Philippine Institute for Development Studies
Policy Notes June 2000
Protecting Deposits in Savings and Credit Cooperatives* Gilberto M. Llanto**
In a previous paper (PIDS Policy Notes No. 98-09), this author called attention to the regulatory vacuum surrounding savings and credit cooperatives. Said paper noted that the lack of regulation and supervision of hundreds of savings and credit cooperatives puts at risk millions of pesos of member deposits. This present Policy Notes carries the issue much further by presenting several measures that may help protect members' deposits.
Mobilized deposits in Philippine savings and credit cooperatives constitute a mere 0.2 percent of the amount of M2 (sum of currency in circulation and deposit liabilities of banks)1 in the countr y. In most Latin American countries, however, credit union loans and deposits are about 1 to 3 percent of banking system loans and deposits while in a number of industrialized countries, their percentage share ranges from 10-20 percent of banking system loans and deposits.2 This implies that as the economy develops and grows over time, deposits mobi-
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lized by local savings and credit cooperatives become a sizeable percentage of total financial resources. As such, now is the time to start a serious discussion of measures to protect member deposits of savings and credit cooperatives (SCCs) in the Philippines. Table 1 shows a graphic, albeit incomplete, picture of the relative size of savings and credit cooperatives in the Philippines. It shows that, based on ver y limited and outdated data available at the Cooperative Development Authority, this subsector of the cooperative has a high concentration of organizations with assets below P1.5 __________ * This draws from Gilberto M. Llanto and Cresente C. Paez, “Protecting Members’ Deposits in Savings and Credit Cooperatives.” Paper read at the Credit Unions’ Technical Forum on Protecting Member Deposits, Rembrandt Hotel, Quezon City, March 10, 2000. This forum was organized by the Department of Finance–National Credit Council (NCC), Credit Policy Improvement Program (CPIP), National Confederation of Cooperatives (NATCCO), Philippine Cooperative Center (PCC) and the Cooperative Development Authority (CDA). The views and opinion expressed by the author do not in any way reflect those of the forum organizers. ** The author is Senior Research Fellow at the Philippine Institute for Development Studies. 1 Lee Arbuckle, Rescy Bhawani, Gilberto M. Llanto, Ma. Piedad Geron and Zeno Abenoja, “Review of the Regulatory Environment for Credit Cooperatives and Multi-Purpose Cooperatives with Large Credit Operations.” Credit Policy Improvement Program, National Credit Council, Department of Finance, November 1998.
Glenn Westley and Brian Branch, "Credit Unions Today: Issues and Recommendations for Latin America." Unpublished (n.d.). 2
PIDS Policy Notes are observations/analyses written by PIDS researchers on certain policy issues. The treatise is wholistic in approach and aims to provide useful inputs for decisionmaking. The views expressed are those of the author and do not necessarily reflect those of PIDS or any of the study's sponsors.
2
Table 1. Savings and Credit Cooperatives, December 1996 Asset Size Classification Above P80 million P15 - P80 million P1.5 - P15 million P0.5 - P1.5 million P0.5 and below Total
Number Community in Class 18 51 241 245 412 967
9 24 103 105 221 462
Institutional
Others
2 21 95 89 85 292
7 6 43 51 106 213
Source of basic data: Cooperative Development Authority
million. In the past few years, though, at least 69 savings and credit cooperatives with an asset range of P15 million to more than P80 million have emerged. These big savings and credit cooperatives collect millions of peso deposits from thousands of small savers all over the countr y, with rough calculations indicating that some P2.2 billion pesos have been collected from them alone! Based on this, it should be clear enough why we advocate the need for protective measures of members' deposits in these cooperatives. And while the deposit liabilities of SCCs may appear insignificant compared to those of the banks, three basic conclusions have emerged in various local studies of SCCs,3 namely: ] There is a potential for rapid growth, both in terms of savings accounts and volume of savings, among SCCs; ] Savers come from the ranks of the low and lowmiddle income class; and
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] SCCs provide basic financial ser vices to small savers and borrowers.
