An Evaluation of the Regulation and Supervision of Co ...

An Evaluation of the Regulation and Supervision of Co-operative

Financial Institutions in South Africa

Mclntosh M Kuhlengisa

Research report presented in partial fulfilment of the requirements for the degree of Masters in Development Finance in the Faculty of Economic and

Management Sciences at Stellenbosch University

Supervisor: Professor Meshach Aziakpono

Degree of Confidentiality: A March 2011

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DECLARATION

By submitting this thesis electronically, I, Mclntosh Mufunani Kuhlengisa, declare that the

entirety of the work contained therein is my own, original work, that I am the sole author thereof

(save to the extent explicitly otherwise stated), that reproduction and publication thereof by

Stellenbosch University will not infringe any third party rights and that I have not previously in its

entirety or in part submitted it for obtaining any qualification.

M.M Kuhlengisa 18 January 2011

Copyright © 2011 Stellenbosch University

All rights reserved

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ACKNOWLEDGMENTS

First and foremost, I would like to acknowledge my God, for whom all things are possible.

I would like to express my sincere and deep gratitude to my supervisor, Professor Meshach

Aziakpono for his professional guidance and constant support throughout the course of the

study. Similarly, I am indebted to my work superiors, Mr. David de Jong and Mr. Robert Mbeza

for their continuous assistance and invaluable advice throughout the course of the thesis.

During this work, I had the privilege of collaborating with many colleagues within the CBDA and

SARB for whom I have great regard and wish to extend my warmest thanks to all those who

have helped me with my work in one way or another.

Last, but certainly not the least, I owe my loving thanks to my wife Judith and our young

gentleman, Christiaan, both who have suffered during this research due to my long working

hours, locked doors and absence. I am sure without their constant support and encouragement,

completing this work would have been an insurmountable task.

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ABSTRACT

Co-operative financial institutions (CFIs) as a concept has been in existence in South Africa for

a number of years either as credit unions, “stokvels”, savings and credit co-operatives and/or

FSC‟s. As a result, regulators have long realized the need and potential of the CFI concept, with

an exemption notice promulgated in 1994 and the Co-operative Bank specific legislation in

2007, allowing institutions modeled around a common bond to take deposits within certain

conditions, to ensure the safety and soundness of such institutions and to facilitate financial

inclusion.

The study provides an overview of the regulatory and supervisory frameworks for CFIs in South

Africa, noting the roles of various regulatory stakeholders as well as the perceptions of the

regulated institutions.

The study finds that despite the small size relative to the overall economy, and the low

penetration rates, the CFI sector in South Africa is providing financial services to marginalized

communities. However, capacity is a major constraint in the development and growth of the

sector. As a result, any supervisory interventions will be pointless in the absence of appropriate

capacity interventions. Despite the existence of various regulators, regulatory and supervisory

oversight is considered weak. There is lack of clarity on the various roles of the different

regulators within the sector, raising scope for regulatory arbitrage. In addition, the role of the

representative body has been called into question, with some CFIs querying its relevance.

Regulations have been put in place to address some of these anomalies, and these were

evaluated in the context of recommending appropriate supervisory frameworks to enhance the

safety and soundness of the sector and minimize regulatory arbitrage. The recommendations

are also aligned to the nature and size of such institutions within the broader national strategy of

promoting access to financial services in a safe and sound manner.

Key Words

Co-operative Financial Institutions; Co-operative Banks; Supervision; Regulation; saving and

credit co-operative; CBDA, SACCOL, SAMAF, FSC, SACCO, CFI

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Table of contents

Declaration ............................................................................................................................... ii

Acknowledgments ...................................................................................................................iii

Abstract ....................................................................................................................................iv

Table of contents ..................................................................................................................... v

List of Tables ............................................................................................................................ix

List of Figures .......................................................................................................................... x

List of Appendices ...................................................................................................................xi

List of Abbreviations ..............................................................................................................xii

CHAPTER 1: INTRODUCTION AND BACKGROUND ........................................................ 1

1.1 Statement of the problem ............................................................................................. 1

1.2 Objective of the study .................................................................................................. 2

1.3 Methodology ................................................................................................................ 3

1.4 Justification of the study ............................................................................................... 3

1.5 Outline of the study ...................................................................................................... 4

CHAPTER 2: LITERATURE REVIEW ................................................................................. 5

2.1 Introduction .................................................................................................................. 5

2.2 Defining and contextualizing CFI‟s within financial intermediation ................................ 5

2.3 Regulation and supervision- basic postulate ................................................................ 8

2.4 An overview of international experiences of CFIs ......................................................... 9

2.4.1 Co-operative financial institutions in Germany .......................................................................... 9

2.4.1.1 Structure of CFIs in Germany ......................................................................................... 10

2.4.1.2 Legislative framework ..................................................................................................... 11

2.4.2 Cooperative financial institutions in USA ................................................................................ 14

2.4.2.1 Legal framework .............................................................................................................. 16

2.4.2.2 Credit union regulatory framework .................................................................................. 17

2.4.3 Cooperative financial institutions in Canada ........................................................................... 19


2.4.3.2 Supervision and supervisory interventions ..................................................................... 21

2.4.4 Cooperative financial institutions in India ................................................................................ 23


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2.4.4.2 Supervisory frameworks and interventions ..................................................................... 24

2.4.5 Irish cooperative financial institutions...................................................................................... 26



2.4.6 Cooperative financial institutions in Brazil ............................................................................... 28

2.4.6.1 Legal framework and prudential requirements ................................................................ 29

2.4.6.2 Supervision approaches .................................................................................................. 30

2.4.7 Cooperative financial institutions in Kenya ............................................................................. 31



2.4.8 CFIs in Jamaica ....................................................................................................................... 34



2.5 Conceptual overview of regulatory and supervision of CFIs ........................................36

2.5.1 Open common bonds vs closed common bonds .................................................................... 37 2.5.2 Capitalisation ........................................................................................................................... 38 2.5.3 Prudential regulation and supervision ..................................................................................... 39

2.5.4 Networking .............................................................................................................................. 40

2.6 Conclusion ..................................................................................................................41

CHAPTER 3: COOPERATIVE FINANCIAL INSTITUTIONS IN SOUTH AFRICA ..............44

3.1 Introduction .................................................................................................................44

3.2 Historical development ................................................................................................44

3.3 Policy and legislative initiatives surrounding CFIs (1990-2009) ...................................44

3.4 Further regulatory and policy interventions (2007 to date) ...........................................46

3.4.1 Overview of the Cooperative Banks Act of 2007 .................................................................... 47 3.4.2 Appointment of supervisors ..................................................................................................... 50

3.4.3 Licensing criteria and functions of CFIs .................................................................................. 50

3.4.4 Minimum prudential requirements ........................................................................................... 52

3.4.4.1 Capital adequacy............................................................................................................. 52

3.4.4.2 Liquidity ........................................................................................................................... 53

3.4.4.3 External borrowing .......................................................................................................... 53

3.4.4.5 Non earnings assets ....................................................................................................... 55

3.4.5 Reporting arrangements and auditors .................................................................................... 55

3.4.6 Corrective and remedial powers of supervisors ...................................................................... 55

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3.5 A Critique of the current legislative and supervisory arrangements for CFIs in SA ......56

3.5.1 Minimum capital requirements ................................................................................................ 56

3.5.2 Types of cooperative banks .................................................................................................... 57 3.5.3 Regulatory arbitrage ................................................................................................................ 58 3.5.4 Supervision structure and independence ................................................................................ 58 3.5.5 Supervisory capacities at self-regulatory organisations .......................................................... 60

3.6. Conclusions ................................................................................................................60

CHAPTER 4: RESEARCH DESIGN & METHODOLOGY ..................................................62

4.1 Introduction .................................................................................................................62

4.2 Research design .........................................................................................................62

4.3 Research methodology ...............................................................................................63

4.3.1 Data collection: Survey questionnaire design ......................................................................... 63 4.3.2 Data collection: Survey questionnaire administration ............................................................. 64 4.3.3 Data collection: Structured interviews ..................................................................................... 65

4.4 Methods of analysis ....................................................................................................66

4.5 Data validity and reliability ...........................................................................................66

4.6 Summary and conclusions ..........................................................................................67

CHAPTER 5: EMPIRICAL ANALYSIS ...............................................................................68

5.1 Introduction .................................................................................................................68

5.2 General information (CFI demographics) ....................................................................68

5.2.1 Profile of respondents ............................................................................................................. 68 5.2.2 Profile of respondent CFIs ...................................................................................................... 70

5.2.3 Current regulatory regime ....................................................................................................... 73

5.3 Cooperative bank legislative requirements (onsite assessment conducted) ................74

5.3.1 Minimum registration requirements ......................................................................................... 74 5.3.2 Completion of prudential returns ............................................................................................. 75 5.3.3 Meeting prudential requirements ............................................................................................. 75

5.3.4 Pre-registration onsite assessments ....................................................................................... 77

5.4 Cooperative bank legislative requirements (not yet assessed onsite) .........................78

5.4.1 Minimum registration requirements ......................................................................................... 79 5.4.2 Prudential returns .................................................................................................................... 80

5.5 On-going monitoring and supervision ..........................................................................80

5.5.1 Frequency of examinations ..................................................................................................... 80 5.5.2 Examination focus areas ......................................................................................................... 81

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5.5.3 Risk management ................................................................................................................... 83

5.6 Summary of structured interviews with regulators .......................................................83

5.6.1 SAMAF .................................................................................................................................... 83 5.6.2 SACCOL .................................................................................................................................. 84 5.6.3 Summary of interview findings ................................................................................................ 84

5.7 Conceptual issues on research findings ......................................................................86

5.7.1 Current regulatory and supervisory aspects ........................................................................... 86 5.7.2 Capacities within CFIs ............................................................................................................. 87 5.7.3 Perceptions of respondents on regulatory oversight............................................................... 88

5.8 Conclusions ................................................................................................................89

CHAPTER 6: RECOMMENDATIONS AND CONCLUSIONS .............................................90

6.1 Introduction .................................................................................................................90

6.2 Summary of literature review ......................................................................................90

6.3 Summary of research findings and implications ..........................................................91

6.4 Recommendations and policy implications ..................................................................92

6.4.1 Prudential regulation and supervision ..................................................................................... 92 6.4.2 Capitalisation ........................................................................................................................... 93

6.4.3 Structure and networks ........................................................................................................... 94

6.4.4 Skills development and capacitating ....................................................................................... 95

6.5 Research limitations and areas for further research (combine with next) ....................96

List of sources ........................................................................................................................97

Appendices ........................................................................................................................... 103

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LIST OF TABLES

Table 2.1: Instruments for gaining institutional knowledge in German .......................................14

Table 2.2: Statistics for credit unions in the United States .........................................................16

Table 2.3: Prompt corrective thresholds for CFI's in USA ..........................................................17

Table 2.4: Supervisory process OSFI Canada ..........................................................................23

Table 2.5: Prudential requirements in Kenya .............................................................................33

Table 3.1: Schedule of qualifying CFIs as at 30 August 2010....................................................49

Table 3.2: Permissible products and services ...........................................................................51

Table 3.3: Prudential capital standards .....................................................................................53

Table 3.4: Prudential standards on liquidity ...............................................................................53

Table 3.5: Provisioning requirements ........................................................................................54

Table 5.1: Respondents position ...............................................................................................69

Table 5.2: Respondents education ............................................................................................69

Table 5.3: Membership levels ...................................................................................................70

Table 5.4: Deposit levels ...........................................................................................................71

Table 5.5: Summary of structured interviews (i) ........................................................................85

Table 5.6: Summary of structured interviews (ii) ........................................................................86

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LIST OF FIGURES

Figure 2.1: The deposit protection program Germany ...............................................................12

Figure 2.2: Credit union regulatory framework...........................................................................18

Figure 3.1: Current structure if the CFI sector in South Africa ...................................................48

Figure 5.1: Common bond ........................................................................................................71

Figure 5.2: Period in operation ..................................................................................................72

Figure 5.3: Average membership income ..................................................................................72

Figure 5.4: Minimum legislative requirements ...........................................................................74

Figure 5.5: Meeting prudential requirements .............................................................................76

Figure 5.6: Meeting provisioning requirements ..........................................................................77

Figure 5.7: Relevance of issues discussed ...............................................................................78

Figure 5.8: Feedback from supervisors .....................................................................................78

Figure 5.9: Minimum legislative requirements ...........................................................................79

Figure 5.10: Prudential returns ..................................................................................................80

Figure 5.11: Frequency of examinations ...................................................................................81

Figure 5.12: Areas to be examined (i) .......................................................................................82

Figure 5.13: Areas to be examined (ii) ......................................................................................82

Figure 5.14: Risk management .................................................................................................83

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LIST OF APPENDICES

Appendix 1: Overview of the regulatory environment for credit unions in Canada ................... 103

Appendix 2: Summary of exemption notices and their differences .......................................... 104

Appendix 3: Questionnaire for cooperative financial institutions .............................................. 105

Appendix 4: Questioning themes for structured interviews with regulators .............................. 112

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LIST OF ABBREVIATIONS

BIS Bank of International Settlements

BSD Bank Supervision Department

CAMEL Capital, Asset Quality, Management, Earnings, Liquidity

CBDA Co-operative Banks Development Agency

CFI Co-operative Financial Institution

CUCC Credit Union Central of Canada

CUNA Credit Union National Association

ICBA International Co-operative Banking Alliance

ILCU Irish League of Credit Unions

KERUSSO Kenyan Rural Savings and Credit Cooperatives Societies

KUSCCO Kenyan Unions of Savings and Credit Cooperatives

NCUA National Credit Union Administration

PEARLS Protection, Effective financial structure, Asset Quality, Rate of Returns and Cost,

Liquidity, Signs of Growth.

RBI Reserve Bank of India

SACCOL Savings and Credit Cooperatives League of South Africa

SAMAF South African Microfinance Apex Fund

SARB South African Reserve Bank

SASRA Sacco Societies Regulatory Authority

UCB Urban Co-operative Banks

WOCCU World Council of Credit Unions

SACCO Saving and Credit Cooperative

FSC Financial Services Cooperative

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CHAPTER 1:

INTRODUCTION AND BACKGROUND

1.1 Statement of the problem

Co-operative financial institutions (CFIs)1 as a concept, has been in existence in South Africa for

a number of years either as credit unions, “stokvels”, savings and credit co-operatives and/or

FSCs. ECI Africa (2003), noted that the collective action concept was already in existence by

1980 with different variants of informal rotating savings and credit institutions throughout Africa,

including South Africa. The ECI Africa paper also notes an unnamed 1928 publication which

refers to the application of the credit union concept in KwaZulu-Natal by German missionaries,

and to credit union-like structures recorded around 1880. Regulators in South Africa have long

realised the need and potential of the CFI concept, with an exemption notice in 1994 allowing

institutions modeled around a common bond to take deposits within certain conditions, to

ensure the safety and soundness of these institutions as well as promote financial inclusion.

The ramifications of this exemption notice was that informal member- based groups could pool

funds and utilise them for the benefit of members, provided that such schemes were operated

within the ambit of the contents of the Exemption Notice. One such condition was that a

common bond exists between members of a group, which relied on self imposed regulation to

protect the interests of its members. This exemption notice particularly focused on stokvels,

savings and credit co-operatives and employee savings clubs. The nature of their business

operations i.e. accepting deposits is similar to the conducting of the “business of a bank” with an

added social upliftment function. A condition of the exemption notice was that an exempt

financial co-operative be a member of a self regulatory body approved by the South African

Reserve Bank.

The exemption notices were in line with the objectives of post 1994 governments in South Africa

to promote the deepening of the financial market and the provision of a wide range of financial

services to promote access to financial services, particularly to the most vulnerable people

characterised by low incomes and lack of access to mainstream financial products. In this

1 In this paper as much as possible the term co-operative financial institution (CFI) will be used to also refer to a credit union,

savings and credit co-operative, financial services co-operative or a co-operative bank. Use of the specific term as used in a particular jurisdiction will only be in so far as it helps to materially differentiate that financial co-operative form from the norm, or is used in naming a specific piece of legislation.

2

regard, the provision of credible and safe financial institutions, such as CFIs helps lower income

individuals to increase their savings deposits (BSD, 2002). Consequently, the fulfillment of two

requirements is essential to the credibility and success of such institutions – firstly, a sound

regulatory framework and, secondly, fair and affordable access to basic banking services,

including efficient payment and transmission services.

Notwithstanding the regulatory dispensation, in 2002, two of the regulatory authorities

terminated their operations when the grant funding stopped (SARB, 2002: 32). A study by

Deloitte following the failure of these self-regulatory authorities showed that the majority of CFIs

were non-viable, and National Treasury made payouts to the members/depositors. The

remaining CFIs were left in a regulatory vacuum. Consequently, additional exemption notices

were issued to regulate the sector given the continued deterioration of CFIs in the absence of a

regulator. The Co-operative Banks Act was promulgated in 2007, in part to address the

challenges the sector face and also to pursue another key policy objective, that of financial

inclusion. This is informed by the premise that CFIs provide an opportunity to extend financial

outreach into rural areas with both deposit and credit services (Calvin & Coetzee, 2010: 2).

The unintended effect of the passage of the Co-operative Banks Act, however, is that a tiered

set of regulatory powers and duties has evolved, with various regulatory authorities overseeing

the sector, creating scope for regulatory arbitrage. In addition, despite the existence of self-

regulatory authorities, there is no evidence that formal supervision of the CFI sector actually

occurred, and the sector is still to grow as envisaged when the exemption notices were issued.

Furthermore, as formal supervision and regulation is a relatively new phenomenon for the

sector, there is need to develop legislative frameworks and supervisory frameworks that take

due regard to the nascent status of the sector as well as the skills set permeating within CFIs.

1.2 Objective of the study

The objective of this study is therefore to assess regulatory and supervisory aspects for CFIs in

various jurisdictions highlighting learning points for South Africa in lieu of the recently

promulgated legislation on co-operative banks and the current regulatory framework in terms of

relevance and appropriateness.

The study also assesses the perceptions of CFIs with regard to the co-operative bank legislative

and supervisory frameworks as well as the capacity to meet the regulatory and supervisory

requirements.

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The study will also make recommendations on an appropriate supervisory framework for the

CFI sector, which minimises regulatory arbitrage while aligning itself well to the nature and size

of such institutions within the broader national strategy of promoting access to financial services

in a safe and sound manner. It will also suggest pre-emptive action with respect to future

amendments.

1.3 Methodology

The study evaluates the current legislative and supervisory framework for CFIs in South Africa.

CFIs are not a unique phenomenon, as various forms of CFIs exist internationally. Following a

review of the available literature on the structure, legislation and supervision of CFIs‟ in a

sample of eight countries in North America, Latin America, Asia, Europe, Africa and the

Caribbean, key features of the regulatory and supervisory frameworks are reviewed and

summarised and lessons drawn, which can be instructive in the South African environment.

A review of secondary data and literature is conducted which informs the history and

development of the sector in South Africa. An assessment of the current legislative and

supervisory framework is conducted with regard to international best practices as espoused by

the Basel Committee on Bank Supervision. Primary data was obtained through two separate

processes administered to the relevant parties. Interviews were conducted with regulators of

CFIs to assess the effectiveness of how the sector has been regulated to date and

questionnaires were circulated to CFIs to determine the perceptions of CFIs on the legislative

and regulative framework. Secondary data was also reviewed on assessments conducted with

the boards and management of some of the CFIs, to determine skills and capacity to comply

with legislative requirements as well as to assess readiness to operate as a formally regulated

entity. Data was also obtained from the SARB, SAMAF, SACCOL and CBDA, in particular their

own statistics on activities within the sector. This data was reviewed and analysed in the report

to provide further contextual information.

1.4 Justification of the study

With the Supervisors of Co-operative Banks now in place, the stage is set for the licensing and

subsequent supervision of CFIs in South Africa. It is therefore critical that an appropriate

supervisory framework is developed, which aligns itself well to the nature and size of CFIs,

cognisant of the objectives of ensuring a safe and sound sector as well as the broader national

strategy for promoting access to financial services, while minimising regulatory arbitrage.

4

1.5 Outline of the study

This chapter is the introductory chapter of the research report and outlines the research

questions, research objectives, and research methodologies as well as the chapter contents.

Chapter two introduces the theory on the subject of CFIs covering the definition of the term and

the different types of CFIs. It also highlights the legislative and supervisory frameworks for CFIs

adopted by different regimes around the world as well as the lessons that can be drawn for

South Africa.

The third chapter contextualises CFIs within the South African context, noting the historical and

legislative developments. It also critically assesses the current regulatory framework for CFIs in

South Africa. Chapter four explains the study design and methodology: data sources, collection

and sampling strategies, organisation and conduct of the study as well as provides the

analytical techniques employed, and chapter five presents an analysis of the results of the

questionnaire findings and of the structured interview findings. Chapter seven provides

recommendations and conclusions.

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CHAPTER 2:

LITERATURE REVIEW

2.1 Introduction

This chapter presents an overview of CFIs and a review of study of various international

experiences with CFI, stressing analysis of the regulatory and supervisory frameworks under

which those institutions operate. Particular emphasis is placed on those countries in which the

co-operative financial sector has a significant presence in terms of membership, penetration and

asset size. Section 2.2 defines co-operative financial institutions and contextualises CFI‟s within

the banking spectrum. Section 2.3 provides a broad discussion of regulation and supervision.

Section 2.4 describes international experience with CFI‟s (or equivalent institutions) in a sample

of eight countries in North America, Latin America, Asia, Europe, Africa and the Caribbean,

where CFI activity is significant in terms of membership, penetration and/or savings. A

description is provided of the historical development of co-operative financial institutions in each

country, the current structures and status of the sector and a review of the regulatory and

supervisory frameworks governing their operation. Section 2.5 presents lessons for South Africa

regarding the likely impact of regulation and supervision on CFI from the experiences of the

various countries, while Section 2.6 concludes.

2.2 Defining and contextualising CFI’s within financial intermediation

According to the International Co-operative Alliance Statement of co-operative identity, a co-

operative is an autonomous association of persons united voluntarily to meet their common

economic, social, and cultural needs and aspirations through a jointly-owned and

democratically-controlled enterprise. Co-operatives are based on the values of self-help, self-

responsibility, democracy, equality, equity and solidarity. In the tradition of their founders, co-

operative members believe in the ethical values of honesty, openness, social responsibility and

caring for others, based on the seven (7) co-operative principles of:

Voluntary and open membership;

Democratic member control;

Member economic participation;

Autonomy and independence;

Education, training and information;

6

Co-operation among Co-operatives; and

Concern for Community.

As the financial derivative of co-operative‟s, CFI‟s are thus member owned and controlled

financial institutions operated for the purpose of promoting thrift, providing credit at reasonable

rates, and providing other financial services to their members (Johnson, 1936: 662). Cuevas

and Fischer (2006: 2) used the term CFI to include all diverse member-owned financial

intermediaries, including credit unions, savings and credit co-operatives, co-operative banks2,

village banks, financial services co-operatives and other terms that differ across regions of the

world. CFI‟s offer members the opportunities to have control over their own finances by making

their own savings work for them. Regular savings form a common pool of money, which in turn

provides many benefits for members such as loans.

According to the World Council of Credit Unions (WOCCU), the CFI sector globally had $1.4

trillion in assets with 183 million members in 2009. However, CFI country profiles vary

significantly in terms of total assets and average institution asset size, ranging from volunteer

operations with a handful of members to institutions with several billion dollars in assets and

hundreds of thousands of members, as will be highlighted in the international experiences.

Generally, though, CFI‟s are typically smaller than banks; for example, the average U.S. CFI

had $125 million in assets, while the average U.S. bank had $1.7 billion, as of 2010. CFI‟s are,

however, differentiated from the other types of financial intermediaries in four ways (Boscia &

Silvio, 2009; 18):

i) mutuality, (owner-members also clients)

ii) relationship based conduct;

iii) economic democracy, based on „one man-one vote‟; and

iv) Surplus distribution.

Mutuality means the primary objective of the CFI is fulfillment of members‟ well being. As a

result, CFI‟s are deeply rooted within local areas and communities, contributing towards the

sustainable development of communities, as members and management boards usually belong

to the communities in which they operate (ICBA, 2009).

2 The phrase co-operative bank will be used primarily to define a co-operative financial entity that holds a banking license issued by

a regulatory or supervisory authority

http://en.wikipedia.org/wiki/Credit_(finance)

7

Relationship based conduct arises because in mitigating agency problems associated with

inadequate information, CFI‟s rely heavily on personalised relationships which essentially raise

the reputation costs of non-compliance and in the process fostering loyalty. As an intermediary,

CFI‟s are savings-oriented, and loan funds need to be financed by the deposits of members.

