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University
AND
COURSE OUTLINE
Course Code: BBM 222
Course Title: Co-operative and Microfinance Management
Course Objectives: By the end of the course unit the student will be able to:
Course Content:
Principles of cooperative management and social development; Cooperative enterprise
management and operations; Cooperatives organization; Cooperative laws; Cooperative financing
institutions- Credit unions; Microfinance principles and practice- credit principles, saving
principles institutional requirements; Savings mobilization and microfinance; The process of
Institutional development; The merging role of NGOs in financial intermediation; Principles of
regulation and prudential supervision in microfinance;
References
Maria O, and Elisabeth R, (2003), The New World of Microenterprise Finance: Building
Health Financial Institutions for the Poor, Kumarian Press.
MODE OF ASSESSMENT
MARKS (%)
30
Final Examination
70
Total
100
Pass mark
40
TABLE OF CONTENTS
Page
COURSE OUTLINE....................................................................................................................i
TABLE OF CONTENTS.............................................................................................................ii
CHAPTER ONE: Co-operative Organization........................................1
1.1 Introduction1
2.1 Introduction..11
2.2 Role of Management..12
2.3 Resources Managed in a Co-operative..15
2.4 Management Functions.17
2.5 Management Tools.18
2.6 Elements and Division of Responsibility21
2.7 Managing Local Operations.25
2.8 Managing Regional Operations..29
2.9 Challenges to Co-operative Management.33
Review Questions.........................................................................................................................34
CHAPTER THREE: Co-operative Financing Institutions- Credit Unions....35
3.0 Introduction.35
3.1 Key Characteristics of the Credit Union Approach to Microfinance..35
3.3 Major Weaknesses and Constraints of Credit Unions37
3.3 Major Weaknesses and Constraints of Credit Unions...37
3.4 Lessons from the Credit Unions.38
Review Questions........................................................................................................................39
CHAPTER FOUR: The Legal Framework of the Co-operative Movement
in Kenya.40
4.0 Introduction.40
4.1 Cap. 490 of the Laws of Kenya, of 196640
4.2 Co-operative Societies Act, No. 12 of 1997..42
4.3 Co-operative Societies Act, No. 12 of 1997 as amended in 2004.44
4.4 Role of Cooperatives in Social Economic Development44
4.5 Role of Government in Cooperative Development..45
4.6 Benefits of Forming Co-operative Organizations46
Review Questions.........................................................................................................................47
CHAPTER FIVE: Microfinance Principles and Practice50
5.0 Introduction.50
5.1 Credit Principles52
iii
6.0 Introduction.68
6.1 Framework for Institutional Development....68
6.1.1 Components69
6.1.2 Stages..70
Review Questions.........................................................................................................................71
CHAPTER SEVEN: The Merging Role of NGOs in Financial Intermediation..72
7.0 Introduction.72
7.1 Characteristics for NGOs Engaging in Financial Intermediation72
7.2 Challenges for NGOs Choosing Financial Intermediation75
Review Questions.........................................................................................................................76
CHAPTER EIGHT: Principles of Regulation and Prudential Supervision and Their
iv
CHAPTER ONE
CO-OPERATIVE ORGANIZATION
Learning Objectives
By the end of this chapter the learner should be able to:
i)
ii)
iii)
iv)
v)
1.1 Introduction
Co-operative is an organization owned by and operated for the benefit of those
using its services. Co-operatives have been successful in such fields as the processing and
marketing of farm products and the purchasing of other kinds of equipment and raw
materials, and in the wholesaling, retailing, electric power, credit and banking, and
housing industries. The modern consumer co-operative traces its roots to Britain's
Rochdale Society of Equitable Pioneers (1844); the movement spread quickly in northern
Europe. In the U.S., agricultural marketing co-operatives developed in rural areas in the
19th century; other contemporary examples include consumer and housing co-operatives
Co-operative management, also co-management, tries to achieve more effective
and equitable systems of resource management. In co-operative management,
representatives of user groups, the scientific community, and government agencies should
share knowledge, power, and responsibility. Co-operative management is closely allied
with collaborative management, participatory management, community management,
joint management, and stakeholder management.
Co-operative management training gives students inducements to learn what is
satisfying to them and useful in future work. The literature of the field is to survey and
identify critical needs in co-operative and mid-management skills and develop an inquiry
form career. The skills are needed to helping executive personnel in merchandising who
supervise mid-managers and mid-managers who occupy such merchandising positions.
Co-operatives in Kenya are not a new phenomenon; its experience can be traced back
from the time before colonial domination to recent where we experience business in cooperatives especially of financial institutions and agribusiness in nature.
1.2 Principles of Co-operatives Management and Social Development
i)
Co-operatives are voluntary organizations, open to all persons able to use their
services and willing to accept the responsibilities of membership, without gender, social,
racial, political or religious discrimination.
ii)
Members contribute equitably to, and democratically control, the capital of their
co-operative. At least part of that capital is usually the common property of the cooperative. They usually receive limited compensation, if any, on capital subscribed as a
condition of membership. Members allocate surpluses for any or all of the following
purposes: developing the co-operative, possibly by setting up reserves, part of which at
least would be indivisible; benefiting members in proportion to their transactions with the
co-operative; and supporting other activities approved by the membership.
iv)
development of their co-operatives. They inform the general public particularly young
people and opinion leaders about the nature and benefits of cooperation.
vi)
Co-operatives serve their members most effectively and strengthen the cooperative movement by working together through local, national, regional and
international structures.
vii)
This meeting takes place in every co-operative but once. Its role is to inaugural the
functioning of the co-operative, to discuss and authorize the 1ist of first members as wel1
as the
bylaws
and
other
regulations
financial and operational plan for the first year's activities and elects all the institutions of
the co-operative.
ii)
The role of this meeting is to assess all aspects of the past year's activities and
to approve financial, social and developmental plans for the following year, as wel1 as
to elect continuing officers to the various bodies of the co-operative organization.
annual
The
but rather by a special ad-hoc committee, responsible for all the sessions.
iii)
This meeting is called only in the event when the following subjects are to be
discussed:
a) Amendment to the bylaws.
Whenever the need arises during the year, this general meeting may be called. It is
presided over by the Manager of the co-operative; though it may be summoned upon
request or demand of the management, the control committee, the audit union, the
registrar of co-operatives or 10-30% of the members, according to the bylaws
of the co-operative.
Conditions for all general, meetings, regardless of type
A general meeting may be convened only when a legal quorum is present. Such a
quorum consists usually of at least 50% of the members, though the bylaws may specify
any number. If no quorum exists, the meeting is postponed to another time, from one
hour to a month later.
Members should be informed about the date, time and place of the general
meeting wel1 in advance, and by appropriate means.
Careful minutes should take the discussions and decisions of every meeting. They should
include:
a) The full name of the society
b) The date of the meeting
c) The number of members present
d) The name of the chairperson presiding
e) The name of the recorder taking minutes
f) The agenda
g) The decisions
h) Any remarks of the chairperson
The general meeting is the highest authority in a co-operative, a role which
permits and demands certain specific functions.
a) It is a forum where the members can express their views freely.
particular purpose.
d) A general meeting may be more successful if a day is chosen when there
are no competing interests, when the agenda is not monotonous and when
the points
at
issue
are
interesting.
The Council
membership is present at a general meeting, decisions made by such a minority are hardly
representative of the entire society.
A council is therefore elected body, which becomes the second highest authority
in the co-operative. It sits every three to four weeks to discuss and decide on current
issues in the co-operative, those which require a forum wider than that merely of
management. It decides as wel1 on matters of investments, management budgets,
production quotas and matters of social and economic importance.
The members of the Council are elected for terms of two years, every year half
the membership being renewed. On one hand, management may pass to the council
issues of great importance which require a broader forum for decisions. While, on the
other hand, social problems, handled unsatisfactorily by a management committee
may be submitted to the council by the members themselves.
The Council is a relatively stable body where members feel
greater
personal
responsibi1ity than in the anonymity of the general meeting. The Council reflects greater
variety of opinion than the management committee and has more public backing, though
there is not the same discrete, personal approach to members' problems as in that body.
ii)
The Management Committee is the highest elected executive institution in a cooperative enterprise. Everything done in the co-operative must be approved by the
management committee. General1y speaking, members of this committee are not paid for
their services, and the time they devote to meetings is limited. Every member of the cooperative may present matters (personal problems, coop problems or public affairs)
for discussion, but only a limited number of subjects can be considered in the twice
weekly meetings of the management committee.
Duties of this committee are;
a) Approval and assignment of contracts
b) Engagement and dismissal of workers
c) Consideration of social problems
d) Decisions on matters of co-operative policy
e) Investment in other co-operatives
f) Planning future activities of the enterprise
or
totally
inappropriate.
