INTERNATIONAL CO-OPERATIVEBANKING ASSOCIATIONJOURNAL NO. 11 1999

INTERNATIONALCO-OPERATIVE BANKING

ASSOCIATION•

SEMINAR•

Capital, Demutualizationand Governance

SPEAKERS :

Commentators

Contacts - ICBA Presidentand Regional Chairmen

INTERNATIONAL CO-OPERATIVEBANKING ASSOCIATION No. 11: 1999

CONTENTS Page

Claude Béland 3A word from the President

Mervyn Pedelty 5“Capital, Democratisationand Governance”

P.V. Prabhu 19Capital, Demutualisation andGovernance - Indian CooperativeCredit & Banking Scenario

Jacques Henrichon 38“The Relationship Between the InspectorGeneral of Financial Institutions and theMouvement Desjardins”

Klaus P. Fischer 48The Colombian Crisis of FinancialCooperatives, a Corporate Governance Crisis

61

Claude Béland 64“Co-operative Banks in a FinancialWorld in Mutation: Challengesand Outlooks”

71

warmly welcome you to beauti-

ful Québec City and to this seminar of

the International Co-operative Banking

Association.

We have chosen as a theme topics

that, in my opinion, are the key issues

facing cooperatives in a global environ-

ment brought about by a very rapid and

spectacular progression of communica-

tion technologies and data transmission.

This has penetrated boundaries and

made markets closer. With this, as you all

know, competition has sharpened and

there is a need for companies to give a

greater push to improve customer ser-

vice. We have been speaking about this

for a few months, not to say for a few

years, in the cooperative sector; we know

that cooperatives cannot escape this real-

ity. Many cooperatives are facing prob-

lems of capitalization and I must tell you

that again yesterday, at the Executive

Committee meeting of the International

Co-operative Banking Association, we

found it regrettable to lose some mem-

bers that are under restrictions of a

national law or market laws to transform

to share capital companies. Cooperatives

are facing problems of capitalization. You

also know that the insurance sector, in

many countries, is being flooded by a

wave of demutualization. All of this

brings us back to the theme of our semi-

nar “Capital, Demutualization and

Governance”.

To discuss these important topics, we

have the great pleasure of having four

speakers who are experts in this field.

First, Mr. Mervyn Pedelty, of United

Kingdom, Mr. P.V. Prabhu, from India,

Mr. Jacques Henrichon, Deputy Ins-

pector General at the Québec govern-

ment, and Mr. Klaus Fischer, professor at

l'Université Laval, in Québec.

Four guests will comment on the

speakers: Mr. Enrique Rodrigez, of

3

A word from the president

Mr. Claude Béland, President of the Mouvementdes caisses Desjardins, and president of the

INTERNATIONAL CO-OPERATIVE BANKING ASSOCIATION

I

Ladies and Gentlemen,

SwedBank, Mr. Carlos Heller, Director

General of Crédicoop of Argentina,

Mr. Erastus Mureithi, Director General

of the Co-operative Bank of Kenya and

finally, Mr. Alban D'Amours, Inspector

and Auditor General of the Mouvement

des caisses Desjardins.

4

Good morning Ladies and Gentlemen

hat makes mutual and co-

operative ventures special? What makes

them different from conventional share-

holder companies? And what makes

them better?

We need answers to all these ques-

tions — because these are the questions

that ordinary people have increasingly

been asking since the 1980s. And until

very recently, I am not convinced that we

have been giving them the answers they

want to hear. As managers of Co-opera-

tive Banks, we are all facing a historic

challenge. The very concept of mutual

ownership appears to be under sustained

attack in many countries. And, at the

same time we are seeing significant

changes in the way that financial services

are conceived, targeted and delivered.

Traditional barriers between banking,

insurance, investments and securities are

melting away, as are the traditionally sep-

arate distribution channels which satisfy

customers’ needs for these various prod-

ucts. It’s not a time for complacency. But

nor is it a time for panic. And it’s certain-

ly not a time for abandoning the values

and principles of co-operation. But now

- as always - we must think about how

we apply these principles and values.

And in particular how we apply them in

three critical areas:

• capital

• democratisation

• and governance.

Capital remains the key to continuing

success. Lower barriers to entry, compe-

tition from all sides – including new

entrants like supermarkets - and innova-

tions like the Internet are transforming

today’s financial services. And to stay at

the cutting edge we must continue to

5

“Capital, Democratisation and Governance”

Mervyn PedeltyChief Executive, Co-operative bank p.l.c.

(Manchester, United Kingdom)

W

invest, and optimise the capital we use in

our businesses. Democracy is a part of

our culture.

In fact, you could say it’s our corner-

stone. Part of what makes mutuals and

co-operatives unique. After all, we are

ultimately owned by our members.

Others, like my own bank, adhere to co-

operative values and principles —

although the bank, of course, is owned

by The Co-operative Wholesale Society

(CWS), not by the bank’s own cus-

tomers.

Even so, CWS, our parent, is very

much a mutually owned membership

organisation. But here, too, in talking

about democracy and membership, we

are dealing with a moving target.

Members must have a real say in the

business. Democracy must have sub-

stance as well as form. Over the past few

decades – in the UK Building Society,

Insurance and Co-operative sectors - I

would argue that many mutually owned

organisations and co-operatives have lost

sight of their ultimate purpose. That

purpose being the need to recognise,

work for and reward their members. As

co-operative and mutual organisations,

we must improve the way in which we

respond to the needs of our members.

We need to think about governance

and ownership. And their relevance in

today’s changing world. That’s why the

word ‘democratisation’ is the right one.

Because profitably and efficiently

meeting the needs of our members and

customers is an ongoing process. Espe-

cially in the face of a rising tide of demu-

tualisation. Demutualisation is not an

isolated phenomenon.

We’ve certainly seen it in the UK. But

it’s also happening in parts of continen-

tal Europe, for example in Belgium and

in Australia, South Africa, Canada and

the United States. And the argument is

always the same.

We’re told that ‘the tide of history’ is

turning against mutual ownership. For

instance, both AMP and Colonial, large

Australian insurers, recently demutu-

alised. AMP’s head of global acquisitions,

Jonathan Schwarts, commented that:

‘The average mutual has a culture, an

organisational structure, a cost structure

and mode of operating that was set for a

set of social circumstances and a regula-

tory environment that no longer exists.’

A pretty clear point of view, I think

you’ll agree. But is it true? Has our mutu-

al, co-operative approach passed its sell-

by date?

For more than 200 years the UK

building societies enjoyed continuing

success as providers of mortgages and

savings products. That changed in 1989

when one of the leading UK societies —

Abbey National — converted itself into a

bank. The decision to convert came not

from the members, but from the Board.

And the results were dramatic. In fact

that single decision created a ‘domino

effect’ which has since fundamentally

changed the mutual movement in the

UK.

So why did Abbey National demu-

talise and convert itself? Their argument

ran as follows. In the 1970s, they saw

6

growing competition as the quoted

banks began to offer mortgage products,

and muscle in on the Building Societies’

traditional territory.

And, of course, banks were able to

provide a much wider range of products

and services because of the way in which

they were financed and regulated. To

respond, the building societies had to

offer more. Which called for investment

— and for more capital. According to

Peter Birch, the Chief Executive of Abbey

National at the time: ‘Abbey National’s

choice was either to see its traditional

and only market erode or test the con-

version hurdles.’ The key advantage of

the status of being a listed Public Limited

Company – a “PLC” - was the ability to

issue shares. In effect, Abbey National

could ‘print money’ in order to raise cap-

ital to expand or to finance the acquisi-

tion of other institutions. Through the

conversion of Abbey National we all

learned some crucial lessons. Lessons, in

particular, about capital, democratisation

and governance. Access to capital was —

and still is — one of the main motives

for demutualising. Mutuals, by their very

nature, are democratic — but that very

democracy can be turned against them.

The argument goes that members of a

mutual should always have the right to

vote on their legal status.

Even if that vote deprives future gen-

erations of the right to membership. And

if the Board decides to recommend con-

version, it’s very difficult for opposing

members to win a ballot on staying as a

mutual. That, in turn, tells us a lot about

attitudes to governance. Building soci-

eties have unique governance structures

— which, apparently, have very little sig-

nificance to most of their members.

Abbey National members believed they

could gain something of immediate

value — its shares, and therefore money

— by sacrificing something with little or

no perceived value to them— their

membership of the society. And that, of

course, could be said to have been very

much a part of a culture of greed that

was increasingly seen in the UK during

the 1980s. It’s difficult to say how much

that culture had to do with the Abbey’s

loss of mutual status. But moral and

long-term arguments do seem almost

powerless against the immediate lure of

‘free money’.

Morally, there was a strong case

against demutualisation. Morally, one

could argue that the members had no

right to fritter away the reserves built up

in trust by the hard working inter and

post-war generations. But that argument

cut little ice with the current members

— nor, apparently, with the government.

Because government, too, has a clear role

in enabling — by simply not preventing

— demutualisation. But for a while the

Abbey National remained out on its

own. Then, in the Spring of 1994, the

Cheltenham and Gloucester Building

Society announced plans to convert and

sell its business to Lloyds Bank. It ulti-

mately became Lloyds Bank’s specialist

mortgage lending arm. Later the same

year, the Halifax Building Society and the

Leeds Permanent Building Society

7

announced their intention of merging

under the Halifax name — and then to

convert to bank status three years later.

As you can see from table 1 (page 16),

many further deals were to follow — and

1997 became a very significant year. At

that point the financial windfalls to

members from converting mutuals

reached a peak.

35 billion pounds – or 55 billion US

dollars - was released into the British

economy through the conversion of the

mutual building societies. And one in

three UK adults received shares. And a

new form of gambling then emerged.

People tried to guess which societies

would be next in line to convert. The

trend of ‘carpetbagging’ began. It’s inter-

esting to note that the term ‘carpetbag-

ger’ dates back to the period of recon-

struction following the American civil

war. ‘Carpetbaggers’ were Americans

from the North who travelled to the

South to take advantage of the low prop-

erty and asset prices, or to gain political

advancement. Southerners believed that

they could tell true Southern American

gentlemen from such opportunists be-

cause Southern ‘gentlemen’ carried prop-

er leather bags, not bags made from car-

pet material. In more recent times it

seems that Peter Robinson, the former

Chief Executive of Woolwich Building

Society, reclaimed the term during the

demutualisation of his building society.

He allowed 30,000 people to join after

the society’s decision to convert was

made public. He then announced a deci-

sion to back-date the qualifying date, so

they were not eligible for the windfall

payments. He explained his actions say-

ing “I have no concern about not enfran-

chising carpetbaggers.”

These so-called ‘carpetbaggers’ placed

money in deposit accounts to become

members and so be in the front line for

free shares This also gave them voting

rights to sway the outcome of a ballot.

However, over the next two years the tide

turned and there was growing reaction

against ‘carpetbagging’ investors. And the

media began to emphasise one of the key

competitive advantages of the building

societies — price. It has been an interest-

ing reaction.

Until quite recently many mutual

organisations treated their members

almost as if they did not exist. As cus-

tomers they were recognised, of course,

but frequently not as members with

membership rights. All too often, many

of these organisations seemed to have

been run primarily for the benefit of the

directors, senior management team and

staff of the institution. Many seemed to

have forgotten or neglected their roots.

And, they were often protected by their

mutual status from the critical gaze of

institutional and individual sharehold-

ers. Certainly, the true owners - the

members - rarely appeared to be encour-

aged to get involved. The importance of

membership – and the rights conferred

by membership – were rarely adequately

communicated or demonstrated.

It is, therefore, probably no surprise

that the members themselves had gener-

ally taken no interest in the way in which

8

their society was run. In fact, until the

1980’s, the majority would not even have

been aware that they were members - or

what that meant. So why has member-

ship not been taken more seriously by

these institutions until recently - that is,

until the advent of the‘carpetbaggers’?

Well, apart from apathy, old habits

and - some might also say - self-interest

by the Boards of Directors, there may be

a deeper philosophical dilemma here.

Long standing mutuals owned by indi-

vidual members tend to acquire a very

large “membership” over time. It is not

difficult for these membership details to

become out of date as time passes. To

clean up this accumulated data, and then

to activate the membership base is a

more difficult, arduous and costly

process the longer it is left undone.

Particularly if it has been left virtually

untouched for ten, twenty or thirty years

- or even longer! And, communicating

actively with a large membership is an

extremely expensive process. Member-

ship can run into millions, or at least

many hundreds of thousands. Few com-

panies publicly quoted on a stock

exchange have a shareholder base of that

size. So, it might be reasonable to allow

the ‘benefit of the doubt’ to some of

those mutuals. Given the costs involved

of communicating properly and actively

reaching out to their membership, per-

haps they simply decided that it could

not be afforded. So they spent what bud-

get they could afford on relating to, and

communicating with, the small minority

of their member base that took member-

ship and democracy seriously. In other

words, they solved their philosophical

dilemma of whether to be an active mass

membership organisation or, alternative-

ly, an organisation that just looks after

the small minority of members who take

an interest, by taking the easier, less

expensive route.

I don’t know. Perhaps we will never

know the real answer, but it is worth

pondering. Because that dilemma is just

as relevant today as it was 10 or 20 years

ago.

Table 2 (page 16) shows the impact of

mergers and conversions on the UK

Building Society sector. In 1988, there

were 131 registered Building Societies in

the UK. Now there are just 71. Balances

within the sector have been decimated

Mortgage assets within the sector

have more than halved over the past two

to three years.(Table 3)

Whilst total assets show an equally

marked decline. (Table 4)

Insurance companies have also

demutualised at a steady rate over the

past 10 years. Currently there are only

23 mutual insurance companies, a 44%

decline since 1988.

Most of the mutual insurance com-

panies that have converted over the past

8 years are shown on (Table 5). The most

current is Scottish Widows which, sub-

ject to approval, will join the Lloyds TSB

Group in the early part of next year. As

the table shows, unlike Building Society

conversions, demutualisation is occur-

ring on a more gradual basis and there-

fore there is not one significant year.

9

Turning back now to the UK Buil-

ding Societies, they are now starting to

fight back. Maybe it is to counteract the

sudden realisation by their members that

they can control the future of their soci-

ety. Many Building Societies have decid-

ed to reduce their “profits” by offering

better mortgage and saving rates than

their non-mutual competitors. If you

like, they have started to provide their

members with some tangible benefits of

membership

As a result, they’re now achieving

consistently high positions in the ‘Best

Buy’ tables.

But there have also been some other

inventive initiatives. For instance, the

Britannia Building Society gives a share

of its annual profits to its members

determined by the number of products

held and the length of membership.

These strategies — and others like them

— have started to win back for the build-

ing societies a growing share of the

mortgage market. And, they are now

starting to punch well above their weight

in the UK mortgage market

As seen on Table 6, page 18, they cur-

rently provide 33 per cent of net new

lending, against their market share of

outstanding balances of 22 per cent.

They also account for about 33 per cent

of new deposit balances, against their

market share of 17 per cent share of out-

standing deposits. This swing back to

mutuality was apparently confirmed in

July 1997. Members of the Nationwide,

the largest remaining UK building soci-

ety, voted overwhelmingly against pro-

conversion candidates standing for elec-

tion to the board. Many commentators

saw this vote as a reaction against the

“get-rich-quick” culture of the 1980s —

and, to some extent at least, as a response

to the tone set by the newly elected

Labour government. Others — more

cynically — put it down to the absence

of credible pro-conversion candidates for

the board. Later, Nationwide announced

that it had changed its rules so that all

new members would have to donate the

proceeds of any conversion windfall to a

charity — and many other societies were

quick to follow suit.

The new rule removed the incentive

for ‘carpetbaggers’ to join the society —

and ensured that members were less like-

ly to be swayed by the lure of short-term

financial gains.

Also in 1997, the new Labour govern-

ment brought in a series of amendments

to the Building Societies Act. To achieve

conversion, at least 50 per cent of invest-

ing members must now take part in the

vote and 75 per cent of those voting

must vote in favour. Among borrowing

members, only a simple majority of

those voting is required. So has the tide

turned? Probably not. In July last year,

1998, members of the Nationwide

Building Society were once again asked

to vote on a motion proposing conver-

sion, and for pro-conversion candidates

standing for election to the board.

The conversion motion was defeated

but, this time, much more narrowly.

Comfortingly — at least for people

like us — the pro-conversion candidates

10

were not particularly successful in win-

ning votes. But pressure on the Nation-

wide continues.

A leading UK national newspaper,

The Sunday Express, argued – and even

led a front page campaign - that if the

society converted, 2 billion pounds

would be donated to good causes via the

new anti-carpetbagger charity rule

adopted by the Nationwide.

That campaign has now died down

— but the threat remains.

