CHAPTER THREE

CO-OPERATIVE FINANCING INSTITUTIONS- CREDIT UNIONS

By the end of this chapter the learner should be able to:

i) Describe the different levels of the credit union system
ii) Describe the key characteristics of credit union approach to microfinancing
iii) Explain the methods of risk management in credit unions
iv) Identify the major weaknesses and constraints of credit unions
v) Identify the lessons to be learned from credit unions in microfinancing

3.0 Introduction
Credit unions are cooperative financial institutions that began operating in
developing countries in the 1950s. The credit union system that comprises the World
Council of Credit Unions (WOCCU) is made up of four different types of institutions-
credit unions, leagues, regional confederations, and the worldwide confederation-each of
which has a specific role and purpose. Credit unions or savings and credit co-operatives
are the base-level financial institutions that provide savings and credit services to
individual members.
As cooperatives, they are organized and operated according to basic cooperative
principles: There are no external shareholders; the members are the owners of the
institution, with each member having the right to one vote in the organization. The
policy-making leadership is drawn from the members themselves, and in new or small
credit unions these positions are unpaid. Credit unions are legally constituted financial
institutions-chartered and supervised, for the most part under national cooperative
legislation.

3.1 Key Characteristics of the Credit Union Approach to Microfinance

i) Client Focus
Credit unions in the developing countries tend to serve low-income and lower
middle-income segments of the population. This low-income market niche of credit
unions is a result of two different factors. First, many credit unions were established by
socially oriented groups that are working with a low-income membership base. Second,
credit unions provide a basic set of services that low-income members find valuable,
because they do not have access to these services through existing formal-sector
alternatives.
These services typically are not attractive enough to entice a more affluent clientele.
Loan amounts are not large enough, interest rates and other terms are not favorable
enough, and credit unions lack the legal power to provide some of the services that more
sophisticated clients need
ii) Services
For the most part, credit unions in the developing countries are single-purpose
cooperatives that specialize in providing financial services to their members. Savings and
relatively short-term installment credit are the two principal financial services offered by
credit onions Very few have developed more sophisticated services such as open-ended
lines of credit, pension programs, checking accounts, or investment services.
iii) Savings
Credit unions develop both a savings and a loan relationship with their members. The
savings relationship is generally first and is the key to the eventual loan relationship. In
most developing countries, members are required to establish and maintain regular saving
programs before they become eligible for loans. This reduces risk by allowing the credit
union to gain experience with the member before making a loan.
iv) Credit
Credit unions follow a “minimalist approach” to credit delivery, very rarely do they
provide training, technical assistance or ancillary services to their microfinance members.
This approach assumes that member is capable of running their business and determining
their financial resources. The role of the credit union is to attempt to serve members’
requests and not to evaluate those decisions except when they relate to members’ ability
to repay the repay loan.
v) Institutional Structure
As cooperatives, credit unions are owned and operated by their members, who are
also the beneficiaries or clients. The people who are saving in and borrowing from the
institution are also those in making the basic decisions on interest rates, terms, and other
policies. This is significantly different from standard microfinance programs, in which
the institutions are established and staffed by outsiders to channel externally provided
resources to local clients. Credit unions are local institutions, owned and operated by the
local population and using locally generated resources within the community. In this way
they are similar to the village banks.
vi) Financial Structure
One key characteristic of credit unions throughout the developing world is that they
operate on self-generated capital. The loans made by credit unions are in most entirely
financed by member savings, not external donations or loans. Savings exceed loans
outstanding. Finally, with only rare exceptions, credit unions are self-sustaining on the
basis of operations; they are generally not dependent on operating subsidies or subsidized
capital funds from either donors or governments

3.2 Managing Risks in Credit Unions

The credit union movement has developed numerous methods for minimizing
credit risk. In employee-based credit unions, the credit union can have knowledge about
the work history and salary of the member. Similarly, in association-based credit unions,
the member is usually affiliated with the group that formed the credit union (such as a
parish) and is known to the membership. Both cases lower information costs, reduce risk,
and increase the rate of collections. Community- chartered credit unions have less
knowledge of their members and have traditionally been weaker than either industrial or
associational credit unions.

3.3 Major Weaknesses and Constraints of Credit Unions

Several factors constrain the performance of credit unions in the developing
world, particularly in the context of their ability to serve the enterprise sector.
Credit unions tend to be small, credit unions of this size cannot be expected to
greatly expand their activities and could not assume the risk involved in developing or
implementing specialized programs designed to reach large numbers of small-scale
enterprises.
 Credit rationing, in one form or another, is the standard practice, it is carried out
through queuing (in which loan applications are processed as funds become available) or
limiting the member’s loan to a relatively low multiples of the amount of savings.
Most are conservative, highly traditional organizations that do not have a modern
growth- and service-oriented philosophy.
Internal credit union policies and operating procedures need modernizing if
credit unions are to significantly expand their role in small scale enterprise lending. In
particular, poor delinquency control and weak portfolio management capabilities limit the
ability of many credit unions to expand loan portfolios or add new services. Management
operational systems and even basic accounting systems need improvement, particularly in
smaller credit unions

3.4 Lessons from the Credit Unions

Savings mobilization- Domestic savings mobilization is both possible and
important. Poor people in developing countries are capable of generating large volumes
of savings.
Fiduciary responsibility- Managing savings implies a fiduciary responsibility.
The fiduciary responsibility requires external regulation and supervision.
Size-related limitations- Benefits are a function of scale, small institutions and
programs, with small client bases, can have only a minimal impact on their clients.
Institutions with small memberships simply cannot generate sufficient resources to satisfy
the financial needs of their membership and provide meaningful levels of credit to
significant numbers of people.
Donor support- Credit union experience in many countries has shown that
dependence on donor agency support can be destabilizing and constrain institutional
growth. It is tempting for a relatively new institution to achieve scale by accepting
externally provided resources.. Many leagues and confederations have had severe
financial problems resulting from the premature termination of donor assistance, on
which they had come to depend.
Diversity- Successful financial intermediation requires a diverse client base. It
requires a client base composed of both net savers and net borrowers-the savers to
generate the resources used for loans to the borrowers. It also
requires a clientele with different cyclical requirements, so that loan
demand during peak periods does not exceed the institution’s
available liquidity. Both these criteria are likely to be missing in
programs specializing only in small-scale enterprise credit, placing
even further constraints on capital adequacy.