Management has a global responsabi1ity for all acts of the co-operative though
there may not always be an immediately discernable connection. It must decide on the
executive acts of the Manager and bears responsabi1ity for the successes and failures of
that officer.
It is incumbent on the management committee to ensure that decisions taken can
in tact be executed. The management committee must guarantee a close correlation
between theory and practice, between decision and execution.
It is always good management policy to view every decision action in the context
of the total activities of the enterprise, present and future. In this case, the management
committee must seek to discover the correlation between current actions and their
future consequences. In a way, it is like seeing not only the forest as a whole, but also
each tree as an integral part thereof.
iii)
The Manager
of the socioeconomic policy of the co-operative. It is the manager who proposes plans,
executes and evaluates.
iv)
The Treasurer
Control/Supervisory Committee
The control committee is elected by the general meeting of the co-operative from
among its members. It is an internal watchdog committee responsible for examining and
supervising the activities of the co-operative in order to guarantee their being legal
and in compliance with its bylaws and constitution, as well as being financially
tenable.
The control committee is completely independent from the management
committee, but in no way replaces that committee. Nor, in tact, does it have the same
powers. A member of the control committee cannot at the same time be a member in
management, council or any other elected bodies of the co-operative.
Some of the specific duties of the control committee involve supervision and
checking of:
a) The general functioning of the enterprise.
b) The activities of management.
c) Various decisions and their execution.
d) The financial situation and the annual balance sheet.
e) The behavior of the different committees.
f) Complaints from members of the co-operative.
Review Questions
i)
ii)
iii)
iv)
v)
vi)
10
CHAPTER TWO
CO-OPERATIVE MANAGEMENT
Learning Objectives
By the end of this chapter the learner should be able to:
i)
ii)
iii)
iv)
v)
Identify and explain the various tools used in the management of co-operatives
vi)
vii)
2.1 Introduction
Management has greatly improved as co-operatives have become larger, more
diversified, and integrated to match similar advances in the marketplace. In the early
years, local co-operative managers not only supervised operations but also maintained
accounting records, waited on customers, and swept floors. Many co-operatives failed
because of inept operating management and poor monitoring by the board.
Specific examples included overextension of credit and unsound collection
practices, poor technique in produce marketing, inadequate attention to keeping products
in condition, overexpansion of facilities, underfinancing, and overadvances to growers in
pooling operations, dominance of the hired manager, and interference in management of
operations. Both surviving and new co-operatives learned important lessons from these
experiences.
As regional co-operatives developed and became stronger, they began providing
more assistance to local boards and managers through general field representatives. This
included helping recruit and train managers and assistants. Later, several provided
financing and direct management service to the weaker locals, and auditing and analysis
service to all member locals.
11
With the advent of the Co-operative Bank, and the co-operative college valuable
management and financial counsel became available to co-operative borrowers. In many
cases, this perhaps is more valuable than the funds loaned to them. Regional cooperatives now employ university graduates with training in business administration,
agribusiness, or sales management and place them in management trainee programs
before moving them to managerial positions. Some regional co-operatives provide
management training for local managers, using their own staffs or management
consulting firms as trainers. Most regionals send key employees to management schools
or seminars.
Co-operatives have increased in size and diversity of products and services, and
have departmentalized their operations. Most farmer-directors have become more
business-minded as their own farm operations grew. They give more attention to their cooperatives management. They employ managers with more training and expect them to
improve their knowledge and skills. Also, a growing number of directors seek to become
more proficient in directing the affairs of their co-operatives.
Public concern about food safety, pollution control, health and the environment,
monopoly, and related issues focuses attention on the competence, integrity, and behavior
of co-operative directors. As a result, co-operatives are becoming more aware of the need
to indemnify directors who are subject to increased legal exposure. The growing impact
of world markets, even on the individual family operation, is changing the management
perspective from the local co-operative level. The local is being viewed less and less as
an independent entity and more and more as part of a system.
Therefore, planning and strategy are evaluated in terms of the locals relationship
to neighboring co-operatives, other areas, agribusinesses, the regional co-operative in
which it has ownership, to the markets into which members products flow, and to the
ultimate use of those products.
12
Adjusting decision making to a business where the customers are also the
owners.
In a supply purchasing co-operative, the manager of an investor-owned firm
(IOF) may discover that many of the successful techniques associated with developing a
salable and satisfactory product (for the customer) and achieving maximum return on
capital (for the owner) no longer apply. A co-operative manager has to adjust priorities
and objectives to the realization that whats best for the customer (also the owner) really
is best for the co-operative. This realization may explain why some low- or no-margin
services continue to be provided and why certain unrelated and perhaps high-margin
activities are not considered in a co-operative.
13
provide a needed marketing, purchasing or service. Hence, every time they use the cooperative they evaluate the service performed by its employees. Often, members may
wish to express their views directly to the manager or to get management advice about
supplies to use or when to market their products.
Therefore, a co-operative manager may feel that he/she is operating in an
enclosed environment, compared with the manager of an IOF whose only interface with
most stockholders occurs at annual meetings when they want an accounting of why there
were changes in the market value of their stock or in the dividends declared on it.
Even in the day-to-day routine of a large co-operative, the new co-operative
manager may encounter a different working environment. an executive or professional
joining a co-operative must adapt himself to the publicity surrounding his work.
14
iv)
Co-operatives
have
unique
management
implications
of
business
People
The most important resource in a co-operative is people. The success of all phases
of the business depends on competent personnel working together smoothly and
efficiently. Personnel management thus is a critical phase of business management. It
begins with the selection of personnel, followed by training and evaluation. Much
depends on personnel supervisors who must plan the work, delegate responsibilities and
authority, analyze jobs, and set performance standards, as well as train workers, review
performance, set up grievance procedures, and provide leadership.
Proper compensation, including fringe benefits and incentives, is important in
personnel management. Management should also motivate and reward employees. This
coaching function involves seeking suggestions from staff, creating an environment
15
where employees can be innovative, establishing goals, inspiring and recognizing good
performance, and developing teamwork and an esprit de corps among employees.
In a co-operative, management also must strongly emphasize member relations
because ownership, control, and patronage all are member functions. This involves
adequate two-way communication and information from management to members and
from members to management. Continuous efforts are also needed to obtain new
members to maintain the organization and an adequate volume of products or services.
Maintaining or improving good member-patron relations involves providing
good, honest service and helpful information about the co-operative and the products it
handles. It means keeping members informed about policies, operating practices, and
financial requirements; and pointing out their responsibilities for making the co-operative
successful.
Management of a co-operative, as in other businesses, also must be concerned with
public relations. If there is to be public understanding and acceptance of the co-operative,
the public must have information on its objectives, accomplishments and benefits, and
limitations.
ii)
Capital
16
iii)
Facilities
17
both individuals and the entire organization accomplish their goals. A manager spends up
to 95 percent of the time communicating. Good communication is essential to
coordinating the organizations human and physical elements into an efficient and
effective working unit.
In controlling, management monitors the progress of planned activities. If
progress is lagging, necessary adjustments are made. Controlling is the checkup part of a
managers job.
Accounting System
A complete and accurate accounting system is vital for effective management. It must
produce several financial statements needed in planning and controlling, such as:
a) Monthly and annual balance sheets and operating statements
b) Functional or enterprise accounts pertaining to departments or specific
lines of business;
c) Special accounts such as patronage records, accounts receivable aging,
member equity, and patron financing
An independent auditor periodically verifies the accuracy of the co-operatives
business records. This is especially useful to directors in performing their controlling and
planning functions. It helps the board determine the extent to which the manager has
followed financial policies, and evaluate how the co-operative is accomplishing its basic
objectives. The external audit is primarily a board tool.
Larger co-operatives also use internal audit reports. The internal auditors primary
duty is to monitor the co-operatives accounting policy. The auditor checks the cost of
prescribed procedures, including their effect on patrons and personnel, and suggests ways
to prevent errors. Usually, the auditor reports to the chief accounting officer, but
sometimes to the general manager or even to the board of directors. Internal audits are
primarily manager tools.
18
ii)
Control Reports
Credit and inventory analysis include a monthly aging of accounts and notes
receivable; selected financial and operating ratios; and a monthly accounting of selected
inventories, including shrinkage reports.
iii)
Incentive Programs
19
vi)
Communications
Budgets
Budgets are valuable tools in planning and controlling the co-operative. Hired
management usually prepares three types of budgets- operating, cash, and capital.
Operating budgets are completed each year. The first step is to project revenue sources,
an estimate of the sales or income volume in physical units and their values. Next,
prepare estimates of variable and fixed costs based on the income projections. Last,
calculate net earnings. To obtain maximum benefit of the budget, operating management
should compare the actual income and expense against the monthly projections. Where
actual results are worse than the projections, corrective actions should be taken.
