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      Despite significant progress in the general financial reform of the People’s Republic of China (PRC), rural financial reform has been lagging. It has been 16 years since the establishment of the Agricultural Development Bank of China in 1994, 14 years since the separation of the Agricultural Bank of China from the rural credit cooperatives (RCCs) in 1996, and 7 years since the current round of RCC reform began in 2003. Nonetheless, rural financial policies, especially those targeting poverty-stricken areas, are still in the exploration stage.

      Many constraints on reform remain to be addressed. For example, urban finance is used to guide rural finance, and informal finance is simply replaced by formal finance. This has led to the domination of RCCs in rural areas and difficulty in enacting rural financial innovation. In addition, the mission of rural finance to sustainably support sannong—agriculture and agricultural industry, including rural areas and farmers—remains unclearly defined. Rural financial institutions should support sannong in a financially sustainable manner and stop the vicious cycle of placing the heaviest burden of support on the poorest areas, which undermines sustainability. Third, the moral hazard of local government intervention in rural financial institutions must be reduced. Government intervention increases the cost of rural finance and creates the perception that rural finance is not sustainable without government support and direction. These constraints call for changes in perception, an improved financial environment, and innovation.

      Ensuring Access to Finance

      Economic reform in the PRC is a process of empowering individuals and enterprises and transferring power from government to market. It also is a process of government and market repositioning. The reform that has occurred in rural areas allows tens of millions of farmers to decide what and how much to produce. The reform in distribution enables suppliers and buyers to sell and purchase, as they desire, at mutually accepted prices. The reform of state-owned enterprises links the performance of managers with enterprises’ revenues, reflecting the rights and value of entrepreneurs as the soul of enterprises. The opening of the labor market endows the labor force with the freedom to migrate to other places and choose jobs. Farmers, as users of collectively owned land, are granted certain land lease right. Private capital is allowed to enter most industries formerly monopolized by state-owned enterprises, including the civil aviation industry, reflecting respect for the rights of investors.

      Until now, however, reform has not touched upon the right of individuals and enterprises to access financing. The only legal financing channel for individuals is through financial institutions dominated by state-owned commercial banks, whereas enterprises can get financing only through bank loans or in the highly regulated capital market. Modern financial theory holds that finance includes both investment and financing. Thus, the financial rights of individuals and enterprises are incomplete if they comprise the right to make investment without access to financing.

      The requirements for diversifying financial rights include cultivating the market, establishing a credit mechanism, and breaking the inertia of the traditional government administration system. The protracted state monopoly of the credit market suppresses informal finance, and unsound market mechanisms or the uncertainties of market operation are principal reasons for concentration of financial rights. For instance, financial institutions have maintained previous interest rates even after bank loan interest rate liberalization. The insensitivity of state-owned financial institutions to interest rates is partly to blame for this, but the lack of an effective interest rate discovery mechanism is a more important cause.

       The insensitivity of state-owned financial institutions to interest rates is partly to blame for this, but the lack of an effective interest rate discovery mechanism is a more important cause

      In addition, an incomplete credit information system may result in individuals infringing upon the state’s credit. Credit information is a basis for financial activities. For a long time, financial institutions have based their businesses on state or collective credit. Without a fully developed credit information system, uncertainties brought about by the diversification of financial rights may shift credit risks to the state. For instance, troubled securities companies and enterprises are put into state custody.

      Finally, the inertia of the traditional system postpones financial diversification. In the command economy, all economic resources, including financial resources, were at the disposal of the state or collective. Given the unique role of finance in resource allocation, financial rights are an extension of the administrative rights of governments. When it comes to economic planning, industrial policies, project approval, and microeconomic adjustment, the combination of financial rights and administrative rights reflects the government’s guarantee. This is why, at a time when most economic rights are diversified, financial rights, especially the right to financing, remain centralized in government-controlled financial institutions.

      Overly centralized financial rights concentrate economic risks in the state and are very costly. One major characteristic of centralized financial rights is a limit on the right of individuals and enterprises to use their own money, forcing them to entrust this right to state-designated and state-guaranteed financial institutions. Due to pervasive information asymmetry in financial markets, the use of others’ money in this way may lead to moral hazards. On the one hand, financial institutions may suffer from moral hazard in selecting clients and monitoring loans. On the other hand, enterprises may be subject to moral hazard when they sacrifice others’ interests in the pursuit of profits. Moreover, the centralization of financial rights may spread the credit risks generated by these two types of moral hazard throughout the entire economy.

      Financial rights centralization also infringes on the economic rights of individuals and enterprises. Many business opportunities are transient and cannot be turned into earnings without the right to financing. In this sense, the right to invest is not complete without a right to financing. The difficulty of small and medium-sized enterprises in accessing funds reflects the conflict between diversified investment rights and centralized financing rights. The only option for most such enterprises is informal finance. However, informal finance is not protected by law and therefore represents a heavy burden rather than a right for individuals and enterprises. In the current system, informal fund-raising and soliciting deposits from the public are criminal conduct; there is only one step between investment and crime.

      Major efforts are needed to guarantee the diversified financial rights of individuals and enterprises, beginning with the repeal of laws and rules that conflict with the establishment of a competitive financial market. For example, Article 176 of the criminal law stipulates that whoever takes deposits from the public illegally or in disguised form or disrupts financial order shall be sentenced to between 3 and 10 years in prison or criminal detention and fined CNY20,000 to CNY500,000, depending on the severity or monetary amount of the offense.

      The basis for such laws is that financial resources belong to the state and no individual has the right to dispose of financial assets because limited financial resources must be used to serve the economic good. According to these provisions, deposit agreements between individuals, between enterprises, or between individuals and enterprises are illegal activities. Such lending and borrowing activities are regarded not as legitimate competition for state-owned financial institutions (including RCCs) but as illegal activities, and lending organizations outside of formal finance are illegal financial organizations. Beyond a certain threshold, taking deposits through private channels also is considered a crime. The coarseness of this legislation results in law enforcement authorities randomly cracking down on lending activities outside the system and puts a damper on financial innovation.

       Major efforts are needed to guarantee the diversified financial rights of individuals and enterprises, beginning with the repeal of laws and rules that conflict with the establishment of a competitive financial market

      The statutes governing usury are unclear. According to provisions of the Supreme People’s Court, private lending interest rates can be higher than the bank interest rate, to a certain extent, subject to the discretion of local people’s courts and in accordance with the local situation. However, the private lending rate may not exceed four times the bank lending rate in the same category;

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