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【原创】Financial Exclusion and Inclusive Finance

He Dexu(何德旭) andMiao Wenlong(苗文龙)

Institute of Finance and Banking, Chinese Academy of Social Sciences (CASS), Beijing, China

Institute of Quantitative and Technical Economics, CASS; Xi’an Branch of People’s Bank of China (PBoC), Xi’an, China

  Abstract:Inclusive finance is intended to address the barriers posed by financial exclusion to economic development. Therefore, an effective inclusive financial system must be designed to address financial exclusion rather than to provide long-term policy subsidies for financial relief. Financial exclusion in China has causes in economic development strategy, financial institutional arrangement, financial market structure, dominance of social relations, and constraints of risk evaluation. Eliminating financial exclusion and increasing financial inclusion essentially requires that our financial system be equipped with those functions through policy adjustment, institutional innovation and improvement of market rules. Existing bottlenecks of financial risk management should be eliminated to provide fair opportunities of financing for projects that contribute to social development with limited deviations from traditional credit costs. Inclusive finance is sometimes confused with policy subsidies, financial assistance and poverty relief loans, which cannot reflect efficiency, fairness and inclusion as the essential attributes of inclusive finance. The existing financial system must be adjusted to enhance risk management performance and advance financial market stratification and competition by creating fair and efficient legal and credit systems.

  Key words: financial exclusion, financial inclusion, inclusive finance

  JEL Classification: G28

  1. Introduction

  Despite its constant evolution over the years, China’s financial system has yet to develop all the ideal functions of a competitive market. Not only are trading entities unable to freely enter or exit financial markets, their access to fair and open opportunities is unequal as well. Lending is not entirely determined by the creditworthiness of borrowers. The problem of financial exclusion is ubiquitous. Some market players, though probably creditworthy, are plagued by lack of access to capital as a result of exorbitant requirements of assets, social connections and “financial rents.” Inefficient financial resource allocation and ballooning risks have created barriers to economic development and social progress.

  In order to address financial exclusion and promote inclusive development, governments around the world have strived to develop inclusive finance. In launching the “International Year of Microcredit 2005”, the United Nations called for the creation of inclusive financial sectors, which are closely related to various aspects of financial, economic and social development across countries and thus aroused great attention. This concept is consistent with the strategic philosophies of “inclusive development” and “harmonious development” advocated by China. Inclusive finance is designed to address the challenges of financial support confronting less empowered sectors such as agriculture, the countryside and farmers as well as small- and medium-sized enterprises by enabling them to fully utilize financial resources to elevate their economic power and social status for the promotion of coordinated economic and social development. “In this context, the development of microcredit transitioned from the single pursuit of poverty relief to an equal emphasis on both poverty relief and institutional sustainability” (Zhang Wei, 2011). This transition witnessed an emergence of a swathe of financial service institutions offering micro credit, deposit, insurance and remittance services specifically for the poor, i.e., “micro-financial institutions, or MFIs” (Imboden, 2005). With the development of micro-finance, a great variety of industry players have been created to provide increasingly diverse financial products and services.

  In the meantime, people have come to recognize that inclusive finance cannot be marginalized. Inclusive finance is an essential component of a country’s mainstream financial system and can provide high-quality financial services to meet the financial demand of the masses, particularly those in poorer and less accessible regions, reducing the cost for both customers and service providers (Du Xiaoshan, 2006). From the perspective of financial development, inclusive finance embodies financial fairness and puts a premium on equal access to modern financial services for all and thus represents an improvement to the existing financial system (Jiao Jinpu & Chen Jin, 2009). From the perspective of economic development, inclusive finance can increase people’s income, reduce poverty and thus expand domestic consumption and bridge the urban-rural divide, which is of great significance to transforming China’s economic growth pattern and achieving sustainable development (Wang Shuguang & Wang Dongbin, 2011).

