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subbranches are the lowest management layer, but they have no authority to appoint or remove staff, to budget independently, or to approve loans. For example, lower subbranches and enterprises spend time and effort rating enterprises applying for loans and then submit the results to provincial branches, which conduct examination only on an annual basis. Moreover, according to the president of one county subbranch, it normally takes 1 to 2 months for loan distribution, much longer than loan distribution from urban and rural credit cooperatives. Such an overstretched line of reporting deprives the ABC of good development opportunities.

      Third, the ABC raised the threshold of access to loans, focusing on businesses in advantageous industries and enterprises in big cities. ABC’s policy is to serve only clients with credit ratings of 2A and above, abandoning clients rated below 2A and subjecting new clients to credit rating by provincial branches. The ABC employs universal criteria for credit ratings, but some enterprises in less-developed regions have difficulty meeting such requirements and therefore cannot get loans. Some high-quality county enterprises do not appear to be viable when compared with peers at the provincial level, and many enterprises are daunted by the standards.

       A PBC survey showed that the interest rate on capital deposited with upper-level entities is much higher than the rate provided by other commercial banks

      After 2003, the ABC strengthened control over credit aggregation and intensified collective management of credit, resulting in a worsening capital shortage at the county level. The ABC’s function in rural areas has shifted from supporting rural development by providing loans to taking deposits, providing settlement and intermediary services, and liquidating nonperforming loans. Operational offices below the county level mainly provide settlement, remittance, and other intermediary services; deposit certificate guaranty loans are the bank’s only credit product. At present, grassroots operational offices take deposits but refrain from lending to township enterprises and farmers, except for a few poverty-reduction loans. Thus, the ABC has been transformed from a state-owned commercial bank that mainly targets rural areas to a bank that gradually reduces its presence in the agriculture sector.

      Finally, the ABC transfers all collected deposits to upper-level entities and centralizes capital by raising the interest rate on such deposits, resulting in capital outflow from rural areas. A PBC survey showed that the interest rate on capital deposited with upper-level entities is much higher than the rate provided by other commercial banks. For example, in the first half of 2006, the 1-year interest rate on capital deposited with upper-level entities was 3.33%—one-half to one percentage point higher than the interest rate at other commercial banks. This policy encourages county subbranches to deposit their capital rather than lending it, impeding the efficiency of capital utilization in the local area. As a result, the balance sheet of county subbranches is quite unbalanced, with a declining deposit–loan ratio.

      Following these major policy shifts, the ABC lost its advantages and now competes with a multitude of financial institutions in large and medium-sized cities. At the same time, certain agriculture loans are more likely to become nonperforming loans. Because it is impossible to get additional loans from the ABC, the bank has become more estranged from its former clients, including enterprises and farmers, and many borrowers are less willing to repay existing loans. This is particularly true of borrowers in certain townships where the ABC has closed down operational offices. As a result, the number of nonperforming loans in county subbranches has skyrocketed in recent years.

      Dominance of the Rural Credit Cooperatives

      Competition in the PRC’s rural financial markets is constrained by state regulation of the entry and exit of financial institutions. The ABC and the ADBC are government-owned financial institutions. RCCs, though defined as cooperatives, are subject to PBC regulation and management and have a corporate governance structure similar to that of state-owned financial institutions. It is virtually impossible for new financial institutions to enter the market, and there is no defined mechanism for individual loss-making RCCs with negative equity to exit the market.

      Despite the creation of the ABC and the transfer of RCC management from the ABC to the PBC, the reforms of 1994 and 1996 failed to make rural financial markets more competitive. On the contrary, the reforms led to the gradual withdrawal of the ABC from rural lending and the collapse of rural cooperative foundations and other informal financial institutions, and the PRC’s rural institutional lending markets have become dominated by RCCs. Nonprice competition for rural deposits has become fierce, especially in more-developed areas, as the ABC continues to fight for rural deposits, and the share of deposits held by rural postal savings has grown over time.

      Building on the experience of a pilot in Jiangsu Province, the 2002 National Financial Working Conference laid down the basic principles of RCC reform. The conference decided that one-size-fits-all organizational patterns are ineffective, that commercialization should be allowed in qualified regions, that management should not be vertical across the country, that microcredit should be continued, and that provincial governments should participate in risk mitigation.

      In June 2003, the State Council launched the pilot RCC reform in eight provinces and cities, including Chongqing, Guizhou, Jiangsu, Jiangxi, Jilin, Shaanxi, Shandong, and Zhejiang. In August 2004, the pilots were expanded to 21 provinces, regions, and cities, including Beijing, Hebei, and Tianjin.

      The 2003 pilot RCC reform was designed to solve the supply–demand contradictions between collective financial institutions and individual credit by improving the governance of financial institutions. Two Communist Party of China Central Committee documents, in 2004 and 2005, further defined the guiding macroeconomic policy principles behind rural financial reform, laying the overall foundation for a modern rural financial system in the PRC.

      By the end of 2006, the RCC pilot reform was launched in Hainan Province, marking the national coverage of the reform (there are no RCCs in Xizang Autonomous Region⁷). The China Banking Regulatory Commission created rules to allow for the establishment of rural financial institutions such as rural banks and lending companies, opening a new chapter in the PRC’s rural financial development. Meanwhile, the pilot of new types of rural financial institutions was gradually expanded to increase competition in the rural financial market.

       In June 2003, the State Council launched the pilot RCC reform in eight provinces and cities, including Chongqing, Guizhou, Jiangsu, Jiangxi, Jilin, Shaanxi, Shandong, and Zhejiang

      The pilot RCC reform allowed private shareholding for ownership restructuring, which drew on the experience of restructuring township and small and medium-sized state-owned enterprises. Conducted under the leadership of the China Banking Regulatory Commission, the major reform measures included giving provincial governments authority for administering RCCs, issuing special central bank bills and loans to support the reform, and granting subsidies and tax exemption for the period 1994 through 1997.

       The reform of postal savings is an important part of the state postal system reform

      Unfortunately, the implementation of RCC reform has yet to address the issue of moral hazard. First, RCCs are not subject to bankruptcy and can incur losses in the name of supporting the rural economy. Second, local governments and RCCs might ask for unreasonably high compensation from the central government as a means of resolving historical burdens. Third, by exploiting the overlap of policy and commercial operations, RCCs can request central bank support, again in the name of supporting the rural economy.

      Postal Savings Reform

      The reform of postal savings is an important part of the state postal system reform. Since 2001, the PBC, the Ministry of Finance, and the Ministry of Posts and Telecommunications have conducted a number of studies and proposed a reform scheme under which different interest rates apply to deposits before and after a cutoff date, and postal savings offices have been encouraged to expand their business scope. In 2003, the National Development and Reform Commission played a leading role in coordinating with relevant ministries and commissions and proposing to the State Council a postal system reform plan that would enable postal savings offices to utilize their funds independently

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