What is also immediately noticeable is that a good number of savings and credit cooperatives have bigger financial resources than some rural and thrift banks. By extension, those cooperatives, with neither advertisement nor glowing reports on their effort at savings mobilization, have quietly and persistently collected deposits from thousands of small savers in the communities where they operate as the only accessible financial intermediar y for small savers and depositors.
Measures to protect members' deposits What are some of the measures that will help protect members' deposits? Below are some proposed measures accompanied by arguments espousing their importance. Put in place efficient and effective regulation and supervision.4 Regulation and super vision can protect members’ deposits by ensuring good per formance by the SCCs. Efficient and effective regulation and super vision can grant incentives for good per formance of savings and credit cooperatives and sanctions or penalties for nonper formance. External sanctions effectively applied can be ver y critical in instilling financial discipline that leads to good behavior and per formance.
——————— 3 Arbuckle et al., ibid., Gilberto M. Llanto, “The Regulation of Deposit-Taking Cooperatives.” Policy Notes 98-09, Philippine Institute for Development Studies, December 1998 and Gilberto M. Llanto, “The Financial Structure and Performance of Philippine Credit Cooperatives.” Discussion Paper No. 94-04, Philippine Institute for Development Studies, 1994.
The Bangko Sentral ng Pilipinas (BSP) has clearly demonstrated during the recent Asian financial crisis the importance of resolve in exercising its regulator y and super visor y power to preser ve the integrity of the banking system. The end result was that the Philippine banking system came out of the Asian financial crisis relatively unscathed compared to other banking systems in the region. Stable banks generate the confidence needed to motivate thousands of depositors to put their hard-earned monies in the banks as deposits.
This sub-section draws from Gilberto M. Llanto, ”On Performance Standards and Regulation of Deposit-Taking Cooperatives.” Paper read at the Fifth Technical Forum on Cooperative Performance Standards and Self-Regulation,” Visayas Cooperative Central Fund Federation (VICTOVCF), Centerpoint Hotel, Cebu City, October 22-23, 1999.
By contrast, the concerned government agency responsible for cooperatives had chosen to focus on the organization and development of cooperatives, in particu-
4
Policy Notes
3
lar, the registration and establishment of SCCs. In the process, it has not and does not fully exercise its power to regulate and super vise SCCs. The effective and efficient regulation of SCCs would have resulted in the removal from the registr y or outright closure of erring savings and credit cooperatives. External sanctions could have helped improve the performance of erring SCCs and breed more confidence in the local communities where they operate. However, as it is, SCCs hardly mind the government agency’s super visor y authority since they perceive its weak super visor y capabilities. Of course, there are those who believe in the adequacy of self-regulation among SCCs to guarantee good financial per formance. This view says that built-in control and checks and the democratic processes within SCCs already guarantee responsible per formance among the SCCs. It maintains that members monitor and impose organizational discipline through rewards and sanctions exercised by the general assembly. But while this is the expectation, the reality is that members, especially active savers, do not have the information to assess the financial per formance of their savings and credit cooperatives. The well-known asymmetr y of information problem common among financial institutions is stacked against the ordinar y saver and member who may know ver y little about the risky behavior of the savings and credit cooperative. How many members attend general assemblies and really scrutinize the reported operations of the savings and credit cooperatives? How many members are really equipped to make informed judgment on the reported per formance during general assemblies? How frequently is financial and operating information shared to members? It is fairly difficult to have a well-represented general assembly, especially if the SCC has grown in membership. This puts at risk the financial and business discipline that an informed and interested general assembly can impose on the organization, especially its manager and staff members. In this regard, self-regulation can only be effective to a certain extent to motivate good per formance. As
