2. SPEAKERS :
Commentators
Contacts - ICBA President
and Regional Chairmen
INTERNATIONAL CO-OPERATIVE
BANKING ASSOCIATION No. 11: 1999
CONTENTS Page
Claude Béland 3
A word from the President
Mervyn Pedelty 5
“Capital, Democratisation
and Governance”
P.V. Prabhu 19
Capital, Demutualisation and
Governance - Indian Cooperative
Credit & Banking Scenario
Jacques Henrichon 38
“The Relationship Between the Inspector
General of Financial Institutions and the
Mouvement Desjardins”
Klaus P.Fischer 48
The Colombian Crisis of Financial
Cooperatives, a Corporate Governance
Crisis
61
Claude Béland 64
“Co-operative Banks in a Financial
World in Mutation: Challenges
and Outlooks”
71
3. warmly welcome you to beauti-
ful Québec City and to this seminar of
the International Co-operative Banking
Association.
We have chosen as a theme topics
that, in my opinion, are the key issues
facing cooperatives in a global environ-
ment brought about by a very rapid and
spectacular progression of communica-
tion technologies and data transmission.
This has penetrated boundaries and
made markets closer. With this, as you all
know, competition has sharpened and
there is a need for companies to give a
greater push to improve customer ser-
vice. We have been speaking about this
for a few months, not to say for a few
years, in the cooperative sector; we know
that cooperatives cannot escape this real-
ity. Many cooperatives are facing prob-
lems of capitalization and I must tell you
that again yesterday, at the Executive
Committee meeting of the International
Co-operative Banking Association, we
found it regrettable to lose some mem-
bers that are under restrictions of a
national law or market laws to transform
to share capital companies. Cooperatives
are facing problems of capitalization.You
also know that the insurance sector, in
many countries, is being flooded by a
wave of demutualization. All of this
brings us back to the theme of our semi-
nar “Capital, Demutualization and
Governance”.
To discuss these important topics, we
have the great pleasure of having four
speakers who are experts in this field.
First, Mr. Mervyn Pedelty, of United
Kingdom, Mr. P.V. Prabhu, from India,
Mr. Jacques Henrichon, Deputy Ins-
pector General at the Québec govern-
ment, and Mr. Klaus Fischer, professor at
l'Université Laval, in Québec.
Four guests will comment on the
speakers: Mr. Enrique Rodrigez, of
3
A word from the president
Mr. Claude Béland, President of the Mouvement
des caisses Desjardins, and president of the
INTERNATIONAL CO-OPERATIVE BANKING ASSOCIATION
I
Ladies and Gentlemen,
4. SwedBank, Mr. Carlos Heller, Director
General of Crédicoop of Argentina,
Mr. Erastus Mureithi, Director General
of the Co-operative Bank of Kenya and
finally, Mr. Alban D'Amours, Inspector
and Auditor General of the Mouvement
des caisses Desjardins.
4
5. Good morning Ladies and Gentlemen
hat makes mutual and co-
operative ventures special? What makes
them different from conventional share-
holder companies? And what makes
them better?
We need answers to all these ques-
tions — because these are the questions
that ordinary people have increasingly
been asking since the 1980s. And until
very recently, I am not convinced that we
have been giving them the answers they
want to hear. As managers of Co-opera-
tive Banks, we are all facing a historic
challenge. The very concept of mutual
ownership appears to be under sustained
attack in many countries. And, at the
same time we are seeing significant
changes in the way that financial services
are conceived, targeted and delivered.
Traditional barriers between banking,
insurance, investments and securities are
melting away, as are the traditionally sep-
arate distribution channels which satisfy
customers’ needs for these various prod-
ucts. It’s not a time for complacency. But
nor is it a time for panic. And it’s certain-
ly not a time for abandoning the values
and principles of co-operation. But now
- as always - we must think about how
we apply these principles and values.
And in particular how we apply them in
three critical areas:
• capital
• democratisation
• and governance.
Capital remains the key to continuing
success. Lower barriers to entry, compe-
tition from all sides – including new
entrants like supermarkets - and innova-
tions like the Internet are transforming
today’s financial services. And to stay at
the cutting edge we must continue to
5
“Capital, Democratisation and Governance”
Mervyn Pedelty
Chief Executive, Co-operative bank p.l.c.
(Manchester, United Kingdom)
W
6. invest, and optimise the capital we use in
our businesses. Democracy is a part of
our culture.
In fact, you could say it’s our corner-
stone. Part of what makes mutuals and
co-operatives unique. After all, we are
ultimately owned by our members.
Others, like my own bank, adhere to co-
operative values and principles —
although the bank, of course, is owned
by The Co-operative Wholesale Society
(CWS), not by the bank’s own cus-
tomers.
Even so, CWS, our parent, is very
much a mutually owned membership
organisation. But here, too, in talking
about democracy and membership, we
are dealing with a moving target.
Members must have a real say in the
business. Democracy must have sub-
stance as well as form. Over the past few
decades – in the UK Building Society,
Insurance and Co-operative sectors - I
would argue that many mutually owned
organisations and co-operatives have lost
sight of their ultimate purpose. That
purpose being the need to recognise,
work for and reward their members. As
co-operative and mutual organisations,
we must improve the way in which we
respond to the needs of our members.
We need to think about governance
and ownership. And their relevance in
today’s changing world. That’s why the
word‘democratisation’ is the right one.
Because profitably and efficiently
meeting the needs of our members and
customers is an ongoing process. Espe-
cially in the face of a rising tide of demu-
tualisation. Demutualisation is not an
isolated phenomenon.
We’ve certainly seen it in the UK. But
it’s also happening in parts of continen-
tal Europe, for example in Belgium and
in Australia, South Africa, Canada and
the United States. And the argument is
always the same.
We’re told that ‘the tide of history’ is
turning against mutual ownership. For
instance, both AMP and Colonial, large
Australian insurers, recently demutu-
alised. AMP’s head of global acquisitions,
Jonathan Schwarts, commented that:
‘The average mutual has a culture, an
organisational structure, a cost structure
and mode of operating that was set for a
set of social circumstances and a regula-
tory environment that no longer exists.’
A pretty clear point of view, I think
you’ll agree. But is it true? Has our mutu-
al, co-operative approach passed its sell-
by date?
For more than 200 years the UK
building societies enjoyed continuing
success as providers of mortgages and
savings products. That changed in 1989
when one of the leading UK societies —
Abbey National — converted itself into a
bank. The decision to convert came not
from the members, but from the Board.
And the results were dramatic. In fact
that single decision created a ‘domino
effect’ which has since fundamentally
changed the mutual movement in the
UK.
So why did Abbey National demu-
talise and convert itself? Their argument
ran as follows. In the 1970s, they saw
6
7. growing competition as the quoted
banks began to offer mortgage products,
and muscle in on the Building Societies’
traditional territory.
And, of course, banks were able to
provide a much wider range of products
and services because of the way in which
they were financed and regulated. To
respond, the building societies had to
offer more. Which called for investment
— and for more capital. According to
Peter Birch, the Chief Executive of Abbey
National at the time: ‘Abbey National’s
choice was either to see its traditional
and only market erode or test the con-
version hurdles.’ The key advantage of
the status of being a listed Public Limited
Company – a “PLC” - was the ability to
issue shares. In effect, Abbey National
could ‘print money’ in order to raise cap-
ital to expand or to finance the acquisi-
tion of other institutions. Through the
conversion of Abbey National we all
learned some crucial lessons. Lessons, in
particular, about capital, democratisation
and governance. Access to capital was —
and still is — one of the main motives
for demutualising. Mutuals, by their very
nature, are democratic — but that very
democracy can be turned against them.
The argument goes that members of a
mutual should always have the right to
vote on their legal status.
Even if that vote deprives future gen-
erations of the right to membership. And
if the Board decides to recommend con-
version, it’s very difficult for opposing
members to win a ballot on staying as a
mutual. That, in turn, tells us a lot about
attitudes to governance. Building soci-
eties have unique governance structures
— which, apparently, have very little sig-
nificance to most of their members.
Abbey National members believed they
could gain something of immediate
value — its shares, and therefore money
— by sacrificing something with little or
no perceived value to them— their
membership of the society. And that, of
course, could be said to have been very
much a part of a culture of greed that
was increasingly seen in the UK during
the 1980s. It’s difficult to say how much
that culture had to do with the Abbey’s
loss of mutual status. But moral and
long-term arguments do seem almost
powerless against the immediate lure of
‘free money’.
Morally, there was a strong case
against demutualisation. Morally, one
could argue that the members had no
right to fritter away the reserves built up
in trust by the hard working inter and
post-war generations. But that argument
cut little ice with the current members
— nor, apparently, with the government.
Because government, too, has a clear role
in enabling — by simply not preventing
— demutualisation. But for a while the
Abbey National remained out on its
own. Then, in the Spring of 1994, the
Cheltenham and Gloucester Building
Society announced plans to convert and
sell its business to Lloyds Bank. It ulti-
mately became Lloyds Bank’s specialist
mortgage lending arm. Later the same
year, the Halifax Building Society and the
Leeds Permanent Building Society
7
8. announced their intention of merging
under the Halifax name — and then to
convert to bank status three years later.
As you can see from table 1 (page 16),
many further deals were to follow — and
1997 became a very significant year. At
that point the financial windfalls to
members from converting mutuals
reached a peak.
35 billion pounds – or 55 billion US
dollars - was released into the British
economy through the conversion of the
mutual building societies. And one in
three UK adults received shares. And a
new form of gambling then emerged.
People tried to guess which societies
would be next in line to convert. The
trend of ‘carpetbagging’ began. It’s inter-
esting to note that the term ‘carpetbag-
ger’ dates back to the period of recon-
struction following the American civil
war. ‘Carpetbaggers’ were Americans
from the North who travelled to the
South to take advantage of the low prop-
erty and asset prices, or to gain political
advancement. Southerners believed that
they could tell true Southern American
gentlemen from such opportunists be-
cause Southern ‘gentlemen’ carried prop-
er leather bags, not bags made from car-
pet material. In more recent times it
seems that Peter Robinson, the former
Chief Executive of Woolwich Building
Society, reclaimed the term during the
demutualisation of his building society.
