Will increased supervision strengthen Latam credit co-operatives?

Regulation and supervision across the savings and credit co-operative sector in Latin America could change rapidly, as governments in the region look to explore these institutions’ potential in fostering financial inclusion.

These financial intermediaries, whose origins trace back to 19th-century Germany, are member-owned organisations as opposed to commercial banks, which are shareholder-owned. They do not seek to maximise profits, but rather bolster capital, support long-term growth and improve their members’ well-being.

Financial co-operatives have a strong presence in remote rural areas and generally serve low- and middle-income parts of the population that struggle in accessing financial services from traditional lenders. In Latin America, the sector makes up around 3.5% of total financial assets, according to the German Cooperative and Raiffeisen Confederation (DGRV). However, in some countries, their presence is more significant, with the percentage exceeding 10% in Ecuador, Costa Rica, El Salvador and Paraguay.

In Brazil, their 3% national market share represents a lot in absolute terms, given the size of the country, and as a whole Brazil makes up 50% of all assets of financial co-operatives at the regional level. While most of these institutions are small, some reach a relevant size. For example, Sicredi is the ninth-largest financial institution in Brazil in terms of assets, with a market share of about 1.6%, and is the sixth-largest in terms of deposits, as of June 2021.

The sector’s economic relevance becomes even more evident when looking beyond market share. The Confederation of Savings and Loan Cooperatives of Mexico represent 2% of assets but its nine million associates constitute 15.5% of the economically active population.

“There have been some positive developments happening in Peru and some changes in Honduras, in terms of supervision,” says Matthias Arzbach, project director at DGRV. “And there are some countries with chronic deficits in supervision of credit co-operatives such as Panama, the Dominican Republic, Guatemala and Nicaragua.”

The legislation varies across the countries. Some countries have a dichotomic system of supervision with some co-operatives well supervised by banking supervisors and another, typically more numerous, group of smaller or medium-sized co-operatives controlled by another institution with less demanding regulation.

Supervision

Those savings and credit co-operatives which are supervised and regulated are perceived as less risky by authorities and, therefore, more likely to be allowed to have access to certain services, such as payment or national deposit protection schemes.

In many cases, financing is restricted due to a lack of access to central bank accounts, while credits from abroad in foreign currency, which may offer more attractive interest rates, are not allowed.

Only 50% of the institutions in Latin America and 25% in the Caribbean have direct access to a domestic payment system, according to a 2021 report by the World Council of Credit Unions.

Brazil and Ecuador have managed to create oversight for the co-operative sector and are regarded as good examples in the region. The co-operative sector in Ecuador is segmented into five levels based on size, with each level adhering to a specific type of supervision. Total assets for the sector are $25bn, with 92% of the assets and 86% of the clients concentrated in the first two tiers.

However, the remaining tiers have an important function for members, and require supervision and regulation according to their activities. “That’s according to the principle of proportionality in supervision,” says Diego Herrera Falla, sector lead financial markets specialist at the Inter-American Development Bank (IDB).

Financial co-operatives in many countries are small and offer a limited range of financial services. Therefore, in some jurisdictions, some form of proportionality is often deployed either in the form of simplified rules, or different capital and liquidity requirements.

“Ecuador started to supervise the whole sector 10 years ago and managed to incorporate all of them, approximately 1000 institutions at that time, in a short period of time,” says sector consultant Álvaro Durán.

In Brazil, two co-operative banks act as “central institutions” for the sector, while all credit co-operatives adhere to the sector’s deposit protection scheme.

In other countries, such as El Salvador and Guatemala, the sector has resolved to establish federations offering membership, guidance and self-regulation on a voluntary basis. “That is better than nothing if a federation is doing that. But it is not a perfect substitute for public supervision with an official mandate,” explains Mr Arzbach. In a potential crisis, public officials can act decisively while a federation is more biased and tends to interact with its members on more agreeable terms, he adds.

José Manuel Bautista, project director at the DGRV, says: “One of the main purposes of regulation of saving and credit co-operatives is not the systemic risk for the financial system, but to protect members’ savings.” Indeed, co-operatives usually present a lower risk profile than large banks, which are integrated in the international financial system. The contagion risk in a potential crisis is therefore small among credit co-operatives in most Latin American countries.

Regulatory challenges

However, regulation comes with several challenges. First, regulators need to understand the business models and the function of these institutions in order to properly segment the different institutions within co-operative banking.

Second, the institutional capacity of regulators should be enhanced so that proportionality and other regulatory principles translate into appropriate supervision. This means using the best practices from the banking sector, along with developing ones that apply to the co-operative sector.

“There is the temptation of believing that we can regulate the co-operative banking sector exactly as the banking sector,” says Mr Herrera Falla. “But the type of ownership is very specific and the credit methodologies they use are different.”