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such, efficient and effective regulation and super vision by an external body will be necessar y to have stable and financially strong SCCs, henceforth leading to the protection of members’ deposits. Generate greater trust through assurance of better integrity of system. Savings and credit cooperatives find it essential to generate mutual trust among members of the organization as a mechanism for deposit mobilization and as a good substitute for traditional collaterals such as real estate mortgage, chattel mortgage, and others. Mutual trust and, of course, attractive yields motivate deposit mobilization among members. However, while these may prove effective in mobilizing sizeable deposits, there is not much room for expansion as the deposit mobilization effort could easily approach a plateau defined by the limited number of active members in the organization. The expansion of membership and deposits, in turn, are usually constrained by the lack of general confidence in the stability and strength of the organization. On the other hand, regulated private banks do not have to use mutual trust or social means such as participation in organizational activities, distribution of patronage refunds, dividends, and others, to attract and maintain clients. They simply rely on hard collateral to discipline their clients and use market incentives, particularly attractive financial products and ser vices, to gain new clients and retain old ones.5 They also exploit to the fullest the public trust conferred on them by effective oversight and regulation by the Bangko Sentral ng Pilipinas to mobilize billions of pesos of deposits. The lack of effective regulation and super vision of deposit-taking entities therefore not only puts doubt on the integrity of the cooperative system but also fails to generate greater trust within the community. And while ———————— 5 A related discussion is in Hans Seibel, Benjamin Quinones, Jr. and Gilberto M. Llanto, “Social Capital in Microfinance: Case Studies in the Philippines.” Asia and Pacific Development Centre, Kuala Lumpur, Malaysia, 1999.
Policy Notes
4
some SCCs continue to argue about the effectiveness of self-regulation through the active and vigilant participation of members, the fact is that many of them operate in a regulator y vacuum which raises fears on how effectively protected are member deposits. How have other countries approached the regulation and super vision of savings and credit cooperatives? Box 1 shows the Bolivian approach to regulation and super vision.6 Institute performance standards for financial discipline.7 How can performance standards lead to the protection of members’ deposits? The causal relationship between per formance standards and protection of mem-
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bers’ deposits may not be self-evident. What may explain this is the principal-agent problem common among financial institutions or for that matter to institutions where shareholders (principal) do not have adequate information on the (risky) behavior of their manager (agent) and make use of specific instruments to monitor, evaluate, reward or sanction that behavior. ———————— 6 From handouts and notes of Cresente Paez (November 1999) and Gilberto M. Llanto (February 1999) made during their respective trips to Latin America. 7 This section draws from Gilberto M. Llanto, “On Performance Standards and Regulation of Deposit-Taking Cooperatives.” Visayas Cooperative Central Fund (VICTO) Fifth Technical Forum on Cooperative Performance Standards and Self-Regulation, Centerpoint Hotel, Cebu City, October 22-23, 1999.
Box 1. Bolivian Approach to Regulation and Supervision of Credit Cooperatives ]
Bolivia has two cooperative laws, namely: (a) general cooperative law; and (b) savings and credit cooperative law. While the credit cooperatives are highly regulated, the government does not have any support for the rehabilitation of distressed ones. Rehabilitation is viewed as a very expensive solution.
]
The same rule of discipline is imposed on both credit cooperatives and banks. Because both are financial institutions, the money that goes into the institution, whether from a member making a deposit with his cooperative or from a person making a deposit with a bank, has to be protected by government. Money in the bank is the same as money in the cooperative. Regulation and supervision are means to ensure the safety and soundness of the institutions.
]
The Superintendency of Banks conducts an evaluation of credit cooperatives every 6 months and requires them to submit financial statements monthly.
]
Under the new banking law enacted in 1993, credit cooperatives are included in the regulation and supervision by the central bank. Credit cooperatives are given 3 years to prepare on whether or not they choose to become open-type cooperatives. Those who will not qualify under the new requirements of the Superintendency of Banks will be subjected to liquidation.
]
As part of the regulatory function of the Superintendency of Banks, credit cooperatives are subjected to categorization based on minimum capitalization and net worth. The purpose is to determine what type of services the credit cooperative would be permitted to provide.