This year the members of the large

Bradford and Bingley Building Society

also voted to convert — directly against

the recommendations of their own

board. It’s the first time this has occurred

— and the conversion of Bradford and

Bingley will now take place over the next

two years. Although we can expect a

strong rearguard action from disen-

chanted members who resisted the

process, it must also be recognised that

the Bradford and Bingley was the only

society which failed to protect itself

against the carpetbaggers with a new rule

change. Not surprisingly, many observers

are puzzled by this. So what does the

future hold for UK building societies?

With mortgage assets of 100 billion

pounds – 160 billion US dollars - and

annual profits of a billion pounds,

they’re still a significant force in the mar-

ket But even so, the Building Societies

Association is arguing for even stronger

legal protection against carpetbaggers.

And it wants demutualisation voting

hurdles for borrowing members to be set

as high as those for investing members.

However, in July this year, the UK

government announced that it did not

have enough parliamentary time to

bring in these measures. The Treasury

Minister, Patricia Hewitt, also felt that

these changes could not be guaranteed to

prevent more conversions anyway. In her

words, “The responsibility for saving the

mutual sector lies above all with the

mutuals themselves and their members”.

A clear and unequivocal message. Even

so, the surviving building societies —

few as they are — have learned their les-

son. They have built their own defences

against the ‘carpetbaggers’. Some of these

defences have been as a result of chang-

ing their Society rules in the ways I have

just described. Other defences have been

as a consequence of recognising that they

have a duty to encourage closer involve-

ment by their members in their societies.

And of the need to communicate more

to them - even if it costs money to do so.

They have come to recognise the

need to make membership meaningful,

and to provide real and tangible benefits

to their members. This recognition has

been in the form of more competitive

pricing on both sides of the balance

sheet, as well as by promoting the

“mutual” difference. Only history will

show whether the rear-guard actions of

the Nationwide and other Building

Societies will be successful in stemming

the tide of demutualisation in the UK.

Even both of the UK’s largest motor-

ing organisations — the AA and the

RAC – have also elected to convert. And

our own parent company, CWS, was

11

obliged to defend itself against a hostile

bid from a corporate raider in 1997. And

the experience in the UK has been mir-

rored in many other parts of the world,

including Canada, the United States and

South Africa. In Canada the four leading

mutual insurers — Mutual Life,

Manulife Financial, Sun Life and Canada

Life — are in the process of demutualis-

ing. They’ll be distributing shares worth

more than 10 billion Canadian dollars to

their Canadian policyholders. The ratio-

nale appears to be the same — easier

access to capital markets, and a currency

for mergers and acquisitions. Here, too,

government agreement has been crucial

— because, here in Canada, the law has

been changed to permit mutual societies

to demutualise. And here, too, in

Canada, there are organisations resisting

the process.

“The Co-operators” is an insurance

co-operative founded more than 50 years

ago by a group of Saskatchewan wheat

farmers. Soon afterwards a similar initia-

tive started in Ontario. The two joined

forces, and became the largest wholly

Canadian-owned multi-line insurance

company. They have announced their

intention to remain true to their origins.

But the flood of international demutuali-

sations continues. Though not, it seems,

everywhere. In some countries —

notably the Netherlands, Germany and

France — the regulatory constraints are

far tougher. There are restrictions on

winding up mutuals — restrictions that

mostly prevent UK-style carpetbagging.

And in the event of a conversion, the

owners of mutual banks are not allowed

to gain any personal benefit from the sale

of their shares. The results speak for

themselves. In the Netherlands, I under-

stand that mutual banks account for

35 per cent of all retail deposits. And, in

Germany the figure for mutuals is about

30 per cent, while just under 20 per cent

of total deposits are held in co-operative

banks.

In fact two out of three German

banks are mutually owned. To keep pace

with new developments in technology —

and service — 164 co-operatives have

merged over the last year.

In fact, some observers believe that

the total number of co-operative banks

in Germany may drop as low as 800

within five years — as modernisation

continues. There is a similar picture in

France, where mutual banks account for

37 per cent of retail deposits. Co-opera-

tive banking groups like Crédit Mutuel

and Crédit Agricole are large and very

successful. They’ve even acquired shares

in commercial banks. Indeed, the mutual

sector has even aroused complaints from

non-mutual competitors about the

‘mutualisation’ of the French economy!

On the strength of these figures, legal

restrictions do seem to help. But is this

the right road to travel? Clearly, it’s

important to create a supportive public

policy environment in which mutuals

can thrive. France and Germany recog-

nise that it’s wrong to turn a healthy,

competitive mutual into an investor-

owned organisation simply to satisfy

short-term interests. So we should, in my

12

belief, continue to champion the cause of

government support for thriving and

independent mutuals. But at the same

time we must address the key issues I’ve

already identified. And we must protect

ourselves, as the Nationwide Building

Society has done in the UK, by tipping

the balance in favour of mutuality and

long-term benefit.

It has taken generations to build up

our mutual institutions into the success-

ful institutions of today. And we owe it to

those generations to protect their legacy

with every resource at our disposal.

Regrettably, moral constraints are not

enough. But nor, on its own, is legal pro-

tection. To make a real success of ‘new

mutualism’ we must return to those

three key issues: capital, democratisation,

and governance. Demutualisations have

often been motivated by the desire to

raise capital on the stock market.

Mutuals need to offer an alternative to

this — and one alternative is to use our

existing capital more efficiently. To max-

imise the loyalty, involvement — and

profitability — of our members. To

reward them for buying more products

and services from us. And to think, cre-

atively, about partnerships with non-

mutual companies. By outsourcing and

joint-venturing — and keeping a clear

focus on the things we do best — we can

increase our efficiency, as well as offering

new products and services. We also need

to think about capital, the lifeblood of

our businesses across the world. We need

to look at the way in which Co-operative

Banks raise capital. We need to share our

experiences, so that we can all learn from

each other. In researching this presenta-

tion, it became evident that there is no

one single source which has an overview

of the many ways in which Co-operative

Banks across the world raise their capital.

This is such an important issue that I

would like to propose a study. A research

project if you like. One to which we

could all contribute. To help us under-

stand this important issue. I therefore

invite the ICBA to look at the possibility

of carrying out an international survey

to review capital raising for co-opera-

tives... And I hope we can all find the

means to help fund it. Because we will all

ultimately benefit from the results.

What about democratisation? Clearly

we need to look at new ways of building

the relationship with members. Ways

that are not solely dependent on price.

We must deliver value in many ways.

Through unrivalled quality of service.

Through the most advanced service

channels — including telephone and

Internet banking. And through competi-

tively priced products. Mutuality is no

excuse for second-rate services. At The

Co-operative Bank in the U.K. we recog-

nise that the definition of value must be

far broader than this — because that’s

what our customers are telling us. We

surveyed 1.2m customer households

using a detailed questionnaire. We asked

how we could deepen our relationship

with them. The results were very clear.

They want democratisation. Because

they want to be more deeply involved in

product, service and policy development.

13

But to encourage that participation —

and increase its value — our customers

were telling us that we must also behave

in a socially responsible and ethical man-

ner. Traditionally, we’ve been seen as

responsive to the concerns of communi-

ty and society. That has been one of our

strengths. Yet many mutuals and co-

operatives have acted in the past like

non-mutual and non-co-operative com-

panies. They sorely neglected their mem-

bership and their customers. My own

bank also went down this road in the

1980s. But the recent success of our ethi-

cal stance shows just how wrong we

were. It has attracted new customers. It

has boosted the value of our brand enor-

mously. And it proves that social respon-

sibility has nothing to do with woolly-

minded philanthropy. Nor has it any-

thing to do with poor quality products,

second rate levels of service and low lev-

els of profitability. In fact it shows that

social responsibility is crucial to the con-

tinuing success of mutuals and co-opera-

tive banks. So how can you define the

social and ethical stance that your partic-

ular co-operative institution should be

taking?

You don’t. The answer must come

from your members and your customers

— after all, it’s their money! Every three

years my own bank invites customers to

vote on how their money should, and

should not, be invested. By putting them

in the driving seat, we’ve deepened our

relationship with them — and given

ourselves a unique position in the UK

banking market.

We’ve also given customers the

chance to participate in the campaigns

that we run with charities, and to decide

how money should be allocated to them.

By building the relationship with cus-

tomers, these schemes provide a power-

ful form of added value. And it’s worth

far more than a short-term price differ-

ence.

In France, Crédit Mutuel, like our-

selves in the UK, have promoted a more

socially responsible approach. For

instance, Crédit Mutuel backed the move

towards a 35-hour week. They also sup-

port youth employment programmes.

And they’ve focused on channelling

resources into local development to

combat economic and social exclusion.

We have actively promoted the benefits

of co-operative and mutual ownership to

the general public and to our govern-

ments. In the UK, for instance, The Co-

operative Political Party has played a sig-

nificant role in reviving the debate about

“new mutualism”.

It has published four papers on the

subject, covering issues as diverse as

ownership of football clubs and social

exclusion. As a movement – within the

UK at least - we’ve often been inward-

looking and we’ve often failed to set out

the intellectual arguments for a healthy

co-operative and mutual sector. That is

changing — and it must continue to

change. But governments also have a

responsibility. A responsibility to think

through these ownership issues more

carefully. Privatisation and demutualisa-

tion are partly the result of an ideology

14

that appears to recognise only one effi-

cient form of ownership - the investor-

owned company. The truth is that we

need a rich diversity of ownership,

because of the social and economic ben-

efits it produces. This year, one of The

UK Co-operative Party's pamphlets

called for a Royal Commission on

Ownership to be established by the new

Labour Government. Its aim would be to

encourage a campaign of mutualisation

in Britain. This is the kind of policy pro-

posal that we need to trigger a real

debate about the potential of mutuality

in the modern world. For two decades,

the political focus has been on the opti-

mal balance between public ownership

versus private ownership. I believe we

need an equal focus on mutuality and

co-operation. I hope that every bank

here will encourage their government to

take a long, hard look at the real impor-

tance of mutual and co-operative owner-

ship. This is the challenge of new mutu-

alism. We cannot — and must not —

resort to sentiment in our efforts to pre-

serve our co-operative status.

But our heritage, and our values,

should inspire our actions — and pro-

vide us with a ‘moral compass’. We

must continue to modernise — and to

democratise — because only through

member democracy can we demon-

strate the real value of mutual and co-

operative ownership. We must continue

to advocate the benefits of mutual

ownership — and continue to ensure

that our governments listen to us.

Because it is our responsibility — and

our duty — to build a strong co-opera-

tive and mutual sector for the genera-

tions that will follow us.

15

16

TABLE 1

TABLE 2

17

TABLE 3

TABLE 4

18

TABLE 5

TABLE 6

19

P.V. PRABHU, trustee-Secretary, national centrefor management development in agriculture & Rural

Development Banking, bangalore, India

Capital, demutualisation and governance- indian cooperative credit & banking scenario

T

I New Economic Policy - Financialand Banking Sector Reforms

he deepening economic crisis in

the country in 1991 characterised by bal-

ance of payment problems, disrupted

industrial production, depleted foreign

exchange reserve, budgetary deficit com-

bined with accelerated inflationary

trends prompted the Government to ini-

tiate major policy changes designed to

correct the macro-economic imbalance

and effect structural adjustments.

Important connotations of this policy

package are:

1. Liberalisation

• Dismantling the control regime

• Delicensing and decontrolling indus-

tries and trade

• Reformation of fiscal and financial

policies

• Encouraging direct foreign invest-

ment; opening up of economy

2. Market orientation

• Minimum role and involvement of

Government in influencing market

mechanism

• Competition

3. Privatisation

• Divesting Government ownership of

economic enterprises

• Encouraging promotion of private

sector enterprises

4. Globalisation

• Encouraging free flow of foreign

capital and technology

• Encouraging establishment of inter-

national joint ventures

• Dismantling restrictive trade regime

and permitting entry of MNCs.

The financial sector reforms are an

important component of the overall

scheme of structural reforms. Reserve

Bank of India, the country's central bank

and monetary authority took initiative to

set up the Reforms Committee and rec-

ommendations of which were aimed at

improving the productivity, efficiency

and profitability of the banking system.

They also aimed at providing the bank-

ing system much needed operational

flexibility and functional autonomy. The

following were the major components of

the reforms recommended by the

Committee:

1. Relaxing the barriers towards entry of

private banks in the banking system.

2. Liberalisation of branch licensing

policy.

3. Reorganisation of the banking struc-

ture.

4. Capital restructuring of Indian

banks.

5. Introduction of prudential norms

covering capital adequacy, income

recognition, asset classification and

provisioning.

6. Administered interest regime to give

way to market driven interest rate

regime.

7. Reduction of the proportion of

directed credit programmes.

8. Reduction of statutory reserve requi-

rements with a view to releasing

resources for profitable lending.

9. Strengthening the organisational and

legal framework for better recovery of

bank loans.

10.Establishment of an Asset Recons-

truction Fund to take care of the loss

assets of banks.

The prudential norms including cap-

ital adequacy were initially made applic-

able to Commercial Banks. Though the

Reforms Committee in its report had not

covered cooperative banking sector, RBI

made some of the recommendations

applicable to cooperative banks includ-

ing Agricultural and Rural Development

Banks and Urban Coop. Banks particu-

larly the norms relating to income recog-

nition, asset classification and provision-

ing for Non-Performing Assets (NPAs).

The Committee on Banking Regula-

tions and Supervisory Practices (Basle

Committee) had, in July 1988, laid down

an agreed framework, on international

convergence of capital measure and capi-

tal standards. This framework required

the banks to measure capital adequacy

on the basis of risk weighted assets and

get a minimum standard of 8% particu-

larly for banks conducting significant

international business. The framework

suggested by the Basle Committee was to

be applied by banking supervisory

authorities of various countries. Indian

commercial banks which have branches

abroad were required to achieve the

norm of 8% by March 31, 1994. Foreign

banks operating in India were required

to achieve this norm by March 31, 1993.

Other banks were required to achieve the

norm of 4% by March 31, 1993 and 8%

by March 31, 1996.

Prudential norms relating to capital

adequacy were perhaps not made applic-

able to RRBs and cooperative banks

(viz., Urban Cooperative Banks, ARDBs

and State / District Coop. Banks) for the

20

reason that they are not doing any signif-

icant international business. Also in the

case of cooperative banks, the share capi-

tal raised is linked to the loans disbursed

by them. Even though the Basle Commi-

ttee released the framework in July 1988,

it was made applicable to Commercial

Banks in India only in 1993 after the eco-

nomic policy reforms were introduced in

the country. It is reported that 25 out of

27 public sector banks have achieved the

8% capital adequacy norm.

Substantial financial assistance has

been provided by the Government of

India for cleansing of the Balance Sheets

and Recapitalisation of public sector

banks including Regional Rural Banks

from out of successive budgetary alloca-

tions. Such funding support provided by

the Government upto February 28, 1998

was of the order of Rs.200 billion. Seve-

ral financially sound public sector banks

including State Bank of India, the biggest

bank in the country and two of its sub-

sidiaries have successfully raised capital

from the capital market at a premium.

In order to introduce greater compe-

tition in the banking system, the RBI

gave approval for establishment of new

banks in the private sector with mini-

mum equity of Rs.1 billion which has

since been raised to Rs.2 billion. Nine

such new private sector banks have been

set up in the country which have raised

capital from primary market. NPAs of

new private sector banks ranged between

1% and 7% whereas in the public sector,

9 banks had NPAs of over 10% in

1998-99. Because of the market pressures

and application of various regulatory

norms, some of the large public sector

banks have reported substantial losses in

1998-99 resulting in total wiping out of

their net worth. For all the 27 public sec-

tor banks put together, their net profit

was 34.6% lower in 1998-99 over the

previous year.

In April 1998, the Reserve Bank of

India proposed to further strengthen the

existing capital adequacy, income recog-

nition, asset classification and provision-

ing norms as well as disclosure require-

ments of banks and achieve greater

transparency in banking operations and

bring these up to or exceed international

standards after taking into account the

recommendations of the Committee on

Banking Sector Reforms (second genera-

tion). Some of the major recommenda-

tions of the Committee for strengthen-

ing the Banking system are as under:

1. Stepping up of the minimum Capital

Adequacy Ratio from the existing

8% to 10% by 2002.

2. A 5 per cent weightage to be assigned

to investments in Government and

Approved Securities to hedge against

market risk.

3. Net NPAs to be brought down to

below 5% by 2000 and 3% by 2002

and banks with international pres-

ence to reduce gross NPA to 5 per

cent and 3 per cent by 2000 and 2002

and net NPAs to 3 per cent and 0 per

cent respectively.

4. Further tightening of the Prudential

Norms relating to Income Recogni-

tion (reduction of present norm of

21

180 days for considering an asset as

NPA to 90 days in a phased manner

by 2002). Asset Classification (redu-

tion in the period for classifying a

NPA as 'Doubtful Asset' to 18 months

and eventually to 12 months) and

Provisioning (1% provision even on

Standard Assets).