  Nevertheless, the current development of inclusive finance is not without imperfections. Inclusive finance remains dependent on national policy support and government initiatives, and more efficient mechanisms of financial inclusion have yet to take shape. Despite national policy guidance, support or funding allocations, financial intermediaries are reluctant to invest more heavily to build internal capabilities and thus are rarely able to identify the most creditworthy borrowers. Consequently, a host of programs carried out in the name of inclusive finance has failedto include socially beneficial and creditworthy projects. In addition, research literature on inclusive finance has not formeda standard theoretical system and is fraught with loopholes and mistakes, which can be manifested in the following aspects. First, the circumstances and causes of financial exclusion have yet to be systematically investigated, resulting in shortage of effective, properly-targeted and systematic recommendations on the development of inclusive finance. Second, the essence and nature of inclusive finance has not been examined in detail, contributing to confusion between inclusive finance and poverty alleviation and the bloated and inefficient system of inclusive finance that exists today. Third, an institutional framework for the establishment of inclusive finance has not been systematically created and most studies have remained at the level of loan issuance. Fourth, recommendations on sound and robust development of inclusive finance are not identified in light of its nature. This study is intended to focus on research and improvement in these four aspects.

  The remainder of this paper is structured as follows. Part 2 discusses the types and causes of financial exclusion and proposes an inclusive approach of financial development. Part 3 corrects the misunderstandings on inclusive finance and deviations in its implementation based on the nature and functions of inclusive finance. Part 4 depicts the basic framework of inclusive finance. Part 5 delves into the further development of the financial system in light of its nature and functions. Part 6 offers some concluding comments.

  2. Financial Exclusion and Inclusion

  The very concept of inclusive finance derives from financial exclusion. Development of inclusive finance aims to address financial exclusion and enhance financial inclusion. Therefore, it is necessary to examine the types and reasons of financial exclusion in order to develop inclusive finance in a targeted and efficient manner. Kempson and Whyley (1999a, 1999b) and Mandira Sarma (2010) described five types of financial exclusion: (1) access exclusion, i.e., certain groups are kept outside the system of financial services due to their remote geographical location or the risk management process of the financial system; (2) condition exclusion, i.e., certain groups are excluded from access to financial services under specific restrictive conditions; (3) price exclusion, i.e., certain groups are excluded from access to financial services due to the exorbitant prices of financial products; (4) marketing exclusion, i.e., certain groups are excluded from access to financial services by the distribution and market positioning of financial products; (5) self-exclusion, i.e., certain groups exclude themselves from the system of financial services due to their fear of being rejected or due to other psychological barriers. These five situations also depictfinancial exclusion in China. Based on the theory of financial exclusion, He Dexu and Rao Ming (2007) investigated the intrinsic causes of the imbalance between supply and demand in China’s rural financial markets by entering uponthe business orientation of formal rural financial institutions, thus exploring a new perspective for research on inclusive finance proceeding from financial exclusion. In order to analyze financial exclusion in a more straightforward and precise way, we have investigated financial exclusion from such aspects as economic development strategy, financial system structure, financial markets structure, social networks and risk management constraints. Meanwhile, due to such reasons as China’s development path, suppliers of capital are much less excluded than those in demand of capital. This paper will thus focus on an analysis of the latter situation.

  2.1 Economic Development Strategy and Financial Exclusion

  After the founding of the People’s Republic of China in 1949, China’s economic development strategy wascharacterized by a priority to develop a handful of key industries, regions and cities. As a result, the financial system was designed to mobilize public deposits to support these industries, regions and cities, excluding those not on the priority list.

  The strategy to develop a few critical industries gave rise to industrial financial exclusion. Against the backdrop of an extremely adverse environment of international economic and military blockade and political confrontation after the founding of the People’s Republic in 1949, putting a priority on national defense and heavy industries became a natural choice for China at the time. Therefore, between 1949 and 1981, the Chinese government focusedon the priority to develop an industrial economy by mobilizing all available national resources (Mao Zedong, 1956). “Farmers in less developed countries are forced to sell their agricultural products below market prices and purchase chemical fertilizers, seeds and other inputs at higher prices, transferring profits from farmers to the state. Capital extracted from farmers through state purchase and price control was then used as state industrial investment” (Powelson, 2000). Therefore, the most efficient means to develop industry was to suppress the prices of agricultural products, lower wages and maximally acquire industrial profits and make capital reinvestment. China followed this approach in establishing its industrial system. At this point, “cooperatives of less developed countries generally became an instrument of the government to collect agricultural surplus” (U Tan Wai, 1962). Instead of extending financial support to the countryside, extraction of rural surplus became a more important function of China’s rural financial system at the service of industrial system development. Hence, rural credit unions wereboth collective financial organizations and the grassroots institutions of national banks in the countryside. After the resumption of agricultural banks by the State Council in March 1979, the Opinions on Reforming and Invigorating Rural Credit Cooperative Unionsdefined the status of credit unions as the grassroots institutions of the Agricultural Bank. While rural financial capital flowed into non-agricultural sectors, farmers still struggled to borrow cash and grain due to the failure of credit unions to perform their function of private lending (Lu Lei & Ding Junfeng, 2006). Under this economic strategy, China’s financial industry vigorously supported the secondary industry while providing very limited assistance to the primary and tertiary industries, giving rise to significant industrial financial exclusion. Despite subsequent government efforts to adjust the economic structure, the legacy impact remainedand the inertia of financial exclusion could not be resolved in the short term.