]
Of the 180 savings and credit cooperatives, 60 were supervised by the Superintendency of Banks in 1993. With strict compliance of standards, only 17 cooperatives were qualified to operate as “open type” as of October 1999. Open-type cooperatives are those that are allowed to transact business with nonmembers. Close-type credit cooperatives are registered and supervised by INALCO, a government agency similar to the Cooperative Development Authority (CDA). Open Coops – (a) can contract obligations; (b) can accept deposits from public; (c) can encash checks; (d) registered and supervised by the Superintendency of Banks. Close Coops – (a) cannot contract obligations; (b) cannot accept deposits from public; (c) cannot encash checks; (d) registered and supervised by INALCO.
Policy Notes
5
Per formance standards give a benchmark indicator of risky behavior or good per formance, thereby helping in setting up credit rating systems for savings and credit cooperatives. Banks already have per formance standards and are currently rated in the credit markets by private rating agencies. Credit rating will be of particular interest to commercial lenders and clients who want to evaluate the financial standing and per formance of savings and credit cooperatives. Without a commonly-accepted and implemented set of industr y per formance standards, it becomes fairly difficult to gauge the financial standing and per formance of savings and credit cooperatives and make informed decisions on their quality as financial intermediaries. While there are those savings and credit cooperatives with adequate capitalization and substantial deposits, there are also those at the other extreme, characterized by inadequate capitalization, poor organizational and operational structures, weak internal control systems and inappropriate financial technologies and systems. Per formance standards are important because they supplement prudential regulation and they can be a good guide for prudent behavior. They can, however, only go so far since their utility may be limited by the fact that adherence to a set of per formance standards may be difficult to achieve without an external disciplining body. In the credit union industr y, a commonly-cited set of per formance standards is that based on the World Council of Credit Union’s PEARLS system, a set of financial ratios or indicators. The PEARLS system is used as a monitoring tool to compare credit unions and has 39 ratios that are grouped to measure the following: P E A R L S
-
Protection Effective financial structure Asset quality Rate of return and cost Liquidity Signs of growth
Box 2 describes the Guatemalan experience regarding the use of per formance standards.
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"Without a commonly-accepted and implemented set of industry performance standards, it becomes fairly difficult to gauge the financial standing and performance of savings and credit cooperatives and make informed decisions on their quality as financial intermediaries."
Build basic information structure. Without a standard and uniform chart of accounts, it will be virtually useless to talk of regulation, supervision and performance standards. An initial step toward this objective is the current effort by the National Credit Council, primar y cooperatives, federations and unions to develop a standard chart of accounts and manual of accounting procedures for savings and credit cooperatives. Different accounting systems have been used by different groups and the federation of credit cooperatives all these years. The situation is compounded among multi-purpose cooperatives in which financial and nonfinancial activities, i.e., mercantile, are both considered important. A standard chart of accounts, a manual of accounting procedures, together with a set of per formance standards, will be important infrastructure for establishing and implementing an appropriate regulator y framework for savings and credit cooperatives. An example of the need to have a standard chart of accounts is shown in the treatment of members’ share capital. A common understanding and approach to the treatment of share capital is critical in view of the capital adequacy regulation that has to be imposed on savings and credit cooperatives to limit their risk exposure. Capital adequacy regulation requires the maintenance of a minimum capital to risk-weighted assets ratio. This helps limit risk-taking by the institution.
Policy Notes
6
June 2000
Box 2. Guatemalan Credit Unions' Serious Attitude towards Performance Standards The Federacion Nacional de Cooperativas de Ahorro y Credito Servicios Varios (FENACOAC) is the National Credit Union Federation in Guatemala which provides technical assistance to member cooperatives and, at the same time, operates a central liquidity fund for members. Market-oriented credit and interest rate policies are being pursued by FENACOAC to ensure sustainability. ]
While FENACOAC regulates its member cooperatives, it also argues that self-regulation has its own limitation. “Check and balance” is still an issue. Because of this situation, the FENACOAC, together with the World Council of Credit Unions (WOCCU), is now putting up an independent rating agency. The rating agency's board will consist of 2 WOCCU representatives and one from the banking sector (Federation of Banks of Latin America).