5. Cooperative Banks to reach a mini-

mum of 8 per cent capital to risk

weigted assets over a period of 5 years

by raising capital from members

without any assistance from Govern-

ment.

The Reserve Bank of India has

already advised the public sector banks

to raise minimum required Capital

Adequacy ratio from 8 per cent to 9 per

cent by end March 2000 and thereafter

10 per cent.

The action on other major recom-

mendations are under examination of

the authorities.

II Cooperative Credit and BankingStructure

India adopted Raiffeisen model of

rural credit cooperatives in the begin-

ning of this century to combat the prob-

lems of usury and indebtedness of farm-

ers and to rejuvenate the then stagnant

rural economy. From that stage, the

cooperative movement in India came a

long way, mainly through the efforts and

contribution of cooperators, Govern-

ments and members. Today, the short-

term credit structure specialising in pro-

duction credit is functioning with 3-tier

structure (SCB at apex level, DCCBs at

district level and PACS at grassroot level)

in 15 States and with 2-tier structure

(without DCCBs) in 12 States/Union

Territories. The LT structure specialising

in investment credit, is functioning with

a federal 2-tier structure (SCARDBs at

apex level and PCARDBs at block level,

with or without branches) in 11 States

and with unitary structure (SCARDB

with branches at lower level) in 8 States.

In one State, ST and LT structures are

integrated and the integrated structure is

catering to both investment and produc-

tion credit needs of its clients through

SCBs, DCCBs and PACS.

The origin of urban credit movement

in India can be traced to the close of the

nineteenth century. Following the suc-

cess of urban credit institutions in

Germany and Italy during the latter half

of eighteenth century, some middle class

Maharastrian families settled in the erst-

while Baroda State started a mutual aid

society in 1889. When the Cooperative

Societies Act of 1904 conferred legal sta-

tus to credit societies, the first urban

cooperative credit society was registered

in the then Madras province in October

1904. The failure of local joint stock

banks in the country gave an impetus to

the urban cooperative credit societies.

Later the economic boom created by the

Second World War provided a stimulus

to the growth of urban banks in India.

They grew not only in number but also

in size, diversifying their activities con-

siderably.

22

The network of financial coopera-

tives is presented in the following chart:

Credit Societies: Apart from the

above three major structures of coopera-

tive credit and banking sector, there are

38000 credit societies which are similar

to Credit Unions providing credit ser-

vices to members from the savings raised

from them.

Cooperative Bank of India (COBI):

Establishment of Cooperative Bank of

India at the national level has been a

major development in our country as

this is expected to fill the systemic gap in

the cooperative banking sector. COBI

will also serve as a balancing centre for

drawing surplusses and for deploying

funds covering the entire cooperative

banking sector. The capital base of

Rs.1000 million of COBI is expected to

be raised from member institutions in

relation to their relative financial

strenght. This Bank, however, has not

been operationalised because of delay in

securing the formal

banking licence from

RBI due to certain legal

hurdles.

Performance

The cooperative credit

structure covering ST

and LT put together

accounts for 69% of the

rural credit outlets

(107639 out of 155398).

Though they are not

comparable with com-

mercial banks in terms

of resources (CBs: Rs.5000 billion,

Cooperatives Rs.1067 billion) mainly

due to their poor deposit base, they are

favourably placed in terms of coverage

and outreach. They cover 647636 vil-

lages spread across 514 districts and

102 million operational holdings. Their

total membership is 98 million (bor-

rowing membership 42%). Of them,

42% are small farmers and 26% belong

to the weaker sections. On an average, a

primary unit covers 7 villages. Their

share in outstanding rural credit is

about 40% and they account for almost

50% of the annual credit flow in the

rural sector, of which about 60% is pro-

duction credit and 30% investment

credit.

Urban cooperative banks which

operate mostly in urban areas, play a

significant role in the non-agriculture

sector with over 6 million members

serving the banking needs of people

with small and modest means. They

23

account for about 6% of the entire

banking deposits and are totally self-

reliant in the matter of resources.

The position of resources and out-

reach of all the 3 structures viz., ST, LT

and UCBs as on March 31, 1998 is

pressented in the following table:

Major strengths and weaknesses of

Cooperatives

The major strengths and weaknesses

of cooperatives (ST & LT structures)

which serve agricultural and rural sector

are discussed below:

Strengths:

Network: As already stated, the

branches / grassroot level network of

cooperatives form 69% of rural credit

network in the country, virtually cover-

ing every village.

Vast human resources: The ST coop-

eratives employ around 220000 persons

and LT structure another 31000 persons.

Most of them are from local areas, well

versed with their area / clientele, their

needs and psychology. This invaluable

asset is one of the reasons for sustainable

performance of cooperatives in terms of

provision of credit, despite constraints

and competition.

Long standing experience in purvey-

ing rural credit: Cooperatives represent

the oldest rural credit delivery system

with over 8 decades of experience in

agricultural lending and they are fully

aware of problems and prospects of rural

lending.

Functional Societies: Besides provid-

ing avenues for deployment of resources,

the functional societies (marketing,

weavers, salary earners, consumer, etc.)

provide the benefit of linking of credit

with marketing.

Lower reserve requirements: Ever

since the application of Banking Regula-

tion Act to cooperatives, they are requir-

ed to maintain 3% and 25% of their time

and demand liabilities towards CRR

and SLR respectively. (CBs presently:

10% and 25%). This provides a greater

24

liquidity to cooperatives.

Refinance on concessional terms: Out

of the annual refinance provided by

National Bank for Agriculture and Rural

Development (NABARD), cooperatives

are presently enjoying more than 75%

share under production credit and 60%

share under investment credit. They also

enjoy concessions with regard to interest

rate and tenure of refinance.

Other support: NABARD is provid-

ing financial assistance to cooperatives

both through loans and grants from

Cooperative Development Fund and

R & D Fund for their operational impro-

vement and HRD.

Weaknesses :

Poor Resource Base: The total

resources of cooperatives were Rs.1067

billion of which around Rs.360 billion

were borrowings. The deposits mobilised

by rural and semi-urban branches of

commercial banks were Rs.1500 billion.

Except in 2 or 3 States, the resources of

primary units are very poor. On account

of poor resource base, a vertical depen-

dence on higher financial institutions is

evident. ARDBs are non-resource based

institutions though in the recent years,

some of them have made a beginning in

mobilising deposits.

Low business levels: The low business

levels, particularly at the level of PACS

(Average Rs.1.3 million), is one of the

major reasons for non-viability of coop-

eratives. The problem is more pro-

nounced in LT structure, particularly at

PCARDB level in some States.

Poor Recovery: The macro level reco-

very (loan repayment) rates were 84%

for SCBs, 60% for SCARDBs, 68% for

DCCBs and 56% for PCARDBs. 12 out

of 28 SCBs (less than 80%), 11 out

of 19 SCARDBs and 171 out of 363

DCCBs have comparatively less recovery

(less than 60%). 9 each of SCBs and

SCARDBs and 67 DCCBs suffer with

recovery less than 40%. Chronic over-

dues under ST (Rs.28 billion) and LT

structure (Rs.5 billion) pose serious

problem to the recycling of funds by

these institutions.

Inadequate financial margin: The fol-

lowing table reflects the inadequacy of

financial margin as compared to Tran-

saction Cost and other costs.

25

It may be seen that the financial mar-

gin is inadequate to meet transaction

and risk costs. On the basis of State aver-

ages, SCBs in 8 States, DCCBs in 20

States and SCARDBs / PCARDBs in all

the 19 States had negative net margins.

The increase in the negative net margin

as on March 31, 1998 was due to sizeable

increase in the risk cost on account of

implementation of provisioning norms.

Poor MIS: On account of poor data

flow, the managerial decision process is

not properly supported resulting in

delayed or imperfect decisions or both.

Process of computerisation of coopera-

tives is rather slow.

Lack of functional autonomy: Exter-

nal factors, affecting the functional

autonomy of cooperatives are targeting

both their democratic character and

operational liberty. This is affecting the

operations and efficiency of the coopera-

tives.

Unrealisable Asset: The unrealisable

assets consisting of accumulated losses,

imbalances in asset coverage and short-

fall in provisions for non-performing

assets in respect of a large number of

cooperatives (ST & LT structure) are esti-

mated at around Rs.70 billion (Rs.60 bil-

lion under ST and Rs.10 billion under LT

structures) against owned funds of

Rs.117 billion.

Imbalances in Profitability: Coopera-

tives in India are a strange pyramid with

large profitability at apex level and lower

profits or losses at grassroot level.

Operational Losses: The operational

losses of cooperation credit institutions

is a matter of serious concern and the

banks should make earnest efforts to

attain current and sustainable viability.

The working results as on March 31,

1998 are presented in the following table:

Non-compliance with Banking Regu-

lations: Due to erosion in capital as also

in deposits, several DCCBs are not com-

plying with the provisions of the Ban-

king Regulation Act and as such, are not

26

eligible for concessional funding support

from national financial institutions like

NABARD.

III Nature of Capitalisation issuesin India

Capital

Capital is one of the major indicators

of the financial strength of an enterprise.

For a banking institution, capital covers

risk of losses apart from reposing confi-

dence of the depositors and other credi-

tors.

In our context, capital has one more

important function and relevance.

Borrowing power of a financial cooper-

ative is linked to net worth as stipulated

in the Law. Net worth here means equi-

ty plus reserves minus accumulated

losses. For example, in Karnataka State,

borrowing power of a cooperative bank

is limited to 10 times the net worth.

This means the bank can raise deposits,

borrow funds from market or obtain

loan / refinance from financial institu-

tion to the extent of the borrowing

power in relation to net worth. Because

of this limitation, business expansion of

a bank is directly linked to its capital

base. In the case of Cooperative Agri-

culture & Rural Development Banks

engaged in term lending for agricul-

ture, the central bank has imposed a

ceiling on their raising deposits from

public which is limited to the banks net

worth. If the net worth or equity has

been eroded by losses, the bank will be

too keen to enhance the capital for

facilitating raising additional public

deposits.

Capital, in a broader sense is the

owned funds consisting of share capital

and reserves. Reserves represent profit

earned over the years that have not been

distributed to shareholders and retained

in the business. The accumulation of

such retained reserves reflects financial

soundness, stability and growth of

banks.

The capital base of cooperative credit

and banking institutions increases

steadily with the growth in business as it

is linked to loans and borrowers are

compulsorily required to contribute to

the share capital certain percentage of

loans ranging from 2.5% to 10%. This

system is quite different from Commer-

cial Banks, both public and private sector

banks, who raise capital from Govern-

ment and market by public issues. In

most of the public sector banks, capital is

held wholly or partly by the Government

with controlling interests. It is for this

reason, in the recent years, for augment-

ing the capital base of public sector

banks, Government of India have con-

tributed substantial sum to meet the

capital adequacy norms.

Reserves are results of profits and

there is limitation for augmentation of

reserves by S.T. and L.T. cooperative

structures due to inadequacy of profits

or because of operational losses as dis-

cussed earlier. Statutorily the coopera-

tives are required to set apart 25% of the

profits to Reserves and invest such

Reserves outside their business.

27

The positon of owned funds of coop-

erative banking structure consisting of

share capital and statutory reserves as on

March 31, 1997 is given in the following

table:

Cooperative banks in India, other

than Urban Cooperative Banks, besides

raising share capital from members,

which is linked to loans, also receive

equity contribution from the Govern-

ment as a matter of State policy. Such

capital held by State Governments in the

cooperative banking structure ranges

from 10% to 20% as indicated in the

Table below:

Though the Government contribu-

tion to the equity of cooperatives was

helpful initially, there is a growing feeling

among cooperatives, some of which are

fairly strong, to repatriate Government

equity in order to minimise State control

and interference in their working. In any

case, in the context of new economic

policy and financial sector reforms,

Government support by way of addi-

tional capital is not likely to forthcome to

cooperative banks in any significant

manner in the coming years.

In the private sector banks, equity is

held mostly by public and financial insti-

tutions. Besides promotors' investment

in equity, they enter the capital market

on their own strength to augment capital

to meet the international standards and

it may not pose any serious problem

unless they are in bad shape.

Capitalisation

As mentioned earlier in this paper,

cooperatives have share linking norm in

terms of which the borrowing members

are required to take up a certain percent-

age of loans towards share capital. While

the banks would like to augment capital

by increasing this ratio of capital to loan,

the borrower may not be interested in

increasing the rate of linkage as it would

put additional burden on him and ren-

der the loan less attractive. Also, there is

'nil' or inadequate return on such capital.

Because of low level of profitability,

majority of the banks have not been pay-

ing dividend on share capital. Even the

best of the cooperatives cannot normally

pay dividend over 15% on capital in view

of the legal restrictions and cooperative

28

policy of limited return on capital.

Cooperatives are expected to utilise prof-

its for augmenting owned funds by way

of reserves.

Based on the recommandation of All

India Rural Credit Survey Committee in

1954, Government as a matter of State

policy, has been contributing to the share

capital of cooperative credit and banking

institutions to make them financially

strong. For such shareholding by Gover-

nments, NABARD provides loans at con-

cessional rate from out of the special

fund viz., National Rural Credit (Long-

term Operation) Fund maintained by it.

There is no equity contribution to Urban

Coop. Banks by the Government and

they raise their equity entirely from

members.

As compared to public and private

sector banks, the shares of cooperatives

neither appreciate in value nor they are

traded in the secondary market. Also,

they are constrained to raise capital

through the primary market. These are

the bottlenecks for augmenting capital

by cooperatives.

Cooperative Banks have not made

any significant attempt for capitalisation

and most of them continue the age old

practice of raising equity from members

in relation to the borrowing. One reason

for this could be non-application of cap-

ital adequacy norm. They may soon

realise the inadequacy of capital with

application of international standards.

The growth in the capital is found to be

not commensurate with the growth in

business for the following reasons:

• Borrowers obtaining second and sub-

sequent loans may have to take up

additional shares only marginally.

• Face value of the share which was

earlier Rs.10 /- has not been raised in

some banks even though the rupee

value has decreased over the years

due to inflation. Even where changes

are made, it is still found to be much

lower. Face value of the share should

be much higher for ensuring growth

in equity.

• Share linking to loans is still lower at

3% and 5% in some banks and unless

this ratio is enhanced, equity growth

will not be substantial.

• Shareholders have a right to redeem

their holdings when loan liability is

cleared. However, by convention, it is

observed in some Cooperative Banks

(particularly L.T. structure) that the

entire equity holding of a member is

adjusted against the last loan instal-

ment thus depriving the bank of

much needed capital. This practice

needs a relook for retaining some

portion of the shares held by mem-

ber-borrowers.

Recapitalisation

Cooperatives, in keeping with their

principles, have been operating as service

sector institutions. There was no serious-

ness on their part to work as economic

enterprises. They were subjected to sev-

eral controls and restrictions by mone-

tary / refinancing authorities and Gover-

nment. Until 1994, they were required to

mobilise deposits and provide loans at

29

regulated interest rates with inadequate

spread / margin even to meet their trans-

action and other costs. The advances

were also regulated by the Government

through a system of directed credit for

priority sectors or poverty alleviation

programmes. Cooperative banks along

with public sector banks were also

required to implement Agricultural and

Rural Debt Relief Scheme (ARDRS) in

1990 under which benefits given to

farmers (towards defaulted loans) upto

certain extent were to be reimbursed to

the banks by the Government. The coop-

eratives were put to a disadvantage and

suffered liquidity problems as Govern-

ment support in relation to volume of

loans waived was not provided for fully

and that, further, there was considerable

delay even in the settlement and release

of dues. More than anything, implemen-

tation of this populist scheme resulted in

vitiating the recovery climate which even

otherwise was not so good. These, cou-

pled with the application of provisioning

norms for NPAs have resulted in sub-

stantial losses to cooperative banks.

Hence, cooperatives have been pleading

with the Government for funding sup-

port as one time measure to cover losses

by recapitalisation on the lines of sup-

port extended to public sector banks.

The estimated funding support for banks

in ST and LT structures for cleansing

their balance sheets is of the order of

Rs.70 billion. Response to this demand

has not been positive so far. There is,

however, no such proposal for support to

UCBs, as most of them are working in

profits and where Governments have no

equity holding. In the context of changed

economic policy, State Governments'

future support for increasing capital base

of cooperative banks will not be encour-

aging. On the contrary, cooperatives may

have to retire Government equity hold-

ing by stages in due course for their own

autonomy.