Cognisance is taken of the fact that credit is a special good, which requires repayment, and

repayment is not always done by the borrower. Further, small businesses and households,

which are the general target of CFIs, usually suffer from a deficiency of information creating

adverse selection and moral hazard. The critical question becomes how CFI‟s can be

sustainable in an environment in which access to information on borrowers is very costly.

Gobezie (2008: 13) summarised the intermediation challenges in developing economies by

noting that most of the instruments that can mitigate asymmetric information do not exist or

perform poorly and even if markets existed and are left free, supply and demand forces in these

markets may meet, but do not reach equilibrium. Thus traditional banks limit the supply of credit

(credit rationing) because they cannot rely upon the price mechanisms to do its normal market

clearing function. The market-determined price of loans would be high, especially if capital is

scarce and at high interest rates.

CFIs‟ thus reduces transaction and agency costs between client-members and the CFI itself via

the peer monitoring mechanism which reduces information asymmetry on the part of the client-

member. Boscia and Di Salvo (2009: 19) also argue that locality provides for social interactions

and mutual trust between the institution‟s credit officers and borrowers which in turn leads to

lower monitoring costs. The self-regulatory tendencies of most of the CFI models, however,

also create potentially serious agency problems (Wyman, 2008: 1).

The intermediation role of co-operative financial institutions has been recognised globally at

both micro-economic and macro-economic levels. Birchall (2003: 12), noted through cross

country case studies of co-operatives in both developing and developed countries, that under

the right conditions, they can substantially reduce poverty among some of the world‟s poorest

people. As alluded to earlier, credit extension, for example, to the poor, is a function of intimate

interactions with the market to get information or the personal characteristics of the borrower or

saver. Technological and financial innovation has led to traditional financial intermediaries, such

as commercial banks relying on credit scoring which standardises and automates the lending

process from the relationship model which works for the low income sector further alienating low

income households.

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In essence, a CFI, as a self-governing institution is a „bottom-up phenomenon‟ (Fonteyne, 2007:

6), which is jointly owned by its members and in terms of which benefits are shared by its

members (customer owned entities). Each member has an equal vote (democratic member

control) in the organisation and, in general, decisions are based on the aforementioned

internationally accepted co-operative principles. As a result, it is not uncommon to find that the

objective of most CFIs‟ is not to maximise shareholder/member wealth but to provide the best

possible products and services to its members. Based on this, it seems apparent that a CFI‟s

primary duty is to its members, not to anyone else outside the CFI.

Additionally portions of the CFI‟s surpluses are allocated to reserves or allocated to members

either through a patronage dividend (related to the use of the institution‟s products and services

by each member) or through an interest or a dividend, which is related to the number of shares

subscribed by each member.

2.3 Regulation and supervision- basic postulate

Broadly, bank regulation entails the form and manner (primarily legislative) that governments

(mostly via central banks or supervisory authorities) subject banks to certain operational

requirements, restrictions and guidelines. Given their nature, i.e. prescribing and proscribing

what must be done and what may not be done in specific area, regulations tend to be backward-

looking given that in most cases they arise from policy makers‟ attempts to solve certain

challenges such as directed lending and improving financial access. The complement of bank

regulation, banking supervision, is intended to be flexible and to be carried out on any individual

bank basis, as well as being designed to limit, rather than eliminate, the risk of failure. Thus

bank regulation and supervision is part of a broader interrelated financial safety net, aimed at

restoring confidence among both financial intermediaries and the wider public (Schich, 2008: 3).

CFIs have to comply with co-operative rules as well as rules established by financial authorities.

The governance and operational characteristics of CFIs as discussed in the preceding section,

present significant complexities to their regulation and supervision. For instance, because in

most instances, CFIs start small, operate in remote areas and can be numerous in number,

regulating and supervising them is more difficult and costly. In addition, because the focus of

CFIs is service to members rather than profit making, members have no incentive to expose the

institution to risk or speculate on risky positions for the sake of making a profit (Cuevas &

Fischer, 2006: 37). In addition, Kumar (2006: 152) argues that the public-interest motive for

financial regulation and supervision is reduced to only those who are members of the co-

9

operative. Thus, while it is undeniable that there is a public interest regarding the solvency,

protection of depositor funds and the stability of the financial co-operative sector, several

questions arise i.e.

i) is a supervisory and regulatory framework focused on investor-owned banks, given

the shareholder-depositor conflict, suitable for CFIs?

ii) How then can regulatory and supervisory arrangements be made relevant and

appropriate for the nature and size of CFIs, without detracting from their

competitiveness?

iii) How can regulatory tools, such as reporting requirements, be developed in a

manner so as to minimise the cost burden on CFIs?

iv) Which CFIs should be supervised, and who should undertake this? Appropriately

answering these questions is key, given that CFIs cater for sectors of the economy

that are most economically vulnerable, hence regulatory frameworks become

pivotal for the sustainability and growth of the sector (World Bank, 2007).

2.4 An overview of international experiences of CFIs

This section reviews the situation of financial co-operatives in different countries, most of which

record a significant co-operative presence in their financial sectors. The intention is to analyse

applicable regulations, as well as the development of the activity in each country‟s history,

focusing on factors that could have impacted on, or determined the success or failure of their

business.

2.4.1 Co-operative financial institutions in Germany

Delfiner et al (2006: 19) credits German with pioneering co-operatives through the works of

Hermann Schulze-Delitsch (1808-1883) and Friedrich Wilhelm Raiffeson (1818-1888). In 1850,

Hermann Schulze-Delitsch initiated the formation of the first credit co-operative whose objective

was to give loans to craftsmen on fair conditions. As such credit co-operatives grew in numbers

and popularity, they became known as „Volksbanken‟ or peoples banks. Fourteen years later,

Friedrich W. Raiffeson initiated a credit co-operative combined with supply and marketing

services, „the Flammersfeld Loan Association‟, which was strictly based on the principles of self-

help and focused primarily on the economic welfare of its members. Friedrich Raiffeson later

developed a system of rural CFI‟s which were unified in 1877. This was the origin of the

Raiffeisen structure, noted for strong autonomy at local level, with the delegation of powers to a

central structure (Delfiner et al, 2006: 19).

10

Another peculiar feature of the movement was that non-members were allowed to make

deposits though extension of credit was limited to members. Such external deposits were a

source of strength to the co-operatives and provided for the accumulation of working capital and

reserves as well as competitive interest rates. Craftsmen, small and medium enterprises and

traders as well as farmers established their own co-operative banks, a process in which they

were assisted by founders who did not necessarily come from the same professions. The state

merely provided the legal framework.

The basic idea behind the early co-operatives was and is that people such as farmers,

craftsmen and traders decide to join forces for specific economic purposes and run a business

jointly, solving problems fairly, (notably financial exclusion, according to Wyman, 2008: 7) and

effectively as required by the market situation. Activities, previously performed individually by

each member unit were transferred to the co-operative, thus cutting costs and increasing

productivity for each member.

2.4.1.1 Structure of CFIs in Germany

The German banking system has three sectors, namely the private banking, co-operative

financial institution and public banking, each with a market share (of deposits) of 36 percent, 25

percent and 39 percent, respectively (DZ Bank, 2010). CFI‟s, which number 1,156, operate at a

primary level (locally) and these have established a number of central organisations at regional

level such as apex banks and a national federation. The central organisation of the co-operative

financial structure is the National Federation of People‟s Banks and Raiffeisen Banks (BVR). All

local CFI‟s, co-operative central banks, the co-operative financial federation and the audit

examiners are members. Its tasks include:

v) Representing the interests of CFI‟s at national and international level;

vi) Coordinating and developing joint CFI strategy, including the central handling of

services for the entire group;

vii) Advising and supporting its members on legal, tax and operational matters; and

viii) Publishing information of a political and commercial nature with an impact on

banking activity.

The work of the central organisation is additionally complemented at regional level by two co-

operatives centrals i.e. the DZ Bank (Deutsche Zentral-Genossenschaftsbank/German Central

Co-operative Bank) and WGZ Bank. The establishment of the two entities with central banking

features is an acknowledgement of the necessity for supporting facilities for clearing and

11

liquidity management purposes. The creation of such central bank entities is based on the

premise that a CFI must always be in a position to satisfy any reasonable request for loans from

members, and must be prepared to accept money deposited by them at a reasonable interest

rate (Harms, 2007). The regional federations are responsible for administering relations

between the CFI‟s and supervising their prudential administration. In addition, they advise them

on tax and legal matters, and they have the important responsibility for the training of current

management level personnel and potential future group employees.

Currently, Germany's CFI sector is the country's second-largest financial services group after

the savings banks, with total reported assets of €1,025 billion and about 16 million members

(Standard & Poor, 2009). The business is predominantly focused on the domestic market, with

select niche activities abroad through its central banks and specialised product providers, such

as insurance, building-savings contracts, mutual funds, and leasing. The local CFIs are

autonomous entities from a legal and commercial standpoint, and adapt to the social, cultural

and economic conditions in the region in which they operate. Direct contact with their customers

guides their business policy, and they work with a clear focus on their own region (Delfiner et al,

2006; Standard and Poor, 2009).

2.4.1.2 Legislative framework

The Reich Co-operatives Act (RCA) of 1889 was the first piece of legislation governing all co-

operative forms (including CFI‟s) in Germany. The RCA emanated from pressure for rules for

co-operatives following financial difficulties in the sector attributable to a lack of external

supervision and lack of trained managers, who worked on an honorary basis. Amendments to

the RCA in 1934 introduced a mandatory requirement for membership of a Federation and an

audit by it (Delfiner et al, 2006).

In the case of CFI‟s, as well as being subject to the RCA, they are subject to the Credit Sector

Law and all its related regulations, the Code of Commerce and the German Bank Act (GBA).

The GBA applies to all banks, regardless of whether they are co-operatives or not, except for

limited exceptions that apply to co-operative financial institutions. The regulations distinguish

between banks that are “Trading Book” (those which hold more than 5 percent of their assets in

trading positions) and those that are not, but co-operatives all fall within the “non-trading book”

category because of their retail profile (Delfiner et al, 2006: 24).

12

i. Capital adequacy

Within the corresponding classification, the same capital requirements and the same initial

minimum capital are applied (5 million euros3), as well as the same credit limits. The limitation

by size of loan mainly affects local CFI‟s because their capital is lower. They generally report to

syndicated loans together with federal or regional co-operatives to be able to grant loans. In the

case of liquidity, regulations adopt a mismatching criterion: assets for less than 30 days must

exceed liabilities for the same term. (Delfiner et al, 2006: 23).

The only regulatory difference lies in the treatment of capital. All banks have their capital divided

into Tier I and II. CFIs‟ have a Tier II component known as an “additional amount.” In the event

of a co-operative bank failure, members are required to make capital contributions (to a limited

extent), which represents an additional contingent responsibility (Delfiner et al, 2006: 23)

ii. Deposit insurance

Members of CFIs have unlimited deposit protection as well as comprehensive institutional

protection for all members of the BVR. The CFI sector in Germany has not experienced a

bankruptcy since 1930 (DZ Bank, 2010). The sector‟s preventive and rescue measures are

based on the „guarantee fund‟ and the „guarantee network‟ (Fig 2.1).

Figure 2.1: The deposit protection program Germany

Source: DZ Bank

3 Approximately R43.5 million as at December 2010

13

iii. Supervision of CFIs in Germany

The CFI co-operative financial centrals sector in Germany is regulated and supervised by the

Federal Financial Supervisory Authority (BaFin), the supervisory authority in Germany. BaFin

distinguishes between four groups of institutions among the banks under its supervision i.e.

lending banks, institutions belonging to the savings bank sector, institutions belonging to the

cooperative financial sector and other institutions. A total of 1,156 primary institutions, two

central banks, ten institutions that are similar to central banks and 46 building cooperatives with

savings schemes are recognised as part of the cooperative banking sector (BaFin, 2008: 114).

BaFin makes use of the risk-oriented supervision approach to supervise the sector.

Within the scope of banking supervision, BaFin collaborates with the appropriate Regional

Office of the Bundesbank to determine the risk classification as derived from the risk profile of

the co-operative bank. The Bundesbank assesses all major areas of a credit institution as part

of its ongoing monitoring and combines the results in a risk profile which encompasses its risk

situation and regulatory capital adequacy, its risk management as well as the quality of its

organisation and management. It is based on the results of the annual audit and contains all

other relevant information relating to the institution, as well as the results of a model-based

rating system, which is itself based on the banking supervisory reporting system (BaFin, 2008:

125).

With regard to supervisory action and special supervisory audits, BaFin distinguishes between

those requested by institutions; those initiated by BaFin and scheduled audits. In the first case,

BaFin only carries out an audit at the request of an institution, in the second case the initiative

emanates solely from BaFin‟s requirements to establish the facts correctly. The third case

includes audits where BaFin is involved on the basis of a schedule prescribed by law (BaFin,

2009). Supervisors‟ risk identification instruments used by BaFin are summarised below:

14

Table 2.1: Instruments for gaining institutional knowledge in German

Instrument Description

1. Routine supervisory

interviews

Used primarily for a routine discussion of the financial performance, risk

situation and general business situation of the institutions on the basis of

their annual accounts documents once they have been analysed.

2. Adhoc supervisory

interviews

Concerned with facts or topics which require a special supervisory

appraisal because of significant developments at the co-operative bank

3. Interviews with third

parties

Interviews with audit firms or other third parties relating to individual

institutions.

4. Analysis of annual

accounts and audit

reports

As prescribed by Law

5. Requests for

Information

As prescribed by Law

6. Ordering and

analysis of audits

As prescribed by Law and mandated to third parties

7. Audits of banking

operations

As prescribed by Law and carried out to assess co-operative bank‟s capital

adequacy and risk management and control systems

The regional federations are responsible for administering relations between the CFI‟s and

supervising their prudent administration. All CFI‟s must submit monthly reports to the co-

operative central bank, which consolidates the reports and submits them to the Superintendent.

The BVR provides CFIs‟ with an early-warning system based on risk recognition and prevention

methods. A modern classification system identifies potential problems at member CFIs, so as to

enable early measures to be taken. If they should nevertheless encounter problems, support is

provided for the necessary recovery and safety measures so that they can meet their legal

obligations in the best manner possible. Another co-operative safety measure is the process of

bank examination as laid down in legislation on co-operatives, which is carried out by the

regional federations and the two special examining associations.

2.4.2 Cooperative financial institutions in USA

In the USA, the first cooperative financial institution was established in 1909, and immediately

thereafter Massachusetts became the first state to have a credit union charter, the

Massachusetts Union Credit Act. The legislation was driven by activists concerned by high

interest rates charged to the working class (US Treasury, 1997). In 1934, the Federal Credit

15

Union Act (FCUA) was passed which established a national system to charter4 and supervise

federal CFIs. Amendments to the FCUA in 1970 led to the establishment of the National Credit

Union Administration (NCUA) as an independent federal agency to charter and supervise

federal CFIs. The amendments also included the formation of the National Credit Union Share

Insurance Fund (NCUSIF) to insure members‟ deposits. High interest rates and unemployment

in the early 80s brought supervisory changes, at the same time as losses were recorded by the

deposit insurance fund, which led the community to call on Congress to approve a plan to

recapitalise the fund. In 1985, CFIs deposited 1 percent of their shares to capitalise the

NCUSIF, which is now fully backed by the by the "full faith and credit" of the U.S. Government

(Delfiner et al, 2006: 8).

Financial deregulation and increased flexibility for mergers resulted in CFIs becoming major

financial institutions in the US giving rise to conflict and litigation by smaller commercial banks.

For example, in the NCUA vs. First National Bank & Trust case in February 1998, the Supreme

Court of the United States ruled that banks had prudential standing to challenge regulations that

permitted credit unions to enroll unaffiliated members. The Credit Union Membership Access

Act (CUMA), passed in August 1998 reversed the Supreme Court decision (Bahnmueller, 1999).

The CUMA Act also re-affirmed the tax exemption status of credit unions in the US.

The Federal Credit Union Act was subsequently amended in 2007 to factor in the provisions of

the Credit Union Membership Access Act, notably on the common bond. As shown in Table 2.2

below, while the number of CFIs has continued to decline due to mergers and closures,

membership and asset size has continued to grow.

4 A charter is the grant of authority or rights, stating that the granter formally recognises the prerogative of the recipient to exercise

the rights specified (wikipedia)

http://en.wikipedia.org/wiki/Supreme_Court_of_the_United_States

http://en.wikipedia.org/wiki/Supreme_Court_of_the_United_States

http://en.wikipedia.org/wiki/Authority

http://en.wikipedia.org/wiki/Rights

16

Table 2.2: Statistics for credit unions in the United States

Year No of CU No of

members Full time

employees Savings

($m) Loans

($m) Reserves

($m) Assets

($m)

Assets per

member ($)

2004 9,210 83,333,019 193,177 549,650 394,912 67,388 635,615 7,627

2005 8,871 84,488,920 198,038 572,414 434,496 73,375 669,698 7,926

2006 8,540 85,376,542 204,291 593,668 476,348 77,800 696,990 8,164

2007 8,238 86,580,287 211,419 630,296 506,372 83,701 740,659 8,555

2008 7,972 87,971,483 219,501 676,873 547,964 87,457 803,998 9,139

2009 7,691 89,650,832 220,046 735,529 570,044 85,772 870,157 9,706

2010 7,445 90,477,835 220,088 777,845 566,416 89,528 903,955 9,991

Source: Based on National Credit Union Administration (www.ncua.gov)

2.4.2.1 Legal framework

The current piece of legislation governing CFIs in the USA is the FCUA Act as amended in

2007. Broadly, the Act provides for the NCUA and its responsibilities, defines membership of a

credit union5, functions and responsibilities of credit union management, board and committees,

deposit insurance and the central liquidity fund. The FCUA provides for, and limits membership

to three broad types of common bonds i.e.:

Single common-bond CFI: One group that has a common bond of occupation or association;

Multiple common-bond CFI: More than one group, each of which has (within the group) a

common bond of occupation or association, however, only a group with fewer than 3,000

members are eligible to be included in the field of membership; and

Community CFI: Persons or organisations within a well-defined local community,

neighborhood, or rural district.

Exceptions to the three broad categories are permitted in instances where the CFI intends to

include membership from a local community, neighborhood, or rural district deemed as an

„investment area‟, or „underserved‟. An „investment area or underserved area is a local

5 The Act also distinguishes between a “federal credit union‟‟ as a cooperative association organised in accordance with the

provisions of the FCUA, and a „„State credit union‟‟ and „„State-chartered credit union‟‟ as a credit union organised and operated according to the laws of any State in the US, which laws provide for the organisation of credit unions similar in principle and objectives to Federal credit unions.

17

community experiencing poverty, low income and/or unemployment. The onus is on the CFI to

prove that the local community is „underserved‟ or an „investment area‟.

Membership to the deposit insurance fund is not automatic, with credit unions applying to the

NCUSIF for membership. The NCUSIF is permitted to conduct separate examinations of the

applying credit union before a decision is made. Upon the approval of any application for

insurance, CFI is issued with a certificate evidencing the fact that it is, as of the date of issuance

of the certificate, an insured credit union.

i. Prompt corrective action (PCA)

The Act also provides for mechanisms to resolve problems at insured credit unions promptly

while taking into account that CFIs are not-for-profit cooperatives that do not issue capital stock;

must rely on retained earnings to build net worth; and have boards of directors that consist

primarily of volunteers. The PCA thresholds for CFIs are summarised in Table 2.3 below:

Table 2.3: Prompt corrective thresholds for CFI's in USA

Net Worth Category Net Worth Ratio

Risk based Net Worth Ratio

Well Capitalised 5 percent or

greater

8 percent or greater

Adequately Capitalised 4 percent to

<5 percent

8 percent or greater

Undercapitalised 3 percent to

<4 percent

6 percent to <8 percent

Significantly

Undercapitalised

2 percent to

<3 percent

<6 percent

Critically Undercapitalised <2 percent N/A

Source: NCUA

The PCA framework summarised above does not regulate what constitutes sound capital

management relative to the business needs of an institution, but that credit unions are expected

to operate above minimum regulatory capital levels based on their institution specific business

needs and holistic assessment of all relevant risks.

2.4.2.2 Credit union regulatory framework

The US credit union system currently consists of three distinct levels: the local level/retail (credit

unions), the state/regional level (corporate credit unions), and the national level, (U.S. Central

18

Credit Union). The third tier of the U.S. CFI system is the U.S. Central Credit Union, which

serves as a wholesale financial centre for corporate credit unions. U.S. Central‟s business focus

centers on providing payment and investment solutions for corporate credit unions as well as

investment offerings to provide funding to corporate CFIs through cash-management products,

risk-management and analytical capabilities, asset/liability reporting and brokerage advisory

services. These services include overnight loans, term investments and guaranteed early

morning funding.

Federally chartered credit unions are subject to federal credit union laws and are routinely

examined by NCUA and these constitute 61 percent of credit unions in the US (Robbins, 2005:

5). State chartered credit unions are subject to the state credit union laws as well as federal

credit union laws if they are insured by the NCUSIF. State chartered credit unions are

supervised by their state examiners but are required to submit quarterly financial reports to the

NCUA (Fig 2.2). The NCUA has the authority to supervise any federally insured credit union,

whether federally or state chartered.

Figure 2.2: Credit union regulatory framework

Source: Adapted from Robbins, 2005: 3

In 2001, NCUA did away with the 100 percent annual examination (examining all credit unions

every year) schedule as it deemed it costly, and adopted and implemented a risk-based

examination schedule (NCUA Annual Report, 2001). The risk based examination does not

require all credit unions to be examined each calendar year, but rather, the examination cycle is

determined by risk to the NCUSIF, economic trends, and staff and resource availability. The

National Credit Union

Administration (NCUA)

State Credit Union

Regulators

Federal Charter

Insured by NCUSIF

State Charter

Insured by NCUSIF

State Charter

Insured by other

19

implications are that low-risk credit unions6 experience delayed exams (two exams in a three-

year period), while others will be examined within 8 to 14 months.

Risk-focused examinations are a forward thinking approach that enables examiners to focus on

validating management‟s ability to identify, measure, monitor and control risk. The risk profile is

made up of seven specific risk categories: (1) credit, (2) interest rate, (3) liquidity, (4)

transactions, (5) compliance, (6) strategic planning, and (7) reputation.

Each risk category is assessed as high, moderate or low reflecting current and prospective risk

to the credit union‟s earnings and capital. Assessing risk provides the examiner with a common

supervisory tool while recognising different levels and complexities of risk in each credit union.

Throughout the year, examiners will monitor changes in the risk profile of their district credit

unions to determine:

a) Frequency of examinations;

b) Number of hours needed to complete examinations and provide supervision;

c) Additional resource needs (subject matter examiners, specialists, team members,

etc.); and

d) The focus areas of each exam.

The risk-focused examination is only one piece of the supervisory program, with the entire

supervision program establishing a system of continuous supervision by offsite monitoring

through collecting quarterly call reports, encouraging dialogue between credit unions and

examiners, establishing a risk-based examination schedule, developing staff experts in specific

subject matters, and enabling the agency to plan for future credit union and NCUSIF risks.

2.4.3 Cooperative financial institutions in Canada

According to WOCCU, after the USA, Canada has the largest credit union movement in the

world, which began earlier than that of the US, in 1900, in response to the financial needs of

fishermen, farmers and miners. By the 30s and 40s, growth in the sector was attributed to

difficulties communities faced in obtaining financial services (Delfiner et al, 2006: 11). In the 40s,

credit unions, began to emerge in Ontario formed around parishes, employee groups,

professional and trade associations as well as ethnic and geographical communities. Although

6 A low risk credit union is one that has been assigned a CAMEL rating of 1 or 2 in the last two consecutive examinations and it

displays characteristics such as being operational for 10 years or more, positive return on average assets, net worth ratio of over 7 percent, or, if applicable, meets risk-based net worth requirement, adequate ALM mechanism, adequate internal controls, accurate, up-to-date books and records, no current administrative actions and no potentially adverse balance sheet changes.

20

there are still credit unions based on common workplaces, the majority of credit unions no

longer require one to belong to the same profession or the same workplace.

There are two CFI movements in Canada, the Desjardin Group7 and the Credit Union Central of

Canada (CUCC). The distinctive factor between the two Canadian systems is the way in which

they are organised with Desjardins much more centrally organised whereas the credit union

movement is much more autonomous (Goulard, 2010).