]
In their view, supervision is important because of the following: (a) It is a great responsibility to protect the money of the members; (b) Members' money are small people’s money and are therefore sacred; and (c) Savings and credit cooperatives are identified as one sector of the financial system.
]
As part of the FENACOAC, every credit cooperative has to abide with a set of uniform accounting and performance standards known as "financial discipline." In their view, if there is market transparency in the credit cooperative system, the public will have more confidence. This is the role of the regulator and supervisor. There is no point of talking about deposit guarantee system if the credit cooperatives do not have a good supervisory mechanism.
]
There are 32 member credit cooperatives with 108 service centers or branches and with a combined membership of 300,000. FENACOAC manages a central liquidity fund; 18 of the 32 credit cooperatives joined the fund whose total assets reached $33.5 million (P1.34 billion). Regulation is necessary to protect the fund.
]
FENACOAC provides liquidity loan to member cooperatives. Equity contribution of members amounted to $82 million (P3.2 B) and delinquency rate, to 8 percent.
]
Of the 330 municipalities, 26 percent are covered by the FENACOAC members.
]
Thirty-five banks are now experiencing serious liquidity problems.
]
Credit cooperatives have a share of 3.5 percent to 4 percent of the total assets of the financial system.
]
With the assistance of WOCCU since 1983, there has been a change in the mindset of the cooperative leaders as to development orientation and direction. WOCCU provides the technology on accounting system and financial monitoring.
]
The system of financial performance rating of credit cooperatives is computerized and generated monthly. It excludes the qualitative assessment conducted periodically.
On this issue, two schools of thought emerged during the deliberations of the Technical Working Group on the Chart of Accounts organized by the National Credit Council. The first wants to treat share capital as part of institutional capital. This means that it becomes part of the long-term resources of the savings and credit cooperative. Members who want to terminate their membership from the cooperative will not be allowed immediate and on-demand withdrawal of their share capital. Instead, they will be required to look for buyers of those shares. As such, the savings and credit cooperative’s institutional capital will not be affected by the withdrawal of
Policy Notes
members. The downside is that members will have to exert effort to find willing buyers; otherwise, the shares get locked up with the savings and credit cooperative. The second approach is to exclude members’ shares from institutional capital. Thus, members who want to withdraw their membership from the savings and credit cooperative will be able to immediately withdraw their shares. This is a policy favorable to members but can be detrimental to certain cooperatives that have failed to maintain an appropriate ratio of institutional capital to risk assets. The institutional capital is supposed to pro-
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vide a “significant cushion to protect both the deposits and shares of members, to meet emergencies, and to fund long-term growth.”8 A savings and credit cooperative that has neglected to build its institutional capital base will be severely weakened by the withdrawal of a substantial amount of member shares. Other issues concern the minimum capital adequacy ratio. The common obser vation is that this should be higher for savings and credit cooperatives than for banks because of the limited geographical diversification of their loan portfolios and funding sources, among others. Since there are no strategic investors in savings and credit cooperatives with the incentive to monitor their profitability, efficiency and solvency,9 it is best to prescribe a higher capital adequacy ratio for cooperatives to ensure their stability. Consider a deposit insurance for SCC deposits. Concern for the safety of public deposits in banks has driven governments to provide deposit insurance. Banks use deposits to fund loans and investments. However, there could be a mismatch between the desire of depositors to have these deposits payable on demand and the bank’s provision of loans that are collected in time. The mismatch gives rise to prudential concerns since depositors rarely have adequate information on bank lending and investment behavior. Banks are in the business of “maturity transformation,” a situation where deficit units of the economy borrow and repay over a relatively long period of time and surplus units surrender their liquidity at a price but at the same time expect deposits to be ———————— 8 Glenn Westley and Brian Branch, “Issues and Recommendations for Latin America.” Chapter in a soon-to-be published book, no date given.