Prudential Norms: As a follow-up of

the financial sector Reforms Committee

recommendations, prudential norms

involving income recognition, asset clas-

sification, provisioning, valuation of

investments and capital adequacy were

introduced to various banks in India

beginning from 1992-93 as under:

The capital adequacy norms have not

been made applicable to cooperative

banks (including UCBs) and Regional

Rural Banks so far.

With a view to preparing the Balance

Sheet and Profit & Loss Account and

reflecting bank's actual financial health, a

proper system for recognition of income,

classification of assets and provisioning

on a prudential basis was found to be

essential. While the norms for income

recognition is based on record of recov-

ery (realised income), the classification

30

of assets has to be done on the basis of

objective criteria which would ensure a

uniform and consistent application of

norms. It would be necessary that the

provisions are made on the basis of clas-

sification of assets into 4 different cate-

gories viz., standard, sub-standard,

doubtful and loss.

After classification of assets, the

aggregate NPAs and their proportion to

total outstanding advances in respect of

banks in the ST and LT structures as on

March 31, 1998 are given in the follow-

ing table :

While the first reforms committee dit

not examine and make any specific rec-

ommendation to cooperative banks as to

the application of various norms, the

second generation of reforms (yet to be

made applicable) include the following

specific references to cooperative banks :

• There should be no recourse to the

scheme of debt waiver.

• Cooperative banks should reach capi-

tal adequacy of 8% over a period of

5 years.

• Cooperative credit institutions to

enhance their capital through sub-

scription by members and not by

Government.

• The present duality of control over

the cooperative credit institutions

by State Governments and RBI /

NABARD should be eliminated and

all coop. banking institutions should

come under the discipline of B.R. Act

by suitable amendments of the said

Act.

The capital adequacy norms are

expected to be introduced to cooperative

banks shortly. A big question is whether

cooperative banks would be able to

adhere to the capital adequacy norm of

8% especially when the erosion in their

assets has been increasing from year to

year. A quick study of the two banks in

Karnataka State (SCB & SCARDB) made

for assessing the adequacy or inadequacy

of capital requirement by application of

norms stipulated for commercial banks

reveals that while the SCB's capital of

10% of the risk weighted assets is found

to be above the prescribed standard, in

respect of SCARDB, the equity ratio of

5.3% is much below the required level.

Quality of Assets: There is one basic

difference in the standard of assets

acquired by the cooperative rural bank-

ing sector in India as compared to the

public and private sector banks. The

aggregate exposure of cooperative banks

loans portfolio in agricultural advances

is as high as 80% while that of commer-

cial banks at best may not exceed 20%.

The risk of lending is greater in our con-

ditions of agriculture looking to the

small size of holding, lack of irrigation

facilities, non-adoption of modern tech-

nology, fluctuation in the prices of

31

agri-products, marketing inadequacies

and above all poor economic conditions

of majority of farmers. Their risks are

not adequately covered by insurance

though the Government have recently

announced a package of comprehensive

crop insurance cover.

The assets created by cooperative

banks by advancing term loans for agri-

culture are secured by mortgages, whose

market value in no case is less than the

loans advanced. But these secured

advances or standard assets of the banks

are in reality substandard or risk assets

because of difficulties in converting them

into cash for realisation of dues. This has

posed serious problem and non-per-

forming assets (NPAs) of banks are dan-

gerously much above the containable

limit or above any accepted international

standard. Though in the balance sheet,

the capital of several cooperative banks is

apparently regarded as adequate, it might

prove grossly inadequate in several cases

to meet the international standards

against the risk weighted assets and thus

this threat of capital erosion has to be

converted as an opportunity for recapi-

talisation or funding by innovative

means from the global experiences. I am

afraid that this serious problem of high

level of NPAs, depleting profitability due

to provisioning on the lines stipulated by

the regulatory agency and certain opera-

tional compulsions of business develop-

ment in a liberalised competitive market

economy, may endanger the future of

cooperative credit and banking sector in

India unless remedial measures are taken

in a systematic and time bound manner.

This calls for in-depth study of the prob-

lems, gaining knowledge from the expe-

riences and practices of comparable

cooperative banking enterprises in other

countries, steps to improve the quality of

assets and their risk coverage, innova-

tions in the long practiced cooperative

way of carrying out business operations

and above all augmenting funds and

capital base through non-traditional

means.

IV Demutualisation

Cooperative identity and values have

been intensively deliberated upon at the

international forum and even the princi-

ples have been redefined not long ago.

Though there have been some compro-

mises here and there, the basic principles

have remained intact. One-member-

one-vote and limited returns on capital

are in fact the major constraints in aug-

menting capital in cooperatives. For a

successful and profitable cooperative

bank, there are quite a few of them even

in India, raising capital from market

besides member-holdings, is not going to

be a major problem. But how it is going

to be beneficial to the general public or

the corporate sector by holding on to the

cooperative principles of one-member-

one-vote and limited returns? We want

access to capital market and at the same

time do not wish to give up or dilute the

cooperative principles. Unfortunately,

'self-help' and 'mutual help' aspects in

cooperatives are not strong enough to

raise capital from members more than

32

what is mandatorily necessary. Like in a

credit cooperative, equity holding by

member in certain ratio is essential for

loan availment. If option is given, bor-

rowing member may not opt for holding

any additional shares except perhaps

what is essential for membership. I

would say that lack of member-interest,

member-involvement, member-partici-

pation and above all member-loyalty to

the cooperatives is a major cause of

worry for the future of cooperatives.

'Mutuality' in cooperatives is a major

casualty which will also act as a major

constraint for augmenting capital

through members.

There have been some isolated

attempts in France and Canada revealed

in ICBA Journals where shares and cer-

tificates are issued to members and non-

members quoted in stock markets carry-

ing dividends but without voting rights.

I feel that a cooperative bank with long

standing and popular by its services can

successfully raise capital from the market

through innovative capital instruments -

shares or otherwise - even without vot-

ing rights provided the bank is able to

repose investors confidence about rea-

sonable safety of investment and returns

on capital. Without resorting to demutu-

alisation as to members' rights and own-

ership, cooperative banks will also have

to evolve measures for member loyalty

and mutuality.

V Governance - Quality and Impact

Cooperative credit and banking

organisations (barring the Urban Coo-

perative Banks) were promoted and

established mostly at the instance of the

Government in its search for an institu-

tional arrangement to dispense rural

credit. The Government patronage and

preferential treatment besides conces-

sional funding support and equity par-

ticipation in the banking sector have, in a

way, helped in building up the structure.

At the same time, however, banks have

suffered by not being able to build up the

organisation on sound business princi-

ples and transact their operations like

any other enconomic enterprise. They

performed tasks as directed with exces-

sive control exercised by the Government

both in the Management and business

operations. Providing service was the

main concern and not the financial

results and viability. Good governance &

professionalism by and large are much

below the required standards. A large

number of banking institutions are not

financially viable though they continue

to perform the routine functions of

retailing credit without accountability.

Members of the Board of Manage-

ment of the banks elected democratically

by members are not necessarily profes-

sionals. There is no possibility of any sys-

tems change in this regard without viola-

tion or dilution of the basic cooperative

principle. Elected members of the Board

need orientation for performing the

tasks of policy making in an effective

manner. Such orientation and educa-

tional programmes are not organised on

a regular and continuing basis. The paid

management of the banks - top and

33

middle level management - also lack

professionalism to understand and oper-

ate in a fast changing financial market

and to evolve innovations in their opera-

tions due to faulty HRMD practices fol-

lowed by them.

The above brief background about

Governance in the cooperative banking

sector is adequate enough to draw con-

clusions about inadequacies of their

competitive strength in the market for

raising funds or for augmenting capital

base through innovative financial instru-

ments practiced in some of the devel-

oped countries. We need good and

responsive Governance. How else to

evoke investors and member-share hold-

ers confidence? Frankly, several of our

credit and banking institutions lack cred-

ibility and cannot stand the test of rating

which is essential to operate in the capi-

tal market or debt market. Good gover-

nance should be result-oriented and

serve the members economic interests.

Improvement in the quality of gover-

nance is, therefore, a prerequisite for

realising favourable impact of any capi-

talisation measures.

VI Relations with Governments

In India, "Cooperation" is a State

subject whereas "Banking" is with federal

Government. Laws governing the man-

agement and operations of the coopera-

tive financial institutions are therefore

not uniform. There are several restrictive

provisions in these laws hindering the

operations and management functions.

Government control over institutions is

excessive and interference is unwar-

ranted. Very often, elected Boards /

Managements are superseded not for

reasons of mismanagement or violation

of law but on political consideration.

Apex level financial institutions invari-

ably are managed at the top level not by

professionals but by deputed Govern-

ment officers.

In a way there is duality in the control

and regulatory mechanism of the finan-

cial / banking cooperatives in India by

the State Governments and the central

bank. Equity holding by the State

Government as a matter of State policy is

perhaps one argument for Government

control. State Government equity hold-

ing ration in the Cooperative Banking

structure is given earlier in this paper.

If Government decides to withdraw

its equity holding or the Banks decide to

redeem by repayment to State Govern-

ments, avenues will have to be found to

recoup the erosion in the capital.

Quite a few national financial institu-

tions, which are Government enterprises,

like National Bank for Agriculture &

Rural Development (NABARD), Nation-

al Housing Bank and National Coopera-

tive Development Corporation do insist

on State Government guarantee for pro-

viding refinance or loans to Cooperative

Banking and Financial institutions.

This necessitates their dependence on

Government for guarantee and in turn

gives cause for Government control.

Central Government's support or

control is not always direct. It is through

the Central Bank by way of banking

34

regulations or as a part of monetary

policy and through public sector finan-

cial institutions on which the cooperative

banks depend for funding / refinance.

Cooperatives over the last few years

have been demanding amendments in

the cooperative laws for their autonomy.

Some State Governments have taken

steps but the process of changing the

laws is rather slow and there is some

degree of reluctance on the part of

bureaucracy and the Governments to

give up their powers and control. The

issue has evoked a national debate and

pressures are mounting on the Govern-

ments for amendments in the laws.

Economic liberalisation and reforms

have no meaning without functional

autonomy.

Neither the Central nor the State

Governments have any specific policy for

financial cooperatives though they are

indispensable for credit support to agri-

cultural sector. Alternative institutional

arrangements for rural credit are grossly

inadequate. A major concession enjoyed

by credit and banking cooperatives from

the central Government is in the matter

of Taxation as no tax is levied on Income

derived from normal business operations

with members. This has helped, to some

extent, capital augmentation through

reserves built out from profits.

VII Suggestions

After diagnosing the malady, it is nec-

essary to evolve solutions to remedy the

situation. Let me be frank, it is not easy

in our conditions particularly when the

problems are mostly enterprise-specific

though the threat perception is universal.

I am particularly encouraged by some

innovative practices of French and Cana-

dian cooperative banking enterprises in

raising capital through a combination of

approaches. I thus see the possibility of

converting the perceived threat of capital

inadequacy in financial cooperatives in

India due to application of international

prudential norms into opportunities for

recapitalisation or building up capital

through certain changes in the tradition-

al means and also by other financial

market instruments. Having said this, let

me summarise below some of my pro-

posals to improve the situation in the

Indian context.

• Economic liberalisation and conse-

quent measures of financial and

banking sector reforms are less

meaningful without restoring opera-

tional autonomy and democratic

management of the cooperatives.

Excessive Government control and

interference in the management of

financial cooperatives needs elimina-

tion by comprehensive amendments

in the concerned cooperative Laws.

• Cooperative credit and banking

enterprises need to be profession-

alised for improving competitive

strength and operational efficiency.

"Corporate Governance" in the words

of Hon. the Lord Thomas, esteemed

former ICBA President is more rele-

vant in our context. Corporate Go-

vernance is missing due to lack of

professionalism.

35

• Immediate task is to bring about per-

ceptible improvement in the quality

of assets and bring down NPAs.

Mismatch in Asset-Liability has to be

corrected to repose confidence of the

members and the public. Supervision

and control mechanism needs to be

strengthened and streamlined.

• Traditional business operations of

banks excessively in agriculture and

rural sector should give way to

broadbased / diversified lending to

reduce risks of bad debts inherent in

farm financing. Further, cooperative

banks should develop and introduce

such service products, without

involvement of funds. If income level

and profitability goes up by non-

credit business operations, capital

base will be strenghtened by retained

earnings - Reserves.

• Cooperative rural credit institutions'

excessive dependence on funds bor-

rowed from national financial insti-

tutions like NABARD has been one

of the major factors affecting the

business expansion plan as also the

liquidity of several banks in meeting

the repayment obligations to the

creditors. Cooperative financial

enterprises, therefore should raise

funds through deposits and other

financial market instruments in order

to be self-reliant and for flexibility in

their operations.

• Lastly, to enhance the financial base

and for capital augmentation to meet

fully the international standards,

innovative capital instruments are

essential. At present, equity capital is

raised only from member-borrowers

and from Government which has

limitations as explained. Measures

adopted by cooperative banks in

some countries by issuance of other

types of equity instruments including

preferential shares with assured

returns and converting dividend into

equity with members approval will

be valuable to emulate for building

capital or for recapitalisation.

Somehow cooperative banks should

also have access to large capital mar-

ket that exists in India and their

instruments made tradable in the

stock market. This does not necessar-

ily means compromising on coopera-

tive principles like member suprema-

cy and one member one vote. Capital

inflow from corporate sector in col-

laborative business operations serv-

ing the members interest is a possibil-

ity which remains to be explored.

In conclusion, I should admit, apart

from presenting the status of our

Banking Cooperatives, highlighting their

problems of capital inadequacy, growing

NPAs, lack of professionalism in the

management, etc. and making a few

broad suggestions, there are hardly any

innovative practices which can be shared

with other successful Cooperative Banks

represented here. The Topic chosen for

this Seminar is more appropriate as it

covers the problem of Cooperative

Banking in totality (Capital, Demu-

tualisation and Governance) as issues

36

like 'Capital' cannot be tackled in

isolation. I am happy that Cooperatives

have started working on strengthening

capital and certain innovative practices

have been successfully experimented

without diluting the cooperative princi-

ples.

In India, we have not even seriously

examined the issue and perhaps awaiting

application of capital adequacy norm by

the regulatory authority to realise the

seriousness of the impact. Looked at

from the view points of declined viabili-

ty, high level of NPAs, non-professional

management and relatively lower level of

competitive strength in a competitive

banking scenario, a sizeable number of

cooperative credit and banking institu-

tions have no future or might prove

irrelevant soon in the rapidly changing

economy. This threat perception has

prompted me to analyse the problems

more critically and to suggest certain

radical changes in policy, structure, oper-

ations and management of the financial

Cooperatives.

37

38

s in most other jurisdictions,

the new technologies associated with the

globalization of markets and the new

context of increasingly aggressive com-

petition are compelling Québec deposit-

taking institutions to develop new finan-

cial products and services, rationalize

their operating costs, and completely

overhaul their strategic orientations.

In order to ensure their long-term

viability, our institutions must manage -

in the most efficient manner possible -

the financial risks to which they are

exposed. Adding to this context is an

increasing flux of innovations and infor-

mation, as well as a myriad of financial

techniques and instruments, and issues

of regulation, deregulation and “decom-

partmentalization”. The outcome is a

new and turbulent financial environ-

ment. Due to this, our institutions are in

need of dynamic management tech-

niques, while the government authorities

require updated intervention procedures

and expertise, constantly called upon to

adapt and change.

More specifically, I will deal with the

major themes and challenges that influ-

ence the relationship between the Ins-

pector General of Financial Institutions

and the Mouvement Desjardins.

Brief history and legal context

On the heels of the liquidity crisis

which led to the demise of “caisses d’en-

traide et d’économie” in the early 1980s,

the Québec government set up, in 1983,

an independent agency called “The Ins-

pector General of Financial Institutions”,

or the IGFI.

Its mission consists in monitoring

and controlling the financial institutions

and the market intermediaries that oper-

ate in Québec, with the exception of

banks that fall exclusively under federal

Canadian jurisdiction. Its field of

MR. Jacques Henrichon, fca, deputy inspector generalINSPECTOR GENERAL OF FINANCIAL

INSTITUTIONS GOVERNMENT OF QUÉBEC

“The Relationship Between the inspector general offinancial institutions and the mouvement desjardins”

A

39

activities encompasses four broad sec-

tors: deposit-taking institutions, insur-

ance companies, market intermediaries

and real estate brokerage firms, and

business enterprises. The Inspector

General also has the responsibility of

advising the Québec Minister of

Finance in terms of guidelines and

reforms to be made to the laws and reg-

ulations relating to financial institu-

tions.

Although the first Desjardins caisse

began operating close to one hundred

years ago, it was only in 1963 that the

first piece of legislation was passed

specifically aimed at governing savings

and credit union activities. Since then,

the legislative framework and the gov-

ernment monitoring of institutions

coming under the Mouvement Desjar-

dins banner have changed a great deal,

all the more so since they have had to

adapt to the realities of the financial

market.