There are three different levels of “CFI” organisations with the CUCC movement; (1) Credit

Union Central of Canada (CUCC) itself, which is the national body governed solely at the

federal level by the Cooperative Credit Associations Act (CCAA), (2) the provincial/regional

centrals which are mostly governed by their provincial legislation but are also subject to Part 17

of the CCAA, and (3) individual credit unions which are subject to their provincial legislation.

Each province has its own legislation. CUCC was initially created to provide liquidity to credit

unions; however from 1977 it assumed increased developmental responsibilities to assist credit

unions in service improvements, training and knowledge sharing. As at 30 September 2010,

CFI‟s affiliated to the Credit Union Central of Canada had over 5 million members with $124

billion in assets (CUCC, 2010).


The Cooperative Credit Associations Act (CCAA) of 1991, as amended in 2010 governs the

operations of CUCC and in part governs the provincial centrals. However, the provincial centrals

are mostly governed by their own provincial legislation. Each province has separate provincial

legislation that governs the credit unions in that province resulting in ten (10) different pieces of

provincial legislation; hence regulatory capital requirements also vary by province. For example,

five provinces have adopted Basel Accord-type risk-weighted capital adequacy requirements i.e.

British Columbia, Alberta, Saskatchewan, Manitoba, and Ontario. Three of these, British

Columbia, Saskatchewan, and Ontario, have adopted elements of the Basel II simplified

standardised approach, while Manitoba and Alberta retain modified versions of Basel I (Goulard,

2010: 2). As a result of the various pieces of legislation (Appendix 1), the ensuing discussion will

focuses on the CCAA which is at the federal level.

7 This is a network of financial services cooperatives in Quebec.(http://www.desjardins.com/en/). The caisses populaire under the

Desjardin Group operate under a single brand name.

http://www.desjardins.com/en/

21

Recent amendments to the CCAA Act provide for the establishment of federal credit unions,

which by definition are „„banks‟‟ under the Banks Act but are organised and carry on business as

cooperatives. At least five or more persons, a majority of whom are individuals, can form a

federal credit union and are also subject to a minimum capital requirement of $5 million as with

banks. A federal financial cooperative governed by the Bank Act can (but is not obligated to) call

itself a „„federal credit union‟‟ or a „„cooperative bank‟‟. (Goulard, 2010; Elliot et al, 2010).

Capital structure and raising of capital

The CCAA Act requires a federal credit union to maintain adequate capital. In this regard, the

three primary considerations for defining the capital of a cooperative financial institution for

purposes of measuring capital adequacy are its permanence, its being free of mandatory fixed

charges against earnings, and its subordinated legal position to the rights of depositors and

other creditors of the institution.

One of the distinguishing factors between traditional banks and CFIs, including the FCU, is the

traditional bank‟s ability to raise capital through equity markets. CFIs, because of their

cooperative structure, have very limited access to equity markets. The amendments do allow an

FCU to raise capital through the issuance of non-membership shares to both members and non-

members. The CFI can thus create a class of shares and a person can own 100 percent of the

shares of that class. However, to ensure adherence to cooperative principles such shares would

have restrictions i.e. a holder of such shares can never control or own the CFI, and is not

allowed to vote at the AGM (Goulard, 2010).

2.4.3.2 Supervision and supervisory interventions

The sector is almost exclusively regulated at the provincial level for prudential soundness and

market conduct. The national central, the CUCC, is chartered and regulated by the federal

government under the Cooperative Credit Associations Act, with the Office of the

Superintendent of Financial Institutions (OSFI) as the Regulator. The federal government can

provide the CUCC with liquidity support through the Bank of Canada or the Canada Deposit

Insurance Corporation. In addition, all provincial centrals (except for those in New Brunswick,

Prince Edward Island and Newfoundland and Labrador) are regulated at the federal level, as

well as at the provincial level, under the Cooperative Credit Associations Act.

The regulatory framework for credit unions and caisses populaires generally parallels that of

federal financial institutions, such as banks and the central cooperative financial institutions.

22

Both the national and provincial centrals are inspected for prudential purposes by the federal

Office of the Superintendent of Financial Institutions (OSFI). The OSFI‟s Supervisory

Framework is intended to provide an effective process to assess the safety and soundness of

regulated financial institutions. This is achieved by evaluating an institution‟s risk8 profile,

financial condition, risk management processes, and compliance with applicable laws and

regulations (OSFI, 1999). The level and frequency of supervisory scrutiny is a function of the

risk assessment of the CFI, with institutions that are well managed relative to their risk profile

requiring less supervision. The supervisory process is summarised in Table 2.4 below and while

the steps appear sequential, updating of the risk assessment is a dynamic process requiring

frequent reassessments at various stages of the supervisory process.

Supervisory interventions available to the regulator in terms of the CCAA Act include:

i) entering into an agreement, called a “prudential agreement”, with a CFI for the

purposes of implementing any measure designed to maintain or improve its safety

and soundness;

ii) cease and refrain orders;

iii) apply for a court order where a CFI has failed to comply with a prudential agreement

or cease and refrain order;

iv) Disqualify unsuitable persons‟ from being elected or appointed as a director of a CFI

or from being appointed as a senior officer;

v) Remove or suspend a person from office as a director or senior officer of a CFI if

the Regulator is of the opinion that the person is not suitable to hold that office on

the basis of the competence, business record, experience, conduct or character of

the person; and

vi) Take control of the assets of the CFI.

8 The seven risks evaluated include credit, market, insurance, operational, liquidity, legal & regulatory and strategic.

23

Table 2.4: Supervisory process OSFI Canada

Steps Output

1. Analysis

(Understanding the institution and developing

a risk profile)

Risk Matrix

Risk Assessment Summary

2. Planning

(Scheduling and planning activities for the

supervisory period)

Supervisory Plans

3. Action

(Conducting on-site reviews and on-going

monitoring)

Information requests

4. Documentation

(Preparing and filing information to support

findings)

Section Notes Working papers

5. Reporting

(Report of findings and recommendations

to the institution)

Management Report Updated RAS

6. Follow-up of findings and recommendations Updated RAS

Sourced from the Office of the Superintendent of Financial Institutions (www.osfi-bsif.gc.ca)

2.4.4 Cooperative financial institutions in India

In 1904, the Cooperative Credit Societies Act (CCSA) was passed in India, paving the way for

the establishment of cooperative credit societies (Ramesha, 2003). In urban areas, CFIs‟

emergence was a result of local response to an enabling legislative environment (Thorat, 2006;

Barat, 2009). The rural CFI movement, however, was different in the sense that it was state

initiated (hence top down) as opposed to a bottom up approach as envisaged by the German

pioneers. The paradoxical consequence of this state intervention is that this created a

„dependence trap‟ (Sriram, 1999: 5).

Cooperative credit institutions in the country are classified into urban credit cooperatives and

rural credit cooperatives, with the sector constituting about 10 percent of the aggregate banking

business (Kramesha, 2003). Urban cooperative banks (UCBs) are an important channel of

financial inclusion for the middle and low income sections in the semi-urban and urban areas.

The operations of both scheduled and nonscheduled UCBs are limited to either one State

(single-state) or stretch across States (multi- state), while most of the non-scheduled UCBs are

primarily single State UCBs having a single tier structure (Tier 1 banks, have deposits below Rs

24

100 crore/approx R164 million, Tier II cooperative banks are generally treated for prudential

purposes as at par with commercial banks hence more stringent regulatory requirements).

UCB‟s can also accept deposits from non-members and are part of the payment system

(Thorat, 2006).


The Cooperative Societies Act of 1912 recognised the formation of non-credit societies and the

central cooperative organisations/federations. However, “cooperation” is a State subject under

the Indian Constitution; hence all registration, incorporation, management, amalgamation etc

are governed by the Registrar of Cooperatives of the particular State (Sarma, 2007).

In terms of the Banking Regulation Act of 1949, only State Cooperative Apex Banks, District

Central Cooperative Banks and select Urban Credit Cooperatives are licensed to conduct full-

fledged banking business, hence are the only „true‟ banks in the cooperative sector. Co-

operative banks in India are akin to credit unions found abroad, except that they can also accept

deposits from non-members and form a part of the payments systems.

According to Kramesh (2003) there was no well-defined concept of urban cooperative banks till

1996, when banking laws (provisions of Section 5 (CCV) of Banking Regulation Act 1949) were

made applicable to cooperative banks. At present, UCBs‟ have a minimum capital adequacy

requirement of 9 percent

2.4.4.2 Supervisory frameworks and interventions

Following banking sector reforms around the 90s, prudential standards covering capital

adequacy, income recognition, asset classification and provisioning norms were made

applicable to cooperative banks in a phased manner. Cooperative banks in India are subjected

to duality of control, meaning that the administration related aspects (incorporation, registration,

management, amalgamation, reconstruction or liquidation) are being supervised and regulated

by State Government and the banking operations (license to start new banks or branches,

matters relating to interest rates, policies on loans and investments & prudential norms) are

supervised and regulated by the Reserve Bank of India (BIS, 2006; RBI, 2009: 189-222).

Kramesh (2003) highlighted the challenges arising from such dual control on the sector, noting

that the Central Bank requires the intervention of the Registrar of Co-operatives (state

government) in carrying out some of its mandates. This is further corroborated by a study on the

Indian financial system by the Committee on Financial Sector Assessment (2009) which

25

characterised the dual control as “the single most important regulatory and supervisory

weakness” in the cooperative banking sector.

Regulatory coordination between the two main regulatory authorities of the cooperative banking

sector, i.e. the Reserve Bank and the respective State Governments has been put in place

through Memorandum of Understanding (MoU) in each State to address the problems of dual

control, within the existing legal framework. Following this, the Reserve Bank of India now

implements a two-tiered regulatory and supervisory regime. Banks with deposits under Rs.100

crore (approx R164 million) and whose operations are limited to a single district, are considered

to be more closely epitomising the spirit of cooperative banking and as such are placed under

simplified regulations to enable them to gradually gain in strength, such that, over a period of 3

years they can be brought at par with all other banks in term of performance, strength and

regulatory prescriptions. The periodicity of inspection of cooperative banks varies according to

the scheduled status of the cooperative bank or the financial position as reflected by its grade.

For example, while scheduled and Grade III and IV non-scheduled UCBs are inspected on an

annual basis, the non-scheduled UCBs with healthier financial performance (classified under

Grade I and II) are inspected once in two years.

The central bank also allows the smaller banks to adopt less stringent prudential standards to

provide relief and allow an improvement in financial performance through lower Non Performing

Loans, hence lower provisioning and high profits which can improve capital positions9. Smaller

co-operative banks also get exemptions from investing in prescribed assets.

With regard to the mechanism for supervision, the smaller banks, which are limited by their size

and type of operations, pose lower systemic risks and are therefore supervised by a

combination of simplified off-site surveillance system of the RBI and on-site audit by the state

governments, lowering the supervisory burden of the small entities (WB, 2007).

The National Bank for Agriculture and Rural Development (NABARD) has been entrusted with

the statutory responsibility of conducting inspections of rural CFIs under the provision of the

Banking Regulation Act, 1949. NABARD‟s inspections are focused on ensuring conformity with

banking regulations and facilitating internalisation of prudential norms. NABARD conducts

annual statutory inspections of all rural CFI‟s which do not comply with minimum capital

requirements, while CFIs‟ with a positive net worth where inspected once every two years (RBI,

9 An example is the 180 days delinquency norms for classification of assets as non-performing, instead of the 90 days norm which is

applicable for the larger cooperative and all commercial banks in India.

26

2009). Additionally, a system of `Off-site Surveillance' has been introduced as a supplementary

tool to the on-site inspection, to act as an early warning tool.

2.4.5 Irish cooperative financial institutions

The first credit union established in 1958, arose from incidences of poverty, unemployment,

money lending and other social vices prevailing during the period. The Credit Union Act (CUA)

of 1997, which governs the operations of CFI‟s in Ireland identifies two main common bond

classes i.e. community (residing or being employed in a particular locality) and

industrial/associational (industrial being working in a particular industry and associational being

a member of a bona fide organisation), with the former being the majority i.e. 92 percent,

according to Glass, McKillop & Rasaratnam (2009: 67).

For a sector, that is less than fifty (50) years old, the CFI sector in Ireland has grown remarkably

and is widely considered a „success story‟ with the largest penetration in the world at 75 percent

of the country‟s population of just over 4.2 million (WOCCU, 2009). In 2009, there were 503

CFIs, with assets of approximately $20 billion and a total membership of almost 3 million.


The Credit Union Act of 1997 is the primary legislature governing the operations of CFI‟s in

Ireland. The CUA mandates the Regulator to ensure CFIs‟ protect the funds of their members

and maintain the financial stability and well being of CFI‟s. The CUA also gives substantial

powers to the Regulator, i.e. it allows the Regulator the ‘power to do anything which, in his

opinion, is necessary to facilitate the exercise of his functions or is incidental to or consequential

on their exercise…’

Registration as a CFI is open to fifteen (15) members or more, subject to the members meeting

the registration requirements, including feasibility and fit & proper tests, while it is not overly

restrictive in terms of what a CFI can do. The CUA sets the minimum share value at £1,000

(approx US$1,600). CFI‟s are required to apply to the Regulator to take on additional services

such as mortgages, life and pensions, personal retirement savings accounts and longer term

lending.

A CFI may borrow money and may issue debentures, however, such outstanding exposures

should not exceed 50 percent of the aggregate of the shares balance and the deposits balance

of the CFI. Additionally CFIs are required by law to give notice to the Regulator should the

institution intend to borrow funds which will exceed 25 percent of liabilities.

27

The CUA also sets out long term lending limits for CFI‟s i.e. loans with a tenure of 5 years can

only constitute a maximum of 20 percent of the loan portfolio, while loans with a tenure of 10

years can only constitute a maximum of 10 percent of the loan portfolio. A provision has been

included in the Central Bank Reform Bill, 2010 to increase the lending limit for loans over five

years for all CFIs from 20 percent to 30 percent subject to conditions which will be imposed on

credit unions relating to liquidity, provisioning and management and reporting of rescheduled

loans (Central Bank of Ireland, 2010).

A CFI may invest any of its funds which are surplus to its operating requirements and are not

immediately required for the purposes of the CFI into prescribed assets.

CFI‟s are required to establish a regulatory reserve consisting of statutory reserves and any

amount held in non-distributable additional regulatory reserve accounts. The regulatory reserve

to total assets (after allowances for bad and doubtful debts) ratio should be no less than 10

percent. Such reserves cannot be capitalised by issuing bonus shares or dividends. In terms of

the new provisions CFIs in Ireland were required to hold a regulatory reserve ratio (RRR) of 7,5

percent by mid 2009. CFI‟s were, however, given a staggered timeframe (up to September

2013) to reach the 10 percent RRR threshold. A failure by CFIs to comply with the RRR

thresholds will result in restrictions in operations i.e. not being permitted to pay a dividend in

excess of 1 percent (ILCU, 2009). In addition, a CFI that reports a surplus, but has a RRR below

the 10 percent threshold or would be below the 10 percent threshold after paying the dividend

will require regulatory approval to pay out the dividend.

It should be noted that CFI‟s that take deposits are also required to hold a deposit with the

central bank based on 2 percent of each CFI‟s liabilities (shares and deposits).


While the regulatory infrastructure contextualises the modus operandi of CFI‟s, the supervisory

framework ensures the financial soundness and rectitude of individual CFIs and, in so doing,

safeguards the movement as a whole, (Glass, McKillop & Rasaratnam, 2009: 67). The

regulation and supervision of CFI‟s in Ireland is the responsibility of the Registrar of Credit

Unions (RoCU), a distinct entity operating under the Irish Financial Services Regulatory

Authority (IFSRA) which was established in 2003. Prior to this, CFI‟s were regulated by the

Registrar of Friendly Societies (RoFS) who also regulated activities of all cooperatives. While

under RoFS, CFIs‟ were only required to submit annual returns. Kaupelyte & McCarthy (2006:

28

185) indicated that rigorous monitoring of the sector was conducted by the ILCU on a non-

statutory basis as part of the savings protection scheme. ILCU used the CAMELS (i.e. capital,

asset quality, management, earnings, liquidity and sensitivity to market risk) framework to

evaluate CFIs‟ until 2003 when it changed to the PEARLS10 framework as advocated by

WOCCU.

The RoCU uses a risk based framework to supervise the sector on the basis of impact and risk,

consistent with the approach used by IFSRA. CFIs are considered low impact/low risk hence

are subject to a less intensive regime which derives primarily from early warning triggers or

„system generated‟ red flags from the prudential returns. Triggers highlight significantly different

risk characteristics of individual CFIs, their peers, their past performance or projected future

performance based on actual or stress scenarios. The CFI‟s are informed of the scores and risk

areas. As a result, they are expected to come up with appropriate risk mitigation plans to

address the anomalies.

2.4.6 Cooperative financial institutions in Brazil

While literature reviewed is consistent with respect to when CFIs‟ were established in Brazil,

(1902 in the state of Rio Grande do Sul), there is less congruency with regard to the first model

of CFI‟s. For example, Brusky (2007: 10), intimated that the first CFIs‟ in Brazil were modeled on

the Raiffessen model (rural based, restricted to one municipality), while Kumar (2005: 132)

opined that the first model was of the luzzatti type i.e. open to urban populations of one or more

municipalities. Notwithstanding the variations, CFIs‟ in Brazil developed relatively fast, with other

types of CFIs emerging resulting in over 500 CFIs being registered with the Ministry of

Agriculture by 1961 (Brusky, 2007: 10). Three years later, the registration of CFIs was

transferred to the Central Bank. Financial shenanigans in the banking sector related to banking

law reforms in 1967 exposed the risks inherent in the sector, resulting in an outright ban in the

establishment of new „open membership‟ CFIs (Kumar, 2005: 132).

New cooperative laws promulgated in 1971 sharply restricted activities of existing CFIs and set

very stringent membership criteria which led to closures of several institutions and loss of

savings by members of the affected CFIs. In the 80s, central CFIs were allowed to operate as

apex bodies for member CFIs, and in essence addressed liquidity management in the sector. In

1995, the National Monetary Council authorised the establishment of cooperative banks which

10

PEARLS is an acronym for Protection, Effective financial structure, Asset Quality, Rate of Returns and Cost, Liquidity, Signs of

Growth. It is financial performance monitoring system designed to offer management guidance for CFIs and other savings institutions.

29

are primarily commercial banks owned and controlled by cooperatives. This afforded the CFI

sector the benefits of the banking system such as access to a payment system and lender of

last resort facilities from the central bank.

Central CFI‟s11 are the apex institutions for member cooperatives and operate at state level.

Such CFIs can be owned by at least three cooperatives. Central CFIs serve to review standards

applied by members around finance, staffing and credit management. Central CFIs also offer

liquidity management to affiliated cooperatives and assume some delegated supervision from

the central bank. In addition, following legislative amendments in 1995, the central CFIs have

established cooperative banks; Banco Cooperativo do Brasil (Cooperative Bank of Brasil;

BANCOOB) and Banco Cooperativo SICREDI (Cooperative Bank SICREDI, BANSICREDI).

This has allowed central CFIs access to the national payment system as correspondent banks

for their respective networks, leading to the growth of the sector.

2.4.6.1 Legal framework and prudential requirements

Prior to 2003, CFIs were subject to the general laws for cooperatives, though as financial

institutions were also subject to the general Financial Institutions Law and the resolutions of the

Monetary Council (Kumar, 2005). Such resolutions included Resolution 2.608/99 which

stipulated the supervisory role of central CFIs, including responsibility for auditing affiliates. It

more broadly defined the target public of cooperatives and set minimum capital requirements. It

took a position in favor of integrated systems supervised by a centralising entity.

Resolution 2.771/00 reduced capital requirements for individual cooperatives by adopting limits

that set according to the degree of risk of the capital structure. Resolution 3.058/02 authorised

credit cooperatives for small businesses and micro-entrepreneurs, and Resolution 3.041/02

addressed the conditions required (for example, personal solvency, no criminal record, and

sufficient training or experience) to be an elected representative. Resolution 3.106/03

authorised a constitution of open-admission12 cooperatives in regions of less than 100,000

inhabitants and the transformation of other cooperative forms into open-admission cooperatives

in regions of less than 750,000 inhabitants. It also laid out the requirements for forming a

11

The three main CFIs are Credit Cooperative System (SICREDI), Brazilian Credit Cooperative System (SICOOB), and the Mutual

Credit Cooperative (CRESOL) 12 As in the United States, CFIs in Brazil enjoy tax exemptions that commercial banks do not have, hence restrictions on eligibility of

membership to avoid „unfair‟ competition with banks.

30

cooperative, including an economic viability study, a description of internal controls, credit

policies and products, and a description of the systems and technologies to be used to serve

members. Resolution 3.321/05 revised the population limits for creating open-admission

cooperatives (allowed now in regions with up to 300,000 inhabitants), authorised electronic

service points, and emphasised the importance of external auditing (World Bank, 2007).

Prudential requirements are in place for credit and minimum capital. Exposures to a single party

are limited to 10 percent and 5 percent of liquid capital respectively for affiliated and non-

affiliated CFIs. The minimum capital for central CFIs is pegged at R$60,000 (approx

US$35,000) for new institutions which gradually increases to R$300,000 (approx US$175,000)

by the fifth year. For member cooperatives, the capital is set at R$3,000 (approx US$1,750) for

new entrants and is expected to increase to R$60,000 (approx US$35,000) by the fifth year.

There is no specific capital adequacy ratio for CFIs, but there are limits on leverage (10x liquid

capital affiliated CFIs and 5x liquid capital for non-affiliated CFIs). The leverage limits are

relaxed for rural CFIS that participate in government funding programs.

CFIs are not obligated to place reserves with the central bank, however central CFIs oblige

member cooperatives to place 90 percent of demand deposits and 25 percent of time deposits

in liquid assets, effectively reducing loanable resources. The high level of liquidity reserve

requirements is attributable to the absence of a deposit insurance scheme for CFIs, though

some central CFIs provide member cooperatives with a form of stabilisation fund (Kumar, 2005).

Cooperative banks can also provide partial lender of last resort through their own access to the

lender of last resort funds. All loans of R$5,000 or more must be reported to the Central de

Risco de Crédito, or central credit bureau run by the Central Bank, thus, clients who fail to repay

one institution should be unable to obtain credit at others.

2.4.6.2 Supervision approaches

The central bank has a distinct department responsible for the supervision of CFI‟s. The

department approves applications for the establishment and appointments of boards of directors

of CFIs and establishes reporting requirements. It conducts direct supervision of central CFIs

and unaffiliated CFIs through onsite inspections via regional offices and monitors liquidity and

credit risk.

Routine oversight, as a form of auxiliary supervision, is offered by all cooperative networks to

their member CFIs. These networks apply standards to varying degrees through their central

31

credit cooperatives, which use moral suasion to enforce prudential standards (Kumar, 2005:

151). Kumar, 2005 further postulates that this moral suasion is backed by legal remedies in

extreme cases, but more typically, standards are enforced through performance- related pay for

cooperative managers, network-applied sanctions against the single cooperatives‟ directors in

the event of noncompliance with guidelines, restrictions on credit to weaker cooperatives (for

example, BANCOOB does not lend to member cooperatives with C ratings in its internal scoring

system), and the ultimate sanction of expulsion of the cooperative from the network (while the

ultimate sanction of the Central Bank is closure and liquidation). In addition, all central and non-

affiliated CFIs must submit to annual external audits, while rural CFIs and open admission CFIs

are expected to be audited once and twice a year, respectively, by their central CFIs.

2.4.7 Cooperative financial institutions in Kenya

In Kenya, the term savings and credit cooperative (SACCO) is dominantly used to refer to

deposit taking institutions with cooperative background, i.e. sharing a common bond. According

to an ILO 2009 report, the first CFIs were registered in Kenya in 1964, and in the ensuing years

the number of SACCOs increased based upon common bonds linked to residence, occupation

and churches. A government directive in 1969 restricted the common bond to a secure crop or

employment relationship. Such crop or employer-based bonds ensured that CFIs received

payments directly from employers, processors (cooperatives, parastatals or private companies)

or marketing organisations. This system ensured that a member‟s income would have automatic

deductions to repay loans and was a significant factor in the development of CFIs in the country.

Kenya also has several rural CFIs which evolved in the early 1990s from the Union Banking

Sections in District Unions of cooperatives. The Union Banking Sections were essentially

Raiffeisen-type financial cooperatives because they were part of unions that operated at the

provincial level and had branches at each of the member cooperatives. Following widespread

bank failures in Kenya in the 1980s and 1990s, rural CFIs thrived further as the banks generally

withdrew from these rural areas. Many rural CFIs later became shareholders in the Co-operative

Bank of Kenya (Nair & Kloeppinger-Todd, 2007: 35). A number of the CFIs carry out full retail

banking services commonly referred to as Front Office Services with strong linkages to the Co-

operative Bank of Kenya, while others run back office operations.

