loans of CD Finance were given to poor counties; 97% of active customers were farmers; 81% of customers had never borrowed from other financial institutions; and 93% were women. As CD Finance provides mortgage and guarantee-free loans and door-to-door services, customers can apply for and repay the loans at home, which significantly save farmers’ economic and time cost. In the article The Role and Influence of Microcredit – Empirical Research with China Foundation for Poverty Alleviation Microcredit as Instances, the Center for Chinese Agricultural Policy, Chinese Academy of Sciences, appraised CD Finance as follows: “CD Finance microcredit is popular among farmers. Most microcredit customers say that CD Finance is always their first choice if they need money. 84% of microcredit farmers believe that microcredit is more convenient and rapid compared to formal financial loans.”

See the composition of the intended use of CD Finance loans in Fig. 1.

Fig. 1

(Data source 2014 annual report of CD Finance)

Composition of the intended use of CD finance loans

1.7 Summary and Discussion

1.7.1 Attribute of CD Finance

Is CD Finance a poverty-alleviation agency or a financial institution? As an organization established by CFPA, CD Finance adheres to the original intention of providing the inclusive financial service instead of making profit by releasing loans. In the rural credit market, the Rural Credit Cooperatives plays the most important role, followed by the Agricultural Bank of China and the Postal Savings Bank of China. However, these three major financial institutions see a sharp rise of the transaction cost when they offer credit to “agriculture, rural areas and farmers”. As the profit can hardly be made for the loans smaller than RMB 50,000, so these three major financial institutions can hardly reach farmers at the lowest level. For example, the Rural Credit Cooperatives covers 87 thousand farmer households as its credit customers, only accounting for a little more than 1/3 of farmers all over the country. A great number of farmers are excluded from these financial services and can only rely on private lending for financing. CD Finance is actually serving the other 2/3 farmers through micro loans instead of donations, to support their entrepreneurial development and achieve the goal of hemopoiesis-like poverty alleviation. In view of the particularity of the level of customers, in the rural financial market, CD Finance is a supplement to the current financial system rather than a competitor to other financial institutions.

Therefore, CD Finance is not a financial institution in a strict sense based on its current state of development. It is a social enterprise derived from an NGO with microcredit as the means and poverty alleviation as the fundamental goal.

1.7.2 Replicability of CD Finance

CD Finance is a successful case among China’s public-welfare micro-loan companies. Hence people concern about whether the model of CD Finance can be duplicated, and whether other agencies can also achieve both commercial sustainability and public welfare in rural credit market by copying the operation procedure and management method of CD Finance.

CD Finance is a specialized microcredit project management company controlled by CFPA, while CFPA is a corporation under the Poverty Alleviation and Development Office of the State Council. Based on its professional microcredit management ability and outstanding social performance, CD Finance has won vigorous support of the government in terms of preferential policies, qualification to microcredit pilot projects and bank funds etc. The support is mainly embodied in the follows: CD Finance enjoys the preferential tax policy exclusive for formal financial institutions that the agriculture-supporting loans smaller than RMB 50,000 are exempted from the business tax and income tax; CD Finance is allowed to access to the credit information system of the People’s Bank of China as a regional financial institution and shares its customer credit information in the system; CD Finance can acquire wholesale loans totaling hundreds of millions yuan from large financial institutions including China Development Bank and Agricultural Bank of China; it is the first microcredit institution admitted to the pilot project of credit asset securitization after the registration system is implemented; and it has received the visits by and the care of relevant departments.

Featuring manifold advantages in policy support, tax relief and financial support, CD Finance has improved its reputation and business efficiency, and meanwhile lowered its operating cost. By comparison, it is more difficult for other ordinary public-welfare micro-loan institutions to survive the severe market challenges, practice their social missions, and transform their operating principles by introducing the market-oriented management model and operation system. As a matter of fact, policy support and the institutions’ favorable development lay the foundation for each other. If a microcredit institution is weak in operation and management, it may finally lose the support it acquired due to its management problem.

