Financial Cooperatives Issues in Regulation, Supervision, and Institutional Strengthening © 2018 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff and external authors of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non- commercial purposes. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Directors or Executive Directors of the respective institutions of the World Bank Group or the governments they represent. The World Bank Group does not guarantee the accuracy of the data included in this work. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. All queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. Photo Credits: World Bank Photo Library and Shutterstock WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES Carlos E. Cuevas | University of Washington Evans School of Public Policy and Governance Juan Buchenau | Finance, Competitiveness, and Innovation Global Practice | World Bank Group Table of Contents Abbreviations and Acronyms.................................................................................III Acknowledgments.................................................................................................... V Executive Summary............................................................................................... VII Main Themes and the Way Forward......................................................................... X 1. Introduction............................................................................................................ 1 2. Overview – Financial Cooperatives Outreach and Potential..........................3 3. Issues in Regulation and Supervision................................................................5 Regulation Issues.......................................................................................................... 6 Supervision Issues......................................................................................................... 8 4. Institutional Strengthening.............................................................................. 11 5. Combining Regulatory/Supervisory Reform with Institutional Strengthening..........................................................................................................13 6. An Agenda for Discussion and the Way Forward...........................................15 The Way Forward.........................................................................................................17 Annex 1. Financial Cooperatives Growth.............................................................19 Annex 2. FC Regulation and Supervision Categories – Selected Countries...21 Annex 3. Supervision of FCs................................................................................. 23 Annex 4. Selected Country-Cases Highlights.....................................................27 Albania........................................................................................................................... 27 Colombia.......................................................................................................................28 Guatemala....................................................................................................................28 India................................................................................................................................29 Kenya.............................................................................................................................30 Mexico............................................................................................................................ 31 Philippines.....................................................................................................................32 FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING I Rwanda.........................................................................................................................33 West Africa Monetary Union (WAMU)...................................................................33 Endnotes.................................................................................................................. 35 References............................................................................................................... 39 LIST OF BOXES Box 1. Agricultural and Other Multipurpose Cooperatives in Finance Provision...................................................................................................................4 Box 2. Indirect – Delegated/Auxiliary – Supervision.........................................10 Box 3. Tiers for Supervision in Different Countries........................................... 23 LIST OF FIGURES Figure 1. Credit Unions and Members Evolution, 1996 – 2003........................19 Figure 2. Savings and Loans Evolution, 1996 – 2003........................................19 Figure 3. WOCCU: FCs and Membership, 2007 – 2015.................................... 20 Figure 4. WOCCU: FCs Savings and Loans, 2007 – 2015................................. 20 Figure 5. Mexico: FCs Authorized by CNBV 2001 – 2014..................................31 TABLE OF CONTENTS II Abbreviations and Acronyms BANSEFI Banco del Ahorro Nacional y Servicios Financieros (México) BCBS Basel Committee on Banking Supervision BCEAO Banque Centrale des Etats de l’Afrique de l’Ouest (West Africa Central Bank) BIS Bank for International Settlements CAC Cooperativa de Ahorro y Crédito (savings and credit cooperative, Guatemala) CDA Cooperative Development Authority (Philippines) CNBV Comisión Nacional Bancaria y de Valores (Mexico Banking Commission) DiD Développement International Desjardins (Québec, Canada) FC Financial Cooperative ICURN International Credit Union Regulators’ Network IADI International Association of Deposit Insurers IFC International Finance Corporation LRASCAP Ley para Regular las Actividades de las Sociedades Cooperativas de Ahorro y Préstamo (Mexico Financial Cooperatives Law) SACCO Savings and Credit Cooperative (mainly East Africa) SCA Savings and Credit Association (Albania) WAMU West Africa Monetary Union (UMOA in the French acronym) WOCCU World Council of Credit Unions FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING III IV Acknowledgments The content of this document benefitted greatly from the presentations and comments made at the International Workshop on “Financial Cooperatives in Financial Inclusion: Challenges and Risks” held on April 17, 2018 in Washington DC and we would like to acknowledge especially: • Alceu de Albuquerque, Banco Sicredi, Brazil • Eleanor Astaphan, Eastern Caribbean Central Bank, St Vincent • Éric Bélanger, Desjardins International, Quebec, Canada • Michael Edwards, World Council of Credit Unions (WOCCU), USA • Martin Holtmann, IFC, USA • Nadeem Karmali, World Bank, USA • Zara Konini, FED Invest, Albania • Tara Lacey, Software Group, USA • Alan Moore, Irish League of Credit Unions Foundation, Ireland • John Mwaka, SACCO Societies Regulatory Authority (SASRA), Kenya • Korotoumou Ouattara, World Bank, Congo • Julien Reid, Autorité des marchés financiers, and International Association of Deposit Insurers, IADI, Canada • Fernando Restoy, Financial Stability Institute, Switzerland • Bjorn Schrijver, Rabo Partnerships B.V. Netherlands • Martin Stewart, ICURN and Bank of England The authors also gratefully acknowledge the insightful comments received from David Gerbrands (Rabo Bank Partnerships), from Dave Grace (ICURN), from Timothy Lyman (CGAP) as well as from Alfonso García Mora, Steen Byskov, Ilka Funke, and Juan Carlos Izaguirre (World Bank). Our appreciation is extended to Musakanyakombe Mwape for coordination and support during publication and to Aichin Lim Jones for the design and production services of this publication. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING V VI Executive Summary Financial Cooperatives (FCs) are important providers of financial services to poor and middle-income people, and significant drivers of financial inclusion. Aside from their strong presence and relevance in developed economies, especially Europe and North America, the significance of financial cooperatives in terms of financial inclusion in the developing world cannot be underestimated. Their pervasive presence in rural areas, and their potential to expand financial inclusion with multiple services to under-served segments make enabling the sustainable functioning of FCs a sensible policy objective. This issues paper reviews current knowledge about, and recent examples of FC development practice that generate lessons deemed valuable and useable in diverse contexts. The review provides background for an informed discussion around the following propositions: • Legal and regulatory frameworks for FCs adapted to the organizational nature and institutional structure of local FC entities, especially their governance and capital structure, are essential for FC stability and growth. • Adequate legal and regulatory frameworks including appropriate safety nets need to closely follow the development of the local FC market segment. Failure to provide an enabling framework runs the risk of stunting FC development, and undermining trust among the potential clientele/ membership. In addition to ensuring financial soundness, effective regulation and supervision are essential to help FCs achieve scale by fostering mergers, or enabling the integration of individual retail entities into federated (apex) structures. • Integrated approaches that combine legal and regulatory reforms with support to the institutional strengthening of the FC sector have shown important results in terms of financial inclusion, and fostered the modernization of financial cooperatives as effective financial institutions. Rapid introduction of electronic banking in FC networks seems to be badly needed, but requires a degree of preparedness, and a functional structure that most FC networks have yet to attain. A previous draft of the paper served as background material for the International Workshop on Financial Cooperatives and Financial Inclusion, FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING VII held in Washington DC in April 2018. This revised financial regulator and the supervisory authority, version includes valuable insights emerging from thus allowing for a mismatch between entry this Workshop where a unique blend of financial requirements, basic prudential functioning systems specialists, financial cooperatives experts standards, and supervisory capacity. and practitioners candidly exchanged knowledge • When entry requirements allow the proliferation and opinions. The “way forward” put forth below of small, unviable entities that escape supervision greatly benefitted from that exchange. and place deposits of poor people at risk. Regulation. The nature of financial cooperatives • When exit mechanisms, even if provided for in ownership and basic principles – member-owners the regulation, do not exist in practice. as clients, one-member/one-vote – underlies Supervision. Main challenges in the supervision of governance risks quite distinct from those associated FCs are: (a) diversity of financial cooperatives both with investor-owned banks. Agency conflicts in term of size and structure (freestanding versus (usually referred to as member-manager conflicts federated financial cooperatives); (b) weaknesses or “management capture”) are a major source in terms of internal control, and management of failure of financial cooperatives. Addressing information systems; (c) low level of capacity these agency conflicts ought to be at the center of of financial cooperatives’ staff and management prudential regulation for FCs. impacting their ability to comply with regulators/ Recognizing the key differences with respect to supervisors’ requirements; and (d) large numbers commercial banks, there is apparent consensus of small retail financial cooperatives operating in among financial development practitioners in remote locations, posing both time and resource that regulation and supervision of FCs belong in challenges for the supervisory agency to enforce the domain of the financial sector authority. In new requirements and monitor compliance. This practice, however, many countries still maintain review suggests that the heterogeneity of the sector FCs under non-financial regulatory authorities is best addressed through a risk-based supervision tasked by general cooperative laws that may or approach that considers several tiers of entities may not explicitly recognize the financial nature typically defined by scale. of FCs and that can open the door for significant Implementation, costs and effectiveness, of offsite regulatory and supervisory arbitrage. There is little supervision and onsite inspection are heavily controversy around what constitutes good practice influenced by the type(s) of financial cooperative in the regulation of FCs, although adherence to institutional model authorized by financial good practice differs across countries and even authorities. A large diversity of sector structures within countries when there are split regulatory exists between a total free-standing, atomized systems. Legal and regulatory frameworks need FC system, and a fully federated model with to clearly define: (a) the authority to regulate; (b) integrated financial cooperatives supervised by an entry requirements (including tiered systems); (b) apex organization, and a high degree of functional governance rules; (d) risk management controls; specialization between the base individual (retail and (e) resolution (exit) mechanisms. unit) cooperatives and the apex level (federation Main issues in regulation identified in this review or confederation) where most common services are: are housed. The adoption of direct versus indirect (delegated, or auxiliary) supervision systems • When the licensing (entry) authority for FCs is clearly context driven. A relatively common is different from, or disconnected with, the arrangement is to directly supervise the large EXECUTIVE SUMMARY VIII individual FCs and the apex (second or third tier) Combining regulatory reform and capacity organization, and