Red silk grass is a powerful herb that hastens recovery by binding the wounded flesh together. It is a plot item, used to help heal Kia Min so that you can compete in Smiling Mountain's test for a "special prize".
After defeating the bandits, you can return to the Two Rivers School and speak to Kia Min. She will mention her injury and the fact that she can't compete in Smiling Mountain's special test because of it. You can ask her if there is anything you can do to speed up the healing process. She then mentions that she has a vague recollection of a type of grass that might speed her healing.
If you persist on the matter, she will tell you that Old Ming is the person to see about the rare healing grass. Old Ming can be found on the beach, sweeping the sand. He tells you that merchant Fen Do should have some and warns you not to let him talk you into clippings of bearded tongue grass.
The difference between the two grasses is that red silk grass will actually bind the wound and make it so she can get back to her practices, while bearded tongue grass will make her feel healed, when it really only deadens the pain.
With that in mind, you can go find Fen Do in the Two Rivers Village. He tells you that red silk grass is expensive and very hard to acquire and proceeds to tell you that he knows "something just as good". He tries to tempt you into purchasing bearded tongue grass, just as Old Ming told you he would.
A Player following the Way of the Open Palm would ignore him and choose to buy the red silk grass so that Kia Min is properly healed. While a Player following the Way of the Closed Fist would see an opportunity to eliminate Kia Min as competition for good, thus choosing to buy the bearded tongue grass.
If you choose to purchase the red silk grass you can persuade Fen Do to lower the price for a "humanitarian cause". Charm, Intuition and Intimidation are all options you can choose from. It is recommended that you choose the option you are strongest in, for better chances at success.
Whatever your choice, once you have purchased the poultice, you should return to Kia Min and choose the dialogue options that best suit your alignment. Closed Fist players have the opportunity to con some money out of Kia Min by lying about the price of the red silk grass.