1989 was pivotal, as it was a year

marked by a major legislative reform.

The Savings and Credit Unions Act was

amended to update the cooperative

framework of its institutions and offer

them new means of capitalization. In

addition, the duties of monitoring and

control were split between the institu-

tions of the Mouvement Desjardins and

the Inspector General of Financial

Institutions. In particular, the “Confé-

dération des caisses populaires et

d’économie Desjardins du Québec”

(CCPEDQ), hereinafter referred to as

the Confédération, was clearly recog-

nized, through its Bureau for Financial

Monitoring and Policy Enforcement

(BFMPE), for its role of inspecting the

caisses and federations.

We might also point out that the

legislative amendments which came

into force in 1997 streamlined the

democratic and decision-making struc-

ture of each caisse, and introduced to

the new management the rule of corpo-

rate governance. Steps were also taken

to allow them to adopt flexible stan-

dards applicable to the caisses to

enhance sound and prudent manage-

ment practices.

While various laws make it compul-

sory for institutions such as the federa-

tions and the Confédération to set up

monitoring mechanisms designed to

ensure broader public protection, the

Inspector General possesses the neces-

sary power to intervene to make sure

the public’s trust in the Québec finan-

cial sphere does not erode, and to pro-

tect and watch over the best interests of

depositors, investors, insureds and deb-

tors, thanks to a monitoring system

wherein institutions are bound to hon-

our their obligations.

Self-monitoring by the MouvementDesjardins / cooperative network

The cooperative network of the

Mouvement Desjardins is made up of

savings and credit caisses which in turn

are divided into eleven federated net-

works to which the following major

components are added: Caisse centrale

Desjardins as the financial arm of the

Mouvement, the Corporation de fonds

de sécurité Desjardins, a private organi-

zation of deposit-guaranteed funds,

and the Confédération Desjardins.

While rendering those institutions

under our jurisdiction more responsible

for their activities, self-monitoring as

practised by the BFMPE, and set up by

the Confédération is the approach we

favour, as it facilitates the synergy needed

between the Inspector General and the

Desjardins institutions (including the

federations and the Confédération) to

assume our responsibility of protecting

depositors.

The BFMPE has the duty to conduct

an inspection of each and every Desjar-

dins caisse every year and a half, and of

the federations and Caisse centrale

Desjardins on a yearly basis. Through its

supervisory activities, the BFMPE

attempts to look for any shortcomings in

in-house control mechanisms, evaluates

management, and reports on the policies

of the various activity sectors of the

institution, the commercial and adminis-

trative practices, as well as compliance

with legislation. It must be noted that the

Audit Commission of the Confédération

Inspection and must, among other

duties, ensure that the BFMPE is inde-

pendent and objective when fulfilling its

mission.

The results of this monitoring activi-

ty by the BFMPE - the self-monitoring

agency - are also conveyed in the form of

inspection reports to the Inspector

General of Financial Institutions, the

authoritative body of the Québec gov-

ernment, as well as the federation that

conducts the follow-up activity.

Any shortcomings in management

practices that are raised, any breaches in

rules of ethic, and any occurrences of

legislative non-compliance must give rise

to the appropriate follow-up actions by

the various levels of authority of the

caisse, the federation, the Confédération

and the in-house committees of the

Mouvement Desjardins.

These all have the duty of making

sure the necessary measures are adopted

to remedy the most problematic situa-

tions. If, however, the federated network

neglects to intervene in a caisse’s dealings

when a situation so dictates, the law

allows the Inspector General to give

instructions to that caisse. He can also

order a caisse whose line of conduct is

contrary to sound practices or consti-

tutes an offence under a piece of legisla-

tion to adhere to a recovery plan or,

where a breach to the code of ethics has

been noted, to put an end to such con-

duct.

Furthermore, the BFMPE audits the

annual financial statements of all Desjar-

dins caisses and federations. However,

the federation’s audit must be carried out

jointly with an outside firm.

We must point out that other specific

actions to deal with caisses in problematic

situations or to respond to special con-

cerns may take place and take the form

of either on-site or distance monitoring

activities. Such activities can be per-

formed by the Confédération or by a

federation, as dictated by the situation,

40

or when problematic issues are suspect-

ed. If not, the Inspector General must

intervene, in cases where the latter orga-

nizations fail to adequately assume this

responsibility.

In the context of financial disclosure,

other data are required from Desjardins

institutions, in particular, to the federa-

tions, Caisse centrale Desjardins, the

Corporation de fonds de sécurité Desjar-

dins and the Confédération. These are

periodically transmitted to the Inspector

General.

In terms of sound and prudent man-

agement, the Mouvement Desjardins has

put in place efficient mechanisms, par-

ticularly by the adoption a few years ago

of a directory of sound and prudent

practices regarding financial risks to

which it is exposed.

From a legal perspective, the respon-

sibilities of a caisse have been reinforced

as to the respect of management stan-

dards and the code of ethics enacted by a

federation or, if there are none, by the

Confédération.

Moreover, the process by which such

standards are adopted has been made

more flexible, allowing the Confédéra-

tion to adopt standards on any adminis-

trative and financial matter when

required in the interest of the federations

and the Desjardins caisses. The federa-

tion and the Confédération must, by way

of efficient mechanisms, also ensure that

the standards they enact are followed.

Today, the self-monitoring task per-

formed by the Mouvement Desjardins is

increasingly based on directors’ resolu-

tions to the effect that guidelines, stan-

dards or rules regarding sound and pru-

dent management have been adopted,

applied and respected. It is essential to

ensure the quality of this type of man-

agement, and the reliability of this

reporting.

Self-monitoring by the MouvementDesjardins / corporate network

In addition to the federated structure

designated as the cooperative network of

the Mouvement Desjardins, there is a

corporate network which encompasses

corporations that conduct financial

activities (trust, life insurance, compre-

hensive insurance, securities) and non-

financial activities. Ten years or so ago,

the latter that had been acquired or

developed over time by the Mouvement

were grouped under the banner of hold-

ing companies held by the Confédéra-

tion Desjardins.

The internal audit of the Confédéra-

tion must assess whether the Confédé-

ration and the corporations of the cor-

porate network are managing their activ-

ities soundly and prudently. It must also

make sure that the policies and manage-

ment practices are applied to adequately

control the risks to which these corpora-

tions are exposed.

In terms of financial disclosure, the

holding companies and their controlled

subsidiaries dispatch their audited finan-

cial statements every year to the Inspec-

tor General. Some of these companies

that deal in trust or insurance opera-

tions, in particular, are subject to a more

41

42

frequent and detailed disclosure. The

latter are also subject to monitoring

adapted to their activity sector.

The Inspector General and govern-ment monitoring

The primary objective of the moni-

toring performed by the Inspector

General is to check to see whether the

Desjardins institutions are in good finan-

cial health and if they have a sound and

prudent management. Its preventive

aspect is designed to unearth any item

that could eventually undermine the

security of insureds and depositors.

The Inspector General maintains its

monitoring approach of the savings and

credit unions or caisses, the federations

and Caisse centrale Desjardins in accor-

dance with its role of monitoring and

control conferred by the Savings and

Credit Unions Act on the Confédération

and federations. In addition, it examines

and conducts specific analyses on some

of the components of the Mouvement

Desjardins, including the Corporation de

fonds de sécurité and the Confédération.

The monitoring of insurance companies

and trust company held by the Mouve-

ment Desjardins is conducted by the

Inspector General in compliance with

the laws that govern them. As for the

holding companies, our work is generally

limited to a comprehensive monitoring

activity which allows us to obtain a firm

grasp of the changing corporate struc-

ture of these entities.

The approach of government monitoring:

• recognizes the Inspector General as

the ultimate body responsible in

terms of monitoring;

• coordinates monitoring activities at

the government level with those car-

ried out by the self-monitoring agen-

cy, the Confédération Desjardins;

• oversees the enforcement of several

sections contained in the Savings and

Credit Unions Act regarding, in par-

ticular, financial disclosure, capital-

ization, monitoring, new financial

products, and so on;

• arrives at a practical knowledge of

these institutions while developing an

expertise based on the maintenance

of a certain presence among the insti-

tutions belonging to the Mouvement

Desjardins.

The monitoring of Desjardins insti-

tutions currently conducted by the

Inspector General are targetted more at

the appraisal of risk management by the

Confédération and its federations, much

more than simply following up on their

changing financial situation. The govern-

ment monitoring activities of the Mou-

vement Desjardins are aimed at making

a judgement on their financial viability,

assessing the quality of their manage-

ment, and finding out to what extent

such institutions are exposed to a variety

of financial risks.

In the case of the caisses, federations

and Caisse centrale Desjardins, the

inspection carried out by the Confédéra-

tion, through the BFMPE, is the key item

43

on which government-performed moni-

toring is based.

In other words, as a government

body, we will periodically evaluate the

work of a self - monitoring organization

to make sure that the inspection and

audit activities devised by the BFMPE

reach the objectives set out and meet the

needs of the government authority.

We designate monitoring heads for

each caisses-federation network, Caisse

centrale, the Confédération and the

other major cooperative and corporate

institutions of the Mouvement Desjar-

dins. Depending on the nature of the

entities monitored, we conduct an

appropriate examination and follow-up

of the information sent on to the Inspec-

tor General.

The information thus culled deals

with each caisses-federation network and

the other main components of the

Mouvement Desjardins, and are used to

determine so-called early warning indi-

cators.

Reports are drafted and regularly dis-

patched to authorities at the Inspector

General’s office to assess the financial

health of the various Desjardins institu-

tions and inform the staff of the most

worrisome cases. A meeting is held at

least every year with the authorities of

each caisses-federation network and all

other components monitored.

The Inspector General must take full

advantage of this information that he

may use to better target the nature and

scope of any intervention deemed neces-

sary. Thus, he makes optimum use of the

information taken from various sources,

the main ones being: the inspection

reports for each caisse produced by the

Confédération, the financial disclosure of

the caisses-federation networks and the

audited financial statements of all the

caisses and federations.

We promote an open dialogue with

Desjardins, particularly with those

responsible for the BFMPE. It should be

noted that the BFMPE directly con-

tributes to the security of members’

deposits.

The Inspector General has the duty

to ensure that all caisses, federations and

Caisse centrale Desjardins are inspected

within the prescribed time period and in

a satisfactory manner. Our monitoring

tools are updated constantly to allow us

to adapt to the Mouvement Desjardins

which is in a state of constant flux.

Changing monitoring andintervention strategies

The climate of flux in the financial

sector and the complex nature of the

risks to which financial institutions are

exposed entail greater work loads from

every point of view, whether we are deal-

ing with financial studies, standardiza-

tion, the assessment and review of laws

and regulations, fine-tuning our work

methods or adapting monitoring activi-

ties to suit new realities.

Over ten years ago, the advent of a

monitoring framework focussed more

along the line of risks faced by the sav-

ings and credit union network made it

necessary both to devise and appraise

44

work methods and tools likely to render

such monitoring effective.

Accordingly, at the time, government

monitoring of the Mouvement Desjar-

dins was carried out on a decentralized

basis. On the one hand, caisses were

inspected yearly by the Confédération

Desjardins and, on the other, the Régie

de l’assurance-dépôts du Québec, the

public body managing the deposit insur-

ance fund, also had the power of inspec-

tion it exercised on a sampling of caisses.

The Inspector General performed this

inspection on behalf of the Régie.

The legal reforms of 1989 shifted the

monitoring work carried out by the

Inspector General more along the lines

of a “caisses-federation” network rather

than the caisses taken individually. This

led to a network-based approach to

monitoring. Transitional delays were

necessary, as the approach implied a new

base of network information that was

structured in a particular fashion.

In September 1998, we initiated a

procedure to completely overhaul the

intervention strategies in terms of moni-

toring in order to optimize the use of our

resources, all the while taking into

account the reinforcement of the powers

of self-regulation, self-monitoring and

self-control that were conferred on those

organizations subject to scrutiny by

the Québec government. Among other

things, we based the monitoring ap-

proach on sound and prudent risk man-

agement.

We also acknowledged that the pri-

mary responsibility of the management

of institutions belongs to their directors.

We determined that all financial institu-

tions were to be subject to a minimum

level of control, and that a graduated

approach was called for in relation to the

identified existing and potential risks. We

also agreed that an integrated monitor-

ing of financial groups (conglomerates)

was to be recommended.

Our organization intervenes in the

affairs of deposit-taking institutions with

merely 30% of the staff it had a decade

ago. Nevertheless, our skilled teams are

able to adequately monitor the savings

and credit unions, particularly by closely

examining the changing financial situa-

tion and risks incurred, as well as

through an effective administration of

applicable legislation.

It should be pointed out that the

Inspector General’s monitoring and con-

trol activities are financed by the institu-

tions themselves. Indeed, the costs

incurred by our work is billed as a whole

the following year to the financial insti-

tutions concerned.

Our agency has increased the level of

exchanges it carries out with various

authorities and associations involved in

the regulation of financial institutions.

In fact, fruitful exchanges promote the

acquisition and sharing of the expertise

developed here and abroad.

In addition to the close collaboration

we have developed with the Office of the

Superintendent of Financial Institutions

(OSFI) of Canada to discuss our work

methods and activities, we would like

to emphasize our participation as a

member of the Canadian Council of

Insurance Regulators (CCIR), the

International Association of Insurance

Supervisors (IAIS) and those in charge of

the regulation of trust companies and

savings and credit unions.

Information systems: An interface withDesjardins

The institutions under the Desjardins

banner, in particular, the caisses, federa-

tions, Caisse centrale Desjardins and the

Confédération, must have access to satis-

factory information systems that meet

the needs of the disclosure of financial

data to the Inspector General.

It goes without saying that such

information must be reliable and also

allow the various levels of the Mouve-

ment Desjardins and the Inspector

General to periodically monitor the

financial performance of these institu-

tions and find out, through the appro-

priate financial indicators, their degree of

exposure to different financial risks.

The monitoring approach favours an

optimal use of this information through

complementary activities. As such, it

calls for efficient information systems to

be utilized to compile the results from

the self-monitoring agency’s inspections

and the early warning signs conveyed in

the context of financial disclosure. We

might point out that the inspection

reports and audited financial statements

from each Desjardins caisse are sent by

the BFMPE to the Inspector General

who uses them in his monitoring activi-

ties.

Until quite recently, the Inspector

General invested more time and resour-

ces to develop and operate its own infor-

mation systems. In one years’ time, we

have successfully taken steps with the

resources of the Confédération to pool

data bases, and share and link certain

information systems perfected by

Desjardins.

Having recourse to the electronic sys-

tems already in place at the Mouvement

Desjardins holds on advantage for the

Inspector General in terms access to sys-

tems that, for the most part, meet its

needs in terms of efficiency and reliabili-

ty. Major savings in technology and bud-

gets have been realized through this

approach, where a duplication would

have been unrealistic.

For reasons of efficiency, reliability

and budgets, therefore, the Inspector

General avails itself of the sophisticated

information systems and data banks that

have been developed and used by the

BFMPE. A fair proportion of the infor-

mation is sent via electronic means,

whereas paper support was formerly

used. We are linked up to the BFMPE’s

Intranet network.

The fact that the Inspector General

uses, in full or in part, the BFMPE’s

information systems also allows us to

ensure the reliability and appreciate the

accuracy of these systems that also serve

the purposes of the BFMPE and the fed-

erations.

45

Other factors to consider inmonitoring

Other factors and realities must be

considered by the Inspector General in

the scope of his duties and his global

monitoring approach.

1. Structural transformation of theMouvement Desjardins

A far-reaching project, aimed at the

structural transformation of the Mouve-

ment Desjardins, received the green light

in March 1999. The guidelines proposed

were designed to pare down the deci-

sion-making levels of the organization

through a grouping of the federations

and even the Confédération. Obviously,

if such a restructuring into a single feder-

ation were to take place, this would have

a significant impact on our monitoring

approach. We are currently in the process

of studying the impact of such a reform

on the monitoring activities of the

Inspector General and those performed

by the BFMPE and the federations.

2. Government budgetary context

Government budget cuts have forced

us to realign our monitoring approach in

terms of reduced resources and a grow-

ing complexity in duties, without com-

promising the objectives our agency

strives to reach. This evolving context

has, of course, intensified our concern

for the board of directors of any financial

institution to adequately fulfill its

responsibilities.

3. Reform of financial services at thefederal level

The Finance Minister of Canada

recently confirmed the federal govern-

ment’s opposition to the merging of the

major Canadian banks and has upheld

the prohibition of banks and trust com-

panies to sell insurance products and

offer leasing services to consumers.