He allowed 30,000 people to join after
the society’s decision to convert was
made public. He then announced a deci-
sion to back-date the qualifying date, so
they were not eligible for the windfall
payments. He explained his actions say-
ing “I have no concern about not enfran-
chising carpetbaggers.”
These so-called ‘carpetbaggers’ placed
money in deposit accounts to become
members and so be in the front line for
free shares This also gave them voting
rights to sway the outcome of a ballot.
However, over the next two years the tide
turned and there was growing reaction
against ‘carpetbagging’ investors. And the
media began to emphasise one of the key
competitive advantages of the building
societies — price. It has been an interest-
ing reaction.
Until quite recently many mutual
organisations treated their members
almost as if they did not exist. As cus-
tomers they were recognised, of course,
but frequently not as members with
membership rights. All too often, many
of these organisations seemed to have
been run primarily for the benefit of the
directors, senior management team and
staff of the institution. Many seemed to
have forgotten or neglected their roots.
And, they were often protected by their
mutual status from the critical gaze of
institutional and individual sharehold-
ers. Certainly, the true owners - the
members - rarely appeared to be encour-
aged to get involved. The importance of
membership – and the rights conferred
by membership – were rarely adequately
communicated or demonstrated.
It is, therefore, probably no surprise
that the members themselves had gener-
ally taken no interest in the way in which
8
9. their society was run. In fact, until the
1980’s, the majority would not even have
been aware that they were members - or
what that meant. So why has member-
ship not been taken more seriously by
these institutions until recently - that is,
until the advent of the‘carpetbaggers’?
Well, apart from apathy, old habits
and - some might also say - self-interest
by the Boards of Directors, there may be
a deeper philosophical dilemma here.
Long standing mutuals owned by indi-
vidual members tend to acquire a very
large “membership” over time. It is not
difficult for these membership details to
become out of date as time passes. To
clean up this accumulated data, and then
to activate the membership base is a
more difficult, arduous and costly
process the longer it is left undone.
Particularly if it has been left virtually
untouched for ten, twenty or thirty years
- or even longer! And, communicating
actively with a large membership is an
extremely expensive process. Member-
ship can run into millions, or at least
many hundreds of thousands. Few com-
panies publicly quoted on a stock
exchange have a shareholder base of that
size. So, it might be reasonable to allow
the ‘benefit of the doubt’ to some of
those mutuals. Given the costs involved
of communicating properly and actively
reaching out to their membership, per-
haps they simply decided that it could
not be afforded. So they spent what bud-
get they could afford on relating to, and
communicating with, the small minority
of their member base that took member-
ship and democracy seriously. In other
words, they solved their philosophical
dilemma of whether to be an active mass
membership organisation or, alternative-
ly, an organisation that just looks after
the small minority of members who take
an interest, by taking the easier, less
expensive route.
I don’t know. Perhaps we will never
know the real answer, but it is worth
pondering. Because that dilemma is just
as relevant today as it was 10 or 20 years
ago.
Table 2 (page 16) shows the impact of
mergers and conversions on the UK
Building Society sector. In 1988, there
were 131 registered Building Societies in
the UK. Now there are just 71. Balances
within the sector have been decimated
Mortgage assets within the sector
have more than halved over the past two
to three years.(Table 3)
Whilst total assets show an equally
marked decline. (Table 4)
Insurance companies have also
demutualised at a steady rate over the
past 10 years. Currently there are only
23 mutual insurance companies, a 44%
decline since 1988.
Most of the mutual insurance com-
panies that have converted over the past
8 years are shown on (Table 5). The most
current is Scottish Widows which, sub-
ject to approval, will join the Lloyds TSB
Group in the early part of next year. As
the table shows, unlike Building Society
conversions, demutualisation is occur-
ring on a more gradual basis and there-
fore there is not one significant year.
9
10. Turning back now to the UK Buil-
ding Societies, they are now starting to
fight back. Maybe it is to counteract the
sudden realisation by their members that
they can control the future of their soci-
ety. Many Building Societies have decid-
ed to reduce their “profits” by offering
better mortgage and saving rates than
their non-mutual competitors. If you
like, they have started to provide their
members with some tangible benefits of
membership
As a result, they’re now achieving
consistently high positions in the ‘Best
Buy’ tables.
But there have also been some other
inventive initiatives. For instance, the
Britannia Building Society gives a share
of its annual profits to its members
determined by the number of products
held and the length of membership.
These strategies — and others like them
— have started to win back for the build-
ing societies a growing share of the
mortgage market. And, they are now
starting to punch well above their weight
in the UK mortgage market
As seen on Table 6, page 18, they cur-
rently provide 33 per cent of net new
lending, against their market share of
outstanding balances of 22 per cent.
They also account for about 33 per cent
of new deposit balances, against their
market share of 17 per cent share of out-
standing deposits. This swing back to
mutuality was apparently confirmed in
July 1997. Members of the Nationwide,
the largest remaining UK building soci-
ety, voted overwhelmingly against pro-
conversion candidates standing for elec-
tion to the board. Many commentators
saw this vote as a reaction against the
“get-rich-quick” culture of the 1980s —
and, to some extent at least, as a response
to the tone set by the newly elected
Labour government. Others — more
cynically — put it down to the absence
of credible pro-conversion candidates for
the board. Later, Nationwide announced
that it had changed its rules so that all
new members would have to donate the
proceeds of any conversion windfall to a
charity — and many other societies were
quick to follow suit.
The new rule removed the incentive
for ‘carpetbaggers’ to join the society —
and ensured that members were less like-
ly to be swayed by the lure of short-term
financial gains.
Also in 1997, the new Labour govern-
ment brought in a series of amendments
to the Building Societies Act. To achieve
conversion, at least 50 per cent of invest-
ing members must now take part in the
vote and 75 per cent of those voting
must vote in favour. Among borrowing
members, only a simple majority of
those voting is required. So has the tide
turned? Probably not. In July last year,
1998, members of the Nationwide
Building Society were once again asked
to vote on a motion proposing conver-
sion, and for pro-conversion candidates
standing for election to the board.
The conversion motion was defeated
but, this time, much more narrowly.
Comfortingly — at least for people
like us — the pro-conversion candidates
10
11. were not particularly successful in win-
ning votes. But pressure on the Nation-
wide continues.
A leading UK national newspaper,
The Sunday Express, argued – and even
led a front page campaign - that if the
society converted, 2 billion pounds
would be donated to good causes via the
new anti-carpetbagger charity rule
adopted by the Nationwide.
That campaign has now died down
— but the threat remains.
This year the members of the large
Bradford and Bingley Building Society
also voted to convert — directly against
the recommendations of their own
board. It’s the first time this has occurred
— and the conversion of Bradford and
Bingley will now take place over the next
two years. Although we can expect a
strong rearguard action from disen-
chanted members who resisted the
process, it must also be recognised that
the Bradford and Bingley was the only
society which failed to protect itself
against the carpetbaggers with a new rule
change. Not surprisingly, many observers
are puzzled by this. So what does the
future hold for UK building societies?
With mortgage assets of 100 billion
pounds – 160 billion US dollars - and
annual profits of a billion pounds,
they’re still a significant force in the mar-
ket But even so, the Building Societies
Association is arguing for even stronger
legal protection against carpetbaggers.
And it wants demutualisation voting
hurdles for borrowing members to be set
as high as those for investing members.
However, in July this year, the UK
government announced that it did not
have enough parliamentary time to
bring in these measures. The Treasury
Minister, Patricia Hewitt, also felt that
these changes could not be guaranteed to
prevent more conversions anyway. In her
words, “The responsibility for saving the
mutual sector lies above all with the
mutuals themselves and their members”.
A clear and unequivocal message. Even
so, the surviving building societies —
few as they are — have learned their les-
son. They have built their own defences
against the ‘carpetbaggers’. Some of these
defences have been as a result of chang-
ing their Society rules in the ways I have
just described. Other defences have been
as a consequence of recognising that they
have a duty to encourage closer involve-
ment by their members in their societies.
And of the need to communicate more
to them - even if it costs money to do so.
They have come to recognise the
need to make membership meaningful,
and to provide real and tangible benefits
to their members. This recognition has
been in the form of more competitive
pricing on both sides of the balance
sheet, as well as by promoting the
“mutual” difference. Only history will
show whether the rear-guard actions of
the Nationwide and other Building
Societies will be successful in stemming
the tide of demutualisation in the UK.
Even both of the UK’s largest motor-
ing organisations — the AA and the
RAC – have also elected to convert. And
our own parent company, CWS, was
11
12. obliged to defend itself against a hostile
bid from a corporate raider in 1997. And
the experience in the UK has been mir-
rored in many other parts of the world,
including Canada, the United States and
South Africa. In Canada the four leading
mutual insurers — Mutual Life,
Manulife Financial, Sun Life and Canada
Life — are in the process of demutualis-
ing. They’ll be distributing shares worth
more than 10 billion Canadian dollars to
their Canadian policyholders. The ratio-
nale appears to be the same — easier
access to capital markets, and a currency
for mergers and acquisitions. Here, too,
government agreement has been crucial
— because, here in Canada, the law has
been changed to permit mutual societies
to demutualise. And here, too, in
Canada, there are organisations resisting
the process.
“The Co-operators” is an insurance
co-operative founded more than 50 years
ago by a group of Saskatchewan wheat
farmers. Soon afterwards a similar initia-
tive started in Ontario. The two joined
forces, and became the largest wholly
Canadian-owned multi-line insurance
company. They have announced their
intention to remain true to their origins.
But the flood of international demutuali-
sations continues. Though not, it seems,
everywhere. In some countries —
notably the Netherlands, Germany and
France — the regulatory constraints are
far tougher. There are restrictions on
winding up mutuals — restrictions that
mostly prevent UK-style carpetbagging.
And in the event of a conversion, the
owners of mutual banks are not allowed
to gain any personal benefit from the sale
of their shares. The results speak for
themselves. In the Netherlands, I under-
stand that mutual banks account for
35 per cent of all retail deposits. And, in
Germany the figure for mutuals is about
30 per cent, while just under 20 per cent
of total deposits are held in co-operative
banks.