Kenyan Union of Savings and Credit Co-operatives Limited (KUSCCO) is the umbrella

organisation of all SACCOs in Kenya including rural SACCOs which are also affiliated to the

Kenya Rural Savings and Credit Cooperative Society Union (KERUSSU). KUSCCO offers

32

advisory, advocacy and support services to its entire member SACCOs. It also runs a risk

management program and a central finance facility, which is an inter-lending facility to which

member CFIs can access loans.

The CFI movement in Kenya has been long recognised as a key vehicle for expanding

affordable financial services and products to the majority of Kenyans, especially the low-income

households and SMSEs in both urban and rural areas (Central Bank of Kenya, 2009). As an

example, prior to 2008, the Co-operative Bank of Kenya whose membership included rural

SACCOs and cooperative societies and unions, was part of the cooperative landscape having

been registered in terms of the Cooperatives Societies Act in 1965. In June 2008 the

Cooperative Bank of Kenya was incorporated under the Companies Act, and subsequently went

public and was listed on the Nairobi Stock Exchange (NSE).

According to WOCCU, in 2009 there were over 3,900 active SACCOs in Kenya, accounting for

3.8 million members worth $2.6 billion with loans outstanding of $2.5 billion.


Given the relative significance of the sector, the Central Bank of Kenya, in various annual

reports dating back to 2001 noted that the major challenge facing the sector was an absence of

prudential regulation and supervision. Consequently, in 2008, a SACCO Societies Act 2008 (No.

14 of 2008) was enacted into law to make provision for the licensing, regulation and supervision

of the Sacco Societies as well as establish the Sacco Societies Regulatory Authority (SASRA).

SASRA is responsible for the licensing and supervision of Sacco societies intending to engage

in deposit taking business as well as the establishment of the deposit guarantee fund.

In terms of the Act, all deposit taking CFIs are expected to apply for licensing from SASRA as

well as be registered in terms of the Cooperatives Societies Act. The Act also allows SASRA to

carry out both offsite and onsite examinations of registered CFIs. To enforce supervisory

actions, SASRA has three main administrative sanctions i.e. memorandums of understanding,

letters of understanding &agreements and cease and desist orders. It also has other non-

administrative sanctions which include prohibitions and removal of officers; placing a Sacco

society under statutory management; and imposing monetary penalties.

The legislative framework governing cooperative financial institutions should empower them,

enabling their development and encourage outreach towards the targeted population while

33

ensuring that financial sector rules are applied appropriately, particularly with regard to member

and depositor protection (World Bank, 2007).

i. Minimum prudential requirements

The minimum capital adequacy ratio (CAR) of 10 percent uses total assets instead of risk-

weighted assets in the computation of the ratio, which compares favourably to the Basel 2

recommendation of 8 percent. The Kenyan regulations use the number of missed installment

payments as a determinant of delinquency e.g. a loan that has missed one installment is

classified as watchful, while any loan that misses two to six installment payments is considered

doubtful. The respective prudential requirements for regulated CFI‟s in Kenya are summarised

in Table 2.5 below:

Table 2.5: Prudential requirements in Kenya

Prudential Calculation Threshold

Capital adequacy Core capital > SH 10 million (approx

US$120,000)

Core capital/total assets ≥ 10 percent

Institutional capital/total assets ≥ 8 percent

Core Capital/total deposits ≥ 8 percent

Liquidity Liquid assets/ (savings deposits + short term

liabilities)

15 percent

External borrowing External Borrowing/Total Assets ≤ 25 percent

Loan loss allowance Allowance on performing loans 1 percent

Allowance on watch 5 percent (1-30 Days)

Allowance on substandard 25 percent (31-90 days)

Allowance on doubtful 50 percent (91-180 days)

Allowance on loss 100 percent (360 days or

more)

Insider lending Loan to insider/total assets ≤ 5 percent

Non earning assets Non earning assets/total assets ≤ 10 percent

Source: SACCO Societies regulations


SASRA is the regulatory and supervisory authority of all SACCO‟s in Kenya and is funded from

government and annual license fees levied over and above the application fee. The SASRA

34

regulations in Kenya forbid a regulated CFI from paying member dividends unless it has

complied with the prescribed minimum capital adequacy as well as the other prudential

requirements. If the Authority deems the CFI to be in a position to address the supervisory

concerns, a memorandum of understanding and agreement (MUA) is entered into with the CFI‟s

board. The MUA essentially gives the CFI specific corrective action/remedies to address the

anomalies within a given time limit. A letter of understanding is issued if the CFI does not

adequately address the supervisory concerns as indicated in the MUA, failure of which a Cease

and Desist Order (C&D) is issued. The C&D states the specific actions that must be ceased,

who is to cease from doing the action, and the time period. At any stage during the

aforementioned process, the SACCO Societies Authority can instigate any of the following

administrative tools in the event of non compliance by a registered CFI:

i) suspension of lending and investment;

ii) prohibition from acquiring, through purchase or lease of any additional land and

buildings;

iii) prohibition from accepting further deposits or other lines of credit;

iv) prohibition from acquisition of additional non-core assets; and

v) prohibition from declaring dividends, paying bonuses, salary incentives and other

discretionary compensation to officers of the CFI.

In more severe instances, the Authority has the power to revoke a license and the implications

for the affected CFI is a possible liquidation and its key officials being prohibited from holding

any position in any CFI.

2.4.8 CFIs in Jamaica

A 2004 report on the history of CFIs in Jamaica by the Jamaican Credit Union League (JCUL)

attributed the establishment of CFIs in the country to the need to address a myriad of social

problems which culminated in mass riots against poor wages and inhumane working conditions

in 1938. Consequently, the first CFI, the Sodality Credit Union was formed in 1941, and the

sector grew rapidly until the 70s, when the sector consolidated, however, membership growth

remained on an upward trajectory. Co-operative Societies on the island were registered under

the Industrial and Provident Societies Law, which was considered inadequate for CFIs (JCUL,

2004). A new Act enacted in 1950, the Co-operative Societies Act‟, also failed to deal with

matters pertinent to CFIs as it covered all types of co-operatives with a special section for CFIs,

notwithstanding the rapid growth of the sector.

35

The JCUL, a co-operative central body embracing all the CFIs in Jamaica, represents members

by contacting the Government about issues such as legislation, conducts central business

services, receives deposits from CFIs and other co-operative societies, issues out loans to its

member CFIs, undertakes investments for its member CFIs and organises new CFIs.

CFIs in Jamaica have extensive outreach, with an estimated 980,000 members (about 49

percent of the adult population), giving one of the highest penetration rate of CFIs in the world.

In terms of assets, they are not large compared to banking system deposits, but CFI members

are more numerous than bank depositors and the number of CFI loans exceeds that of bank

personal loans. Rapid growth has made the larger CFIs appear increasingly like conventional

banks (IMF).


The primary legislature governing CFIs in Jamaica is the Cooperative Societies Act, which falls

under the Ministry of Industry, Investment and Commerce (MIIC), which is the ministry with

portfolio responsibility for cooperative societies.

Current amendments to the Cooperative Societies Act, still to be tabled in parliament, will seek

to restrict the deposit-taking activities of cooperative societies to those cooperative societies

which operate as financial cooperatives. Secondly, it will seek to bring CFIs under the regulatory

ambit of the Minister of Finance and the Bank of Jamaica (BoJ, 2009).

Regulations, to be issued in terms of the Bank of Jamaica Act, will establish a supervisory

regime that will be applicable to CFIs, and will place CFIs under the full prudential supervisory

regime of the Bank of Jamaica. These regulations will, among other things, prescribe prudential

criteria and minimum solvency standards covering, inter alia, essential areas such as capital

adequacy, liquid assets, credit limits, non-accrual and provisioning requirements, submission of

financial statements and remedial action that can be taken by supervisory authorities with

respect to unsafe and unsound practices or insolvency.

During 2008, several CFIs obtained the approval of their membership to amend their rules to

allow for the issue of permanent shares to strengthen capital. This arose from their recognition

that withdrawable share savings do not qualify as capital and are not to be treated as such

under the draft Bank of Jamaica (Credit Unions) Regulations or International Financial

Reporting Standards (IFRS) requirements. It is envisaged that this will facilitate a transition from

36

the long standing tradition and practice of recognising withdrawable members‟ share savings as

part of a CFIs institutional capital.


The Central Bank currently conducts on-going monitoring of CFIs by way of analysis of monthly

and quarterly prudential submissions to the Bank. In addition to prudential returns, CFIs are

required to submit audited financial statements to the central bank. In addition, central bank has

been embarking on on-site examinations of CFIs, which included the provision of feedback to

the boards and management of CFIs forming the basis for strengthening of the overall

operations and practices of most CFIs in lieu of licensing under the imminent Regulations.

The supervisory methodology combines annual on-site examinations of each licensee with on-

going off-site monitoring, facilitated primarily by prudential reporting requirements. The process

allows for continuous and timely review of developments in the financial condition of supervised

entities both at the micro institutional level as well as at the macro systemic level.

On-site examinations are statutorily conducted at least once each year by the Supervisor.

These examinations include assessments of key aspects of an entity‟s operations such as

capital adequacy, treasury operations, asset quality, earnings sustainability, market risk

sensitivities, information systems infrastructure and disaster recovery/ business continuity

arrangements. In recent years, the Bank has also been transitioning to a risk focused approach

to supervision. This involves enhanced offsite and pre-examination procedures, with increased

scrutiny on licensees‟ corporate governance frameworks, risk management and

operational/group structures. The results of these assessments identify those areas that pose

the greatest potential risk to each institution‟s operations and inform the scope of on-site

reviews and the level and focus of supervisory resources to be assigned to each examination.

Off-site assessments are primarily facilitated by prudential returns submitted to the Bank

weekly, monthly, quarterly and annually, as well as by reviews of audit and other external

reports. Such reviews include the use of an „Early Warning System‟.

2.5 Conceptual overview of regulatory and supervision of CFIs

This section provides an overview of key issues facing CFIs in the various countries reviewed

and identifies learning points for the CFI sector in South Africa. Key issues discussed include

the common bond, CFI capitalisation, structure and networks and prudential regulations.

37

2.5.1 Open common bonds vs closed common bonds

The historical development of CFIs in the eight countries reviewed is based primarily on the

common bond, be it a common employer, association or geographical location. The key issue is

whether „open common bonds‟ or „closed common bonds‟ are instrumental in the development

of the sector. The „closed common bond theorem‟ is supported by an analysis based on a

theoretical model of CFI formation and consolidation using an extensive United States CFIs

dataset and a nonlinear approach by Emmond & Schmid (1999: 47). In this particular study, the

authors concluded that the larger the pool from which a CFI can draw membership, the less

effective it is in attracting members.

However, using the same dataset, albeit a few years later, Goddard et al (2002: 2328) noted

that less restrictive interpretation of the common bond in US CFIs created opportunities for

growth and mergers, with the number of CFIs declining from 15,000 in 1987 to 10,858 in 1999.

Remarkably however, membership, as an indicator of outreach, increased from 53 million to

76.6 million and asset size from US$571 million to US$1.9 billion over the same period. This

was also confirmed by a separate study by Robbins (2005) who noted that less restrictive

common bonds in the US resulted in improved financial conditions of CFIs as well as increased

competition between banks and CFIs. The growth in the CFI sector in Kenya has also been

largely attributed to early restrictions limiting common bonds to a secure crop or employment

(World Bank, 2007).

The inverse relationship between membership and number of CFIs in a country is also

observable in four other countries reviewed in this study i.e. Canada, Ireland, India and

Jamaica. In some of the jurisdictions, the law on CFIs provides for three categories of CFI‟s,

those with an open bond i.e. open to the public without membership requirements, those with a

closed bond i.e. only transact with members, and those that are a hybrid of the two extremes i.e.

allowing non-members to carry out limited transactions with the CFI.

Fuller (1998) also observed that the rigid demarcation of common bond boundaries, whether

based around pre-existing common attributes or what are perceived to be common attributes is

exclusionary in nature. He further pointed out that legislation requiring statutory declaration of

common bonds tends to result in CFIs seeking to attain the widest possible coverage. In a study

of CFI‟s in Ireland, Glass et al (2010: 67) observed that relative to those with a community

common bond, industrial/associational CFIs have a greater relative share of CFIs with low levels

of inefficiency and a smaller relative share of CFIs with high levels of inefficiency.

38

The regulatory effect of an open bond is that such CFI‟s will require higher capital and prudential

requirements. This is a result of increased risk as the CFI‟s reliance on the mutuality relationship

predominant in „closed bond‟ CFIs is replaced by a need for skills in credit risk appraisal. In

other words, common bond restrictions are assumed to reduce the cost of gathering credit

information, thereby minimising exposure of individual CFIs to bad debt losses (Davis, 1994).

An additional alternative to the common bond dilemma is to allow CFI‟s to go both ways, i.e.

allowing CFIs to serve non-members but with different risk management criteria for transacting

with the CFI. However, such arrangements also have a direct bearing on capitalisation

requirements for CFIs as will be highlighted in the next section.

2.5.2 Capitalisation

In most jurisdictions, regulators have imposed minimum capital requirement on CFIs with

Gonzalez & Fonseca (2009: 892) citing Furlong & Keeley (1989) and Episcopos (2008) noting

that capital requirements have a stabilising effect on institutions according to the option pricing

model. Capital serves as cushion/buffer to absorb unexpected losses, thus allowing the

institution to continue operations even in difficult times. However, other banking literature (Kim &

Santomero, 1988: 1231) observe that capital requirements force a reduction in leverage

reducing an institution‟s expected returns forcing institutions to undertake investments with a

higher return and higher risk. More often, than not, however, such increases in risk will

ultimately offset the intended increase in capital, hence the current regulatory drive towards risk

based capital standards.

CFIs, by definition, do not have a class of “owner-shareholders” identifiably different from their

member-customers. Typically, all clients must become members, through the purchase (at a

notional cost) of a minimum of one share which carries an entitlement to one vote at meetings of

members, with membership restricted to a common bond based on a geographical, industrial or

community basis. Thus by default “permanent” capital can only be accumulated through

retained surpluses from operating activities, unless member shares are designated as

permanent in nature within the laws of the country. Further, the capital structure of the

cooperative is likewise fragile when members can essentially withdraw their share capital by not

repaying their loans. In New Zealand, for example, statutory prohibition against CFIs having any

share capital other than members deposit shares has directly contributed to CFIs‟ inability to

generate sufficient income to maximise growth while having to meet existing capital

requirements.

39

Surpluses, when transferred to accumulated reserves (capital) transfers wealth from private

ownership of members to communal wealth ownership. Thus, the unintended consequence of

capital requirements is that it forces CFIs to focus on achieving a surplus each year (to grow the

capital) regardless of whether this is in the best interest of members or not (Davis, 1994). Brown

and Davis (2008: 444) drew a link between such private wealth transfer and communal wealth

transfer by noting the effect of the common bond on the willingness of members to accumulate

communal wealth (in the form of capital). In a study of 47 CFI bond in the US, the two concluded

that restricted common bonds tend to reduce member resistance to accumulation of communal

wealth.

In the absence of surpluses, CFIs would need to consider alternative ways to raise capital within

the confines of their constitutions and laws. One route would be to allow CFIs to issue equity

securities or subordinated debt to members or non-members, provided such equity can be

transferrable among members only, contain a reasonable exit mechanism (such as a share

repurchase facility) and do not compromise on the quality of voting. It should be noted that

external capital imposes a cost on current membership in the form of increased interest spread

between loans and deposits as well as fees needed to generate profits without a marketable

claim on the resultant accumulated surplus (Brown & Davis, 2008: 444).

2.5.3 Prudential regulation and supervision

Glass et al (2010: 75), in a study of Irish CFIs observed that an appropriate regulatory and

supervisory infrastructure is a critical element in the successful development and good

functioning of a CFI movement. The regulatory infrastructure contextualises the modus operandi

of CFIs while the supervisory framework ensures the financial soundness and rectitude of

individual CFIs and, in so doing, safeguards the movement as a whole. The key word, however,

is appropriate, as CFIs face a dual legislation in most countries, a general cooperative law and

CFI specific legislation. Onerous prudential regulations may place major barriers to entry in the

CFI sector thereby precluding start-up of new CFIs. A newly established CFI, even with

substantial deposits, would be unable to lend those funds to members unless significant share

capital is available. When CFIs are small and lend only share capital and a few retained

earnings, they may function effectively through self-regulation (Branch, 1992).

A national organisation may assist in this by enhancing the quality of management, through

some supervision, and by providing liquidity in times of emergency. The strongest incentive for

people to continue to support a CFI, thereby regulating its performance; is the confidence that it

40

will persist. Problems of prudential regulation increase as the amount of retained earnings used

in lending increases, as credit unions begin to mobilise deposits, and when they receive outside

funds for lending. The CFI movements reviewed in this paper are considered among the most

successful in the world, and in all cases, the sector is regulated either by the movement itself,

i.e. dedicated regulatory authority (USA, Kenya), or the traditional central bank/supervisory

authority (Canada, German, Ireland, Brazil). Where CFIs are considered relatively small,

delegated supervision is conducted (Jamaica, Canada, Brazil).

Pasiouras et al (2009: 295) observed that prudential regulations on capital for example, have a

positive impact on cost efficiency but a negative impact on profit efficiency. A possible

explanation for the positive cost efficiency effect is that higher capital requirements reduce the

likelihood of financial distress and thus lower the need for costly risk management activities,

whereas the lower profit efficiency could be associated with a balance sheet tilt towards more

liquid, lower return assets.

The majority of countries in the survey have adopted risk based supervision or derivation of the

same to supervise the sector on an ongoing basis. This is important in that by definition, risk

based supervision acknowledges the variations in size and nature of supervised entities, and

consequently advocates for supervisory processes that are appropriate for the nature and size

of supervised institutions.

2.5.4 Networking

Virtually all the countries studied had a vibrant CFI network offering different levels of services

depending on the sophistication of the sector i.e. CUNA in Canada, ILCU in Ireland, KUSCCO in

Kenya, among others. Networking describes the arrangements between financial institutions

under which one institution provides its customers with access to products or services issued by

the other. The ability to "network" financial services is essential to CFIs. In fact, to achieve a

level playing field, there must be fewer restrictions on networking for CFIs than any other type of

financial institution currently faces. Networking provides an opportunity for independent and

small financial institutions to offer a broader range of financial services than they could

otherwise (World Bank, 2007).

As consumers, CFI members will benefit from the ability to satisfy their total financial needs in

one location. Appropriate licensing and "know-your-client" rules, and regulations to prevent tied-

selling and protection of confidential information, can ensure member protection.

41

Networking can also be used by CFIs to pool their liquidity as is the case in Canada and the

USA. The national organisations or leagues can act as central bankers through their ability to

move cash from cash surplus CFIs to CFIs requiring cash.

The World Bank (2007) recognises three main levels of integration for CFI networks. The first

level consists of a loose network (atomistic network) where each CFI remains a fully

autonomous, stand-alone unit, but adheres to a network to access common services such as

advocacy, lobbying, and representation, as well training. At a more integrated second level,

primary CFIs pool some of their resources and underwrite some pooled liabilities, while at the

third level, a cooperative bank can be set up with different levels of integration. The cooperative

bank is collectively owned by the member cooperatives, and acts as a central bank to the

sector, managing liquidity, recycling deposits, accessing financial markets, and sometimes also

providing retail financial services.

2.6 Conclusion

Following relative success in German, the CFI model was exported to the rest of the world,

though variations in the model have since emerged due to different country-specific and cultural

factors. In developed economies, the CFIs have developed to the extent that the quality and

range of products and services, their pricing and the applied distribution concepts are at par with

traditional commercial banks. Technological development in the more mature economies

(German, Canada and USA) has also meant that, access to banking services and products is

no longer a major issue and dependence on members for funding has eroded as CFIs increase

gain access to capital markets, either individually or through central cooperative networks. As

noted by Rabobank13 (2010) member involvement has also weakened due to deposit insurance

schemes, autonomy and discretion of local member CFIs in managing their affairs due to the

increased requirement for centralised business functions to deliver efficiency gains through

economies of scale and scope.

In developing economies (Kenya, Ireland, & Jamaica), CFI‟s are proving to be a relevant model

to facilitate financial inclusion and access to financial services but also spurs the growth of small

and medium enterprises as well as individuals, such as farmers, and people residing in outlying

rural areas where access to finance is restricted by geographic dispersion and other structural

characteristics. However, the success of the model as a financial intermediation depends

13

Rabobank Group is an international financial services provider operating on the basis of the co-operative principles,

serving 9.5 million members across 48 countries

42

greatly on the sustainability of the co-operative bank as a lender, the depositor, the borrower

and the sector as a whole. If borrowers become chronically indebted, nothing else can be

sustained. If savings cannot be mobilised on a consistent and continuing basis, there will not be

resources to lend. If the lenders do not recover all the money they lend, they will soon cease to

exist. If the co-operative bank cannot fully recover the cost of mobilising recourses (money cost,

i.e. interest paid to depositors, plus administrative costs of intermediation), the intermediary will

soon have to shut its doors.

In all the countries reviewed, a three tier CFI network is in place, with either the league (Ireland)

or central CFIs (India) playing a pivotal role with respect to advocacy, supervision and liquidity

management. In some of the economies (India, Brazil, Canada) the supervision of CFIs is

delegated to the centrals, while in other jurisdictions (Ireland and Jamaica), the central bank

assumes the role of supervision.

Cooperative financial institutions, while fundamentally the same across countries (in terms of

specific common ethics on locality, member ownership, social cohesion etc) have evolved

differently over the years and within jurisdictions (Boscia and Di Salvo, 2009: 20-23). But

consistent with the cooperative principles, the main driving factor for the establishment of CFIs

has been the need to enable people who do not have access to traditional financial services the

opportunity to organise and create access to financial services on a affordable and sustainable

basis.

However, in order to ensure affordable and sustainable access, there is need to develop

appropriate regulatory and supervisory infrastructures, which contextualises the modus

operandi of CFIs while preserving the extensive outreach of CFIs to small savers and

borrowers. The trend is generally towards regulatory authorities, mainly central banks, setting

certain standards and regulations for CFI activities that define risk and specified limits for CFI

risk exposure through prudential limits. At a minimum, to effectively regulate and supervise

CFIs, the legislative framework should cover the following areas: capital adequacy, asset

classifications/allowance for asset losses, licensing and entry requirements, liquidity risk,

investments into fixed assets, member loans and portfolio diversification, calculation of loan

delinquency, external credit, investment activities, standardised accounting, external audits,

nonmember deposits, and voluntary and involuntary liquidation and merger . Such rules and

regulations should ensure that the adherence to the rules and regulations is not overly

43

burdensome for the CFI or their members; and the rules and regulations are appropriate to the

size of the institutions regulated.

Depending on the size of the sector, direct supervision is provided by regulatory authorities to

central CFIs, which in turn are responsible for the oversight of their own member CFI. It seems

though that such a supervisory structure works optimally when the delegated authority has the

capacity to carry out such functions as in the USA and when it takes into account how to best

deploy scarce supervisory resources to regulate a myriad of CFIs.

Another learning point is that supervisory frameworks evolve through time in line with the

developments within the financial sector. In the early years of development, regulation and

supervision may focus on basic functions such as licensing and registration, implying a rule

based approach is more appropriate. As markets mature, standards for prudential behavior tend

to emerge – for example capital, liquidity and other risk management requirements. And

following the establishment of prudential standards typically a risk assessment process is

established by the supervisor to ensure compliance with legislated requirements. These

processes would normally include financial and regulatory reporting and on-site field

examinations. Once these mechanisms are in place, a risk-based supervisory approach is

introduced to measure and assess risk on an institution by institution basis. These frameworks

also begin to introduce enforcement measures to mitigate risk to the depositors through

required prompt corrective action. Finally, in a mature system, a deposit guarantee system is

introduced in order to provide explicit comfort to depositors that their funds are partly or fully

protected.

It is not uncommon to encounter, as in Brazil, more relaxed regulation in terms of entry capital,

and in some cases more relaxed capital ratios (in the case of the United States). Reserve

requirements at the central bank are not usually required, although CFIs take deposits from their

members, as is the case with Brazil, Kenya and Jamaica, though Ireland was a notable

exception. Some jurisdiction instead place a statutory reserve limit (which are not distributable)

with the CFI or a central CFI keeping the funds, rather than transferring them to the central

bank.

