Abstract
Does co-operative banking constitute a viable alternative to the prevailing joint-stock model of modern times? This chapter examines the role of the co-operative movement from the early credit co-operatives, established by the founding fathers Schulze-Delitzsch and Raiffeisen in famine-struck nineteenth-century Germany, to the complex and hybrid iterations of the model in contemporary European economies. It outlines co-operative banking’s historical roots, with its groundbreaking practices of self-help, solidarity between members and financial inclusion irrespective of social condition or wealth, its ongoing conceptualization, the principles and values associated with co-operative banking, its role in modern economies, and examines empirical evidence on the performance of the sector relative to commercial alternatives and its contribution to financial stability in the European context.
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Notes
- 1.
The Rochdale Society of Equitable Pioneers was the co-operative enterprise founded by the Rochdale Pioneers in Rochdale, England, which commenced trading on 21 December 1844.
- 2.
Referring to Goschen in England and Luzzatti in Italy, two committed liberals and firm believers in laissez-faire, Say wrote, “They perfectly know what democracy may call into life, and what it may destroy; they take it as it is. What they want to demonstrate, is that liberty, self-help and foresight are able to find a principle of development and to breathe in the very atmosphere of democracy”. See Inglis Palgrave (2015).
- 3.
In 1850 Schulze-Delitzsch founded his first credit co-operative which was initially supported by rich philanthropists and artisans. However, as reported by Birchall (2013), “at the same time, Bernhardi, set up a bank in the nearby Eilenburg that was more genuinely co-operative and so in 1852 Schulze modified his own bank to become self-supporting with members contributing share capital”.
- 4.
For instance, Dutch Boerenleenbanks and Italian Casse Rurali (rural co-operative banks) were closely linked with the Catholic Church. In other cases, such as in the UK or in Germany, they were more linked with Protestantism.
- 5.
As stated by ICA (2012), “co-operatives exist to meet the needs of people, not primarily to generate a speculative return on capital invested in them. The primary motive for people forming a co-operative is to be self-reliant”. This condition is necessary to assure the autonomy and financial independence of a co-operative.
- 6.
This definition is provided in the seventh section of the premises to the introduction of the EU Regulation 1435/2003 on the Statute for European Co-operative Society (Societas Cooperativa Europaea—SCE).
- 7.
Credit unions are fully mutual financial intermediaries as membership is required to become a customer. Membership is defined on the basis of a common bond which mitigates any information asymmetries in the provision of financial services even to the most financially excluded members. As noted by McKillop et al. (2006), credit unions’ roots are in the German ideas of Raiffeisen and Schulze-Delitzsch. Outside Europe, they spread first in the Canadian region of Quebec in 1900 thanks to the efforts of Alphonse Desjardins. In the United States, the first credit union was established in New Hampshire in 1909.
- 8.
Goddard et al. (2016) include savings banks among the vast category of mutual banks. Historically and to this day, several savings banks have been owned by their members, typically depositors, and in many instances also by local or regional public authorities (as in the German case, up to the present day) which sponsored their establishment. Apart from where these banks have been privatized, the pure savings banks have some distinctive features: they are non-profit organizations, and they pursue social aims and are often included within large networks (Ferri et al. 2013).
- 9.
The Statement on the Co-operative Identity—Values and Principles was adopted in 1995 during the gathering of the international co-operative movement at the general assembly of the International Co-operative Alliance (ICA) in Manchester, England. The United Nations General Assembly recognized the essential nature of co-operative enterprise in resolution 56/1145 of 2001.
- 10.
Ibidem.
- 11.
Depending on the type of co-operative business.
- 12.
As recommended by ICA (2012) if non-member trade exceeds trading with members, or members’ usage of co-operative services is low, the reasons should be examined, and new measures should be adopted to encourage non-members to become members, or to stimulate members to use services. There is no doubt that when these circumstances arise, some of the motivations that gave rise to the co-operatives are therefore weakened, such as the exclusivity of the offer made to the shareholders in the absence of a profit incentive. Members’ incentives can be significantly altered when the offer of co-operative services is increasingly made in favor of subjects other than members. Membership may become more driven by the achievement of profits in the form of dividends, where this is allowed and not appropriately counterbalanced by appropriate mechanisms (e.g. through limits on the distribution of profits, accumulated reserves).
- 13.