Appendix 2: Research Report on Branches of CD Finance

In order to better understand the microcredit operation process, risk control method and development achievements of CD Finance, the research team⁷ of Microfinance Research Center of Renmin University of China went to Haixing County, Cangzhou, Hebei Province for field research in April 2015. The research was mainly conducted on Haixing Farmers’ Self-supporting Service Community and microcredit customers through in-depth interviews with relevant personnel and on-site observation of the lending process.

1.1 Overview of Haixing Farmers’ Self-Supporting Service Community

Located in the southeast of Hebei Province and by Bohai Sea, Haixing is one of the key counties of national poverty alleviation and development. A famous local saying goes like “Planting ten thousand hectares of land to harvest a thousand kilograms of grain”, which demonstrates the extremely low grain output. Covering 965 square kilometers, Haixing County consists of 3 towns and 4 townships and has a population of 220 thousand. In 2014, its regional gross domestic product (GDP) was RMB 3.73 billion, its per-capita disposable income of urban residents was RMB 19,166 and per-capita net income of farmers was RMB 5,196.⁸

The branch of CD Finance in Haixing, Haixing Farmers’ Self-supporting Service Community, as established on March 7, 2011, providing services to 7 townships and towns and 197 administrative villages. It has 10 staff members: three are executives, including a director, an accountant and a cashier (the accountant and the cashier concurrently work as supervisors); and seven are loan officers. The office of the Farmers’ Self-supporting Service Community is in an ordinary two-story building, and the office conditions are not that good.

The director of the Farmers’ Self-supporting Service Community is selected by the head office of CD Finance. The major selection criterion is the grassroot work experience and the sense of responsibility, followed by the requirement on the professional level of finance. The current director Wang had held a deputy post in three townships, served as the deputy director of the poverty alleviation office of the county and worked in grass-root units for 10 years. Wang had no finance-related experience before taking the office.

The head office has set up the process. We shall implement the process, which means to communicate with the people face to face.

—Director Wang

When choosing loan officers, the main points are whether the candidates have credit problems and extensive social connections, and whether they are living in the villages of convenient traffic, high population density and large information flow, which may facilitate their travel and information gathering.

Loan officers shall be strictly examined in an all-round way. A person’s reputation is very important in rural areas, so the personal character is considered the primary factor. Loan officers shall have a good understanding of local conditions and live in an advantageous region, i.e. the towns or townships of a large size along the vital communication line. In addition, they shall have many relatives, grasp a large amount of information and be hardworking.

Loan officers of Haixing Service Community are 40 years old on average. Their base salary is RMB 2,000 per month, which will be raised according to their performance. At present, their monthly salary is RMB 3,000 or 4,000 on average, and each can earn a net income of approximately RMB 2,000 or 3,000 after the “five insurances and the housing fund” and all traffic, communication and advertising costs are deducted. Compared to the urban per-capita net income of RMB 2,700 per month in Haixing, a poverty-stricken region, the monthly salary of RMB 2,000 or 3,000 and the welfare of “five insurances and the housing fund” are fairly good for ordinary farmers.

Since the income is associated with the performance, workers keep high enthusiasm. CD Finance assigns loan officers regionally according to the regions the loan officers live in, population density and loan officers’ personal ability. Loan officers provide services to the entire population of the county, i.e. 220 thousand people, and each of them is responsible for 31 thousand people on average. Loan officers shoulder heavy workload. For example, to run a one-year loan (group) of RMB 50,000, loan officers have to visit the group on site for at least 12 times, 1 for investigation, 1 for loan release and 10 for loan recovery.

