Imperfect Substitutes: The Local Political Economy of Informal Finance and Microfinance in Rural China and India

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World Development Vol. 32, No. 9, pp. 1487–1507, 2004
Ó 2004 Elsevier Ltd. All rights reserved
Printed in Great Britain
0305-750X/$ - see front matter
Imperfect Substitutes: The Local Political Economy
of Informal Finance and Microfinance
in Rural China and India
Johns Hopkins University, Baltimore, MD, USA
Available online
Summary. — Banking authorities in both China and India have attempted to limit most forms of
informal finance by regulating them, banning them, and allowing certain types of microfinance
institutions. The latter policy aims to increase the availability of credit to low-income entrepreneurs
and eliminate their reliance on usurious financing. Nonetheless, the intended clients of microfinance
continue to draw on informal finance in both rural China and India. This article argues that the
persistence of informal finance may be traced to four complementary reasons––the limited supply
of formal credit, limits in state capacity to implement its policies, the political and economic
segmentation of local markets, and the institutional weaknesses of many microfinance programs.
Ó 2004 Elsevier Ltd. All rights reserved.
Key words — Asia, China, India, informal finance, microfinance, rural finance
‘‘[O]fficial reports of the moneylender’s impending de-
well-located rural households that have the
mise are much exaggerated.’’–– Clive Bell on India
option of keeping their savings in official
financial institutions may lack access to formal
‘‘The fact that these private or underground credit
sector credit and rely instead on a wide range of
money houses exist and sometimes thrive in the coun-
informal, curb market mechanisms.
tryside even today has revealed that farmers need
It is in this context that governments
them.’’––People’s Daily on China (November 29,
throughout the developing world have regarded
informal finance as a negative reflection of
deficiencies in the formal financial system. In
both China and India, the traditional image of
the usurious moneylender adds an additional
pejorative dimension to the official depiction of
Developmental economists have long noted
the complexity of providing effective rural
credit delivery in large, agrarian countries such
* Earlier versions of this paper were presented at the
as India and China. 1 Establishing and main-
Workshop on Local Governance in India and China:
taining a network of rural financial institutions
Rural Development and Social Change, Kolkata, Jan-
is expensive, and managing their operations
uary 6–8, 2003, and the Duke University Comparative
is difficult in the absence of proper training,
Politics Workshop, February 24, 2003. The paper bene-
monitoring, and incentive structures. The
fited greatly from the constructive input of the workshop
operational challenges of rural financial inter-
participants. I am also grateful for the insights of
mediation are compounded by state develop-
Richard Baum, Anirudh Krishna, Laura Locker, Eddie
ment strategies that promote industrialization
Malesky, Mark Selden, Suman Sureshbabu, Sarah
and urbanization at the expense of agricultural
Tsien, Fei-ling Wang, Steven Wilkinson, David Zweig,
production. At the macrolevel, the notorious
and four anonymous reviewers. They are, of course,
scissors gap between agriculture and industry
absolved from the article’s inadequacies. Financial sup-
redistributes savings from rural to urban areas,
port from the Ford Foundation Public Policy Grant
thereby limiting the relative supply of rural
Competition is gratefully acknowledged. Final revision
credit. At the microlevel, this means that even
accepted: 10 May 2004.

informal finance: when the poor lack access to
case studies from India and China, respectively,
to illustrate how the combination of credit
exploited by loan sharks and other illegal curb
supply, local political economic conditions, and
market operators. Following this logic, the
institutional characteristics of financial inter-
prescription thus requires increasing state
mediaries mediates the dynamics of rural
efforts to eliminate informal finance, while
enhancing the availability of state-sanctioned
financial intermediaries, especially microfinance
programs devoted to poverty alleviation. Even
with these policy measures, however, small
business owners and farmers continue to rely
primarily on curb market finance in both China
To understand the formal institutional con-
and India. Moreover, in some cases, the scale of
text against which curb market activities have
informal finance actually increases in commu-
flourished, this section highlights major chan-
nities that have been targeted for a greater
ges in the basic structure of rural finance. Both
supply of official credit. This raises the question
countries have established credit cooperatives,
of why official attempts at limiting informal
commercial banks, and poverty alleviation mi-
finance and expanding the accessibility of for-
crofinance programs in rural areas, but these
mal finance may have such unintended conse-
formal sector institutions have not displaced
quences. One basic reason for the persistence of
informal and semi-formal sources of credit. 2
informal finance is that the supply of formal
finance is limited and insufficient to meet the
(a) Formal financial sector
demand for credit. A second explanation is that
official state policies are not being implemented
After India’s independence in 1947 and the
properly. In addition to these economic and
establishment of the People’s Republic of
state-centric explanations, this article argues
China in 1949, the 1950s represented a rela-
that informal finance and formal finance are
tively optimistic and ambitious phase for both
imperfect substitutes for two additional, com-
countries in establishing a national system for
plementary reasons: First, because credit mar-
agricultural finance. Both newly inaugurated
kets are segmented by local political and social
regimes shared the developmental goals of
dynamics; and second, because government-
promoting growth without exploitation, and
sanctioned microfinance programs are often
creating grassroots-level savings and credit
structured in a manner that fails to serve its
institutions to serve farmers.