This reform, directed at financial ser-

vices per se and no longer the four tradi-

tional pillars, could result in major reper-

cussions on the entire Canadian financial

sector. Two other points discussed by the

Minister were (1) that , if the reform is

accepted, the federal monitoring author-

ity will have thirty days in which to react

to an application for authorization of a

financial institution. Failure to respond

would mean the authorization is deemed

to be granted; and (2) access to the pay-

ment system will be extended to life

insurance companies, security brokers

and mutual fund firms. This could have

a major impact on the structure of

financial institutions in Canada and

Québec.

Conclusion

This context in which we - the

Mouvement Desjardins and the Inspec-

tor General - operate requires frequent

and efficient interactions. We must work

together in an increasing concerted fash-

ion.

The Inspector General fosters rela-

tions with the Mouvement Desjardins

more along the lines of communication,

interaction, accountability, transparency,

46

collaboration and the propensity to be

“proactive”, while promoting a sound

and prudent conduct of business affairs.

Aware of the growing complexity of the

financial field impacting the savings and

credit unions under its jurisdiction, and

concerned with the growing risks to

which they are exposed, the Québec gov-

ernment is greatly benefitting from the

self-disciplinary structure of the Mouve-

ment Desjardins.

Indeed, the Inspector General must

keep on honing its ability to innovate

and integrate new information and ways

of conducting monitoring and control

activities - regulating on one side and

deregulating on the other. However, it

remains the government monitoring

authority of the institutions belonging to

the Mouvement Desjardins.

We have a duty to hold onto skilled,

attentive and respected human resour-

ces, both with the Inspector General and

the Mouvement Desjardins, in order to

make our respective contributions to the

development of a sound, dynamic finan-

cial sector, worthy of the trust of its

depositors and the public in the institu-

tions of the Mouvement Desjardins and

the Québec state.

47

48

Introduction

he purpose of this exposition is

to present an analysis of the crisis that

shook financial cooperatives (FC) and

cooperative banks in Colombia between

1997 and 1999. Then I will draw lessons

that can be learned from this crisis and

the implications for our understanding

of the working of a system of FC in a

developing country, its governance and

the regulatory and supervisory environ-

ment.

The Colombian crisis in numbers

Among first-tier FC, as of July 1999,

57 cooperatives had been liquidated with

several of other intervened, including the

country’s second largest FC. Still other

FC were merged with a bank to secure

their continued existence (including the

largest and third largest FC of the coun-

try).

Among second-tier organizations,

one “cooperative bank” (UCONAL)

failed and was sold to the privates sector

(and thus “lost” to the FC movement),

another (BanCoop) failed and was

forced to merge with the only remaining

“cooperative bank” (CoopDesarrollo).

This third bank had to absorb not only

the other failed “cooperative bank” but

also two huge FC (Cupocrédito and

CoopSibaté) to prevent a run on them

and perhaps failure. The future of this

third and only remaining cooperative

bank is now in line. It shows all the signs

of a huge indigestion, manifested, as I

understand, in liquidity and cash flow

problems. These problems are the direct

result of the forced acquisition of the

other bank and large FC. With these

developments in the second-tier struc-

ture, about a third of first-tier FC have

already lost not only their investment in

their respective “cooperative banks” but

THE COLOMBIAN CRISIS OF FINANCIAL COOPERATIVES,A CORPORATE GOVERNANCE CRISIS.

KLAUS P. FIScHER, PH.D.

CENTRE DE RECHERCHE EN ÉCONOMIE ET FINANCE APPLIQUÉES

(CREFA) UNIVERSITÉ LAVAL, QUÉBEC, CANADA1

T

49

their link to the financial system. A loss

of the third bank would mean the total

disappearance of every second-tier

financial services institution organized

by the movement over the last quarter of

a century.

A recent law created a cooperative

deposit insurance fund (Fogacoop) with

taxpayers money. Despite attempts to

develop extremely rigorous inscription

standards. Fogacoop, however has been

forced to provide financial assistance to

all of the few FC that have managed to

achieve the status of conditionally regis-

tered FC to the Fund. This dangerous sit-

uation could lead to the failure of the

fund even before it is fully setup and

working.

By any account, the crisis was cata-

strophic. Because of it, the system shrank

by at least one third of its assets and over

a million persons have seen their finan-

cial institutions liquidated, intervened or

merged away.2 The effect of the crisis on

the availability of credit and financial

services to rural and urban SME, farmers

and other less favored social sectors in

Colombia is unmeasurable!

The causes of the crisis

To provide a useful analysis in terms

of lessons to be extracted we must make

a distinction between causes and the

triggering events. Unfortunately trigger-

ing events are being mixed up with (or

being used to hide) the causes, and this is

an error that is being committed un-

knowingly or intentionally quite often.

Just as an advance, I have strong reasons

to believe that the causes are massive

agency costs. These are related to a fun-

damental problem of governance of the

FC system. We will analyze this later. Let

us start with the triggering events.

The triggering events

Toward the end of 1997 (but after the

second largest FC had already failed), the

government committed a grave error

that triggered a liquidity crisis in some

FC. All government agencies were forced

to withdraw their funds from financial

institutions that where not supervised by

the Superintendence of Banks. That was,

of course, the situation of practically all

FC and gave a considerable shock to the

system. Later, toward the middle of 1998

a severe liquidity crisis swept the whole

financial system (a crisis that ended with

the nationalization of another privately

owned and supposedly “well managed”

S&L, Granahorrar). The crisis forced

interest rates sky-high in a bone-dry

market. This is when the FC crisis really

exploded. Both “cooperative banks” were

intervened soon after by the Supe-

rintendence of Banks and disposed off

— one to the private sector and the other

to be absorbed by the third and only

healthy “cooperative bank” remaining.

Toward the end of 1998, in a still very

tight market the situation of FC deterio-

rated. A run on them developed forcing

the hand of the Superintendence to close

several in a rapid sequence. The Supe-

rintendence of Banks had just taken over

the supervision of about 50 (largest) FC

from the Cooperative Supervision Body.

50

Demonstrations in front of the Supe-

rintendence followed in December 1998.

The run was halted when the only sur-

viving “cooperative bank” was forced to

take over the largest and third largest FC

in early 1999. Actors agree that there was

an enormous wisdom in the run, sparing

not all but most of the better (and small)

FC.

In the search (naive or bad inten-

tioned) of scapegoats, many Colombian

observers tend to squarely blame the

government. They blame absence of effi-

cient supervision and errors (already

described) in its policy toward the FC.

Some market participants mention cor-

ruption (and indeed many cases are

being treated by the justice system).

Would the crisis not have occurred with-

out the triggering events, corruption

(whatever there might have been), and

the FC would have been under supervi-

sion of the Bank Superintendence? Hard

to say, but I believe can better be

described as a mine waiting for someone

to step on it to explode. The government

errors and liquidity crisis were just that,

the triggers. As for efficient supervision,

all “cooperative banks” where under the

supervision of the Superintendence of

Banks (toted as one of the best in LA)

and this did not prevent that two out of

three to fail. Not having slammed on FC

a bank-like supervision on time cannot

be viewed as the cause of the crisis and

sounds more like a smokescreen.

The causes

So, what are the causes? When we are

looking for the causes, we are really try-

ing to pinpoint the differences between

the ones that failed and the ones that

survived. That they had all to weather a

storm that was no of their own making,

there is no doubt about that. Theoretical

arguments suggest that, as in the com-

mercial banking sector, moral hazard

problems are present in a FC, although

with some subtle differences to note. A

FC can be either debtor dominated or

creditor dominated. This influences the

level of risk that the FC will assume and

thus can be viewed as moral hazard for

net creditors. Interestingly and surpris-

ingly, the data, in a consistent way for the

last year and half, do not support the

hypothesis that the crisis was caused by

massive moral hazard problems as was

the case, for example, in the American

S&L crisis. I said suprisingly because,

used to observe bank failures, one would

expect bad loans to be the — or one of

the--main cause of failures. It is not for

the Colombian FC. Not that there are

not problems of bad loans, this is a prob-

lem that has the whole Colombian finan-

cial system in serious difficulties.

Although borrower dominated FC have

a weaker capital base and have higher

levels of bad debts neither explains fail-

ure in a statistical sense.3

Also, based on theoretical arguments

we know that agency conflicts between

managers and members can be quite

substantial, leading to the accumulation

of agency costs. I do not want to enter

into the details here for the sake of time,

but the work done using agency costs to

explain the Colombian crisis (See

Desrochers and Fischer, 1999) has solid

theoretical and empirical backing from

research performed in the United States

and elsewhere (See, Akella and Green-

baum, 1988; Branch and Baker, 1998;

Keating and Keating, 1992; Mester, 1989

among others). Agency costs where iden-

tified as a leading cause of “malfunction”

of FC in Europe (Volker, 1995). When

looking at the numbers, in the Colom-

bian case they support unambiguously

that the leading cause of failure is agency

costs. The two variables (out of only

three to four with any statistical signifi-

cance) most consistently predicting /

explaining failure in Colombia are

squarely measures of agency costs. They

are, in order of importance, the ratio of

deposits to credits (positive and signifi-

cant) and salaries (positive and signifi-

cant). In the EWS we also estimate

speed of expected failures and the same

variables show up. Other statistical tests

such as non-parametric Wilcoxon tests

confirm that agency cost proxies are

among the most significantly and con-

sistently different for the failed and

non-failed samples. Also, there is a neg-

ative and statistically significant rela-

tion between agency costs and the

strength of the capital base as well as

liquidity ratios, this evidently con-

tributes to the weakness of these FC.

Nonetheless we obtained a negative and

significant relationship between agency

costs and bad debts, supporting the

notion that bad debts were not the

cause of failures.

It is interesting to point to some non-

statistical circumstantial evidences. It is

not to provide evidence but to illustrate

how things came about. In Colombia the

FC that failed where the large ones

(national or multiregional, but not pro-

fessional bond based) where control of

management by members had been

diluted to almost nothing and little

remained of the old bond that gave rise

to the cooperative in the first place. In

the “cooperative banks” through retail

banking operations, the concept of sub-

sidiarity had all but disappeared and

control by the original “cooperative

shareholders” reduced to nothing leaving

managers and some few key powerful

net-borrower directors free and uncon-

trolled of any out-of-pocket money

investor, to do as they pleased.and so

they did! Absurd investment decisions

were made in both the “cooperative

banks” and the large, FC with no appar-

ent value to members at the base of the

system, but making the organization just

that, bigger, with the dubious reputation

of being “a fast growing bank”, with nicer

offices, larger salaries and more expen-

sive cars and even a golf course on the

payroll the usual. Imagine how many

real-money-investor-farmer-members of

(say) Boyaca and Santander knew how to

play golf! Members had lost all control

over management, a true governance cri-

sis!

Thus, I believe that the fault does not

reside with the Colombian government

51

but with the Colombian FC movement

itself. At most, the responsibility is

shared. After exploiting the favorable

conditions created by the government

for a vigorous growth, it failed to orga-

nize itself to cope with the possible con-

sequences of the weaknesses in the gov-

ernance of many cooperative organiza-

tions. In fact, it exacerbated them ignor-

ing some well established principles of

cooperative movement organization

(such as subsidiarity of second-tier orga-

nizations) creating ungovernable institu-

tions like the LA-styled “cooperative

banks” that are succeeding to go bust one

after the other not only in Colombia but

all over LA.

With respect to CoopDesarrollo, the

last of the “cooperative banks” left in

Colombia. I believe that this institution

has a fair chance to survive under the

current leadership (after all it survived

this crisis, this must mean something!).

However, what will happen once the

current leadership is gone? It's a wrong

policy to make the survival of institu-

tion to depend on the virtues of some

particular leader. What is needed are

institutions with proper checks and

balances, where managers have the

proper authority, and the proper con-

trol. This is not the case of these types

of “cooperative banks”.

The crisis in other LA countries

Is this a phenomena limited to

Colombia? Most likely not! Unfortu-

nately I do not have the comfort of a sta-

tistical test result that I can flash at you to

support this statement as I do for

Colombia. Let us look at some facts:

• In other countries of LA, as in Co-

lombia, the cooperative institutions

that failed and are failing are large

national FC and the LA styled mixed

wholesale and retail “cooperative

banks”. The small FC are just leaning

against the storm, getting wet but

otherwise fine in general. Let us be

clear, the problem is almost never in

the small first-tier FC but in the larg-

er ones and the second-tier organiza-

tions where control of management

is strongly weakened.

• There is no reason to believe that the

R&S environment of Colombia is any

more lax toward the exercise of moral

hazard or agency conflicts than in

other countries. If the governance of

the FC movement and the R&S

frameworks of the other countries

are not designed to better control

these conflicts, then it is likely that

the problem is not very different and

the crisis of Argentina, Ecuador,

Panama and Peru, among others,

have most likely the same causes.

• The study we have already referred to

from Volker (1995) covers Europe

and refers to problems that are simi-

lar to those of Colombia. The differ-

ence is that European FC movements

have developed a governance, R&S

structure that tends to control these

conflicts more efficiently.

What does all this mean? First, in the

1970’s Chaves concludes that all FC are

condemned to become net borrower

52

controlled and thus more or less

condemned to massive moral hazard

problems. The result of that was that,

among others, the World Bank lost all

interest in FC as instruments of develop-

ment for the last 20 years, and still insists

in its pessimism. This is indeed a very

regrettable result. Now, perhaps even

backed by some theoretical literature

(just as Chaves) I conclude that FC are

prone to be ungovernable due to massive

agency conflicts because the governance

structure of the typical FC is too weak to

control its managers. However, I intend

to take some distance from conclusions

such as the ones drawn by Chavez.

Edward Kane, a distinguished resear-

cher of the American banking system,

suggests that due to the nature of the

contracts that exist in a classical stock

held bank (and particularly in the pres-

ence of explicit or implicit deposit insur-

ance), a bank tends to suffer from similar

auto-control problems as a cow. The lat-

ter, fed without limit will feed itself to

death. So will a bank, with risk. This has

not lead to anyone to attempt to ban

banks or to tarnish the perception of the

role played by these institutions in the

functioning of the countries (and world)

economy. Why should we then do it (as

was done!) with FC? The presence of

perverse incentives such as moral hazard

(much milder than in a bank) and

agency conflicts (much harder to control

than in bank) is just an information, an

unavoidable fact that comes along with

the existence of any financial contract.

These contracts and institutions should

then be re-designed to control more effi-

ciently these conflicts through incentives.

Regulation and supervision should also

be designed to control for perverse

incentives. Finally, when institutional

structures are designed or new lines of

business are opened that imply new

organizations, the design should explicit-

ly seek to minimize the effect of these

perverse incentives.

What I believe is that these perverse

incentives (moral hazard and agency

conflicts) that no doubt are present in

the FC, realistically assessed (and not

fudged away) can be controlled. Obviou-

sly you believe in that too, otherwise you

wouldn’t be here, unless, of course, you

categorize yourself as a net borrower-

administrator engaged in building your

own little empire at the cost of some

naive FC members (including me). Let

us start with the implications.

The re-regulation of the LatinAmerican FC system

I think a key question here is: what

was the model of corporate organiza-

tion and governance LA FC movements

were following? In fact, what is the

model of corporate organization and

governance that are pursuing many of

the reforms that are occurring at this

very moment in LA, or even in other

developing countries? The American?

The German? The French Canadian? A

Latin American? None and all! Most

countries in LA are experimenting with

little or no understanding of conse-

quences and implications of their

53

reforms. How is this possible? The

banking sector is being aligned in the

whole continent around one single stan-

dard produced by the Bank of Inter-

national Settlement of Basle and the

regulation and supervision of other

financial intermediaries such as insur-

ance companies, pension fund managers,

etc. is rapidly being copied from the

more successful experiences (from with-

in or outside of the continent). However,

when it comes to he FC sector, we have

almost as many R&S frameworks as we

have countries. All those different mod-

els just cannot all be equally good and

thought through! We will come back on

this.

It is clear that FC movements in LA

must engage in a serious reflection about

their future: how they organize them-

selves, what type of institutions will they

encourage (e.g. what will they do with

their “cooperative banks” where they

have not failed), under which regulatory

and supervisory framework will they

operate. This is a serious challenge with

many stumbling blocks from within and

without. They have taken it up, perhaps

because they have no choice. Everywhere

are there recently accomplished or in-

process legal reforms. Some promoted by

the FC movement itself, some forced by

crisis, some because the monetary and

banking authorities have decided to act

with respect to the FC sector. Unfortu-

nately, the only thing they have in com-

mon is that they have little in common.

If you take the cooperative laws (recently

passed or in discussion) of Chile,

Colombia, Costa Rica, Dominican Repu-

blic, El Salvador, Mexico, Panama or

Peru, there is little on which they coin-

cide.

In several of these reforms banking

authorities, as they should, have had

their hands in, and if that is the case one

of three things happen:

1 They Integrate FC to he R&S norms

of the banking system respecting to

some extent their particularities.