CD Finance’s loan risk control largely depends on the grass-roots loan officers’ understanding and judgment of the farmers. Therefore, the sense of responsibility of grass-roots loan officers plays a vital part in the execution of loans; and credit risk will occur if they are out of control. CD Finance incorporates the total amount of loans, the recovery of loans and the number of non-performing loans in the examination of loan officers. For the appraisal of the director of the branch office, the “staff turnover” is included. With this special design, CD Finance makes sure that its employees regard micro loans as their long-term careers, assure the security of each loan, and develop businesses and expand the volume of credit.

1.2 Specific Process of Microcredit

1.2.1 Loan Process

The loan application is completed in the following 4 steps:

• 1. The farmer applies for borrowings to CD Finance, and the loan officer visits the farmer and understands the farmer’s intention and purpose of borrowings.

• 2. The loan officer introduces the rules of the application for and repayment of loans to the farmer.

• 3. The farmers set up the credit group independently, which generally comprises 5 people who all have borrowing demand and bear the joint and several liability of repayment for each other. Five-household joint guarantee was adopted before 2014; and after 2014, three to five-household joint guarantee has been applied according to specific local conditions.

  There is no special regulation on the group members, so relatives (except the immediate family) or neighbors can establish a group together. As a strong entrepreneurial awareness has been formed among local farmers, the “borrowing” culture has been created here.

  In this place, when a son needs money to start a business, he often chooses to apply for a loan instead of borrowing from his father, as he does not want to depend on his father.

  Group lending has fully aroused farmers’ initiative to participate in financial activities and makes full use of the trust formed in interpersonal communication in Chinese local society to solve the issues in pre-loan review, loan monitoring and after-loan management and reduce the adverse selection and moral risks that are commonly seen in borrowings

  Grouping is not a simple task. Farmers have to organize a group by their own. Grouping relies on farmers’ reputation, while some relatively rich farmers cannot find a group. Once a credit officer asked a farmer whether she was willing to make repayments for the other four people if they could not pay the loan. She said yes because they had helped her out when she was building her house. In another case, a customer who worked in the transportation industry had an accident, other group members paid money back for her…This is how the joint-guarantee group works. Group members make commitments to each other while grouping. As these women live in the same village and know each other well, they are willing to repay the loan for others and help each other.

• 4. The loan officer reports the borrowing demand to the Service Community for approval. Upon approval, the loan will be released.

1.2.2 Characteristics of CD Finance Microcredit

The financial institutions that can offer credit services in Haixing include commercial banks, rural credit cooperatives and micro-loan companies, but they target customers of a higher level and provide a higher loan limit compared to CD Finance. Microcredit of CD Finance is distinguished from these financial institutions by following characteristics:

• 1. CD Finance adopts microcredit. By providing borrowings of a small amount, it shows no direct impact on farmers’ major investments, and will not induce farmers’ willful default at the cost of credit. It is mainly used to help meet an urgent need or used as a supplement. To be specific, customers can be divided into three grades by their repayment records. The customer of a higher grade can borrow more money. The customer applying for a loan for the first time is identified as Grade 1 and can borrow no more than RMB 10,000; the customer applying for a loan for the second time will be identified as Grade 2 and can borrow no more than RMB 12,000; and the customer applying for a loan for the third time will be identified as Grade 3 and have a loan limit of RMB 16,000.

  Our aim is to “assist micro-entrepreneurship”. By “assisting” we mean lend some money when entrepreneurs still have not enough money after self-financing instead of giving them all the money they need.

• 2. The term of the loan is one year, and the repayment in equal installments is adopted. The loan interest rate of the equal repayment of principal and interest is 13.5% (annualized interest rate of 20.64%, covering the insurance), which can be further lowered to 12.5% (annualized interest rate of 19.2%). The repayment shall be made since the third month, and 10-month equal repayment of principal and interest is adopted, so farmers’ repayment pressure is amortized in the whole loan period, making the loan more acceptable to farmers and lowering the risk of the institution. The higher interest rate effectively prevents people who have other financing channels from lending from microcredit institutions, and therefore assures that the microcredit funds flow to the groups who cannot acquire loans from other financial institutions. In this way, the mission of microcredit institutions can be fulfilled. According to the practice, this interest rate is acceptable to farmers.

