Regulation and Supervision of the Financial Cooperatives Research Paper June 2013
The Financial Cooperatives in Nepal The concept of mutual benefit through selfhelp has always been instilled in Nepali customs in the form of Guthi, Parma, Dhikuri etc. long before the cooperative movement. While the idea was in practice, the Government of Nepal adopted the cooperative system in order to use it as a driver towards social, economic and rural development. The Department of Cooperatives (DoC) was established in 1953 A.D. (2010 B.S.) under the Ministry of Planning, Development and Agriculture to promote, monitor and develop this sector. However, it was only after the establishment of democracy in 1990 A.D. (2047 B.S.) that the movement picked up. Worldwide, cooperatives operate on a few fundamental principles such as Open and voluntary membership, democratically controlled by the members, Members economic participation, Autonomy and independence, Cooperative education, training and information, Cooperation among cooperatives and Concern for community.
The cooperatives sector has grown tremendously, in size and scope over the past decade. As of October 2012, deposits in Financial Cooperatives represented 16% of total financial deposits, the same as the total for Banks and Finance Companies. This growth coincided with the liquidity crisis in the financial sector. Saving and credit cooperatives as well as multipurpose cooperatives, thereafter started offering services similar to that of the banking sector. However, the lack of proper regulations coupled with the growth in financial cooperatives, has posed a threat to the financial stability of the economy. Therefore, other stakeholders in the financial Source: Department of Cooperatives sector through the Financial, Monetary and Insurance Affairs Share of Financial Cooperatives in the Cooperatives Sector
Financial Cooperatives Mushrooming in Urban Areas In Nepal, broadly speaking, there are three types of cooperatives. Savings and credit cooperatives are formed to take deposits and provide credit to its members. Specific purpose cooperatives aid in specific activities such as agriculture, dairy, electricity etc. Lastly, multipurpose cooperatives are formed to conduct more than one activity. Most multipurpose cooperatives in Nepal also conduct saving and credit activities. Therefore, savings and credit cooperatives and multipurpose cooperatives can be clubbed together and termed as ‘financial cooperatives’. The cooperatives sector in Nepal has seen tremendous growth in the number and size of business over the past decade. The number of cooperatives in Nepal has been growing at a compounded annual growth rate (CAGR) of more than 18% over the past 7 years. Currently, there are 26,620 cooperatives operating in Nepal. This growth would otherwise be a positive indicator of the growing business of cooperatives. However, of the various types of cooperatives, financial cooperatives constitute 61% of the total number of cooperatives and an alarming growth of such cooperatives is concentrated in urban areas where financial services are more easily available.
Role of the Nepal Business Forum The growth of cooperatives in number and in the area of their business operations coupled with the financial services they are offering similar to those of BFIs has alarmed the banking sector as they see cooperatives as institutions encroaching on banking services. Additionally, it is felt that on account of being loosely regulated, the risk brought about by cooperatives for the financial sector could affect the overall financial stability, which is why the Financial, Monetary and Insurance Affairs Working Group of the Nepal Business Forum raised the need for tight regulation in the cooperatives sector on 28 September 2010. The Working Group is co chaired by the Deputy Governor of the Nepal Rastra Bank and the President of the Nepal Bankers’ Association. As per the Working Group members concerns, a task force was formed with the concerned stakeholders and two people were placed in the Department of Cooperatives from the NRB to provide technical and financial assistance in collection of statistics relating to cooperatives. Similarly, on 17 August, 2012 High Level Business Forum Meeting, chaired by then Hon’bl Prime Minister Mr. B.R.Bhattarai approved the recommendation that an independent agency akin to Nepal Rastra Bank should be established for regulation, monitoring and supervision of Savings and Credit Cooperatives through the Ministry of Finance. As of date, a high level cooperative strengthening committee has been formed to initiate a study on troubled cooperatives and the representatives include national cooperative federation, department of cooperatives, national federation of saving and credited cooperative union and national cooperative bank.
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Regulation and Supervision of the Financial Cooperatives
Table 1: Snapshot of the Cooperatives Sector as of Mid October, 2012
Type of cooperative
Share of Kathmandu Valley in the total Financial Cooperatives of Nepal
Table 2: Comparison of Business Volume of B and C Class Institution with Financial Cooperatives
Amount in NPR Billions
Financial Institution
Deposit Amnt
% of Total
Financial Cooperatives
200.4
16%
Development Banks
134
10%
78
6%
Finance Companies
Supervision Revealed Misuse of Functions and Authority by Financial Cooperatives As a result of weak regulation, financial cooperatives have been conducting activities that go against the basic principles of cooperatives. As per the findings of a joint supervision conducted by NRB and DOC, in FY 2009/10, Sitapaila Multipurpose Cooperative, Guna Multipurpose Cooperative, Kantipur Saving and Credit Cooperatives, and Civil Saving and Credit Cooperative have mobilized deposits up to 110 times higher than their share capital amount. Providing favorable loans to promoters without pledging collateral, investing more than 50% of the loans in unproductive sectors such as the housing sector, getting involved in remittance business, maintaining inadequate loan loss provisions, capitalizing interest earned as principal amount and mobilizing deposits higher than the required amounts are few of the activities conducted by fraudulent cooperatives. Such activities are a combined result of a weak regulatory body and also weak regulations in place From conducting banking transactions like remittance business to even setting up ATMs, financial cooperatives have practically being working like a parallel banking system. Since the number is increasing, their collective bargaining power is also increasing over time.