to set up auxiliary or delegated building. The cases reviewed in Annex 4 suggest supervision of the small individual FCs in a manner that a combined approach is preferable to that prevents conflicts of interest. Ultimately, in regulatory reforms disconnected from institutional practice, supervisors resort to different forms of strengthening, and vice versa, to implement risk-based approaches that attempt to optimize the policies that aim at developing the FC sector. While use of scarce resources. the cases of Mexico and Albania clearly show the benefits of an integrated approach, other cases point A hybrid model that provides incentives for to the limitations found when capacity building lags individual FCs to meet prudential and efficiency regulatory reforms, or worse yet when the legal and standards even though they are not technically regulatory framework is stagnant and adjusts to the supervised by the banking authority relies upon development of the sector sluggishly or not at all. some sort of guarantee or deposit insurance facility. It is imperative in this model, however, that some Mitigating failure and dealing with failing regulatory authority empowers the facility to entities. A major issue uncovered in the study review, enforce penalties and even liquidation upon failure and specifically discussed in the International to meet the prudential standards. Workshop, points towards preventive actions as the preferable manner to address potentially failing Arguably, a superior incentive to meet rigorous entities and networks (see chapter VI). Resolution standards is access to the financial infrastructure of FCs should be an exception, rather than the rule (payments platform and such), as is the case for to intervene in FC networks. FCs in the USA and Europe. This incentive, however, requires that both the infrastructure Role of government. A commonly cited (hands- platforms, and the individual institutions (FCs) off) position on this is summarized by Seibel, 2013: have the requisite capacity and systems. Those of “a successful credit cooperative system requires the FCs, this review suggests, tend to lag behind in autonomy and self-reliance, a conducive legal most developing countries. and regulatory environment, effective supervision and enforcement of compliance by an autonomous Institutional strengthening. Capacity building financial authority, … . The role of the state may be efforts are advocated given the potential for FCs supportive, but within limits, providing a conducive to expand financial inclusion among under-served operating environment, but not intrusive.” segments of the population, especially when the policy objective is to make available safe alternatives to State support, however, may go beyond the traditional forms of asset holdings and accumulation provision of a “conducive operating environment” among low-income households. A key premise is that without becoming “intrusive.” Institutional regulators/supervisors should not be development strengthening programs, and integrated approaches agencies due to conflicts of interest. Given this, show that market-friendly state interventions are well-designed and monitored technical assistance feasible in the FC sector.1 In fact, this review shows by reliable providers, technology approaches that that political will, and state resources, are important bring electronic platforms to enable modernization enablers of FC growth. Government policies to and cost reduction of common services, and (in establish proportionate regulatory frameworks and very special cases) capitalization and management capable supervisory mechanisms are essential for partnerships, are potentially powerful institutional FC development. State support is also valuable in strengthening mechanisms. setting up deposit insurance or stabilization funds for FC networks. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING IX Main Themes and the Way Forward needs to be fully respected, entry into the practice of financial services provision needs to be properly Three main themes emerging from the study were regimented in alignment with a country’s financial put forth before participants at the International sector legal and regulatory framework. Following Workshop: (a) regulation and supervision; (b) the proportionality principle in regulation, and dealing with failing entities; and (c) FC growth, ensuring adequate resources for supervision are diversification and integration through technology. two basic tenets. Many of the guiding questions for each theme were addressed. While there seemed to be clear answers Mitigating failure. It seems clear that prevention is in many cases, addressing others or fine-tuning the best cure for failure. Deposit Insurance schemes, solutions in a manner that is useful for practitioners or more generally FC stabilization mechanisms require further study or deeper understanding of could be actively promoted, and initially subsidized the issues involved. Overarching general directions (e.g., to enable a lender-of-last resort role). In terms formulated in the International Workshop were of further knowledge acquisition in this area, the “ambition,” pursuit of “smart solutions,” and example of IADI’s creation of a Subcommittee “pragmatism.” on Resolution Issues for Financial Cooperatives (SRIFC) could be extended (and encouraged) to Regulation and Supervision. Existing systems in deal with “Mitigation Issues” specific of FCs. developed countries and in emerging economies could serve as specific guidance for large FC Growth and technology. There is room to networks in developing countries. There is a need improve in enabling FCs to benefit from for diagnostic tools, so that the specific features (keep up with) the rapid pace of technological of an emerging system can be closely matched innovations. Consistent with the arguments in with well-functioning existing networks. Focused favor of institutional strengthening in parallel interchange among the countries involved – with regulatory reforms formulated in this paper, internships, study periods – could facilitate leap- the Workshop discussions highlighted the role frogging through the design and implementation of of solid, professional international networks in suitable regulatory and supervisory systems, fostering that strengthening, in partnerships with FC networks, donors, and governments. Policy A policy area where action is needed, highlighted dialogue with governments to induce their support in both the study and the Workshop, is resolving in a market-friendly manner is a natural component the overlapping authorities over FCs observed in of multilateral and bi-lateral donor agendas. many countries. While the right of free association EXECUTIVE SUMMARY X 1. Introduction Financial Cooperatives (FCs) are an important component of the existing institutional base for financial intermediation, and significant drivers of financial inclusion.2 Aside from their strong presence and relevance in developed economies, especially Europe and North America, the significance of financial cooperatives in terms of financial inclusion in the developing world cannot be underestimated. While their “systemic” importance is usually small by standard measures (e.g., share in total financial system deposits),3 their relevance in reaching poor segments of the population, their pervasive presence in rural areas, and their potential to expand financial inclusion with multiple services to under-served segments make enabling the sustainable functioning of FCs a sensible policy objective.4 This issues paper aims at taking stock of current knowledge, and especially recent examples of FC development practice, that generate lessons deemed valuable and useable in diverse contexts. The main purpose of the paper is to inform a discussion around several propositions the review identifies, that could serve as guidance for policy interventions: • Legal and regulatory frameworks for FCs adapted to the organizational nature and institutional structure of local FC entities, especially their governance and capital structure, are essential for FC stability and growth. • Adequate legal and regulatory frameworks as well as appropriate safety nets need to closely follow the development of the local FC market segment. Failure to provide an enabling framework runs the risk of stunting FC development and undermining their trust among the potential clientele/membership. In addition to ensuring financial soundness, effective regulation and supervision are essential to help FCs achieve scale by fostering mergers or enabling the integration of individual retail entities into federated (apex) structures. • Integrated approaches that combine legal and regulatory reforms with support to the institutional strengthening of the FC sector have shown important results in terms of financial inclusion and fostered the modernization of financial cooperatives as effective financial institutions. Rapid introduction of electronic banking in FC networks seems to be badly needed, but requires a degree of preparedness, and a functional structure that most FC networks have yet to attain. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 1 2 2. Overview – Financial Cooperatives Outreach and Potential Slow and steady growth defines the evolution of financial cooperatives over time in most of the usual indicators of institutional development. The member-based nature of their organization underlies this feature, albeit modern FCs in many countries (that restrict FC services to members) are being aggressive at attracting membership in different ways, such as lowering the amount of the required share purchase to joinand broadening of the common-bond definition that makes an individual eligible to become a member. A “Global Census of Cooperatives” puts the number of cooperatives classified as “banking/credit unions” at 212,000, with 704 million members (D. Grace, 2014). Using the FINDEX 2014 results - 62 % of adults with an account - plus world demographics, FCs would therefore account for about 19 % of the “banked” adults. No time series of comparable census data is available, hence data from the World Council of Credit Unions (WOCCU) Statistical Report are used here to reflect trends in FC growth.5 WOCCU data for 2007 – 2015 suggests a steady membership (cumulative) growth rate of 2.9 % per year. Total membership growth between 2007 and 2015 was about 26 %, while membership growth reported for a slightly shorter period about a decade prior (1996 – 2003) was 40 %.6 Similarly, growth of FC deposits and loans while significant between 2007 and 2015 (53 and 47 % respectively), was much less than that observed between 1996 and 2003 (about double in both deposits and loans). This comparison underscores the steady, albeit slow, nature of FC growth (see Annex 1 for further insights). Interestingly, the FC figures for 2007-2009 do not show much of a sign of being affected by the financial crisis on-going at that time. Comparing with FINDEX, that reports a 24 % increase in account holdings between 2011 and 2014 (from 50 to 62 %), FCs membership grew 10.6 % in the same period. Proximity, a key factor in reducing user transaction costs, is arguably one of the comparative advantages of FCs.7 FCs are pervasive, especially in rural areas, even in the presence of new entrants and the advent of digitization and mobile banking. In addition to providing diversified services that include credit,8 FCs tend to be part of the social capital of rural communities. A key condition for this proximal/ atomized presence not to work against FCs’ performance and sustainability is FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 3 that they operate in a functionally integrated network and international), Government to Person (G2P) where the risks of operating in small retail markets transfers, bill payments and other People to Business can be shared and mitigated (see section IV). payments (P2B) such as school fees or other. FCs are uniquely positioned to contribute to fill these Despite the advances in agent banking and mobile gaps, if they are able to modernize their operations banking, there are still large gaps in the provision (join the digital age)and are supported by conducive of basic deposit and loan services, and payments regulatory and business environments. services of different kinds – remittances (domestic Box 1. Agricultural and Other Multipurpose Cooperatives in Finance Provision The financial cooperatives covered in this issues paper are just one component of the vast “world of cooperatives.” Worldwide, cooperatives in agriculture and food industries are about five times as large, by annual turnover, as banking and financial services cooperatives (the closest to our definition of FCs). Many cooperatives not considered strictly “financial” provide financing services in different segments of the economy, notably in agriculture. Farmer cooperatives (supply, marketing, services) are pervasive in many countries, and created the basis for large and powerful organizations notably in Europe (Crédit Agricole, France; Rabobank, the Netherlands), and Asia (Zen-Noh, Japan; National Agricultural Cooperative Federation, South Korea). The story of agricultural cooperatives in the developing world is one of mixed results, dominated by government manipulation, and their use as top down “tools’ in national development plans (Mercier, 2017). The India case is usually cited to portray this “misuse” of the cooperative idea (Ashtankar, 2015), but many other examples exist. On the other hand, large farmer cooperative systems in Latin America (e.g., Brazil, Argentina), and Sub-Saharan Africa (e.g., Kenya, South Africa, Uganda) have shown positive results and substantial growth in membership, as they succeed in organizing farmers’ access to inputs and markets. Both the input supply and the marketing functions involve some sort of financing role, as inputs and/or advances are provided against future harvest proceeds. Multiple other services, such as procurement of basic staples, farming equipment, home appliances and such are commonly added to the portfolios of those cooperatives. While a thorough discussion of agriculture and other multi-purpose cooperatives that entail some level of financing to their members is far beyond the scope of this issues paper, their presence and potential need to be considered next to that of purely financial cooperatives. Accepting that the dividing line between financial and non-strictly financial cooperatives would be the ability (license) to collect deposits, all of them could play a role in enabling agricultural value-chain financing arrangements for smallholder farmers. Farmer cooperatives can be successful aggregators and processors in the multi-lateral contracting associated with value-chain finance. Further, they can serve as reliable agents in the provision of banking services by the financial partner in these arrangements. A deeper enquiry into agriculture and multi-purpose cooperatives than what is feasible here seems warranted. Their role in serving small farmer households, and how these cooperatives could/should interact with financial services providers (FCs or not) should be documented and analyzed. The issues that emerge from the joint provision of finance and non-financial services would be part of this analysis. Sources: International Co-operative Alliance, ICA (2017). Data compiled from about 2,500 organizations. No parallel is possible with the “global census’ referred to above, or the WOCCU statistics, since the ICA data does not include membership, or total assets, and the credit union census does not report turnover. Cuevas and Pagura (2016). 