By Yan LI
Centre for Microfinance Initiatives & Networks
Renmin University of China (CMIN)
It is my great honour to represent the Centre for Microfinance Initiatives & Networks of Renmin University of China, to introduce our recently released ‘China Financial Inclusion Development Report in 2015’, which is also called ‘Green Paper’ on Financial Inclusion. This report consists of three sections: firstly, it has a distinctive theme, secondly it focuses on specific research questions, and thirdly we examine the practical questions by employing case studies.
I. Theme: Good finance and good society
The green paper is titled ‘Good finance and good society”. Since 2014 our research team has been studying the optimal relationship between economics, financial services, and society. Our findings show that although financial services can help people learn money management, improve economic efficiency, and generate GDP growth and wealth growth, finance can equally create chaos. Severe financial crises and stock market crashes induce economic shocks, thereby causing recessions and economic crises.
The financial activities exacerbate serious polarization of wealth distribution. As French economist Thomas Piketty mentions in his book ‘Capital in the Twenty-First Century’: Since the industrial revolution in the 19th century, capital income has grown at a faster rate than labour income. Consequently, the unjust distribution of social wealth has widened the gap between the rich and the poor. Prof. Piketty also argued that services with the aim of improving money management further increase the polarization between the rich and poor. We do not expect economic instability and wealth inequality to be resolved any time soon. Therefore, we must consider what the function of finance means to us. Thus far, many economists have discussed the relationship between finance and the economy, but limited research exists on the relationship between finance and society.
In his 2012 book ‘Finance and the good society’, Nobel Laureate and economist Robert Shiller explains how the financial sector contributes towards a good society. The idea of finance being able to achieve greater societal outcomes stimulated my curiosity. If we define the good society as a harmonious and stable society, then good finance should help reduce the polarization between rich and poor, improve economic stability and enhance harmonious and stable social development. Based on these measurements, it is clear that we currently do not have good finance. There is a distribution imbalance of financial resources and financial structure. Nobel Laureate Joseph E. Stiglitz mentioned that the financial sector should service for other industries in the economy rather than vice versa. However, prior to the financial crisis in 2008, 40% of firm profits flowed into financial sector. Is this situation reasonable?
As shown in Figure 1, the financial sector wasaccountable for1/3 of total societal profits and 96% total industrial sector profits. Besides, the investment return of Chinese firms on average was close to or even lower than the1 year bank lending rate. It illustrates an imbalance of social profit distribution. We believe that this can be attributed to an excess or shortage of supply of financial service.
Figure 1 Profits on financial sector and whole society
Secondly, there is an imbalance of supply of financial services. Access to financial resources varies between micro and small enterprises, and large and stated-owned enterprises. First of all, there is a serious shortage of financial resources for Chinese private firms, and for micro and small enterprises. In 2011 the number of private enterprises, particularly medium-and-small enterprises, reached 10 million, occupying 99% of the total number of enterprises. The output accounted for 60% of total GDP. They completed 70% of innovation outputs, contributed 50% of total tax revenue and 80% of employment. However, they only received 30% of total bank credit. Moreover, a large number of self-employed businessmen including farmers, small entrepreneurs and individuals have financial constraints. When medium-and-small enterprises are seeking financial resources, the financial resources for large and state-owned enterprises are relatively abundant. In 1980 the number of state-owned enterprises comprised82% of all enterprises, and accounted for 99% of total fixed asset investment lending. By 2012, the number of state-owned enterprises reduced to 26% of total number of enterprises. However, the large and stated-owned enterprises still enjoyed 60% of total credit.
Figure 2 shows the financial needs of the whole society. The top of the pyramid represents the financial demands of richer, larger enterprises, government and financial sector. The bottom of the pyramid represents the large number of working-class groups, small and micro enterprises, and self-employed workers, who demand much diversified financial service. The inverted pyramid represents the supply of financial capital. These two pyramids indicate that there is a serious structural mismatch between financial demand and supply, and an imbalance financial resource distribution.
