Sat, July 13

The Rise and Risks of China’s Village Banks 2024

Introduction

Recently, data indicates that at least ten of China’s Village Banks dissolved last year. According to statistics from Shangguan News, the main reason for the dissolutions was acquisition and mergers by larger banks. For example, Beijing Daxing Huaxia Village Bank was acquired by Huaxia Bank, Inner Mongolia Helingeer Mengshang Village Bank was taken over by Mengshang Bank, Liaoning Qianshan Jinquan Village Bank was merged into Anshan Bank and Guangxi Rongshui Liuyin Village Bank was merged into Liuzhou Bank. In recent years, there have been numerous instances of rural bank failures, which have impacted the nation, such as the Henan village banks affecting the entire country. Today, let’s discuss the origins of these rural and village banks, their status within the banking system, the issues they face, and the lessons they provide for financial management.

The Origins of Village Banks

The emergence of village banks is significantly related to the financial development of rural areas. In 1997, as part of large bank reforms, state-owned banks massively withdrew from rural areas, making rural credit cooperatives the primary financial institutions in active service at the grassroots level. However, due to low coverage and insufficient financial services, these cooperatives impacted the “last mile” of financial services in China. By 2006, pilot projects to establish village banks were initiated in rural areas of six provinces including Hubei, Sichuan, and Jilin, marking the start of the national village bank pilot program. This initiative aimed to better serve the agricultural sector (“san nong”), and the conditions set for establishing these banks were extremely lenient. According to the Commercial Bank Law, a typical commercial bank needs a minimum registered capital of 1 billion yuan. In contrast, to register a village bank, it is only necessary to find a domestic bank to hold more than 20% of the shares, with other investors holding no more than 10% each, enabling the registration and establishment of a village bank with just 1 million yuan.

The relaxed registration requirements, which are 1,000 times less stringent than those for typical commercial banks (1 billion yuan versus 1 million yuan), led to a rapid emergence of village banks. However, public trust in these banks is quite low. People with some spare cash generally prefer to deposit it in larger banks rather than in village banks. In 2011, a survey of 1,000 residents and farmers in Chongqing showed that 86% of respondents were sceptical of the credibility of village banks, and 93.5% said they were unwilling to deposit their money in them. They expressed concerns that village banks, due to their small scale, posed greater risks and were less secure. Therefore, despite the numerous registrations and establishments of village banks, their business operations have not been smooth.

Village Banks in China’s Banking System Hierarchy

So, what position do China’s village banks hold within the Chinese banking system? Banks in China are primarily categorized into several types.

The first category includes the well-known “Big Four” state-owned banks directly funded and controlled by the state: Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and China Construction Bank. This group was later expanded to include two more large state-owned commercial banks: China Postal Savings Bank and Bank of Communications, collectively known as the “Big Six Banks” of China.

The second category encompasses national joint-stock commercial banks, including 12 banks such as China Merchants Bank, Shanghai Pudong Development Bank, and CITIC Bank.

The third category consists of city commercial banks, which were formed by reorganizing local city credit cooperatives and incorporating local government and enterprise investments. These banks typically start with a geographic name, such as Guangzhou Bank, Dongguan Bank, Guangdong Nanyue Bank, Guangdong Huaxing Bank, and Zhuhai Huaren Bank. As of 2022, there are 125 city commercial banks in total.

The fourth category is rural commercial banks, such as Shanghai Rural Commercial Bank, Beijing Rural Commercial Bank, and Xiamen Rural Commercial Bank, typically featuring the local area name followed by “Rural Commercial Bank.” These banks are restructured from rural credit cooperatives.

The fifth category includes other types of banks, such as foreign banks, joint-venture banks, and the village banks being discussed.

