Study on the Operation Risk and Risk Management of Banks of Village and Town in China YU Lihong 1, HAO Xinhao 2 1. School of Economics and Management, Shenyang Agricultural University, China, 110866 2. Foreign Language Teaching Department, Shenyang Agricultural University, China, 110866 jane_yu2008@163.com Abstract: The establishment of banks of village and town is an innovative measure to solve the insufficient supply of rural finance and enhance the quality of rural financial services. Banks of village and town bring competitions and vitality for the rural financial market; however, they also bring higher risks than common financial institutions on operation and management, due to the special attributes of their organizational setting, staff quality and serving targets etc. While in terms of commercial banks, risk management capabilities will directly affect their survival and sustainable development capabilities; therefore, strengthening the risk management of banks of village and town is even more important. Based on the actual situation of banks of village and town, this article systematically analyzes various risks facing in the process of their operation and management, and finally puts forward suggestions on risk management. Keywords: Banks of village and town, Operation risk, Risk management 1. Introduction In view of rural financial difficulties, the CBRC issued Several opinions about adjusting and relaxing the entry policy of the banking financial institutions in rural areas, and better support the building of new socialist countryside at the end of 2006, and banks of village and town have been recognized as the typical representative of the new type rural financial institutions, and they develop rapidly. Up to 2009 September, there had been already more than 100 banks of village and town in China. As the main achievement of incremental reform in the rural financial field, banks of village and town has played an important role on enhancing rural financial structure and improving the status of farmer credit in China. Foreign researches on rural microfinance institutions are more mature, for example, the researches on microfinance institutions, such as the Grameen Bank in Bangladesh, microfinance department of People's Bank in Indonesia, Sunshine Bank in Bolivia, and mutual-aid team of Village Bank in Uganda are relatively successful. The researches are mainly on successful experience in respects such as their management ideas, institutional framework, risk management, incentive mechanism, regulatory mechanism, etc. At present, domestic scholars researches about banks of village and town are still in the initial stage of exploration. Some representative researches are in the following. Guo Jun (2008) analyzed the market positioning of banks of village and town. Zhang Leilei(2010)analyzed the operation problems of banks of village and town, and put forward suggestions. Hou Junhua (2009) studied the sustainable development of banks of village and town. Zhou Shuo(2009) and Zhang Jing (2009) had done related researches. Overall, the main researches of banks of village and town are focused on market positioning, the status introduction and sustainable development issues. There are few researches on the risk and risk management of banks of village and town. In fact, as the newly established banks, risk problem is one of major problems faced by banks of village and town in the developing process. Therefore, the study on risk management of banks of village and town has important practical significance. This paper is a phased achievement of the social science plan fund project of Liaoning Province (L09DJY098), the project of education department of Liaoning Province(W2010368), the young fund of 825
Shenyang Agricultural University and the young fund of school of economic management of Shenyang Agricultural University(20081007) 2. The Risk Characteristics of Banks of Village and Town 2.1 The special attributes of servicing targets and the higher risks of credit Credit risk is the major risk faced by banks, especially for banks of village and town. Because the major servicing targets of banks of village and town are farmers and small and medium-sized enterprises, they have neither credit history in the past nor a sound financial and industrial system available for evaluation. Meanwhile, there aren t any relevant professional evaluation agencies to evaluate them nowadays. For example, the loans of farmers agricultural production and aquaculture can be a great risk to banks. No matter the occurrence of natural disasters or breeding infectious diseases or poor market information resulting in excessive plant, farmers will be unable to obtain the expected return, and they will not pay back loans on time. In addition, farmers personal credit sense is poor, and they couldn t understand the importance of in-time money return; all these will increase the credit risk. 2.2 The poor overall staff quality and the high operation risk Most banks of village and town are set up in less developed rural areas. Because of poor working conditions and low salaries, it is very difficult to recruit highly qualified staff with highly-educated background and excellent working experiences. Besides, the traffic conditions are bad and living conditions are low, so banks of village and town have to recruit someone with low-educated background and less working experiences locally. Those staff s awareness of compliance operation is poor and risk consciousness is dim. When they work in the business sector where just only two or three practitioners included, they are easy to substitute emotion for the internal control system. In this way, the regulation restriction on each operation stage has been loosened and the operation has been conducted carelessly. Then it is easy to cause risk. In addition, the staff appointed by the major shareholders for banks of village and town are basically from the grass-roots unit of the original big banks, and they lack the overall capacity of risk control, and it is difficult for them to grasp the key and difficult points of risk control in process of operation. Besides, the key risk links aren t unidentified and undistinguished in the business procedure and the key risk points and risk control measures are not clear, and it is difficult to identify the key and difficult points of risk control for the business operators, so the pressure of operation risk management is high, and the efficiency is low. This is likely to result the problems that operation risk is hard to control due to human factors. 