Cash budgets estimate the flow of funds for a fiscal year. If completed on a monthly
basis, they help plan borrowing or investing of operating capital, the ability to take
advantage of discounts, and serve as a financial control. Cash budgets are important for
seasonal businesses.
Capital budgets have a longer planning span, usually 5 years. These budgets might
include the co-operatives needs for more land, buildings, equipment, services and
operating capital. An integral part of this budget is feasibility studies on projected asset
purchases and to consider alternative investments that could produce greater returns and
still satisfy the mission of the association. Finally, identify the source of funds for capital
projects. Sources to consider could be equity capital, borrowed funds, or retained net
earnings.
These three types of budgets quantify the financial resources needed to satisfy the
capital requirement of the overall strategic business plan.
viii)
Strategic Planning
20
21
22
ii)
Set goals and develop short-term strategic plans including budgets and cash
flow statement as requested by the board;
iii)
iv)
23
v)
vi)
vii)
viii)
Often, questions arise about the division of responsibilities between the board of
directors and hired management. Sometimes they overlap and an exact division cannot be
made.
Consider these factors:
i)
ii)
Idea decisions are usually handled by the board and action decisions by
management;
iii)
Trustee decisions involving policy are the responsibility of the board while
trustee actions are handled by management;
iv)
Broad primary control activities fall to the board while secondary controls
pertaining to short-run operations are the responsibility of management;
v)
vi)
vii)
The use of policy and procedure manuals and job descriptions along with frank
discussion of problems when they arise help maintain an understanding of the division of
responsibility.
24
a) Marketing
Marketing products involves local assembling, packing, semi-processing,
processing, storing, selling, merchandising, and transporting the commodity. Many farm
products are perishable. Co-operatives sell them either in an unprocessed (fresh or whole)
or processed form. Co-operatives also market them in two basic ways- buy-and-sell or
pooling. These are some typical basic business decisions that characterize the daily
operations of a marketing co-operative. Where large businesses, including co-operatives,
may have economic and business analysts to assist the manager, the smaller local
associations must rely largely on the knowledge, experience, and judgment of the
individual manager.
Among decisions the manager faces are:
i)
Decisions must be made regarding the level of service from farm to market and
rates to be charged. Should the co-operative own or lease trucks or contract for hauling?
ii)
In buy and sell operations, co-operatives determine how daily paying prices will
be set and what the gross margin per unit of product should be. Also, discounts and
premiums for quality considerations are part of the activity.
In pooling operations, policies regarding cash advances to growers at time of
delivery are important. There may be no advance, an initial small advance with
succeeding advances or progress payments, an advance based on a fixed percent of the
market price, or the advance may reflect the current market price. Also important is the
length of the pool-daily, weekly, or seasonal. Will a pool be established for each product
or a group of similar products, and for each grade or quality of the product?
iii)
25
iv)
Managing inventories.
Firm credit terms or escrow policies in dealing with them are needed.
viii)
26
The local managers job may be easier if the co-operative is affiliated with
regional co-operative suppliers who offer a wide range of products. This means the local
manager deals with fewer people for more supplies. Regional co-operatives are oriented
to the needs of the locals and lift some of the burden from the local manager for
comparing supplies for quality, price, uniformity, and performance and serves as an
assured source of supply.
A local manager has to substitute expertise and experience for the larger organizations
team of specialists in making decisions connected with daily operations.
Typical areas requiring decisions are:
i)
The manager with board approval determines the types and qualities of supplies and
equipment to handle. Managers determine the quantity, when to buy, and factors like
warehouse space, volume discounts, seasonal needs, and the price trends. Ingredients
purchases include those for feed milling or soil amendments.
The wholesale sources of supply involve decisions by the manager. Many local cooperatives are members of regional wholesaling-manufacturing co-operatives and buy
their needs through them if their pricing structure is competitive. Some belong to several
regional supply co-operatives. Most co-operatives buy, warehouse, and resell supplies,
while others own franchises or dealerships.
ii)
27
iii)
Pricing supplies
Co-operatives usually price their supplies at the market for items of comparable
quality. But sometimes other pricing practices are necessary when price wars occur, or
other firms have lower prices and fewer services.
Decisions must also be made about using quantity or volume discounts, cash
discounts or credit carrying charges, and discounts for early booking or delivery of
supplies and the rates to offer on each. Discounts, services and delivery charges, and
booking programs must be communicated to all patrons and applied fairly.
iv)
This area involves the selling, merchandising, and delivering of supplies. Bulk
feed and petroleum products are generally delivered by the co-operative with the product
and delivery costs figured into price. Some provide allowances for patrons who want to
do the hauling. Wholesale firms may set separate prices for products purchased at their
plant or warehouse and another if delivered. The local co-operative may haul its supplies
or contract for transportation service.
Co-operatives generally use common merchandising methods such as displays,
newspaper, television, or radio advertising, newsletters, flyers, or sales campaigns and
contests. Providing technical services and field support augments the sales effort.
v)
Controlling credit.
Demand for custom and technical services increase as farm labor become costlier
and production technology becomes more advanced. Conservation and environmental
issues demand increased technological advice.
Management with board approval must decide what services to offer and whether they
should become self-supporting or be subsidized by product margins.
28
vii)
Co-operatives can be of real service by providing facts to farmers on the right kind
and amount of supplies to use that will give them greatest yields, gains, or satisfaction.
Some co-operatives offer recordkeeping, accounting, and hedging or optional markets to
their patrons.
viii)
Management needs annual estimates on potential volumes for various supplies, and
trends in agriculture and business may affect this potential in the trade area.
Delegation of
responsibility and authority is required to attain specialization and control of services and
efficient performance. Staff assistance often available includes personnel, legal, longterm strategic planning, engineering, and economic research. Several associations have
formed wholly or majority-owned subsidiaries, and joint ventures with others to perform
certain types of commodity or service-related operations.
ii)
the overall management process. They may serve in the management council of the chief
29
executive officer who receives their counsel in making final decisions. This system
replaces the more autocratic management in small co-operatives.
iii)
Member relations become more difficult as co-operatives become larger. Userowners cannot talk directly with the general manager or department heads. Many may not
live near the director serving their district. Farmers must rely mainly on a local
supervisor, field representative, and employees who deliver supplies or pickup products.
Newsletters, magazines, and area meetings are used to complement communications with
members. Local co-operatives affiliated with regionals that serve several States have less
frequent contact with regional top management and must rely more on field
representatives and telephone contact.
vi)
30
possible subsidization of location losses. Some of these problems involve both operating
management and boards of directors.
vii)
products or backward in purchasing supplies, they should decide whether to do this alone
or in cooperation with others. Often, lack of funds or in-compatibility of management
personnel and operating policies may delay these moves.
x)
As multilateral trade agreements such as the COMESA and PTA ease national
border restrictions to create both larger markets but greater competition, co-operatives
like other types of firms must plan strategically either to take advantage of new marketing
opportunities or to protect once-stable domestic or foreign markets.
Co-operatives can use a wide array of creative mechanisms and structures which
complement core business and can put them on a more competitive footing without
necessarily sacrificing their unique mission and structures. Subsidiaries, co-ventures, or
31
other joint agreements -with other co-operatives or non-co-operative firms can be used
successfully to gain access to additional resources and markets.
Marketing co-operatives may grow horizontally-to supplement their corecommodity base, broaden product lines, lengthen marketing seasons, tap new markets
through the addition of foreign growers as members or through procurement of limited
volumes of nonmember products.
Both marketing and supply co-operatives can craft non-price strategies involving
market segmentation, niche marketing, and product differentiation to remain competitive.
Supply co-operatives may find foreign producers a ready outlet for farm inputs, and
liberalized trading and investment climates could facilitate development of new supply or
raw material sources.
xi)
The general public gets a favorable image of co-operatives if, through its efforts,
the marketing system becomes more efficient with the resulting economic benefits shared
by consumers as well as with farmers. In addition, democratic control of co-operatives
also conveys a favorable image to the general public. Regional co-operatives, by their
performance and leadership, are expected to serve agriculture and consumers in a manner
that will warrant a considerable degree of public approval.
32
How can I improve the quality and reduce the cost of supplies I manage in my
farm operation?
ii)
How can I increase the returns from the products entering the marketing
stream from my farm?
33
Thus, leadership should pursue avenues of commerce that can most effectively take
advantage of volume, grade, size, uniformity, and quality factors that co-operatives bring
to the marketplace.
Co-operative leadership will only succeed through intelligent use of the tools of
economic planning. The leader must become prepared for such a role by accumulating
skill in managing assets, corporate growth, research, executive development, outside
industry relationships, and, most critically, people. The future belongs to those cooperative managers who translate knowledge, experience, and understanding into action.
It belongs to those who evolve from skilled managers into astute leaders.
