> Posted by Kaj Malden, Consultant, PlaNet Finance China

For China’s young microfinance sector, which could benefit from more regulatory oversight and transparency, ratings have the potential to catalyze healthy growth. Efforts to incorporate ratings throughout the country’s market, however, have so far been largely ineffectual. A new report from PlaNet Finance China and Planet Rating, The Role of Microfinance Ratings in the Sustainable Development of China’s Financial Inclusion Sector, part of PlaNet Finance and Credit Suisse’s “Microfinance Robustness Program”, outlines how ratings could provide welcome growth and strengthening for Chinese microfinance, and describes the current obstacles that stand in the way.

Mainstream ratings systems evaluate creditworthiness of debt and financial products for companies. They also contribute to setting benchmarks for the wider financial services industry. Specialized microfinance rating agencies evaluate some of the same qualities traditional rating agencies do, but they are trained in microfinance and investigate other financial inclusion-specific indicators, such as social performance. Microfinance ratings function as institutional ratings, not credit ratings, as in the case of mainstream ratings. These more nuanced ratings for the microfinance sector first emerged in Latin America, where microfinance boomed in the late 1990s.

In the Latin American region, ratings armed investors, government leaders, and other stakeholders with a clearer picture of the microfinance landscape, eventually leading to increased debt funding and growth-conducive policy. Today, Peru, Colombia, and Chile feature robust microfinance markets, as suggested by their ranking among the top five countries for financially inclusive environments in the 2014 Global Microscope from the Economist Intelligence Unit (EIU). While ratings are far from the whole story of success in Latin American microfinance, they made – and continue to make – important contributions.

In China, there has been an expansion in the number and type of institutions serving the base of the pyramid. For instance, policy initiatives have encouraged traditional lenders to downscale their services in the form of Village and Township Banks, and there are also over 8,000 microcredit companies (MCCs) across the country. In spite of this encouraging growth, however, the policy environment for inclusive finance in China ranks 42nd in the EIU’s 2014 Global Microscope.

Many of the Chinese institutions engaged in inclusive lending could benefit from third-party feedback on how to scale their operations – exactly the kind of feedback ratings provide. Supervisors would also benefit from the best practices and experiences of other MFIs. If history in Latin America provides any lessons, perhaps specialized ratings for microfinance operations in China could form the next crucial step in the sustainable development of the sector.

However, as the PlaNet Finance China report clarifies, comparing the history of ratings undertaken globally to those recently done in China is a complex exercise. China faces unique developmental conditions in using ratings for microfinance:

  • MFIs in China so far have only undergone superficial credit ratings performed by mainstream domestic agencies, as mandated by central government leaders trying to make sense of a complex market. These agencies spend minimal time on site, and given their generalized approach, do not provide deep feedback or insight to the young financial institutions.
  • The responsibility of implementing these pilot rating projects is devolved to provincial offices of financial affairs (POFAs). While ratings should stay “local” given China’s provincial diversity, these POFAs perform ratings as mandated by central authorities and they do not share their findings with each other. Central coordination when rating and evaluating these new institutions will be key in defining national benchmarks for the industry.
  • Ratings have not armed Chinese MFIs and MCCs with increased access to debt funding, a concern further exacerbated by the fact that foreign investors with interest in microfinance have difficulties investing in the Chinese market. In contrast, non-banking financial institutions globally have enjoyed easier access to debt funding and preferential policy treatment as a result of ratings, making them a worthwhile value-added exercise that garners industry support and boosts capacity building. Mainstream rating pilots in China’s microfinance sector have not so far delivered these kinds of benefits.

There’s much that ratings can do for the robust growth of microfinance. However, the sector is still emerging in China, and fragmented coordination of surface rating pilots do not yet offer Chinese players the benefits needed for increased growth. The new report hopes to mediate that missing knowledge and provoke discussion on the part of stakeholders.

To read the report, click here.

Image credit: Harald Groven

Have you read?

Ratings to Loosen the Regulatory Noose on China’s Microcredit Companies

How Client Protection and Ratings Work Together

Gender Dynamics in Rural China Illuminate the Need for Financial Education