2.3 The difficulty in taking deposits and prominent liquidity risk On the one hand, as the new type banks, comparing with the large state-owned banks, there is weakness in taking deposits for banks of village and town. Besides, farmers still have skeptical attitudes towards the credibility of banks of village and town because of the negative impact of the closure of rural cooperative foundations and savings associations in the previous years. On the other hand, banks of village and town will continue to expand the scale of loans at the pressure of making profits, at present, and the deposit-loan ratio of some banks of village and town is 75% above the regulatory red line. Therefore, in difficult circumstances of taking deposits, banks of village and town constantly expands the scale of loans which can easily lead to liquidity risk. 2.4 The imperfect mechanism and the high risk of internal staff control As the scale of banks of village and town is small, bank insiders have to take on more responsibilities; therefore the internal control regulation is inadequate, so it is likely to produce internal control risks. Internal control will not only change the fundamental purpose of the establishment of banks of village and town, but also produce a large number of internal relation people's loans or affiliated party loans, then banks of village and town will accumulate a large number of financial risks. 826
2.5 The high operation cost and high profit risk Most banks of village and town are established in the less developed rural areas, and there are fewer leading enterprises and high-tech industries in the areas, mainly based on conventional agriculture; besides, the weakness of agricultural industry has caused rural economy underdeveloped; there aren t any highly effective projects supporting banks of village and town, therefore, the profit margin is low. The clients of banks of village and town are mostly peasants, and they have more loans of planting and breeding; while the profit of this kind of loan is low, and the risk is relatively high; and peasants live remotely and scattered. All these lead to higher operation cost of banks of village and town, which affects the economic efficiency of banks of village and town and increases the profit risk of banks of village and town undoubtedly. 2.6 The high regulatory pressure and high regulatory risk Regulatory risk is the possibility of losses of the financial institutions that is caused by the financial regulatory institutions imperfect regulation (the imperfect regulation is because of the number and quality of regulators). After the access policy of rural financial market loosened, banks of village and town and other new type financial institutions have been springing up, however, in the rural areas, there are limited staff in the grass-roots regulatory department, after the establishment of banks of village and town, and the regulatory assignments and responsibilities of regulatory department are significantly increased, and the existing regulatory power is clearly insufficient. In addition, the regulatory institutions focus on major cities which are far away from the county town; there are only about three office-holders in most of regulatory offices in the county town, and some areas have even withdrawn regulatory offices; therefore, it is difficult to launch the on-site regulation and the site survey to the rural financial institutions. 2.7 The high sensitivity of state support and high policy risk Policy risk is the possibility of losses of the financial institutions that is caused by the changes and adjustments of the state policy and legislation. Banks of village and town are established with the strong support of government policies, as the new financial organizing form, they strongly dependent on the policies, but at present the government doesn t give enough policy supports, such as subsidies, tax preferences etc. In addition, there are over interference in local governments at some areas, and they over-interfered on the loans of banks of village and town by some inappropriate administrative means, which increase the credit risk. 3. Suggestions on Strengthening Risk Management of Banks of Village and Town 3.1 Measures to strengthening credit risk management On the one hand, banks of village and town should study and establish a simple, efficient and scientific assessment method of rural credit, which is easy for relevant staff to master and make decisions quickly and correctly. The simple and scientific assessment method of rural credit is very important. At present banks of village and town can assess and screen the client through the quantitative scoring system and credit rating system. On the other hand, it needs to build credit environment through stimulating policies of local government, such as sustaining credit-building activities including credit enterprises, credit town, credit communities etc, which is fundamental to improve the credit environment in rural areas. 3.2 Measures to strengthening operation risk management Firstly, banks of village and town should enhance staff training, comprehensively improve the theoretical level, operational skills and risk-identification skills of staff, and reduce the adverse effects and operation risk caused by their unfamiliarity with the business. Secondly, banks of village and town should sort out the key risk points; employ risk controlling technicians from shareholder banks. 827