• 3. The loan is released based on the credit and needs no mortgage or collateral.

• 4. At present, cash is used in the borrowing and repayment. The loan officer directly sends the borrowing to and collects repayments from the customers’ homes. Later electronic money will be gradually adopted.

• 5. All group members must be on the spot when the loan is released, to attend the special ceremony of signing, sealing and photo-taking. The borrowers shall submit their ID cards and household registers. After having gone through the formalities, the loan officer shall immediately send relevant information to the head office for real-time monitoring through the mobile end of the credit tracking system independently developed by CD Finance.

• 6. Borrowings can be applied to multiple purposes, including production and business such as planting, breeding and processing, durable goods consumption such as house building, and also medical expenses, wedding costs and school expenses etc. There is no specific provision on the purpose of borrowings. Customers can apply for the loan as long as they can repay it.

• 7. The loans are released to farmers at the bottom level and are exclusive for married women aged between 20 and 65.

  Farmers use their mobile phones only to make or answer calls, and some of them have no fixed-line phone, not to mention smart phones. Some women even cannot sign their names and have to learn it on the spot.

  In regard to the borrowing, women have a greater sense of responsibility and risk control than men do. In this region, men cherish friendship a lot and they may spend their money when they drink together.

  Women will not leave their families and run away.

• 8. Convenient access to loans. The advertisements of CD Finance microcredit are seen in many places on the walls at the village entrance。 When farmers were asked why they applied for loans from CD Finance in the investigation, the most common answer was “convenience”. They only need to make a call, and CD Finance will offer them door-to-door services, saving them from complex formalities and high transport expenses and lowering their time and economic cost. Moreover, distinguished from the mortgage-free credit loans provided by CD Finance, the banks’ loans require housing mortgage or guarantors’ guarantee, so the traditional method of loans costs too much compared to farmers’ small capital demand.

After the farmer calls to apply for a loan, a loan officer will provide the door-to-door service, and must visit the farmer customer’s home for at least 12 times for each loan. The loan officer visits the customer for the first time to ask for information, to release the loan in cash for the first time, and to recover the loan monthly in the 10-month repayment period totaling 10 times.

1.2.3 Microcredit Risk Control Model of CD Finance

CD Finance has established a whole set of loan process applicable to rural microcredit. However, the risk control means that play a part are not the credit system or the risk control model, but are the “folk methods” that cannot be standardized or quantified, which include the small loans, joint guarantee, information transparency among different regions and relatives and moral culture. It is said that Haixing Service Community has run into no overdue loan in the four years since its establishment.

Small loans mean that the maximum amount of a loan of CD Finance is small, and the average loan amount per capita is RMB 10,000. By doing this, it assures that a single loss will not exert big influence and the risk is relatively decentralized, lowering the unsystematic risk of CD Finance.

The joint-guarantee group assures risk control based on the independent selection and mutual supervision among group members. CD Finance does not involve the establishment of the group and the allocation of the loan, but mainly examines the group members’ willingness to shoulder the joint responsibility, i.e. the connections within the group.

The loan officer attaches importance to the credit of the whole group.

Though the director is responsible for loan approval after the loan officer reports the group’s information, it is the grass-roots units’ task to decide whether to release the loan. Two supervisors shall conduct investigation at the farmers’ home at the release of the loan.

We have rejected the cases by which the applicant borrowed money for others, rejected to bear the joint responsibility or failed to acquire the consent from her husband.

We always ask the customer whether she has reached an agreement with her husband, as we can only lend money if both of them agree on applying for a loan.

