He said the innovative institutions include privately-run banks and private rural cooperatives, which are not officially allowed in China yet, but have been discussed for years and are gaining favor among regulators.

Only the withdrawal of the poor-performing institutions and the entry of vigorous new financial forces will ensure the normal operation of the rural financial system and avoid financial risks, Zhou said.

In the past, the authorities may have been too lenient on the poor-performers and too reluctant to issue new licenses, but it should no longer be so, he said.

"We have entered a new stage of reform and therefore should allow newcomers to replace some of the old and poorly-run institutions, otherwise the reform will not pay off," he said.

Experts said that the introduction of private banks is an unavoidable trend, especially with the expected full advance of foreign banks. However there is still much legal and regulatory preparation to be made.

The banking industry needs such innovation to break the State monopoly, intensify market competition and better serve the financial demands of the private sector, said Xu Dianqing, a professor at the University of West Ontario, Canada, who has also been an advocate of private banks in China in recent years.

Though some people still have concerns about the risks and moral hazards of the private sector, it is worth trying, he said.

Insiders said the authorities would initially like private businesses to take over indebted RCCs and help them turn around.

But although that would help private entrepreneurs gain access to the banking industry, the cost may be too high.

The resolution of the heavy debts of the RCCs, left as a result of the planned economy, has been a challenging task for the Chinese authorities, who are trying to rejuvenate rural financing via the introduction of freer interest rates and more market-driven rules.

Authorities kicked off the reform of RCCs in eight provinces last summer, allowing them to float lending rates according to the credit worthiness of borrowers.

Local residents are also permitted to purchase stakes in the RCCs to help increase capital adequacy and transfer some of the RCCs into cooperative or shareholding banks.

Generally speaking, the experiment has been working quite smoothly, said Zhou. It will be expanded to most regions in China this summer.

Zhou said that it is also an urgent task to build up a deposit insurance system to guarantee payment to depositors in case of the closure of rural financial institutions.

Normally the government would pay the bill for poorly-managed cooperatives, but as the sector gradually introduces more private investment, it is crucial to have a commercialized system of deposit insurance, he said.

After this first round of reform, the authorities will adopt the lessons learnt to strengthen supervision and avoid risks, said Zhou.

For example, new policies will be adopted to check the asset adequacy and quality of rural financial institutions and take prompt corrective actions, including setting curbs on business activities, when such indices drop to a certain level and send out warning signals.

(China Daily June 21, 2004)