2. OVERVIEW – FINANCIAL COOPERATIVES OUTREACH AND POTENTIAL 4 3. Issues in Regulation and Supervision Financial cooperative members/clients in the USA, Canada and Europe enjoy at least the same deposit and customer protection as do bank clients, provided by a sound deposit guarantee scheme and a public regulator/supervisor, e.g., the Federal Credit Union Administration (FCUA) in the USA, or an industry regulator/ supervisor empowered by a government authority such as the Desjardins system in Quebec, Canada or the German Cooperative Banking System. The same is not true for most of the developing world, where large numbers of poor clients are exposed to risks inherent to the ownership/governance structure of financial cooperatives that are not adequately regulated and supervised. While systems rooted in delegated or auxiliary supervision have emerged and shown reasonable success (e.g., Mexico), even these efforts have met with diverse challenges and most of the world – notably Sub-Saharan Africa – seems to be lagging in terms of its ability to regulate and effectively supervise large numbers of (often small and remote) retail institutions. The issues associated with regulation of FCs are different from those that can be categorized as supervisory issues. Hence, they are treated separately below. Regulation and supervision of financial cooperatives belong in the domain of the financial sector authority Recognizing the key differences with respect to commercial banks (see below), there is apparent consensus among financial development practitioners in that regulation and supervision of FCs belong in the domain of the financial sector authority. The BIS guidance calls for “proportionality” in regulation and supervision relative to the systemic importance and risk profile of the supervised institutions, while acknowledging the resource and capacity constraints of supervision systems commonly observed in low-income countries (BIS, 2016). In many countries, authorities also need to address existing regulatory and supervisory arbitrage situations which may arise if FCs are overseen by non- financial regulatory authorities tasked by general cooperative laws and if the financial nature of FCs is not recognized.9 The BIS Range of Practice review (2015) found numerous instances of licensing and registration of FCs by non-financial authorities, jurisdictions requiring only registration (no licensing), even though in a majority of the surveyed jurisdictions FCs were able to practice multiple “bank- FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 5 like” activities, such as issuing of checking accounts, systems do not provide for exit mechanisms i.e., set payments cards, and insurance products. In some up conditions for ceasing operations, compensate countries, such differences have made it possible depositors and other creditors, and create resolution for fraudsters to misuse FCs with the sole purpose processes (mergers, acquisitions, interventions) of gaining undue access to members’ deposits that properly funded and staffed. As a result, many FC are then diverted into private investments or into sectors in developing countries have practically no pyramid schemes. Annex 2 presents a categorization entry restrictions, suffer from supervisory constraints of regulatory and supervisory systems for several that can only cover a fraction of the total number of selected countries. entities, and have large numbers of inactive and/or failing FCs that the authority is unable to resolve. Regulation Issues The review identifies several regulatory issues that FC Governance issues, and their can be deemed specific to financial cooperatives. implications for regulation The nature of financial cooperatives ownership First, the diversity of authorities involved in licensing and basic principles – member-owners as clients, or registration, functional and prudential regulation, one-member/one-vote – underlies governance risks and resolution (exit) is a main concern, as it creates the quite distinct from those associated with investor- large atomized FC sectors that are then a nightmare owned banks. Agency conflicts (usually referred to supervise. Second, the cooperative principles to as member-manager conflicts or “management defining FC ownership generates governance capture”) are a major source of failure of financial issues that distinguish FCs from investor-owned cooperatives. Stories of managers and/or board financial institutions. Third, regulations that apply to members fleeing with members’ deposits abound, institutions in distress or failing either do not exist in while less extreme examples of weakening entities developing countries or are devoid of mechanisms due to poor uncontested decisions are perhaps the to resolve these institutions in a manner that protects most common situation leading to failure. Addressing depositors and prevent fraud. these conflicts should be (as it is done in developed countries) a central theme of prudential regulation Misalignment of authorities and and supervision of financial cooperatives.10 In FCs, mechanisms for entry, functional the key internal conflict is the member-manager regulation, and exit conflict, also known as the “expense preferences” Regulatory systems for financial institutions generally (EP) by managers. EP control should be at the center distinguish between conditions that apply to entry of prudential regulation for FCs.11 (licensing), functioning (financial and operational standards) of licensed entities, and exit (resolution The member-owned nature of FCs also determines of failing entities). A major overarching issue in the a key difference between FCs and investor-owned regulation of financial cooperatives is the degree to banks in terms of the alignment of interests of which those three components are (not) aligned. A owners with those of the regulator. For FCs, the frequent misalignment in developing countries is interests of the members-shareholders and those of that entry conditions are minimal or non-existent, the regulators are essentially aligned, since members i.e., limited to registration with a (non-financial) are also the primary depositors (i.e., creditors of the authority. The diverse scale of FCs also leads to institution). In investor-owned banks, in contrast, tiered systems of prudential regulation that, if not regulators seek to protect depositors, while properly structured and supervised, invite regulatory shareholders are keen on management seeking arbitrage. Most concerning, many FC regulatory profits, even as they take new risks. 3. ISSUES IN REGULATION AND SUPERVISION 6 Governance rules, therefore, are a critical and distinctive Regulating risk mitigation, and failure – component of FCs’ legal and regulatory framework.102 deposit protection and early warning systems A clear definition of the composition of governance An entire paper could be written just on this subject. bodies is essential. Fit and proper requirements for Most regulatory systems establish off-site and on- both governance bodies, and the selection of senior site assessment and rating systems intended to track management and their succession, are crucial albeit the performance of FCs.16 The regulatory side of the often loosely defined or simply not observed. A BIS issue (there is also a supervisory side) relates to the survey found that one-third of FC supervisors observed nature of the tracking system chosen for the FCs weaknesses in this respect.13 While it may be unrealistic and their apexes, the frequency of reporting, and the to expect fit and proper requirements to be met in many system’s ability to detect signs of distress when there contexts, mandatory training and certification could be is still time to do something about it. In the absence required, and/or allow for the hiring of qualified people of explicit deposit insurance, many regulators turn to for governance functions. deposit protection through guaranteeing the stability of the institutions (i.e., a network would ensure that Governance bodies. The composition, and an individual institution does not fail) by providing requirements, for Board of Directors, Credit for mergers and acquisitions as recourse to individual Committee, and Audit (Supervision) Committee need FC failure. The extent to which this mechanism truly to be clearly established. The rules should address protects the depositors, i.e., their ability to withdraw and prevent all possible conflicts of interest, e.g., their funds when distress is apparent, varies widely board members deciding on loans to themselves or across the systems this review has covered.17 close relatives. As FCs grow in scale and complexity, fit and proper rules need to be adapted, management Early Warning Systems (EWS) have been advocated will typically become (or include) professional hired as tools to prevent institutional or network failures personnel, hence the governance bodies overseeing that work better than CAMELS or other systems management ought to be able to prevent and monitor by tracking risk indicators not included in these “expense preference” behavior. systems.18 While EWS seem advisable for every system, their installation beyond a pilot program Sector structure – single tier, multiple tiers. Laws (usually donor funded) have not been widespread. and regulations will define whether they apply the same to all FCs, or whether they recognize multiple Resolution tools do exist for FCs, in most cases adapted tiers, depending on scale (typically defined by asset from those used for the resolution of banks. Their use size; see Annex 3, Box 3.1))14 Likewise, the law may and effectiveness vary widely across jurisdictions.19 distinguish between clauses that apply to individual On-going work at the International Association of FCs, from those that pertain to second-tier (network) Deposit Insurers (IADI) aiming at providing guidance entities such as federations.15 It is important to in this respect is to be encouraged.20 recognize that the existence of networks and apexes entails governance questions beyond those associated Other elements of functional regulation with that of individual FCs. Depending on the nature Aside from governance, the features that matter in of the network apexes, from purely representation the regulation of FCs are outlined below. There is and advocacy roles to specialized business entities little controversy around what constitutes good where common services are housed (see below), the practice in the regulation of FCs, although adherence regulatory system may establish governance rules to good practice differs across countries and even that apply to the apexes to prevent dominance and within countries when there are split regulatory abuse of power of the large entities in the network. systems (e.g., Colombia, Philippines). Compliance FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 7 with regulatory standards, and enforcement, are Consumer protection. Responsible finance and matters dealt with in the section on supervision. consumer protection principles are also important in an inclusive framework for FCs. A peculiar feature of Membership. Laws and regulations define the FCs in this respect is the other type of internal conflict criteria for membership in FCs. These criteria are – borrower dominance – which tended to prevail for typically broad and flexible, recognizing the usual some time in many FC systems until governance “bottom-up” nature of FC creation. Closed-bond FCs rules protecting depositors were established. such as those defined by a workplace are sometimes specifically recognized. Supervision Issues Capital. The legal and regulatory framework defines In developing countries, even when adequate capital rules – minimum capital, capital adequacy legislation and regulations have been enacted, a key – and what is considered FC capital for regulatory challenge remains to enable effective supervision purposes. It is generally accepted that “regulatory and ensure compliance. In most countries, financial capital means the broadest scope of (FCs’) capital cooperatives compete for “supervisory attention” that can be used to absorb losses and to grow the not only with the established commercial banks, institution” (WOCCU, 2015, p. 12). It encompasses but often with large numbers of small scale both institutional capital and secondary capital. financial institutions that serve clienteles like those Institutional capital refers for the most part to non- of the FCs. India, Indonesia are good examples of distributable reserves associated with retained thousands of FCs and non-FCs functioning under earnings, as well as ownership shares; it is generally diverse regulatory systems, and