Since the credit group is set up independently by villagers, group members will examine each other when selecting members. Any rational person will reject anyone of bad reputation to avoid any impact on the group credit. Since neighbors often communicate with each, have rich and high-quality information about each other and know each other’s background and moral quality well and deeply, greatly reducing information asymmetry. Based on this screening method, all members of the credit group will enjoy a good reputation. However, vigilance shall be maintained against the credit group completely made up by people of bad reputation.

In the pre-loan stage, some bad customers are directly screened out by the joint guarantee system. This system is an invisible process of credit investigation. In order not to affect the group’s reputation, the members of the credit group will help each other out in repayment, so the repayment risk in the joint guarantee method is born by three to five people rather than only one person. The unsystematic risk borne by the company has been evidently lowered.

However, this joint guarantee system is not universally applicable to all places, but only applies to rural areas where people are simple and honest, neighbors are close and the population is relatively dense.

Loan officers have better local connections. They are mostly laymen in finance and do not meet the rules of official financial institutions. As they come from the local village or neighboring village, they are more acquainted with the farmers and can better promote credit products and control the risk in real time.

As a matter of fact, the work of CD Finance is different from that of the banks, and will benefit from visiting relatives and friends. Loan officers have relatives in their own villages or neighboring villages and have a deep understanding about local customs and villagers’ economic status and family conditions. CD Finance lends money only to the people at the bottom level but not to large projects or anything like that. Its loan officers have a special understanding of the grassroots. Instead of going to and getting off work at a regular time, they visit farmers including their relatives to find out more information.

1.3 Field Observation of the Loan Release of CD Finance

The research team visited Zhangchu Village and observed the practical process of loan release by the Serving Community. In this case, the borrowing team was made up by four women aged between 30 and 50 who all applied for the loan for the first time. They intended to use the loan to raise chickens or build a house. The specific loan information is as follows:

• Group leader Wang borrowed RMB 8,000 to build a house;

• Group member Han borrowed RMB 8,000 to build a house;

• Group member Wang borrowed RMB 6,000 to raise chickens;

• Group member Zhang borrowed RMB 8,000 to raise chickens.

This group borrowed RMB 30,000 in total, with a term of one year and an interest rate of 13.5%. Half of the borrowing was applied to production, and half to consumption. Two supervisors respectively asked group members some questions, followed them to their homes for investigation, then came back to the group leader’s home to verify borrowers’ willing to borrow, read out the rules of the loan, examined borrowers’ certificates if no objection to the rules, had borrowers sign and put their thumb prints on the documents, and released the loan in cash. The four borrowers counted money on site for confirmation, held their own borrowings and took a group photo with CD Finance workers again.

The questions that two supervisors asked repeatedly included: “Do you clearly know that you have to repay the loan for other three group members if they cannot make repayments?” “How will you use the borrowing?” “Have you reached an agreement with your family?” “Is there anything you don’t understand about our rules?”

In addition, the research team also asked about the proportion of loan amount to demand. Take the house building as an example. The customer borrowed RMB 8,000, while RMB 60,000 was needed to build a house. The borrowing amount accounted for approximately 13% of the demand, and the rest should be raised by the customer or borrowed from other channels.

1.4 Field Investigation on Previous Customers of CD Finance

The research team visited Biwangwen Village and had an interview and deep communication with farmers.

The team first visited Liu in Biwangwen Village. Liu, 53 years old, is a Grade-3 customer. Her husband and son are working out of town. She applied for a loan for the first time in 2013 to raise pigs, and now she has become a specialized pig farmer. She raises 80 or 90 pigs and the feed for each cost over RMB 1,300, so she needs approximately RMB 120,000 for capital turnover. A pig becomes full grown and ready for slaughter after 9 months of breeding and earns the farmer around RMB 400. Therefore, the total income per year reaches over RMB 30,000.