No. of coops
Membership
Savings (In bI.)
Investment (In bI.)
Employment (In bI.)
Savings & Credit Multipurpose Sub Total (Financial coops)
11901
1970571
175.2
131
23673
4127 16028
1823172 3793743
25.1 200.4
33 164
7836 31509
Others
10592
832790
3.6
5.8
8530
Total
26620
4626533
204.0*
169.8*
40039
Source: provisional data, Department of Cooperatives
Financial cooperatives are functioning well in the rural areas where financial services are either unavailable or hard to obtain due to lack of collateral or good credibility. However, Kathmandu valley alone has 4044 savings and credit cooperatives and 558 multipurpose cooperatives, which constitute 29% of the total financial cooperatives in Nepal. As on Mid October, 2012, the total deposits collected by banks, financial institutions and cooperatives stood at NPR 1.29 trillion. The deposits in cooperatives constituted 16% of this
figure as against the deposits in development banks and finance companies which constituted only 10% and 6% respectively.1 This means that the volume of business conducted by cooperatives is much larger than what is conducted by development banks and finance companies. The reason for the growth of cooperatives as against development banks and finance companies, according to bankers, is due to the decline of interest rates of the latter and an increase of such rates for the former. Also, the proportion of depos-
its and investments held by these cooperatives constitute 82% and 77% respectively of the total holdings of financial cooperatives in Nepal. In addition, approximately 580 BFIs operate in the valley taking the total number of financial institutions to 5182. Where financial infrastructure is more established, the question that arises is the motive behind the formation of such cooperatives; whether it is to actually increase access to finance or to take care of the vested interests of select few members.
Financial Cooperatives weakly Regulated; increased savings due to lack of awareness Due to the competitive nature of the financial sector in urban areas, financial cooperatives mostly cater to members that are primarily rejected by banks and financial institutions. Therefore they inherently carry a higher risk for which they charge a higher interest rate. Therefore the loans of such cooperatives have characteristics of subprime lending with higher interest rates and less favorable terms to compensate for the higher credit risk. However, none of the parties have created awareness about such lending to depositors. In
1. Monthly Statistics FY 2011/12, Nepal Rastra Bank
order to be able to make sound financial decisions, such depositors must be made aware of the fact that the higher interest rate fetched by their deposits is because these deposits are used for loans with higher risk which puts their deposits at greater risks as well. Lack of awareness and weak regulations have led to savings and investments taking an upward trend. Financial cooperatives hold NPR 200.4 billion and NPR 164 billion in savings and investment as on mid October 2012. The CAGR for deposits years have
grown at a whooping rate of 60% and 134% respectively. The deposit size of cooperatives is larger than that of development banks and financial institutions, since cooperatives are offering a higher interest rate as compared to these financial institutions. The higher interest rates are luring depositors and a few cooperatives are also accepting deposits above the statutory requirements. In the absence of tight regulation, such practices will continue and in turn lead to default in deposits.
Research Paper
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Micro and Macro Level Impact created if Cooperatives are unregulated A bubble in the cooperatives sector has been created which if not dealt with will create a snowballing effect on the economy. The impact on economy can be segregated into the micro level impact which impacts the security of depositors and the macro level impact that affects the overall stability of the economy.
With a total of 3.7 million members in financial cooperatives, these constitute approximately 28% of the population with access to finance in Nepal. If cooperatives collapse, 28% of the population will be hit as their savings will be lost. Financial cooperatives have mobilized NPR 200 billion in deposits which constitutes 16% of the total deposits in the economy. The average deposit per member stands at approximately NPR 53,000 while the per capita income is NPR 57,000. Further these deposits represent the contributions of the lowest tier of the society therefore the impact of a collapse will be further amplified as it will hit the bottom of the pyramid. In Nepal, savings and credit cooperatives maintain a credit to capital, deposit and reserves ratio of 66% while the same ratio for multipurpose cooperatives is 105.5%. International practices suggest a ratio below 80% to be appropriate, suggesting that in the case of Nepal, financial cooperatives are either not lending out close to an optimum amount thereby reducing the earnings or lending out more which poses more risk.