no feasible effective equivalent to Basel III’s “Common Equity Tier 1” supervision given their numbers and locations. capital.21 Secondary capital includes subordinated Supervision issues, therefore, are not unique of FCs, debt and general provisions, generally equivalent to but addressing these is in many cases a good way Basel III’s “Tier 2” capital. to start given their numbers, scale of membership, Capital clauses in FC laws may define “minimum and especially the fact that FCs are deposit-taking capital” requirements (multiple levels in tiered institutions, a function many other providers in low- systems) and establish a timeframe for a new FC to income markets cannot legally perform. meet the requirement. The framework will (should) also indicate minimum capital adequacy ratios, and Large numbers of supervisees, inadequate whether risk-weighting of assets to calculate the ratio supervisory resources is needed.22 This ratio is usually set in the 8 to 10 % For FCs, among other challenges, we can highlight: range, i.e., like the capital adequacy that is required (a) diversity of financial cooperatives both in term of from similar entities (e.g. MFIs, finance companies). size and structure (such as freestanding non-affiliated retail financial cooperative and federated institutions Liquidity. FC laws typically define a minimum in the same market); (b) weaknesses in terms of liquidity ratio, as a proportion of short-term liabilities internal control, and management information (10 % is a common standard). FCs tend to operate on systems; (c) low level of capacity/expertise of the liquid side. financial cooperatives’ staff and management Loan portfolio quality. In some countries, FC laws impacting their ability to effectively be in compliance and regulations also establish a maximum rate of with regulators/supervisors’ requirements; and (d) default (Non-Performing Loans), which can lead to large numbers of small retail financial cooperatives sanctions and supervisory measures if exceeded. operating in remote locations, posing both time and resource challenges for the supervisory agency to enforce new requirements and monitor compliance. 3. ISSUES IN REGULATION AND SUPERVISION 8 The type of financial cooperative institutional representation functions (e.g., the Credit Union model authorized by financial authorities and the National Association in the USA), from “strategic” structure of the sector has a great impact on how networks where formal multilateral agreements exist offsite supervision and onsite inspection will (could) between first-tier and upper-tier bodies, with the be effectively implemented. Two models can be apex becoming a “hub-node” with meta coordination outlined as the polar extremes in a continuum of functions (Rabobank, and Desjardins portray this financial cooperative systems: type of organization well, albeit with different features). It is the latter – “strategic” – networks • Free-standing (atomized) financial that hold promise, or rather could be deemed cooperatives23 which have relatively limited relationships with each other in terms of resource “necessary,” to establish functional delegated or sharing, harmonized governance and systems. auxiliary supervision systems that make supervising In theory, this type of institution would require large numbers of retail entities cost-effective. Annex direct supervision by the financial authority, 3 (Box 4) summarizes international experience in though in practice this is often impossible, auxiliary supervision. particularly in the case of smaller and more remote cooperatives and capacity-constrained Supervision: direct or indirect? countries. As a result, in several jurisdictions Unlike regulation, there is no clear consensus regulators opt to leave smaller and more remote on what supervision arrangements are adequate. financial cooperatives outside of the scope of Advocates of atomized free-standing systems favor mandatory supervision. direct supervision, yet supervisory capacity quickly • Federated model24 with integrated financial becomes a limiting factor when there are many FCs cooperatives supervised by an apex organization, to oversee.26 Highly integrated strategic networks and a high degree of functional specialization will tend to establish auxiliary (Germany, Mexico) between the base individual (retail unit) or delegated (Quebec) supervision arrangements. cooperatives and the apex level (federation or Supervisory autonomy and independence, and confederation)25 where most common services prevention of conflicts of interest are important factors are housed, e.g., back office processing, in this arrangement. Ultimately, solutions tend to be IT services, technical assistance, training. largely context-specific, where supervisors resort to The regulator may empower and “delegate” different forms of risk-based approaches that attempt oversight to second- or third-tier entities when to optimize the use of scarce resources. A relatively there is reasonable evidence that an effective structure of integration and specialized business common arrangement is to directly supervise the relationships exists, and there is clear separation large individual FCs and the apex (second or third of supervision functions from services provision tier) organization and set up auxiliary supervision in to avoid conflicts of interest. This will enable a manner that prevents conflicts of interest. feasible and cost-effective indirect (delegated A special case of this “hybrid” approach is that or auxiliary) supervision for large numbers of followed by the West Africa Monetary Union small retail units (see Box 2 for the distinction between delegated and auxiliary). (WAMU) where all FCs with outstanding loan portfolio above around USD 4 million fall under Between these two extremes there are many types the direct supervision of the regional Central Bank of intermediate levels of integration and functional (BCEAO) and the regional Banking Commission specialization. The literature distinguishes (see Annex 4). FCs with loan portfolios below that “consensual” networks of otherwise free-standing threshold are the responsibility of the respective financial cooperatives which perform mostly Ministry of Finance of the WAMU member country FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 9 Box 2. Indirect – Delegated/Auxiliary – Supervision Indirect supervision is a regulatory regime in which an agent (the delegated or auxiliary supervisor) performs certain tasks associated to the supervisory function on behalf of the state authority (the principal supervisor). The agent may be (and usually is) a body specially setup by the network of FCs but could potentially be any other independent party like an auditing firm or a rating agency. The ultimate responsibility of the functioning of the regime rests squarely with the principal supervisor, and no indirect supervision regime should be expected to work without a commitment of the latter to make it work. How is “delegated” different from “auxiliary” supervision? In the former case, in addition to the execution of functions of data collection, processing and information, and recommendations for action, the delegated supervisor is empowered to enforce corrective actions, cease and desist, or, rarely, intervention and or liquidation orders (see Annex 2 for examples). No such empowerment exists in auxiliary systems. Source: Cuevas and Fischer, 2006. (8 in total). It is possible, therefore, that in a country stability of the FC sector by not providing a strong, that has one major federation (union) with say formal backing that would enforce discipline and by 20 affiliated cooperatives, of which 5 have loan that greatly enhance the trust current and prospective portfolios above USD 4 million, the BCEAO and members can place in the system. Banking Commission will directly supervise those 5 Arguably, a superior incentive to meet rigorous plus the apex, typically in joint supervision missions. standards is access to the financial infrastructure Coordination issues are important in this kind of (payments platform and such), as is the case for FCs arrangement, not only between the BCEAO and the in the USA and Europe. This incentive, however, Banking Commission, but also with the respective requires that both the infrastructure platforms, and Ministry of Finance. the individual institutions (FCs) have the requisite capacity and systems. Those of the FCs, this review Incentive models suggests, tend to lag in most developing countries, A model that provides incentives for individual FCs a matter where institutional strengthening could/ to meet prudential and efficiency standards even should make a difference (see below). though they are not technically supervised by the banking authority, such as most Colombian FCs, While “cost-effectiveness” is always a concern and some of Guatemala FCs, relies upon some sort in supervisory models, this paper could not find a of guarantee or deposit insurance facility (see case reliable study that compares costs across alternative summaries in Annex 4). Under this model, FCs may systems – direct, delegated, auxiliary, mixed. The access the guarantee or deposit insurance facility if “costs” part is not that difficult to measure, but they meet a number of requirements fairly close to there seems to be a need to define what constitute what a formal banking regulatory authority would “effectiveness” and how it can be measured. Basic establish. The problem with this approach is that indicators would be the degree of compliance with participation is not mandatory, and an entity may prudential rules, e.g., proportion of the supervisees simply avoid compliance and withdraw from the that meet the standards, but further refinement would facility with no penalty.27 This is perhaps the clearest be needed to arrive at reliable measures of risk- case of formal regulation and supervision lagging reduction in the system under different supervisory behind sector development, and compromising the models. This is an area where clearly further research is warranted. 3. ISSUES IN REGULATION AND SUPERVISION 10 4. Institutional Strengthening Strengthening FCs has been a mantra of governments and development agencies for a long time, albeit with a mixed performance record. This section highlights what seem to be accepted principles and good practice in this area. Section V below covers in greater depth those strengthening efforts that are combined with legal and regulatory reforms. Why it matters? What typically drives capacity building efforts that target FCs is the perception, or the expectation, that they represent a stable form of outreach with multiple services to under-served segments of the population. Hence, FC components are found in general financial inclusion efforts (e.g., Kenya), microfinance and poverty reduction using microcredit programs (e.g., the Philippines), or programs aimed at improving financial access for agriculture smallholders (Philippines). FC are especially targeted when the purpose is to reach low-income sectors with formal financial services, as a means of making available safe alternatives to traditional forms of asset holdings and accumulation (part of the Mexico motivation). See country-cases highlights in Annex 4. Important issues, principles, and good practice are outlined below. Institutional development agencies that are also regulators/supervisors, not a good combination. Conflicts of interest in this kind of initiatives are clear, as the promoter finds itself in the position of judging as regulator/ supervisor the outcomes of its own promotion efforts (South Africa Cooperative Banks Development Agency, CBDA, Philippines Cooperative Development Authority, CDA). Technical assistance. High power, high quality technical assistance (TA) driven by goal-based incentives and penalties, with clear milestones regularly monitored, seems to work well although it may be expensive, and will usually take time. The Mexico experience suggests that the expense is worth it when a substantial expansion of financial inclusion, and a significant broadening and upgrade of financial infrastructure are adequately valued. Although the TA work of large international networks such as Développement International Desjardins (DiD), France’s Crédit Mutuel, Germany’s DGRV, Netherland’s Rabobank International Advisory Services (RIAS), the Irish League of Credit Unions International Development Foundation (ILCU-F), and USA’s WOCCU, has not always FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 11 excelled, it does include several success stories on transactions (see Annex 4). The challenge, one could which new initiatives can (and do) capitalize. These argue given the experience in Mexico and Kenya, international entities have a reputation to protect, and is the absorption capacity of individual entities this makes a difference in terms of their commitment and their apex organizations to acquire and operate to achieve results. modern technology (sophisticated) systems. On the other hand, the new systems may have room for Of interest for the effectiveness of indirect improvement in making them intuitive enough for supervision is how these TA interventions affect small entities. Federated systems (described above) the relative strength and capabilities of second- and have a relative advantage in that the more complex third-tier (apex) structures in FC networks. The technology is handled at the apex by specialized member-based, community-based nature of FCs staff, while the retail affiliates only need to master seems to make progress slow, a factor that tends to the customer transactions modules. discourage sponsors seeking quick results that will tend to discontinue programs long before they begin Capitalization and management partnerships. to show positive outcomes. Rabobank has carried out important investment and management interventions with large FC networks, Technology approaches. The BANSEFI platform notably Rwanda (see Annex 4), but also in China in Mexico, WOCCU’s common IT services platform with large Regional Rural Credit Cooperatives. with Kenya’s savings and credit cooperatives These interventions amount to “modernizing” (SACCOs), and the “Temenos proposition” and traditional cooperative membership rules (namely its feasibility in the Philippines and other Asian one-member one-vote) by introducing voting rights countries members of the Asian Confederation proportional to capital contributions.28 In addition, of Credit Unions (ACCU) represent examples of and perhaps more importantly, the intervention highly promising means of building capacity and brings about management agreements that confer the integrating FCs into the fast-moving evolution senior partner (Rabo Development) full control over of electronic platforms supporting financial the business functioning of the organization. 