44

CHAPTER 3:

COOPERATIVE FINANCIAL INSTITUTIONS IN SOUTH AFRICA

3.1 Introduction

This chapter presents a review of CFIs in South Africa. Section 3.2 provides a historical

background to the development of the CFI sector in South Africa. In Section 3.2, policy and

legislative initiatives surrounding CFIs are discussed, while Section 3.3 provides an overview of

the status/structure of financial cooperatives in the country. Section 3.4 evaluates the regulatory

and supervisory framework as espoused by the Cooperative Banks Act of 2007 within the

context of international supervision standards such as the Basel requirements. Section 3.5

identifies strengths and weaknesses within the current supervisory and legislative framework for

CFIs in SA based on the chapter discussions while Section 3.6 concludes.

3.2 Historical development

The first cooperatives in South Africa were established as consumers‟ co-operatives in terms of

the Companies Act in 1892 (Nigrini, 2001 & Schoeman, 2006). However, as early as 1939, a

Catholic priest in Natal, South Africa, Fr Bernard Huss, urged for the establishment of

cooperative credit for African farmers as a means of encouraging economic thrift and financial

prudence (Huss, 1939). This early effort had limited success due to the emergence of radical

political influences in African politics as well as poor support from local government apparatus at

the time (Rich, 1993: 308). Consequently, it was only through the Cooperatives Act of 1981 that

CFIs were legally acknowledged as a form of business and could be registered as trading

cooperatives. The Co-operative Act of 1981 did not, however, provide for co-operatives to

accept deposits from members.

3.3 Policy and legislative initiatives surrounding CFIs (1990-2009)

Post 1994 governments have tried to promote the deepening of the financial markets and the

provision of a wide range of financial services to promote access to financial services,

particularly to the most vulnerable people characterised by low incomes and lack of access to

mainstream financial products.

The South African Reserve Bank, as a custodian of the Banks‟ Act, has long acknowledged that

the provision of credible and safe financial institutions does help lower income individuals to

45

increase their savings deposits (BSD, 2002). Consequently, the fulfillment of two requirements

is essential to the credibility and success of such institutions – firstly, a sound regulatory

framework and, secondly, fair and affordable access to basic banking services, including

efficient payment and transmission services.

Cognisant of this, the Reserve Bank sought to formalise „informal financial schemes‟, based on

the “common bond” principle through the first exemption from the Banks Act in 1994. The

ramification of this exemption notice was that informal member based groups could pool funds

and utilise them for the benefit of members, provided that such schemes were operated within

the ambit of the contents of the Exemption Notice. One such condition was that a common

bond exists between members of a group, which relied on self imposed regulation to protect the

interests of its members. This exemption notice particularly focused on stokvels, savings and

credit co-operatives and employee savings clubs. The nature of their business operations i.e.

accepting deposits is similar to the conducting of the “business of a bank” with an added social

upliftment function.

A condition of the exemption notice was that an exempt financial cooperative be a member of a

self-regulatory body approved, in writing, by the South African Reserve Bank. This made it

mandatory for such institutions to be affiliated with Savings and Credit Co-operative League of

South Africa (SACCOL) and National Stokvel Association of South Africa (NASASA), the first

self regulatory authorities (SRO) to be approved in writing. SACCOL is a registered co-operative

whose objectives include carrying out monitoring activities on savings and credit cooperatives

(SACCOs14) and also providing capacity building services. NASASA is a 'super-stokvel‟ that

represents the interests of the stokvel movement country-wide.

A second exemption notice15 was issued in 1998 provided for the establishment and regulation

of financial services cooperatives, through the Financial Services Authority (FSA). The FSA was

formed to offer a centralised support structure for FSCs under a specific statute and law and it

also assumed regulatory responsibility for member FSCs. Through donor funding, and grants

from government the FSA‟s activities were formalised i.e. structure and capacity including

human resources and physical infrastructure. In November, 1999, a third exemption notice was

14

While these are CFIs and essentially the same as a financial services cooperative (FSC), the distinction is made in this section to

reflect the nature of affiliations, i.e. SACCOs with SACCOL and FSC‟s with FinaSol, FSA and later SAMAF. It has also been observed by the author, through onsite visits, that while SACCOs have traditionally focused on both savings and credit, FSCs have traditionally been primarily deposit taking with limited credit extension. 15

Gazette No 18741, Vol. 393, No 367, issued on 10 March 1998

46

issued giving another umbrella body, Financial Solutions (FinaSol) the mandate to regulate

financial services cooperatives which were part of its franchise system, with funding from

USAID‟s Improved Micro-enterprises Liquidity Program.

In 2002 FSA and FinaSol, which both depended on grants from private donors and government

to undertake their financial regulation and support functions had to terminate their operations

when the grant funding stopped (SARB, 2002: 32). Subsequent investigations also revealed that

neither of these self-regulatory bodies had records of audits of the financial services

cooperatives (FSCs) under their control (Deloitte & Touche, 2003). Two assessments in 2003

and 2006 by Deloitte‟s showed that both FinaSol and FSA had regulated a total of 63 FSCs. Of

these, a total of twenty (20), were considered as potentially viable and could be resuscitated

provided additional capacity enhancement was done on governance, pricing, accounting and

record keeping. The remainder were deemed non-viable, and pay-outs in excess of R5 million

were made to the members/depositors. Some of the economically viable FSCs affiliated with

FSA and FinaSol continued to operate despite the absence of a regulatory body. An attempt

was made by the FSCs, during the period 2003-2006 to form a new support and self regulatory

body, with the support of the Department of Agriculture, called FINCOSA, however this did not

materialise. Thus between the periods of 2002 – 2006 there was effectively no oversight or

supervision and regulation of FSCs, and FSCs which continued to operate were in violation of

the exemption notice.

In 2007, the National Treasury motivated for another regulator for the sector, given capacity

constraints on the part of the central bank. An already existing government entity, the South

African Microfinance Fund (SAMAF) was mandated to assume the regulatory responsibilities for

FSCs on an interim basis, through Exemption Notice No 887 issued in 2008. SACCOL

continued with the regulation of SACCOs as per the 2006 Exemption Notice16. This was

motivated by the continued deterioration of FSCs in the absence of a regulator.

3.4 Further regulatory and policy interventions (2007 to date)

The key policy intervention by Government was the enactment of the Cooperative Banks Act in

2007 and the operationalisation of the said Act which resulted in the establishment of the

Cooperative Banks Development Agency (CBDA) and the appointment of Supervisors for

Cooperative Banks.

16

Appendix 2 proffers a summary of the differences in the various exemption notices, the regulators and the common bond

47

In August 2010 there were seventy five (75) registered CFIs, with either SAMAF or SACCOL, in

South Africa distributed across all provinces with a total of R126 million in deposits and 32,000

members. However, only sixty two (62) CFIs are considered operational or active (CBDA,

2010).

3.4.1 Overview of the Cooperative Banks Act of 2007

The Cooperative Banks Act was promulgated in 2007, in part to address the challenges the

sector face and also to pursue another key policy objective; that of financial inclusion. This is

informed by the premise that cooperative financial institutions provide an opportunity to extend

financial outreach into rural areas with both deposit and credit services (Calvin & Coetzee,

2010). CFIs are still required to register as a cooperative first, in terms of the Cooperatives Act

of 2005, through the Department of Trade and industry (DTI).

Act establishes an appropriate regulatory framework for cooperative financial institutions

providing members the same safety and stability enjoyed by traditional commercial banks‟

clients. In lieu of the developmental nature of the Act, it provides for the creation of support

organisations for the cooperative banks in order to ensure a continuous and sustainable

capacity building programme for the industry. This is necessary to ensure the growth and the

stability of the sector.

Consequently, South Africa has developed a tiered set of regulatory powers and duties with the

exemption notices mandating SACCOL and SAMAF to regulate cooperative financial institutions

that are below set minimum regulatory thresholds, i.e. 200 members and R1 million in deposits.

The Act provides for the direct supervision of cooperative financial institutions with members of

200 or more and deposits in excess of R1 million and R20 million by the Cooperative Banks

Development Agency (CBDA) Supervisor and the SARB Supervisor respectively. Additionally,

SARB has supervisory responsibilities for all secondary and tertiary financial institutions.

SACCOL and SAMAF maintain their delegated supervisory powers as per the exemption

notices as indicated below:

48

Figure 3.1: Current structure if the CFI sector in South Africa

Source: Researcher‟s Interpretation based on existing legislation

The Act and subsequent rules and regulations issued by the Supervisors specify prudential

requirements covering capital adequacy, loan provisioning requirements, liquidity levels and

reserve requirements, but only for registered cooperative banks. A complexity arises when a

CFI that meets the minimum criteria for applying to register i.e. 200 members and R1 million in

deposits fails to meet the requirements for registration with regard to operational capacity and

solvency.

The CBDA 2010 annual report indicate that a total of seventeen (17) cooperative financial

institutions currently meet the minimum criteria for registration i.e. 200 members and R1 million

in deposits, of which fourteen (14) have formally applied for registration as cooperative banks.

The qualifying cooperative financial cooperatives had a total of 22,500 members with R119

million in deposits as at 30 August 2010 as shown in the schedule below:

49

Table 3.1: Schedule of qualifying CFIs as at 30 August 2010

CFI Type Members Assets (R) Loans (R) Savings (R)

Kleinfontein SACCO 266 29,439,510 21,140,300 29,264,193

Orania SACCO 201 27,075,291 21,509,501 26,752,291

Oranjekas SACCO 466 16,700,000 8,700,000 15,700,000

Alrode SACCO 1,738 10,402,383 8,092,950 8,648,959

Ditsobotla SACCO 902 6,716,708 5,063,951 6,314,405

Sibanye SACCO 2,100 4,801,519 4,279,633 4,370,685

SAMWU SACCO 2,800 5,498,851 2,388,547 4,257,713

Ziphakamise SACCO 480 4,322,252 1,734,199 2,808,292

NEHAWU SACCO 2,784 2,777,858 1,451,691 2,680,920

CFF SACCO 25 3,568,875 3,343,958 2,417,075

Mayibuye SACCO 223 1,475,283 1,054,126 1,315,290

Beehive SACCO 3,148 1,262,679 0 1,262,679

Motswedi FSC 3,275 6,231,549 31,041 6,219,408

Kraaipan FSC 2,131 2,602,314 Not available 2,463,479

Lethlakane FSC 1,088 Not available 13,700 1,600,000

Mathabatha FSC 2,124 1,839,751 576,485 1,454,893

Disaneng FSC 886 1,000,106 99,686 1,362,000

Total 22,513 125,714,929 79,479,768 118,892,282

Source: CBDA

The few FSCs represented in the schedule reflect the high fatalities in the sector relative to the

SACCOs following the demise of their support organisations, FSA and FinaSol as highlighted in

Section 3.3. In addition, the total membership in qualifying CFIs 22,500 against South Africa‟s

population of over 35 million, gives a low penetration rate of 0.06 percent. This compares

unfavorably to Africa‟s average CFI member penetration of 6.8 percent, with some African

countries such as Kenya and Senegal having member penetration of 18 percent and 25 percent

respectively. This may be indicative of the nascent nature of the sector or an apparent lack of

confidence in cooperative financial institutions in the country. As highlighted by Calvin and

Coetzee (2010: 2) the key challenge for policy makers and the CBDA, which is mandated with

the development of the sector, is thus to address the low penetration level of cooperative

financial institutions in the country.

50

3.4.2 Appointment of supervisors

The Cooperative Banks Act provides for the appointment of Supervisors of Cooperative Banks

within the CBDA and the South African Reserve Bank (SARB). Pursuant to this, the SARB

established the Co-operative Banking Supervision Unit (CBSU) within the Financial Stability

Department and the CBDA established its own supervision unit (CBDA Supervision); with both

units responsible for the supervision and regulation of co-operative banks. (SARB, 2010)

The supervisors have been working jointly on the operational parameters and the rules and

regulations pertaining to prudential requirements and return submissions by the cooperative

banks. Given the developmental needs of the CFIs in South Africa, cognisance has been made

of the capacity constraints on the part of the financial cooperatives and as such prudential

requirements are not too stringent, relative to other jurisdictions. With regard to resources at the

CBDA, currently the supervision unit has two employees, the Supervisor and the Examiner,

which is reflective of the embryonic stage of the Agency.

The Cooperative Banks Act also mandates the CBDA to provide liquidity assistance to the

sector which is akin to the lender of last resort facility offered by central banks. In line with

international best practice, the liquidity assistance has been kept separate from the supervisory

function (CBDA, 2010)

3.4.3 Licensing criteria and functions of CFIs

According to the Basel Committee on Bank Supervision17 a licensing authority must have the

power to set licensing criteria and reject applications for institutions that do not meet the

standards set18. Such preventive regulation seeks to control the risk exposure of the sector. At a

minimum, such criteria should consist of an assessment of the ownership structure,

governance, fit and propriety of board members and senior management as well as strategic

and operational plans of the institution19. The intention is to ensure that only institutions that are

competent and financially sustainable can operate within the financial sector, notwithstanding

the minimal systemic significance of most cooperative financial institutions.

In this regard, the Cooperative Bank Act stipulates that all CFIs with members above 200 and

deposits in excess of R1 million must apply for registration as a cooperative bank, and once

17

The Basel Committee on Banking Supervision is a committee of banking supervisory authorities established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from 27 countries, including South Africa 18

Principle 2-Permissible Activities 19

Principle 3 (Licensing Criteria) of the Basel Core Principles on Bank Supervision

51

registered be supervised by the CBDA. The SARB is tasked with the registration, regulation and

supervision of financial services cooperatives with deposits in excess of R20 million, as well as

secondary and tertiary cooperative banks. The different types of services offered by the four

tiers of cooperative banks in South Africa are illustrated in Table 3.2 below:

Table 3.2: Permissible products and services

Type Formation Services offered

Primary Savings

Cooperatives

Bank

200 or more members

and R1 million or more

in deposits

1. Solicit and accept deposits from its members;

2. Open savings accounts for its members, into which

that member may deposit or withdraw money from;

3. Borrow money from the Agency and members, up to

a prescribed percentage;

4. Open a savings account or cheque account in the

name of that co-operative bank with any banking

institution;

5. Make, draw, accept, endorse, or negotiate

negotiable instruments.

6. Provide trust or custody services to members;

7. Invest money deposited with it in prescribed

investments20

.

Primary Savings

& Loans

Cooperative Bank

200 or more members

and R1 million or more

in deposits

1. As per primary savings cooperatives bank, and;

2. Grant secured and unsecured loans to members to a

maximum aggregate value

Secondary

Cooperative Bank

1. As per primary savings & loans cooperatives bank,

and;

2. trading financial instruments on behalf of its

members;

3. Facilitating foreign currency transactions.

Tertiary

Cooperative Bank

1. As per secondary cooperatives bank, and;

2. Conducting such additional banking services and

invest money deposited with it in any investments

prescribed

The 200 members and R1 million in deposits are minimum requirements and do not guarantee

that an applicant cooperative bank will be registered. In addition to meeting the minimum

criteria, a qualifying cooperative financial institution must also demonstrate to the satisfaction of

20

National Treasury is currently developing Co-operative Banks Retail Bonds in the following Series; 1-year Co-operative Bank Retail Bond, 2-year Co-operative Bank Retail Bond and 3-year Co-operative Bank Retail Bond

52

the Supervisor that the business it proposes to conduct is that of a cooperative bank and that it

has sufficient human, financial and operational know-how to carry on the business of a

cooperative bank. In this regard, key to the registration process, is ensuring that the „common

bond‟ of the proposed cooperative bank meets the definition of a cooperative bank as enshrined

in the Cooperative Banks Act i.e. a cooperative with members who:

a) are of similar occupation or profession or who are employed by a common employer or

who are employed within the same business district; or

b) have common membership in an association or organisation, including a business,

religious, social, co-operative, labour or educational group; or

c) reside within the same defined community or geographical area.

Though restrictive in order to ensure that the Act is not seen as a cheap route into the banking

sector, the definition of cooperative banks is intended to safeguard the cooperative principles by

localising operations of a cooperative bank while ensuring member participation. Member

participation is also emphasised by the mandatory requirement of a constitution which will

govern the operations of the proposed cooperative bank and is adopted by the members at an

annual general meeting prior to the application for registration. From the narrow definition, a

common bond which is „closed‟ effectively limits the level of outreach provided by the CFIs.

3.4.4 Minimum prudential requirements

Minimum prudential requirements set the standards with which regulated institutions have to

comply with in order to not only maintain their registration, but also to monitor their own viability.

Prudential standards include expectations on capital adequacy, loan provisioning, liquidity and

insider lending.

3.4.4.1 Capital adequacy

At a minimum, regulatory frameworks should have meaningful minimum capital adequacy

requirements and the ability to impose restrictions on dividend payments when the CFI is

incurring losses21. This is because in the absence of adequate capital, a CFI‟s potential for

failure is greatly enhanced, precipitating a liquidity crisis and in some cases forcing government

to bail out such institutions. Thus CFI‟s must ensure an adequate capital to risk-weighted assets

ratio as stipulated in regulations. However, the challenge for regulators is to seek the most

optimal relationship between the need to facilitate the intermediation process, while at the same

21

Principle 6- Capital Adequacy

53

time not imposing excessive costs to the CFI (Kassa, 2010). The respective capital adequacy

requirements for regulated CFI‟s in South Africa are summarised below:

Table 3.3: Prudential capital standards

Capital Adequacy Core capital None

Core capital/total assets ≥ 6 percent

Source: Cooperative Banks Act, 2007: Regulations

For purposes of calculating minimum capital adequacy the Supervisors in South Africa permit

member shares issued by the CFI, indivisible reserves, non distributable reserves created from

surpluses and any other non-distributable funds of a permanent nature

3.4.4.2 Liquidity

Liquidity is crucial to the ongoing viability of any cooperative financial institutions. CFI‟s capital

positions can have an effect on their ability to obtain liquidity, especially in a crisis. CFIs often

face liquidity problems because they do not have access to a lender of last resort facility like

commercial banks do with central banks. Even were central finance facilities are available at

apex bodies for CFIs, these may have insufficient funds to meet systemic liquidity needs of the

institutions. Liquidity risks arising from cash-flow challenges have been a major cause of failure

of many financial cooperatives (Jazayeri, 2006), necessitating that regulators stipulate minimum

liquidity thresholds for all regulated institutions. Non-compliance with the liquidity thresholds

may warrant closer supervisory scrutiny. Liquid assets are deemed to be those with tenure of

less than 32 days and the liquidity thresholds are indicated below:

Table 3.4: Prudential standards on liquidity

Liquidity Liquid assets/deposits 10 percent

Statutory liquid investments22

≥ 2.5 percent


3.4.4.3 External borrowing

Cooperative financial institutions are sometimes used to channel targeted credit programs and

such external debt may encourage the domination of net borrowers with adverse consequences

for governance. Commercial borrowing should also be limited to amounts that are within the

repayment capacity of the cooperative financial institution and would not distort their costs and

22

Deposits to the Co-operative Banks Development Agency (CBDA) or with a secondary or tertiary co-operative bank relative to total deposits

54

income. Prudential requirements that place a limit on external borrowings acknowledge that the

sustained success of co-operative financial institutions lie in their ability to grow slowly and

organically through the “self-help” principles. It is therefore appropriate to limit the extent of

reliance on external funding, as excessive external funding could jeopardise the sustainability of

co-operative financial institutions. In this regard, CFIs in SA are not permitted to have external

borrowings that exceed 15 percent of total assets.

Additionally, the South African legislation also limits the extent to which co-operative financial

institutions can rely on donations, which is set at a maximum of 15 percent of total deposits. The

intention is to ensure that a CFI relies on deposits from its members for on-lending purposes

and aim to stimulate a savings culture and to ensure sustainable organic growth. In relation to a

co-operative bank that provides saving and loan services, loans granted to members that are

sourced from cash donations may not exceed 15 percent of total deposits.

3.4.4.4 Asset quality and insider lending

Principle 9 covering problem assets and reserves of the Basel Core Principles require

supervisory authorities to ensure that regulated institutions establish and adhere to adequate

policies and processes for managing problem assets, including the evaluation of provisions and

reserves. Problem assets give rise to credit risk, especially for cooperative financial institutions

that also lend funds to members. This usually arises from loan delinquency arising from the

members‟ unwillingness or inability to pay, and is particularly serious if the loan security is

insufficient or inadequate to cover the outstanding amounts. The different provisioning

requirements as per the Cooperative Banks Act are highlighted below:

Table 3.5: Provisioning requirements

Loan Loss Allowance Allowance on performing loans ≤ 2 percent (of all loans)

Allowance on substandard 35 percent (31-180 days)

Allowance on doubtful 50 percent (181-360 days)

Allowance on loss 100 percent (361 days or more)


While there are no specific prudential restrictions on loans to insiders, CFIs are required to

disclose loans disbursed to insiders. Insider lending can be a problem in cooperative financial

institutions when board members and staff take advantage of their position and privileged

information and issue loans to themselves or their friends and relatives. According to Jazayeri

55

(2006), insider loans are a common phenomenon especially in small communities where social

ties can override professionalism in management.

3.4.4.5 Non earnings assets

Regulators also place limits on the percentage of assets that do not produce an income that a

cooperative financial institution can hold. Non-earning assets do not provide income or return,

and therefore do not build institutional capital. Furthermore, a CFI that has too much funds tied

up in fixed and non-earning assets result in members‟ funds being unavailable to members in

the form of loans or available to the CFI to invest in other assets that may otherwise generate

income for the institution. The prudential limit on non-earning assets is 5 percent.

3.4.5 Reporting arrangements and auditors

Principle 21 on supervisory reporting requires supervisory authorities to have a means of

collecting, reviewing and analysing prudential reports and statistical returns from regulated

institutions. Additionally, the principle requires the authorities to have a mechanism for the

independent verification of such reports, through the use of external experts, for example. Such

reports are an integral component of the offsite supervisory process for regulated institutions.

The Cooperative Banks Act only provides for the functions of an auditor, without specifying

suitability and/or whether external or internal. It also gives the auditor the discretion to determine

what „in the opinion of the auditor‟ can be reported to the Supervisor with respect to deposits

being at risk or the cooperative bank ceasing to be a going concern. The approach in South

Africa is to a large extend motivated by the small size of the cooperative financial institutions,

and hence the desire to minimise audit costs for the sector. However, it is crucial that CFIs, at a

minimum be able to produce reliable and timely data on delinquencies, write-offs and overall

financial performance in a manner that is transparent. This is even more critical with the need to

regularly compute accurate deposit insurance coverage.

3.4.6 Corrective and remedial powers of supervisors

The Cooperative Banks Act gives the Supervisor broad powers, i.e. to take steps necessary to

protect the public in their dealings with cooperative banks. It allows the Supervisor to issue

directives to a CFI to take specific courses of corrective action or to prohibit certain practices or

processes. The Supervisor also has the power to force through an amendment of a CFI‟s

constitution if it does not comply with the requirements of the legislation. Furthermore, the

Supervisor can impose administrative penalties on any registered CFI if it fails to comply with

56

any of the prudential requirements. If non of the above corrective actions resolve the situation,

the Supervisor has the mandate to de-register or suspend a registered CFI if the institution fails

to comply with the requirements of the Act.

The broad mandate of the Supervisor is however, restricted to CFIs registered as a cooperative

bank, creating regulatory ambiguities in instances where CFIs meet the minimum qualifying

criteria for applying for registration as a bank, but fall short in terms of the requirements for

registration with respect to operational capacities.

3.5 A Critique of the current legislative and supervisory arrangements for CFIs

in SA

This section provides an evaluation of some key supervisory and regulatory aspects of the

Cooperative Banks Act vis-a-viz international best practices.

3.5.1 Minimum capital requirements

As evidenced in the schedule above, a key weakness of the Cooperative Banks Act is that it

does not set a minimum initial capital as criteria for registration. This is an exception rather than

the rule as reflected by a 2009 survey of 31 countries by the Bank of International Settlements

(BIS) which showed that in jurisdictions where CFIs are subject to prudential requirements the

majority require such CFIs to comply with minimum initial capital standards. The unsavory effect

of this anomaly is that South African Supervisors have the prospect of being forced to consider

applications which meet the 200 members and R1 million in deposits but have low capital

adequacy ratios or are technically insolvent.

