Q&A with Brian Branch

Brian Branch shares his wisdom about how financial cooperatives can overcome the governance and regulatory challenges.

Brian Branch, Chief Operating Officer (COO) of the World Council of Credit Unions (WOCCU), answers six frequently-asked questions about governance and regulatory issues facing financial cooperatives (also known as credit unions).

Brian Branch at an Ecuadorian credit union called CAPECO

1. What are the advantages to financial cooperatives in mobilizing deposits from poor and low-income people?

Credit unions (also known as financial cooperatives or savings and credit cooperatives) mobilize large numbers of small, voluntary savings accounts. According to the 2003 WOCCU Statistical Report, the average number of savings per member is $787. Low-income savers often seek small accounts that offer accessibility, no or very low minimum balance requirements to open and maintain, and a competitive rate of return. These types of accounts can be expensive accounts for an institution to administer, often with low balances and frequent transactions. Credit unions have consistently found ways to serve this lower-end of the savings market by using volunteer services, keeping administrative costs low, and managing interest rate returns on small balance accounts. Credit unions typically are founded by local community leaders driven by a social mission to serve their members and low-income communities, where individuals did not previously have access to formal financial sector services.

Credit unions also help members increase their assets over their economic lifetimes via both savings and credit services. Historical records present a pattern of members saving in small amounts, gradually accumulating to significant amounts over time. At varying periods in their lives, members may demand more savings services while at other times in their life, the same members may demand credit services. Loans, funded by these savings, help low-income members increase their economic activity--and therefore income and assets--during their working years. As their assets and incomes increase, members save more and borrow less. In addition, the ability of credit unions to combine savings and remittance distribution allows individuals to directly deposit remittances into savings accounts, thereby encouraging previously un-banked remittance recipients to integrate into the financial sector and save a portion of their remittances for productive uses.

2. What are the main risks of saving in a credit union? Are poor people more likely to lose their savings in a financial cooperative (compared to other savings options)?

People can lose their savings in credit unions which are not managed well, suffer poor governance, or lack sound financial sector supervision. This is why savers should consider the financial reputation and strength of the credit union. Questions such as, "Do the directors or the professional management group make management decisions?" and "Is the credit union regulated by the formal financial sector supervisor?" are good questions to ask.

Credit unions that operate at a small community or closed-group level often depend upon volunteers to know their neighbors and screen the risk of lending to them. As credit unions become larger, they engage in more sophisticated operations and need professional loan risk screening tools and methodologies. As credit unions move to this level of professional operation, problems of asset quality and then savings impairment or solvency occur if volunteer credit committees are not replaced with professional loan officers and technical credit committees.

Credit union governance risk comes from a balancing act of savers and borrowers. The institutional governance system of credit unions must respond to these two sets of owner-clients with contradictory interests. Net borrowers demand low interest rates on loans, low transaction costs, and lax prudential discipline; while net savers demand high deposit rates and strong prudential discipline to protect their savings. Where credit unions are dominated by net borrowers (who are sometimes the more influential and wealthy individuals in the community), savings are subject to greater risk because net borrowers' incentives run counter to savings protection. Conversely, greater net saver presence in credit union membership and on the Board of Directors will generate savings protection discipline and behaviors that reduce the risk to savers.

3. How can management and governance problems inherent in membership-based institutions like financial cooperatives be overcome?

The International Credit Union Governance Principles call for clear separation of the Board of Directors' monitoring and oversight duties from the operational decision-making responsibilities of management.

By-laws also need to establish clear qualifications for Director-level positions. Directors should have adequate preparation and business experience. This can be strengthened and institutionalized through a training program that provides directors guidance in their roles, and tools such as financial analysis, delinquency reports and business planning techniques to monitor standards and the implementation of policies.

If loans to members of the Board of Directors, the Supervisory Committee, the General Manager or their relatives are permitted, they must be approved by the Board itself according to the same criteria and policies as loans to all other members These loans must be subjected to periodic review. If a Director becomes delinquent in a loan, he/she must resign from his/her position as Director.