4. INSTITUTIONAL STRENGTHENING 12 5. Combining Regulatory/ Supervisory Reform with Institutional Strengthening The cases reviewed in Annex 4 suggest that a combined approach is preferable to regulatory reforms disconnected from institutional strengthening, and vice versa, to implement policies that aim at developing the FC sector. While the cases of Mexico and Albania clearly show the benefits of an integrated approach, other cases point to the limitations found when capacity building lags regulatory reforms, or worse yet when the legal and regulatory framework is stagnant and adjusts to the development of the sector sluggishly or not at all (Guatemala, Kenya, Philippines).29 A non-intrusive role for government The Mexico experience highlights the role of political will among leading agencies to sustain a capacity building and regulatory reform effort for longer than a decade. In spite of political pressures in different directions, the process maintained its impetus through three administrations. The savings and credit sector in Mexico evolved from about 650 retail entities in the year 2000, of which only about 40 were under supervision by the financial authority (CNBV in the Spanish acronym), with 2.6 million members, to a fairly solid sector with 133 entities supervised by the CNBV in 2014 (76 % of all members in the system, 82 % of the assets), and 6.5 million members. Two major legal and regulatory reforms, a strong institution charged with a development mandate for the sector (BANSEFI), and specialized technical assistance by internationally recognized providers were key components in the process (see Annex 4). Albania, on the other hand, with the advantage of having two dominant FC networks, completed a consolidation of the sector in parallel with a law reform in about 18 months between 2014 and 2016. A coherent approach supported by the Bank of Albania, the World Bank Group, RIAS and ILCU-F as technical assistance providers was at the root of this rapid development. Good data and effective technical assistance The importance of data gathering, understanding the diversity of the sector, and expert advice to delineate and implement a growth strategy cannot be underestimated. Further, the capacity building that accompanied the regulatory reforms, mainly TA provided by international FC networks, was an essential enabling component FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 13 especially for those entities initially in a rather suggest the advantages of setting up deposit insurance rudimentary financial and operational state. Making facilities to encourage adoption of prudential an electronic platform available for the sector was an standards by FCs. Making the regulatory system important cooperating factor. consistent with the adoption of these mechanisms remains the key challenge in many countries. Addressing risks and resolving failures As suggested earlier, resolution mechanisms for Deposit insurance, guarantees, early warning failing FCs is an important area where good practice systems, and other sector-wide systems/bodies may and guidance are needed. Clear exit mechanisms play important roles in developing/strengthening the are about as important as entry standards to enable sector. In addition to the Mexico example, Albania, healthy FC systems. Colombia, and with some limitations Guatemala, 5. COMBINING REGULATORY/SUPERVISORY REFORM WITH INSTITUTIONAL STRENGTHENING 14 6. An Agenda for Discussion and the Way Forward We conclude this issues paper outlining an agenda for discussion suggested by the findings of this review, and several valuable comments received on a previous draft. Three main themes emerged where the expert opinion of colleagues from diverse backgrounds was sought at the International Workshop on Financial Cooperatives in Financial Inclusion held in Washington DC in April 2018: (a) regulation and supervision; (b) dealing with failing entities; and (c) FC growth, diversification and integration through technology. The guiding questions for the discussion of these themes, and the presentations and debate among a unique blend of financial systems and financial cooperatives experts and practitioners are summarized below. The study findings, enriched by the contributions at the International Workshop help establish: first, guidelines for FC development and support already warranted by existing knowledge and recent experiences; and second, areas where additional evidence is needed, or where digging deep into cases of high learning value will be required to best define strategies and mechanisms for improving FCs’ performance as financial intermediaries, and enhancing their role in financial inclusion. Our closing remarks focus on these two areas. Regulation and Supervision of Financial Cooperatives What are suitable approaches to regulate and supervise heterogeneous FC sectors? • Should all FCs be part of the formal financial system or only the largest? • Entry: how to ensure that only viable entities are licensed? • Can regulatory and supervisory approaches foster the integration and consolidation of FC systems? How? • Limited supervisory capacity and heterogeneous sectors with many (mostly small) entities: Can tiered approaches work? What are the experiences with the delegation of supervision to apex entities? With the delegation to government agencies? • Experiences with information technology to facilitate reporting and risk- based oversight. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 15 A key concept in regulation and supervision is -- What are the experiences in cleaning up “proportionality:” minimizing the regulatory troubled FC sectors? intervention necessary to achieve policy objectives.30 -- How can failing FCs be resolved best in In regulation, this means avoiding unnecessary absence of deposit insurance? How can the complexity that lead to excessive compliance costs of resolution be minimized? costs, while for supervision it entails adjusting its -- Which early actions have proven useful to intensity to risk profiles, so that supervision costs help turn-around viable but troubled entities? are minimized. Proportionality is deemed helpful in Which actions can facilitate the merger of leveling the playing field for relatively small financial viable but troubled entities with sound FCs? institutions (such as FCs), since compliance costs associated with complex rules (intended for complex Mitigating and preventing failures constitute large banks) unduly burden small entities. preferred ways of dealing with troubled entities.32 Resolution of FCs should be a last resort exception, The specific case of FC regulation would preferably and not the rule. Umbrella (apex) organizations with be embedded in a general proportionality regime, proper governance, and able to provide technical, as opposed to a separate special FC regime. Yet legal, and financial assistance are important sources the general regime should consider specific risks of stability in FC networks. Mandatory participation associated with FCs, such as their governance in an apex-based stabilization fund (e.g., Ireland), features, and risk concentration, as well as the and/or in a deposit insurance fund (e.g., Sicredi, exposures of Institutional Protection Systems.31 Brazil) has been found to be an effective tool in Recognizing the uniqueness of FCs should not lead preventing FC distress. Institutional Protection to overprotection from competitive forces. Instead, Schemes (IPSs) can be established at the umbrella tailoring regulation and supervision to the specific level to host a liquidity or solvency fund, as a “first country context, including due consideration of line of defense” against failure. the diverse scale of FCs, and resolving issues of multiple overlapping authorities over FCs are Likewise, Deposit Insurance (DI) could be an important areas of concern for financial authorities, effective stabilization tool when established under and FC practitioners. sound regulation, robust supervision, and with participation of a lender of last resort. In this respect, Mitigating failure and dealing with failing cooperation between supervisors and deposit entities insurers is key. While DI schemes have typically • Mitigating failure, design of financial safety been established as a response to distress, there is nets. clearly no need to wait for a crisis to design a DI scheme for financial cooperatives. -- What are the experiences with safety net instruments for FCs such as solvency funds, Resolution of FCs, as an exception, could use some liquidity funds and deposit insurance? How but not all, of the usual bank resolution tools, due useful are they? in part to the specific features and broad diversity -- When does it make sense to establish such of FCs.33 Traditional resolution tools in developed schemes? Where should they be hosted? How countries may not be available or relevant in should they be funded? developing countries. For example, an extreme -- Which FCs should be covered? What happens resolution tool specific to FCs – demutualization with those FCs that are not covered? – may not be feasible in the absence of interested private investors. • Dealing with troubled entities: 6. AN AGENDA FOR DISCUSSION AND THE WAY FORWARD 16 Growth, diversification and integration Investing in technology, a powerful tool for financial through technology inclusion, is a priority. Technology is not only Financial cooperatives are part of the local social important to modernize transactional services – capital, they have a close relationship with their deposits, payments, remittances, loan disbursements members, a strong focus on savings and on fostering and repayments – and gather and process their members’ financial literacy, but are they still operational data, but it should be emphasized to relevant as providers of financial services in rural make management and controls more efficient, and and marginal – urban areas considering the evolution facilitate effective, transparent governance. Recent of digital finance and branchless banking? successful experiences are the operational integration of FCs in Andhra Pradesh and Telangana in India Guiding questions for this discussion are: (Rabobank), the reorganization of Fedinvest Albania • Which are the best ways for FCs to achieve (Rabobank, World Bank), the common banking scale, add value to members/clients and diversify and payments platform of the Association of Asian services so that they can succeed in increasingly Confederation of Credit Unions in the Philippines competitive financial landscapes? (Temenos and Software Group), financial centers for • Is it their merger into large entities? Is it their entrepreneurs in Africa (DiD), and a service bureau integration into tightly knit networks? in Haiti (WOCCU). • What are the experiences in using information The list of recent examples underscores the technology to enhance cooperatives’ performance, importance of effective partnerships. These will relations with members and governance? typically involve FC networks, donors, technical • How can IT help address the challenges faced assistance and managerial services providers. by FC sectors with large numbers of small (and They will benefit from government involvement in relatively unsophisticated) entities? reducing the costs of technology adoption, setting • What are viable arrangements to work with up regulatory and supervisory standards using the third-party IT providers? proportionality principle, and creating or improving the environment for secured transactions, especially As stated earlier, FCs are highly diverse in scale, those involving movable property. in their institutional capacity to deliver financial services and, importantly, in their degree of The Way Forward integration into networks, as opposed to atomized operations.34 Understanding FCs as essentially retail Overarching general directions formulated in the financial institutions, desirable directions for FC International Workshop were “ambition,” pursuit system to pursue are: vertical integration, delinking of “smart solutions,” and “pragmatism.” Other key governance from operational structure, and full words such as “proportionality” and “partnerships” diversification of the financial services they provide, were deemed significant in guiding subsequent work. a necessary condition to adequately manage risk, On the three main themes put forth at the beginning and be competitive. While FCs do have comparative of this chapter, the International Workshop addressed advantages providing services in rural areas, their many of the guiding questions for each theme. services ought not to be limited to agricultural credit. While there seemed to be clear answers in many On the contrary, FCs need to be able to cross-sell cases, addressing others or fine-tuning solutions in a deposit, payments, and other services to their rural manner that is useful for practitioners require further base, taking advantage of readily available digital study or deeper understanding of the issues involved. means of delivery FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 17 Regulation and Supervision. Existing systems in Mitigating failure. It seems clear that prevention is developed countries and in emerging economies the best cure for failure. Deposit Insurance schemes, could serve as specific guidance for large FC or more generally FC stabilization mechanisms networks in developing countries. There is a need could be actively promoted, and initially subsidized for diagnostic tools, so that the specific features of an (e.g., to enable a lender-of-last resort role). In terms emerging system can be closely matched with well- of further knowledge acquisition in this area, the functioning existing networks. Focused interchange example of IADI’s creation of a Subcommittee among the countries involved – internships, study on Resolution Issues for Financial Cooperatives periods – could facilitate leap-frogging through the (SRIFC) could be extended (and encouraged) to deal design and implementation of suitable regulatory with “Mitigation Issues” specific of FCs. and supervisory systems, Growth and technology. There is room to improve in A policy area where action is needed, highlighted enabling FCs to benefit from (keep up with) the rapid in both the study and the Workshop, is resolving the pace of technological innovations. Consistent with overlapping authorities over FCs observed in many the arguments in favor of institutional strengthening countries. While the right of free association needs to in parallel with regulatory reforms formulated earlier be fully respected, entry into the practice of financial in this paper, the Workshop discussions highlighted services provision needs to be properly regimented in the role of solid, professional international networks alignment with a country’s financial sector legal and in fostering that strengthening, in partnerships with regulatory framework. Following the proportionality FC networks, donors, and governments. Policy principle in regulation and ensuring adequate dialogue with governments to induce their support in resources for supervision are two basic tenets. a market-friendly manner is a natural component of multilateral and bi-lateral donor agendas. 