intended clientele. This suggests that informal
Although India inherited a basic network of
finance is not simply a manifestation of weak-
credit cooperatives from the colonial era, the
nesses in the formal financial system, but also, a
Reserve Bank of India’s (RBI) first decennial
product of local political, institutional, and
All-India Debt and Investment Survey in 1951
market interactions. The analytical value in
found that 93% of rural households relied on
recognizing these local interactions lies in their
informal finance (Bouman et al., 1989, pp. 12–
ability to explain why developmental outcomes
14). This finding inspired a strong political
deviate from state intentions.
commitment to establishing formal sector
The article proceeds as follows: Section 2
alternatives to the curb, which was popularly
reviews the key expressions of formal and semi-
viewed as being exploitative and even ‘‘evil’’
formal finance in China and India, and shows
(RBI, 1954). Hence, throughout the 1950s and
how the countries’ strategies in rural financial
1960s, the government actively promoted the
intermediation compare with one another.
expansion of cooperatives ‘‘to provide a posi-
Both have relied on directed credit and
tive institutional alternative to the moneylender
encouraged the growth of microfinance pro-
himself, something which will compete with
grams, albeit to differing degrees. Section 3
him, remove him from the forefront, and put
outlines the main expressions of informal
him in his place (RBI, 1954, pp. 481–482)––or
finance in China and India and discusses the
more generally, to enhance the availability of
extent to which they have been subject to state
agricultural credit and alleviate rural poverty.
regulation. Section 4 delineates four comple-
In the mid-1970s, India’s rural financial system
mentary explanations for why state efforts to
went through another expansionary stage with
substitute informal finance with microfinance
the establishment of regional rural banks
have not been successful, and presents two local
(RRBs) at the district level, farmers’ service

societies at the village level, and further growth
serving rural enterprises and households. Since
of nonbanking finance companies. 3 Even
then, central banking authorities have deliber-
though the number of bank branches tripled
ated over how to improve their performance
during 1969–79, the government considered
(Watson, 2003), and injected approximately
rural access to be too low at 37,000 people per
US$4 billion in recapitalization funds into the
rural bank branch; therefore, in 1980 another
RCC system because RCCs are technically
seven commercial banks were nationalized to
insolvent. As of mid-2003, RCCs accounted for
extend their outreach in rural areas (AFC,
11.5% of total savings and 10.8% of loans
1988, in Nagarajan & Meyer, 2000, p. 172). In
extended by formal financial institutions, and a
quantitative terms, progress has been made on
pilot reform scheme for decentralizing their
this latter objective: according to the RBI, by
management was underway in eight provinces
1998 India had a total of 64,547 RRB branches,
(PD, November 30, 2003).
which was equivalent to 17,000–21,000 rural
citizens per bank branch. 4 But, the RRBs have
(b) The rise of microfinance
proven to be financially unsustainable and
inefficient in loan delivery (Bhatt & Thorat,
Given the inability of most formal sector
banking institutions to reach rural populations
Shortly after the founding of the People’s
and the popularity of informal sector alterna-
Republic of China, the Chinese communists
tives, microfinance programs have emerged as a
ordered the closure of all forms of private
potential solution for bridging the gap between
finance and banned popular forms of curb
the supply and demand for rural finance. In
market financing, including pawnbrokering
both India and China, microfinance has taken
and ‘‘loan sharking’’ (Hsiao, 1971). During the
the form of subsidized loans in government-
1950s, China also set up a network of rural
supported poverty alleviation (PA) programs,
credit cooperatives (RCCs), but unlike the
cooperatives in India, China’s original RCCs
organization (NGO)-lead endeavors. While the
acted mainly as fiscal institutions that funneled
actual expressions and overall scale of micro-
credit between the state and the people’s com-
finance differs in the two countries, the relative
munes rather than serving as commercial
effectiveness of these two main forms of mi-
credit-granting institutions. It was not until the
crofinance is similar. Specifically, subsidized
commencement of market-oriented reforms in
microloans in government-supported PA pro-
the late 1970s that RCCs started to function
grams tend to have low repayment rates and
more as grassroots banking institutions that
tend not to reach the intended clientele; and
served rural households and collective enter-
microfinance programs run by NGOs are more
prises, and the Agricultural Bank of China
effective in reaching poor clients when loans are
(ABC) was re-established to handle larger scale
structured in a financially sustainable manner
commercial banking activities. 5 Meanwhile, in
and use lending methodologies that are adapted
the early 1980s, the Ministry of Agriculture
to the particular economic needs of the inten-
established a network of Rural Cooperative
ded clients.