Review Questions
i)
ii)
Identify the resources managed in a co-operative. Are they different from the
resources managed in a typical corporation?
iii)
iv)
Identify and explain the various tools used in the management of co-operatives
v)
vi)
vii)
viii)
ix)
34
CHAPTER THREE
CO-OPERATIVE FINANCING INSTITUTIONS- CREDIT UNIONS
ii)
iii)
iv)
v)
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 institutionscredit 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.
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
35
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
36
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
37
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 members 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
38
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 institutions 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.
Review Questions
i)
ii)
iii)
iv)
v)
39
CHAPTER FOUR
THE LEGAL FRAMEWORK OF THE CO-OPERATIVE MOVEMENT IN
KENYA
Learning Objectives
By the end of this chapter the learner should be able to:
i)
Trace the development of the cooperative societies legal framework since 1966
ii)
iii)
iv)
4.0 Introduction
The legal framework of the co-operative movement in Kenya can be trace from
Cap. 490 of the Laws of Kenya, of 1966, Co-operative Societies Act, No. 12 of 1997and
Co-operative Societies Act, No. 12 of 1997 as amended in 2004 which is the current law
under which cooperatives operate in Kenya.
40
join a co-operative union. And such an action is founded on what the commissioner
considers desirable for the efficient functioning of the co-operative movement. Such
powers deprived the societies and their members of their freedom to co-operate with
others of their own choice, which was inconsistent with the co-operative principle of cooperation among cooperatives.
Some of the highlights of Cap.490, 1966 include:
i)
Society may enter into contracts with their members to dispose of all or part
of their agricultural produce section 30(1).
ii)
iii)
iv)
v)
The charge over the assets for the members lasted for one year
vi)
If the societies were to charge their property, they had to seek the approval
of the Commissioner
vii)
viii)
ix)
x)
xi)
xii)
41
xiii)
xiv)
Societies can only employ graded staff with the Commissioners consent.
xv)
Under the Act and Rules, the Commissioner had absolute powers in the day
to day running of the affairs of the registered co-operative societies.
xvi)
Society may enter into contracts with their members to dispose of all or part of
their agricultural produce section 30(1).
ii)
The penalty for violation of the societies by laws was Ksh. 5000.00.
iii)
iv)
42
v)
The first charge over the assets for the members to last or subsist for such period
as the loan remains unpaid.
vi)
Societies free to charge the whole or part of their properties if their by-laws allow
them to do so, provided the annual general meeting allows.
vii)
Societies free to get their own auditors provided that such auditors are
professionally qualified. The audit under Section 25(1) must be prepared in
accordance with generally accepted accounting standards.
viii)
ix)
x)
Societies may charge the whole or part of their property if their bylaws approve
and subject to a resolution of the general meeting.
xi)
The Registrar may now only inquire into the conduct of a person who has
committed a surchargeable act and report his findings and recommendations to
the annual general meeting who will take action accordingly.
xii)
Registrar may carry out an inquiry and then table his findings and
recommendations to the annual general meeting who will take any action they
deem appropriate.
xiii)
Under section 89, the society may pay its officers or members such honorarium,
salary, commissions or other payment, as the society may resolve at a general
meeting.
xiv)
Like other business entities, societies have the power to hire and fire according to
their by-laws.
xv)
The penalty for violation of the provisions of the Act was Ksh. 10,000.00
43
xvi)
The Act empowers the members to be responsible for their own registered cooperative societies. They should, through their elected committees run their
societies in accordance the internationally accepted co-operative principles i.e.
open and voluntary membership, democratic member control, economic member
participation, autonomy and independence, education, training and information,
co-operation among co-operatives and concern for the community in general.
(Section 4).
xvii)
The Act gave a new relationship between societies and the government. The
Commissioner under Section (3) is only responsible for cooperative development
and growth.
ii)
iii)
iv)
v)
vi)
44
vii)
Helping to raise the level of general and technical knowledge of their members
ii)
iii)
Ensure that the policy was integrated in development plans in so far as this is
consistent with the essential features of co-operatives
iv)
Keep the policy under review and adopted to change in social and economic
needs and to technological progress
v)
Ensure that the existing co-operatives should be associated with the formulation,
and where possible, application of the policy
vi)
vii)
viii)
ix)
x)
xi)
45
xii)
xiii)
xiv)
xv)
xvi)
xvii)
xviii)
xix)
xx)
46
ii)
iii)
iv)
v)
vi)
vii)
Review Questions
i)
Read the Co-operative Societies Act, No. 12 of 1997 as amended in 2004 (the
Act is given may be downloaded from the internet) and answer the following
questions.
a) According to the Act, who is charged with the responsibility of registering
cooperative societies? Who was responsible in the past?
47
m) What is the penalty for violation of the Act? How has it changed over
time?
ii)
48
iii)
iv)
49
CHAPTER FIVE
MICROFINANCE PRINCIPLES AND PRACTICE
i)
ii)
iii)
iv)
v)
5.0 Introduction
The term microfinance refers to the provision of financial services such as small
collateral free loans, deposits, pension and retirement, and insurance to low-income
groups and their micro enterprises. Microfinance institutions also frequently add to their
portfolio of financial services the provision of social services such as healthcare, literacy
training or business development consulting services. Microfinance institutions lend
money to small scale business persons/firms. Examples includes; K-Rep Bank, Faulu
Kenya, Jami Bora, Pride Africa etc.
Origins of Small Lending
Micro lending often starts in small villages, where family members and friends
get together in money-sharing groups. These savings clubs can be traced to all parts of
the world and have operated for centuries probably since the introduction of currency.
From region to region, these clubs developed their own names. In West Africa, they were
known as "tontines;" in Bolivia, "pasanaku;" and across Mexico and Central America,
"tandas." Tanda means "shift" in Spanish and works on the premise that members of the
group contribute to a pool of money, which shifts to a single member that has the most
need. The tontines of West Africa can be traced back to 17th-century and are named for
the Italian banker Lorenzo de Tonti.
50
An early version of micro lending was the Irish Loan Fund system, introduced in
the early 1700s, by writer and nationalist Jonathan Swift. Swift's early success helped the
Irish when many were living in impoverished conditions. Swift's original system was
standardized in 1837, when hundreds of independent loan funds were brought under the
control of the Loan Fund Board. By law, no loan could be more than 10 or run for
longer than a 20-week term, with weekly repayments. As with many contemporary micro
credit institutions, interest rates were low in this case around 8 percent per year much
lower than those charged by local profiteers.
The Pioneers of Modern-Day Microfinance
The concept of micro loans took a big leap in the 1960s and 1970s, when groups
such as ACCION International, in Venezuela, and Yunus's Grameen Bank, in
Bangladesh, began to institutionalize the process. By formalizing and expanding the basic
concept of sharing programs, these microfinance institutions helped to build capital for
small businesses rather than just loaning for basic necessities such as food, water and
clothing.
Yunus first came across the idea of micro credit while studying the lives of poor
entrepreneurs in his native Bangladesh during the famine of 1974. He began by loaning
to groups of women, and his program soon proved that small loans could not only quickly
improve lives but were paid back with interest and on time.
The next step was setting up a consistent on-the-ground program. In the case of the
successful institutions, this meant sending a representative, or "field manager," to the
prospective region to educate and advise and to oversee the loans locally.
After a few members of the group were accepted for a loan, the rest had to wait for that
initial loan to be repaid before they could obtain their own loans. "Peer pressure" from
other members of the group to repay the initial loan helped to set the bar high.
In 1961, another early pioneer, ACCION, opened its doors in Caracas, Venezuela,
when law student Joseph Blatchford raised $90,000 to start a community development
program to help the poor jump-start their own businesses.
Over the next two decades, ACCION set up scores of independent microfinance
institutions and expanded across Latin America. It, too, offered people a choice besides
51
the local loan shark, who would charge rates as high as 500 percent a year and often
pushed people into permanent debt.
Like the founders of ACCION, Yunus realized that if individuals who wanted to
start their own businesses could not free themselves from start-up debt, they would never
be able to grow. Since the Grameen Bank was founded, it has paid out more than $5.7
billion in loans, and more than $5.1 billion of that has been repaid -- a recovery rate of
approximately 98.9 percent. It has made more than 950,000 loans and has 6.7 million
members, around 96 percent of whom are women.
The Norwegian Nobel Committee has recognized Yunus's long-term vision of
eliminating poverty in the world. That vision cannot be realized by means of micro credit
alone. But Muhammad Yunus and Grameen Bank have shown that in the continuing
efforts to achieve it, micro credit must play a major part.