  With limited resources, the “rational” economic strategy would be to concentrate national resources to develop a handful of priority regions. The financial industry, which services the real economy, must adopt a differentiated policy preference as well. For instance, the centralgovernment followed a differentiated interest rate policy. In the early 1980s, China’s central bank offered low-interest loans to special economic zones in the eastern region and granted Guangdong and a few other provinces the right of floating interest rates and the autonomy of financial innovation. These initiatives undoubtedly tipped the economic and financial balance in favor of the eastern region. “Adopting a preferential interest rate policy was a watershed that marked the end of the balanced regional financial policy adopted at the beginning of reform and opening up and inaugurated the transition from an equilibrium state to a government-led non-equilibrium state of China’s regional finance” (Cui Guangqing & Wang Jingwu, 2006). Such a differentiated interest rate policy and non-equilibrium financial strategy represents the most typical forms of price exclusion. In addition, thecentral government practiced a differentiated financing policy. In 1991, China established a financing system for the stock market, which was a milestone in its financial development. However, the state did not fully bring the stock market under market mechanisms and imposed distribution and quota control of stock market listing (lifted in 1999), and the distribution of quota was uneven across provinces. China’s eastern region represented by Guangdong and Shanghai wereallocated with a lopsided proportion of quota for listed companies and the only two stock exchanges in China wereestablished in Shanghai and Shenzhen as well. By December 2013, the nine provinces of China’s eastern region accounted for 65% of the total number of listed companies, while the 12 provinces of the western region only accounted for 40.7% and the 10 provinces of the central region represented 20.3%. Regionally differentiated financial allocation reflects regional financial exclusion to a certain extent.

  2.2 Structure of the Financial System and Financial Exclusion

  The structure of the financial system, which is determined by economic growth strategy, also contributes to financial exclusion. According to Zhang Jie (1998), the state designed tax and financial systems to convert the financial surplus in the form of extremely scattered household savings into capital available at its disposal. The strong state at the top and scattered economic organizations at the bottom (a dual structure) neededto be buffered and coordinated by an intermediate level. Under China’s decentralization system, local governments protectednew forms of financial assets while the local utility function was inconsistent with a national utility function (Miao Wenlong, 2012a). Interactions between the state and localities providedopportunities for the extension of new forms of financial assets. In this context, China’s financial system evolved from a dual structure to a stable triple structure.

  Under the triple structure, the objectives and policy instruments of local and central governmentsweresignificantly different and such difference inevitably affectedfinancial allocation and financial exclusion. Information constraint compromised the efficiency of central government’scontrol over aggregate social investments. Hence, efforts weremade to mobilize local government enthusiasm to increase efficiency through fiscal decentralization. China experienced three rounds of such fiscal decentralization in its transition from a planned economy to a market-based one (Hu Dongshu, 2001). While increasing the independence of local interests, each round of decentralization also reduced the proportion of local fiscal revenues while local fiscal spending kept on the rise (Miao Wenlong, 2012b), which further stimulated localities to maximize their original total output. Aside from bargaining with the central government for more fiscal allocations, the most effective measure was to conduct financial expansion by means of government influence. Intervention by local government largely subjected the interest function of the state-owned financial sector tothe dominance and influence of local interest preferences. When the state tightens financial control, the state-owned financial sector actedin accordance with nationalinterest; where state financial control relaxed, its financial behavior convergedwith localinterest (Zhang Jie, 1998). This tripartite system explains the institutional arrangement and theoretical logic of China’s financial, fiscal and economic systems. However, the triple structure of the financial system did not achieve expected effects, nor did it increase financial inclusiveness and efficiency;the only difference was the inclusion of another stakeholder. Attracted by policy guidance, risk accountability and relief assurance, the financial sector vigorously supported the priority groups, regions and projects identified by the government; other groups, regions and projects not benefiting from such government pressures and policy support, by contrast, struggled to access financial services. The lion’s share of financing from state-owned banks went to large state-owned enterprises, particularly pivotal enterprises in sectors like petroleum, electricity and real estate. Local branches of state-owned banks, shareholding banks and local financial institutions concentrated their financing activities on local state-owned enterprises supported by local government, while small and medium-sized enterprises and venture investment werekept outside mainstream finance despite their important role in the economy.