Foundations (RCFs) to serve farmers, but the
People’s Bank of China never considered them
(i) Directed subsidized credit in public poverty
formal ‘‘financial institutions’’ and succeeded in
alleviation programs
shutting them down at the end of the 1990s.
Extending subsidized loans to low-income
Indeed, throughout the reform era central
areas and households has traditionally been the
authorities have repeatedly waged national
first, and perhaps least effective strategy that
political campaigns to crackdown on the curb.
governments use in their rural development
In July 1998, China’s State Council even issued
strategies, and India and China are no excep-
formal ‘‘Provisions on the Cancellation of
tions (Adams, Graham, & von Pischke, 1984;
Illegal Financial Institutions and Activities,’’
cf. Morduch, 2000). The Indian Integrated
which reiterated that illicit financial institutions
Rural Development Programme (IRDP) was
should be banned (Xinhua, July 22, 1998, cited
established in 1978 with the mandate of
in Tsai, 2002a, p. 1).
extending microloans through the banking
The elimination of RCFs left about 44,000
system to impoverished households and now
RCCs at the township level (with about 280,000
regards itself as the ‘‘world’s largest program
village branches) as the only formally approved
for providing microloans to the poor (Sinha,
nonbanking financial institution devoted to
2000, p. 66).’’ In its first two decades, the IRDP

extended Rs. 250 billion (US$12.3 billion)
households would be directly targeted for sub-
worth of subsidized loans to approximately 55
sidized poverty loans. In quite a change from
million families who have an annual income of
the previous mode of distributing subsidized
less than Rs. 11,000 (US$305). 6 Given that 70
credit to local enterprises, in 1996 many of the
million families live below the poverty line in
counties adopted the Grameen Bank model of
India, it is apparent that the IRDP has had
group lending whereby groups of five borrow-
significant outreach. In addition to the loans,
ers would mutually guarantee the repayment of
IRDP borrowers also receive a cash subsidy at
their respective microloans in multiple instal-
the time of loan disbursal equivalent to 25–50%
ments (Bornstein, 1997; Holcombe, 1995;
of the project cost (Nagarajan & Meyer, 2000,
Khandker, Khalily, & Khan, 1995). These
p. 170). The program has certainly disbursed a
loans ranged from 1,000 to 2,000 RMB
high volume of loans, but funds have been
(US$120–240) and they continued to be subsi-
misused via the subsidy component such that
dized at the official PA lending rate of 2.88%.
cash is diverted to local elites rather than the
Once the decision was made to disburse PA
intended borrowers; as a result, the program
loans directly to households in officially desig-
has had a repayment rate of only 25–33%
nated impoverished counties, they were dis-
(Sinha, 2000, p. 66). Meanwhile, the RRBs and
bursed rapidly, almost quota style:
primary agricultural credit societies have not
performed any better. The RRBs have been
By August 1998, official microcredit schemes were
saddled with soft loans to priority sectors, while
operating in more than 600 counties in 22 provinces,
primary cooperatives have served mainly as
with the largest programs (in Shaanxi and Yunnan)
tools of political patronage. 7 Due to the non-
reaching over 500,000 households. . . In 1999, with be-
tween 30 and 40 million people still classified as poor,
commercial orientation of these programs,
the central government’s budget for the 8–7 Plan
basically all of the formal sector institutions
called for expenditures of Y24.8 billion ($3 billion),
involved in microfinance have depended on
of which Y15.3 billion ($1.84 billion, or 62%) was
refinancing and recapitalization by apex insti-
for loans funds (Conroy, 2000, p. 36).
tutions on a regular basis (Nagarajan & Meyer,
2000, pp. 177–179).
By 2000, the government had disbursed
State-subsidized microfinance in China has
US$775 million worth of subsidized microloans
had a shorter history than in India, mainly
(Tsien, 2001), and by 2002 nearly US$3.7
because China started poverty lending about
billion (or half) of the central governments
one decade later than India. To be sure, both
poverty-relief funds were going toward pov-
central and local governments in China have
erty-relief loans (Xinhua, March 2, 2002). As in
directed subsidized credit to particular sectors
the earlier model of poverty lending, however,
or industries, but that type of ‘‘policy lending’’
repayment rates in these government programs
has not occurred in the name of microfinance
have been low, i.e., less than 60%. Even though
or poverty alleviation. 8 In 1986, a subsidized
the Agricultural Bank of China (a state com-
lending scheme for poverty relief was intro-
mercial bank) took over the poverty lending
duced, which targeted collective enterprises at
program from the Agricultural Development
the township and village level rather than
Bank (a policy bank) in 1998, the People’s
individual households (Rozelle, Park, Ren, &
Bank of China (PBC) has not been involved in
Bezinger, 1998). While official interest rates on
monitoring the microcredit component of the
loans ranged between 8% and 10%, the poverty
Agricultural Bank of China’s operations, and
alleviation loans charged only 2.88% annual
the loans are treated more as social grants
interest. As is the case with most subsidized
rather than as commercial loans. In other
credit schemes, the loans were distributed to
words, the microcredit component of PA
politically important enterprises and higher-
lending has been treated as one-time fixes
income households, and the repayment rates
rather than exhibiting a commitment to sus-
were about 50% (Park, 1999).
tainable models of microfinance (Cheng, 2003).