In fact two out of three German
banks are mutually owned. To keep pace
with new developments in technology —
and service — 164 co-operatives have
merged over the last year.
In fact, some observers believe that
the total number of co-operative banks
in Germany may drop as low as 800
within five years — as modernisation
continues. There is a similar picture in
France, where mutual banks account for
37 per cent of retail deposits. Co-opera-
tive banking groups like Crédit Mutuel
and Crédit Agricole are large and very
successful. They’ve even acquired shares
in commercial banks. Indeed, the mutual
sector has even aroused complaints from
non-mutual competitors about the
‘mutualisation’ of the French economy!
On the strength of these figures, legal
restrictions do seem to help. But is this
the right road to travel? Clearly, it’s
important to create a supportive public
policy environment in which mutuals
can thrive. France and Germany recog-
nise that it’s wrong to turn a healthy,
competitive mutual into an investor-
owned organisation simply to satisfy
short-term interests. So we should, in my
12
13. belief, continue to champion the cause of
government support for thriving and
independent mutuals. But at the same
time we must address the key issues I’ve
already identified. And we must protect
ourselves, as the Nationwide Building
Society has done in the UK, by tipping
the balance in favour of mutuality and
long-term benefit.
It has taken generations to build up
our mutual institutions into the success-
ful institutions of today. And we owe it to
those generations to protect their legacy
with every resource at our disposal.
Regrettably, moral constraints are not
enough. But nor, on its own, is legal pro-
tection. To make a real success of ‘new
mutualism’ we must return to those
three key issues: capital, democratisation,
and governance. Demutualisations have
often been motivated by the desire to
raise capital on the stock market.
Mutuals need to offer an alternative to
this — and one alternative is to use our
existing capital more efficiently. To max-
imise the loyalty, involvement — and
profitability — of our members. To
reward them for buying more products
and services from us. And to think, cre-
atively, about partnerships with non-
mutual companies. By outsourcing and
joint-venturing — and keeping a clear
focus on the things we do best — we can
increase our efficiency, as well as offering
new products and services. We also need
to think about capital, the lifeblood of
our businesses across the world. We need
to look at the way in which Co-operative
Banks raise capital. We need to share our
experiences, so that we can all learn from
each other. In researching this presenta-
tion, it became evident that there is no
one single source which has an overview
of the many ways in which Co-operative
Banks across the world raise their capital.
This is such an important issue that I
would like to propose a study. A research
project if you like. One to which we
could all contribute. To help us under-
stand this important issue. I therefore
invite the ICBA to look at the possibility
of carrying out an international survey
to review capital raising for co-opera-
tives... And I hope we can all find the
means to help fund it. Because we will all
ultimately benefit from the results.
What about democratisation? Clearly
we need to look at new ways of building
the relationship with members. Ways
that are not solely dependent on price.
We must deliver value in many ways.
Through unrivalled quality of service.
Through the most advanced service
channels — including telephone and
Internet banking. And through competi-
tively priced products. Mutuality is no
excuse for second-rate services. At The
Co-operative Bank in the U.K. we recog-
nise that the definition of value must be
far broader than this — because that’s
what our customers are telling us. We
surveyed 1.2m customer households
using a detailed questionnaire. We asked
how we could deepen our relationship
with them. The results were very clear.
They want democratisation. Because
they want to be more deeply involved in
product, service and policy development.
13
14. But to encourage that participation —
and increase its value — our customers
were telling us that we must also behave
in a socially responsible and ethical man-
ner. Traditionally, we’ve been seen as
responsive to the concerns of communi-
ty and society. That has been one of our
strengths. Yet many mutuals and co-
operatives have acted in the past like
non-mutual and non-co-operative com-
panies. They sorely neglected their mem-
bership and their customers. My own
bank also went down this road in the
1980s. But the recent success of our ethi-
cal stance shows just how wrong we
were. It has attracted new customers. It
has boosted the value of our brand enor-
mously. And it proves that social respon-
sibility has nothing to do with woolly-
minded philanthropy. Nor has it any-
thing to do with poor quality products,
second rate levels of service and low lev-
els of profitability. In fact it shows that
social responsibility is crucial to the con-
tinuing success of mutuals and co-opera-
tive banks. So how can you define the
social and ethical stance that your partic-
ular co-operative institution should be
taking?
You don’t. The answer must come
from your members and your customers
— after all, it’s their money! Every three
years my own bank invites customers to
vote on how their money should, and
should not, be invested. By putting them
in the driving seat, we’ve deepened our
relationship with them — and given
ourselves a unique position in the UK
banking market.
We’ve also given customers the
chance to participate in the campaigns
that we run with charities, and to decide
how money should be allocated to them.
By building the relationship with cus-
tomers, these schemes provide a power-
ful form of added value. And it’s worth
far more than a short-term price differ-
ence.
In France, Crédit Mutuel, like our-
selves in the UK, have promoted a more
socially responsible approach. For
instance, Crédit Mutuel backed the move
towards a 35-hour week. They also sup-
port youth employment programmes.
And they’ve focused on channelling
resources into local development to
combat economic and social exclusion.
We have actively promoted the benefits
of co-operative and mutual ownership to
the general public and to our govern-
ments. In the UK, for instance, The Co-
operative Political Party has played a sig-
nificant role in reviving the debate about
“new mutualism”.
It has published four papers on the
subject, covering issues as diverse as
ownership of football clubs and social
exclusion. As a movement – within the
UK at least - we’ve often been inward-
looking and we’ve often failed to set out
the intellectual arguments for a healthy
co-operative and mutual sector. That is
changing — and it must continue to
change. But governments also have a
responsibility. A responsibility to think
through these ownership issues more
carefully. Privatisation and demutualisa-
tion are partly the result of an ideology
14
15. that appears to recognise only one effi-
cient form of ownership - the investor-
owned company. The truth is that we
need a rich diversity of ownership,
because of the social and economic ben-
efits it produces. This year, one of The
UK Co-operative Party's pamphlets
called for a Royal Commission on
Ownership to be established by the new
Labour Government. Its aim would be to
encourage a campaign of mutualisation
in Britain. This is the kind of policy pro-
posal that we need to trigger a real
debate about the potential of mutuality
in the modern world. For two decades,
the political focus has been on the opti-
mal balance between public ownership
versus private ownership. I believe we
need an equal focus on mutuality and
co-operation. I hope that every bank
here will encourage their government to
take a long, hard look at the real impor-
tance of mutual and co-operative owner-
ship. This is the challenge of new mutu-
alism. We cannot — and must not —
resort to sentiment in our efforts to pre-
serve our co-operative status.
But our heritage, and our values,
should inspire our actions — and pro-
vide us with a ‘moral compass’. We
must continue to modernise — and to
democratise — because only through
member democracy can we demon-
strate the real value of mutual and co-
operative ownership. We must continue
to advocate the benefits of mutual
ownership — and continue to ensure
that our governments listen to us.
Because it is our responsibility — and
our duty — to build a strong co-opera-
tive and mutual sector for the genera-
tions that will follow us.
15
19. 19
P.V. PRABHU, trustee-Secretary, national centre
for management development in agriculture & Rural
Development Banking, bangalore, India
Capital, demutualisation and governance
- indian cooperative credit & banking scenario
T
I New Economic Policy - Financial
and Banking Sector Reforms
he deepening economic crisis in
the country in 1991 characterised by bal-
ance of payment problems, disrupted
industrial production, depleted foreign
exchange reserve, budgetary deficit com-
bined with accelerated inflationary
trends prompted the Government to ini-
tiate major policy changes designed to
correct the macro-economic imbalance
and effect structural adjustments.
Important connotations of this policy
package are:
1. Liberalisation
• Dismantling the control regime
• Delicensing and decontrolling indus-
tries and trade
• Reformation of fiscal and financial
policies
• Encouraging direct foreign invest-
ment; opening up of economy
2. Market orientation
• Minimum role and involvement of
Government in influencing market
mechanism
• Competition
3. Privatisation
• Divesting Government ownership of
economic enterprises
• Encouraging promotion of private
sector enterprises
4. Globalisation
• Encouraging free flow of foreign
capital and technology
• Encouraging establishment of inter-
national joint ventures
• Dismantling restrictive trade regime
and permitting entry of MNCs.
The financial sector reforms are an
important component of the overall
scheme of structural reforms. Reserve
20. Bank of India, the country's central bank
and monetary authority took initiative to
set up the Reforms Committee and rec-
ommendations of which were aimed at
improving the productivity, efficiency
and profitability of the banking system.
They also aimed at providing the bank-
ing system much needed operational
flexibility and functional autonomy. The
following were the major components of
the reforms recommended by the
Committee:
1. Relaxing the barriers towards entry of
private banks in the banking system.
2. Liberalisation of branch licensing
policy.
3. Reorganisation of the banking struc-
ture.
4. Capital restructuring of Indian
banks.
5. Introduction of prudential norms
covering capital adequacy, income
recognition, asset classification and
provisioning.
6. Administered interest regime to give
way to market driven interest rate
regime.
7. Reduction of the proportion of
directed credit programmes.
8. Reduction of statutory reserve requi-
rements with a view to releasing
resources for profitable lending.
9. Strengthening the organisational and
legal framework for better recovery of
bank loans.
10.Establishment of an Asset Recons-
truction Fund to take care of the loss
assets of banks.
The prudential norms including cap-
ital adequacy were initially made applic-
able to Commercial Banks. Though the
Reforms Committee in its report had not
covered cooperative banking sector, RBI
made some of the recommendations
applicable to cooperative banks includ-
ing Agricultural and Rural Development
Banks and Urban Coop. Banks particu-
larly the norms relating to income recog-
nition, asset classification and provision-
ing for Non-Performing Assets (NPAs).
The Committee on Banking Regula-
tions and Supervisory Practices (Basle
Committee) had, in July 1988, laid down
an agreed framework, on international
convergence of capital measure and capi-
tal standards. This framework required
the banks to measure capital adequacy
on the basis of risk weighted assets and
get a minimum standard of 8% particu-
larly for banks conducting significant
international business. The framework
suggested by the Basle Committee was to
be applied by banking supervisory
authorities of various countries. Indian
commercial banks which have branches
abroad were required to achieve the
norm of 8% by March 31, 1994. Foreign
banks operating in India were required
to achieve this norm by March 31, 1993.