In theory, the co-operative sector should be organised as a group with second- and third-tier central institutions and working together with local, regional and central banks, as in Germany, France and Austria. In these countries, the central institution usually also ensures the liquidity within the group, along with other services.

Working as a system would also deliver the full advantages of economies of scale. In Germany, there are around 730 co-operative banks, some of whom are very small. This is possible because they can rely on second-tier institutions for compliance, guidance in risk management, core banking services and full access to payment systems. Thus, even small co-operative banks in Germany are able to offer the same quality financial products and the same high safety standards as larger co-operative banks.

Credit co-operatives which are not part of a group must meet a minimum size to make a reasonable contribution and be viable, especially if they are subject to tight regulations with the associated compliance costs.

As such, they should agree to working within a specific area or with a defined clientele, in order not to be in direct competition with each other. Unfortunately, across practically all of Latin America, co-operatives compete against each other. This means their potential is not fully realised, according to Mr Arzbach.

In some countries, there are co-operatives — typically the larger and more advanced ones — that are asking to be supervised. However, from the supervisor’s point of view there is not much incentive to do so. For example, in a country where the co-operative sector represents 2% of total assets spread over 150 institutions with a high regional dispersion, regulators will incur considerable operational cost without winning much by way of assets by supervising them.

Of course, from an ethical point of view, clearly it would be fairer to protect a deposit independently from the size of the financial institution — especially in the case of co-operatives, which cater to vulnerable citizens and thus make valuable contributions to financial inclusion, notes Mr Arzbach.

Recent developments

The most explicit political endorsement of the savings and credit co-operative sector has come from Colombia, where President Gustavo Petro’s government announced earlier this year that co-operatives will be key to the country’s credit inclusion strategy. The financial regulation unit, under the Ministry of Finance, has plans to create a specific regulation for the co-operative sector in the next few years.

In Peru, the sector was initially supervised by the sector’s federation. “In the past few years, the responsibility of supervision has shifted to the Superintendency of Banks,” says Mr Bautista.

The change, implemented by a 2019 law, followed growth in the sector that reached 20% in annual terms between 2010 and 2018, well above the growth of the economy at the time. Since then, many institutions have been dissolved by the regulator for failing to comply with the rules. More consolidation in the sector is expected as the regulation takes hold.

In Costa Rica, where the sector is basically supervised and regulated in the same way as banks, a public deposit protection scheme was established two years ago with a full application to the well-regulated co-operatives. 

“Because they are supervised in an adequate way, the central bank also is opening its payment system to them,” notes Mr Arzbach. “Several co-operatives in the country have around $2bn in assets.”

However, regulation can also be partially reversed. Two years ago, Costa Rica approved a regulation that established that co-operatives with less than $70m in assets were not going to be supervised by the superintendency. “This might cause deposit [outflows] in the affected smaller co-operatives, as members may be worried by the repercussions from the lack of supervision,” according to Mr Durán.

In some cases, too much regulation can also be seen as detrimental. Last year, Mexican credit unions complained about overregulation of the sector and expressed concerns about the increase in the amount of fines, according to reports in the press.

“The banking problems in the US are demonstrating that smart regulation is probably a good idea for co-operatives, which usually serve members within a specific sector of activity, such as agriculture,” says Eduardo Suárez Mogollón, vice-president of Latin America economics at Scotiabank.

Financial inclusion

With financial inclusion being one of the biggest challenges for the region, credit co-operatives can definitely help solve the issue of underbanked, or even unbanked, parts of the population.

These people might access their first financial product from a co-operative and then mature to become commercial banking clients. While this happens a lot in Latin America, it is less obvious in Germany or in France because in those countries the co-operative sector has been allowed to mature and offer the full range of financial services.

Today, the challenges in Latin America may be exacerbated by changes imposed by the move to digital transactions. Many co-operative lenders are not fully digitised and are used to working in close contact with their clientele.

However, digitalisation may also provide new opportunities. In Colombia, Banco Cooperativo Coopcentral entered into agreements with eight different fintechs using them as digital correspondent banking institutions. “This is fantastic, because it has allowed the co-operative sector to deliver a number of services including digital payments,” explains Mr Herrera Falla.

Withstanding a crisis

Throughout history, credit unions have often proven able to provide a countercyclical liquidity buffer during times of crisis by increasing deposits and maintaining lending. More recently, following the 2007-09 global financial crisis, the sector has proven to be more resilient, according to the International Labour Organization.

Ecuador went through an economic crisis during the 1980s and 1990s, which forced many banks to file for bankruptcy while the credit unions in the country remained relatively stable. Such resilience stems from several factors. As owners of the entities, co-operatives’ depositors are likely to maintain savings in periods of economic uncertainty, thereby ensuring retail funding stability.

The sector is also more risk averse compared to commercial banks, since it aims for social and economic development objectives rather than shareholder value maximisation. Plus, co-operatives are not dependent on capital markets for funding, but are funded through member deposits.