Meanwhile, the PBC has been encouraging
households did not start until a few years into
RCCs to extend microloans to rural house-
China’s National 8–7 Poverty Alleviation Plan,
holds. As of 2002, the PBC reported that RCCs
introduced in 1993. As part of the strategy to
had extended a total of 78.9 billion RMB
raise 80 million people out of poverty in seven
(US$9.54 billion) worth of microloans and that
years (i.e., during 1994–2000), the central gov-
25% of all rural households in the country had
ernment identified 592 poor counties where
received such loans (CIIC, November 5, 2002).

Although RCCs report higher repayment rates
ment of one million bank-linked SHGs by
than the PA programs, as of year-end 2003,
2008. (Bansal, 2003, p. 24).
their ratio of nonperforming loans was still
Aside from participating in the SHG–bank
quite high at nearly 30% (SIC, January 14,
linkage model, over 500 NGOs serve as finan-
cial intermediaries themselves by brokering
funds between banks and low-income borrow-
(ii) NGO and donor-managed microfinance
ers. There are also a handful of cooperatives
such as SEWA Bank, the Indian Cooperative
The involvement of NGOs in running mi-
Network for Women, Tamil Nadu, and coop-
crofinance institutions (MFIs) varies signifi-
erative credit societies associated with the
cantly in India versus China. This is due in part
Cooperative Development Foundation that are
to differences in the policy environment for
involved in microfinance. Finally, about 10
both NGOs and nonbanking financial institu-
organizations may be considered Grameen re-
tions. While the government of India has pro-
plicators. The largest ones are SHARE, Activ-
moted the growth of self-governing NGOs and
ists for Social Alternatives Trust, and Rural
Development Organization, Manipur (Sinha,
institutions to collaborate with them, China’s
2000, p. 70).
NGOs are sponsored by a particular govern-
Overall, MFIs in India have not been subject
ment unit (making them government-organized
to stringent regulations, especially those that
NGOs rather than pure NGOs) or established
are not registered as cooperatives or nonbank-
by international donors. To date, India’s
ing finance companies. Given the developmen-
NGOs have had more extensive reach in mi-
tal contribution of MFIs, the RBI has not
crofinance than their counterparts in China,
enforced Section 45S of the RBI Act, which
but in both countries, few MFIs are financially
prohibits savings mobilization from the public
sustainable while the market for MFIs remains
without RBI permission. Furthermore, finan-
cial liberalization since the 1990–91 economic
In India, microfinance NGOs have generally
crisis has loosened interest rate controls on
taken one of the following three forms: self-
microcredit, which offers MFIs in India the
help group (SHG) programs that have linkages
space to structure their loans in a financially
with banks; cooperatives; or Grameen replica-
self-sustainable manner. Whether this occurs,
tors (EDA Rural Systems, 1996). Organized by
however, depends in large part on changing
NGOs, SHGs consist of 10–12 people with
popular perceptions that low-income borrowers
similar socioeconomic and demographic char-
cannot afford commercially viable interest
acteristics (e.g., low-income women in rural
areas). As of 2002, there were one million
In contrast to the relative ease with which
SHGs with 17 million members (Ashe, 2002,
NGOs may register themselves and act as MFIs
cited in Wilson, 2002, p. 221). The purpose of
in India, China’s policy environment is much
the SHGs is to help the members save small
more restrictive. All NGOs in China must have
amounts of money on a regular basis, to create
an official government unit sponsor their
an internal insurance fund for members to draw
application to register as ‘‘social organizations’’
on in times of emergencies, to empower the
with the Civil Affairs Bureau (Saich, 2000). As
members through collective decision-making,
such, China does not have purely nongovern-
and to extend uncollateralized loans to group
mental organizations engaged in microfinance
even though they may be functionally equiva-
1999, p. 7). Since 1992, the National Bank for
lent to NGOs. The introduction of the Gram-
Agriculture and Rural Development (NA-
een model of microfinance provides a good
BARD) has experimented with creating link-
example of the close relationship between
ages between SHGs and banks, such that banks
government entities and NGOs in China.