According to the business operation process of banks of village and town, these technicians should check the important risk points in the key business segments which easily lead to the risk loss or have prominent influence on causing damages, according to the rules and regulations, and draw up appropriate risk control measures. The aim is to help banks of village and town identify the key points of risk control, reduce the pressure of risk management, and set a rule for management and operation staff to follow. In addition, it should strengthen restrain to the management and operation staff of banks of village and town, and increase accountability system in order to have a stronger sense of responsibility in business for the staff. 3.3 Measures to strengthening liquidity risk management First of all, banks of village and town should strengthen the capacity of taking deposits. Banks of village and town should have a long-term vision, operate honestly and establish its own brand advantages continuously. Then, they can win more trust from their clients, take more deposits, broaden their fund-raising channels and reduce liquidity risk. Second, banks of village and town should expand business scope and increasing revenue. The loan business is the main business and revenue source of banks of village and town, so it should loosen the interest rate control gradually, carry out floating interest rate, so that banks of village and town can achieve their steady growth of profit and ensure their sustainable management. Within the range of policy, banks of village and town should expand the business scope actively, such as the intermediary business including fund business, notes business, bank card business etc. Once more, it should establish actively the deposit insurance system, and the aim is to ensure the interests of depositors and defend the reputation of banks of village and town in the event of liquidity difficulties. 3.4 Measures to strengthening internal control risk management Banks of village and town should establish a sound internal organization, including the corporate governance structure section composed by the board of directors and supervisors; this will help prevent incidents unfavorable to organization's normal operation from happening, and the incidents can be the individual arrogating power and the individual embezzling the interior property of financial institutions etc. Banks of village and town should also establish the interior control system and risk management system to implement strictly separation of duties to relevant positions which can play the role of mutually check and regulation. Then it can reduce the insider control risk of banks of village and town. 3.5 Measures to strengthening profit risk management Banks of village and town should be different from some big banks in financial services aspects; and it should be flexible, and act according to circumstances. Banks of village and town should be built as "the poor s bank", and then farmers can have the feelings that it is their own bank. Especially in the village level, combining the finance with production, distribution and procurement, is helpful to the innovation of financial services, while also reduce credit risk. Banks of village and town should go down to the grass-roots unit, collect and understand a lot of client information, reduce the credit risk due to the unfamiliarity with client information. Banks of village and town should seek and develop new guarantee methods, for example, they may require professional cooperatives to provide guarantees when they supply loans for the members of the professional cooperatives. The innovative financial services of banks of village and town are beneficial to expand their scale and scope of services, reduce operation costs and increase profitability. 3.6 Measures to strengthening regulatory risk management Regulatory department should strengthen the regulatory resources and regulatory capacity. Particularly, the regulatory department should make full use of the existing monitoring network, closely follow the risk situation of the pilot institutions, establish off-site monitoring system, set up main regulatory staff, carry out on-site inspections, correct especially the illegal behavior of exceeding business scope 828
management, at the same time urge banks of village and town to perfect the corporate governance structure, improve the internal control system, and strictly guard against the risk. In addition, the regulatory department should, based on the regulation of classification, dispose regulatory resources rationally, further improve the regulatory system, effectively promote and make good use of the extended inspection right, and constantly increase the ability of discovering and handling problems. 3.7 Measures to strengthening policy risk management We need to establish and improve relevant laws and regulations of banks of village and town badly at present, and make appropriate preferential policies for the further development of banks of village and town to reduce the impact of the policy risks, in order to promote the sustainable development of banks of village and town. The preferential policies can be reducing or remitting taxes, reducing the ratio of deposit reserve, offering policy-related loan interest margin subsidies, allowing to apply for Central Bank re-lend, and actively guiding and encouraging foreign financial institutions to set up banks of village and town alone or with other Chinese local banks. 4. Conclusion The establishment and development of banks of village and town bring vitality for the rural finance, and the effect of their supporting agriculture is beginning to show, but as the new financial organizing form, their sustainable development is still influenced by a series of factors. The risk problem is a key factor of influencing sustainable development of banks of village and town; therefore, it is particularly important to strengthen risk management for banks of village and town. This article systematically analyses the operation risk of banks of village and town, and puts up suggestions on risk management, so it has important practical significance. References [1].Zou Lihong Yao Ying. Study on the market positioning of banks of village and town in China. Finance and Economy. 2008 (4):58-60 (in Chinese) [2].Xiong Yujun. Study on the market positioning of China's banks of village and town from the experience of the American community banks. E-Financial.2008 (5): 56-59(in Chinese) [3].Hou Junhua, Tang Zuohua. The strategy analysis of the sustainable development of banks of village and town.rural Economy, 2009 (7):71-72(in Chinese) [4].Zhang Leilei, Liu Xiangqian. The analysis of the current situation and development countermeasures of banks of village and town in China, Rural Financial Research 2010 (2):76-78(in Chinese) [5].DALE W. ADAMS, rural financial markets in low-income countries: recent controversies and lessons, world development, Vol.14, No.4, pp.477-487, 1986 [6].Elisabeth Rhyne, Microfinancee in latin America lessons for the middle east, working paper, ACCION, 2004 829