Rural credit co-ops give China a headache

The ruling Communist Party broke new ground last week by announcing it would let private and foreign investors take stakes in the co-ops, the main formal source of credit in rural areas that are home to 750 million of China's 1.3 billion people.

A few foreign institutions, including the Dutch cooperative bank Rabobank (RABN.UL: Quote, Profile, Research), have been working on deals in China's prosperous east in anticipation of the barriers coming down.

But most of the 30,000 cooperatives are in such poor shape that analysts doubt the government will be able to offer tempting enough incentives to get investors to venture into the poorer parts of China where their cash and expertise are most needed.

"An ugly woman needs a large dowry to get married," said Zhong Wei, a professor of Beijing Normal University.

"The rural credit cooperatives have the biggest problems of any Chinese financial institutions."

Zhong said the rules covering foreign investment in China's banking sector would have to be relaxed in the case of the co-ops, which still had a non-performing loan ratio of 14.8 percent at the end of 2005, down from 23.1 percent in 2004.

"Although some improvements have been made in restructuring the units, the fundamental problems of inadequate risk controls, poor corporate governance and a shortage of qualified staff have yet to be solved," Tang Shuangning, vice-chairman of the China Banking Regulatory Commission, said last week.

The agency has already turned some of the better performers into rural commercial banks or cooperative banks and backed the idea of foreign investment to improve their corporate governance.

Two such banks -- the Tianjin Cooperative Commercial Bank and the United Rural Cooperative Bank of Hangzhou -- have been discussing the sale of minority stakes to Rabobank and the International Finance Corp., the World Bank's private investment arm.

PILOT PROJECTS

A regulatory source said the plans to sell stakes in the Tianjin and Hangzhou banks could be regarded as pilot projects.

He said more test-bed deals would follow.

"We are working on new rules on shareholding reform and letting foreign investors into rural co-ops," the source said.

Chief Executive Bert Heemskerk said in January that Rabobank expected to buy stakes of around 15 percent in two Chinese rural co-op banks in partnership with the IFC by the end of 2006.

But the two are still awaiting approval some 15 months after signing a memorandum of understanding with the Hangzhou bank for a combined 24.9 percent stake.

Lydia Lin, an analyst at Fitch Ratings in Beijing, said it would take quite a while for the regulator to draft new rules.

"At the moment, foreign investors are only keen on opportunities in China's urban regions. They have no interest in RCCs in the poor countryside," she said.

Rural co-ops had extended 2.2 trillion yuan in loans at the end of 2005, 10.9 percent of all financial sector loans.

Australia and New Zealand Banking Group Ltd. (ANZ.AX: Quote, Profile, Research) is also eyeing a former co-op that, like those in Hangzhou and Tianjin, is rural only in name. Australia's third-largest bank has said it hopes to wrap up long-running talks this year to buy a stake in Shanghai Country Commercial Bank.

"If the government wants to attract foreign investors to go to the central and western regions where the market is less vibrant, it must offer favorable policies," said Zhang Xuechun, an analyst with the Asian Development Bank in Beijing.

She said the government would have to provide tax breaks and let the co-ops expand beyond their home base.

But Dong Chen, head of research with China Securities in Beijing, questioned just how much room the government had to maneuver. Letting foreign banks gain management control would be controversial given the recent backlash against the sale of minority stakes in state-owned banks to foreigners.

Dong said China should look closer to home for a solution.

"For the less-developed parts of China, the RCCs should be opened to domestic private investors who have a good understanding of the situation at the grassroots," he said.