lend through NGOs or directly to SHGs. As of
The replication of the Grameen model in
March 2003, over 444 banks were participating
China first came about through the individual
in microfinance linkages with 717,360 SHGs; in
initiative of researchers at the Rural Develop-
total, the SHG–bank linkage program had
ment Institute of the Chinese Academy of
served an estimated 7.8 million low-income
households (NABARD, 2002, 2003). 9 Ulti-
donors; but to date, the most successful
mately, NABARD hopes to reach one-third of
Grameen replications are managed from an
India’s rural population through the establish-
office housed at CASS. With funding from

Grameen Trust, the Ford Foundation, and the
Canada Fund, in 1994 a small group of CASS
researchers led by Professor Du Xiaoshan
established the Funding the Poor Cooperative
As suggested already, despite the substantial
(FPC) in Yixian, Hebei (Tsai, 2002a, pp. 200–
expansion of rural financial institutions in both
202). To implement the project they collabo-
countries over the last several decades, informal
rated with the Yixian county-level Poverty
finance still represents a major source of credit
Assistance Bureau and the Civil Affairs Office.
for farmers and petty traders. In China, a study
As of March 2003, there were three FPCs in
by IFAD estimates that farmers obtain four
Yixian, Yucheng (Henan), and Nanzhao (He-
times more credit from the curb market than
nan) counties, respectively, and together, the
from formal financial institutions (IFAD, 2001,
three FPCs had served a total of 15,244 bor-
p. C11), and another study of small business
rowers (Du, 2003). With repayment rates
owners found that the curb accounted for up to
ranging from 95% to 99%, the FPCs are con-
three-quarters of private sector financing dur-
sidered the best examples of Grameen-style
ing the first two decades of reform (Tsai, 2002a,
microfinance in China. A central part of their
pp. 36–37). In India, the 1992 AIDIS survey
success has been structuring the loans in a
revealed that nearly 40% of rural households
manner that covers their operational costs, i.e.,
continue to rely on informal finance––or more
at 16% effective interest per annum. 10 Scaling
technically, ‘‘noninstitutional credit agencies,’’
up to extend their reach and experimenting
which include agricultural moneylenders, pro-
with nonGrameen lending methodologies is
fessional moneylenders, traders, relatives and
their next challenge. 11
friends, and others. 14 Table 1 outlines the
Besides the FPC Grameen replications,
primary forms of informal and semi-formal
international donors have initiated over 200
finance in both countries and notes the extent
microfinance programs throughout central and
to which they are sanctioned or prohibited. In
western China (Cheng, 2003, p. 123). The
both countries, private transactions involving
donors have all implemented their projects with
high interest rates are in violation of banking
different local governmental partners. For
regulations, as are organizations that mobilize
example, the AusAid project in Haidong,
savings without registering with the appropri-
Qinghai that started in 1996 collaborates with
ate authorities. 15 Beyond those two restric-
the Agricultural Bank of China and the Qing-
tions, however, the legal marginalization of
hai Commission of Foreign Trade and Eco-
curb market activity has not been consistently
defined or enforced. In practice, curb market
International has been collaborating with the
actors in both China and India have proven to
Sichuan Animal Husbandry Bureau since 1985;
be adaptable despite multiple rounds of disci-
and since 1995, the International Crane Foun-
plinary action by financial regulators.
dation has implemented a Trickle-Up Program
in Guizhou with the cooperation of the Guiz-
(a) Grey areas in China’s curb market financing
Bureau. 12 With few exceptions, the donor-ini-
In China, the extremes of legal versus illegal
tiated programs have been structured as pro-
forms of financing are distinguished by whether
jects with a limited lifespan rather than as MFIs
or not they are sanctioned by the PBC, which
aiming for sustainability (Cheng, 2003; IFAD,
hinges on whether they mobilize savings from
2001, pp. 20–21; Park & Ren, 2001). Although
the general public and offer/charge interest
this may be attributed in part to the official
rates above the repressed interest rate ceilings.
interest rate ceilings on poverty loans, the FPCs
Interpersonal lending and trade credit, for
have shown that it is possible to build in a
example, are among the most basic strategies
higher, sustainable rate of interest in the
that entrepreneurs use to deal with short-term
Grameen model; and that rural borrowers are
liquidity requirements. Small business owners
willing and able to pay those rates. Indeed, a
frequently borrow money from friends, rela-
study of NGO MFI clients found that the
tives, and neighboring shopkeepers. Wholesal-
highest monthly interest rate that they would be
ers may deliver goods to retailers on 10-day or
willing to pay is 32.6%. 13 This is consistent
even 30-day credit if they have an established
with the popularity of informal financing
relationship. Such practices are not illegal to
mechanisms (discussed below) that charge even
the extent that they do not entail interest above
higher interest rates.