6. AN AGENDA FOR DISCUSSION AND THE WAY FORWARD 18 Annex 1. Financial Cooperatives Growth Figure 1. Credit Unions and Members Evolution, 1996 – 2003 41,000 140,000,000 40,000 120,000,000 Number of Credit Unions Number of Members 39,000 100,000,000 38,000 80,000,000 37,000 60,000,000 36,000 40,000,000 35,000 20,000,000 34,000 0 1996 1997 1998 1999 2000 2001 2002 2003 Credit Unions Members Source: Cuevas and Fischer, 2006, using WOCCU data. Figure 2. Savings and Loans Evolution, 1996 – 2003 700,000 600,000 Savings & Lonas in US$ 500,000 400,000 300,000 200,000 100,000 0 1996 1997 1998 1999 2000 2001 2002 2003 Savings Loans Source: Cuevas and Fischer, 2006, using WOCCU data. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 19 Figure 3. WOCCU: FCs and Membership, 2007 – 2015 250,000 200,000 Number of FCs and Members 150,000 100,000 50,000 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 FCs Members Source: Authors’ based on WOCCU 2015. Figure 4. WOCCU: FCs Savings and Loans, 2007 – 2015 1,600,000 1,400,000 1,200,000 Savings & Lonas in US$ 1,000,000 800,000 600,000 400,000 200,000 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Savings Loans Source: Authors’ based on WOCCU 2015. ANNEX 1. FINANCIAL COOPERATIVES GROWTH 20 Annex 2. FC Regulation and Supervision Categories – Selected Countries Supervision Regulatory and Supervisory Authority Mode/ Country General Specialized Banking Category2 Cooperative Financial Cooperatives Direct Developed New Zealand; Ontario, Italy (B. countries UK Saskatchewan, Popolari); Canada;1 Switzerland United States Developing Bangladesh, Belize, Albania, countries Botswana, Bolivia, Colombia Bolivia, Brazil, Chile (DECOOP), (SES), Kenya Chile (SBIF), Colombia, Costa (SASRA) Colombia Rica, Ecuador, (SFC), Costa Ghana, Guatemala, Rica, Ecuador, India, Kenya (CSA), Jamaica, Malaysia, Nigeria, Guinea, Panama, Paraguay, Nigeria, Philippines, WAMU Thailand countries Indirect WAMU countries3 Auxiliary Developed Australia, countries Austria, British Columbia, Canada; France, Germany, Ireland, Italy (BCC) FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 21 Box 2. Indirect– Delegated/Auxiliary – Supervision Supervision Regulatory and Supervisory Authority Mode/ Country General Cooperative Specialized Banking Category2 Financial Cooperatives Developing Brazil, Lithuania, countries Madagascar, Mexico, S. Korea Delegated Developed Quebec, Canada countries Developing Argentina, Uruguay;4 Peru countries Source: Updated by authors, from Cuevas and Fisher, 2006. Countries change across categories, as regulatory regimes and definitions evolve. Notes: 1. The Deposit Insurance Corporation performs the supervision on behalf of the state. 2. Countries entered in more than one cell are under a split regime in which large FCs are under direct banking authority supervision, and “small” or “closed” FCs are under cooperative authority supervision. 3. The WAMU (UMOA in the French acronym) is categorized as a “hybrid” of indirect supervision given the roles assigned to individual country Finance ministries, under the overall regional authority of the BCEAO, along with the functional delegation to second- and third-tier entities. 4. Argentina and Uruguay are categorized as delegated since the federations are regarded as networks forced to merge by the regulators. ANNEX 2. FC REGULATION AND SUPERVISION CATEGORIES – SELECTED COUNTRIES 22 Annex 3. Supervision of FCs Box 3. Tiers for Supervision in Different Countries The tiered supervisory approach has been implemented in Latin America region since the mid-1990s and it is currently implemented in Bolivia, Chile, Colombia, Ecuador, El Salvador, and Mexico. In those countries the central bank or banking supervision authority provides direct supervision services to the larger credit unions subject to certain thresholds. In some instances, as Ecuador and El Salvador, smaller institutions that the regulator does not oversee receive limited non-prudential oversight from a government agency not responsible for banking matters. In Chile and in Uruguay a ministry responsible for other non-bank institutions such as the regulator for mortgage brokers, insurance and money transfer firms supervises the smaller institutors, which small FCs are overseen in Mexico by the supervisory agency that operates under the deposit insurance. Country Conditions to Include Tiers by Asset Minimum Credit Unions Under Size Capital in USD Formal Supervision Bolivia Financial Cooperatives Open bond CUs intermediation (CUs) with assets USD 169,000 above USD 84,000 Closed bond35 CUs USD 85,000 Chile Paid capital USD 19.1 million Mexico All CUs authorized IV – USD 8.3 1 million USD by the banking million commission with III – USD 1.5 assets equal or million above USD 1 II – USS 189,000 million I – USD 38,000 Basic – Not Uruguay Cooperatives USD 17.1 (CUs) providing million multiple, or USD 2.6 million limited, financial services. Source: WOCCU, Technical guide, credit union regulation and supervision. DGRV. 2013, Regulation and supervision of savings and credit cooperatives in Latin America and the Caribbean. Costa Rica FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 23 Box 4. International Experience in Auxiliary / Delegated Supervision for Credit Unions Auxiliary Supervision According to the Basel Committee on Banking Supervision (BCBS) survey on MFIs supervision (BIS, 2015), while the supervisor has the authority to perform on-site supervision in banks, not all are authorized to examine other deposit taking institutions (ODTIs), and except for those countries with a specialized microfinance unit, supervisory processes and techniques are largely identical to those used for monitoring banks. BCBS found out that only seven supervisory authorities are explicitly allowed to delegate supervisory roles to another entity. None of them are high income countries, reflecting an emerging arrangement to deal with the burden of supervising large numbers of small institutions such as financial cooperatives. Such delegated or auxiliary supervision arrangements can be found in Brazil, Mexico, Colombia, Chile, and Ecuador. It should be noted that neither supervisors have authorization to delegate entirely their supervisory responsibilities. Supervisors are still fully liable for prudential soundness of these institutions. Brazil relies certain supervisory activities to the Central Cooperatives (second tier organizations), Colombia delegates to a confederation of cooperatives (CONFECOOP), Mexican authorities created an Auxiliary Supervision Committee attached to the deposit insurance fund for the credit unions, Chilean authorities rely in two external auditors, and Ecuador delegates in other wholesale organization. Mexican banking commission (CNBV) directly supervise the larger financial cooperative institutions (second tier), whilst auxiliary supervision is responsible for monitoring the larger group of smallest institutions and regularly disclose the financial and managerial information of all entities that they monitor. Country Legal Auxiliary/ Possibility Monitoring Main Payment by Arrangement Supervision to Issue Methods Supervisor the State. to Norms by from AS the Auxiliary AS Supervisor Brazil Resolution Central No Specific Banco Central No 3859 CMN Cooperatives sets from do Brazil each Central (Special Unit) Cooperatives Colombia Law 454 CONFECOOP No N/A Solidarity No (1998) legal (regional Economic figure of associations Superintendence “technical and others) advisor” Chile Resolution Two private No N/A Economy Yes (50% of 540 from the external Ministry contributions Economy auditors for Ministry; supervision) General Cooperatives Law Art. 11 ANNEX 3. SUPERVISION OF FCS 24 Ecuador Popular and Wholesale No Early Popular and Yes Solidary organizations Warnings Economic Economic Direct Sup. Superintendence Law CAMELS Mexico Savings (Auxiliary No Early National No and Loans Supervision Warnings Banking and Cooperatives Protection Direct Sup. Securities Law (2009) Committee CNBV’s Commission Fund) methodology (CNBV) Source: DGRV. 2013, Regulation and supervision of savings and credit cooperatives in Latin America and the Caribbean. Costa Rica. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 25 26 Annex 4. Selected Country-Cases Highlights Albania36 Context Rapid growth of the Savings and Credit Association (SCA) in recent years. SCAs organized mainly in two Credit Unions (In Albania, the term “Credit Union” refers to a federation of SCAs)– the Albania Savings and Credit Union (ASCU) with about 80 % of the SCA market, and the Jehona Credit Union. Market penetration is still relatively low, just under 3 % of the working age population (compared to 8 – 10 % globally). Financial performance of the main two Unions had been weak, with high levels of non-performing loans (NPL)s, and significant losses. NPL levels had been reduced via consolidation and liquidation of troubled SCAs. Salient features (why this case is relevant) A new SCA Law has been in the works in recent years, and was enacted by the Bank of Albania in 2016. An important feature of the new law was the establishment of large minimum size requirements, forcing small FCs to consolidate. In addition, in discussions with the sector during law preparation, it was made clear that the supervisor would enforce the new, stricter rules, including reporting rules. This motivated the two federations to decide implementing a full merger of their affiliates into two new first-tier entities in which operations became largely centralized (while maintaining a tiered governance structure). With technical assistance an operational support from Rabobank (RIAS), and the Irish League of Credit Unions Foundation (ILCU-F), and the backing of major development funders - World Bank, IFC, KfW, European Fund for Southeast Europe (EFSE) – a major consolidation of small FCs into one large FC had been completed in late 2015 even before the new cooperative law had been ratified. Under the scheme that was pursued, participating SCAs became operationally branches of the new entity, which is now governed by a council that is composed from delegates who are elected in the local assemblies of the SCAs. Access to a deposit insurance system for their members was a major driver for this relatively fast consolidation. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 27 The regulatory reforms would enable verification of expert opinion to adjust coinsurance, coverage and financial and governance soundness of the SCAs and premium parameters. It has been shown to be way their Unions prior to joining the deposit insurance above international standards in fund size, and in system. Subsequently, the legal and regulatory good position to expand coverage, lower premiums, framework will set a roadmap for scaling-up and and/or eliminate coinsurance. consolidation of the sector. The Colombia system (unlike Guatemala) seems well established and mature, in that the functioning Colombia37 of the deposit-insurance fund is backed up by the legislation that created the “SuperSolidaria” Context and established the mandate and attributions of Important sector in terms of financial inclusion. About FOGACOOP. 6 million cooperative members (in cooperatives that take deposits), which represents about 20 % of the “banked” in Colombia, relative to the FINDEX Guatemala statistics for 2014. The entire savings and credit Context cooperative system was fully reorganized after a Savings and credit cooperatives (CACs in the major crisis in the late 1990s. Spanish acronym) are important in Guatemala. Currently, the sector is structured as a “tiered” or About 300 active CACs have 1.7 million members, mixed system where large FCs (“Cooperativas just about 26 % of the active economic population.39 Financieras,” 5 in total) are under the banking Yet for decades the CAC sector has not been supervisory authority – “Superintendencia considered part of the financial system, and has been Financiera” - while small FCs are under a different ruled by the same General Law of Cooperatives and supervisory authority – the “Superintendencia its regulations, issued in the late 1970s. The two de Economía Solidaria.” The latter supervises all autonomous public institutions provided for in the cooperatives, including “employee funds,”38 but law to register, regulate and sanction (INACOP) for the purposes of this report what counts is that it as well as to supervise (INGECOP) the estimated oversees about 180 savings and credit cooperatives. 