Figure 2 Chinese financial structure on demand and supply
How should we solve these issues? First of all, we have to develop financial inclusion. Economists believe that financial exclusion is caused by an insufficient and unstructured supply of financial resources. However, from the social development point of view, this unfair distribution of financial rights and inequality development will harm social harmony. This is not the good finance that we expect.
How can we achieve good finance? Financial inclusion is good finance, which is conductive to a good society. There are several reasons for this. First of all, financial inclusion mainly services groups that have been neglected by traditional finance. Thus, financial inclusion can release distorted capital and mismatched financial resources to achieve resource allocation equality. The balance between supply and demand addresses the excess or shortage of finances, avoids economic and social fluctuations, and contributes towards stable economic development and social stability. Secondly, financial inclusion teaches people how to use money rather than simply give it to them. This helps medium-and-small enterprises and individuals achieve self-sufficiency. The inclusive finance also provides equal rights for people to create wealth in order to achieve inclusive growth and economic development. Someone said we have to strengthen purchasing power in society. On one hand, we have to give money to poor people, so that they can afford to buy goods and services. On the other hand, lowering entry barriers offers everyone an opportunity to start a business or to be a capitalist. Based on this statement, financial inclusion is a mechanism to reduce entry barriers. Consequently, everyone has a chance to achieve self-development and dreams. Therefore, it is necessary to develop financial inclusion in order to achieve a good society. Just like the Chairman Assistant of China Banking Regulatory Commission Mr. Jiacai Yang said: financial inclusion occupies the social and moral high ground.
II. Definition of financial inclusion
Financial inclusion aims to provide finance to all people who demand financial services. Thus, financial inclusion comprises of the following features:
There is fair and inclusive access to financial service.
Target customers are diversified. The preference of mainstream financial institutions should be different to SMEs and individuals due to different economic and institutional conditions. It means that the target customers of financial inclusion should differ based on economic conditions at different time periods. The Chinese economic and institutional structure determines the financial structure, whereby large-size enterprises receive the greatest share of finance distributed by large banks. This financial structure creates a situation where low-income groups, micro enterprises, and small enterprises can receive limited financial services. Thus, in China, financial inclusion does not only concerning micro entrepreneurs, but also impacts on SMEs, altogether named MSMEs.
Comprehensive financial products. As shown in Figure 3 below, the main product for financial inclusion is microcredit. But financial inclusion should include savings, insurance, payments, agents and leasing. It provides multifunctional financial services beyond the microcredit business.
Figure 3 Financial inclusion service
Participants are extensive and diverse. With the development of information technology, excluding financial institutions, many non-professional individuals will join financial institutions through the internet. The development of internet finance and information technology offers great technical support to financial inclusion participants.
Business model sustainability. We have to emphasize that financial inclusion is not all about charity, but rather sustainability through business exchange. Lenders urge borrowers to repay interest on loans, but also seek to improve the quality of management and business income. Thereby ensuring the sustainable development of both parties. Hence, the transaction fee of financial inclusion has a bottom line.
III. Financial inclusion development in China
We conclude by exploring three phases of Chinese financial inclusion development. In the 1990s financial inclusion focused primarily on poor consumers. Many people recognised financial inclusion as a poverty alleviator and a type of charity. The second phase in 2000-2005 was microfinance. Rural finance began evolving into financial inclusion by providing small and micro finance for farmers and the agriculture sector. We (China) are currently in the third phase which began in 2005, the financial inclusion stage. Many financial institutions, large-size commercial banks, and medium-and-small commercial banks have expressed interest to financial inclusion and their service regions have expanded from rural areas to cities.
Recently Chinese financial inclusion has been through a high-speed development stage. The service has been improved, there are diversified service targets, and a growing number of various types of financial services.
I would like to point out that excluding banks and small loan companies working on microfinance, there is a boom of internet finance joining financial inclusion. The figures below illustrate the scale and scope of internet finance including third-party payments, P2P, and crowd funding.They experienced a growth spurt during 2014 and 2015, which contributes to the development and diversification of financial inclusion. Thus, we have to pay more attention to the important role of internet finance.