Mentioning why she chose CD Finance for borrowing, Liu said it was convenient and only one call was needed to apply for a loan, while the rural credit cooperatives required mortgage for a loan and was more complicated. As a Grade-3 customer, Liu could borrow a maximum of RMB 16,000 at an interest rate of 12.5%, but she borrowed only RMB 8,000 in most cases. Regarding this matter, she answered that she mainly depended on her own money and applied for the loan only for capital turnover. Other group members also borrowed money to run businesses, including shrimp aquaculture, pig raising and driving. When establishing the group, Liu gave priority to the group member’s personal character and credit, and then examined whether the member could make good money for timely repayment. She also considered whether the member’s family members had a stable income such as salary. She had organized three groups successively by now, which were made up by the same members. In over two years, they had not encountered any problem. When asked why she did not borrow such a small amount of money from her friends or relatives, she answered: “Everyone is willing to do something with money rather than saving it.” “Sometimes I need only 1,000 yuan, but I find it very difficult to borrow it in the rural area.” “Nobody saves money. They all invest all their money to do businesses.” There was also a subjective reason that it is unworthy to owe other people favors for such a small amount of money, especially in rural areas of close local connections.

Then the team visited Liu in Biwangwen Village. Liu is nearly 50 years old, Grade-3 customer, and borrowed RMB 16,000 for her third loan at an interest rate of 12.5%. She borrowed money mainly for her husband and her oldest son’s plastic steel window business, though she knew only a little about their business conditions. Despite the success of their business, their tie-up money had reached over a hundred thousand yuan. Liu was not the group leader. Another member of the group also ran the plastic steel window business, and others were raising chickens or ducks. All members were quite familiar with each other. Liu’s family income per year was RMB 30,000 to 50,000. When asked about her demand on microcredit, Liu answered: “Borrowing is used only as a last resort considering the interest.” When asked “how to find group members who also need money”, Liu said she would ask her acquaintances, and “they might not need money at that moment, but I can wait until they need and then borrow money together.”

1.5 Conclusions and Discussions

• 1. Being an effective supplement to rural finance in China, the microcredit of CD Finance serves the bottom level as a part of inclusive financial service. The service objects of CD Finance microcredit, completely distinguished from that of traditional financial institutions and emerging for-profit micro-loan companies, are middle and low-income farmers who can barely acquire any loan from financial institutions. The microcredit service of CD Finance is inclusive and different from transfusion-like poverty alleviation, as farmers will repay the principal and certain interest.

• 2. The loan interest rate of CD Finance is not low, but is acceptable to farmers, demonstrating the rationality of the high interest rate. A substantial portion of the interest income is used to cover the operating cost. According to the investigation, the operating cost of microcredit is high. Considering the “labor-intensive” loan process of CD Finance, loan officers have to spend a lot of time and energy, which cannot be realized by traditional financial institutions. Therefore, the income of loan officers shall be substantially raised as compensation, leading to the significant rise of the cost. The branches of CD Finance are mostly set up in poverty-stricken areas, and loan officers are all farmers. They can be engaged in agriculture and loan release at the same time, so the labor cost is still low. Under the circumstances, “labor-intensive” loan process is still the better choice. When the local labor cost increases or the CD Finance model is promoted to richer areas, this credit model may cause a higher operating cost.

• 3. The main risk-control mechanism of CD Finance is five-household joint guarantee. The service community plays a significantly smaller part in loan monitoring, and mainly develops customers and releases and recovers loans. The risk control before, during and after the loan is basically completed by the headquarter office and the loan groups. This is different with traditional commercial banks, the risk control of which stresses on the technical model to some extent. By comparison, micro-loans do not need the risk control model, but mainly rely on the system design, i.e. three to five people joint guarantee group. However, the group joint-guarantee model is neither applicable in sparsely populated areas (such as prairies) nor effective in areas of damaged rural culture. Microloans also do not apply to places of high per-capita income and developed commerce, since the small amount of loans can hardly satisfy the demand here. Hence the promotion of microcredit shall be in line with the local actual situation.

