Efficiency and Supervision of Financial Cooperatives: The role of federations/apex institutions and the legal/regulatory framework

By Jose Rutman, Rachel Sberro-Kessler and Rubiga Sivakumaran 

“We are in a sandwich” says one participant of the FECOLFIN workshop in Colombia, organized on March 25th to promote the integration of Cooperative Financial Institutions (CFIs). Financial cooperatives in Colombia serve around 6 million people, and are member-based financial institutions, governed by and for their members. Although they have existed for decades and fulfill an important economic and social role in the country, providing financial services to low-income segments (including in rural areas), many of them are too small to remain competitive today. For this workshop participant, “being in a sandwich” refers to two simultaneous trends: on the one hand -in a low interest rate environment- nominal spreads and financial margins have been significantly reduced, negatively impacting CFIs whose main income comes from interest on loans), and, on the other hand, FinTechs as well as commercial banks compete with CFIs, due to their possibility to offer digital finance (mobile payments) and real-time credit to rural borrowers (e.g., usage of alternative data-based algorithms that facilitate credit risk assessment and speed up the credit process). Struggling to keep up with the increasing investments in technology and innovation of their competitors, CFIs are in a competitive disadvantage, leading to an aging customer group and being unable to grow with their most successful customers.

In this context, and as part of the global partnership with Rabo Partnerships to strengthen financial cooperatives networks, the World Bank is supporting Supersolidaria, the supervisory agency of CFIs (credit and savings financial cooperatives) in Colombia, to strengthen the regulation and supervision of CFIs and ultimately strengthen CFIs in Colombia[1]. International experience shows that the regulatory and supervisory framework of the CFI sector can indeed play a key role in facilitating its sound development and growth (including the viability of the individual CFIs) and that they have -beyond their core function to ensure stability- important consequences on the structure and efficiency of the CFI sector.

For instance, CFI's regulatory framework can mandate or facilitate a certain level of consolidation within the sector. This can be done in various shapes and forms – raging from full consolidation to the formation and operationalization of federations and other types of apex institutions that provide different types of services to CFIs (such as treasury, IT/core banking, internal control, marketing, product design, among others). The development of   shared functions can improve the sustainability of CFIs through two main channels: 1) By offering various type of services to CFIs in an efficient and affordable way, federations/apex institutions can help achieve economies of scale and get access to these services that CFIs would not be able to get individually and ensure that the network remains competitive and adds value to members ; 2) By providing some type of centralized service of accounting and administrative processes/policies, as well as support for the internal control, federations/apex institutions can improve the efficiency of the supervisory process and therefore reduce the costs for both the supervisory agency as well as CFIs (e.g., the access and process of information for supervisory purpose are facilitated thanks to a better core banking system of CFIs; the strengthened internal control outsourced in the federation/apex institutions improves the risk management and reliability of data of CFIs ); in some case the federation/apex can even perform some type of supervision duties on behalf of Supervisors (the so-called “auxiliary” or “delegated” supervision).

How this looks like in practice: some examples from around the world

In the case of Poland, CFIs established as cooperative banks are obliged to be part of a network called “Institutional Protection Scheme” (IPS)[2]. Each IPS network also comprises a commercial bank that has the main purpose to provide funding to CFIs and to manage the funds of the IPS. The IPS plays a central role in ensuring the stability of the network and its affiliates as it performs the internal control tasks of the affiliated CFIs and as it can provide CFIs in distress with solvency and liquidity support in coordination with the supervisory agency (the Polish Financial Supervisory Agency).

In the case of Brazil, CFIs are incentivized to be part of the apex institutions called “Central Cooperatives”, as they offer several services to CFIs (complemented by confederations -composed by several “Central Cooperatives”- as well as associated cooperative banks) and perform some supervisory duties on behalf of the Central Bank of Brazil (CBB). For a small CFI, being affiliated/member of a “Central Cooperative” facilitates the access to key services while the supervisory process is more efficient and less costly than being supervised directly by the CBB.

Finally, in Mexico all CFIs must be registered in the Protection Fund (named FOCOOP). Those CFIs whose assets are above a certain threshold must be also authorized by the banking supervisory agency (CNBV)[3]; they are under the regulation and supervision of the CNBV with the support of the Auxiliary Supervision Committee (part of FOCOOP). The powers, functions and responsibilities of the latter include keeping of records, exercising auxiliary supervision, making recommendations / observations to the CFIs, reporting supervision results to CNBV, among other. CBNV (which has a specific CFIs´ supervision department) keeps the authority to license, regulate, supervise, and sanction CFIs.  

Some conclusions

We started this blog with the “sandwich statement”, explaining the main challenges of Colombia’s financial cooperative sector. We end it by concluding that achieving economies of scale - in a way that is suitable for the network - is part of the solution. In the long-term we envision a joint approach among financial cooperatives. However, the scattered landscape of regional cooperatives, varying in size and professionalism, should align on this strategic direction first. The regulatory and supervisory framework can play a role in facilitating this,  providing instruments and incentives to enhance efficiency for the benefit of the stability and development of the CFI sector. In that regards, the strategy of regulation and supervision should consider the following aspects:

• Importance of an appropriate design of an auxiliary supervision / control scheme to deal with a large number of small and dispersed CFIs.
• Need to define mechanisms from the regulation (Incentives? Obligation?) so that CFIs (especially small ones) adhere to integration schemes that allow them to benefit from economies of scale, in order to:
  • Improve CFIs´ management (technology, internal control, risk management, etc.)
  • Facilitate their supervision.
• Efforts to improve regulations and supervision must be accompanied by a strengthening of the CFI sector, including federations and apex institutions.
• Transition period: has to be clearly defined (considering the goals and intermediate targets to be met), with a close follow-up and actions to be taken in the event of non-compliance.