Following the success of these early institutions, other microfinance organizations
began to launch throughout the developing world. Among the largest is FINCA
International, established by economist and Fulbright scholar John Hatch. Hatch believed
that using locals' knowledge rather than bringing in outsiders was key to building
successful local economies. Using an approach he has always stood by, Hatch said, "Give
poor communities the opportunity, and then get out of the way!" By 2005, FINCA had
400,000 clients in 21 countries across Latin America, Africa, Central Asia and Eastern
Europe.
One year after the United Nations called 2005 the International Year of Micro
credit, the World Bank estimates that there are more than 7,000 microfinance institutions
now operating around the world.
52
conscious adaptation, those that have developed in the informal financial sector over
many years. The following three principles represent the core of the new techniques:
Know the market- the poor are willing to pay for access and convenience. The
major service need among the poor is credit for liquidity and working capital, with loan
terms of one year or less and with little attempt to direct credit to specific uses.
Transaction costs for borrowers are lowered by locating lending outlets near the client,
providing simple application processes, and disbursing quickly. Interest rates are high
relative to prevailing rates in the formal financial system, but they are low compared with
typical informal-system rates.
Special techniques slash administrative costs. The simplest procedures are used
for the smallest loans. Loan applications are often no more than one page. Approvals are
decentralized and are based on readily verifiable eligibility criteria rather than business
appraisal. Borrower groups often handle much of the loan-processing burden.
Special techniques motivate repayments. Lenders substitute other techniques for
security and loan appraisals, such as group guarantees or pressure from social networks,
the promise of repeat loans in increasing amounts, and savings requirements. Although
programs dealing with larger microenterprises may require tangible collateral, most do
not.
Application of these principles is the foundation for financial viability of a
lending operation that serves poor microenterprises. The essence of the difference
between these techniques and commercial banking practices is the use of a repayment
incentive structure instead of costly information gathering. This substitution enables
lenders to serve micro enterprise at a reasonable cost.
Group formation is often employed by microenterprise programs, particularly for
the poorest clientele. The group plays a role in reducing the cost of gathering information
about the borrower, but its more important role in motivating repayments through shared
liability for default. Lenders can shift some of the loan-processing and loan-approval
tasks onto groups because the groups have better access to information on the character
and creditworthiness of potential borrowers. When very poor clients care more about
access to credit than the terms on which it is offered groups can be used without
significantly imp airing demand.
53
are
approached
using
the
following
principles,
customers
respond
enthusiastically.
First, the most widely desired savings instruments offer safety, convenience,
ready access to money, and a positive real return.
Second, more people want a good place to save than want loans. Thus, savings
services can reach deeper into the community. The opportunity to save should not be
limited to those who borrow.
Last, lending to microenterprises can be financed to a significant extent by
savings from the same communities provided savings services are designed with
customer needs in mind.
Traditionally, most microenterprise programs with savings elements used some
form of compulsory savings, whereby borrowers were required to save a portion of the
amount they borrowed. Typically, under such programs, borrowers did not have access to
their savings until their loan was repaid. The savings mechanism thus functioned as asset
storage in a very illiquid form.
A voluntary savings instrument, such as passbook savings with free access to
deposits, better meets savers requirements and has the potential to raise much larger
amounts of funds. The BRI Unit Banking system in Indonesia, is now fully savings
financed, demonstrating this potential.
Nevertheless, the programs employing these principles should still be regarded as
incomplete. Their full potential to grow, spread, and achieve greater financial selfsufficiency has not yet been reached. Below are the institutional requirements for
expanding the use of these techniques, beginning with questions of internal financial selfsufficiency and then moving to the external institutional and policy settings.
54
following through fees and interest charges: operating costs, including loan loss reserves;
the cost of funds; and inflation. To achieve genuine commercial viability, it must also
yield a profit to owners. Institutional performance can be analyzed in terms of four
distinct levels of self-sufficiency.
Level One
The lowest level, level one, is associated with traditional, highly subsidized
programs. At this level, grants or soft loan cover operating expenses and establish a
revolving loan fund. When programs are heavily subsidized and performing poorly,
however, the value of the loan fund erodes quickly through delinquency and inflation.
Revenues fall short of operating expenses, resulting in a continuing need for grants.
Many microenterprise credit programs operate at this level.
Level Two
Most programs that use the proven principles described here can attain the second
level of self-sufficiency. At level two, programs raise funds by borrowing on terms near,
but still below, market rates, Interest income covers the cost of funds and a portion of
operating expenses, but grants are still required to finance some aspects of operations.
Most programs at this level are quite proud of their breakthrough, as they should be,
because the subsidy required is significantly smaller than the one required at level one.
Level Three
At level three, most subsidies are eliminated, but programs find it difficult to
eradicate a persistent dependence on some element of subsidy. This is the level associated
with most of the well-known credit programs, and it is probably necessary to reach at
least this point in order to achieve large-scale operations. Programs at this level are rarely
required to take the next step, because both they and their sources of support are pleased
with performance at this level.
Level Four
The final level of self-sufficiency, level four, is reached when the program is fully
financed from the savings of its clients and funds raised at commercial rates from formal
financial institutions. Fees and interest income cover the real cost of funds, loan loss
reserves, operations, and inflation. The only major microenterprise programs to have
55
reached this level are those of the credit union movement in certain countries and the BRI
Unit Desa system in Indonesia.
Programs should be judged less by their current level of achievement than by their
progress toward higher levels. By analyzing each type of cost as well as fee and interest
income, we can determine how credit programs move from one level to the next.
Operating Costs- Traditional credit programs at level one typically have very
high operating costs; it is not uncommon for programs to spend a dollar to lend a dollar,
particularly among smaller programs. Programs at higher levels of self-sufficiency
achieve most of their movement toward viability by using methods that cost far less, that
is, by adopting the principles outlined above, which brings them to level two.
Once these methods are adopted, however, changes come incrementally from
increasing efficiency and scale economies in operations. Efficiencies may come from
marginal improvements in processes, computerization of management information,
improved financial management, and the like. Staffing and physical plant are major costs
that must be addressed on a case-by- case basis. Therefore, continued streamlining is not
the primary strategy for moving to higher levels of self sufficiency.
Loan Losses- Programs that have adopted the principles outlined here have
achieved substantially better repayment rates than traditional programs, often reaching
levels that compare favorably with commercial bank operations. One can observe many
programs, particularly at levels two and three, that claim losses at or below 3 percent of
principal. Delinquency and default cannot be eliminated, but they can be maintained at a
level that does not threaten the financial integrity of the institution.
Cost of Funds- Lending operations must pay to raise funds, either by borrowing
or by generating savings. Programs operating on grants and very soft loans are spared this
cost: Donors bear it. Dependence on soft sources of funds is a limiting factor, as soft
sources are in short supply. Institutions at level two may still use them, but by level three
the transition to commercial or nearly commercial sources should have been made. This
is, in fact, one of the key distinctions between the two levels.
Inflation- All programs bear the costs of inflation, whether they recognize them
or not. In a well-functioning financial system, the inflation factor is built into the interest
rate paid on funds raised or offered to depositors. This practice returns the real value of
56
the funds to the suppliers and therefore maintains that value in the financial system.
However, when programs use concessional funds, they are not charted this inflation
factor. Despite an appearance of self-sufficiency, the real value of the loan fund dwindles,
and the programs are able to serve fewer clients. If hyperinflation sets in, virtually all
progress toward self-sufficiency is destroyed. Microenterprise programs have a good
chance of reaching levels three and four only if they operate in countries where inflation
is kept to moderate levels.
Fee and Interest Income- Traditional loan programs have been reluctant to
charge full-cost interest rates to microenterprises. in many level-one programs, the rate
charged is negative in real terms.
Many of the microenterprise credit programs run by NGOs are not in a position to
become true financial institutions that finance their lending largely from deposits. They
may face legal restrictions on deposit taking, or they may decide not to take on the added
responsibilities that come with handling individual deposits. The future of such programs
depends on their ability to forge funding relationships with formal financial institutions.
The simplest arrangement is for microenterprise programs to finance their lending
by borrowing from commercial banks. In order to be able to borrow in this way,
microenterprise programs must meet two stringent criteria: First, they must be able to
repay borrowed funds at a rate acceptable to the bank.
Second, programs must be able to assure banks that they are creditworthy. Very few
microenterprise programs have as yet been able to meet these tests on their own.
ii)
Microenterprise programs are carried out by a variety of institutions, from grantoriented NGOs to those striving for self-sufficiency. These institutions must undergo
several changes to become financial institutions that engage in lending and capturing
deposits.
57
At the structural level, these institutions must reorganize to provide both savings
and credit in a manner that will allow for expansion. At the first opportunity, the
organizational structure must be modified to support the capturing of deposits and the
provision of credit. The functions and the makeup of each department, as well as the
relationship among departments, must also be reorganized.
A second structural change required is for the organization to use some form of
franchise or branch office system to continue expanding its operations. Therefore, the
organizational structure would require information systems adequate for a decentralized
operation.