Capital by its definition is a basic resource of an institution supplied by owners/members and

serves as cushion/buffer to absorb unexpected losses, thus allowing the institution to continue

operations even in difficult times. It also serves as a base for credit operations & expansion

while supporting reasonable growth and maintaining public confidence in the institution and

system. Recognising deposits as a criteria rewards the cooperative‟s ability to mobilise savings

resources from the members, but such resources are very volatile and in most cases are

matched against loans so cannot be used to expand operations. Members contribute mandatory

shares which are a condition of membership and surpluses are used to set up reserves, some

of which are indivisible i.e. core capital. The Basel Committee recommends though that unless

regulations impose restrictions on the withdrawal of member shares, then such mandatory

shares should not be considered as a part of a higher regulatory capital (BIS, 2010).

57

Core capital has the benefit of being non-volatile, non withdrawable and if set as a minimum

entry requirement would encourage members to generate enough surpluses over time to meet

the registration requirements. This may have a dual positive consequence i.e. coerced savings

through surpluses and providing for the sustainability of the cooperative. Minimum core capital

can thus be set at a level that allows the cooperative bank to set up basic banking infrastructure

i.e. banking hall and to acquire a suitable management information systems (MIS).

The proxy for capital used in South Africa is capital adequacy which is currently set at 6 percent

of total assets. Using total assets does not fully reflect the risk inherent in the institution and it

penalises institutions for holding assets that have low risk, i.e. buildings. Jazayeri, 2006, in a

paper on the regulation and supervision of savings and credit cooperatives argues that CAR for

CFI‟s should be set at levels higher than the level for commercial banks because of lower

diversification and more problematic governance structure in the sector. At its most basic level

CAR is concerned with minimum capital levels to cover credit risk, and in so far as such capital

charges cover other risk categories, these are assumed to be proportional to credit risk.

Developments in CAR computation driven by the Basel Committee now recognise two more risk

categories market risk and operational risk and require separate capital charges for these. The

net effect is that the CAR for an institution will more closely reflect the risks inherent in the CFI.

3.5.2 Types of cooperative banks

The Act provides for four different types of cooperative banks, 1) primary savings cooperative

banks 2) primary savings and credit cooperative banks 3) secondary cooperative banks and 4)

tertiary cooperative banks (Section 5).

It is opined that as a business model, primary savings cooperative banks are neither viable nor

sustainable. While it is appreciated that the intention of the Act was to bring within the regulatory

ambit, CFIs, primarily FSCs which were based on the savings model collapsed in 2003,

primarily due to viability challenges associated with such a model. This model is a clear

disjuncture from the intermediation process. Such primary savings cooperative banks do not

have a sufficient asset base (loans) through which sufficient income can be generated to cover

operational costs and compensate savers on the liability side.

In addition, the Act does not clearly distinguish a tertiary cooperative bank from a secondary

cooperative bank, with the functions, as prescribed in Section 5 the same. It appears that the

intention was to align the Act with the Cooperative Act of 2005 which provides for a tertiary

58

cooperative as a cooperative apex. The primary purpose of tertiary cooperatives as defined in

chapter 1 of the Cooperatives Act is essentially advocacy and representation.

3.5.3 Regulatory arbitrage

To further compound the challenges, an unintended consequence of the Cooperative Banks Act

and the exemption notices is the regulatory gap created by virtue of the exemption notices

allowing CFIs with up to R20 million to continue to operate under the exemption notices. This

means a CFI which meets the minimum registration criteria can opt not to apply for registration

as a cooperative bank and still operate legally in terms of the exemption notice leading to

regulatory arbitrage. In addition, while a qualifying CFI may meet the minimum registration

criteria, the Supervisors may still not register it if it does not meet the other prudential

requirements. Given such scenarios, several questions need to be addressed i.e.:

a) Who assumes the regulatory responsibilities for these operating financial co-

operatives, knowing that they have weakness that must be addressed?;

b) How should the Supervisors deal with CFI‟s that meet the qualifying criteria, having

been operating for over five years, but are not registered with a self-regulatory body in

terms of the exemption notices, as is the case with a number of rural CFIs, bearing in

mind such institutions are providing access to financial services in excluded areas?

c) In cases where an eligible applicant intentionally avoids applying, for whatever reason,

what powers would the Supervisor have to ensure such a CFI complies with the Act?

3.5.4 Supervision structure and independence

The Basel Committee on Banking Supervision‟s document on Microfinance and the Basel Core

Principles For Effective Bank Supervision emphasises that supervisors of other deposit taking

institutions (ODTIs) such as CFIs require the same clarity of mandate, independence,

accountability, transparency, legal foundation, legal powers, and inter-agency/ministry

cooperation as supervisors of commercial banks. The supervisor – or other authority with similar

skills, expertise, resources and credibility - is normally the most appropriate supervisory body for

such ODTIs of sufficient significance to warrant prudential oversight, leveraging its existing skills

and infrastructure and ensuring a level and coherent playing field. Where multiple agencies are

involved in the supervisory process, they should ensure that there is sufficient coordination,

cooperation and information sharing necessary for the discharge of their duties. Thus,

59

independence23 of a financial sector supervisor is one of the major factors affecting the

effectiveness of supervision (Seelig & Novoa, 2009). With most supervisory authorities the legal

basis for their existence also makes clear their operational independence on matters of financial

sector supervision. Moreover, where supervision activities are housed in a central bank, the

central bank law or other laws recognise the operational independence of the central bank with

regards to financial sector supervision (Seelig & Novoa, 2009).

With the current legislative setup, the CBDA is responsible for the licensing, and supervision,

including problem bank resolution of CFIs above prescribed thresholds. The agency also

assumes the „central bank‟ of lender of last resort role by providing financial support to

registered CFIs as well as liquidity management for the sector. The agency is also responsible

for establishing and managing a deposit insurance fund for registered CFIs. Essentially all

financial safety nets necessary for the stability of the sector are embedded in the Agency.

Pellegrina et al (2010) point out that concentration of such powers (including in the field of

supervision) can increase endogenously the moral hazard risks and consequently the risks of

accommodative liquidity management actions. If the agency is empowered with excessive

discretion to monetise financial distress, a sector-systemic risk will be more likely to emerge,

derailing CFI sector financial stability.

In addition, the risk of reputational losses is likely to increase if the Agency is deeply involved in

supervision, while the reputational benefits are less likely to emerge, given the nature of the

supervision policies, where failures are more visible than successes. In order to avoid

reputational losses (including losses to the deposit insurance fund), the Agency is more likely to

accommodate bailout pressures using the liquidity tools.

In other words, the cons of the Agency involvement in supervision are crucially based on the

view that the temptation of relaxing liquidity management policy standards in order to mitigate

liquidity problems may in turn exacerbate instability in the sector. The key question to address

therefore is how to manage the trade-off between expected benefits and costs in determining

the Agency involvement in supervision, in light of the developmental needs of the sector.

23 A critical factor for both the independence of a supervisory agency and its effectiveness is whether it can determine its budget

and funding allocations. Almost 60 percent of all financial sector supervisors indicated that they had this capability. Just under 70 percent of all banking-only and insurance-only supervisors could determine their budgets, but slightly less than half of integrated supervisors had budget autonomy.

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3.5.5 Supervisory capacities at self-regulatory organisations

As alluded to in Section 3.3, two self-regulatory bodies are in place to regulate non qualifying

CFIs, within a broader mandate.

The first one, SACCOL, is a member based institution and relies on its members‟ contributions,

fees and dues for sustainability. It has 58 CFIs as members dispersed around the country

(SACCOL, 2010). The small membership base requires a relatively expensive fee to cover

operation expenses together with the regulatory and developmental services rendered to

members. This has also been detrimental to the financial resources of the CFIs. In reality, while

the SACCOL has been able to sustain itself, it has done so with a much reduced staffing level.

Thus it is unable to meet all the demands by its members for a comprehensive supervisory

function. SACCOL, as an affiliate of WOCCU, makes use of tools developed by WOCCU such

as PEARLS ratios and monthly reporting to monitor the sector. No examinations are currently

being carried out by SACCOL due to resource restraints.

SAMAF is a fully funded Government agencies whose mandate is to facilitate the provision of

affordable access to finance by micro small and survivalist business for the purpose of growing

their own income and asset base through a network of self-sufficient and sustainable micro-

finance institutions. It works primarily with rural CFIs, though recently it has started courting

CFIs that are affiliated to SACCOL. The agency has provincial officials who working with rural

FSCs around capacity and compliance and within the head office, is a designated “acting

Regulator” to ensure compliance with the Gazette notification under which rural CFIs register

with the SAMAF. The institution also has an approved policy and Registration, Regulation,

Supervision and Stabilisation (RRSS) committee responsible for monitoring approved FSCs, but

does not carry out onsite examinations of the CFIs. It should be noted that regulation of the

sector is not a core mandate of SAMAF.

In acknowledging the various institutional make-ups of the self-regulatory organisations,

pertinent to the development of the sector is how the regulatory framework can be integrated to

minimise regulatory arbitrage and optimally use the limited supervisory resources without

placing too much of a regulatory burden on the sector.

3.6. Conclusions

The CFI sector in South Africa is miniscule relative to peers within the African continent and the

rest of the world. Policy and regulatory initiatives have been put in place to grow the sector,

61

however, these do not seem to be comprehensively integrated so as to ensure a seamless

development of the sector. The challenge is thus how all these policy and regulatory

interventions can be appropriately enhanced for the growth of the sector.

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CHAPTER 4:

RESEARCH DESIGN & METHODOLOGY

4.1 Introduction

The reliability, completeness and the clarity of research findings and results are of utmost

importance to a successful research work. Consequently, it is of paramount importance that the

most appropriate methods and devices to achieve the desired outcome are used.

This chapter explains the study design and methodology: data sources, collection and sampling

strategies, organisation and conduct of the study as well as provides the analytical techniques

employed.

4.2 Research design

Welman et al (2005) defined research design as the plan according to which we obtain subjects

(units of analysis) and collect information from them. In that regard, the unit of analysis for this

study was the CFIs in South Africa, which was split into sub-categories i.e. the regulators and

the regulated CFIs. This was in tandem with the research‟s twin objective of assessing the

currently regulatory and supervisory aspects for CFIs in SA, and assessing the perceptions of

CFIs with regard to the cooperative bank legislative and supervisory frameworks.

The main objective of the research design is to ensure that the evidence obtained allows the

researcher to meet the research objectives as clearly as possible. Warsame (2009), citing

Robson (2007) noted that a proper research design simplifies the research process by dividing

the task into smaller, more manageable parts thus turning research questions into projects.

Consequently research tools specific to each sub-category of the unit of analysis were designed

and used, taking into account the level of expertise as well as time and cost constraints on both

the researcher and the respondents.

Combining two or more research methods gives better interpretation as the information missed

by one method might be captured by the other and thus an enhanced and integrated result may

emerge from the analysis through triangulation.

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4.3 Research methodology

Research methodology refers to the method or methods of collecting, analysing and reporting

data, i.e. the framework in which the researcher works to collect, analyse and interpret

information in order to find satisfactory and meaningful answers to his/her research questions.

This section thus explains the research methodology, with the objective of justifying the

selection of survey questionnaire and structured interviews as the most appropriate and relevant

data collection methods. A final copy of the email questionnaire and the structured interviews

question themes are presented in the Appendix section of the research report for further perusal

and reference.

The methodology of the research consisted of two aspects, data collection and data analysis.

Primary data was collected through a survey questionnaire and structured interviews. Data

collected from the primary sources was also cross-checked against secondary data available

from the records of the CBDA, notably institutional profiles and CFI application submission

documentation.

4.3.1 Data collection: Survey questionnaire design

A survey questionnaire, Appendix 2, was designed to collect primary data about experiences,

views and perceptions of CFIs of the recently promulgated CFI legislation and supervisory

process. The survey questionnaire had four sections, with sections A and D completed by all

respondents, while CFIs that have applied for registration and been assessed were required to

complete Section B, CFIs that were still to submit applications for registration or were still to be

assessed were asked to complete Section C. The separation of responses was considered

necessary to determine if there is a difference in opinion between CFIs that have gone through

the registration process and those that are still to do so, notably regarding challenges faced. A

summary of the issues covered in the survey questionnaire are given below:

i) Section A: - The purpose of questions in this section was to understand the CFI

environment. Consequently information extracted focused on current capacity

levels (the respondents education levels, education levels of staff at the CFI,

membership levels, deposit levels, common bond) and current regulatory and

supervisory arrangements (period of operations, current regulators, reporting

arrangements and frequency of current examinations).

64

ii) Section B:-the purpose of questions in this section was to obtain the perceptions of

CFI respondents that have gone through the registration process on the

cooperative bank legislative requirements.

iii) Section C: - the purpose of questions in this section was to obtain the perceptions

of CFI respondents that are still to go through the registration process on the

cooperative bank legislative requirements. As a result, respondents were asked to

indicate how listed legislative requirements had affected their ability to apply.

iv) Section D: - questions required respondents to give their thoughts on ongoing

monitoring and supervision, specifically frequency of examinations, examination

focus areas and risk management.

It was not feasible to carry out a pre-test of the questionnaires with a pilot group because of time

constraints. The questionnaires were, however, discussed with and reviewed by senior officials

within the CBDA and the SARB, and they underwent further scrutiny by the thesis Supervisor of

the University before finalisation.

4.3.2 Data collection: Survey questionnaire administration

Information available from the CBDA indicated the entire CFI population in South Africa consists

of seventy five (75) registered CFIs distributed across all provinces with a total of R126 million in

deposits and 32,000 members as at 30 August 2010 (CBDA, 2010). However, only sixty two

(62) CFIs are considered operational or active.

The researcher thus used non-probability sampling i.e. purposive sampling, with the key criteria

for study being that the CFI had to be active or operational while meeting the minimum

registration criteria of 200 members and R1 million in deposits. This criterion was used because

these are the institutions whose contact details are readily available and are covered by the

legislation. As a result, seventeen (17) CFIs met this criterion. The seventeen (17) eligible CFIs,

with R118 million in deposits as at 30 August 2010, constitute 94 percent of the total CFI

deposits in the country and are thus considered a representative sample of the CFI population

in South Africa.

The survey questionnaires, in the form of email surveys were circulated to all the seventeen (17)

eligible CFIs with auto-confirmation of reception. Email details were obtained from the CBDA.

This was considered cost effective and would take less time to distribute and collect. Further,

65

interviewer error or bias, through facial expressions, body language or the way the interviewer

is, was reduced because the interviewer was not on-sight.

Auto confirmation of reception was not received from four (4) of the CFIs, resulting in the

researcher faxing the questionnaire to the CFIs‟ offices. In addition, the questionnaire was also

sent to the provincial regulator‟s office, who in-turn distributed the questionnaire to the affected

respondent. On completion of the questionnaire, the respondents either faxed back the

responses or sent it back through the provincial office.

Low response rate is a challenge with email surveys as noted in literature (Robbins, 2009;

Cresswell, 2007; Welman et al, 2008). A low response rate may restrict the usefulness of the

survey as it could introduce bias (Welman et al, 2008). To reduce the low response rate, the

researcher followed up the questionnaires with telephone calls as well as email reminders.

On receiving the responses from the survey questionnaire, each questionnaire was checked for

completeness, and in instances where information was missing follow up telephone calls were

made to clarify the outstanding information. In addition, information provided in the

questionnaire was also cross checked against data available within CBDA, notably on member

statistics and staff profiles.

4.3.3 Data collection: Structured interviews

Primary data was also collected through structured interviews with the existing regulators of

cooperative financial institutions, namely SAMAF and SACCOL. The designated regulators in

these institutions were selected for the interview.

The objective of the structured interviews with the regulators was to get a better understanding

of the current regulatory and supervisory regime for CFIs in South Africa. As this is a limited

population, the entire population was considered. However, while the CBDA and the SARB are

also designated regulators of CFIs above a certain threshold, the researcher opted to exclude

this group because as at the time of the survey, there was no CFI that had met the registration

requirements for their level of regulation. The interview followed four main regulation and

supervisory themes as identified in literature (Levine et al, 2001; Rhyne, 2002; Poprawa, 2009)

and the international country review:

i) The registration and licensing process;

ii) Supervisory independence and resource;

66

iii) Supervisors‟ powers; and

iv) Corrective actions.

Where necessary, follow up questions were used to probe a matter further and get more

insightful understanding. It should be noted that the complexity of interpreting and analysing

qualitative data collected from structured interviews as well as sample sizes can threaten the

validity of the research, hence it is widely considered more appropriate for an exploratory study

(Robbins, 2009). In this study, this sampling size was not considered a constraint as the entire

population of current regulators, SAMAF and SACCOL was considered. Robbins (2009) also

noted that the knowledge of the researcher can threaten the reliability of the data, i.e. by

influencing the responses of the interviewee through leading questions. In this study, during the

interviews, the researcher, gave the respondent a broad overview of the matter under

discussion, and asked the respondent to proffer their views on the subject. Probing questions

were used to clarify issues raised by the respondents.

4.4 Methods of analysis

In order to analyse the questionnaire responses, the data was coded. Data coding is a

systematic way of condensing extensive data sets into smaller analysable units through the

creation of categories and concepts derived from the data (Lockyer, 2004). Unique codes were

identified for each of the respondents to allow for data screening and ease of reference when

cross checking information. A database of the responses was created in Excel, with each of the

questions in the questionnaire being treated as a separate variable, with the responses as

categories. The completed database template of responses was then loaded into a statistical

package for analysis.

Descriptive statistics such as means, frequencies, cross tabulations and percentages were

derived and these were then interpreted.

4.5 Data validity and reliability

Data validity is the extent to which the research findings accurately represent what is really

happening in the situation (Welman et al, 2008). The validity of the data is crucial, regardless of

the method used to collect such data, as invalidity renders it worthless. The validity of the

questionnaire largely depends on how accurate and honest the responses given by the

respondents are. Measuring accuracy and honesty is a difficult task and no one can give

absolute assurance on it. However, this study has sought to minimise the risk of compromising

67

the validity of the data by following up with telephone calls to the respondents to fully explain the

questions and purpose of the research thus reducing the possibility of errors resulting from lack

of understanding and ambiguity. In addition, cross-checking of information was also conducted

against information already in the domain of the regulators.

Having an introductory paragraph at the beginning of the survey questionnaire and personally

assuring the respondents of the questionnaires of the anonymity of both their identity and

personal responses contributed to the validity of the data collected. Additionally, triangulation

has also been used to determine the correct position, by using three measures, questionnaires

and interviews with regulators and secondary data from the CBDA and SARB emanating from

the pre-registration onsite assessments.

Reliability is concerned with the findings of the research and relates to the credibility of the

findings (Welman et al, 2009). It is another vital characteristic that every sound research should

posses and it refers to the consistency and the repeatability of the same results over time. In

essence, if anyone else where to conduct the same research, they would obtain the same

results, all other things being equal. The reliability and the validity of data will be enhanced by

the ability and the skills of the researcher in predicting potential bias and errors and eliminating

them at an early stage. An obvious example is the danger that the respondents know the

researcher as a regulator and this may affect respondents, leading them to distort their

responses or abstain from giving answers. In communicating to the respondents, the researcher

assured the respondents that the research was for academic purposes. In addition, the cover

letter accompanying the survey questionnaire also reiterated the same and also had the

University‟s logo as opposed to the CBDA to confirm the academic nature of the study.

4.6 Summary and conclusions

This chapter focused on describing the research design and methodology of study employed.

These are essential elements as they make the study more focused in terms of its

methodological approaches and units of analysis. The study methodology described the

sampling techniques used within each methodology, the data collection techniques used and

the data analysis techniques employed.

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CHAPTER 5:

EMPIRICAL ANALYSIS

5.1 Introduction

This chapter provides an analysis of the data collected through the survey questionnaire and the

structured interviews. It also provides some basic descriptive analysis of the general

characteristics of the respondents (position in the organisation, education level) and

characteristic of surveyed CFIs (common bond, number of employees, education level of

employees, number of members etc). The objective was to summarise the data by using

frequencies, percentages and tables known as profile analysis or exploring the data set

(Robson, 2007).

As indicated in the preceding chapter, the questionnaire was administered to all the seventeen

(17) CFIs that have R1 million in deposits and 200 or more members and constituting 94

percent of the total CFI base in the country. Out of the seventeen (17) questionnaires

distributed, a total of eleven (11) responses were received, which is a 65 percent response rate.

The CFIs that responded had a total of R84.6 million in deposits, constituting 67 percent of the

total deposits in the sector and thus considered a representative sample of the population under

study.

5.2 General information (CFI demographics)

Section A of the questionnaire prompted for general information about the CFI such as

membership levels, deposit base, common bond, current regulators and frequency of current

examinations.

5.2.1 Profile of respondents

This section provides the general characteristics of the respondents who participated in the

survey questionnaire are explained.

As reflected in table 5.1 below, the 91 percent of the respondents are managers at their

respective institutions, while only 9 percent (or one institution) had a respondent who was the

board chairman. Education is more evenly distributed, with 46 percent (5 respondents) having

diplomas, and only 18 percent (or two respondents) having undergraduate degrees.

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Table 5.1: Respondents position

Position Frequency Percent (%)

Manager 10 90.9

Chairman 1 9.1

Total 11 100.0

Table 5.2: Respondents education

Position Frequency Percent (%)

Matric 3 27.3

Diploma 5 45.5

Undergrad Degree 2 18.2

Other 1 9.1

Total 11 100.0

Consistent with the level of skills at management level (Table 5.2), all staff members have either

diplomas or matric, with just two respondents indicating staff with a degree or higher. Diplomas

are prevalent at SACCOs‟ with none of the FSC respondents having management or staff with

anything better than a matric.

The absence of bank/finance specific skills (which are normally available through university

degrees) is indicative of the membership of CFIs in the country in general, through which most

of the CFIs get staff members. This finding was also confirmed by the regulators during the

structured interviews who indicated that skills capacity constraints were adversely affecting CFIs

ability to comply with regulatory requirements as well as their ability to grow beyond the current

levels. At most of the CFIs, management and staff have been there since inception. However,

such „experience‟ has not translated into improved performance for the sector. Weak skills and

competencies has a direct adverse effect on the ability of Supervisors to conduct supervision as

it materially impacts on the quality of reports generated by regulated institutions for submission

to the regulator.

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5.2.2 Profile of respondent CFIs

The respondent CFIs are mostly SACCOs (at 82 percent) with only 18 percent (or two) of the

survey participants being FSCs and only one of the respondents a secondary CFI, classified as

a SACCO. High response rate from SACCOs is indicative of two things 1) better deposit

mobilisation in SACCOs and 2) a certain level of compliance. It is thus important to highlight the

positive correlation between affiliation to SACCOL and relatively better CFI performance,

including compliance. This finding is consistent with Calvin and Coetzee (2010: 26) who

indicated that members of SACCOL have benefited from support, while CFIs not affiliated to

SACCOL have largely been operating without a strong institutional development support. This

also parallels findings from the other countries where CFIs affiliated to a network or

representative body have performed well, such as Kenya, Canada and Ireland (Croteau, 1951;

McCarthy et al, 2000; World Bank, 2007; Desjardin Annual Report, 2009).

Table 5.3 below shows that 55 percent of the respondents have membership which is below

1000 (evenly distributed between up to 500 members and 501 to 1000 members). About18.2

percent of the respondents (or two institutions had membership in excess of 2000. Table 5.4

highlights that over 63 percent of the respondent CFIs have deposits below R6 million, with only

two institutions (18.2 percent) having deposits in excess of R10 million. These two institutions

are outliers in the survey, each with deposits in excess of R34 million, and a membership that is

primarily white-Afrikaner, possibly indicative of the income distribution in the country. These two

CFIs have less than 500 members in total and yet their deposit base makes up 44 percent of

the total CFI deposits in the country.

Table 5.3: Membership levels

Members Frequency Percent (%)

100-500 3 27.3

501-1000 3 27.3

1001-1500 1 9.1

1501-2000 2 18.2

2001+ 2 18.2

Total 11 100.0

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Table 5.4: Deposit levels

Amount (R) Frequency Percent (%)

R1m-R3m 4 36.4

R3m-6m 3 27.2

R6m-10m 2 18.2

R10m+ 2 18.2

Total 11 100.0

The survey indicated that the majority of CFIs‟ common bond is primarily community driven, with

six of the respondents or (55 percent), with 18 percent of the common bond being employer

based and 27 percent being a combination of the two common bond types, fig 5.1. CFIs have a

relatively high survival rate, with an estimated 64 percent (seven respondents) having been in

operation for 9 years or more, as shown in Fig 5.2 below. Only 18 percent of the respondent

CFIs have been in operation for less than five (5) years.