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payable on demand. In this regard, equity and borrowing have to be complemented by deposit liabilities. Regarding the view that deposit insurance leads to excessively risky behavior by banks at the expense of the depositors and taxpayers who ultimately shoulder the cost of protecting deposits,10 this author accepts the idea that deposit insurance cannot be taken as a stand-alone measure to protect members' deposits in SCCs and cannot be separated from the two other previously-mentioned measures, namely, efficient and effective regulation of SCCs and per formance standards for SCCs.
"...Deposit insurance cannot be taken as a stand-alone measure to protect members' deposits in SCCs and cannot be separated from...efficient and effective regulation of SCCs and performance standards for SCCs."
Nonetheless, there is merit in considering the usefulness of deposit insurance or guarantee to deposits in savings and credit cooperatives typically made by small savers. Certainly, small savers should not be made to pay for the failure of a bank although some would argue that in a “caveat emptor” market, it is incumbent on each depositor to make judgments about the solvency of his depositor y institution. But if the government and large depositors who have access to better information cannot themselves monitor and make accurate judgments on the solvency of a depositor y institution, how can we even expect small depositors to do the same?11
Westley and Branch.
9
10 An astute observer of Asian financial markets has this to say: “Although such systems (of deposit insurance) distort competition as they tinker with the balance between risk and reward, the moral hazard they engender is usually outweighed by the increased public confidence they bring to an imperfect market.” P. Delhaise, Asia in Crisis: The Implosion of the Banking and Finance Systems. Singapore: John Wiley & Sons, 1998.
See ibid.
11
By the same token, this is an opportune time to call for a serious study on the wisdom of making deposit insurance available to SCC depositors. The study should consider the basic insurance principles, namely, (a) application of deductible amount; (b) the use of risk-related insurance premiums; and (c) adequate capitalization of the company or entity that provides insurance.
Policy Notes
8 Conclusions and recommendations Throughout the years, savings and credit cooperatives (SCCs) have shown how effective they are in mobilizing millions of pesos of deposits from thousands of members, mostly coming from the low and middle income classes. They have grown to be even bigger than some rural and thrift banks and have provided small borrowers with a reliable alternative to informal moneylenders in various communities. What is even more important is that they have given thousands of small savers accessible deposit facilities. In view of this, the need to institute prudential norms and oversight measures to protect members’ deposits in these organizations becomes pronounced. As the SCCs tr y to expand and grow both in terms of membership and assets, members will certainly feel the need to have more and better information about these organizations. Members, as owners of the SCCs, need to know how efficiently the managers and the board of directors run the shop. Is there integrity in the transactions? Does management provide loans that are going to be collected on
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time? Are members’ deposits safe and earning adequate returns? These and other questions arise. A number of measures have been proposed in this Notes. These measures will help instill discipline on the part of the SCC management and staff members so as to make the cooperatives even stronger. At the same time, the role of deposit insurance to protect members' deposits is something that needs to be given serious thought. 4
For further information, please contact The Research Information Staff Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street Legaspi Village, Makati City Telephone Nos: 8924059 and 8935705; Fax Nos: 8939589 and 8161091 E-mail: gllanto@pidsnet.pids.gov.ph jliguton@pidsnet.pids.gov.ph The Policy Notes series is available online at http://www.pids.gov.ph
List of Policy Notes for 2000 2000-01
Hatchery-Bred Milkfish Fry: A Must for Fisheries Development! Danilo C. Israel
2000-02
Competitiveness of the Philippine IT Industry: What Lies Ahead Myrna S. Austria
2000-03
Mercury Pollution Due to Small-Scale Gold Mining: A Serious Menace! Danilo C. Israel
2000-04
Is LandBank EO138 Ready? Mario B. Lamberte
2000-05
Shifting the Country's Customs Valuation System to Transaction Value: What Can We Expect? Erlinda M. Medalla
2000-06
Defining the Agricultural Biotechnology Policy of the Philippines Saturnina C. Halos
2000-07
Banning Commercial Foresting: What are the Costs? Christian M. Dufournaud, Michael Jerrett, U-Primo Rodriguez, John T. Quinn, Arlene B. Inocencio and Joseph J. Harrington
Policy Notes