Other banks were required to achieve the
norm of 4% by March 31, 1993 and 8%
by March 31, 1996.
Prudential norms relating to capital
adequacy were perhaps not made applic-
able to RRBs and cooperative banks
(viz., Urban Cooperative Banks, ARDBs
and State / District Coop. Banks) for the
20
21. reason that they are not doing any signif-
icant international business. Also in the
case of cooperative banks, the share capi-
tal raised is linked to the loans disbursed
by them. Even though the Basle Commi-
ttee released the framework in July 1988,
it was made applicable to Commercial
Banks in India only in 1993 after the eco-
nomic policy reforms were introduced in
the country. It is reported that 25 out of
27 public sector banks have achieved the
8% capital adequacy norm.
Substantial financial assistance has
been provided by the Government of
India for cleansing of the Balance Sheets
and Recapitalisation of public sector
banks including Regional Rural Banks
from out of successive budgetary alloca-
tions. Such funding support provided by
the Government upto February 28, 1998
was of the order of Rs.200 billion. Seve-
ral financially sound public sector banks
including State Bank of India, the biggest
bank in the country and two of its sub-
sidiaries have successfully raised capital
from the capital market at a premium.
In order to introduce greater compe-
tition in the banking system, the RBI
gave approval for establishment of new
banks in the private sector with mini-
mum equity of Rs.1 billion which has
since been raised to Rs.2 billion. Nine
such new private sector banks have been
set up in the country which have raised
capital from primary market. NPAs of
new private sector banks ranged between
1% and 7% whereas in the public sector,
9 banks had NPAs of over 10% in
1998-99. Because of the market pressures
and application of various regulatory
norms, some of the large public sector
banks have reported substantial losses in
1998-99 resulting in total wiping out of
their net worth. For all the 27 public sec-
tor banks put together, their net profit
was 34.6% lower in 1998-99 over the
previous year.
In April 1998, the Reserve Bank of
India proposed to further strengthen the
existing capital adequacy, income recog-
nition, asset classification and provision-
ing norms as well as disclosure require-
ments of banks and achieve greater
transparency in banking operations and
bring these up to or exceed international
standards after taking into account the
recommendations of the Committee on
Banking Sector Reforms (second genera-
tion). Some of the major recommenda-
tions of the Committee for strengthen-
ing the Banking system are as under:
1. Stepping up of the minimum Capital
Adequacy Ratio from the existing
8% to 10% by 2002.
2. A 5 per cent weightage to be assigned
to investments in Government and
Approved Securities to hedge against
market risk.
3. Net NPAs to be brought down to
below 5% by 2000 and 3% by 2002
and banks with international pres-
ence to reduce gross NPA to 5 per
cent and 3 per cent by 2000 and 2002
and net NPAs to 3 per cent and 0 per
cent respectively.
4. Further tightening of the Prudential
Norms relating to Income Recogni-
tion (reduction of present norm of
21
22. 180 days for considering an asset as
NPA to 90 days in a phased manner
by 2002). Asset Classification (redu-
tion in the period for classifying a
NPA as 'Doubtful Asset' to 18 months
and eventually to 12 months) and
Provisioning (1% provision even on
Standard Assets).
5. Cooperative Banks to reach a mini-
mum of 8 per cent capital to risk
weigted assets over a period of 5 years
by raising capital from members
without any assistance from Govern-
ment.
The Reserve Bank of India has
already advised the public sector banks
to raise minimum required Capital
Adequacy ratio from 8 per cent to 9 per
cent by end March 2000 and thereafter
10 per cent.
The action on other major recom-
mendations are under examination of
the authorities.
II Cooperative Credit and Banking
Structure
India adopted Raiffeisen model of
rural credit cooperatives in the begin-
ning of this century to combat the prob-
lems of usury and indebtedness of farm-
ers and to rejuvenate the then stagnant
rural economy. From that stage, the
cooperative movement in India came a
long way, mainly through the efforts and
contribution of cooperators, Govern-
ments and members. Today, the short-
term credit structure specialising in pro-
duction credit is functioning with 3-tier
structure (SCB at apex level, DCCBs at
district level and PACS at grassroot level)
in 15 States and with 2-tier structure
(without DCCBs) in 12 States/Union
Territories. The LT structure specialising
in investment credit, is functioning with
a federal 2-tier structure (SCARDBs at
apex level and PCARDBs at block level,
with or without branches) in 11 States
and with unitary structure (SCARDB
with branches at lower level) in 8 States.
In one State, ST and LT structures are
integrated and the integrated structure is
catering to both investment and produc-
tion credit needs of its clients through
SCBs, DCCBs and PACS.
The origin of urban credit movement
in India can be traced to the close of the
nineteenth century. Following the suc-
cess of urban credit institutions in
Germany and Italy during the latter half
of eighteenth century, some middle class
Maharastrian families settled in the erst-
while Baroda State started a mutual aid
society in 1889. When the Cooperative
Societies Act of 1904 conferred legal sta-
tus to credit societies, the first urban
cooperative credit society was registered
in the then Madras province in October
1904. The failure of local joint stock
banks in the country gave an impetus to
the urban cooperative credit societies.
Later the economic boom created by the
Second World War provided a stimulus
to the growth of urban banks in India.
They grew not only in number but also
in size, diversifying their activities con-
siderably.
22
23. The network of financial coopera-
tives is presented in the following chart:
Credit Societies: Apart from the
above three major structures of coopera-
tive credit and banking sector, there are
38000 credit societies which are similar
to Credit Unions providing credit ser-
vices to members from the savings raised
from them.
Cooperative Bank of India (COBI):
Establishment of Cooperative Bank of
India at the national level has been a
major development in our country as
this is expected to fill the systemic gap in
the cooperative banking sector. COBI
will also serve as a balancing centre for
drawing surplusses and for deploying
funds covering the entire cooperative
banking sector. The capital base of
Rs.1000 million of COBI is expected to
be raised from member institutions in
relation to their relative financial
strenght. This Bank, however, has not
been operationalised because of delay in
securing the formal
banking licence from
RBI due to certain legal
hurdles.
Performance
The cooperative credit
structure covering ST
and LT put together
accounts for 69% of the
rural credit outlets
(107639 out of 155398).
Though they are not
comparable with com-
mercial banks in terms
of resources (CBs: Rs.5000 billion,
Cooperatives Rs.1067 billion) mainly
due to their poor deposit base, they are
favourably placed in terms of coverage
and outreach. They cover 647636 vil-
lages spread across 514 districts and
102 million operational holdings. Their
total membership is 98 million (bor-
rowing membership 42%). Of them,
42% are small farmers and 26% belong
to the weaker sections. On an average, a
primary unit covers 7 villages. Their
share in outstanding rural credit is
about 40% and they account for almost
50% of the annual credit flow in the
rural sector, of which about 60% is pro-
duction credit and 30% investment
credit.
Urban cooperative banks which
operate mostly in urban areas, play a
significant role in the non-agriculture
sector with over 6 million members
serving the banking needs of people
with small and modest means. They
23
24. account for about 6% of the entire
banking deposits and are totally self-
reliant in the matter of resources.
The position of resources and out-
reach of all the 3 structures viz., ST, LT
and UCBs as on March 31, 1998 is
pressented in the following table:
Major strengths and weaknesses of
Cooperatives
The major strengths and weaknesses
of cooperatives (ST & LT structures)
which serve agricultural and rural sector
are discussed below:
Strengths:
Network: As already stated, the
branches / grassroot level network of
cooperatives form 69% of rural credit
network in the country, virtually cover-
ing every village.
Vast human resources: The ST coop-
eratives employ around 220000 persons
and LT structure another 31000 persons.
Most of them are from local areas, well
versed with their area / clientele, their
needs and psychology. This invaluable
asset is one of the reasons for sustainable
performance of cooperatives in terms of
provision of credit, despite constraints
and competition.
Long standing experience in purvey-
ing rural credit: Cooperatives represent
the oldest rural credit delivery system
with over 8 decades of experience in
agricultural lending and they are fully
aware of problems and prospects of rural
lending.
Functional Societies: Besides provid-
ing avenues for deployment of resources,
the functional societies (marketing,
weavers, salary earners, consumer, etc.)
provide the benefit of linking of credit
with marketing.
Lower reserve requirements: Ever
since the application of Banking Regula-
tion Act to cooperatives, they are requir-
ed to maintain 3% and 25% of their time
and demand liabilities towards CRR
and SLR respectively. (CBs presently:
10% and 25%). This provides a greater
24
25. liquidity to cooperatives.
Refinance on concessional terms: Out
of the annual refinance provided by
National Bank for Agriculture and Rural
Development (NABARD), cooperatives
are presently enjoying more than 75%
share under production credit and 60%
share under investment credit. They also
enjoy concessions with regard to interest
rate and tenure of refinance.
Other support: NABARD is provid-
ing financial assistance to cooperatives
both through loans and grants from
Cooperative Development Fund and
R & D Fund for their operational impro-
vement and HRD.
Weaknesses :
Poor Resource Base: The total
resources of cooperatives were Rs.1067
billion of which around Rs.360 billion
were borrowings. The deposits mobilised
by rural and semi-urban branches of
commercial banks were Rs.1500 billion.
Except in 2 or 3 States, the resources of
primary units are very poor. On account
of poor resource base, a vertical depen-
dence on higher financial institutions is
evident. ARDBs are non-resource based
institutions though in the recent years,
some of them have made a beginning in
mobilising deposits.
Low business levels: The low business
levels, particularly at the level of PACS
(Average Rs.1.3 million), is one of the
major reasons for non-viability of coop-
eratives. The problem is more pro-
nounced in LT structure, particularly at
PCARDB level in some States.
