The Performance of Financial Co-operatives in the Financial

Crisis: The European Experience (so far)

Panu Kalmi

CCCBE, UVic

Nov 28, 2010

The performance of co-operative banks in the crisis

• Some controversy on the performance of co-operative banks during the crisis

• For instance, compare FT Sept. 2, 2009 (”Mutual Suspicion”) to Economist Jan 21, 2010 (”Mutual Respect”)

• The issue can be resolved only by using statistical analysis and adequate samples

The structure of presentation

• The forms of stakeholder-oriented banks in Europe

• Some reasons why co-operative banks may be less (or more) affected in the crisis

• Actual experience during the crisis

The typology of stakeholder-owned banks

• The stakeholder banks in Europe can be divided into two main categories:

• 1) co-operative banks• 2) savings banks• A crucial difference between the two is that co-operative

banks are member-owned (members share the surplus and control), whereas savings banks are non-profit organization (those who control the bank cannot appropriate the surplus; customers do not have voting rights)

• In both cases, the sharing of surplus is limited and there are other goals than profit maximization; social goals such as financial inclusion and enhancing the welfare of the communities in which they are located

Historical origins

• Savings banks have their origins in the charitable organizations: ”Mounts of Piety” run by Catholic church in the middle ages, German municipal banks starting in the early 19th century, and charitable banks started by wealthy individuals (Germany, Scotland, Scandinavia)

• Co-operative banks were started as mutual self-help organizations in the second half of 19th century by two German reformers (Raiffeisen and Schultze-Delitzsch) and spread quickly to other European countries: division between rural and urban credit co-operatives

• UK building societies, co-operative organizations involved in housing finance (starting from the 18th century)

Economic importance of stakeholder banking: examples

• In France, the four co-operative banking groups have around 60% share in deposits

• Other countries where the market shares of stakeholder-owned banks in the retail market is over 50% include:

• Germany (savings banks and coop banks)• Austria (coop banks and savings banks)• Spain (mostly savings banks)

Forms of co-operative banking in Europe

• Formation of networks is a common feature of financial co-operatives everywhere; however, the strength of the network differs

• Desrochers and Fischer (2005) made a distinction between consensual and strategic networks

Consensual networks

• Pooling of resources: payment systems, credit cards, IT systems, employee training etc.

• Limited competition of members within the same network

• Joint brand name

• Strategic planning from the centre; however, no mandatory compliance

Strategic networks

• Include the above characteristics, and in addition• Strategic direction from the centre; mandatory

compliance (especially in the case of banks with financial problems)

• Mandatory auditing of member banks by the network, centre has rights to intervene

• Contractual solidarity: member banks jointly liable for the debts of each other through mutual insurance schemes

• The centre often owns subsidiaries, that provide e.g. insurance, investment and corporate banking, international operations

Examples from both groups

• Consensual networks: UK building societies, Italian Banche Popolari, Spanish co-operative banks

• Strategic networks: French co-operative banking groups, German, Austrian, Dutch, Finnish, Swiss groups, Italian BCC

Savings banks

• Private (foundation) ownership: Spain, Scandinavia

• Public ownership: Germany, Austria, Switzerland

Characteristics of stakeholder banking

• Maximization of consumer surplus instead of profitability

• Focus on SME lending and consumer markets (especially mortgages) instead of large companies

• Relatively high loan-to-assets and deposit-to-liabilities ratios

• Often higher equity reserves

How these characteristics are related to crisis exposure: potential advantages

• Limited risk taking

• Information benefits (know the borrowers)

• Higher equity reserves as cushion during crisis

• Deposits as main funding source: more stable than interbank borrowing

How the characteristics are related to crisis exposure: potential disadvantages

• Higher exposure to mortgage loans, lower degree of securitization

• More dependent on the state of real economy: might have become more vulnerable when ”financial” crisis turned into ”economic” crisis

• In other words, stakeholder-owned banks may have suffered from problems they did not generate in the first place

What is the impact of integration?

• Both types of integration, but especially tight federation, allow small banks reap economies in scale

• Auditing of member banks helps to control the managers• Network members are able to pool risks (e.g. regional

differences in housing markets)• However, the entire network may be jeopardized by

individual bad decisions (e.g. in derivatives markets)• The exposure of centres in investment banking and

international operations have increased this risk

Empirical evidence: initial analysis

• Source: bank ratings from international ratings agencies (Fitch, Moody’s)

• Data consists from around 150 European banks

• Ratings changes between 2006-2009

• Note: the raters evaluate only large banks or networks; the results may not be generalizable to small financial institutions

Results

• I concentrate here only on Moody’s ratings (however Fitch results are similar)

• In 2006, tightly federated co-operative banks (or strategic networks), private savings banks and commercial banks had roughly similar ratings; however, share of problem banks higher among commercial banks already then

• Independent co-operative banks and publicly-owned savings banks are perceived as being less strong

Further results

• In 2007, private savings banks are downgraded; this is likely a reaction to subprime crisis and its implication to mortgage markets: Spanish Cajas were heavily involved in mortgage markets

• In 2008, tightly integrated co-operative banks downgraded more than commercial banks

• In 2009, downgrades in all classes; however federated co-operative banks do relatively well compared to commercial banks; independent co-operative banks (especially UK building socieites) are heavily downgraded

Performance of groups of banks

• Best performers: Rabobank (consistently ranked as among the best banks in Europe), Credit Agricole, OP-Pohjola

• Problem federated banks: Austrian Raiffeisen and Volksbank groups, due to their investments in East Europe

• Building societies and Spanish savings banks ranked low because of their involvement in mortgage markets

The merits of the ”strategic network” model of financial co-operatives

• Already before the crisis, the tightly integrated co-operative banking groups in Europe were among the best performing European banks

• During the crisis, their position has been more stable than that of profit-maximizing commercial banks or private savings banks

• In addition, they have been regarded as more stable than more loosely networked co-operative banks

Merits of strategic networks, continued

• Allow simultaneously to reach economies of scale from pooling resources, and retain local control of individual banks

• More diversified than banks in looser networks; are not locked in in problematic markets (cf. building societies or Spanish cajas)

• More resistant to demutualization processes than individual co-operative banks

Problems of strategic networks

• However, sometimes there are conflicts between local banks and the centre, especially if the centre has ambitious plans for expanding to non-core markets (e.g. Austria, investment banking policies of some French banks)

• If these problems are sufficiently serious, they may bring down a network consisting of healthy local banks

Comparison with credit unions

• The economics literature finds consistently that credit unions (unlike European federated coop banks) have economies to scale; credit unions respond to this issue by mergers, rather than tighter federation

• Tight integration among European coop banks an outcome of historical process; not easy to replicate to another context

• Continental European firms in general rely more on networks than North American or UK firms; a cultural issue?