Legal considerations are a key factor in defining how these institutions will change
internally. The legal framework in a country determines whether an institution can take
deposits. In some countries, the law permits organizations outside the banking system to
capture savings directly. In most countries, however, this is not the case. Institutions may
modify themselves in order to fit within the existing law, for example, by creating a
cooperative or a credit union arm,
iii)
58
ii)
iii)
iv)
In addressing each of these tasks, the first priority should be interest rate
deregulation. The ability to charge full-cost interest rates is the best strategy
microenterprise lending programs have for becoming financially self-sufficient, after they
have adopted the lending techniques advocated here.
v)
Governments, lenders, and donors can lead the way in changing attitudes
by making and following firm policy determinations to require full-cost
pricing policies from any organization that requests financing or special
assistance from them.
vi)
vii)
viii)
59
x)
xi)
60
xiii)
xiv)
xv)
61
Emergencies
ii)
Investment
iii)
Consumption
iv)
social obligations
v)
education of children
vi)
pilgrimages
vii)
sickness
viii)
disability
ix)
retirement
ii)
The second is the assumptions that demand for financial savings instruments
is low in most rural areas of developing countries.
62
Grain
ii)
Animals
iii)
iv)
Land etc
63
financial channels and market shares of lenders are inextricably related to the local
distribution of wealth and power, market inter linkages, political alliances, information
flows, and so forth.
The extent and character of the interactions among formal, quasi-formal and
informal financial markets in rural areas can vary considerably, depending on the degree
of regulation in the formal sector; the extent of monetization in the rural areas; the
publics confidence in the government in general and in the available financial
institutions in particular; the ease of customer access to formal financial services; the
activities of parallel and black markets; and a variety of geographic, economic, cultural,
and other factors .
Benefits of Institutional Savings
Well-designed and well-delivered deposit services can simultaneously benefit
households, enterprises, groups, the participating financial institutions, and the
government. Good savings programs can contribute to local, regional, and national
economic development and can help improve equity. The benefits from institutional
savings at local levels may include the following:
Benefits to Households: Institutional savings provide numerous benefits to
households, including the following:
Liquidity- Rapid access to at least some financial savings is considered essential
by many households in monetized or partially monetized economies. Liquidity is crucial
for mobilizing household savings. The demand for deposit instruments permitting an
unlimited number of withdrawals is high because people save for emergencies and for
investment opportunities, which may arise at any time. Thus, in areas characterized by
economic growth and development and by a reasonable level of political stability,
potential household demand for liquid deposit instruments in financial institutions may he
unexpectedly high.
Returns on deposits- Positive real returns on deposits are typically not available at
low-risk outside financial institutions. When such institutions offer appropriate deposit
instruments, the interest can be used by the household as an income flow or as savings.
Fixed-deposit accounts featuring lower liquidity and higher returns, especially when held
64
in conjunction with liquid accounts, are suitable in various ways for the types of savings
mentioned below,
Savings for consumption- Households with uneven income streams (from
agriculture, fishing, and enterprises with seasonal variations) can save for consumption
during
low-income periods.
Savings for investment- Saving for development of household enterprises is
discussed below. Households also tend to save for other kinds of investment, such as
childrens education, house construction, and electrification.
Savings for social and religious purposes and for consumer durables-Social
ceremonies birth, puberty rites, weddings, and funerals) and religious donations or
pilgrimages are some of the long-term goals for which people frequently save. Others are
consumer durables; depending on household income level, these vary from cooking pots
to automobiles.
Savings for retirement, ill health, or disability- Saving for old age or disability
may take the form of building retirement savings or helping to establish junior members
of the household, who will then have the responsibility of caring for their elders.
Savings instead of or in addition to credit- Households save in order to selffinance investments and to avoid paying what are often very high interest rates in the
informal commercial credit market, Self-financed investments are particularly important
for middle- and lower-income households, which often do not have access to institutional
credit.
Savings to build credit ratings and as collateral- Institutional savers may also use
their deposits to build credit ratings and as collateral for loans. These features are
especially important for those who do not own land.
Benefits to Enterprises: Many of the benefits gained from institutional savings by
households are also applicable to enterprises (security, returns, self-finance of
investment, and so on). Enterprises at all scales tend to have high demand for liquidity
many also have high demand for transfer facilities.
Household savings are typically the main source of small and microenterprise finance,
but in many cases small entrepreneurs must also borrow on the informal credit market.
65
ii)
iii)
Describe the myths surrounding savings among the poor and hoe the debunking
of these myths has helped in the development of microfinance
iv)
financial self-
sufficiency
v)
66
adopt
vi)
vii)
67
CHAPTER SIX
THE PROCESS OF INSTITUTIONAL DEVELOPMENT
ii)
iii)
iv)
Explain the relationships between the components and the stages of the
framework for institutional development
6.0 Introduction
Institutional development is a complex process touching on values, mission,
program, and intended goals. Contained in its definition are four important concepts:
Process- Institutional development is not static, it is organic and evolving. It
affects all facets of an organization and it implies learning, adaptation, and change.
Capacity- Institutional development involves human resources as well as
organizational structure and systems. Both need to be strengthened in concert.
Sustainability- The aim of institutional development is an organization that can
sustain the flow of valued benefits and services to its members or clients over time.
Impact- Institutional development is not a goal. It is a means to solve problems,
create a more favorable economic or policy environment, and improve the quality of
peoples lives.
68
DEVELOPMENT
STAGE
SUSTAINABLITY
EXPANSION
VISION
CAPACITY
RESOURCE
CAPABILITY
LINKAGES
6.1.1 Components
Vision-Vision is the ability to think creatively and critically about the
organization. Vision is guided and formed by basic principles and beliefs that define the
mission and purpose of an organization. It articulates a picture of the world that would
result from the successful achievement of an organizations goals It is important that
vision grow out of, and respond to, locally defined needs.
Finally, it should reflect the social and moral principles, and contain principles of
cost-consciousness, sustainability, autofinancing of credit, growth, and expansion.
Capacity- Capacity is the ability to move thinking to action. It is the institutions
ability to organize itself to achieve its mission effectively and efficiently. Capacity
requires a structure through which people can channel their energy and creativity, which
anchors the organization in the mold of the vision, supports the organizations activities, is
responsive to program and client needs, ensures that decisions get made at appropriate
levels, and engenders appropriate forms of participation.
Systems and procedures that ensure that the structure operates smoothly, that
there is a timely flow of accurate information and that staff and clients are treated fairly.
A staff with the skills and motivation to implement the programs and manipulate the
systems to achieve the objectives of the organization, a methodology that is an organized
set of tactical steps that allows the organization to carry out its mission.
Resource capability- Resource capability is the ability to earn or raise sufficient funds
to cover expenses without compromising vision or program design. An organization
operating efficiently has achieved an assured flow of money that matches client demand
and operational need. In addition to acquiring funds, organizations must be able to do
financial planning and management and ensure accountability. Key factors include fund69
raising policies and practices, credit policies budgeting and accounting systems1 financial
projection and cash flow analysis, and portfolio management.
Linkage- Linkage is the ability to develop productive relationships with t wide
variety of organizations. Linkage includes regular communication, interaction, and
exchange of information and resources. To he an effective implementer of its activities,
an organization must be perceived by the community in which it works, and by external
entities, as carrying out activities that meet community needs in socially and culturally
appropriate ways. Additionally, it must be seen as contributing to the overall
improvement of the community. This legitimacy strengthens an organization and further
supports the accomplishment of its mission.
Each component of the framework represents a distinctive organizational ability and
involves an integral set of roles, policies, procedures, and tasks that need to be
accomplished in systematic ways. The nature of the issues faced in each component and
their importance and impact on the organization change over time and thus require
constant attention. Failure to appropriately address any of these issues has the potential to
seriously weaken an organization and reduce its ability to serve its client population.
6.1.2 Stages
The three stages identified in the framework present new challenges to be
mastered.
Development Stage- The development stage begins at the initial point when an
organization decides to undertake a small enterprise activity. During this stage, the
organization makes major strides in crafting its methodology and begins structuring itself
to carry out its mandate. The discussion of this stage is relevant for both new
organizations in the process of establishing themselves and existing organizations. This
stage can he further divided into the preparation phase, during which planning is carried
out and the foundation is laid for an organization and its program methodology; the startup phase, when the program model is tested and modified; and the implementation phase,
which involves the execution of a program ample enough to achieve visible levels of
impact.
70
This framework, like any analytic tool, is an abstraction of reality, reflecting and
highlighting key elements to facilitate understanding. The actual process of institutional
development is much less continuous than the logical progression the framework implies.