Although not the adequate solution it

is thus far the most benign response,

and is the case, for example, of

Colombia.

2 They Integrate FC to the R&S norms

of the banking system allowing them

to keep the form of the FC but

requiring them to comply with all

standards that exist for banks, includ-

ing minimum capital. This is the

case, I understand, of El Salvador, for

example. This is very distressing!

3 Force FC to become “banks of coop-

erative ownership” (but otherwise as

close as possible to the legal form of a

private bank) after consolidation of

many small entities in one “large”

bank. This is the case of Argentina,

for example. There, after creation, the

“cooperative banks” (with the excep-

tion of one) proceeded to go bust.

However, even in the first and more

benign scenario, reforms often are inade-

quate. With due respect, I am convinced

that the last reform just accomplished in

Colombia, the third in just as many

decades, did not take the Colombian FC

system any closer to address the causes of

54

the last traumatic crisis. Supervision of

the (largest) FC by the Superintendence

of Banks (SB) may help but being under

the SB did not prevent two out of three

“cooperative banks” from going bank-

rupt. There is one simple reason: SB

supervision is not designed to control

agency costs and conflicts. This is not an

issue in commercial stock banks and the4

recent law changes little in this sense.

The largest innovation in the law of 1998

is the creation of the cooperative deposit

insurance fund. However, this fund has

such generous functioning rules, that it is

begging to go broke. Only a very prudent

and strict management, and a lot of care

by the FC movement itself will prevent

this.

In short, the FC reform process in LA

has no discernable direction--may I per-

haps say of the developing world? I do

not know if you are comfortable with

this state of affairs. We should certainly

not put too high hopes of the outcome

of such a random process.

The dominant models of FCgovernance, regulation andsupervision

What should then be done? In a sepa-

rate presentation at this conference titled

Regulation and Self-regulation of FC:

The efficiency of Federations as Regula-

tory Instruments (Fischer, 1999). I

argued that historical evolutions of sys-

tems of FC around the world have pro-

duced a limited number of "models" of

cooperative organizations. Among these

models federations of cooperatives oper-

ating in network with a strong self-regu-

latory and delegated monitoring func-

tion, play a dominant role. Crédit Agri-

cole, Desjardins, Raiffeisen (Austria,

Germany), Rabobank are just a few

examples. On the other end we also find

a number of cooperative systems that

appear to display a more loose form of

organization and integration with a set

of different functioning rules. Among

these we find several experiences in

Australia, New Zealand, North America

(United States and English Canada).

One of the common features of these

systems is that they are not organized in

a federative and network fashion

(although they may have a federation

that represents them).

Besides being an interesting curiosity,

the relevance resides in one important

fact: the level of performance, measured

by indicators such as market penetration

and growth, stability (absence of crisis),

levels of services to members, communi-

ty development, etc. differs among these

two models, with the federated-network

model displaying a systematically non-

inferior (that is, equal or higher depend-

ing upon the criteria used) level of per-

formance than the other. We would love

to be able to say more about developing

country systems of FC but we are still in

the process of collecting information…

and in any event there are not too many

“mature” FC systems in the developing

world. It is imperative as a question of

cost and to prevent errors that LA choos-

es a R&S framework that is roughly

uniform across all countries, with

55

adaptation to local conditions. If it is

going to choose one of the two R&S

framework that appear to be historical

constants across many diverse cultures

and societies, then it might just as well

choose the winning horse. And the win-

ning horse's name is federated-networks.

And these systems operate under rela-

tively well established rules of the game

in: governance, institutional organiza-

tion, legislation, regulation and supervi-

sion, national brand recognition, the

strict use of the principle of subsidiarity,

limited branching rights for individual

FC, etc.. Under all of these systems FC

are regulated and supervised by a spe-

cialized (usually quite small) department

of the banking authorities. So it should,

the FC is a financial intermediary that

requires banking styled R&S.

In my opinion, COLAC and ICA-LA

should cooperate to elaborate a com-

mon set of proposals that capture the

essentials of the best-functioning feder-

ated-network cases. These proposals can

then be taken to the either the coopera-

tive basis, or the banking authorities or

most likely both, for debate. Of course,

like always in these things, the devil is in

the detail. It is relatively simple to “rec-

ognize” systems operating under a fed-

erated-network model by some basic

features. However it is more difficult to

formulate a proposal or model that

keeps the essentials of the systems

intact. That’s the challenge.

You might say, so far fine. What is it

in the federated-network system that is

so attractive for LA? Besides being the

winning horse, some interesting addi-

tional arguments. Federated-network

systems have, I believe, succeeded in

controlling for some of the perverse

incentives inherent to the nature of the

contract with remarkable success. They

have developed and used with success

principles that have governed the func-

tioning of these federations for many

decades including:

• Subsidiarity: The principle that sec-

ond-tier organizations play a strictly

subsidiary role to first-tier FC needs,

where the true and only owners of

the structure are. Second-tier orga-

nizations (such as Centrals and

other functional subsidiaries) by

attaching strictly to the subsidiarity

principle are (or rather should be)

effectively supervised by the first-tier

FC through direct ownership. The

adoption (rather, conservation) of

this principle would have prevented

the appearance of the LA-styled

“cooperative banks” with wholesale

and retail function simultaneously

that have been falling one after he

other.

• Limited branching power: This

tend to conserve bonding by keeping

the FC small and focused on (very)

local issues while delegating to sec-

ond-tier organizations to deal with

market-wide issues. This principle is

also implicit in the United States

“bonding” restriction that is being

relaxed. This principle also reduces

agency costs by improving govern-

ability. They do this by keeping the

56

individual FC small, easily control-

lable by members and local govern-

ment bodies and supervised by the

delegated monitoring body.

• Delegated Monitoring and businessadvisory services. This arrangement

supplements supervision of manage-

ment by local bodies and provides

needed skills to improve performance

(in terms of profitability and services

to members). The delegated moni-

toring system, if it has sufficient

autonomy of the power structure,

which it should, will serve to super-

vise second-tier organizations.

• Other features include an internal

safety network, national brand plus

many others we cannot consider in

any detail here.

The difference between the function-

ing of a typical LA FC system and a fed-

erated-network based system are easy to

spot. However, some United States or

English Canadian participant might

argue: “so where is the difference with

what we have?” The question is reason-

able and the answer is: First, limit in the

growth of individual FC. If you take out

the restrictions that have limited he

growth of individual credit unions (CU)

in the United States (bonding) and

Canada (provincial regulation), what

prevents some of these cooperatives

from becoming large national multi-

agency institutions where every control

over administrators is lost and loyalties

tend to disappear? Remember, Desjar-

dins or Rabobank is a federation of FC

each one with local ownership and gov-

erning bodies that only have delegated

voluntarily some of the authority to the

federation and usually have the right to

recover it if they feel so. Interestingly, in

the United States the bonding restriction

has very recently been relaxed and in

Canada “federal” legislation for CU is in

the making!. I am convinced that the

appearance of large multi-agency CU in

English Canada (a reality!) should worry

supervisors! In the United States, if

because of the relaxation of the bonding

restriction, large regional CU start to

appear, supervisors should open their

eyes wide.

Second, you do not have available the

delegated monitoring body that helps to

keep agency costs and moral hazards in

check. One should not expect that agency

costs in particular, should be monitored

by the government supervisory authority.

They are a governance issue that should

be addressed within the FC system itself.

When a FC system lacks this mechanism,

it will have a hard time to control agency

cost abuses such as the ones that lead to

the Colombian, and other, crisis.

Third, you do not have a national

brand, nation-wide services and the pro-

vision of services that require economies

of scale. This was pointed out by the

Canadian Minister of Finance, Paul

Martin. I concede, today there are more

and more ways to get around the limita-

tions that result from not operating as a

national network. These problems have

thoroughly been solved in federated net-

works long time ago. There are other

arguments that I could make here to

57

underline the differences but these are the

main.

What makes the federated networksystem work?

Being only at the beginning of this

research, I can only speculate about

some of the factors that contribute to its

efficiency. Much more work needs to be

done to obtain an in-depth understand-

ing of the key ingredients of its success. I

will point to some of them, not because I

have all the evidences to support their

candidacy but as pointers in the direc-

tion of the research work that has to be

done. My hypothesis is that federated-

network systems possibly outperform

atomized-competitive systems because

they:

1 Conserve and capitalize to its maxi-

mum the value of the bonding rela-

tions to reduce asset search, contract-

ing and monitoring costs.

2 Respect the individual participants of

the movement in the decision pro-

cess, particularly with respect to

issues of most direct concern: local

issues (a superb marketing strategy!)

This also increases efficiency in mon-

itoring at the individual first-tier FC

level.

3 Allow the unconstrained growth of

the FC movement while limiting the

growth of agency costs.

4 Allows the full exploitation of

economies of scale in the research,

development and production of

financial services while conserving

the individualized member-sensitive

delivery system (something banks are

searching desperately to do, but

achieving it only for the rich around

the “personal banking” concept.

J.P.Morgan add: “Our measure of

success: one customer at a time”).

5 Capitalizes the value of “insider

information” in the process of pru-

dential and business-practices super-

vision and systemic risk prevention.

The first two factors are certainly pre-

sent in the United States CU system (due

to the bonding restriction), but not so in

many other cases, perhaps including the

English Canadian where some CU are

growing to be very large with no evident

conservation of bonding principles. The

last three are certainly absent of any

atomized-competitive system, including

the United States. It will be a challenge to

test these hypotheses, some of which we

may never be able to test because they

are just untestable or because we lack the

required data. However, their study is

certainly worth.

Not that everything is fine in federat-

ed-network systems and that every

aplication has been a smashing success.

There are forces that are tearing these

systems from inside, both centralizing

forces that accumulate power at the level

of second-tier organizations and atomiz-

ing forces that seek to eliminate the disci-

pline of the network. On the other hand,

picking out just as few elements is no

guarantee of success if the main princi-

ples are not respected. However, this is

beyond our scope.

58

Innovation and governability

Does this mean that FC cannot inno-

vate in institutional developments and

governance formulas? Certainly not. FC

in Europe and NA and certainly Latin

America and the rest of the developing

world, must innovate and create new

products and institutions to keep up with

the market and offer its members the best

possible service. However, these changes

should not result in corporate structures

in which all-powerful administrators

become uncontrollable and unaccount-

able, a risk already inherent in the weak-

ness of the individual FC governance

structure. Eventually excesses will occur,

and expensive business decisions made

with somebody else’s money will go sour,

and losses will accumulate… at the cost

of members. Thus these changes should

conserve the fundamental characteristics

that have made these structures success-

ful in the first place.

Perhaps somebody here is willing to

tell me that these highly democratic

structures are on their way out and there

is no future for them. If so, I would love

to hear from that person. In the mean-

time, one should tinker with them very

carefully to avoid loosing the balance.

Robbing the cooperative base (the first-

tier cooperatives) of its power appears to

me to be just as dangerous as allowing

the federations that have proven to be so

successful to fall apart because some local

too-rich FC and its administrators and

directors (and most likely it is them that

are making the noise) are not allowed to

build their own local empire.

You may have noticed that in all this

presentation I have not used the words

“cooperative principles” not even once.

You may perceive this as a weakness, but

it is not. I believe that FC are a market

innovation in the sense that the FC,

through its bond, and loyalties that result

from paying attention to the little person,

is capable to penetrate market niches in

which a stock owned bank cannot.

Simply put, the FC has an informational

and operating procedure advantage that

makes it competitive in these markets.

Conclusion

So, to conclude, what is the point of

this presentation? The Colombian crisis

is a corporate governance crisis. Why?

Because it was not caused by bad loan, or

a deposit run (which followed!) from its

members but from investment decisions

of all sort that did little to enhance the

value of the FC to its members but did

substantially to enlarge the corporate

structure of the organization. In the end,

those members whose interest should

have been protected did not win, but

loose… dramatically. We called this an

agency cost that came from the way the

FC is organized and governed. These

statements are supported by statistical

analysis.

Similar crisis in other countries of

Latin America, and actual efforts one

observes, suggest that there is a need to

focus on governance, R&S of FC.

Looking around “mature” FC systems,

one can see two models, one apparently

at least or more successful than the other

59

one. These represent models on which

Latin America can base its own reflection

on what is the governance, R&S frame-

work to choose. Presumably, the winning

formula should be given a closer look.

These crises also force reflection upon

related issues. If agency conflicts in the

FC are so important, then it follows that

control of them is a central issue for any

system of FC. Thus, whatever innovation

we may want to undertake to improve

services to members or meet the chal-

lenges of the market, this innovation

should not be an excuse to accumulate

power in he hands of administrators, be

this at the level of some particularly

grown-up-and-rich first-tier FC or in the

second-tier organizations of the federa-

tion. The founding fathers of the FC

movement knew better, they had proba-

bly more moral authority than anyone to

transfer power from members to leaders,

and did not.

References

Srinivasan R. Akella and Stuart I. Greenbaum.Savings and loan ownership structure andexpense preference. Journal of Banking andFinance, 12: 419 – 437, 1988.

Brian Branch and Christopher Baker. Overcominggovernance problems: What does it take?Technical report, Interamerican DevelopmentBank (IADB), March, 1998.

Klaus P. Fischer. Regulation and Self-regulation ofFC: The efficiency of Federations as RegulatoryInstruments. ICA Conference, Québec, August,1999.

Klaus P. Fischer and Martin Desrochers. Costos deagencia y la crisis de cooperativas financieras encolombia. In Marietta Bucheli and RicardoDavil, editors, Las Cooperativas Financieras Y elDesarrollo Regional, pages 45 – 90. Instituto deEstudios Rurales, Universidad Javeriana, Bogotá,1999.

Barry P. Keating and Maryann O. Keating. An empiri-cal estimation of the degree of expense prefer-ence behavior between credit unions by com-mon bond type. Quarterly Review of Economicsand Finance, 32: 71 – 84, Summer, 1992.

Loretta Mester. Testing for expense preference behav-iour: Mutual vs. stock savings and loans. RandJournal of Economics, 20: 483 – 498, 1989.

1Special thanks are due to Développement interna-tional Desjardins (DID) for the financial assistancethat makes possible the research program on the reg-ulation and supervision of financial cooperatives andother community oriented financial Intermediaries(COFI) on which are based most of the findingsmentioned in this exposition.2The data about the scope of the crisis was obtainedfrom diverse press releases, official documents andpersonal accounts.3All statements about absence or presence of statisti-cal significance are based on a study made of theColumbian crisis in conjunction with the develop-ment of a non-linear early warning system (EWS) forthe FC system of that country. The EWS was devel-oped as a supervision tool for the Superintendency ofBanks and Fogacoop, the cooperative deposit insur-ance fund. Details of the study can be obtained inDesrochers and Fischer (1998).4I do not favor an adoption of Bassle Standards forthe FC sector textually, although some componentscan and should be adopted without much hesitation.However, we should keep in mind that these stan-dards are the result of the accumulated experience ofbank supervisors of the Group of 10. This meansthey are specifically designed to control perverseincentives in a bank and not a FC. This an issue thatis too large to even attempt to address in this presen-tation.

60

our speakers invited by the ICBA

were called in turn to the podium to

make their comments to the audience.

The first, Mr. Enrique Rodrigez, rep-

resentative from SwedBank, presented

the evolution of Swedish cooperative

banking institutions during the last ten

years and in particular the crisis experi-

enced during the 1980s and the restruc-

turing of the 90s.

The second speaker, Mr. Carlos

Heller, of the Banco Credicoop, Argen-

tina, commented on the prevailing situa-

tion in his country, in reaction to the

opinion of Mr. Fischer. According to him

one of the two large cooperative organi-

zations of Argentina has changed its

structure and renounced its cooperative

status. In short, if it failed, it is because it

was not a real cooperative from the

beginning.

Mr. Heller believed that cooperative

directors must today show that coopera-

tion is a form of superior management.

Credicoop functions facing two realities:

as a well-run business and as a coopera-

tive social movement. Both should be

necessary. Solutions to the question of

capital must be found and work must be

done so that the government support the

cooperative sector.

Mr. Heller also recalled the necessity

for a larger presence of the cooperative

movement worldwide. According to him,

the cooperative banks in the world all

have the same problems: capital and the

need for a larger volume of business. He

wished that the cooperative movement

would be able to display a more offensive

attitude and work more concretely

towards integration.

61

COMMENTators

F

EnriqueRodrigez

Carlos Heller

Mr. Mureithi, of the Co-operative

Bank of Kenya, thanked all the organiza-

tions that supported his bank following

the destruction of the bank’s building.

He admitted capital is the key to the

growth of the cooperative movement

and that one of the questions that must

be asked concerns the way change is

managed. He insisted on the fact that the

quality of cooperative governance, by

raising investor confidence, should create

a more stable capital situation.