  2.3 Market Structure Characteristics and Financial Exclusion

  The monopolistic structure of the financial market has led to threetypes of financial exclusion. First, price exclusion to the disadvantage of depositors: low and negative interest rates allowed banks to borrow at minimal cost. Extensive bank outlets became venues of one-way capital absorption. Such price exclusion fueled the development of private financing. Second, conditional exclusion: without a mechanism for the screening of innovative projects, loans have been primarily made to major projects supported by the government or backed by officials. Third, distorted cost of borrowing: although financial institutions offer interest rate discounts for their pet projects, under-rated enterprises or projects are burdened with a much higher cost of interest, shoe leather cost, relational cost and procedural cost.

  Uniformity of financial market hierarchy and centralization of regulatory approval will also cause financial exclusion, which is often overlooked. Uniformity of financial market hierarchy means that there is only one hierarchy of financial market in a country. All the stock markets in China are at the national level. Regional firms have to be listed in national stock markets or they cannot openly distribute shares at all, while there is no equity market at provincial or municipal levels. Centralized approval of financial market access means that institutions must be approved by central authorities in order to engage in financial services and in national or regional financial markets. China’s financial markets are subject to highly centralized market access approval. The high threshold of national financial markets has barred many small and micro businesses. Without resorting to connections, fraud in financial statements and bribery, promising firms are not able to get listed in the national stock markets, nor do they have access to financing platforms in regional financial markets at county, municipal and provincial levels. Furthermore, a vicious market environment posed another barrier to market access. Under a market environment with incomplete regulatory systems and imperfect credibility, market transactions of individuals, firms and government are fraught with dishonest practices that spawn financial risks. Creating a permissive environment that allows fraudulent practices will accumulate risks that ultimately lead to financial turmoil while tightening regulation will stifle financing channels. Lastly, the trading venues of financial markets have unintentionally increased the financial opportunities of neighboring provinces and municipalities while creating exclusion of non-local firms.

  2.4 Social Connections and Financial Exclusion

  Excessive reliance on personal connections orGuanxideriving from China’s traditional culture in the market economy engendered extensive financial exclusion. Fei Xiaotong (1947) defined social connections in China to feature a “differentiated pattern”, which includes at least two dimensions of family and geographical relations whose diameters are both decided by the competence of individuals. Under this pattern, social connections represent the totality of personal connections. Nodes of network are bound by traditional ethical principles. In China’s economic transition, such a differentiated pattern of social connections and its underlying ethical system still remain. Rules alone are not sufficient to govern market transactions. In a society where personal connections hold sway, connections with bank executives will determine the ease or difficulty of access to finance. Those who are well-connected will enjoy priority in their access to finance when financial resources are scarce, while those without connections are much less likely to secure a bank loan. In their research on bank credit pricing, Xie Ping and Lu Lei (2005) created a model that includes three typesof income aside from normal interest revenues: Type Irent-seeking revenues (borrowers pay a considerable amount of “commission” to bank staff, referred to as the cost of threshold), Type IIrent-seeking revenues (with the increasing liberalization of interest rates, financial institutions continuously demand exorbitant off-book interests and Type III capital injection from the central bank to write off tremendous non-performing loans (NPL) to prevent liquidation.)