Poor Recovery: The macro level reco-
very (loan repayment) rates were 84%
for SCBs, 60% for SCARDBs, 68% for
DCCBs and 56% for PCARDBs. 12 out
of 28 SCBs (less than 80%), 11 out
of 19 SCARDBs and 171 out of 363
DCCBs have comparatively less recovery
(less than 60%). 9 each of SCBs and
SCARDBs and 67 DCCBs suffer with
recovery less than 40%. Chronic over-
dues under ST (Rs.28 billion) and LT
structure (Rs.5 billion) pose serious
problem to the recycling of funds by
these institutions.
Inadequate financial margin: The fol-
lowing table reflects the inadequacy of
financial margin as compared to Tran-
saction Cost and other costs.
25
26. It may be seen that the financial mar-
gin is inadequate to meet transaction
and risk costs. On the basis of State aver-
ages, SCBs in 8 States, DCCBs in 20
States and SCARDBs / PCARDBs in all
the 19 States had negative net margins.
The increase in the negative net margin
as on March 31, 1998 was due to sizeable
increase in the risk cost on account of
implementation of provisioning norms.
Poor MIS: On account of poor data
flow, the managerial decision process is
not properly supported resulting in
delayed or imperfect decisions or both.
Process of computerisation of coopera-
tives is rather slow.
Lack of functional autonomy: Exter-
nal factors, affecting the functional
autonomy of cooperatives are targeting
both their democratic character and
operational liberty. This is affecting the
operations and efficiency of the coopera-
tives.
Unrealisable Asset: The unrealisable
assets consisting of accumulated losses,
imbalances in asset coverage and short-
fall in provisions for non-performing
assets in respect of a large number of
cooperatives (ST & LT structure) are esti-
mated at around Rs.70 billion (Rs.60 bil-
lion under ST and Rs.10 billion under LT
structures) against owned funds of
Rs.117 billion.
Imbalances in Profitability: Coopera-
tives in India are a strange pyramid with
large profitability at apex level and lower
profits or losses at grassroot level.
Operational Losses: The operational
losses of cooperation credit institutions
is a matter of serious concern and the
banks should make earnest efforts to
attain current and sustainable viability.
The working results as on March 31,
1998 are presented in the following table:
Non-compliance with Banking Regu-
lations: Due to erosion in capital as also
in deposits, several DCCBs are not com-
plying with the provisions of the Ban-
king Regulation Act and as such, are not
26
27. eligible for concessional funding support
from national financial institutions like
NABARD.
III Nature of Capitalisation issues
in India
Capital
Capital is one of the major indicators
of the financial strength of an enterprise.
For a banking institution, capital covers
risk of losses apart from reposing confi-
dence of the depositors and other credi-
tors.
In our context, capital has one more
important function and relevance.
Borrowing power of a financial cooper-
ative is linked to net worth as stipulated
in the Law. Net worth here means equi-
ty plus reserves minus accumulated
losses. For example, in Karnataka State,
borrowing power of a cooperative bank
is limited to 10 times the net worth.
This means the bank can raise deposits,
borrow funds from market or obtain
loan / refinance from financial institu-
tion to the extent of the borrowing
power in relation to net worth. Because
of this limitation, business expansion of
a bank is directly linked to its capital
base. In the case of Cooperative Agri-
culture & Rural Development Banks
engaged in term lending for agricul-
ture, the central bank has imposed a
ceiling on their raising deposits from
public which is limited to the banks net
worth. If the net worth or equity has
been eroded by losses, the bank will be
too keen to enhance the capital for
facilitating raising additional public
deposits.
Capital, in a broader sense is the
owned funds consisting of share capital
and reserves. Reserves represent profit
earned over the years that have not been
distributed to shareholders and retained
in the business. The accumulation of
such retained reserves reflects financial
soundness, stability and growth of
banks.
The capital base of cooperative credit
and banking institutions increases
steadily with the growth in business as it
is linked to loans and borrowers are
compulsorily required to contribute to
the share capital certain percentage of
loans ranging from 2.5% to 10%. This
system is quite different from Commer-
cial Banks, both public and private sector
banks, who raise capital from Govern-
ment and market by public issues. In
most of the public sector banks, capital is
held wholly or partly by the Government
with controlling interests. It is for this
reason, in the recent years, for augment-
ing the capital base of public sector
banks, Government of India have con-
tributed substantial sum to meet the
capital adequacy norms.
Reserves are results of profits and
there is limitation for augmentation of
reserves by S.T. and L.T. cooperative
structures due to inadequacy of profits
or because of operational losses as dis-
cussed earlier. Statutorily the coopera-
tives are required to set apart 25% of the
profits to Reserves and invest such
Reserves outside their business.
27
28. The positon of owned funds of coop-
erative banking structure consisting of
share capital and statutory reserves as on
March 31, 1997 is given in the following
table:
Cooperative banks in India, other
than Urban Cooperative Banks, besides
raising share capital from members,
which is linked to loans, also receive
equity contribution from the Govern-
ment as a matter of State policy. Such
capital held by State Governments in the
cooperative banking structure ranges
from 10% to 20% as indicated in the
Table below:
Though the Government contribu-
tion to the equity of cooperatives was
helpful initially, there is a growing feeling
among cooperatives, some of which are
fairly strong, to repatriate Government
equity in order to minimise State control
and interference in their working. In any
case, in the context of new economic
policy and financial sector reforms,
Government support by way of addi-
tional capital is not likely to forthcome to
cooperative banks in any significant
manner in the coming years.
In the private sector banks, equity is
held mostly by public and financial insti-
tutions. Besides promotors' investment
in equity, they enter the capital market
on their own strength to augment capital
to meet the international standards and
it may not pose any serious problem
unless they are in bad shape.
Capitalisation
As mentioned earlier in this paper,
cooperatives have share linking norm in
terms of which the borrowing members
are required to take up a certain percent-
age of loans towards share capital. While
the banks would like to augment capital
by increasing this ratio of capital to loan,
the borrower may not be interested in
increasing the rate of linkage as it would
put additional burden on him and ren-
der the loan less attractive. Also, there is
'nil' or inadequate return on such capital.
Because of low level of profitability,
majority of the banks have not been pay-
ing dividend on share capital. Even the
best of the cooperatives cannot normally
pay dividend over 15% on capital in view
of the legal restrictions and cooperative
28
29. policy of limited return on capital.
Cooperatives are expected to utilise prof-
its for augmenting owned funds by way
of reserves.
Based on the recommandation of All
India Rural Credit Survey Committee in
1954, Government as a matter of State
policy, has been contributing to the share
capital of cooperative credit and banking
institutions to make them financially
strong. For such shareholding by Gover-
nments, NABARD provides loans at con-
cessional rate from out of the special
fund viz., National Rural Credit (Long-
term Operation) Fund maintained by it.
There is no equity contribution to Urban
Coop. Banks by the Government and
they raise their equity entirely from
members.
As compared to public and private
sector banks, the shares of cooperatives
neither appreciate in value nor they are
traded in the secondary market. Also,
they are constrained to raise capital
through the primary market. These are
the bottlenecks for augmenting capital
by cooperatives.
Cooperative Banks have not made
any significant attempt for capitalisation
and most of them continue the age old
practice of raising equity from members
in relation to the borrowing. One reason
for this could be non-application of cap-
ital adequacy norm. They may soon
realise the inadequacy of capital with
application of international standards.
The growth in the capital is found to be
not commensurate with the growth in
business for the following reasons:
• Borrowers obtaining second and sub-
sequent loans may have to take up
additional shares only marginally.
• Face value of the share which was
earlier Rs.10 /- has not been raised in
some banks even though the rupee
value has decreased over the years
due to inflation. Even where changes
are made, it is still found to be much
lower. Face value of the share should
be much higher for ensuring growth
in equity.
• Share linking to loans is still lower at
3% and 5% in some banks and unless
this ratio is enhanced, equity growth
will not be substantial.
• Shareholders have a right to redeem
their holdings when loan liability is
cleared. However, by convention, it is
observed in some Cooperative Banks
(particularly L.T. structure) that the
entire equity holding of a member is
adjusted against the last loan instal-
ment thus depriving the bank of
much needed capital. This practice
needs a relook for retaining some
portion of the shares held by mem-
ber-borrowers.
Recapitalisation
Cooperatives, in keeping with their
principles, have been operating as service
sector institutions. There was no serious-
ness on their part to work as economic
enterprises. They were subjected to sev-
eral controls and restrictions by mone-
tary / refinancing authorities and Gover-
nment. Until 1994, they were required to
mobilise deposits and provide loans at
29
30. regulated interest rates with inadequate
spread / margin even to meet their trans-
action and other costs. The advances
were also regulated by the Government
through a system of directed credit for
priority sectors or poverty alleviation
programmes. Cooperative banks along
with public sector banks were also
required to implement Agricultural and
Rural Debt Relief Scheme (ARDRS) in
1990 under which benefits given to
farmers (towards defaulted loans) upto
certain extent were to be reimbursed to
the banks by the Government. The coop-
eratives were put to a disadvantage and
suffered liquidity problems as Govern-
ment support in relation to volume of
loans waived was not provided for fully
and that, further, there was considerable
delay even in the settlement and release
of dues. More than anything, implemen-
tation of this populist scheme resulted in
vitiating the recovery climate which even
otherwise was not so good. These, cou-
pled with the application of provisioning
norms for NPAs have resulted in sub-
stantial losses to cooperative banks.
Hence, cooperatives have been pleading
with the Government for funding sup-
port as one time measure to cover losses
by recapitalisation on the lines of sup-
port extended to public sector banks.
The estimated funding support for banks
in ST and LT structures for cleansing
their balance sheets is of the order of
Rs.70 billion. Response to this demand
has not been positive so far. There is,
however, no such proposal for support to
UCBs, as most of them are working in
profits and where Governments have no
equity holding. In the context of changed
economic policy, State Governments'
future support for increasing capital base
of cooperative banks will not be encour-
aging. On the contrary, cooperatives may
have to retire Government equity hold-
ing by stages in due course for their own
autonomy.
Prudential Norms: As a follow-up of
the financial sector Reforms Committee
recommendations, prudential norms
involving income recognition, asset clas-
sification, provisioning, valuation of
investments and capital adequacy were
introduced to various banks in India
beginning from 1992-93 as under:
The capital adequacy norms have not
been made applicable to cooperative
banks (including UCBs) and Regional
Rural Banks so far.