The following terms are defined by ICA (2012): a primary co-operative is a co-operative that operates a co-operative enterprise for the benefit of its members. A multi-stakeholder co-operative is a co-operative with more than one class of legal persons as members. A hybrid co-operative is a co-operative that has issued equity shares to non-member investors. A secondary co-operative is a co-operative whose members are primary co-operatives. Tertiary co-operatives are national co-operatives, co-operative unions, or co-operative federations that represent the interests of its member co-operatives nationally and internationally.
- 14.
See, for instance, European Association of Co-operative Banks (EACB), 2012, The Process for the Redemption of Shares in CBs in different EU Countries; a Comparative Overview, Brussels.
- 15.
Redemption of shares is sometimes at nominal value or may include a limited compensatory return.
- 16.
As federations, or as co-operative or even non-co-operative enterprises, they are used by first-tier member co-operatives to gain access to different types of activities, including training, managerial advisory, auditing, and financial services.
- 17.
As stated by Cuevas and Fischer (2006), “mutual financial intermediaries require a specialized regulatory environment that supports the special nature of the contracts imbedded in the institutions”.
- 18.
The term “institutional structure”, as introduced by Merton and Bodie (2005), includes financial institutions, financial markets, products, services, organization of operations, and supporting infrastructure such as regulatory rules and the accounting system.
- 19.
Konczal and Abernathy (2015) define financialization as “the growth of the financial sector, its increased power over the real economy, the explosion in the power of wealth, and the reduction of all of society to the realm of finance”.
- 20.
Commercial laws originate from two broad legal traditions. The first is the common law which has English origin, while the second is the civil law, which comes from Roman law. Within the civil tradition, there are only three major families that modern commercial laws originate from: French, German, and Scandinavian. Legal systems in the German and Scandinavian law traditions fall between common law and French civil law traditions in terms of the protection they offer to arm’s-length investors (La Porta et al. 1998).
- 21.
According to Levine (1991), “stock markets arise to help agents manage liquidity and productivity risk, and, in so doing, stock markets accelerate growth. In the absence of financial markets, firm-specific productivity shocks may discourage risk-averse investors from investing in firms. Stock markets, however, allow individuals to invest in a large number of firms and diversify against idiosyncratic firm shocks. This raises the fraction of resources allocated to firms, expedites human capital accumulation, and promotes economic growth”.
- 22.
Holmström and Tirole (1993) indicate the stock market’s role in monitoring managerial performance. They show that a firm’s stock price incorporates performance information that cannot be gained from the firm’s current or future profit data, and that this information is useful in structuring managerial incentives.
- 23.
As stated by Boot and Thakor (1997), “a key attribute of the financial market, and one that delineates its role from that of a bank, is that there is valuable information feedback from the equilibrium market prices of securities to the real decisions of firms that impact those market prices. This information loop provides a propagation mechanism by which the effects of financial market trading are felt in the real sector. Bank financing does not have such an information loop. Hence, real decisions are not impacted by the information contained in bank credit contracts”.
- 24.
According to a survey by Oliver Wyman (2014), two-thirds of the European CBs surveyed have initiatives to help less favored client segments, including alternative repayment schemes, educating clients about personal finance and money management, and dedicating branches to restoring the financial health of customers in financial distress.
- 25.
In contemporary banking, where the presence of deposit insurance has made deposits safer, it might have contributed to breaking the alignment between the interests of depositors and members in sound banking, stimulating the risk appetite of the latter. The same can be assumed with regard to the increasing reliance of modern CBs on funding (in the form of deposits and other funding instruments) from non-members.
- 26.
There is an inherent challenge in the way democratic membership is still realized in many CBs: traditionally and to date, co-operatives have set low levels of shareholdings in order to boost membership among the poorest and/or established limitations to individual shareholdings in order to favor diffuse membership. This can favor a member-borrower’s moral hazard as the misalignment between the value of the shares held and the size of the loans obtained increases. In co-operative banking several remedies are in play to mitigate this potential conflict, including the transfer of large borrowing demands to specialized entities within the co-operative groups, or to the apex institutions of the co-operative networks. In this way, the involvement of entities with superior capabilities of screening and monitoring of large borrowers helps to reduce the risk to local banks of exposure to the phenomena of adverse selection and moral hazard in lending, even to members.
- 27.
In this regard, Coco and Ferri (2010), speaking about the increasing role of shareholder-oriented banking from the 1980s, write, “the model of the co-operative bank—the prototype of stakeholder value banks—was depicted as archaic since, assigning value (also) to objectives different from maximising short-term profit and putting on the same par (at least in their statutes)—especially via the principle “one head one vote”, irrespectively of the amount of shares actually held—the weight of each shareholder in the bank’s choices, allows representing a larger set of the bank’s stakeholders”.