Figure 4 The amount and growth rate of online payment
Figure 5The amount and growth rate of mobile payment
Figure 6 Trading amount of P2P
Figure 7 The number of crowd-funding
IV. Issues on Chinese financial inclusion
We think there are two main issues that should be pointed out on Chinese financial inclusion:
The lack of financial deepening. Our financial system has historically been along-term monopoly. The previous financial reform in China has not quite addressed this situation. To some extent, this affects the development of microfinance and finance inclusion.
The infrastructure of the market needs to be improved. First of all, there is a delay of government policies and regulations. Due to the rapid development and innovation of diversified financial inclusion, this is a great challenge to financial system regulation in China, especially the regulation on the supervision and support on internet finance. Secondly, there is a lag in the credit system. According to our research, the lagging and inefficient credit system which is led by the government is unable to adapt to the needs of microfinance. We have to accelerate the development of our credit system. The features of financial inclusion determine that financial inclusion is more dependent on dynamic information and non-financial information compared to traditional finance. This highlights the importance of having a solid credit system. Otherwise, the operating costs of financial inclusion will increase. Our research stated that it is necessary to develop a big data based credit system to improve overall proficiency of credit system. However, there is no international experience to learn from. We have to speed up the legal construction and technological innovation, which is based on institutional innovation. It is a great challenge for the government to perfect laws and regulations to address the issues. However, if it comes true, the credit system may create a new development phase in China.
V. Case studies
We have studied 6 cases in green book, mainly focusing the following 6 issues.
The boundary of microfinance definition. Currently the definition distinguishes the difference between microfinance and traditional finance, mainstream finance and charitable organizations. For example, the CFPA microfinance analysis estimates the minimum lending interest rate to sustain financial growth. Based on CFPA case, the financial inclusion is not pursuing lowest lending interest rate or poverty alleviation because these cannot achieve the sustainable wealth growth.
Credit risk control on small and micro finance of traditional banks. Taking the CMSB as an example, large banks working on microfinance should pay more attention to the big data based credit risk control system, which can avoid high operating costs.
Meixing microcredit enterprises in Nanchong, which works on how to achieve efficient social and financial performance on microfinance.
‘3+1’ honest organisation in Zhengzhou, Henan province. We are looking for how third parties use innovative models to control credit risk. This organisation pursues a good and honest concept. An honest score incentivises more enterprises to join the organisation. It controls credit risk through organisational management to monitor, mitigate, and transfer risks, which provides an example of understanding enterprises and eases financial constraints on them. Higher risks faced by small and medium enterprises result in a higher probability of failure. It is a challenge to manage credit risk when they receive the loans. ‘3+1’ honest organisation offers us an example.
PPdai is doing business on an online P2P lending platform. We try to discuss how Chinese P2P internet lending projects work, and find out the essential causes of dynamic business models under the absence of regulation and a social credit system. It is not easy for online P2P lending enterprises to conduct business as a media platform. Through this case, we call on our regulators to publish the relevant regulations and improve the social credit system as soon as possible.
Bairong under Baifengdian enterprises. Through this case, we examine the effects of big data on financial inclusion and credit risk control in microfinance. It analyses how big data impacts credit products to compensate for the shortages of traditional credit, as well as reflect the advantages of information technology and big data. It is necessary to speed up to the process of legal construction and open the credit markets.
In conclusion, this ‘Green Paper on Financial Inclusion’ is the beginning of financial inclusion research. From here on, we will publish a green paper each year with a specific topic. We hope that this will contribute to the development and practice of financial inclusion in China and the world.
We believe that financial inclusion is a good finance and offers benefits that can help us achieve a good society. We are willing to be good practitioners and watchmen.
Finally, we would like to thank all the followers and participants of financial inclusion. Thank our sponsor CMBC on ‘China Financial Inclusion Report in 2015’ and all the staff on our research team.