While rules and regulations are necessary for good governance, incentives are also needed to induce good behavior. Savings mobilization provides credit unions with incentive patterns for good governance. Net savers are attracted to the membership and participate on the Board of Directors, demanding financial discipline and internal controls to protect their savings. Competition is another effective catalyst for credit union reform and improvement. Improved savings and credit products and balanced governance are often driven by increased competition from downward-reaching formal financial institutions.

4. What are some examples of effective cooperative federations? What makes them effective?

Today, political federations are increasingly being replaced with business networks organized around credit unions that are supervised, meet prudential standards, and have appropriate software and controls. The networks such as REDCOOP in Ecuador and SERVIRED in Bolivia are based on mutual confidence among institutions, common adherence to financial discipline, and an appreciation of the mutual economic benefits of networking. Credit unions participating in the networks present a cohesive image through common logos, signage, and colors for easy recognition, such as Cooperativa Financiera in Nicaragua and Sistema Federado Financiero of Guatemala. Members can conduct their business at any credit union or branch point of service in the network. Networks pool their resources for investment in capital-intensive information systems or negotiating payment services with vendors.

5. What is the best form of cooperative supervision (direct, delegated, self-supervision, or another form) and in what circumstances?

Credit unions are private sector institutions owned and controlled by their members. As such, credit unions operate best without government involvement in first- or second-tier operations. The critical role for government, vis-a-vis credit unions, is to provide technically sound, prudential supervision.

In many countries such as Uganda, Trinidad and Paraguay credit unions are registered under a general cooperatives law, the legislative framework lacks sound financial management statutes and directives. In others, where credit unions fall under a law specific to credit unions, such as Costa Rica, regulatory parameters better address financial sector risk.

The best case scenario has credit unions supervised by the agency, superintendancy or central bank responsible for supervising formal financial sector institutions. The regulatory body then organizes an internal department specializing in credit unions. However, one of the main obstacles tends to be the limited capacity of regulatory bodies to supervise a large number of small decentralized credit unions.

A next best strategy, already used in several countries such as Bolivia and Ecuador, is oversight by the regulatory body of larger credit unions that have achieved a minimum amount of assets, and therefore pose a significant level of risk to the financial sector. In this approach, unsupervised credit unions are limited in the breadth of services that they are allowed to offer.

As a distant third-best solution, legislation may empower the government regulatory agency to delegate monitoring functions to an auxiliary body, such as in Peru and Mexico. In this case, the government agency establishes the prudential standards, and the auxiliary body monitors the credit unions submitting these data periodically. The ownership of such auxiliary bodies by the credit unions being supervised creates significant conflict of interest problems in their operations. The government agency has to have the ability to make spot checks on the status of the credit union or the accuracy of the reports of the auxiliary body at any time. This raises the costs of supervision.

6. What is the most effective role that donors and technical assistance organizations like WOCCU can play?

As the CGAP Donor Brief on credit cooperatives explains, both donors and practitioners can best develop credit unions by building institutional capacity and focusing on deposit mobilization rather than injecting external funds for lending. This encourages the establishment of sound governance policies, which is another area in which donors can be helpful. Training directors in governance standards, as well as in monitoring and business planning tools, can improve credit union results. To further support credit union governance and management, donors should support competent, independent external supervision.

Financial standards are at the core of external supervision and internal management. Credit unions need to run a sound financial business to accomplish their social mission. Donor work with credit unions should incorporate international standards that, at a minimum, cover issues such as capital structure, delinquency/default, operating costs, and liquidity. Donors should concentrate resources on those credit unions that are willing to implement sound policies and standards.

Finally, both donors and practitioners can support credit unions in developing new savings and credit products or techniques to reach poorer customers. Such efforts are more likely to succeed in credit unions that are already financially solid.

References and suggested readings