Why Did the Rural Agricultural Cooperation Funds Fail?: A Look at Changde, Hunan Province

Abstract

A modern economy needs financial institutions that facilitate the transfer of funds from people who save to those who have productive investment opportunities. (1) In China, this function is performed overwhelmingly by the banking system. In 1985, a new type of financial institution came into being--the rural cooperative funds (RCFs). They were simple depository institutions that basically took savings deposits from peasant savers and lent them to other peasants and town and village enterprises (TVEs) in the same local area. These institutions filled a gap that was not filled adequately by the existing financial institutions, and they showed great promise. However, many of the RCFs ran into serious problems, primarily with their loan portfolios, and in 1997 they were ordered closed by the central government. Many peasant depositors have never gotten their money back. (2) The RCFs were not able to survive in the Chinese environment, with its heavy-handed government interference, its abuse of power by the privileged and powerful at the expense of the depositors, and its seeming disregard of some basic principles of business and economics. As China strives to develop an efficient, diversified and durable financial system, the short, ill-fated history of the RCFs provides some object lessons. Setting up the RCFs Structure and Need (3) The typical depository financial intermediary borrows at one rate and lends at a higher rate. After allowing for expenses, the difference between the two rates is the profit. Of course, loan losses are an expense, so these must be minimised. In China, some peasants have idle money, while others need money. A financial intermediary was required to absorb the idle money and then lend it to the peasants who needed it. The RCF was just such a financial intermediary. (4) Local governments at each level of government set up the RCFs. That is, there were county funds, town funds and village funds. The RCFs at each of the three levels operated independently of each other, so that village funds were not controlled by the town funds, and the town funds were not controlled by the county funds. The RCFs were under the supervision of the Ministry of Agriculture, not the central bank. (5) The RCFs had important advantages and seemingly could have done a good job, especially in the case of loans to peasants. Fund employees were local people who were familiar with all the peasant families. They knew which peasants were diligent and had the ability to repay loans and which peasants might not pay them back. A need existed in China for a financial institution such as the RCFs. (6) By providing financing to agriculture, the RCFs helped fill an important gap in the financial system. This was a healthy development. In a modern economy, there is need for a variety of financial institutions and financial instruments, not just banks and bank loans. Given the vast size of China as measured by both area and population, a diverse and decentralised financial system would be especially valuable. There exist two types of financing in the Chinese economy--financing done by official (or formal or governmental) institutions and financing that is done outside official institutions. As discussed below, the RCFs were nonofficial (or informal) institutions. (7) Official Financial Institutions The rural sector in China is served primarily by official institutions: a state bank (Agricultural Bank of China), a policy bank (Agricultural Development Bank of China) and thousands of rural credit cooperatives (RCCs). RCCs are small savings and lending organisations that are the main source of small-scale financial services at the local level in the countryside. Their main borrowing clients are farmers and TVEs. Almost every township has at least one RCC. Although created at the township level, their presence in villages through branches and Offices makes them the financial institution with the widest outreach among rural populations. …