Internet banks like Alibaba’s MYbank and Tencent’s WeBank operate outside the traditional banking system. Therefore, in the banking hierarchy, village banks carry relatively little weight because they were originally designed to serve the rural sector (“san nong”) and are considered a form of inclusive finance, which is inherently difficult to scale up. The foundations for these banks are also challenging. However, the emergence of Internet finance has brought new opportunities to village banks. Jack Ma once said, “If banks don’t change, we will change the banks.” In June 2013, Alipay’s Yu’E Bao was launched, utilizing the platform’s merchants and massive user base. More people began depositing their money in Yu’E Bao, which offered interest rates as high as 7%, a significant challenge to traditional commercial banks whose deposit rates were just over 4% at the time. Consequently, Yu’E Bao drew substantial deposits away from the state-owned ‘Big Six’ banks, let alone from village banks.

The Rapid Growth

Since they could not compete, village banks decided to join the change, which allowed them to expand nationally. Previously, village banks were confined to local county areas, but now, with the help of internet platforms, they can reach every corner of the country. Compared to other major banks, village banks fall short in savings absorption and profitability, but their greatest advantage lies in offering higher interest rates. Coupled with the massive traffic from internet finance platforms, village banks have found a new lease on life, soaring to new heights. Many well-known internet finance platforms have partnerships with village banks to some extent. According to a report by the Securities Daily, by the end of 2020, 95 banks had entered into internet platform deposit products, with village banks and other local regional banks like Chenglong Commercial Bank accounting for the highest proportion, at 70%. With the aid of the internet, village banks have welcomed a new spring. Although they are not large in scale, they are numerous. According to a report by First Finance, by the end of 2021, there were 1,651 village banks nationwide, accounting for about 36% of the total number of banking financial institutions in the country.

Current Issues of China’s Village Banks

Village banks are undoubtedly the most numerous type of bank. However, they also have the highest non-performing loan (NPL) rate among all types of banks. Data from Xingtu Financial Research Institute shows that as of 2021, the NPL rate for village banks was 4%, significantly higher than that of other types of banks. This is somewhat expected as high returns often come with high risks. So, what is the biggest risk for village banks? In December 2021, an article on early identification, warning, detection, and handling of financial risks stated that two high-risk banks dealt with that year including one with total assets of about 150 billion yuan, where 93% of the loans were made to its controlling shareholders. Another bank of similar size had 80% of its loans extended to its controlling shareholders. The Henan village bank incident also revealed similar issues.

In June 2022, four village banks in Henan experienced difficulties with withdrawals, including Yuzhou Xinminsheng Village Bank, Shangcai Huimin Village Bank, Zhecheng Huanghuai Village Bank, and Kaifeng Xindongfang Village Bank. Many points about the Henan village bank incident could be discussed, such as the inability to withdraw funds online, the high-interest rates of five or six percent, and the background of its controlling shareholders. The incident involved the actual controller of Henan Xincaifu Group, Li, who is suspected of committing a series of serious crimes using village banks, controlling more than a dozen village banks, thereby turning these banks into his cash reserves, with the high-interest deposits naturally becoming his money. Financial journalists have learned that these four village banks in Henan had relationships with over 30 third-party channels, which presents a major risk as village banks can easily become cash machines for their controlling shareholders. The Henan village bank incident has sounded an alarm for the industry.

The Future

There are two distinctly different views on village banks: one is favourable because of the high deposit rates offered. For example, in 2023, while the six major state-owned banks lowered their deposit rates, many village banks raised theirs. The second view is that village banks are too small and risky, as evident from the high non-performing loan rates mentioned earlier.

So, where does the future lie for China’s village banks? It is believed that they should return to their original mission of serving the rural “san nong” sector and providing inclusive finance. They expanded too quickly without clear visibility on how funds were circulating within the banking system, and without adequate regulatory oversight, which is problematic. Honestly, the general public doesn’t know and doesn’t care about these complexities; they just know they deposited their money. They are not at fault and should have the legal evidence to prove their deposits. But if they can’t withdraw their money, who are they supposed to turn to? Such an event is a disaster for an individual. Therefore, it is advised, especially for those considering long-term fixed deposits, to only place their money in the four major banks and not be tempted by the high-interest rates offered by small banks. It might seem like a deposit, but you could end up being signed up for a financial product instead. People should stay away from small banks and financial schemes and simply save their money securely.