900 active non-financial and financial cooperatives in Guatemala clearly do not have the resources to Salient features (why this case is reliably carry out their functions.40 relevant) 25 of the 300 financial cooperatives (CACs) are The system relies upon a guarantee/deposit self-regulated under mechanisms established by insurance fund – “Fondo de Garantía de their Federation – FENACOAC – which operates Cooperativas” (FOGACOOP) – to encourage as a central finance facility. A deposit insurance adoption of and enforce prudential standards. fund – “Fondo de Garantía MICOOPE” – FOGACOOP has been in existence for 16 years, provides an incentive for the voluntary adoption of grown from 60 members (i.e., FC users) to 186 prudential oversight by FENACOAC/MICOOPE. FCs in 2014. During this period FOGACOOP has It also requires adherence to a commercial brand handled liquidation of 11 cooperatives, with no MICOOPE. Non-compliance with prudential losses to the deposit insurance fund. standards, however, carries no penalties, other than FOGACOOP follows accepted good practice for the loss of deposit insurance coverage. this type of funds, relying upon stress tests and ANNEX 4. SELECTED COUNTRY-CASES HIGHLIGHTS 28 Salient features (why this case is with credit, but also with bulk purchasing and sale, relevant) insurance and various specialized functions.” The Guatemala FC sector, in spite of the deficiencies “Since then the credit cooperative system (CCS) of its formal regulatory system, is relatively stable, has continued to grow in quantity and complexity. and has survived a number of crises. It is a case of After a century, by 2006, the CCS comprised the sector developing way ahead of the legal and almost 15,000 banking outlets and 106,000 primary regulatory framework, reaching the point at which credit cooperatives, with a total number of 135m the absence of an adequate framework is impeding shareholders. However, while cooperative finance is growth and impinging upon the ability of the FCs part of a self-help movement, its establishment and to compete. expansion in India involved the government as an The relative strength of the main federation, active participant and promoter from inception. This FENACOAC, and the MICOOPE guarantee fund stood in sharp contrast to countries like Germany, the provide a basis for reforms that would approximate Netherlands and others where the state was kept at the system to that of Colombia’s FOGACOOP, in bay, entering only in due course upon the request of which failure to meet regulatory standards carries the movement to provide a legal framework.” serious sanctions. The legal framework in Guatemala is in urgent need to catch up. Salient features (why this case is relevant) The contrast indicated above did not escape the India attention of contemporary observers. B. Huss (quoted by Seibel) stated in 1924 that “The fact This section relies on excerpts from Seibel, Hans that the British Government planted the idea of co- D. 2013. Financial Cooperatives – What Role operative credit in the minds of the Indian people and for Government? The Rise and Fall of the Credit guided the movement through the last twenty years Cooperative System in India. In Onafowokan O. is now considered by the Indians as a >pre-natal Oluyombo (ed). Cooperative and Microfinance defect<.” A decade later, in 1934, the Reserve Bank Revolution. Lagos, Soma Prints. Its main intent is to of India Act included provisions for refinancing the highlight the kinds of roles government should NOT cooperative credit system.” This was the beginning play in the development of the FC sector. of a steep downturn. “State cooperative laws passed in the mid-1950s providing for state partnership Context in terms of equity, governance and management The rise of the credit cooperative system stemmed worsened the disease.41 Encumbered by an from the Governor of Madras sending an emissary ideology of central planning, the state assumed full to study the mutualist credit emerging at the time control over all institutions including cooperatives. (1894) in Europe, as a means to confront what was Governance was alienated from members and local perceived as a dominance of (evil) moneylenders communities. Instead, state governments were in rural areas of India. “Ten years later, in 1904, given full authority in matters such as appointment the Co-operative Credit Societies Act was passed of chief executives, suspension of elected boards of in India, … ‘replacing the money lender by… directors, fusion or fission of co-operative banks, the Raiffeisen Bank’.” Thus, credit cooperatives amendment of bylaws, vetoing of bank decisions, in India started with a legal framework. “In 1912 issuing of directives, supervision and enforcement the original act was replaced by the Co-operative of regulation, or rather the politically expedient Societies Act, aiming at societies dealing not only absence of enforcement.” FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 29 “As stated by the Committee on Financial Inclusion, distinction between “deposit-taking” SACCOs in the 1990s “an increasing realization of the (DT-SACCOs) and non-deposit taking SACCOs.42 disruptive effects of intrusive state patronage and Hence, a WOCCU web report in 2013 refers to politicisation of the cooperatives, especially financial “over 13 million Kenyan SACCO members” while cooperatives… resulted in poor governance and another WOCCU posting in 2015 talks about management and the consequent impairment of their 5.4 million members.43 The Kenyan supervisory financial health.” The system became borrower- authority for DT-SACCOs, however, reports 3.1 million members in 176 licensed DT-SACCOs driven, and the concept of mutuality and self-reliance for he same year (SASRA, 2015). The 5.4 million was lost.” “The results have been disastrous: by 2006 figure would represent about 21 % of the “active large numbers of cooperative banks, and more than adult population” (ages 15-64), a high penetration 50% of primary credit cooperatives (PACS), were rate by WOCCU standards. loss-making – probably many more if international accounting standards were applied.” The (overall) SACCO movement in Kenya is deemed to be the largest in Africa, and among the top The author concludes that the one core problem ten globally. It mobilizes savings equivalent to 33 % underlying the fall of the credit cooperative of national savings, and is considered a “major driver system in India is the lack of effective supervision of the economy.”44 It is therefore rather puzzling that and regulation. “… which in turn is due to fuzzy a solid legal and regulatory framework is not yet in delineation of authority and to political control place for a majority of the SACCOs, and that capacity over the cooperative sector. Nabard, an agricultural building efforts seem atomized and piecemeal. central bank carved out of RBI in 1982, supervises the cooperative banks, providing at the same Salient features (why this case is time refinance and capacity-building. The district relevant) central cooperative banks (DCCBs) supervise The rather sluggish adjustment of the legal and the PACS; but no one possesses the authority of regulatory framework to the size and growth of enforcing compliance.” (emphasis added). the overall SACCO sector is noteworthy in that it Seibel’s “conclusion is unequivocal: a successful may be the reason why no major scaling-up and credit cooperative system requires autonomy and consolidation has taken place. The law created to self-reliance, a conducive legal and regulatory regulate SACCOs was passed in late 2008, setting environment, effective supervision and enforcement the stage for the SACCO Societies Regulatory of compliance by an autonomous financial authority, Authority (SASRA). Nine years later SASRA which may be paralleled by auxiliary supervision by has licensed 176 DT-SACCOs, of which 103 are cooperative auditing federations. The role of the state in the “small-scale” category (assets under KSh 1 may be supportive, but within limits, providing a billion, about USD 962 thousand). A reasonable conducive operating environment, but not intrusive, question is the cost-effectiveness of SASRA taking over the operation of the system.” directly supervising a large number of small-scale entities. A follow-up question is whether the direct Kenya supervision approach is limiting the capacity of SASRA to license additional SACCOs. Context Another interesting feature of the Kenya case is the It is difficult to accurately characterize the size of the FC sector in Kenya, known as savings and apparent limited success of technology solutions credit cooperatives (SACCOs), mainly due to the for the SACCO sector. WOCCU’s 2010 effort ANNEX 4. SELECTED COUNTRY-CASES HIGHLIGHTS 30 funded by the Bill & Melinda Gates Foundation the time as “Sector de Ahorro y Crédito Popular” that has yet to report major indicators of performance included FCs and for-profit microfinance entities. in the intended technology development and These two events, however, can be considered deployment. In the country of M-Pesa, one the foundations of the process that ensued. The wonders what kinds of technology developments LACP was replaced by a specific law for FCs – the hold real promise of success. LARSCAP in 2009 – and specialized agencies were created to deal with resolutions of failing entities Mexico (FIPAGO), and with the auxiliary supervision and deposit protection mechanism (FOCOOP) provided Context for upon the passage of the LARSCAP. The transition The savings and credit sector in Mexico evolved of the larger FCs under the oversight of CNBV was from about 650 retail entities in the year 2000, of completed early in 2014, almost 13 years after the which only about 40 were under supervision by the first efforts were undertaken. financial authority (CNBV in the Spanish acronym), with 2.6 million members, to a fairly solid sector with Salient features (why this case is relevant) 133 entities supervised by the CNBV in 2014 (76 % The Mexico case of FC development has lasted, and of all members in the system, 82 % of the assets), remained supported, through three administrations. and 6.5 million members. The figure in the next Political pressures have been exercised in several page portrays the evolution of the sector. Entities not different directions, but overall there has been supervised by CNBV mainly due to their small scale political will to consolidate and modernize the sector do have a set of rules to follow. in the Ministry of Finance, the regulator (CNBV), and the main development agency (BANSEFI). Many adjustments occurred after the issuance of the Significant delays and rescheduling of important “Ley de Ahorro y Crédito Popular” (LACP) in 2001, milestones were forced over the years by pressures and the creation of BANSEFI, a state-owned savings from some politically well connected federations, bank with a mandate to serve as development agent that translated into motions by legislators. for the savings and credit sector – broadly defined at Figure 5. Mexico: FCs Authorized by CNBV 2001 – 2014 140 120 Supervision Committee at 100 Confederation Operational Number of FCs 80 Issuance of the Second Law LRACAP 60 40 Issuance of the Authorization of First Law LACP First Federation 20 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 March 2014 Source: Buchenau, Juan. 2014. “Designing a Path to Regulation and Consolidation for CFIs in Nepal and Guatemala: Lessons from Mexico. World Bank presentation. Unpublished. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 31 Throughout the process, both CNBV and BANSEFI transformed into a multi-service national federation gathered extensive data on the sector, of particular while the regional training centers were transformed importance given the diversity of entities in terms into multi-service cooperative development centers. of scale and level of sophistication, and were able The acronym NATCCO was retained and its meaning to establish a progression from initial state to converted to the present, National Confederation licensing in the appropriate tier, and supervision of Cooperatives. NATCCO has been involved in a either directly by CNBV or through an auxiliary number of programs ranging from microfinance to mechanism. Establishing a process to liquidate cash transfers.45 failing entities (or upgrading since FIPAGO existed PFCCO, the Philippine Federation of Credit Cooperatives before the LACP) is a crucial component in a is comprised by more than 100 Primary Cooperative “complete” regulatory/supervisory system. comprises the NCRL-PFCCO. These cooperatives are Finally, the capacity building that accompanied clustered into different regional Chapters.46 the regulatory reforms, mainly technical assistance Both federations fall under the oversight of the provided by international FC networks, was an Cooperative Development Authority (CDA), along essential enabling component especially for those with many other types of cooperatives. However, CDA entities initially in a rather rudimentary financial has limited powers that hinder it from intervening and operational state. Making an electronic platform in single cooperatives, unless complaints are filed available for the sector (housed at BANSEFI) was a by members and has thus not effectively performed cooperating factor that many FCs utilized.  