With a view to preparing the Balance
Sheet and Profit & Loss Account and
reflecting bank's actual financial health, a
proper system for recognition of income,
classification of assets and provisioning
on a prudential basis was found to be
essential. While the norms for income
recognition is based on record of recov-
ery (realised income), the classification
30
31. of assets has to be done on the basis of
objective criteria which would ensure a
uniform and consistent application of
norms. It would be necessary that the
provisions are made on the basis of clas-
sification of assets into 4 different cate-
gories viz., standard, sub-standard,
doubtful and loss.
After classification of assets, the
aggregate NPAs and their proportion to
total outstanding advances in respect of
banks in the ST and LT structures as on
March 31, 1998 are given in the follow-
ing table :
While the first reforms committee dit
not examine and make any specific rec-
ommendation to cooperative banks as to
the application of various norms, the
second generation of reforms (yet to be
made applicable) include the following
specific references to cooperative banks :
• There should be no recourse to the
scheme of debt waiver.
• Cooperative banks should reach capi-
tal adequacy of 8% over a period of
5 years.
• Cooperative credit institutions to
enhance their capital through sub-
scription by members and not by
Government.
• The present duality of control over
the cooperative credit institutions
by State Governments and RBI /
NABARD should be eliminated and
all coop. banking institutions should
come under the discipline of B.R. Act
by suitable amendments of the said
Act.
The capital adequacy norms are
expected to be introduced to cooperative
banks shortly. A big question is whether
cooperative banks would be able to
adhere to the capital adequacy norm of
8% especially when the erosion in their
assets has been increasing from year to
year. A quick study of the two banks in
Karnataka State (SCB & SCARDB) made
for assessing the adequacy or inadequacy
of capital requirement by application of
norms stipulated for commercial banks
reveals that while the SCB's capital of
10% of the risk weighted assets is found
to be above the prescribed standard, in
respect of SCARDB, the equity ratio of
5.3% is much below the required level.
Quality of Assets: There is one basic
difference in the standard of assets
acquired by the cooperative rural bank-
ing sector in India as compared to the
public and private sector banks. The
aggregate exposure of cooperative banks
loans portfolio in agricultural advances
is as high as 80% while that of commer-
cial banks at best may not exceed 20%.
The risk of lending is greater in our con-
ditions of agriculture looking to the
small size of holding, lack of irrigation
facilities, non-adoption of modern tech-
nology, fluctuation in the prices of
31
32. agri-products, marketing inadequacies
and above all poor economic conditions
of majority of farmers. Their risks are
not adequately covered by insurance
though the Government have recently
announced a package of comprehensive
crop insurance cover.
The assets created by cooperative
banks by advancing term loans for agri-
culture are secured by mortgages, whose
market value in no case is less than the
loans advanced. But these secured
advances or standard assets of the banks
are in reality substandard or risk assets
because of difficulties in converting them
into cash for realisation of dues. This has
posed serious problem and non-per-
forming assets (NPAs) of banks are dan-
gerously much above the containable
limit or above any accepted international
standard. Though in the balance sheet,
the capital of several cooperative banks is
apparently regarded as adequate, it might
prove grossly inadequate in several cases
to meet the international standards
against the risk weighted assets and thus
this threat of capital erosion has to be
converted as an opportunity for recapi-
talisation or funding by innovative
means from the global experiences. I am
afraid that this serious problem of high
level of NPAs, depleting profitability due
to provisioning on the lines stipulated by
the regulatory agency and certain opera-
tional compulsions of business develop-
ment in a liberalised competitive market
economy, may endanger the future of
cooperative credit and banking sector in
India unless remedial measures are taken
in a systematic and time bound manner.
This calls for in-depth study of the prob-
lems, gaining knowledge from the expe-
riences and practices of comparable
cooperative banking enterprises in other
countries, steps to improve the quality of
assets and their risk coverage, innova-
tions in the long practiced cooperative
way of carrying out business operations
and above all augmenting funds and
capital base through non-traditional
means.
IV Demutualisation
Cooperative identity and values have
been intensively deliberated upon at the
international forum and even the princi-
ples have been redefined not long ago.
Though there have been some compro-
mises here and there, the basic principles
have remained intact. One-member-
one-vote and limited returns on capital
are in fact the major constraints in aug-
menting capital in cooperatives. For a
successful and profitable cooperative
bank, there are quite a few of them even
in India, raising capital from market
besides member-holdings, is not going to
be a major problem. But how it is going
to be beneficial to the general public or
the corporate sector by holding on to the
cooperative principles of one-member-
one-vote and limited returns? We want
access to capital market and at the same
time do not wish to give up or dilute the
cooperative principles. Unfortunately,
'self-help' and 'mutual help' aspects in
cooperatives are not strong enough to
raise capital from members more than
32
33. what is mandatorily necessary. Like in a
credit cooperative, equity holding by
member in certain ratio is essential for
loan availment. If option is given, bor-
rowing member may not opt for holding
any additional shares except perhaps
what is essential for membership. I
would say that lack of member-interest,
member-involvement, member-partici-
pation and above all member-loyalty to
the cooperatives is a major cause of
worry for the future of cooperatives.
'Mutuality' in cooperatives is a major
casualty which will also act as a major
constraint for augmenting capital
through members.
There have been some isolated
attempts in France and Canada revealed
in ICBA Journals where shares and cer-
tificates are issued to members and non-
members quoted in stock markets carry-
ing dividends but without voting rights.
I feel that a cooperative bank with long
standing and popular by its services can
successfully raise capital from the market
through innovative capital instruments -
shares or otherwise - even without vot-
ing rights provided the bank is able to
repose investors confidence about rea-
sonable safety of investment and returns
on capital. Without resorting to demutu-
alisation as to members' rights and own-
ership, cooperative banks will also have
to evolve measures for member loyalty
and mutuality.
V Governance - Quality and Impact
Cooperative credit and banking
organisations (barring the Urban Coo-
perative Banks) were promoted and
established mostly at the instance of the
Government in its search for an institu-
tional arrangement to dispense rural
credit. The Government patronage and
preferential treatment besides conces-
sional funding support and equity par-
ticipation in the banking sector have, in a
way, helped in building up the structure.
At the same time, however, banks have
suffered by not being able to build up the
organisation on sound business princi-
ples and transact their operations like
any other enconomic enterprise. They
performed tasks as directed with exces-
sive control exercised by the Government
both in the Management and business
operations. Providing service was the
main concern and not the financial
results and viability. Good governance &
professionalism by and large are much
below the required standards. A large
number of banking institutions are not
financially viable though they continue
to perform the routine functions of
retailing credit without accountability.
Members of the Board of Manage-
ment of the banks elected democratically
by members are not necessarily profes-
sionals. There is no possibility of any sys-
tems change in this regard without viola-
tion or dilution of the basic cooperative
principle. Elected members of the Board
need orientation for performing the
tasks of policy making in an effective
manner. Such orientation and educa-
tional programmes are not organised on
a regular and continuing basis. The paid
management of the banks - top and
33
34. middle level management - also lack
professionalism to understand and oper-
ate in a fast changing financial market
and to evolve innovations in their opera-
tions due to faulty HRMD practices fol-
lowed by them.
The above brief background about
Governance in the cooperative banking
sector is adequate enough to draw con-
clusions about inadequacies of their
competitive strength in the market for
raising funds or for augmenting capital
base through innovative financial instru-
ments practiced in some of the devel-
oped countries. We need good and
responsive Governance. How else to
evoke investors and member-share hold-
ers confidence? Frankly, several of our
credit and banking institutions lack cred-
ibility and cannot stand the test of rating
which is essential to operate in the capi-
tal market or debt market. Good gover-
nance should be result-oriented and
serve the members economic interests.
Improvement in the quality of gover-
nance is, therefore, a prerequisite for
realising favourable impact of any capi-
talisation measures.
VI Relations with Governments
In India, "Cooperation" is a State
subject whereas "Banking" is with federal
Government. Laws governing the man-
agement and operations of the coopera-
tive financial institutions are therefore
not uniform. There are several restrictive
provisions in these laws hindering the
operations and management functions.
Government control over institutions is
excessive and interference is unwar-
ranted. Very often, elected Boards /
Managements are superseded not for
reasons of mismanagement or violation
of law but on political consideration.
Apex level financial institutions invari-
ably are managed at the top level not by
professionals but by deputed Govern-
ment officers.
In a way there is duality in the control
and regulatory mechanism of the finan-
cial / banking cooperatives in India by
the State Governments and the central
bank. Equity holding by the State
Government as a matter of State policy is
perhaps one argument for Government
control. State Government equity hold-
ing ration in the Cooperative Banking
structure is given earlier in this paper.
If Government decides to withdraw
its equity holding or the Banks decide to
redeem by repayment to State Govern-
ments, avenues will have to be found to
recoup the erosion in the capital.
Quite a few national financial institu-
tions, which are Government enterprises,
like National Bank for Agriculture &
Rural Development (NABARD), Nation-
al Housing Bank and National Coopera-
tive Development Corporation do insist
on State Government guarantee for pro-
viding refinance or loans to Cooperative
Banking and Financial institutions.
This necessitates their dependence on
Government for guarantee and in turn
gives cause for Government control.
Central Government's support or
control is not always direct. It is through
the Central Bank by way of banking
34
35. regulations or as a part of monetary
policy and through public sector finan-
cial institutions on which the cooperative
banks depend for funding / refinance.
Cooperatives over the last few years
have been demanding amendments in
the cooperative laws for their autonomy.
Some State Governments have taken
steps but the process of changing the
laws is rather slow and there is some
degree of reluctance on the part of
bureaucracy and the Governments to
give up their powers and control. The
issue has evoked a national debate and
pressures are mounting on the Govern-
ments for amendments in the laws.
Economic liberalisation and reforms
have no meaning without functional
autonomy.