While in the first case, the capability to pay back the interest on deposits in undermined, in the second case, lending out more than what is collected directly impact the default rate on deposits which is not even justified by a higher risk. Since the cooperatives sector is running as a parallel banking sector offering similar financial services, it is bound to impact the functioning of the banking sector as well. While looking at the growth of deposit and investments in financial cooperatives it is very interesting to observe that right at the time of the liquidity crisis in FY 2009/10, the deposits and investments grew at a rate of 166% and 100% respectively. This clearly revealed that depositors were withdrawing money from BFIs and depositing it in cooperatives and also shows how a movement in one definitely leads to an impact in the other. It has been established that concentration of financial cooperatives in urban areas is higher where access to finance is easier. As a result there is bound to be competition, therefore they inherently take higher risk which negative-
ly affects the default rate of such cooperatives. With the advent of regulations to limit the exposure of BFIs in real estate, this exposure has transferred to the cooperatives sector. Few cooperatives have almost 93% of their total portfolio constituted of real estate loans. Due to the real estate slump, these investments do not yield returns, which again increase the risk of default. In the absence of a Credit Information Bureau for cooperatives, loans from cooperatives do not feature in the credit worthiness of borrowers. As a result a borrower having a high exposure of loans from financial cooperatives might pose a serious default risk if they attain fresh loans from BFIs. And finally, the total deposits with financial cooperatives form 52% of the total national budget of Nepal and 13% of its total GDP. Should the bubble burst, bailing out this amount will have a serious impact on the expenditure of the government; rather it would be impossible to actually bail out this amount when it constitutes 52% of the entire budget.
Recent Developments in the Cooperatives Sector Realizing the need for the cooperatives sector to be regulated, there have been some developments in the cooperatives sector which are listed below.
The Micro Finance Authority Bill drafted by NRB has been passed to the government which envisions forming an authority to regulate micro finance institutions (MFIs), cooperatives and non-government organizations that deal with deposits and credit.
National Cooperative Policy 2013 has been approved by the cabinet; which seeks monitoring of financial transactions and conduct of cooperatives, with combined efforts from concerned stakeholders.
Ministry of Cooperative and Poverty Alleviation is in the process of formulating a working guideline for deposit security fund, credit security fund and credit information center.
NRB Governor also stressed on the need of setting up a specialized body to regulate and supervise cooperatives.
Merger directives for cooperatives introduced.
This research note was commissioned by the Nepal Business Forum and undertaken by beed Pvt Management (beed), as part of a series of papers to provide independent analysis and background information on selected issues raised by the working groups of the Nepal Business Forum. The views expressed are those of beed, and do not necessarily represent the views of the Nepal Business Forum. The Nepal Business Forum is a public private dialogue established by the Government of Nepal and Private Sector, including a Secretariat supported by SEDF.
Need for Regulation Identified ment of a second tier organization had The impacts amply substantiate the gravity of the situation and the fact that the cooperative sector needs tight regulation. However, there is ambiguity as to the body that will govern the sector. In an ideal situation, the National and Regional Cooperative Federations should govern the sector based on the principle of self regulation. However, this would work successfully only if transparency in the operations of cooperatives existed.
been passed in FY 2004/05 and again in 17 August 2012 through the HLBF of the NBF. However, even after seven years, no significant developments have been made. The establishment of a second tier institution will take a considerable amount of time and resources to reach the capacity it can to regulate the sector, meanwhile, the situation in the cooperatives sector will only worsen, and the probability of a collapse may also increase.
ment steps to establish relevant institutions will solve address the crux of the problem in the cooperatives sector. Furthermore, in the absence of relevant data for the cooperatives sector, a detailed study should be conducted to analyze the contribution of the sector to the economy and to obtain a true picture of what is really at stake. With the compilation of such data, the transparency of cooperatives should be gradually improved and information must be easily made available to depositors and other stakeholders. Awareness of the depositors and other stakeholders should be increased through education about the difference between BFIs and cooperatives and their comparative objectives, processes, risks and benefits so that depositors can
The Department of Cooperatives on the other hand lacks human and technical resources to effectively monitor the continuously growing sector. Comparing the human resources in NRB to govern a total of 2289 financial institutions to those in the DoC, to govern close to 26,620 cooperatives clearly illustrates the capacity gap. In comparison to 1364 staffs in NRB, averaging approximately 0.6 staffs per institution, the DoC houses only 486 staffs, averaging 0.02 staffs per cooperative. With such a crunch in human resources, managing such a huge number of institutions will be a difficult task. Recommendations for the establish-
The cooperatives sector has yet not been included in the formal financial sector. Setting up a second tier organization to supervise this sector will definitely help formalize the sector. NRB plans to remove the D class financial institutions (finance companies) from its purview and place it under the STO. Being governed by the same organization as finance companies will also help instill confidence in financial cooperatives. There have been discussions to incorporate information of borrowers of financial cooperatives through the Credit Information Bureau. However, despite the decision to do so, a phase wise action plan has been decided to bring the cooperatives under their wing. This is dependent on the political will to bring financial cooperatives under the formal sector. Necessary govern-
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This research note was commissioned by the Nepal Business Forum and undertaken by beed Pvt Management (beed), as part of a series of papers to provide independent analysis and background information on selected issues raised by the working groups of the Nepal Business Forum.
The views expressed are those of beed, and do not necessarily represent the views of the Nepal Business Forum.
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