Figure 5.1: Common bond

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Figure 5.2: Period in operation

Fig 5.3 below shows that 46 percent of the respondents indicated that the average monthly

income of their membership was between R5,000 and R10,000, with 36 percent indicating

income levels below R5,000. Records within CBDA are consistent with these income levels as

they indicate average member savings of R5,000, at 30 August 2010. This point to the potential

for growth of CFIs in South Africa, especially savings, more so when one considers that the

majority are community owned as opposed to employer-based where there is a regular income

flow. With sufficient interventions, savings within the sector can increase providing the

wherewithal for capital formation which, in turn, is essential for economic development (Prinsloo,

2000).

Figure 5.3: Average membership income

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5.2.3 Current regulatory regime

All the surveyed CFIs indicated that they are regulated by at least one regulator, with 82

percent, or nine respondents highlighting SACCOL as the current regulator and 18 percent

reflecting SAMAF as the regulator. Consistent with observations made on the capacity of

regulators in Chapter 3, as well as the structured interviews, 46 percent (five) of the

respondents indicated that their current regulator had never conducted an onsite

assessment/examination of the CFI. Only three of the respondents (27 percent) indicated that

onsite assessments are conducted by the current regulator quarterly, and 18 percent or two

indicated onsite assessments/examinations are conducted once a year. Of interest is that at

least three of the respondents that have been in operation for at least six years indicated they

have never been assessed by their regulator, again highlighting capacity constraints on the part

of the regulators.

All the survey participants except one indicated that they submit some form of regulatory report

to their current regulator. However, there is no consistency across the responses in terms of the

reporting that is done, with annual financial statements and monthly compliance reports in the

case of SACCOL regulated CFIs and monthly management accounts and annual financials in

the case of SAMAF regulated CFIs. This again points to the need for a coordinated and

standardised approach to the regulation and supervision of the sector, so that the risk profile of

the sector in its entirety can be easily determined.

A total of ten (10) respondents or 91 percent indicated that they had submitted an application for

registration as a cooperative bank, with one institution indicating it had not yet applied. Of the

ten respondents that had submitted applications, seven (7) CFIs had been assessed by either

the CBDA or SARB for operational readiness to convert to cooperative banks. Despite seven

CFIs having been assessed, by the end of December 2010, only one institution had been

successfully considered for registration (CBDA, 2010). This is reflective of capacity and

operational weaknesses within the sector. In addition, during the follow-up telephone calls,

some of the respondents felt the CBDA/SARB will take over the regulation and supervision of all

the CFIs from SAMAF and SACCOL, effectively doing away with the representative

organisations, necessitating the need for a coordinated approach to supervision.

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5.3 Cooperative bank legislative requirements (onsite assessment conducted)

As indicated earlier, seven (7) CFIs had submitted applications and been assessed by either the

CBDA or SARB. These CFIs constituted 64 percent of the respondents, and completed

Sections A, B and D of the questionnaire.

5.3.1 Minimum registration requirements

Fig 5.4 below shows perceptions of respondents on the minimum cooperative bank registration

requirements. Generally, the majority of respondents, over 50 percent (four respondents) did not

feel the minimum deposit threshold of R1 million was very high, though at least 29 percent

strongly agreed with the statement that the threshold was too high.

Figure 5.4: Minimum legislative requirements

There was an even split with two respondents (29 percent) agreeing that the minimum

membership threshold of 200 members was too restrictive and another two respondents who

did not agree that it was too restrictive. Perception on the common bond requirement was

evenly distributed with at least 29 percent of the respondents strongly considering the common

bond requirement as too restrictive, 14 percent agreeing that the common bond was restrictive

while 29 percent disagreed with the notion that the common bond was restrictive. The

remainder was neutral.

The respondents found most of the documentation required manageable or easy to comply with.

Notable exceptions where name reservation which was considered very difficult by 29 percent

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of the respondents, and the requirement to meet the definition of a „cooperative bank‟ which was

considered difficult to comply with by 29 percent of the participants. A small percentage of the

respondents (14 percent) considered completing the directors register difficult. This observation

is not consistent with practice as documentation within CBDA suggests that most of the

applicants are failing to comply with the documentation requirements.

5.3.2 Completion of prudential returns

The law requires CFIs registered with SARB or CBDA to complete prudential returns and submit

to the Supervisor on a monthly basis. These include the income statement, balance sheet,

credit risk, maturity ladder and large exposures returns.

Consequently respondents were asked how difficult they perceived completing the prudential

returns. Over 40 percent or three respondents considered completion of the balance sheet

return, income statement and prudential requirements returns‟ to be manageable, however, 14

percent opined that the balance sheet, income statement and prudential requirements forms

were very difficult, while a similar percentage considered the same returns as difficult. None of

the respondents considered the board and staff related loans returns as difficult or very difficult,

with over 40 percent considering the return as manageable.

The maturity ladder return and the credit risk return were considered very difficult by one

respondent, while the maturity ladder and large exposures return were considered difficult by 28

percent or two respondents. It should be noted that none of the respondents has had an

opportunity to actually complete the prudential returns, however, some of the returns, notably

the balance sheet and income statement are modeled along the reports used by SACCOL.

However, the rest of the returns are entirely new, notably the maturity ladder and large

exposures return hence opinions may change once they actually try complying with the returns.

5.3.3 Meeting prudential requirements

The questions relating to meeting prudential requirements sought to gauge respondents‟

perceptions on whether they currently meet minimum prudential standards as per the legislative

requirements. These prudential standards include capital adequacy, liquid assets, external

borrowing, as well as provisioning levels.

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As illustrated in Fig 5.5 below, with respect to capital adequacy, 43 percent or three

respondents indicated they were below the minimum requirement, while 2 respondents

indicated they were above the minimum capital adequacy ratio of 6 percent. Most of the

respondents (71 percent) indicated that the fixed and non-earning assets to total assets ratio

was the same as the regulatory threshold maximum of 5 percent, while no respondent indicated

a ratio above the maximum threshold. Liquid assets were also perceived to be within the limit of

10 percent (i.e. 57 percent of respondents) above the minimum limit, with 47 percent of

respondents indicating a liquid position above the regulatory threshold.

Figure 5.5: Meeting prudential requirements

More than 50 percent of the respondents indicated they were not in compliance with the

regulatory requirement to maintain at least 2.5 percent of deposits in secondary CFI institutions.

This is not surprising in view of the lack of confidence the sector currently has in its

representative body. The majority of respondents, 71 percent indicated loans to asset ratios

similar to the regulatory maximum threshold of 80 percent, while 29 percent indicated they were

below the threshold.

Respondents indicated a relatively high level of funding self-reliance with 57 percent or four

respondents indicating they are below the maximum limit of external funding sources of 15

percent for cash donations and external borrowings. In addition, 43 percent of the respondents

(three) indicated they had no cash donations on their books.

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Respondents indicated a prevalence of under-provisioning on loans with 28 percent of

respondents not making any provisions at all for the standard 2 percent provisions on all loans,

and a further 14 percent indicating they are below the requisite provisions level (Fig 5.6). 43

percent of all respondents indicated under-provisioning for loans delinquent up to six (6)

months, and up to 12 months, with 58 percent of participants indicating under-provisioning for

loans in default for periods exceeding one year. Furthermore, 14 percent of respondents

indicated that they do not make any provisions for loans in default over one year.

Figure 5.6: Meeting provisioning requirements

5.3.4 Pre-registration onsite assessments

As part of the registration process, Supervisors conduct onsite assessment of applicant CFIs to

verify information submitted for registration as well as to assess the institutions‟ readiness to

operate as a cooperative bank. The onsite assessment process takes an average of two days,

the intention being to get as much information as possible about the institution from discussions

with the board and management of the CFIs, while minimising disruptions to normal operations.

Of the CFIs that had been assessed, 71 percent or five institutions considered the time taken by

the Supervisors to conduct the onsite assessment as adequate, while 29 percent considered the

time as very adequate. Similar responses were noted with regard to the issued discussed by

the Supervisors during the assessment, with 71 percent or five institutions considering the

issues discussed as relevant and 29 percent considering the issues as very relevant to their

operations (Fig 5.7). Fig 5.8 illustrates that 57 percent or four of the respondents considered the

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feedback they received from the Supervisors during the assessments as very adequate, 29

percent considered the feedback as adequate and 14 percent perceived the feedback received

as inadequate. This demonstrates that CFIs consider the supervision process as integral to their

operations.

Figure 5.7: Relevance of issues discussed

Figure 5.8: Feedback from supervisors

5.4 Cooperative bank legislative requirements (not yet assessed onsite)

As mentioned previously, three (3) CFIs had submitted applications and were still to be

assessed at the time of the survey, with one other CFI was still to submit an application. These

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institutions constituted 36 percent of the respondents, and completed Sections A, C and D of

the questionnaire.

5.4.1 Minimum registration requirements

All the four respondents (100 percent) agreed that the common bond criterion was too

restrictive, with 50 percent disagreeing with the statement that the membership criterion is too

restrictive, and 75 percent of the respondents perceiving the deposit threshold as too high (Fig

5.9).

Figure 5.9: Minimum legislative requirements

The majority of respondents indicated they perceived complying with documents required for the

registration process as manageable or easy. This is in contrast with secondary data at CBDA

which indicates that with the exception of one institution, none of these CFIs have been able to

make a complete application submission. It has taken more than a year since the publication of

the regulations and rules and submission of documentation by some of these institutions, again

pointing to the weak capacities at the CFIs. Documents perceived to be difficult included the

constitution, lending policy and audited financial statements, with 25 percent perceiving these as

difficult.

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5.4.2 Prudential returns

With regard to prudential returns, one respondent perceived the balance sheet, income

statement and prudential requirement returns as difficult, while two respondents considered the

same returns as easy (Fig 5.10).

Figure 5.10: Prudential returns

5.5 On-going monitoring and supervision

Section D of the questionnaire sought respondents‟ perceptions on frequency of examinations

going forward; matters respondents perceived were pertinent to the examination process as well

as risk management evaluation within the CFIs. All participants were asked to make responses

to this section.

5.5.1 Frequency of examinations

Participants were informed that if registered as a cooperative bank, the Supervisors will carry

out detailed onsite examinations of their institutions; consequently, participants were asked how

frequently they would prefer the detailed onsite examinations.

Quarterly examinations were the preferred frequency, with 46 percent or five respondents

advocating for examinations once every three months, while 36 percent or four respondents

perceiving examinations once every six (6) months as necessary. 18 percent of the respondents

indicated they would prefer the Supervisors to conduct examinations once a year, as shown in

Fig 5.11 below. One can thus conclude that the sector considers regulatory oversight as

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important for their operations, as they would prefer more regular examination by the

supervisors. The variation in preferred frequency suggests a supervisory process tailored to the

unique circumstances of each institution may be necessary.

Figure 5.11: Frequency of examinations

5.5.2 Examination focus areas

Participants were also informed that during the onsite examinations, the supervisors will carry

out a detailed assessment of the operations of the institution. These areas include financial

management, credit (loans), liquidity, operations, earnings and management information

systems (MIS). They were therefore asked to highlight their areas of operations which they

perceived would benefit most from the assessment, responses which are summarised in Fig

5.12 below. About 55 percent of the respondents perceived an evaluation of compliance and

governance as very necessary, while 45 percent considered evaluation of financial

management as very necessary. 9 percent of the respondents perceived evaluation of

compliance and governance as unnecessary.

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Figure 5.12: Areas to be examined (i)

Figure 5.13: Areas to be examined (ii)

Fig 5.13 above summarises the perceptions of respondents, with more six respondents (55

percent) considering onsite evaluation of credit (loans), operations and capital as necessary,

while four considered evaluation of credit (loans) and capital as very necessary. One institution

(9 percent) considered the evaluation of loans, operations and capital as unnecessary.

All respondents considered the evaluation of liquidity as at least necessary, with four

respondents perceiving the evaluation of management information systems as very necessary

or necessary. With regard to earnings, 46 percent of respondents perceived the evaluation as

necessary, while two respondents opined that this was unnecessary.

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5.5.3 Risk management

Survey participants were advised that during the onsite examinations, the supervisors will carry

out a detailed assessment of the risks of the institution. They were then asked to indicate the

level of difficulty in managing the risks inherent in their institutions, i.e. credit, liquidity,

operational, reputation, interest and compliance risk.

Figure 5.14: Risk management

As shown in Fig 5.14 above, most of the respondents found the risk categories manageable,

with the notable exception of compliance risk which 82 percent of respondents perceived as

difficult. Liquidity and credit risk were perceived as difficult by 27 percent of the respondents,

while reputation risk was considered difficult by 9 percent of the respondents. Interest rate risk

was also considered easy by 27 percent of the respondents.

5.6 Summary of structured interviews with regulators

Structured interviews were conducted with Mr. Jacob Gumbo, the Regulator of FSCs at SAMAF

and Mr. Musa Mbingo, the CEO of SACCOL. Themes for the interviews are included as

Appendix 4.

5.6.1 SAMAF

SAMAF is a government entity established in 2006 and whose mandate is to contribute to

government‟s poverty reduction goals by acting as a catalyst for the development of an effective

microfinance sector by:

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Providing support for the establishment of sustainable micro-finance institutions that

can reach deeper and broader to the enterprising poor;

Facilitating the establishment of an enabling environment for effective financial

intermediation and creation of working markets for the enterprising poor; and

Building a strong, effective and efficient Apex Fund

The institution was issued with an exemption notice in July 2007 to regulate FSCs which expired

in December 2007. It currently derives its powers to regulate and supervise CFIs from

Exemption Notice 31342 issued in August 2008 which mandates it to register and supervise

financial services cooperatives. A dedicated regulator is appointed for this purpose.

5.6.2 SACCOL

SACCOL is the representative/apex body of all savings and credit cooperatives and was formed

in 1993. Consequently, it is funded by the CFIs affiliated to it through annual membership fees.

It has three main functions:

Representation of SACCOs both locally and internationally;

Provision of developmental services to SACCOs both in rural and urban areas by

giving a range of technical and capacity building services as well as practical tools to

run and operate a SACCO; and

To regulate SACCOs through regulation and supervision of the movement and

conducting compliance audits to SACCOs.

The institution derives its powers to regulate and supervise CFIs from Exemption Notice 29412

which mandates it to register and supervise savings and credit cooperatives, with the CEO the

designated regulator.

5.6.3 Summary of interview findings

The regulators have detailed licensing processes for the registration and licensing of CFIs,

though there is no uniformity in the processes. Generally all CFIs offer the same types of

products and services, i.e. emergency loans, „long term‟ loans (up to six months), education

savings, Christmas savings and ordinary savings. The results from the structured interviews are

categorised and summarised in Tables 5.5 and 5.6 below.

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Table 5.5: Summary of structured interviews (i)

SAMAF SACCOL

No of institutions

regulated

22 FSCs as at 30 November 2010

regulated

Currently 48 registered SACCOs,

though variations in terms of capacity

Licensing Process Provincial staff conducts outreach to

communities, communities mobilise

resources and lodge application to

regulator.

Provincial office assists with the

application process.

Requires minimum deposit of R20,000

and 150 members, common bond and

resolution

Regulator presents application to RSS

committee which can approve or reject

Licenses valid for 12 months.

No stipulated minimum criteria but has

never registered CFI with less than 50

members.

SACCOL, through its developmental

officers, encourages CFIs to form study

groups which champion formation

before provincial registration (16 step

process)

Capacity constraints and lack of powers are the major challenge that the regulators face given

the self-regulatory nature of their operations. The main supervisory tool to enforce corrective

action would be withdrawal of the license, however, in incidences were this has been applied

some CFIs have continued to operate regardless of the withdrawal. The recourse in this case is

to request the central bank, as the custodian of deposit taking licenses to pursue legal and

criminal action against such institutions for illegal deposit taking. However, because of the small

size of the institutions, and the negligible systemic risk, it is not cost effective for the central

bank to investigate such institutions. As a result, they continue to operate illegally until they

were shut down by the central bank.

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Table 5.6: Summary of structured interviews (ii)

SAMAF SACCOL

Supervisory

Regime

Registered FSCs submit quarterly

reports to regulator via provincial offices.

Quarterly reports include financial

statements, management and policy

reports and prudential standards.

Conducts surprise site visits (mini-due

diligence), only conducted two such

visits in 2010

Provincial examiners conduct monitoring

and evaluation.

Compliance officers visit SACCOs on a

regular basis (no compliance officers in

the past three years)

Check record keeping, adherence to

policy and membership growth

Uses PEARLS to generate reports

Powers of

Regulators

Can withdraw license, but cannot

deregister, only the Companies and

Intellectual Property Registration Office

(CIPRO) can deregister.

No real power, can only threaten.

Can issue infringement notices

Other issues Need for deposit insurance for FSCs

Education of members

Staffing constraints, with resigning staff

not being replaced

SACCOs adopting policies wholesale

without adapting to their needs.

Additional challenges noted by the regulators include lack of continued funding/weak financial

base, weak CFIs and underdeveloped or poorly capacitated provincial structures. Another

theme which emanated from the interviews as a challenge was the absence of a clear

clarification of the roles and responsibilities of the various stakeholders, i.e. CBDA, SAMAF and

SACCOL. This lack of clarity was purported to be causing confusion within the sector, with

some CFIs not paying dues to representative organisations on the pretext that with the

emergence of the CBDA, the representative bodies were no longer necessary.

5.7 Conceptual issues on research findings

This was in tandem with the research‟s twin objective of assessing the current regulatory and

supervisory aspects for CFIs in SA, and assessing the perceptions and capacities of CFIs with

regard to the cooperative bank legislative and supervisory frameworks.

5.7.1 Current regulatory and supervisory aspects

The CFI sector in South Africa is loosely regulated by SAMAF and SACCOL. There is lack of

clarity on the various roles of the different regulators within the sector, raising scope for

regulatory arbitrage. SAMAF and SACCOL, are actively involved in the registration and

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licensing of new CFIs essentially assuming a developmental role by „walking‟ the applicants

through the registration and licensing process. However, the independence of the regulator in

such instances is compromised, given the competing mandates of the organisation as

highlighted in Section 3 and confirmed during the structured interviews. In addition, SACCOL,

which is self-funding, has been operating with limited financial and staff resources which has

adversely affected the frequency and quality of examinations and reports. SAMAF, on the other

hand, in pursuing its developmental mandate runs the risk of creating a large number of

unsustainable CFIs which will be difficult to regulate.

It was also noted in the survey responses that despite being registered, 46 percent of the CFIs

had never had on onsite assessment/examination conducted by their regulator. This was further

confirmed in the structured interviews with the regulators indicating examinations have not been

conducted regularly. It is acknowledged that in the early stages of the CFI sectors‟ development,

regulation and supervision regulation can focus on basic functions such as licensing and

registration, and submission of prudential reports aka rules based approach. This is consistent

with the survey findings that all the survey participants except one, indicated that they submit

some form of regulatory report to their current regulator. However, as the sector grows and

assumes larger deposits, standards for prudential behavior would be required and necessitates

more detailed financial and regulatory reporting and on-site field examinations.

5.7.2 Capacities within CFIs

Capacity in terms of skills and competencies is a challenge within the CFI sector in South Africa.

Of the surveyed CFIs, the main qualification within management and staff at CFIs is a diploma

or matric certificate. Cross-checking with secondary data from the submitted application

documents at the CBDA also confirms this findings, with skills deficiencies also notable at board

level. The regulators, during the structured interviews also highlighted educational levels of not

only the board, staff and management as a key challenge, but also that of the general

membership. It is observable from the secondary data that CFIs tend to recruit staff and

management from the communities they reside in, who must be members of the institution

which severely limits the pool of competent people the institutions can tap into. Weak skills and

competencies has a direct adverse effect on the ability of Supervisors to conduct supervision as

it materially impacts on the quality of reports generated by regulated institutions for submission

to the regulator. As a result, any supervisory interventions would be rendered irrelevant unless

there is substantial capacity building and development.

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5.7.3 Perceptions of respondents on regulatory oversight

The even distribution of responses regarding the restrictiveness of the minimum registration

criteria suggests that generally the levels are acceptable as there is no discernable skewness in

the responses. This is very remarkable, given that all the respondents meet the minimum

registration requirements.

With regard to minimum prudential standards the majority of respondents indicated they were

below the minimum requirements with regard to capital and provisions, while within limits with

regard to other prudential standards such as liquidity, cash donations external borrowings and

fixed assets ratios. This is consistent with secondary data reviewed, which reflects that the

majority of CFIs fall short in terms of provisioning which ultimately also affects capital adequacy.

As a result, interventions will need to be put in place to capacitate CFIs on proper credit risk

management, including provisioning, and subsequently cleaning up the loan portfolio of the

sector, determine the actual capitalisation levels and capital deficiencies.

A large number of respondents also perceived completing the prudential returns as manageable

or easy. At first glance, this seems to contradict the earlier assertion about capacity within the

sector moreso in view of the fact that none of the CFIs has actually completed the returns.

However, after cross-referencing with the structured interviews and secondary data it is clear

that most CFIs do not see a challenge in completing prudential returns as in most cases this will

be done by a third party on their behalf. For example, provincial officers within SAMAF currently

assist CFIs in preparing quarterly reports that are submitted to the regulator. In addition, the

prudential returns have been modeled largely on current reporting formats. However, as SAMAF

expands to include stockvels , the level of oversight and assistance is likely to be compromised.

In terms of supervisory processes, respondents seem to understand the importance of

supervision to their operations, with a majority advocating for more frequent onsite

examinations, as much as quarterly in some instances. An equally large number of respondents

also considered the proposed areas for examinations as very relevant or necessary.

Risk management was considered manageable or easy across most risk categories, with the

notable exception being compliance risk. However, this is not consistent with evidence provided

in secondary data and the interviews. The sector has no risk management policies and in

instances where policies (mainly savings and loans) are available these do not adequately

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address risks inherent in operations of the CFIs. As a result, no „contingency‟ arrangements are

in place in the event of credit default or failures in systems, for example.

Some respondents, from the follow-up telephone conversations, perceive that once registered in

terms of the Cooperative Banks Act, there is no need to remain affiliated to a representative

body, reflecting a loss of confidence in the representative body. However, in the absence of

such a body, there will be no advocacy around issues pertaining to the sector, and CFIs will also

lose out on economies of scale emanating from such networks.

5.8 Conclusions

Capacity is a major constrain in the development and growth of the sector. In fact, any

supervisory interventions will be pointless in the absence of appropriate capacity interventions.

Despite the existence of various regulators, regulatory and supervisory oversight is considered

weak. There is lack of clarity on the various roles of the different regulators within the sector,

raising scope for regulatory arbitrage. In addition, the role of the representative body has been

called into question, with some CFIs querying its relevance. Notwithstanding these weaknesses,

the sector is providing a much needed service to communities.

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CHAPTER 6:

RECOMMENDATIONS AND CONCLUSIONS

6.1 Introduction

This section provides a summary of the research, the key findings and the implications of the

findings. The section concludes with policy and legislative recommendation as well as the

implications of the proposed recommendations.

6.2 Summary of literature review

Experience of eight (8) countries where there is a strong and vibrant CFI sector was reviewed

and key lessons for South Africa picked out. These countries include the USA, Canada,

German, Kenya, Jamaica, Ireland, Brazil and India. Key lessons from the experiences of these

countries are highlighted below:

i) There is no consensus on whether an open bond or closed bond is a requisite for

the growth of the sector. What is observable is that, while initially regulations

restricted the common bond, as economies evolved, such restrictions have been

lifted resulting in a decrease in the number of CFIs but an increase in membership.

However, as common bond become more open, regulators tend to require CFIs to

meet higher capital and increased prudential levels to compensate for the

increased risk;

ii) In most countries, the capital level of CFIs is a cause of concern with regulators

imposing minimum capital requirements. The cooperative business form works

against the ability of CFIs to capitalise. As a result, regulators have recently started

considering alternative capital sources for CFIs which recognise the cooperative

principles while allowing CFIs to recapitalise;

iii) Regulation and supervision of CFIs is the norm rather than the exception.

Cognisance should be made, however, of the nature and size of CFIs when

developing regulatory and supervisory frameworks; and

iv) The growth and success of CFIs is hinged on a strong CFI network.

In South Africa, the CFI sector is still relatively small and penetration levels are low. The

legislation, in its current form, has resulted in a number of regulators for the sector giving rising

to regulatory arbitrage. Further, the legislation, while a positive step towards ensuring the safety

and soundness of CFIs, will require amendments to enhance the level of supervisory oversight.

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6.3 Summary of research findings and implications

Through survey questionnaires and structured interviews, perceptions on the regulatory and

supervisory framework were sort from eligible CFIs and the two current regulators. The findings

from the research and implications are highlighted below:

i) CFIs are playing a fundamental role in providing access to financial services

to low income levels. There is a growing interest at the community level for

participation in CFIs providing scope for growth of the sector as evidenced by

demand for the services offered by CFIs as noted by the modest income levels

and subsequent deposit levels in areas perceived marginalised in some instances.