• 4. The five-household joint-guarantee of CD Finance is also exposed to certain operation difficulties and potential risks. The first problem is “how to match borrowing needs to establish a group”. According to the rules, a group can only be set up and the loan can only be released when 3 to 5 borrowers are brought together. However, different people’s borrowing demands do not always emerge at the same time, and it is even more difficult for people who know and trust each other to have a credit demand of a similar amount within a similar period. Farmers have to match their needs within the village, resulting in a high transaction cost. The second problem is how to prevent “multiple people borrowing money for only one person”, that is they conspiring together to acquire the loan by cheating. As group members are all relatives or close friends, they may lie that they all need the borrowing but give all the money to one person. According to the investigation, the RMB 10,000 per-capita loan limit is not high even in poor areas, so collusion may arise when the customer’s large capital demand cannot be satisfied. Against this situation, loan officers shall improve their identification ability, and the loan limit shall be appropriately adjusted based on research accordingly.

• 5. CD Finance provides one-year loans and the repayment shall be made since the third month; but it takes as long as half a year or a whole year before the return on the investment in production and operation is acquired. It means that farmers have no cash flow income and have to seek funds from other channels for monthly repayment. Another flexible alternative of farmers is to apply for a loan greater than their practical need. For example, they need to invest RMB 5,000 and can only gain revenue a year later, so they borrow RMB 10,000 to assure that they do not need to repay the RMB 5,000 too early. Farmers are rational enough to find the best balance between the interest expense and the capital demand, forcing the expansion of the credit scale.

Case Comments

Microfinance offers necessary financial services to the low-income group ignored by traditional finance and is characterized by a small amount, timeliness and convenience. In practice, we often encounter these questions: what are the differences between microfinance and traditional finance, and between microfinance and charity? This case study not only discusses the definition of microfinance, but also clearly identifies the differences between microfinance and traditional finance and between microfinance and charity, and proposes the concepts of the “upper boundary” and “lower boundary”.

How to understand the boundary between microfinance and traditional finance, i.e. the upper boundary of microfinance? With CD Finance specialized in microcredit, the author puts forward the four differences in terms of customer positioning, loan limit, credit product and risk control measures. To be specific, microfinance targets the low-income group s customers; its loan limit is below RMB 50,000; it adopts credit loans as its major lending mode; and its risk control mainly depends on self-managed communities. By comparison, traditional finance targets large-sized enterprises, provides large loans, offers mortgage loans and relies on professionals for risk control. These four differences demonstrate that the business mode as well as the organization, human resource structure and incentive and restraint mechanism decided by the business mode vary completely between microfinance and traditional finance. Great organizational adjustments are required if traditional financial institutions venture into microfinance. If without strategic changes, they cannot succeed.

Then how to understand the boundary between microfinance and charity, i.e. the lower boundary of microfinance? According to the author, the dividing criterion is self-sustainability. Charity only gives without considering about the revenue, but microfinance does not and cannot do so. First, microfinance stresses on the nature of transaction of finance. The principal and interest must be repaid for a loan; otherwise it is giving but not trading. Second, if microfinance gives its money away or offers interest-free loans, the credit culture will be damaged, which may even ruin the beneficiaries. Microfinance attaches importance to both commercial sustainability and social missions, and strives to balance and adhere to the both goals.

The author has put forward an important point in the case study, which is to fulfill the goal of social missions (seeking a relatively lower profit rate), and meanwhile determine a loan interest rate that enables financial self-sufficiency. According to the author, CD Finance adopts a typical microfinance credit model. Therefore, considering the high operating cost resulting from the high labor cost, the loan interest rate of microfinance is higher than that of large or middle-sized mortgage loans, thus to achieve financial sustainability. Since there is no other measure to lower the cost, the high interest rate has become an unavoidable feature of microfinance. As digital technology is playing an increasing role in lowering the human cost, it is expected that this unavoidable feature of microfinance will fade away.

Commentator: Yan Li