  2.5 Risk Evaluation and Financial Exclusion

  Most commercial banks follow the “5C” approach in their credit lending evaluation, focusing on such financial information as the character, capital, capacity, collateral and conditions of borrowers. Nevertheless, such an evaluation system and information associated with it cannot depict the true creditworthiness of borrowers and their probability of repayment. As such, numerous credit lending projects are rejected despite their value to social development and creditworthiness, giving rise to broader financial exclusion. Take Internet finance for instance. By using a different risk evaluation approach and focusing on different credit data, Kabbage and Aliloan have extremely low default rates in issuing loans to Internet businesses that would be rejected by traditional commercial banks (Kabbage mainly lends to businesses on e-commerce platforms like eBay and Amazon, businesses on UPS logistical platforms and other Internet businesses, while Aliloan primarily lends to Alibaba, Taobao and T-mall businesses).

  Kabbage’s data sources include the following: (1) sales volumes of Internet businesses, credit record and user flow of the borrowers with reference to their competitors’ commodity prices, sales record and inventory, as well as their social networking data and logistical delivery information; (2) businesses taking the initiative to provide data of other correlated accounts to online lending account for reference of loan approval; (3) delivery data of strategic investors including delivery volume and transaction information, which specifically includes transaction data from e-commerce platforms such as eBay and Amazon, logistical data from UPS logistical platform, accounting data from small accounting software like QuickBooks and social networking data from Facebook and Twitter.

  Aliloan collects the online and off-line information of loan applicants. Online information includes customer transaction and credit records at Alibaba’s B2B, Taobao’s C2C and T-mall’s B2C platforms, industry comparison, inventory valuation, financial information and non-financial evaluation, while off-line data mainly include site survey and credit reference report. Information gathered by Kabbage and Aliloan may reflect the creditworthiness of a borrower more precisely than the “5C” approach and thus increase financial inclusion. Regretfully, traditional banks remain highly exclusive in the information they use for credit risk evaluation.

  3. Financial Exclusion and Deviations in the Development of Inclusive Finance

  The United Nations proposed the concept of inclusive finance to call upon countries to create a system that provides appropriate financial products and services for all, especially those currently excluded by the existing financial system. The intention is to provide fair opportunities of financial transaction for the masses. However, inclusive finance has been defined in China as a concept of public assistance and reliefby governments and academic communities,which failed to developsolutionsto address the problem of financial exclusion,and the development of inclusive finance hasnot fundamentally increasedfinancial inclusion in China. For instance, China has carried out the “Jin Hui Project” to provide poverty relief loans, student loans, loans for small and micro businesses and loans for the application of high technologies supported by preferential interest rate policies, which are in fact repetitions of previous inefficient lending practices despite contrary rhetoric in their work reports. This has led some to doubt the rationality and enforceability of inclusive finance and thus put forward the issueof the “paradox of inclusive finance” (Lu Lei, 2014). We believe that a few concepts must be clearly distinguished in order to clarify the connotations and substance of inclusive finance and unravel the deviations of the current inclusive financial system in China.

  First, inclusive finance is different from fiscal transfer payment. Fiscal transfer payment is one-way transfer of fiscal funds to specific groups who meet certain criteria and includes fiscal relief, allowance and subsidy. In comparison, inclusive finance is based on the corner stone of credit and obligates borrowers to repay loans. Borrowers of inclusive finance must repay the loan in principal and interest in accordance with contract. Some scholars and policymakers pressure commercial banks to cover such borrowers as students and farmers regardless of the risk management level and default losses on the part of banks. They even think that repayments for loans for inclusive finance can be delayed or forgiven. Clearly, such a one-way notion of “inclusive finance” is contrary to the nature of finance.

  Second, inclusive finance is different from poverty relief. It is often believed that an inclusive financial system should be built to provide more credit resources to the poor. “The macro perspective of financial poverty relief is to reduce poverty through financial development including improvement of the financial system, while the micro perspective is to offer credit resources to the poor by offering credit support through such means as microcredit. Proceeding from different explanations on the sources of poverty, the mechanism of financial poverty relief may follow a capital perspective and acompetence perspective. The former is the basic instrument of financial poverty relief and the latter represents a higher requirement for financial poverty relief” (Wang Shuguang, 2012). Based on this argument, scholars have proposed that efforts should be made to develop micro-finance institutions that are closer to the target market, more knowledgeable about their communities and equipped with better credit technologies to compensate for the inadequacies of the formal financial system and thus help reduce income gaps between the haves and have-nots.

  

  

  

  

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