China's financial authorities are speeding up efforts to transform the nation's 30,000-plus rural credit co-operatives into banks, to prevent further losses at the institutions and to guarantee future financial support for the country's agricultural sector and rural-based enterprises.

Thousands of rural credit co-operatives in 21 provinces have applied to participate in the reform programme, which is being administered by the China Banking Regulatory Commission (CBRC), which is the industry's watchdog.

By last June, eight provinces had adopted the pilot programme, CBRC officials said.

The initiative is meant to close down loss-making institutions and to merge small lenders into bank unions, CBRC said.

Most rural lenders in the eight provinces say they have generated profits and implemented better risk-management systems since they have received guidelines, which explains how to operate as commercial banks, from CBRC.

That reportedly has encouraged rural credit co-operatives in other provinces to follow suit, and to apply to participate in CBRC's reform package, analysts said.

CBRC officials predict China's rural credit co-operatives this year will - for the first time in a decade - post a combined profit.

"China's rural credit co-operatives are shouldering the responsibility for providing financial services in rural areas," said Wen Tiejun, an economist, specializing in agriculture, with the China Society for Economic Reform.

"Therefore, it is urgent that the country's financial authorities launch reforms that will rejuvenate the sector."

Wen is a long-term observer of financial reforms in rural China.

Rural credit co-operatives currently are the only lenders in China's vast rural areas. Commercial banks closed their rural branches in the early 1990s.

"Although the optimistic prediction is rural credit co-operatives will, by year's end, cover 80 per cent of rural communities' financial needs, the actual coverage will likely be far less," Wen said.

By May 2001, the Agricultural Development Bank of China provided 21 per cent of the total loans to China's rural communities. The Agricultural Bank of China, meanwhile, provided 45 per cent of the total loans. Rural credit co-operatives, on the other hand, provided 34 per cent of total loans.

"Given the rampant problem of non-performing loans (NPLs) associated with these rural lenders, they now face huge difficulties, even in coping with their daily operations. Reforms cannot be delayed," Wen said.

Some analysts estimate the combined NPL ratio of rural credit co-operatives tops the combined ratio of the Big Four commercial lenders - possibly exceeding 50 per cent, on average, and reaching 80 per cent in some ill-managed institutions.

Last year, the government of Southwest China's Chongqing Municipality began clearing its rural financial sector. During the process, it disclosed 5 billion yuan (US$603.8 million) worth of NPLs in 700-plus rural lenders that held 1 billion yuan (US$120.7 million) in capital.

"The NPL problem ... is the main hurdle for local governments as they launch reforms in the sector," Wen said.

Some of the bad loans held by rural credit co-operatives can be traced back to 1996, when they were split off from the Agricultural Bank of China, Wen added.

"Another source of bad loans was the recent closure of rural co-operative funds in some areas," he said.

Rural co-operative funds were initiated by rural credit co-operatives, and farmers and local residents contributed to them to support lending to the agricultural sector.

But poor management of the private funds resulted in losses to investors. That prompted financial authorities to crack down on the funds.

"Rural credit co-operatives are usually small and lack well-trained staff for daily management. This situation concerns financial authorities, and has given them reason to believe mergers and acquisitions in the sector are needed," said Xu Dianqing, director of the Great Wall Financial Research Institute and a professor at Canada's University of Western Ontario.

"The ultimate goal is to restructure existing rural lenders into rural co-operative banks, which will have some of the characteristics of shareholding banks."

Some rural residents and enterprises will become shareholders in the co-operative banks. As shareholders, Xu said, they will have a say in the institutions' management.

In the second half of 2001, rural credit co-operatives in Changshu, Zhangjiagang and Jiangyin, all in Jiangsu Province, were merged and restructured into rural commercial banks.

Compared with city commercial banks, where the government holds shares, the rural commercial banks only accept deposits from individuals, employees and private enterprises, Xu said.

The rural commercial banks' structure is slightly different from that adopted by co-operative banks, Xu added.

By the end of 2002, loans for farm-related projects accounted for 5.4 per cent of the national total, while those for township enterprises accounted for 5.2 per cent. However, farming and township enterprises, combined, contributed 46 per cent of the country's gross domestic product (GDP).

Rural credit co-operatives held a combined 1.4 trillion yuan (US$168 billion) in assets at the end of 2002, while their combined non-performing loans reached 514.7 billion yuan (US$62.01 billion).

The co-operatives' combined capital adequacy ratio was only 2.35 per cent, much lower than the internationally accepted level of 8 per cent.

(Business Weekly 10/20/2004 page5)