However, there is need for a relook at the product offering and service delivery

channels to remain relevant as well as to tap into the middle income class.

ii) The levels of skills and capacity are very weak and capacity interventions are

uncoordinated. In the absence of immediate intervention, lack of skills and

capacity are likely to constrict growth within the sector. Weak capacity also

increases the risk of mismanagement or unsustainable business practices

resulting in members losing their money or not getting a viable return/service. In

addition, weak capacity impacts negatively on the quality of reports generated by

regulated institutions for submission to the regulators.

iii) This sector is significantly undercapitalised and technically insolvent. The

implication is that the sector may not be able expand and introduce innovative

products and services. However, such institutions may continue to operate for a

long time until they run out of depositors‟ funds which are used to sustain

operations.

iv) The sector is poorly supervised and regulated, with uncoordinated

supervisory frameworks. There is no standardised approach to regulation and

supervision of the sector, though CFIs perceive regulation and supervision as

essential to their operations. Each of the regulators has different approaches to

regulation and supervision of CFIs. The effect is that as CFIs graduate through the

various levels, registration, reporting and compliance requirements change

significantly and coupled with weak capacity may result in a weak compliance

culture. In addition, different reporting requirements make it difficult to determine a

uniform and consistent status of the sector for policy making purposes.

92

v) The existence of four different regulators for the sector provides scope for

regulatory arbitrage. The implication is that regulatory arbitrage allows a CFI to

„look‟ for the „least-cost‟ regulator, least cost in terms of the level of supervisory

oversight, with adverse effect on the safety and soundness of the sector. In

addition, the absence or lack of clarity on regulatory bodies has resulted in some

members opting out of representative bodies much to the detriment of the

movement.

vi) There is need for a strong and vibrant single network of CFIs. Despite the

existence of a self-representative body, advocacy for the sector is weak. As a

result, consultations on matters pertaining to CFIs occur at the individual level

weakening the bargaining power of the sector. In addition, the small sizes of the

CFIs make it difficult to attain critical mass and offer better products and services

in the absence of a network which offers economies of scale.

6.4 Recommendations and policy implications

Having identified the main research findings, this section will provide some recommendations

were possible. While this research report took a deliberate approach to focus on the regulation

and supervisory aspects within the CFI sector, it is worth noting here that developing an

appropriate framework is manifold and multifaceted and requires a comprehensive and

coordinated approach as opposed to piecemeal solutions. Furthermore, any proposed

supervisory frameworks will not achieve the desired results without proper capacitation and up-

skilling of CFI staff, board and management as well as re-evaluating the role of representative

bodies to align them with growing needs for modern products and services such as ATMs and

internet banking.

6.4.1 Prudential regulation and supervision

The main legislative instruments within the sector are the Cooperatives Act, the Banks Act,

through which the two exemption notices are issued and by default provide for tiered legislation,

and the Cooperative Banks Act, the Cooperatives Act and the two exemption notices, which by

default provide for tiered legislation. There is need to address the regulatory arbitrage

emanating from the existence of the two exemption notices and the Cooperative Banks Act, as

well as the multitude of regulators provided for by the legislation.

This thesis therefore recommends that the exemption notices be withdrawn. In addition, there

should only be one regulator/supervisor for the primary and secondary CFI sector for uniformity

93

of standards and approaches as well as to eliminate regulatory arbitrage. It is proposed that this

Supervisor be within the CBDA, with sufficient operational independence to discharge this

mandate effectively. This regulator/supervisor will be responsible for registration and

supervision of all CFIs within the country, hence will have the powers to withdraw licenses and

close non-compliant institutions. The regulator/supervisor can then delegate supervisory powers

(i.e. reporting and examinations/audits) for smaller CFIs (below R1 million and 200 members) to

a representative body or network structure. The alternative is to make SARB the sole regulator.

However, literature has shown that in instances where regulation of the sector is under a central

bank, the level of oversight is commensurate with the systemic risk posed by the sector, with the

tendency that the CFI sector would have weak supervisory oversight given the low systemic

risk.

The author also recommends the review of the four types of cooperative banks as envisaged in

Section 5, with primary savings cooperative banks being removed in their entirety, as this form

as a business type is neither sustainable nor viable. In addition, all the CFIs have shifted away

from savings only cooperatives to savings and loans cooperatives. There is no discernible

difference in banking services offered by tertiary cooperative banks and secondary cooperative

banks, consequently, the sector can do with either one or the other but not both.

Policy-wise, this entails withdrawing the exemption notices from SAMAF and SACCOL, and

placing them under the designated regulator. This will also entail amendments to relevant

sections of the Cooperative Banks Act, notably Section 5 on types of cooperative banks and

Section 41 on administration of the Act.

Given the significant variations in profiles of CFIs in South Africa, it is also recommended that

the Supervisors adopt a risk based supervision approach to the sector. It is envisaged that this

will allow for the development of a standardised risk management and reporting culture within

the sector, where the measurement and evaluation of risks and reporting requirements are

commensurate with the nature and size of CFIs.

6.4.2 Capitalisation

As highlighted in earlier sections of this report, capitalisation is a major constraint within the

sector. It is thus recommended that the CBDA determine the minimum capital necessary to run

a CFI at the various tiers, i.e. minimum capital levels requisite for CFIs below the R1 million

deposit threshold and 200 members, minimum capital levels necessary for CFIs above R1

94

million and for secondary CFIs. This places the prerogative on the membership to raise the

required capital through conversion of savings into shares, or increase voluntary shares

provided there are conditions restricting the ability to withdraw sharesy.

Additionally, the Supervisors may consider allowing CFIs to raise external capital through

subordinated debt or external equity provided voting rights or members are adequately

preserved. In the case of subordinated debt, it can be considered as part of capital if it meets

conditions regarding permanence, i.e. should have tenure of more than five (5) years, is free of

mandatory fixed charges against earnings, and ranks below depositors and other creditors of

the institution in the event of liquidation.

In the case of external equity, amendments can allow CFIs to raise capital through the issuance

of non-membership equity to both members and non-members. The CFI can thus create a class

of shares that permits a person to only that class of shares. However, to ensure adherence to

cooperative principles such shares would have restrictions i.e. a holder of such shares can

never control or own the CFI, and may not be allowed to vote at the AGM.

From a policy perspective, this will also entail reviewing the Cooperative Banks Act to factor in

minimum capital requirements and permissible capital raising methods.

6.4.3 Structure and networks

From the literature reviewed, surveys of CFIs in other jurisdictions and interviews conducted it is

apparent that a strong and vibrant structure/network is critical not only for the growth of the

sector, but the efficient supervision and regulation of same.

It is therefore recommended that the CFI sector in South Africa moves towards developing a

strong network structure with greater integration of policies and procedures in order to realise

cost savings and to ensure maximum leverage of the sector‟s resources (for example, by

standardising products, and developing minimum skills standards for management and boards).

Membership to a network structure must be mandatory, with restrictions on the number of CFIs

that can form a network structure (e.g. no less than ten CFIs can form a network structure as in

Canada). Examples of networking and integration must include the following:

Treasury functions, including the management of excess liquidity, to be managed by

the central organisation. For example, local CFIs deposit excess liquidity with their

central organisation, which re-deploys it to other CFIs within the network finding

95

themselves short of funds. Market risk, such as interest rate risk, is assumed by the

central organisation.

Integration of risk management practises as mentioned above. Credit approval

procedures may be defined centrally, with the central organisation (tertiary

cooperative bank or association) becoming involved in the approval of credits over a

certain amount. Acceptance criteria and credit scoring may also be standardised.

CFI sector branding, product range and product design may be handled centrally.

That is not to say that the central organisation is necessarily setting sales targets for

particular products/services but simply that CFIs take products/services developed

centrally, and do not undertake any activities inconsistent with the overall strategy and

risk profile of the rest of the sector.

IT systems must be developed and centralised across the sector, to facilitate ease of

access to the national payment system and subsequently issuance of credit cards,

debit cards etc.

6.4.4 Skills development and capacitating

It is recommended that capacity building and development interventions be implemented

focusing on:

i) Institutional strengthening of CFIs through strengthened governance and

management structures as a necessary condition for the improvement of their

overall strategic direction, financial soundness and operational control. To do this,

the Agency, in collaboration with local universities, should establish training

centres at universities and colleges, with financial cooperative specific courses and

programs. Regulatory approval for board nominations and management of CFIs

can be made subject to attendance and completion of such courses. Institutions

which fund capacity building, such as SAMAF through its capacity granting

scheme can direct funds to attendance of such courses.

ii) Improved CFI operational capabilities to improve the administration and

operation of their financial and credit operations. Key activities may include a

diagnostic assessment of the specific managerial and operational situation of

individual CFI, with a particular emphasis on their MIS needs, to provide a baseline

for the institutional strengthening efforts. In the short term, the Agency, can recruit

a team of professionals on key operational issues such as accounting, IT and risk

management. Such professionals can be seconded to CFIs on a short term basis

96

to mentor existing management at CFIs, in the process developing their capacity,

much like the „Siyenza Manje’24 project of the DBSA.

6.5 Research limitations and areas for further research (combine with next)

The legislative framework governing CFIs (the Cooperative Bank Act) has been in place for

three years, though it has been operationalised over the past eighteen (18) months.

Consequently, no CFI has been registered in terms of the Act and thus none of the CFIs have

actually started reporting as envisaged in the Act. This placed a significant limit with regard to

the ability to conduct a detailed impact assessment of the legislation on the costs of the CFIs as

well as costs to the regulators. In addition, the collapse of previous self-regulatory authorities,

limited capacity of current self-regulators, as well as inconsistent and incomplete reporting

arrangements made it difficult to conduct an impact assessment of the exemption notices as a

legislative tool.

A key area pertinent to the sector, capacity building, has not been dealt with in detail, as the

focus was on regulation and supervision, though it is acknowledged that capacity development

within the CFI sector in SA will have a significant bearing on the abilities of Supervisors to

discharge their duties. Consequently, a detailed study will need to be conducted to specifically

identify the exact skills and capacity gaps within the sector, before recommended interventions

can be developed.

Further, in a number of cases CFIs are providing a service where traditional commercial banks

have withdrawn their services. However, the size and nature of CFIs may constraint their ability

to proffer a variety of services. Consequently, there is scope for a study on the role of traditional

banks in providing assistance to CFIs, if any, especially in light of the financial charter.

It has been identified in this study that networks and structures are pivotal for the growth of the

sector. It is thus necessary to conduct a study on how such a network can be developed and

sustained within the South African context.

24

The Siyenza Manje initiative, launched by government and managed by the Development Bank of Southern Africa‟s (DBSA)

Development Fund, focuses on building capacity at municipal level. Experts are deployed in under-capacitated municipalities in

eight provinces to assist with the implementation of infrastructure projects, planning and financial capacity building.

97

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APPENDICES

Appendix 1: Overview of the regulatory environment for credit unions in Canada

Overview of the Regulatory Environment for Credit Unions In Canada

Level of Govt Legislation Ministry/Department Affected Deposit Insurer

Federal Cooperative Credit Associations Act (CCAA)

Department of Finance

Office of the Superintendent of Financial Institutions (OSFI)

Credit Union Central of Canada

All credit union centrals except those of PEI, NS & NFLD

Credit Union Deposit Insurance Corp (CDIC)

Provincial deposit insurers

Provincial Level

Alberta Credit Union Act Financial Institutions Division, Department of Finance

All credit unions and caisses populaires

Credit Union Deposit Guarantee Corporation

British Columbia Credit Union Incorporation Act

Financial Institutions Act

Minister of Finance & Corporate Relations, Financial Institutions Commission (FICOM)


Credit Union Deposit Insurance Corporation

Manitoba Credit Union and Caisses Populaires Act

Registrar, Cooperatives, Credit Unions/Caisses Populaires Regulation Branch



New Brunswick Credit Unions Act Department of Justice, Superintendent of Credit Unions


New Brunswick Credit Union deposit Insurance Corporation

New Foundland & Labrador

Credit Unions Act Department of Government Services and Lands, Commercial and Corporate Affairs Superintendent of Credit Unions



Nova Scotia Credit Union Act Department of Environmental and Labour, Financial Institutions & Revenue Division, Superintendent of Credit Unions



Ontario Credit Unions & Caisses Populaires Act

Ministry of Finance for Ontario


Deposit Insurance Corporation of Ontario

Prince Edward Island

Credit Unions Act Department of Justice

Registrar of Credit Unions



Saskatchewan Credit Union Act Department of Justice

Registrar of Credit Unions



104

Appendix 2: Summary of exemption notices and their differences

Finasol and FSA regulated FSCs

Gov Gaz. No 2784, Vol 462, No 1848 Dec 2003.

SAMAF regulated FSC

Gov Gaz. No 31342, No. 887, 22 Aug 2008

SACCOs and Credit Unions regulated by SACCOL

25

Gov Gaz. 29412, R 1176, Dec 2006

Membership Members within a defined geographic area not serviced by a bank

Closed co-operative (members only)

Common bond based on geographic location, association, occupation or employer

Services Accept funds in return for member shares

Accepts deposits

Advances loans

Profit sharing

Nominates management

Accept funds in return for member shares

Accepts deposits

Advances loans

Profit sharing

Nominates management

Savings and pension schemes

Provision of a sum of money for education, training and business

Acquisition of movable goods, acquisition of land, fire or contingency insurance, social or recreational expenses, unemployment fund

Provision of means whereby members may receive interests or dividends.

Conditions Must have a business relationship with a link bank

Only trade with members Must not fall foul of the Pension Funds Act

Not call or infer itself a bank Not call or infer itself a bank

Prohibits unconditional withdrawal of full contribution

May not acquire bonds, debentures, stock and other securities

May not acquire bonds, debentures, stock and other securities

Benefits must not be provided exclusively by loans

May not acquire shares, or interests in any other company

May not acquire shares, or interests in any other company

Must have written approval from the Registrar of Banks to register or amend its statutes

Must have written approval from the Registrar of Banks to register or amend its statutes

Must keep accounting records

Comply with Chapter 7 of Coop Act in relation to auditing

Comply with Chapter 7 of Coop Act in relation to auditing

Must present any audit qualifications to SACCOL

Not hold deposits to the value of more than R 10 million

Not hold deposit to the value of more than R20 million

May not hold subscription from members amounting to, in aggregate more than R30 million

Be a member of a SRO approved by the Registrar of Banks

Subject itself to supervision and regulation by SAMAF

Must be a member of SACCOL or DRO approved by the Registrar of Banks

Expiring 31 December 2005 Indefinite Indefinite

25

Relates mostly to pooling of member funds for utilization in a broad array of functions as opposed to specific products/services.

This was because the notice sought to capture employee based savings and credit schemes, stokvels and SACCOs

105

Appendix 3: Questionnaire for cooperative financial institutions

Covering Letter: Questionnaire Survey

Dear Sir or Madam

The compiler of this research questionnaire is a final year student in the Masters in

Development Finance degree program at the University of Stellenbosch Business School, Cape

Town.

Kindly assist by providing answers to the questions below. The information is strictly private and

confidential. Your name or personal details are not required. This research may assist policy

makers in assessing the regulatory and supervisory framework for cooperative financial

institutions in South Africa.

Please email back your responses to [email protected] or fax to 086 604 0882.

Your cooperation is greatly appreciated.

Regards

M.Kuhlengisa

mailto:[email protected]

106

Section A: General Information

1. Name of institution:

2. Please state your position in the institution:

3. Please indicate your highest level of education:

Matric Diploma Undergraduate

Degree

Masters Degree

Other (specify)

4. Please indicate the following for your institution:

Members Deposits

5. Please indicate the following staff members for your institution:

Male Female

6. Please indicate how many of your staff members have the following education level:

Matric Diploma Undergraduate Degree

Masters Degree

Other (specify)

7. Please indicate the common bond of your institution (please tick one):

Predominantly community (51 percent or more)

Predominantly employer based (51 percent or more)

Balanced between community and employers

8. Please indicate how long your institution has been in operation (please tick one).

Below 3 years

3-5 years 6-8 years

9-12 years

More than 12 years

9. Please indicate the average monthly income of your membership (please tick one):

Less than R2,000 R2,001- 5,000

R5,001-10,000 More than R10,001

10. Who are you currently registered with for regulatory purposes (please tick one):

SAMAF SACCOL CBDA

11. How many times does your current regulator carry out onsite assessments of your institution (please tick one):

Once every six months

Once every three months

Once every year

Once in two years

Never

12. Please indicate, if any, reports that you submit to your current regulator:

……………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………

13. Has your institution submitted an application for Yes No

107

If your response to question 13 is yes, please go to Section B. if no, please go to Section C

SECTION B: COOPERATIVE BANK LEGISLATIVE REQUIREMENTS

14. The common bond requirement is too restrictive (Please circulate the answer which reflects your opinion)

1 Strongly disagree 2 disagree 3 neutral 4 agree 5 strongly agree

15. The minimum membership requirement of 200 is too restrictive (Please circulate the answer which reflects your opinion)


16. The minimum deposit threshold of R1,000,000 is very high (Please circulate the answer which reflects your opinion)


17. The following are required in order to qualify for registration as a proposed cooperative bank. Please indicate how you have experienced in complying with each of the following (Please tick the appropriate box):

Requirement Very difficult Difficult Manageable Easy Very Easy

a) Completing the Application Form (Form CBF1)

b) Special Resolution from Members to apply to operate as a cooperative bank (Form CR6)

c) Two certified copies of the constitution of the proposed cooperative bank

d) A certified copy of registration certificate as a cooperative under the Cooperative Act

e) Lending Policy

f) Savings Policy

g) Business Plan

h) Statement describing the Suitability of Premises

i) Name Reservation with CIPRO (Form CR5)

j) Declaration by directors and executive officers (Form CBF2)

k) Director‟s register

l) Certified Copy of a Register of Directors interest in contracts or undertakings

m) Statement of Compliance with definition of „Cooperative Bank‟

n) Most Recent audited financial statements

o) Notice of Appointment of Auditor

18. The Supervisor requires all registered cooperative banks to submit financial returns in a prescribed format. Please indicate your ability to complete the following returns as indicated (Please tick the appropriate box):

Prudential Return Very difficult Difficult Manageable Easy Very Easy

1. Balance Sheet (CBR1)

2. Income Statement (CBR2)

3. Report on Prudential Requirements (CBR3)

4. Report on Board and Staff related

registration as a cooperative bank?

108

Loans (CBR4)

5. Large Exposures (CBR5)

6. Maturity Ladder (CBR6)

7. Credit Risk (CBR7)

19. To what extent does your institution meet the following prudential requirements (Please tick the appropriate box) :

Requirement Above limit

Same as limit

Below limit

a) Capital adequacy as percent of total assets minimum of 6 percent

b) Fixed and non earning assets/total assets maximum of 5 percent

c) Liquid assets as percentage of deposits minimum of 10 percent

d) Deposits held with agency or high tier cooperative bank minimum of 2.5 percent

e) Total loans to total assets maximum of 80 percent

f) Total external borrowing to total assets maximum of 15 percent

g) Loans granted from cash donations as a percentage of deposits maximum of 15 percent

h) At least 2 percent provision on all loans

i) At least 35 percent provisioning on delinquent loans (1-6 months)

j) At least 50 percent provisioning on delinquent loans (6-12 months)

k) At least 100 percent provisioning on delinquent loans over 12 months

20. The supervisors conducted an onsite visit of your institution to discuss your application. Please evaluate the pre-registration onsite assessment on the following criteria:

Requirement Very Adequate Adequate Inadequate

a) Time taken to conduct the assessment at your premises

b) Issues discussed by supervisors

c) Feedback from supervisors

21. Please evaluate the relevance of the following issues discussed during the pre-registration assessment to your operations:

Item Discussed Very relevant Relevant Unnecessary Very Unnecessary

a) Membership and meetings

b) Board structures and Committees

c) Management

d) Products and services

e) Management Information Systems

f) Related organisations and affiliations

PLEASE TURN TO SECTION D

………………………………………………………………………………………………………………………

SECTION C: COOPERATIVE BANK LEGISLATIVE REQUIREMENTS (NOT YET APPLIED)

22. The common bond requirement is too restrictive (Please circulate the answer which reflects your opinion)


23. The minimum membership requirement of 200 is too restrictive (Please circulate the answer which reflects your opinion)


24. The minimum deposit threshold of R1,000,000 is very high (Please circulate the answer which reflects your opinion)

109


25. The following are required in order to qualify for registration as a proposed cooperative bank. Please indicate how the following have affected your ability to apply (Please tick the appropriate box):

Requirement To a very large extent

To a large extent

Manageable To a small extent

No effect

a) Completing the Application Form (Form CBF1)

b) Special Resolution from Members to apply to operate as a cooperative bank (Form CR6)

c) Two certified copies of the constitution of the proposed cooperative bank

d) A certified copy of registration certificate as a cooperative under the Cooperative Act

e) Lending Policy

f) Savings Policy

g) Business Plan

h) Statement describing the Suitability of Premises

i) Name Reservation with CIPRO (Form CR5)

j) Declaration by directors and executive officers (Form CBF2)

k) Director‟s register

l) Certified Copy of a Register of Directors interest in contracts or undertakings

m) Statement of Compliance with definition of „Cooperative Bank‟

n) Most Recent audited financial statements

o) Notice of Appointment of Auditor

26. The Supervisor requires all registered cooperative banks to submit financial returns in a prescribed format. Please indicate your ability to complete the following returns as indicated if registered(Please tick the appropriate box):

Prudential Return Very difficult Difficult Manageable Easy Very Easy

1. Balance Sheet (CBR1)

2. Income Statement (CBR2)

3. Report on Prudential Requirements (CBR3)

4. Report on Board and Staff related Loans (CBR4)

5. Large Exposures (CBR5)

6. Maturity Ladder (CBR6)

7. Credit Risk (CBR7)

27. To what extent does your institution meet the following prudential requirements (Please tick the appropriate box) :

Requirement Above limit

Same as limit

Below limit

a) Capital adequacy as percent of total assets minimum of 6 percent

b) Fixed and non earning assets/total assets maximum of 5 percent

c) Liquid assets as percentage of deposits minimum of 10 percent

d) Deposits held with agency or high tier cooperative bank minimum of 2.5 percent

110

e) Total loans to total assets maximum of 80 percent

f) Total external borrowing to total assets maximum of 15 percent

g) Loans granted from cash donations as a percentage of deposits maximum of 15 percent

h) At least 2 percent provision on all loans

i) At least 35 percent provisioning on delinquent loans (1-6 months)

j) At least 50 percent provisioning on delinquent loans (6-12 months)

k) At least 100 percent provisioning on delinquent loans over 12 months

28. If you apply, the supervisors will conduct an onsite visit of your institution to discuss your application. Please indicate how much time the supervisors should spent at your premises:

One day Two days Three days

Four days Five days

29. Please evaluate the relevance of the following issues to be discussed during the pre-registration assessment to your operations:

Item Discussed Very relevant Relevant Unnecessary Very Unnecessary

a) Membership and meetings

b) Board structures and Committees

c) Management

d) Products and services

e) Management Information Systems

f) Related organisations and affiliations

Please turn to Section D

………………………………………………………………………………………………………………………….

SECTION D: ONGOING MONITORING AND SUPERVISION

30. If registered, as a cooperative bank, the Supervisors will carry out detailed onsite examinations of your institution. Please indicate the level of frequency of examinations you would want in any financial year.

31. During the onsite examinations, the supervisors will carry out a detailed assessment of the operations of the institution. Please highlight which areas of operations you think will most benefit from assessment:

Requirement Very Necessary Necessary Unnecessary

a) Financial Management

b) Governance

c) Compliance

d) Capital

e) Operations

f) Credit (loans)

g) Earnings

h) Management Information Systems (IT)

i) Liquidity Management

32. During the onsite examinations, the supervisors will carry out a detailed assessment of the risks of the institution. Please highlight which of the following risks are prevalent in your institution:

None Once every six months Once every three months

Once every year

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Risk Very difficult Difficult Manageable Easy Very Easy

a) Credit risk

b) Interest rate risk

c) Liquidity risk

d) Operational risk

e) Reputation risk

f) Compliance and regulatory risk

This completes the questionnaire. Thank you.

112

Appendix 4: Questioning themes for structured interviews with regulators

1. Provide a Background to the Formation of your Institution?

2. Take me through the registration and licensing process?

3. What is the status of the institutions you regulate?

4. Explain your supervisory processes, including reporting requirements

5. What powers does the supervisor have?

6. How do you deal with problem CFIs?

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