Panu Kalmi CCCBE, UVic Nov 28, 2010

1. The Performance of Financial Co-operatives in the Financial Crisis: The European Experience (so far) Panu Kalmi CCCBE, UVic Nov 28, 2010

2. The performance of co-operative banks in the crisis • Some controversy on the performance of co-operative banks during the crisis • For instance, compare FT Sept. 2, 2009 (”Mutual Suspicion”) to Economist Jan 21, 2010 (”Mutual Respect”) • The issue can be resolved only by using statistical analysis and adequate samples

3. The structure of presentation • The forms of stakeholder-oriented banks in Europe • Some reasons why co-operative banks may be less (or more) affected in the crisis • Actual experience during the crisis

4. The typology of stakeholder-owned banks • The stakeholder banks in Europe can be divided into two main categories: • 1) co-operative banks • 2) savings banks • A crucial difference between the two is that co-operative banks are member-owned (members share the surplus and control), whereas savings banks are non-profit organization (those who control the bank cannot appropriate the surplus; customers do not have voting rights) • In both cases, the sharing of surplus is limited and there are other goals than profit maximization; social goals such as financial inclusion and enhancing the welfare of the communities in which they are located

5. Historical origins • Savings banks have their origins in the charitable organizations: ”Mounts of Piety” run by Catholic church in the middle ages, German municipal banks starting in the early 19th century, and charitable banks started by wealthy individuals (Germany, Scotland, Scandinavia) • Co-operative banks were started as mutual self-help organizations in the second half of 19th century by two German reformers (Raiffeisen and Schultze-Delitzsch) and spread quickly to other European countries: division between rural and urban credit co-operatives • UK building societies, co-operative organizations involved in housing finance (starting from the 18th century)

6. Economic importance of stakeholder banking: examples • In France, the four co-operative banking groups have around 60% share in deposits • Other countries where the market shares of stakeholder-owned banks in the retail market is over 50% include: • Germany (savings banks and coop banks) • Austria (coop banks and savings banks) • Spain (mostly savings banks)

7. Forms of co-operative banking in Europe • Formation of networks is a common feature of financial co-operatives everywhere; however, the strength of the network differs • Desrochers and Fischer (2005) made a distinction between consensual and strategic networks

8. Consensual networks • Pooling of resources: payment systems, credit cards, IT systems, employee training etc. • Limited competition of members within the same network • Joint brand name • Strategic planning from the centre; however, no mandatory compliance

9. Strategic networks • Include the above characteristics, and in addition • Strategic direction from the centre; mandatory compliance (especially in the case of banks with financial problems) • Mandatory auditing of member banks by the network, centre has rights to intervene • Contractual solidarity: member banks jointly liable for the debts of each other through mutual insurance schemes • The centre often owns subsidiaries, that provide e.g. insurance, investment and corporate banking, international operations

10. Examples from both groups • Consensual networks: UK building societies, Italian Banche Popolari, Spanish co-operative banks • Strategic networks: French co-operative banking groups, German, Austrian, Dutch, Finnish, Swiss groups, Italian BCC

11. Savings banks • Private (foundation) ownership: Spain, Scandinavia • Public ownership: Germany, Austria, Switzerland

12. Characteristics of stakeholder banking • Maximization of consumer surplus instead of profitability • Focus on SME lending and consumer markets (especially mortgages) instead of large companies • Relatively high loan-to-assets and deposit-to-liabilities ratios • Often higher equity reserves

13. How these characteristics are related to crisis exposure: potential advantages • Limited risk taking • Information benefits (know the borrowers) • Higher equity reserves as cushion during crisis • Deposits as main funding source: more stable than interbank borrowing

14. How the characteristics are related to crisis exposure: potential disadvantages • Higher exposure to mortgage loans, lower degree of securitization • More dependent on the state of real economy: might have become more vulnerable when ”financial” crisis turned into ”economic” crisis • In other words, stakeholder-owned banks may have suffered from problems they did not generate in the first place

15. What is the impact of integration? • Both types of integration, but especially tight federation, allow small banks reap economies in scale • Auditing of member banks helps to control the managers • Network members are able to pool risks (e.g. regional differences in housing markets) • However, the entire network may be jeopardized by individual bad decisions (e.g. in derivatives markets) • The exposure of centres in investment banking and international operations have increased this risk

16. Empirical evidence: initial analysis • Source: bank ratings from international ratings agencies (Fitch, Moody’s) • Data consists from around 150 European banks • Ratings changes between 2006-2009 • Note: the raters evaluate only large banks or networks; the results may not be generalizable to small financial institutions

17. Results • I concentrate here only on Moody’s ratings (however Fitch results are similar) • In 2006, tightly federated co-operative banks (or strategic networks), private savings banks and commercial banks had roughly similar ratings; however, share of problem banks higher among commercial banks already then • Independent co-operative banks and publicly-owned savings banks are perceived as being less strong

18. Further results • In 2007, private savings banks are downgraded; this is likely a reaction to subprime crisis and its implication to mortgage markets: Spanish Cajas were heavily involved in mortgage markets • In 2008, tightly integrated co-operative banks downgraded more than commercial banks • In 2009, downgrades in all classes; however federated co-operative banks do relatively well compared to commercial banks; independent co-operative banks (especially UK building socieites) are heavily downgraded

19. Performance of groups of banks • Best performers: Rabobank (consistently ranked as among the best banks in Europe), Credit Agricole, OP-Pohjola • Problem federated banks: Austrian Raiffeisen and Volksbank groups, due to their investments in East Europe • Building societies and Spanish savings banks ranked low because of their involvement in mortgage markets

20. The merits of the ”strategic network” model of financial co-operatives • Already before the crisis, the tightly integrated co-operative banking groups in Europe were among the best performing European banks • During the crisis, their position has been more stable than that of profit-maximizing commercial banks or private savings banks • In addition, they have been regarded as more stable than more loosely networked co-operative banks

21. Merits of strategic networks, continued • Allow simultaneously to reach economies of scale from pooling resources, and retain local control of individual banks • More diversified than banks in looser networks; are not locked in in problematic markets (cf. building societies or Spanish cajas) • More resistant to demutualization processes than individual co-operative banks

22. Problems of strategic networks • However, sometimes there are conflicts between local banks and the centre, especially if the centre has ambitious plans for expanding to non-core markets (e.g. Austria, investment banking policies of some French banks) • If these problems are sufficiently serious, they may bring down a network consisting of healthy local banks

23. Comparison with credit unions • The economics literature finds consistently that credit unions (unlike European federated coop banks) have economies to scale; credit unions respond to this issue by mergers, rather than tighter federation • Tight integration among European coop banks an outcome of historical process; not easy to replicate to another context • Continental European firms in general rely more on networks than North American or UK firms; a cultural issue?