Financial Reversal in Rural China

Using a unique panel of fixed-site household survey dataset as well as historical bank performance and documents, this paper reveals a significant-but seldom externally recognized-reversal in China's rural financial policy sometime in the early 1990s. This reversal undid much of the rural financial policy of the 1980s, which was quite liberal in its systematic efforts to make credit available to the private sector, reform existing financial institutions, and tacitly permit the operations of informal finance, with a clear goal to support rural households' transition to nonfarm rural entrepreneurship. Two waves of rural household surveys, from 1986 to 1991 and from 1995 to 2002, reveal that rural households' access to both formal and informal loans was far more substantial in the 1980s than in the 1990s, so was the performance and growth of financial institutions in rural areas as the bank performance data show. We examine various possible endogenous economic reasons for the reversal, including the declining profitability of township and village enterprises, entrepreneurship migration, and substitution of informal financing. The empirical evidence, however, provides little support for these assumptions, but exactly mirrors the exogenous political reasons that are unrelated to economic issues yet bring about the policy changes.