Neither the Central nor the State
Governments have any specific policy for
financial cooperatives though they are
indispensable for credit support to agri-
cultural sector. Alternative institutional
arrangements for rural credit are grossly
inadequate. A major concession enjoyed
by credit and banking cooperatives from
the central Government is in the matter
of Taxation as no tax is levied on Income
derived from normal business operations
with members. This has helped, to some
extent, capital augmentation through
reserves built out from profits.
VII Suggestions
After diagnosing the malady, it is nec-
essary to evolve solutions to remedy the
situation. Let me be frank, it is not easy
in our conditions particularly when the
problems are mostly enterprise-specific
though the threat perception is universal.
I am particularly encouraged by some
innovative practices of French and Cana-
dian cooperative banking enterprises in
raising capital through a combination of
approaches. I thus see the possibility of
converting the perceived threat of capital
inadequacy in financial cooperatives in
India due to application of international
prudential norms into opportunities for
recapitalisation or building up capital
through certain changes in the tradition-
al means and also by other financial
market instruments. Having said this, let
me summarise below some of my pro-
posals to improve the situation in the
Indian context.
• Economic liberalisation and conse-
quent measures of financial and
banking sector reforms are less
meaningful without restoring opera-
tional autonomy and democratic
management of the cooperatives.
Excessive Government control and
interference in the management of
financial cooperatives needs elimina-
tion by comprehensive amendments
in the concerned cooperative Laws.
• Cooperative credit and banking
enterprises need to be profession-
alised for improving competitive
strength and operational efficiency.
"Corporate Governance" in the words
of Hon. the Lord Thomas, esteemed
former ICBA President is more rele-
vant in our context. Corporate Go-
vernance is missing due to lack of
professionalism.
35
36. • Immediate task is to bring about per-
ceptible improvement in the quality
of assets and bring down NPAs.
Mismatch in Asset-Liability has to be
corrected to repose confidence of the
members and the public. Supervision
and control mechanism needs to be
strengthened and streamlined.
• Traditional business operations of
banks excessively in agriculture and
rural sector should give way to
broadbased / diversified lending to
reduce risks of bad debts inherent in
farm financing. Further, cooperative
banks should develop and introduce
such service products, without
involvement of funds. If income level
and profitability goes up by non-
credit business operations, capital
base will be strenghtened by retained
earnings - Reserves.
• Cooperative rural credit institutions'
excessive dependence on funds bor-
rowed from national financial insti-
tutions like NABARD has been one
of the major factors affecting the
business expansion plan as also the
liquidity of several banks in meeting
the repayment obligations to the
creditors. Cooperative financial
enterprises, therefore should raise
funds through deposits and other
financial market instruments in order
to be self-reliant and for flexibility in
their operations.
• Lastly, to enhance the financial base
and for capital augmentation to meet
fully the international standards,
innovative capital instruments are
essential. At present, equity capital is
raised only from member-borrowers
and from Government which has
limitations as explained. Measures
adopted by cooperative banks in
some countries by issuance of other
types of equity instruments including
preferential shares with assured
returns and converting dividend into
equity with members approval will
be valuable to emulate for building
capital or for recapitalisation.
Somehow cooperative banks should
also have access to large capital mar-
ket that exists in India and their
instruments made tradable in the
stock market. This does not necessar-
ily means compromising on coopera-
tive principles like member suprema-
cy and one member one vote. Capital
inflow from corporate sector in col-
laborative business operations serv-
ing the members interest is a possibil-
ity which remains to be explored.
In conclusion, I should admit, apart
from presenting the status of our
Banking Cooperatives, highlighting their
problems of capital inadequacy, growing
NPAs, lack of professionalism in the
management, etc. and making a few
broad suggestions, there are hardly any
innovative practices which can be shared
with other successful Cooperative Banks
represented here. The Topic chosen for
this Seminar is more appropriate as it
covers the problem of Cooperative
Banking in totality (Capital, Demu-
tualisation and Governance) as issues
36
37. like 'Capital' cannot be tackled in
isolation. I am happy that Cooperatives
have started working on strengthening
capital and certain innovative practices
have been successfully experimented
without diluting the cooperative princi-
ples.
In India, we have not even seriously
examined the issue and perhaps awaiting
application of capital adequacy norm by
the regulatory authority to realise the
seriousness of the impact. Looked at
from the view points of declined viabili-
ty, high level of NPAs, non-professional
management and relatively lower level of
competitive strength in a competitive
banking scenario, a sizeable number of
cooperative credit and banking institu-
tions have no future or might prove
irrelevant soon in the rapidly changing
economy. This threat perception has
prompted me to analyse the problems
more critically and to suggest certain
radical changes in policy, structure, oper-
ations and management of the financial
Cooperatives.
37
38. 38
s in most other jurisdictions,
the new technologies associated with the
globalization of markets and the new
context of increasingly aggressive com-
petition are compelling Québec deposit-
taking institutions to develop new finan-
cial products and services, rationalize
their operating costs, and completely
overhaul their strategic orientations.
In order to ensure their long-term
viability, our institutions must manage -
in the most efficient manner possible -
the financial risks to which they are
exposed. Adding to this context is an
increasing flux of innovations and infor-
mation, as well as a myriad of financial
techniques and instruments, and issues
of regulation, deregulation and “decom-
partmentalization”. The outcome is a
new and turbulent financial environ-
ment. Due to this, our institutions are in
need of dynamic management tech-
niques, while the government authorities
require updated intervention procedures
and expertise, constantly called upon to
adapt and change.
More specifically, I will deal with the
major themes and challenges that influ-
ence the relationship between the Ins-
pector General of Financial Institutions
and the Mouvement Desjardins.
Brief history and legal context
On the heels of the liquidity crisis
which led to the demise of “caisses d’en-
traide et d’économie” in the early 1980s,
the Québec government set up, in 1983,
an independent agency called “The Ins-
pector General of Financial Institutions”,
or the IGFI.
Its mission consists in monitoring
and controlling the financial institutions
and the market intermediaries that oper-
ate in Québec, with the exception of
banks that fall exclusively under federal
Canadian jurisdiction. Its field of
MR. Jacques Henrichon, fca, deputy inspector general
INSPECTOR GENERAL OF FINANCIAL
INSTITUTIONS GOVERNMENT OF QUÉBEC
“The Relationship Between the inspector general of
financial institutions and the mouvement desjardins”
A
39. 39
activities encompasses four broad sec-
tors: deposit-taking institutions, insur-
ance companies, market intermediaries
and real estate brokerage firms, and
business enterprises. The Inspector
General also has the responsibility of
advising the Québec Minister of
Finance in terms of guidelines and
reforms to be made to the laws and reg-
ulations relating to financial institu-
tions.
Although the first Desjardins caisse
began operating close to one hundred
years ago, it was only in 1963 that the
first piece of legislation was passed
specifically aimed at governing savings
and credit union activities. Since then,
the legislative framework and the gov-
ernment monitoring of institutions
coming under the Mouvement Desjar-
dins banner have changed a great deal,
all the more so since they have had to
adapt to the realities of the financial
market.
1989 was pivotal, as it was a year
marked by a major legislative reform.
The Savings and Credit Unions Act was
amended to update the cooperative
framework of its institutions and offer
them new means of capitalization. In
addition, the duties of monitoring and
control were split between the institu-
tions of the Mouvement Desjardins and
the Inspector General of Financial
Institutions. In particular, the “Confé-
dération des caisses populaires et
d’économie Desjardins du Québec”
(CCPEDQ), hereinafter referred to as
the Confédération, was clearly recog-
nized, through its Bureau for Financial
Monitoring and Policy Enforcement
(BFMPE), for its role of inspecting the
caisses and federations.
We might also point out that the
legislative amendments which came
into force in 1997 streamlined the
democratic and decision-making struc-
ture of each caisse, and introduced to
the new management the rule of corpo-
rate governance. Steps were also taken
to allow them to adopt flexible stan-
dards applicable to the caisses to
enhance sound and prudent manage-
ment practices.
While various laws make it compul-
sory for institutions such as the federa-
tions and the Confédération to set up
monitoring mechanisms designed to
ensure broader public protection, the
Inspector General possesses the neces-
sary power to intervene to make sure
the public’s trust in the Québec finan-
cial sphere does not erode, and to pro-
tect and watch over the best interests of
depositors, investors, insureds and deb-
tors, thanks to a monitoring system
wherein institutions are bound to hon-
our their obligations.
Self-monitoring by the Mouvement
Desjardins / cooperative network
The cooperative network of the
Mouvement Desjardins is made up of
savings and credit caisses which in turn
are divided into eleven federated net-
works to which the following major
components are added: Caisse centrale
Desjardins as the financial arm of the
40. Mouvement, the Corporation de fonds
de sécurité Desjardins, a private organi-
zation of deposit-guaranteed funds,
and the Confédération Desjardins.
While rendering those institutions
under our jurisdiction more responsible
for their activities, self-monitoring as
practised by the BFMPE, and set up by
the Confédération is the approach we
favour, as it facilitates the synergy needed
between the Inspector General and the
Desjardins institutions (including the
federations and the Confédération) to
assume our responsibility of protecting
depositors.
The BFMPE has the duty to conduct
an inspection of each and every Desjar-
dins caisse every year and a half, and of
the federations and Caisse centrale
Desjardins on a yearly basis. Through its
supervisory activities, the BFMPE
attempts to look for any shortcomings in
in-house control mechanisms, evaluates
management, and reports on the policies
of the various activity sectors of the
institution, the commercial and adminis-
trative practices, as well as compliance
with legislation. It must be noted that the
Audit Commission of the Confédération
Inspection and must, among other
duties, ensure that the BFMPE is inde-
pendent and objective when fulfilling its
mission.
The results of this monitoring activi-
ty by the BFMPE - the self-monitoring
agency - are also conveyed in the form of
inspection reports to the Inspector
General of Financial Institutions, the
authoritative body of the Québec gov-
ernment, as well as the federation that
conducts the follow-up activity.
Any shortcomings in management
practices that are raised, any breaches in
rules of ethic, and any occurrences of
legislative non-compliance must give rise
to the appropriate follow-up actions by
the various levels of authority of the
caisse, the federation, the Confédération
and the in-house committees of the
Mouvement Desjardins.