- 28.
The theory predicts that the expense preferences of managers increase with institutional size but that this is less pronounced in networks (Fama and Jensen 1983) as multiple levels of monitoring are at work.
- 29.
Members’ total return includes the explicit remuneration of capital, where adopted, the return on savings, and the so-called consumer surplus which results from the difference between the price he/she is willing to pay and the price actually paid (Fonteyne and Hardy 2011). Surpluses in co-operative banking can be explained as differences in lending rates paid by members-borrowers versus market rates, in price differentials enjoyed in other financial services provided by CBs (i.e. payments, asset management, etc.), or, ceteris paribus, in more remunerative deposits than those collected by commercial banks.
- 30.
This disciplinary effect may, however, be mitigated by the concomitant intervention of two main aspects. On the one hand, by the superior need to preserve bank stability through limiting redemptions of shares which can hurt its financial stability (as stated by bank capital regulation and bank by-laws), and, on the other hand, by the slow speed with which the redemption may take place according to the provisions of by-laws and bank regulations.
A further solution comes from the creation of governance structures founded on the presence of powerful supervisory boards, truly enabled to monitor and intervene in management conduct. In the major European co-operative banking groups, there are, along with executive boards, supervisory boards which are responsible for protecting the co-operative vocation of banks and containing any phenomena of opportunism and moral hazard on the part of management.
- 31.
Indeed, the kind of community bank supported by Minsky (1993) was a profit-seeking community development bank, thus apparently different from a co-operative bank. However, as stated by De Antoni (2013), in Minsky’s view profit maximization had to be considered just as an instrument rather than as a target. His community banks shared all the remaining aims of CBs and are part of that alternative financial system which in grounded in a shared-prosperity capitalism (Minsky and Whalen 1996).
- 32.
According to the Likanen Report (2012), while many not-for-profit banks have undeniably expanded their activities over time and become almost indistinguishable from their commercial bank competitors, co-operative and savings banks have also preserved their focus on local retail business.
- 33.
For instance, Behr et al. (2017) investigate whether the cyclical nature of lending to SMEs is dependent on government involvement in banking. To this aim, they investigate a sample of German savings banks, which have a public mandate, and CBs, which have no public mandate, over the period 1987–2007. The authors find that SME lending by savings banks is on average 25% less sensitive to GDP growth than that of CBs from the same area. The effect is found to be statistically highly significant. They claim that this result is relevant for regulatory purposes (i.e. prudential regulation) as well as for the definition of the optimal local banking structure. Other considerations aside, the greater prudence of CBs over a long and relatively tranquil period may have enabled them to continue to sustain the economy, without facing the severe financial difficulties which the German system of savings banks experienced in the aftermath of the global financial crisis (GFC). As stated by Behr and Schmidt (2015), “being less involved in structured finance and capital markets products than the savings banks, the CBs survived the financial crisis better than any other banking group”.
- 34.
In a Japanese empirical study on the effect of governance-related variables on firm performance across stock and CBs (Shinkin banks) over the period 2009–2013, Yamori et al. (2017) find that having a large number of board members has a negative effect on efficiency measures (obtained from stochastic frontier analysis) for both stock and CBs. On the other hand, the presence of outside directors exerts a significant effect on the efficiency of the individual CBs. These results suggest that outside directors’ discipline is more necessary for CBs than for stock banks, which are under extreme pressure from shareholders. Additionally, the authors show that a high ratio of representative council members in CBs, which is the most important decision-making body for Shinkin banks, has negative effects on efficiency measures.
- 35.
This is a measure of banking industry heterogeneity computed, as in Beck et al. (2013), as the within-country standard deviation of the percentage non-interest income (with respect to total assets) per year and per country. The higher the value of this indicator, the lower the herding behavior in the co-operative banking sector.
- 36.
The importance of localism in banking is addressed by Presbitero et al. (2014) who find that during the global financial crisis in Italy, the contraction of credit was more severe in provinces with larger shares of branches owned by distantly managed large banks. Large and “good-quality” firms in functionally distant credit markets suffered relatively more rationing than those in credit markets largely populated by functionally close banks.
- 37.
Economic growth is measured in two ways: the growth rate of gross domestic product per capita and the growth rate of regional value added per worker.
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Poli, F. (2019). The Theoretical Background of Co-operative Banking. In: Co-operative Banking Networks in Europe. Palgrave Macmillan Studies in Banking and Financial Institutions. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-21699-3_1
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