the rates of state banks, 16 in contrast to those

Table 1. Legal condition of informal finance in China and India
Interpersonal lending––
minjian jiedai––financial authorities do not
Interpersonal lending––financial
loans extended among
interfere with casual, interest-free lending
authorities do not interfere with
friends, relatives, neigh-
casual, interest-free lending
bors, or colleagues
Trade credit––merchandise
hangye xinyong––neither sanctioned nor
Trade credit, forward sales
credit between wholesalers
and retailers
Moneylenders, loan
gaolidai––all high interest lending is illegal
Mahajan and Chettiar bankers––
sharks––loans from profes-
Some are registered as finance com-
sional and nonprofessional
panies, trusts, banks, and partner-
money brokers, typically at
ship firms
high interest rates
Rotating savings and credit
huzhuhui, hehui, biaohui, chenghui, juhui––
Chit funds––registered as companies,
organizations (ROSCAs)––
permitted in localities where they have not
partnerships, and sole proprietor-
indigenously organized
savings and credit groups
Pawnshops––extend collat-
diandang, dangpu––permitted when oper-
Pawnshops––legal if licensed
eralized loans with interest
ated according to regulations
Indigenous banks, money
siren qianzhuang, private money houses––
Deal with short-term credit (hundis)
houses, finance companies––
regarded as private banks, which are illegal;
combined with trade for financing
mobilize savings and extend
most operate underground now
trade––committees have made efforts
collateralized loans
to formalize them
Rural cooperative founda-
nongcun hezuo jijinhui––approved by MOA
until closure by PBC in 1999
Social organizations, mutual
huzhuhui, hezuo chu jijinhui (mutual
Nidhi companies, mutual benefit
benefit funds––registered
assistance societies, cooperative savings
societies, permanent funds (mainly in
entities that are supposed
foundations)––registered with MCA, but
Tamil Nadu)––committees have rec-
to serve lower-income
not supposed to engage in for-profit
ommended that they be regulated
financial intermediation
more stringently
charged by loan sharks or private money
eliminated, but after the first one opened up
houses. The latter are clearly illegal by PBC
during the reform era in Chengdu in 1987, they
standards because they reflect the higher mar-
developed rapidly and by 1993, there were
ket cost of capital in a financially repressed
3,013 documented pawnshops throughout the
environment. Indeed, with the sole exception of
country. Most were operated by various bran-
Minsheng Bank, 17 private commercial banks
ches of government agencies, including state
are prohibited in China and the PBC has
banks, policy departments, tax bureaus, cus-
launched multiple ‘‘financial rectification cam-
toms bureaus, and finance and insurance com-
paigns’’ to shut down private money houses.
Nonetheless, they have continued to operate
registered as ordinary private businesses with
underground, not only in the coastal south
the Industrial and Commercial Management
where private commerce is better developed,
Bureau (ICMB). The official interpretation of
but also in northern central provinces such as
the ‘‘new’’ pawnshops was that they differed
Henan (Tsai, 2002a, Chap. 5).
fundamentally from the traditional exploitative
Pawnshops straddle a finer line between
ones. As explained in a Ministry of Finance
being legal and not quite legal and provide a
good example of Beijing’s regulatory ambiva-
lence in dealing with unconventional financing
It should be noted that today’s pawnshops in the
mechanisms. Their re-emergence during the
country are not entirely what they used to be. Pawn-
reform era has been uneven and ambiguously
shops in old China took in personal effects at very
regulated due to their usurious connotation. 18
low prices when the owners were poverty-stricken.
By 1956 private pawnshops were effectively
However, such businesses today represent a medium

for normal commodity circulation. . . The new-born
share the attribute of being legal according to
pawn brokering aims to serve the people and social
certain governmental agencies, but not sanc-
production (Zhongguo yinhang, 1993, pp. 240–243).
