* Run on rural co-op as depositors rush to withdraw cash
* Funds meant for farm loans shifted to real estate
* Co-ops lightly regulated to encourage innovation
* Farmers' co-ops became platform for grey-market lending
By Gabriel Wildau
YANCHENG, China, March 6 Depositors wanting to
withdraw money from a rural bank in eastern China's prosperous
Jiangsu province ahead of the Lunar New Year holiday found the
doors locked, their money gone and employees offering a simple
"We've lent out all the money. There's none left," an
employee told Reuters, repeating the explanation given to
depositors weeks earlier.
In the run-up to the holiday in late January, word had
spread that at least three rural cooperatives were running short
on funds. In what the local government described as a "panic",
depositors rushed to withdraw cash. Local officials say several
co-op bosses fled after committing fraud.
Though the incident is modest, it highlights the risk that
financial liberalisation intended to channel more credit to
farmers and others who struggle to access loans from big state
banks could open regulatory loopholes that enable a surge in
"The core problem is, after using this (co-op) structure to
raise funds, effective regulation is lacking," said Chen Ping,
director of the Farmers' Credit Co-operative Union, an
association of researchers studying rural co-ops.
"Actually a large amount of funding has been shifted into
large-scale projects like real estate."
Depositors would normally be protected by China's banking
regulator, which requires lenders to keep a certain amount of
cash on reserve to meet depositor demand.
But as participants in a pilot programme, the depositors
quickly woke up to an unpleasant reality: so-called "Farmers'
Mutual Help Funding Cooperatives" aren't technically banks. Not
only did they not have sufficient reserves on hand, they weren't
legally required to.
Officials in Yancheng city told state media that the
situation would be resolved before the holiday, but Reuters
found on a recent trip that two of at least three co-ops that
closed their doors before the holiday remain locked.
ABANDONED IN HASTE
On the city's semi-rural outskirts, the offices of the
Yancheng Environmental Protection Industrial Park co-op appear
to have been abandoned in haste. The lobby, visible behind
padlocked glass doors, was strewn with trash.
In an emailed statement, the propaganda department of Tinghu
district in Yancheng told Reuters that 18.3 million yuan ($3
million) had been returned to depositors of three troubled
co-ops before the Lunar New Year. That compares with 80 million
yuan that state media previously reported had gone missing.
"The related departments of Tinghu district and the co-ops
are working together to take effective measures and actively
raising funds to ensure the timely payment of funds to
depositors," the department said in an unsigned statement.
Farmers' co-ops began appearing in Jiangsu province around
2006, after the Communist Party issued guidelines encouraging
the establishment of innovative rural financial institutions as
part of a broader "New Socialist Countryside" campaign.
But, like many such policy statements, the document was
vague, setting out broad goals for rural development while
leaving specific agencies to fill in the details.
The government was content to allow co-ops to operate with
minimal supervision because, at least in principal, they are
membership institutions, not banks. Only members who have paid
into the co-ops could get loans, and members assumed the risks
from lending to one another.
Rather than the China Banking Regulatory Commission (CBRC),
local agriculture affairs offices, with little experience of
financial regulation, were tasked with supervising farmers'
"These institutions didn't impinge upon the interests of the
general public, so they could be lightly regulated," said He
Guangwen, professor at the College of Economics and Management
at China Agricultural University.
The idea was to allow farmers who knew one another to
co-operate on financing as well as work together on production.
And because each loan would be small, the co-op's overall
portfolio would be diversified, preventing isolated defaults
from bringing down the whole co-op.
By the middle of last year, 137 such co-ops had been
established in Yancheng, with total membership reaching 170,000,
deposits of 2.3 billion yuan, and total loans outstanding of 1.9
billion yuan, according to figures cited by official media.
But in practice, many co-ops shifted into riskier forms of
lending. Jiangsu, along with neighbouring Fujian province, is
known for its vibrant grey-market lending networks, serving
small factory owners and real estate developers who often cannot
obtain bank loans.
Informal lending generally occurs through family and
friends, but the rise of farmers' co-ops created a platform for
informal lenders to scale up their operations by collecting
funds in a bank-like setting.
"The revelations of problems in Yancheng is mainly because
the institutions aren't standardised and regulation isn't in
place," said He. "In China, lots of institutions exist calling
themselves (farmers co-ops), but few are actually based on
agricultural co-operation and sharing funds between members.
Most have undergone mission creep."
Despite the problems, the government is pushing further
expansion of co-ops.
In January, China's cabinet issued new guidelines on rural
reform that called for expanding the co-op system based on
"maintaining the membership system, the principle of closure,
and restricting deposit-taking and loans to members".
At the same time, the government is pushing other financial
reforms designed to expand credit to under-served groups. The
internet-based peer-to-peer (P2P) lending, micro-lending
institutions, and privately-owned banks are among the
initiatives the government is supporting.
Yet there are already signs that the problems afflicting
co-ops in Yancheng may also affect other forms of non-bank
lending. Local media have reported that dozens of P2P lending
firms, which operate fee-based platforms to connect lenders with
borrowers, have gone bankrupt in recent months.
"The truth is that a lot of burgeoning P2P platforms in
China have no basic risk diversification, not to mention risk
management," Liang Xiaozhong, CBRC deputy director, wrote on the
Financial Times website last week.
($1 = 6.1462 Chinese Yuan)
(Additional reporting by Shanghai newsroom; Editing by Ian
Geoghegan and Alex Richardson)