These all have the duty of making
sure the necessary measures are adopted
to remedy the most problematic situa-
tions. If, however, the federated network
neglects to intervene in a caisse’s dealings
when a situation so dictates, the law
allows the Inspector General to give
instructions to that caisse. He can also
order a caisse whose line of conduct is
contrary to sound practices or consti-
tutes an offence under a piece of legisla-
tion to adhere to a recovery plan or,
where a breach to the code of ethics has
been noted, to put an end to such con-
duct.
Furthermore, the BFMPE audits the
annual financial statements of all Desjar-
dins caisses and federations. However,
the federation’s audit must be carried out
jointly with an outside firm.
We must point out that other specific
actions to deal with caisses in problematic
situations or to respond to special con-
cerns may take place and take the form
of either on-site or distance monitoring
activities. Such activities can be per-
formed by the Confédération or by a
federation, as dictated by the situation,
40
41. or when problematic issues are suspect-
ed. If not, the Inspector General must
intervene, in cases where the latter orga-
nizations fail to adequately assume this
responsibility.
In the context of financial disclosure,
other data are required from Desjardins
institutions, in particular, to the federa-
tions, Caisse centrale Desjardins, the
Corporation de fonds de sécurité Desjar-
dins and the Confédération. These are
periodically transmitted to the Inspector
General.
In terms of sound and prudent man-
agement, the Mouvement Desjardins has
put in place efficient mechanisms, par-
ticularly by the adoption a few years ago
of a directory of sound and prudent
practices regarding financial risks to
which it is exposed.
From a legal perspective, the respon-
sibilities of a caisse have been reinforced
as to the respect of management stan-
dards and the code of ethics enacted by a
federation or, if there are none, by the
Confédération.
Moreover, the process by which such
standards are adopted has been made
more flexible, allowing the Confédéra-
tion to adopt standards on any adminis-
trative and financial matter when
required in the interest of the federations
and the Desjardins caisses. The federa-
tion and the Confédération must, by way
of efficient mechanisms, also ensure that
the standards they enact are followed.
Today, the self-monitoring task per-
formed by the Mouvement Desjardins is
increasingly based on directors’ resolu-
tions to the effect that guidelines, stan-
dards or rules regarding sound and pru-
dent management have been adopted,
applied and respected. It is essential to
ensure the quality of this type of man-
agement, and the reliability of this
reporting.
Self-monitoring by the Mouvement
Desjardins / corporate network
In addition to the federated structure
designated as the cooperative network of
the Mouvement Desjardins, there is a
corporate network which encompasses
corporations that conduct financial
activities (trust, life insurance, compre-
hensive insurance, securities) and non-
financial activities. Ten years or so ago,
the latter that had been acquired or
developed over time by the Mouvement
were grouped under the banner of hold-
ing companies held by the Confédéra-
tion Desjardins.
The internal audit of the Confédéra-
tion must assess whether the Confédé-
ration and the corporations of the cor-
porate network are managing their activ-
ities soundly and prudently. It must also
make sure that the policies and manage-
ment practices are applied to adequately
control the risks to which these corpora-
tions are exposed.
In terms of financial disclosure, the
holding companies and their controlled
subsidiaries dispatch their audited finan-
cial statements every year to the Inspec-
tor General. Some of these companies
that deal in trust or insurance opera-
tions, in particular, are subject to a more
41
42. 42
frequent and detailed disclosure. The
latter are also subject to monitoring
adapted to their activity sector.
The Inspector General and govern-
ment monitoring
The primary objective of the moni-
toring performed by the Inspector
General is to check to see whether the
Desjardins institutions are in good finan-
cial health and if they have a sound and
prudent management. Its preventive
aspect is designed to unearth any item
that could eventually undermine the
security of insureds and depositors.
The Inspector General maintains its
monitoring approach of the savings and
credit unions or caisses, the federations
and Caisse centrale Desjardins in accor-
dance with its role of monitoring and
control conferred by the Savings and
Credit Unions Act on the Confédération
and federations. In addition, it examines
and conducts specific analyses on some
of the components of the Mouvement
Desjardins, including the Corporation de
fonds de sécurité and the Confédération.
The monitoring of insurance companies
and trust company held by the Mouve-
ment Desjardins is conducted by the
Inspector General in compliance with
the laws that govern them. As for the
holding companies, our work is generally
limited to a comprehensive monitoring
activity which allows us to obtain a firm
grasp of the changing corporate struc-
ture of these entities.
The approach of government monitoring:
• recognizes the Inspector General as
the ultimate body responsible in
terms of monitoring;
• coordinates monitoring activities at
the government level with those car-
ried out by the self-monitoring agen-
cy, the Confédération Desjardins;
• oversees the enforcement of several
sections contained in the Savings and
Credit Unions Act regarding, in par-
ticular, financial disclosure, capital-
ization, monitoring, new financial
products, and so on;
• arrives at a practical knowledge of
these institutions while developing an
expertise based on the maintenance
of a certain presence among the insti-
tutions belonging to the Mouvement
Desjardins.
The monitoring of Desjardins insti-
tutions currently conducted by the
Inspector General are targetted more at
the appraisal of risk management by the
Confédération and its federations, much
more than simply following up on their
changing financial situation. The govern-
ment monitoring activities of the Mou-
vement Desjardins are aimed at making
a judgement on their financial viability,
assessing the quality of their manage-
ment, and finding out to what extent
such institutions are exposed to a variety
of financial risks.
In the case of the caisses, federations
and Caisse centrale Desjardins, the
inspection carried out by the Confédéra-
tion, through the BFMPE, is the key item
43. 43
on which government-performed moni-
toring is based.
In other words, as a government
body, we will periodically evaluate the
work of a self - monitoring organization
to make sure that the inspection and
audit activities devised by the BFMPE
reach the objectives set out and meet the
needs of the government authority.
We designate monitoring heads for
each caisses-federation network, Caisse
centrale, the Confédération and the
other major cooperative and corporate
institutions of the Mouvement Desjar-
dins. Depending on the nature of the
entities monitored, we conduct an
appropriate examination and follow-up
of the information sent on to the Inspec-
tor General.
The information thus culled deals
with each caisses-federation network and
the other main components of the
Mouvement Desjardins, and are used to
determine so-called early warning indi-
cators.
Reports are drafted and regularly dis-
patched to authorities at the Inspector
General’s office to assess the financial
health of the various Desjardins institu-
tions and inform the staff of the most
worrisome cases. A meeting is held at
least every year with the authorities of
each caisses-federation network and all
other components monitored.
The Inspector General must take full
advantage of this information that he
may use to better target the nature and
scope of any intervention deemed neces-
sary. Thus, he makes optimum use of the
information taken from various sources,
the main ones being: the inspection
reports for each caisse produced by the
Confédération, the financial disclosure of
the caisses-federation networks and the
audited financial statements of all the
caisses and federations.
We promote an open dialogue with
Desjardins, particularly with those
responsible for the BFMPE. It should be
noted that the BFMPE directly con-
tributes to the security of members’
deposits.
The Inspector General has the duty
to ensure that all caisses, federations and
Caisse centrale Desjardins are inspected
within the prescribed time period and in
a satisfactory manner. Our monitoring
tools are updated constantly to allow us
to adapt to the Mouvement Desjardins
which is in a state of constant flux.
Changing monitoring and
intervention strategies
The climate of flux in the financial
sector and the complex nature of the
risks to which financial institutions are
exposed entail greater work loads from
every point of view, whether we are deal-
ing with financial studies, standardiza-
tion, the assessment and review of laws
and regulations, fine-tuning our work
methods or adapting monitoring activi-
ties to suit new realities.
Over ten years ago, the advent of a
monitoring framework focussed more
along the line of risks faced by the sav-
ings and credit union network made it
necessary both to devise and appraise
44. 44
work methods and tools likely to render
such monitoring effective.
Accordingly, at the time, government
monitoring of the Mouvement Desjar-
dins was carried out on a decentralized
basis. On the one hand, caisses were
inspected yearly by the Confédération
Desjardins and, on the other, the Régie
de l’assurance-dépôts du Québec, the
public body managing the deposit insur-
ance fund, also had the power of inspec-
tion it exercised on a sampling of caisses.
The Inspector General performed this
inspection on behalf of the Régie.
The legal reforms of 1989 shifted the
monitoring work carried out by the
Inspector General more along the lines
of a “caisses-federation” network rather
than the caisses taken individually. This
led to a network-based approach to
monitoring. Transitional delays were
necessary, as the approach implied a new
base of network information that was
structured in a particular fashion.
In September 1998, we initiated a
procedure to completely overhaul the
intervention strategies in terms of moni-
toring in order to optimize the use of our
resources, all the while taking into
account the reinforcement of the powers
of self-regulation, self-monitoring and
self-control that were conferred on those
organizations subject to scrutiny by
the Québec government. Among other
things, we based the monitoring ap-
proach on sound and prudent risk man-
agement.
We also acknowledged that the pri-
mary responsibility of the management
of institutions belongs to their directors.
We determined that all financial institu-
tions were to be subject to a minimum
level of control, and that a graduated
approach was called for in relation to the
identified existing and potential risks. We
also agreed that an integrated monitor-
ing of financial groups (conglomerates)
was to be recommended.
Our organization intervenes in the
affairs of deposit-taking institutions with
merely 30% of the staff it had a decade
ago. Nevertheless, our skilled teams are
able to adequately monitor the savings
and credit unions, particularly by closely
examining the changing financial situa-
tion and risks incurred, as well as
through an effective administration of
applicable legislation.
It should be pointed out that the
Inspector General’s monitoring and con-
trol activities are financed by the institu-
tions themselves. Indeed, the costs
incurred by our work is billed as a whole
the following year to the financial insti-
tutions concerned.
Our agency has increased the level of
exchanges it carries out with various
authorities and associations involved in
the regulation of financial institutions.
In fact, fruitful exchanges promote the
acquisition and sharing of the expertise
developed here and abroad.
In addition to the close collaboration
we have developed with the Office of the
Superintendent of Financial Institutions
(OSFI) of Canada to discuss our work
methods and activities, we would like
to emphasize our participation as a