Review Questions
i)
ii)
iii)
iv)
Explain the relationships between the components and the stages of the
framework for institutional development
71
CHAPTER SEVEN
THE MERGING ROLE OF NGOs IN FINANCIAL INTERMEDIATION
Identify the reasons why NGOs choose to the path of financial intermediation
ii)
iii)
7.0 Introduction
There are a growing number of examples of microenterprise in development
organizations that have decided to move toward financial intermediation. The decision to
engage in financial intermediation brings with it the need for a fundamental
transformation in the approach to microenterprise development. NGOs that have made
this decision believe that such a transformation is the only way to address the demand for
financial services over the long term and in a viable in manner.
Financial intermediation is the route taken by NGOs that have decided to
specialize in financial services, scale up their microenterprise lending activities, and
reach tens of thousands of borrowers. Expansion of lending activities becomes the vision
that drives these NGOs forward, influences their operations, and ultimately differentiates
their work from that of other NGOs. These organizations become specialized lending
institutions whose primary objectives are to improve the quality and efficiency of their
lending operations and expand them significantly. Once an NGOs decides to follow this
expansion-led app roach, its potential area of coverage becomes the whole country.
The governance function and the composition of boards under the expansion-led
approach are crucial considerations because the board will decide whether the NGOs
should move toward financial intermediation. Key factors are at play in this decision, in
particular the increased level of effort the board members must accept to make it happen
72
and the much higher level of risk that they assume, both for themselves and for the
institution.
Perhaps the first way in which NGOs link into the financial systems in their
countries is by choosing private-sector individuals, business-people and bankers as board
members. Private-sector board members create access to institutions and sources of
finance that are otherwise unreachable. They also outline a vision for the NGO that can
take it toward financial viability and intermediation. They provide the technical financial
expertise necessary to prepare for expansion and institutional transformation. They
become a priceless and essential resource for the expansion process.
ii)
Clients Reached
The scaling up of operations is the characteristic that most clearly differentiates the
NGOs that are moving toward financial intermediation. Scaling up refers to gradual but
consistent expansion of operations to reach thousands of small-scale entrepreneurs.
Scaling up leads programs to develop a market perspective and to focus on financial
services that respond to the preferences of their clients. NGOs must maintain clarity
about their ultimate oh1ective: provision of services to the poor.
Two indicators assist in determining whether they are lending to the smallest and
neediest borrowers. The average size of a loan indicates who is borrowing. Small loans
tend to reach smaller businesses. Gender is a second indicator. Those NGOs reaching a
significant percentage of women are providing services to the poor, since women
predominate at the bottom of the pyramid of microenterprise production.
NGOs coverage must shift from local to regional and eventually, where feasible, to
national Most NGOs open branches or regional offices in different cities, developing
decentralized systems of operation that resemble bank branches.
iii)
Sources of Capital
The shift from being a donor-funded organization to being one that blends grants
and soft loans with funds borrowed from banks constitutes the most dramatic change for
NGOs. The objective of these organizations is to eliminate subsidies gradually for their
lending operations NGOs moving in this direction currently borrow part of their funds
from banks and still rely on grants and soft money. Expansion into new areas, for
example, continues to require subsidized money.
73
Access to borrowed money and the capacity to use it fundamentally change the
relationship between NGOs and donors and between NGOs and financial-sector
institutions in their countries, the challenge for these NGOs is to find effective ways to
link up with commercial at sources of funds and to work with donors and commercial and
institutions to overcome the internal and external barriers that constrain Nods from
gaining access to adequate sources of capital.
iv)
The techniques for providing financial services to the poor pro1iferated in the
1980s, various NGOs demonstrated that one can lower transaction costs and in maintain
high repayment rates while reaching large numbers of people. To move toward financial
intermediation, NGOs must perfect their lending methodology and concentrate only on
financial services. As NGOs move toward financial intermediation, their objective is to
improve efficiency and increase the size of their lending operations rather than
experiment with new methodologies.
v)
NGOs on the expansion-led track are concerned not only with operational selfsufficiency (covering their costs with income earned) but also with taking on the financial
costs of borrowed money The high unit cot of making very small loans is reflected in the
interest rates they charge, which in some successful programs is 10 to 12 percent above
the market rate. The ability to operate at or near level three of self-sufficiency is one of
the most important determining factors an NGOs capacity to borrow from commercial
sources.
vi)
Financial Management
74
to train its staff. Also, the NGO will have to combine staff from social science disciplines
with finance professionals. Training must provide both the technical and the social
framework to work with the poor in financial intermediation.
The most useful approach to staff training integrates training into ongoing
operations to ensure that staff members receive training in a structured and systematic
way. In addition to training staff in topics related to their specific responsibilities, the
NGOs should upgrade financia1 skills for all staff and in prove their financial
management skills. Financial intermediation requires all staff members to move up the
learning curve in these areas. Program expansion brings with it rapid growth in staff size.
Savings Mobilization
75
Institutional Sustainability
The long-term viability of an organization becomes much more difficult when donor
funds are not the source of capital. Although all microenterprises NGOs aspire to
sustainability, this goal is traditionally seen in the context of available donor monies. In
the case of expansion-led organizations, however, sustainability must be discussed in the
context of decreasing grant funding and increasing borrowed monies or deposits. If an
NGOs borrows money to lend, its continued operation will depend on its capacity to pay
back its loans. Very close supervision of lending operations becomes an important
ingredient for institutional sustainability. The role of the board in this supervisory
function is essential.
Review Questions
i)
Identify the reasons why NGOs choose to the path of financial intermediation
ii)
iii)
76
CHAPTER EIGHT
PRINCIPLES OF REGULATION AND PRUDENTIAL SUPERVISION AND
THEIR RELEVANCE FOR MICROFINANCE ORGANIZATIONS
viii)
ix)
financial intermediaries
x)
xi)
xii)
8.0 Introduction
Regulation refers most broadly to a set of enforceable rules that restrict or direct
the actions of market participants and, as a result, alter the outcomes of those actions. In
this sense, regulation may be performed by the market itself, without government
intervention or participation of other external forces. Efficient markets regulate economic
actors by rewarding or penalizing them for their performance. In principle, an efficient
market guarantees that actors who make incorrect choices eventually go bankrupt.
The ability of markets to regulate actions and enforce contracts should he taken
into account in the design of government regulations. The more regulation by
governments imitates regulation by efficient markets, the more effective it will be.
Optimal regulation seeks to replicate the mechanisms of a perfect market.
Enforceable public regulation substitutes the mandates of the government for
market incentives. In this context, financial regulation becomes the coercive imposition
of a set of rules that affect the behavior of agents in financial markets. The replacement
of market incentives with government rules that restrict certain behavior may have either
beneficial or harmful effects on the performance of the economy. Since financial markets
have been among the most regulated economic activities in every country in the world, it
77
is easy to observe examples of both beneficial and harmful regulations on the basis of
their effects on market efficiency.
Prudential financial regulation refers to the set of general principles or legal
rules that aim to contribute to the stable and efficient performance of financial institutions
and markets. These rules represent constraints placed on the actions of financial
intermediaries to ensure the safety and soundness of the system.
This type of government intervention should serve three basic policy goals:
i)
ii)
iii)
78
granted at below- market interest rates; mandatory credit allocations that target loans for
particular sectors; and usury restrictions,
Frequently, some of the most repressive regulations have been adopted with the
best of intentions. In other words, badly conceived prudential regulations may become
repressive. For instance, excessive barriers to entry into the financial industry are
frequently raised with the intent of promoting a safe and resilient system. Such barriers
may shield existing inefficient organizations from competition from new, more efficient
intermediaries. The observed negative consequences of financial market repression
suggest that inappropriate regulation may frequently be more dangerous than no
regulation at all.
Financial intermediary supervision consists of the examination and monitoring
mechanisms through which the authorities verify compliance with and enforce either
financial repression or prudential financial regulation. Supervision includes the specific
procedures adopted in order to determine the risks faced by an intermediary and to review
regulatory compliance. Supervision of compliance with rules that promote stability and
efficiency is both desirable and a key component of financial progress.
Internal control refers to the activities undertaken by the owners of a given
financial institution in order to prevent, detect, and punish fraudulent behavior by the
organizations personnel; to ensure that the financial policies adopted by the owners are
properly imp1emented; and to ensure that the owners equity is protected. Internal control
activities are, in general, in the private interest of the intermediarys owners and normally
should not be an overriding concern for the supervisory authorities.
It is important to maintain the distinction among the concepts of regulation,
supervision, and internal control, since each leads to separate policy issues. Regulation
requires, in most cases, a legal framework. Once the appropriate regulation is in place,
supervision may be more discretionary. Although these activities are complementary
(regulation without supervision would be useless), one should be able to identify the
separate virtues and defects of each set of activities in order to focus any corrective
actions.