The changes that we are experiencing

put us face to face with many questions

to answer. How to pay members? How to

choose managers and what powers do

you give them? How to give real equity

interest to our shareholders? What role

should governments play? He insisted

also on the necessity of transparency in

the management of cooperatives and on

disclosure and information sharing. If

the governments have a role to play, the

administrators of cooperatives have a

responsibility to use capital well and to

provide good internal controls. The best

ways of accessing capital must be also

given.

Mr. Alban D'Amours, of the Mouve-

ment Desjardins, in Québec, remarked

that the day’s Seminar was the extension

of a theme discussed two years ago in

Geneva. He noted that as the approach

of today’s participants was more opti-

mistic, then more and more solutions to

capitalization problems have to be

expected from the cooperatives them-

selves. Demutualization is the responsi-

bility of cooperatives rather than

capitalists. The cooperatives have the

responsibility to administer themselves

and to capitalize themselves.

In addition, Mr. D'Amours identified

different questions that needed dis-

cussion in greater depth. Such is the case

for the link between capitalism and

democratization. Capitalization accord-

ing to him brought an element of coop-

erative identity and member relations

also goes through capitalization. The

62

Erastus K.Mureithi

AlbanD’Amours

relation between democratization and

governance also brought out many ques-

tions. He insisted on the importance

placed on control and sound manage-

ment of financial cooperatives and on

the necessary responsibility of adminis-

trators in this matter.

For a synthesis in the discussions,

Mr. Béland reminded of how capitaliza-

tion is fundamental for cooperative

banks and how the sense of innovation

should be used in the future and how

forms of capital should be found not

leading to the demutualization of our

institutions. Member education is funda-

mental because it allows us to battle

against attractive but dangerous short-

term gain.

Mr. Béland informed participants

that the ICMIF would be having its con-

gress immediately after ICA’s Congress

and would discuss this problem of capi-

talization. Studies have been undertaken

by this organization that show the mutu-

als’ point of view in the great demutual-

ization debate by showing that the great-

est losers of this process are often the

members.

Rather than looking for expansion

for expansion’s sake, Mr. Béland believed

that we should above all look to serve

our members more efficiently.

Mr. Béland agreed with the sugges-

tion proposed to identify solutions to the

problem of capitalization and to make

recommendations. The necessary funds

should be found to undertake such

studies.

63

64

A presentation made to the "New

Financial Services in a Global Environ-

ment" Forum, held at the 1999 Congress

of the International Co-operative Alliance

Québec City, August 31, 1999.

Ladies and gentlemen,

Dear friends in cooperation,

et me begin by telling you what

you probably already know: the world of

financial services has been going

through major transformations in the

past few years. And these upheavals

compel every banking institution to take

action and adapt to the new reality.

Numerous mergers and acquisitions

The removal of barriers and the inte-

gration of national economies within

larger entities, such as the single Euro-

pean Market or the North American

Free Trade Agreement (NAFTA), are

part of a huge trend to consolidation in

the financial services sector. Since the

early 1990s, we’ve seen an average of

4,000 mergers and acquisitions per year

in the world financial industry.

Financial institutions are seeking to

consolidate their strengths, bring togeth-

er their complementary expertise,

increase their volume of business, reduce

their costs through economies of scale,

and benefit from the deregulation of the

financial services market, so they can

offer a range of services that is even

more complete.

The mergers and the acquisitions —

whose value has also soared in recent

years — are resulting in a concentration

of assets in the banking sector and the

birth of several financial mega-institu-

tions. For example, the United States

now has 9,000 banks where it had

“Co-operative Banks in a Financial Worldin Mutation: Challenges and Outlooks”

Mr. Claude Béland, Presidentof the Mouvement des caisses Desjardins

L

14,500 in the mid-1980s. And the 10

biggest U.S. banks now control two

thirds of the assets for the whole country

.

Major expenditures on technology

This consolidation of power allows

the very large banks, born in recent

years, to benefit from major financial,

human and technological resources in a

different universe from the world of

more modest institutions. Some of these

huge banks can spend $1 to 2 billion a

year on technology, developing systems

that lets them multiply the distribution

channels for their financial services,

refine the information they have about

their customers and increase the offers

targeted to segments of their clientele on

a massive scale. That’s why banks like

Citigroup — the offspring of the merger

of Citibank and Travelers in the United

States — can devote US$200 million per

year to developing its Internet presence

alone .

We know that the technology —

which makes it possible to inform, inno-

vate and make financial products and

services more accessible throughout the

world — is not about to stop developing.

Technology demands huge investments

from all financial institutions, giving the

most powerful an advantage over the

others.

Productivity on the rise

In the past decade, we saw that the

consolidation of strengths, the rational-

ization of distribution networks and the

new and increasingly sophisticated tech-

nological applications have allowed

banks to increase productivity. The cost-

revenue ratio went from an average of 67

percent in the mid-1980s to 58 percent

today. Certain banks even have ratios

below 50 percent. This has an obvious

impact on the capacity of banking insti-

tutions to compete.

All this makes the challenge even

greater for the cooperative banks, which

have a heavier cost structure than their

capitalist competitors. These develop-

ments are pushing down profit margins,

creating a serious challenge for them to

maintain the competitiveness of their

products and services.

In fact, cooperatives have long been

aware their members won’t hesitate a

second to get products and services else-

where if they find a better deal. Better

informed and constantly solicited, their

members have become more demanding

and more likely to look for the best

value. If banking cooperatives let widen

the productivity gap that separates them

from the big capitalist banks, they will

see their membership dwindle over the

long term or, at the very least, their rev-

enues will shrink. Their members will

simply do less business with their coop-

erative.

Growth in competition

In many countries, the outcome is

that banks are facing an army of new

competitors — and the competition is

deploying every means available to offer

financial products and services. They’re

65

66

going after new customers by mail,

phone, the Internet, home and work-

place visits by sales reps, counters and

mini-branches in retail businesses, what-

ever they can think of.

The competition comes not only

from domestic and foreign banks, but

rather from the “near or quasi-banks”

like finance companies, big companies

that offer a single product (credit cards

or mortgages, for example), insurance

companies, mutual fund management

companies and “virtual banks.” Some of

these institutions use very aggressive

marketing methods offering certain

products at a loss for a specific period so

they can get a foothold in a new territory

and grab awareness and a share of the

market. These tactics put enormous

pressure on the institutions already in

these markets.

These trends, which are rapidly

changing the world of financial services,

are worrying bank leaders all over the

world and pushing them to make multi-

ple changes in their institutions. In fact,

the private banks are as much under

threat as the cooperative banks, and they

must take very similar action.

But because cooperatives have a spe-

cial mission, motivated by their own val-

ues and working under different rules,

and especially because they do not have

the same strengths on every continent, it

is clear the current context poses some

special challenges.

Cooperative banks: worlds apart

However, we must admit that not

every institution in the big family of

cooperative banks is up to the challenge.

The members of the International Co-

operative Banking Association come

from a great diversity of backgrounds,

each in their own part of the world, and

they are not equally equipped to face the

future.

In fact, the financial power of cooper-

ative banks is very concentrated in just a

few countries, while elsewhere the coop-

erative financial institutions must rely on

more limited resources. To find out

more, I suggest you read the Profil des

institutions bancaires coopératives dans le

monde (“Profile of Cooperative Banking

Institutions throughout the World”)

produced for the Association by a team

from the École des Hautes Études Com-

merciales affiliated with the Université de

Montréal. This publication is currently

available in Spanish also.

In it, we learn that the Asian conti-

nent has nearly 45 percent of the cooper-

ative assets in the banking sector, and

that Europe has nearly 47 percent of the

total. America has 8 percent, Australia

and New Zealand have 0.2 percent and

Africa 0.1 percent.

In Asia, 90 percent of assets are con-

centrated in Japan. In Europe, the insti-

tutions in France, Germany, Italy and

Holland account for 80 percent of the

continent’s cooperative assets, and the

23 other countries share the rest. In

America, the cooperative banking insti-

tutions of the United States and Canada

have more than 96 percent of assets and

the Latin American countries have the

remaining 4 percent. We can therefore

say there is a significant concentration of

cooperative banks in certain countries.

In fact, among the 350 cooperative

banks listed in the world, with a total of

US$5,600 billion in assets at the time of

the study, the 30 biggest ones had 98.5

percent of the total assets.

The challenge now for a new or

young cooperative is not the same for a

larger institution competing with the big

capitalist banks to maintain their hard-

won share of the market.

In several countries, cooperatives

must first work to build solid founda-

tions, to organize their networks and get

from their government the legislative

environment necessary for growth.

Several modest-sized banking coopera-

tives are still very fragile. For example, in

the last 24 months problems in some

Latin American countries have resulted

in a more than 25 percent decrease in

cooperative banking assets in this part of

the world. In some cases, assets were

transferred to share-capital banking

institutions. The Asian financial crisis

has also shaken up certain institutions in

that part of the world.

Several small cooperative banks, rela-

tively isolated in their country or region

and unable to count on the support of

institutions that share the same values,

now see themselves compelled to change

their legal and financial structures to the

extent that they find it difficult to be

compatible with the cooperative system.

And, regretfully, it must be said that

the international cooperative communi-

ty has not yet found the best ways to

permanently and concretely help the

weakest members get through these

crises or take them a step farther in their

development.

Certainly, we’ve seen big cooperative

organizations come to the rescue of new

cooperatives sporadically, but this is

mainly through individual action, not

concerted, structured and permanent

action. While forums let us find out

what issues each of us must deal with,

we have yet to find the tools that would

let us act like a truly global movement.

The lack of time, financial con-

straints and the size of the challenges

each of us faces in our own context con-

spire to limit the initiatives that are so

necessary for the international coopera-

tive banking community to become

more active in the development of each

of its constituents.

Some cooperative banks, weakened

by the current situation, have an uncer-

tain future. Others, long established and

better positioned in their market, are

involved in major transformations in

order to be equipped to face a tougher

competitive environment. Some cooper-

ative banks have made acquisitions to

increase their volume. And most must

focus intensely on lowering costs,

automating routine operations and

training employees to become more

mature financial advisers.

Not only must cooperative organiza-

tions around the world face the chal-

lenge of equipping themselves to

offer the best quality services for their

67

members, they, in my opinion, must also

face three more special challenges —

capitalization, improved consultation,

worldwide solidarity and cooperative

education.

The challenge of capitalization

Let’s first look at the issue of capital-

ization. We know banks must have suffi-

cient capitalization, a financial cushion

that protects them against the risks of

lending. When banking activities

increase, the capital must increase as

well. But, in cooperatives the holders of

capital must each have the same degree

of control over their common enterprise

— one person, one vote. Since the capital

they own cannot appreciate over time,

the problem of raising new capital is

inherent to cooperatives.

Because they cannot issue shares like

their capitalist rivals, they must find

other ways to let their members or other

investors inject funds into the coopera-

tive while offering them a good yield and

respecting the ownership and control

structure specific to cooperatives.

Unless and until we can find enough

cooperators who believe in the impor-

tance of their cooperative being well cap-

italized and who agree to invest without

demanding the right to additional votes

nor an increase in value, the problem

will remain and alternative solutions

must be found.

In the past few years, the problem of

capitalization has been analyzed from

every angle. But finding solutions has

basically come down to the ingenuity of

every constituent, not a commitment to

solidarity by the international coopera-

tive community.

The core challenge remains for many

cooperative banks — how to develop

new vehicles that will interest holders of

capital without losing the cooperative’s

identity. This is a tough one, because

markets and governments are rarely

sympathetic towards players they regard

as marginal, like cooperatives. Some

cooperatives have pushed the art of com-

promise a little too far and are already at

the limit of what is acceptable in the

cooperative milieu when it comes to the

control and ownership of the business.

As for the future, one thing is certain:

since the need for capital will continue

tomorrow and for some the pressures

will intensify, the danger is very real that

a cooperative group would cross the line

into the capitalist world.

Building unity of action

In addition to the problem of capital-

ization, it looks to me like the challenges

confronting banking cooperatives will,

sooner or later — and I hope it’s sooner

than later — require concrete action

from the international cooperative bank-

ing movement. Until now, I repeat, we

have mostly stayed at the level of words,

not deeds, and very few exciting initia-

tives have been taken to advance the

cooperative movement. There are some

exceptions, with technical cooperative

activities that are usually of high quality

but quickly point out the huge need to

do more.

68

Everyone has the feeling something

must be done, but no one knows quite

what to do. Beyond special moments like

these, at seminars, conferences and

regional conventions where we partici-

pate enthusiastically, our work is much

too isolated. Greater group leadership is

necessary so we can meet the competi-

tion on a level playing field.

It’s true that actions at the local and

national levels are currently draining a

lot of energy and are probably limiting

availability for building alliances on the

global level. While greater integration on

a national level has served our move-

ments well, globalization leaves us no

choice but to strengthen the bonds that

unite us on a higher level and to turn

them into tools and instruments adapted

to our specific needs that can help us

progress collectively.

The need for cooperative education

Lastly, cooperative banks — like all

other cooperative organizations — face

the great challenge of cooperative educa-

tion. In today’s world, what’s important

is that the banking cooperatives be able

to rely on greater numbers of coopera-

tors — real cooperators, not just cus-

tomers — members who believe in the

value-added of the cooperative formula

for the edification of societies that are

more united and more just, where soli-

darity and democracy let everyone have

some control over their institutions,

including their financial institutions.

In this respect, I believe that the

cooperative movement has a great

future, because many factors are in its

favor, including the advantage of finding

ourselves in a period of history when

world economic upheavals mean local

populations have a profound need for

institutions through which they can

work for their own development. Never

have we heard so much about local

development, the social economy or the

economy of solidarity. All over the world,

citizen groups and communities are

doing the opposite of globalization to

correct its excesses.

The cooperative financial institu-

tions, rooted locally, have a major role to

play. This is all the more evident given

that the current trends in finance and

traditional banking reveal a sector which

has forgotten its primary function and is

attracted to speculation, fast profits and

value-added for its shareholders while

ordinary people need financial institu-

tions whose prime objective is to serve

and support the development of the

community.

Increasingly, we recognize the impor-

tance of financial institutions that are

there for people, that counterbalance the

anonymous and stateless financial

groups. This is the case in Canada, for

example, where the minister of Finance

has committed to facilitating the growth

of cooperative banks, notably credit

unions, in the framework of proposed

reform in the financial services sector.

In my opinion, only by providing

top quality services to members, by con-

vincing them of the value-added in the

cooperative approach and by globalizing

69

solidarity among financial cooperatives

will the cooperative banking movement

have a bright future, something I wish

with all my heart.

70

71

PRESIDENT

Mr. Claude BélandPresidentLa Confédération des caisses populaires etd’économie Desjardins du Québec100, avenue des CommandeursLévis (Québec)Canada G6V 7N5

Telephone : (418) 835.2444Fax : (418) 833.4769Telex : 051.3533

ICBA SECRETARY

Ghislain Paradis(same address as President)internet: gparadis@did.qc.ca

VICE PRESIDENTS ANDREGIONAL CHAIRMEN

EUROPE

Mr. Étienne PflimlinPrésidentConfédération Nationale du Crédit Mutuel88-90, rue Cardinet75017 Paris, France

Telephone : (33.1) 44.01.10.01Fax : (33.1) 44.01.11.63

EAST, CENTRAL & SOUTHAFRICA

Mr. Erastus K. MureithiManaging DirectorCo-operative Bank of Kenya Ltd.P.O. Box 48231Nairobi, Kenya

Telephone : (254.2) 334832Fax : (254.2) 336846/227747Telex : 22938

LATIN AMERICA

Sr. Miguel CardozoAsesor InstitucionalCooperativa Nacional de Ahorroy Credito (COFAC)Casa Central, Sarandi 402C.P. 11000Montevideo, Uruguay

Telephone : (598.2) 96.08.26Fax : (598.2) 96.00.31

ICBA ADDRESSES

72

WEST AFRICA

Representative to be elected

ASIA AND THE PACIFIC

Mr. B.S. VishwanathanChairman, Cooperative Bank of India andPresident, National Cooperative Union of India3, Siri Institutional AreaKhel Gaon Marg.New Delhi 110016, India

Telephone : (91.11)662750/664274/665146Fax: : (91.11) 6861573Telex : 31-73113- NCUI - IN

NORTH AFRICA AND MIDDLE EAST

Mr. Mohamed El HalouiDirecteur des Relations Publiques& Vie AssociativeBanque Centrale Populaire101, Bd. Zerktouni, B.P. 10 622Casablanca 02, Royaume du Maroc

Telephone : (212.2) 20.25.33Fax : (212.2) 47.08.03Telex : 21.723

ICBA ADDRESSES