this function. In addition, CDA is mostly involved in development activities, which creates a conflict of Philippines interest with its supervisory activities. Even with the Two main federations of FCs exist in the Philippines intervention of the National Credit Council (NCC) the – the National Confederation of Cooperatives regulation and supervision of credit cooperatives is (NATCCO), and the Philippine Federation of Credit deemed “weak and patchy.” (Llanto, 2015, p. 8). Cooperatives (PFCCO). NATCCO is the largest cooperative federation, with Salient features (why this case is relevant) Both NATCCO and PFCCO “are kicking off a 760 member cooperatives and non-governmental regional strategy developed by ACCU to modernize organizations (NGOs) in 77 Provinces and 130 Cities and and standardize the credit union sector in Asia through Municipalities as of June 2015. It reaches an estimated a common payments platform for its members.” (CU 3.7 million members. As early as the 1950s cooperative Today release 05/19/2016). Under a multi-party sector leaders were aware that in order to succeed they agreement technology services partner Temenos will could not rely on government alone. Instead, coops had provide a cloud-based banking and payment service. to be driven and patronized by their members and it is The service will run on Microsoft Azure. The provider only through co-op education that this level of member presents the “ACCU Payment Platform” (APP) as patronage and responsibility can be established. Thus a preferable alternative for financial cooperatives the creation of NATCCO as the National Association over joining a third-party platform (such as that of of Training Centers for Cooperatives, to coordinate the a bank, or an MNO). It will be relevant to follow training and educational services for cooperatives at the the development of this platform in the Philippines, national level. among the leading countries in Asia in digital finance. In response to the growing needs of primary The capacity and sophistication of the primary FCs cooperative affiliates, in 1986 NATCCO was members of NATCCO and PFCCO will be put to test. ANNEX 4. SELECTED COUNTRY-CASES HIGHLIGHTS 32 Rwanda West Africa Monetary Union (WAMU) Context Banque Populaire du Rwanda (BPR) today is by Context far the largest retail bank in Rwanda with the most Financial cooperatives are particularly important customers (about 1.4 million) and branches/outlets providers of financial services to low-income (190), licensed as a full-service commercial bank. people in the WAMU region.47 Total membership is Its origin, however, dates back to 1975 when the estimated at close to 13 million in the region. In most first “banque populaire” – a savings and credit member countries the share of FC membership in cooperative – was created in rural Rwanda. In the the economically active population is estimated at at ensuing years, other community based savings and least one-third (e.g., Senegal), reaching as high as 59 credit organizations were established elsewhere in % (Togo).48 Typically federated in “unions” in most Rwanda as autonomous “banques populaires.” countries, FCs are pervasive in rural areas. The “Union des Banques Populaires du Rwanda” While entry into the FC sector (registration and (UBPR) was established in 1986 as an umbrella licensing) falls under the authority of the individual organization for the many autonomous savings country’s finance ministry, regulation and supervision and credit cooperatives. About 41 years later in are primarily under the authority of the regional early 2008 UBPR transformed from a cooperative central bank (BCEAO), and the regional Banking bank into a commercial bank – Banque Populaire Commission (see below). du Rwanda S.A. Later that same year, Rabobank acquired 35 % of the shares in BPR, and took over Salient features (why this case is relevant) management responsibilities. The West Africa Monetary Union (WAMU) portrays a special case of a regional authority with Today, BPR majority shareholder is Atlas Mara a “hybrid” approach to regulation and supervision Limited (62 %), a Dutch consortium including where all FCs with outstanding loan portfolio above Rabobank, Norfund, and FMO owns 15 % of the USD 4 million fall under the direct supervision shares, and the remaining 23 % remain in the hands of the regional Central Bank (BCEAO) and the of minority shareholders, presumably the original regional Banking Commission (see Annex 4). FCs savings and credit cooperatives. with loan portfolios below that threshold are the responsibility of the respective Ministry of Finance Salient features (why this case is relevant) of the WAMU member country (8 in total). This case is brought up here as an example of a “possible” evolution of FC systems, especially It is possible, therefore, that in a country that has when a federated entity (as UBPR) was effective in one major federation (union) with say 20 affiliated integrating common functions for its affiliates, while cooperatives, of which 5 have loan portfolios maintaining the democratic governance typical of above USD 4 million, the BCEAO and Banking financial cooperatives. This model, similar to the Commission will directly supervise those 5 plus one applied in Albania, distinguishes governance the apex, typically in joint supervision missions. structure from functional structure and is a promising Needless to say, coordination issues are important one for FCs in financial systems that grow more in this kind of arrangement, not only between the competitive and modern. BCEAO and the Banking Commission, but also with the respective Ministry of Finance. FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 33 34 Endnotes 1. See De la Torre, Gozzi, and Schmukler (2007) for market-friendly interventions in access to finance. 2. This paper uses the term “financial cooperatives” in line with the definitions used by the Bank for International Settlements (BIS): “A member owned and member-controlled financial institution governed by the “one member one vote” rule.” “The term includes credit unions, building societies, caisses, cajas, cooperative banks, mutual banks, and savings and credit cooperatives.” Bank for International Settlements. 2015, p. 6. Another similar all-encompassing term frequently used is “Cooperative Financial Institutions” (CFIs). 3. Systemic relevance of FCs is nonetheless fairly high in certain regions, such as West and Central Africa, where an important share of total deposits is held in FCs. See also WOCCU 2013. 4. This relevance had been underscored in a recent BIS document: “in some countries, non-bank financial institutions, while not systemic based on the value of funds they intermediate, may present a systemic dimension due to the number and type of customers they serve.” Bank for International Settlements. 2016, p. 2. 5. WOCCU Statistical Report figures cover an important sub-segment of the 2014 census data. It reports membership of about 223 million individuals in 2015, in 61 thousand FCs in 109 countries. These data include WOCCU members, affiliates, associates and “other credit union countries.” They do not include European regional/local cooperative banks, about 81 million members as of December 2014 in the WOCCU report. The European Association of Cooperative Banks, however, reports 210 million clients as of December 2015 (www.eacb.eu). 6. Cuevas, Carlos E., and Klaus P. Fischer. 2006. Cooperative Financial Institutions: Issues in Governance, Regulation and Supervision. World Bank Working Paper 82. 7. “Too far away” was the fourth barrier in importance to use formal accounts (20 percent of respondents) in both FINDEX surveys, 2011 and 2014. If two of the other barriers are set aside (not enough money, no need) then proximity is the second barrier in importance, after “account too expensive.” FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 35 8. The structure and functioning rules of of FCs 21. A common good practice clause makes “break the market failure that leads to credit shares non-redeemable if this would mean rationing.” (Cuevas and Fischer, 2016). falling below the regulatory capital-adequacy requirement. 9. Guatemala, for example, places savings and credit cooperatives (CACs) in the “self- 22. Mexico’s LRASCAP, for example, does not regulated” category, and does not consider require risk-weighting for the smallest tier of them part of the formal financial system. They regulated FCs, but it does for all other tiers. operate under a “General Cooperatives Law” 23. Characteristic of credit unions in the United that recognizes CACs as “specialized” in States, English-speaking Canada, and in savings and credit activities. some Latin America countries. East Africa 10. Cuevas and Fischer, 2006. “SACCOs” are also mainly in this category yet with rather loose national alliances, and 11. Cuevas and Fischer, 2006. practically non-existent reliable supervision. 12. See ICURN, 2013. 24. The federated model can be found in Quebec, 13. BIS 2015. Canada, and Europe (Germany, France, and 14. See for example Mexico’s “Ley para Regular The Netherlands). West Africa and Central las Actividades de las Sociedades Cooperativas Africa FCs are influenced by the French and de Ahorro y Préstamo” (LRASCAP) (CNBV, Quebec model. 2017). 25. The term Confederation is used when the 15. For example, the West Africa Monetary Union apex entity regroups federations of financial (WAMU) framework (BCEAO, 2011). cooperatives operating in different countries, e.g. CIF- Confédération des Institutions 16. CAMELS, PEARLS, BAKIS, are examples of Financières regrouping financial cooperatives rating systems used with FCs as well as with in 5 WAMU (UMOA) countries. other financial institutions, based on a number of ratios and peer group analysis. 26. This “first best” of every FC being directly supervised by the financial authority is in fact 17. Explicit or implicit government guarantees not observed in any Latin American country when an entire system is in distress create (Arzbach, 2014). We venture to say that this is perverse incentives (e.g., ghost accounts, true everywhere in the developing world. inflated deposit slips), especially when the resolution of the failed system drags on for a 27. The Colombia system, however, is backed long time. The example of Crédit Mutuel du by a Superintendence, and failure to meet the Guinée (CMG, Conakry) is a classic in this requirements of the deposit insurance agency respect. In distress since the mid-1990s, CMG may result in sanctions and liquidation (see was only declared bankrupt and closed in 2001, Annex 4). No such backing exists in Guatemala. with compensation to depositors following 28. Large-scale SACCOs in Kenya have been a rather complex mechanism that included reported looking into alternative (corporate) verifying the validity of account balances organizational structures in pursuit of enhancing (Godquin, 2002). their competitive position (see Annex 4). 18. See Ehard (2014). 29. Cases of capacity building lagging regulatory 19. IADI, 2018. reforms are not common. The WAMU example in West Africa may be a close example in 20. See outcomes of International Workshop that the decisions on supervisory authority discussion in the last section. have been made without an accompanying ENDNOTES 36 concerted effort of capacity building. Selected 40. Guatemala Bank Superintendency, 2017. networks in the region (e.g., FUCEC Togo, 41. INACOP also has a promotional function that RCPB Burkina Faso) have technical assistance entails a conflict of interest. agreements with international providers such as DiD or Crédit Mutuel France but they are not 42. In line with the cooperative act of 1919, which part of a regional capacity building initiative. had made “co-operation” a provincial subject Kenya, interestingly, after pushing to institute (equivalent now to a subject under the control WOCCU’s “model law of credit unions” for the of the states). country’s SACCOs, it has not followed up with 43. Non-deposit taking SACCOs may collect non- comprehensive capacity building. withdrawable deposits, used as collateral for 30. Excerpts from, and discussion of Workshop credit to members (SASRA, 2015). Of nearly presentation by Fernando Restoy, Financial 4,000 SACCOs in Kenya just over 200 were Stability Institute, Bank for International deposit-taking institutions in 2009 (WOCCU, Settlements, April 2018. 2009). 31. Institutional Protection Systems (IPSs), while 44. This figure may refer to the SACCOs members currently relevant mainly in Europe, are a not- of the Kenya Union of Savings and Credit so-distant cousin of risk-mitigation structures Cooperatives (KUSCCO), a WOCCU affiliate. existing in some developing economies, also The overlap of these SACCOs with the DT- designated as Institutional Protection Schemes SACCOs supervised by SASRA is unclear. (see below). 45. Kenya Union of Savings and Credit 32. Excerpts from, and discussion of Workshop Cooperatives (KUSCCO, 2016, www.kuscco. presentation by Julien Reid, Autorité des com). Marchés Financiers, April 2018. 46. www.NATCCO.coop site. 33. (IADI, 2018). 47. Membership statistics not available in their site, 34. Excerpts from, and discussion of Workshop or in the Asian Confederation of Credit Unions presentation by Bjorn Schrijver, Rabo (ACCU) annual report. Partnerships, April 2018. 48. The WAMU comprises Benin, Burkina Faso, 35. “Cooperativas de ahorro y crédito de Côte d’Ivoire, Guinée-Bissau, Mali, Niger, sociedades” meaning credit unions with Sénegal, and Togo. membership restricted to employees of a firm. 49. Financial cooperatives in the WAMU region 36. Sources: World Bank technical note (internal comprise the large majority of the so-called document, 2014), and Rabobank (2017). “systèmes financiers décentralisés” (SFD) which does include a few non-cooperative 37. Main source: Seelig, Steven A. 2015. Deposit microfinance institutions. Even systemic Insurance for Cooperatives in Colombia. World relevance (in deposit balances) can be relatively 38. Bank Group, unpublished presentation. high in some of the countries, e.g., in Togo FC deposits reach about 29 percent of bank 39. Approximately 1,600 cooperatives take deposits (estimated with BCEAO 2016 data). deposits in Colombia, most of them are “employee funds.” FINANCIAL COOPERATIVES — ISSUES IN REGULATION, SUPERVISION, AND INSTITUTIONAL STRENGTHENING 37 38 References Arzbach, Matthias. 2014. El Sector Cooperativo de Ahorro y Crédito en América Latina – Diagnóstico y Desafíos. III Cumbre Cooperativa de las Américas. Cartagena, Colombia. Ashtankar, OM. 2015. Importance of Cooperative Movement for Indian Agricultural Sector. International Journal of Applied Research, 1(11):557-561. Bank for International Settlements (BIS). 2015. Range of Practice in the Regulation and Supervision of Institutions Relevant to Financial Inclusion. Basel Committee on Banking Supervision. Bank for International Settlements (BIS). 2016. 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