tioned by the PBC. The establishment of
rural cooperative foundations (RCFs) by the
Despite this more favorable, revisionist
Ministry of Agriculture in the mid-1980s
evaluation of pawnshops, it became increas-
exemplifies this phenomenon (Cheng, Findlay,
ingly apparent that many were (illegally)
& Watson, 1998; Du, 1998). As noted earlier,
mobilizing savings deposits from the public and
the PBC never recognized them as legitimate
offering high rates of interest. 19 As a result, in
‘‘financial institutions’’ because another min-
1994 the PBC was granted administrative
isterial bureaucracy created them. Nonethe-
authority over pawnshops and two years later,
less, by the early 1990s RCFs had been
a PBC-lead crackdown on illicit financial
established in approximately one-third of all
institutions closed over half of the registered
townships, and by 1998 there were over
pawnshops, leaving only 1,304 shops with PBC
18,000 RCFs with over five million depositors
licenses. 20 In a further attempt to circumscribe
(Holz, 2001). Since RCFs were not permitted
the financial malfeasance of pawnshops, they
to mobilize deposits or extend loans like
were reclassified in 2000 from being ‘‘financial
institutions’’ under the PBC’s authority, to ‘‘a
euphemistic terms for comparable transac-
special kind of industrial and commercial
tions; instead of paying interest on deposits,
enterprise’’ regulated by the State Economic
for example, they sold ‘‘shares’’ (rugu) and
and Trade Commission (JJRB, 2000). In short,
extended ‘‘capital use fees’’ (zijin zhan fei-
over the course of the reform era, pawnshops
yong). Like pawnshops and other forms of
have been legally registered in some cases,
informal finance, RCFs had a variety of
registered with the incorrect local agency in
governance structures and were more central
others, and engaged in practices that are clearly
to rural finance in some provinces than oth-
ers (Park, Brandt, & Giles, 2003). Their
While pawnshops are now technically sub-
quasi-legal status proved to be short-lived,
ject to central-level regulations, rotating sav-
however. As part of broader national efforts
ings and credit associations (hui) remain
to rectify the financial system, in March
unregulated in most localities. When hui
1999, the State Council announced the clo-
involve relatively small groups of people (5–10
sure of poorly performing RCFs, and the
members on average) who pool set monthly
takeover of better performing RCFs by Rural
contributions and rotate the disbursal of the
Credit Cooperatives. These actions triggered
collective pot of money to each member, local
farmers’ protests in at least six provinces,
governments usually consider them a produc-
including Sichuan, Hubei, Hunan, Henan,
tive form of mutual assistance among ordin-
Guangxi, and Chongqing (AP, March 22,
ary people, typically women. But if a member
1999; AFP, March 23, 1999). Apart from
runs off with the collective pot early in the life
of an association, the members who have not
financial institutions have managed to operate
had their turn in collecting money are cheated
above ground and serve private businesses by
out of their contributions. In the coastal
registering as social organizations, which are
south, a handful of high-profile cases have
administered by the Ministry of Civil Affairs.
accumulated where various types of hui were
These go by a variety of names, including
exposed as fraudulent schemes organized by
mutual assistance societies and cooperative
con artists (Tsai, 2000). The large-scale cases
savings foundations. The credit societies are
were not traditional ROSCAs, however, but
supposed to be nonprofit organizations that
rather, ponzi schemes that are never sustain-
serve impoverished populations. In practice,
able because they generate extremely high
however, they operate like RCFs or private
returns by exponentially expanding the net-
money houses in the sense that they mobilize
work of investors. Hui collapses make head-
savings, extend credit to private entrepreneurs
lines, but they are actually relatively rare. As
who may be well off, and use interest rates
such, it is only in a small handful of localities
that are higher than that set by the PBC.
that hui have been banned by local govern-
These types of social organizations should be
distinguished from those that are genuinely
The ambiguous and shifting legal status of
oriented toward poverty alleviation via mi-
other curb market practices listed in Table 1

(b) Attempts at mainstreaming India’s
example, moneylenders acts at the state level
informal sector
regulate nonborrowing lenders, while borrow-
ing lenders (or intermediaries) are also subject
Relative to China, India has a longer history
to various types of regulation. 21 Furthermore,
of state-directed credit for poverty alleviation,
the RBI has tracked informal financial activi-
yet its formal financial sector is more liberalized
ties in official statistics as a means to measure
and its informal financial sector, better docu-
progress in expanding credit access into rural
mented and more likely to take corporate forms
areas. (Table 2 lists the official categories of
than those of China. These apparent inconsis-
informal finance as defined by RBI and Figure
tencies may be attributed to the fact that
1 shows their relative share of the curb market
India’s financial policy environment has also
over time.) The extent of curb market regula-
fluctuated considerably over the years. Post-
tion and tracking in India stands in contrast to
independence governments in India have been
the situation in China where many types of
concerned about the negative effects of infor-
informal financing activities are simply banned.
mal finance on rural welfare and made repeated
After taking into account sampling and
efforts to regulate and create institutional
nonsampling errors in the decennial surveys,
alternatives to the curb. Indeed, what most
the main trend is that informal credit has cer-
observers would regard as informal financial
tainly declined as a percentage of total debt,
intermediaries are registered under the Com-
and both professional and agricultural money-
panies Act, 1956 or regulated by the RBI. For
lenders have reduced their share of the curb
Table 2. Breakdown of informal finance in rural India over time
Type of noninstitutional sources
Agricultural moneylenders
Professional moneylenders
Traders and commission agents
Relatives and friends
Informal credit as share of total
household debt
Source: Reserve Bank of India, All-India Debt and Investment Survey, various years.
a 1991 figures do not add up to 39.6% even though Table 5 of the 1991–92 AIDIS report clearly states that non-
institutional agencies account for 39.6% of total rural household debt.