Microfinance organizations (MFOs) are organizations that offer credit and
sometimes savings services to microenterprises and others in poor communities. The
79
80
rewards while depositors bear the additional risk. Because deposits carry fixed interest
rates, the owners of the depository institution keep any extraordinary profits if the loans
or investments turn out well, but they can go bankrupt and walk away from losses, This
problem is referred to as Moral hazard, which can be defined as the incentive by
someone (an agent) who holds an asset belonging to another person (the principal) to
endanger the value of that asset because the agent bears less than the full consequence of
any loss.
This problem of moral hazard is also present between a bank and its borrowers.
This is precisely why banks impose requirements on their borrowers-an example of
regulation through the market. These requirements are voluntarily agreed-to loan
covenants designed to ensure-or at least increase the probability-that borrowers will
behave responsibly. All forms of collateral are examples of such loan covenants. For
microenterprises, regulation through the market often takes the form of collateral
substitutes such as group guarantees, the promise of future loans, or the value of the
borrowers reputation. The market failure that results from the asymmetry of information
between banks and depositors and the associated moral hazard on the part of banks is
significant enough to warrant government intervention. The difficult question is how best
to intervene.
A second type of concern that originates from opportunistic or morally hazardous
behavior relates to spillover effects that go beyond the direct (private) costs faced by the
depositors and the owners of a failed depository intermediary to other depositors and
other institutions. There are several ways these spillover effects can take place. For
example, an intermediary that lends to very risky clients would be likely to charge and
receive a high rate of interest on loans. This depository intermediary would, in turn, be
willing to pay higher rates of interest on its deposits. In a competitive market, other
intermediaries would be forced to match the increased deposit rates, covering the increase
by higher interest rates on loans. This price race might escalate the level of risk in the
system as a whole.
Alternatively, the failure of one intermediary may cause a panic or run on the
deposits of other intermediaries that otherwise have healthy financial situations. Runs on
deposits are sudden, massive, and unexpected withdrawals that endanger prudent and
81
imprudent Institutions alike. Even depositors who have informed themselves about the
financial health of their intermediaries may find it rational to suddenly withdraw their
deposits in the expectation that others are doing so or are about to do so.
82
i)
ii)
iii)
iv)
The purpose of regulation should not be to avoid bank failures at all costsSuch a policy objective may not be achievable and to pursue it may induce
severe negative effects. Financial intermediaries that cannot withstand
competition or adapt to changing environments should be allowed to exit
without damaging their depositors interests r the stability of the market the
objective of regulation and supervision should be to avoid unnecessary bank
failures and to minimize the negative effects of failures that must take place.
v)
83
vi)
The regulatory framework should not be static; it must recognize that there
will inevitably be innovations adopted to avoid the original regulationEfforts to alter market solutions through coercive regulation induce
innovations to avoid the initial regulation, such as new products and services
(for example, off-balance sheet liabilities or product substitution. The
efficiency of the process of prudential regulation is reduced as such
innovations spread in the market.
vii)
84
Capital plays two roles. The first one is to absorb losses on the income account. For
moderate losses, capital would allow depositors to redeem their claims at full value.
Nevertheless, due to high levels of debt relative to capital on the liability side of
depository intermediaries) capital does not represent a significant protection. Even losses
that are small as a percentage of assets may wipe capital out.
The second, authentic function of capital in terms of consumer protection is to
perform the role of a deductible, in the sense of an insurance policy. Equity capital is the
amount that would be lost by the owners of the bank in the event of bankruptcy. The
larger the deductible (expected owner losses), the more cautious the behavior of the
intermediary (less risk assumed).
iii)
iv)
85
similar economic risks, such as farmers growing the same crop. In such a
situation, many investments or loans may fail at the same time, causing
sudden deep losses to a system designed to cope with small, regularly
occurring losses. This is a problem for the long-run stability of many
MFOs.
v)
of
supervision
and
risk
assessment
of
financial
b) Protective Regulation
The main purpose of protective interventions is to avoid runs on deposits by
removing the incentive for a depositor to be the first one to withdraw funds from a
troubled intermediary.
i)
86
entire system for macroeconomic reasons. The idea behind the lender-oflast-resort facility is that there may be intermediaries that are temporarily
illiquid but are solvent and fit for long-term survival.
ii)
ii)
87
iii)
iv)
v)
88
site analysis (for example, quality of internal control) and to verify that the data fed to the
off-site surveillance system are correct.
Credit Risk
Whenever a financial intermediary acquires an earning asset, it bears the risk that
the borrower will default, that is, not repay the principal and interest according to the
contract. Credit risk is the potential variation in the intermediarys net income and in the
value of its equity resulting from this lack of or delayed payment. Different types of
assets exhibit different probabilities of default. Typically, loans carry the greatest credit
risk.
ii)
changes in the level of market interest rates. Interest rate risk, together with lack of
appropriate diversification, is the most common source of bank failure in developed
countries. This risk originates from the mismatch of the term to maturity of assets and
liabilities with fixed interest rates (that is, from term transformation). When interest rates
rise, intermediaries must pay more for deposits and short-term liabilities while not
necessarily being able to raise their income on longer-term loans or other long-term
assets.
iii)
Liquidity Risk
Liquidity refers to the owners ability to convert assets into cash with minimal
loss, that is, the ability to sell an asset quickly without incurring significant losses.
Typically, liquidity is needed to meet variation in depositor demand for withdrawals.
iv)
from misappropriation of, theft of, or processing errors against the intermediarys assets
by a customer or employee.
89
v)
90
Thus, as MFOs seek to enhance their savings mobilization efforts, they must
prepare themselves to be regulated and seek dialogue with regulators concerning
appropriate forms of regulation. MFOs have a series of special needs arising first from
the type of financial services they offer, and to whom, and second-from their institutional
structures.
Unique characteristics of MFOs that require specialized regulation:
i)
character-based loans, group loans and the promise of subsequent larger loans are the
main motivators for repayment. Instead of collateral, the best indicators of portfolio value
would be past performance of the portfolio and current status of arrears. Recent
experience has shown that sound microenterprise loan operations need not generate high
delinquency or default rates, but allowable levels of delinquency and default may need to
vary from those sought in more standard commercial lending.
ii)
Insufficient Diversification
Most MFOs have found it necessary to specialize in providing one loan product to
a limited client group. Specialization has helped MFOs hone their programs to reach
greater operational efficiency, but specialization may also increase risk, particularly in
areas where geographic coverage is limited and risks are highly synchronized. Village
banking programs are highly exposed to this type of risk, followed closely by credit
unions (which are not quite as limited in terms of number of members and which offer
loans for a wide variety of purposes). The benefits of such diversification must be
balanced against the increased difficulty of managing a wider array of activities. In
general, the best way for regulators to deal with the difficulty of diversifying in most
microenterprise programs is to require higher emergency reserves than would be required
for standard bank lending.
iii)
have a stake in the solvency of the financial institution, and hence in the safety of
deposits. In most countries, lack of investor capital prevents NGOs from taking savings
(other than limited forced savings from borrowers). This restriction should probably not
91
be relaxed unless NGOs are required to maintain extraordinarily high capital reserve-toasset ratios that can protect against large losses and are subject to stringent monitoring of
their internal controls.
For credit unions and village banks the ownership issue is different. In these
organizations, capital is jointly owned by all members. These types of organizations, the
different interests of savers and borrowers have been the source of conflicts. Particularly
when borrowers are the dominant force, decisions may be made that are in the short-term
interest of borrowers, but because they discourage savers, they work to the long-term
detriment of all parties and may threaten the viability of the financial institution. These
conflicts may make these organizations particularly unstable warranting outside
regulation and supervision.
iv)
Liquidity Risk
Small MFOs are likely to be exposed to high levels of liquidity risk, particularly
seasonal liquidity risk. If they are financially solvent and operating in a relatively healthy
financial system, they should be able to deal with this risk through short-term borrowing
and lending. Non-creditworthy MFOs will not be able to solve liquidity problems.
Regulators must ensure that MFOs permitted to accept deposits are able to handle
liquidity risks.
v)
the need for regulated MFOs to provide regular, high-quality financial information and
the high cost of supervision (relative to assets protected) of MFOs.
vi)
Donor-Related Risks
As discussed above, MFOs receiving grants or concessional loans from donors are
exposed to special types of risk, including those arising from subsidy dependence and
donor influence. This list of potential regulatory issues facing NGOs suggests that many
MFOs need to implement significant structural and operational changes before accepting
deposits. It also suggests that some NGOs should decide not to become depository
institutions. As more MFOs reach this threshold, regulatory authorities will also need to
consider the changes they can safely make to respond to the special characteristics of
microenterprise finance.
92
Review Questions
i)
ii)
iii)
iv)
v)
vi)
vii)
93
Sample Papers
Mt Kenya
University
94
Sample Papers
Mt Kenya
University
95