Traders and
Relatives and
Figure 1. Distribution of informal financing mechanisms, India 1951–91.

market over time. The decline of the money-
completely informal, a number of chit funds in
lender in official statistics reflects in part state
India are registered as companies, partnerships,
efforts to register and regulate professional
and sole proprietorships under the All-India
moneylenders during the 1950s. Some went
Chit Funds Act 1982 or the state acts (Ruth-
underground to avoid regulation and others
erford & Arora, 1997). The state’s rationale for
were probably re-classified as agricultural
regulating them is to increase the security of the
moneylenders or traders
1990). In
members’ contributions and to reduce the
this regard, note that the first three official
incidence of defaults. As such, organizers are
required to have licenses and make security
agricultural moneylenders, and professional
deposits with the Register of Chit Funds; the
cost of collecting the pot (i.e., the de facto
from one another depending on the locality.
interest rate) is capped at 30% of the size of the
But generally speaking, landlord lenders extend
pot; and chit funds are limited to a maximum
credit to tenants; agricultural moneylenders
of 60 months (Ghate et al., 1992, p. 197). These
primarily deal with agricultural laborers and
regulations have not had their intended effect,
small farmers; and professional moneylenders
however. Rather than increasing the stability of
service a wider range of customers and may
chit funds in general, many organizers have
register themselves as companies, partnerships,
gone underground and taken their members
and trusts (Ghate et al., 1992, p. 45).
(who seek higher returns) with them.
Those in the fourth official category of
In addition to chit funds, Nidhi companies or
‘‘traders and commission agents’’ are also
mutual benefit societies are also an important
known as indigenous bankers. In contrast to
part of the nonbanking world of financial
professional moneylenders who lend their own
Incorporated under the Companies Act 1956,
between banks and their clients, who tend to be
Nidhis mobilize savings from their members
traders rather than farmers (Schrader, 1994).
and extend loans that are collateralized with
The Shroffs of Western India, for example,
jewelry and real estate (Nayar, 1992, pp. 197–
provide a short-term credit instrument called
199). When nonmembers wish to make a
darshani hundi to traders who need to travel
deposit or borrow from a Nidhi, they take a
great distances to purchase inventory and
share of the Nihdi. Over the years, the state has
transfer funds (Ghate et al., 1992, pp. 198–200).
made repeated efforts to regulate these mutual
In addition to serving as financial intermedi-
benefit societies; and an Expert Group on
aries, indigenous bankers are also business-
Nihdis constituted by the Department of
people themselves. 22 Besides trading, they may
Company Affairs has recommended a host of
operate commission agencies or hire-purchase
additional regulations to professionalize their
finance (HPF) companies, which are basically
operations (PIB, 2002).
leasing companies that finance automobiles and
other goods over a fixed term for clients who
lack sufficient cash to purchase capital goods
up front (Nayar, 1992, pp. 199–200). Even
though formal sector HPFs exist, one study
found that informal HPFs finance a much
State authorities in both China and India
higher volume of vehicles than official auto
have clearly recognized the importance of for-
finance corporations––probably because lower-
income populations find the informal HPFs
including the expansion of microfinance pro-
more accessible (Das-Gupta & Nayar Associ-
grams for poverty alleviation purposes. Finan-
ates, 1989).
cial regulators have also made repeated efforts
Forms of informal finance in the other cate-
to eliminate and/or regulate of curb market
gory also include indigenous bankers who are
activity. Why, then, has informal finance per-
not registered as traders or commission agents;
sisted and even expanded in both countries?
unregistered finance corporations; nonprofes-
Four complementary explanations may be
sional moneylenders (other than those identi-
derived from the perspective of supply-leading
fied as friends and relatives); various types of
economics, state–society relations, the local
leasing, investment, and housing finance com-
political economy of markets, and the institu-
panies; ROSCAs (chit funds) and Nihdi socie-
tional characteristics of lending programs. As
ties. Unlike the ROSCAs in China, which are
will be shown, the first two hypotheses capture

Document Outline

  • Imperfect Substitutes: The Local Political Economy of Informal Finance and Microfinance in Rural China and India
    • Introduction
    • Financing rural development in China and India
      • Formal financial sector
      • The rise of microfinance
        • Directed subsidized credit in public poverty alleviation programs
        • NGO and donor-managed microfinance institutions
    • The informal and semi-formal financial sector
      • Grey areas in China's curb market financing
      • Attempts at mainstreaming India's informal sector
    • The persistence of informal finance
      • Neoclassical economics: a matter of supply and demand
      • State-society relations: a matter of state capacity
      • Segmented markets: a matter of institutional design and local political economy
        • Tribal, caste, and occupational segmentation in a North Indian village
        • Segmentation within a single surname village in South China
    • Conclusion
    • News Sources
      • Further Reading
    • References