- Consulting with Canadians --

Klaus Fisher and Martin Desrochers' Submission in Response to Finance Canada's Cooperative Banking Consultation:

Mrs. Diane Lafleur, Senior Chief
Financial Institutions Division
Department of Finance
L'Esplanade Laurier
15th Floor, East Tower
140 O'Connor Street
Ottawa, Ontario K1A 0G5

Re: Cooperative Bank Consultation

^[1]

Dear Mrs. Lafleur:

Whatever the state of the current debate and the bends it has taken over the last three years, it all started when the McKay Task Force proposed that

This initiative constitutes a follow-up to those recommendations and an opportunity for the Canadian financial cooperative sector ("English" credit unions and "French" caisse populaires) to create a new governance, regulatory and supervisory framework at the Canadian level. This new framework should not only boost the presence and market share of the sector in Canada, but also the access to sophisticated and diversified financial services to larger sectors of the population who do not have this choice with the traditional banking sector. Even for those sectors of the population (Quebec's population with access to services offered by Desjardins) who already enjoy the access to financial services at par with some of the most competitive financial intermediaries in the world, the reform should consolidate this achievement and create conditions for a further expansion of those services.

The opinions presented in this response have a double character. They represent, no doubt, those of academics involved in research on issues of management, governance, regulation and supervision of cooperative financial institutions. But they are intentionally expressed also in terms of satisfied members of a caisse populaire (Caisse Populaire Desjardins de l'Université Laval and Lévis respectively), fully aware that this opinion will be one of the few (if not the only) coming from the all-important constituency of the silent majority, the members themselves. Most positions, instead, will come from cooperative leaders —often administrators of a coop--, who generally represent us with great competence, dedication and integrity, but who, in this cold world of financial contracts, are definitively subject to incentives to expropriate us (members) for their own benefit. And, all too often, they do yield to those incentives.

You may ask, how important is it to obtain an independent opinion from that of our leaders in the cooperative sector? It is important because these leaders are agents with their own agenda of interests that often differs from that of ours, the principals. Thus, by definition they should be suspect. Would you want to obtain a fair assessment of how to protect the interests of bank depositors (principals) by asking the shareholders (agents) of the bank, who because they hold a call option on the value of the bank's assets, are subject to incentives and possess many means to exploit them? Thus, in this position we will represent the interests of member-owners and clients of a financial cooperative –or cooperative bank (FC to use a generic name).

We will focus on key issues raised by the Cooperative Bank Consultation Paper (CBCP), either explicitly or by implication. As we will argue below, the most serious one is the issue of governance of the institutions that may be created with new regulatory framework. Other issues, however, are also important. They include: performance (elsewhere in the world) of the models being considered, the problems facing the federal government of picking a model, the harmonization between federal and provincial regulatory frameworks, among others. About these latter points, we will be very brief.

Coming from the government, the consultation obviously focuses on regulation and supervision. However, in doing so it also touches upon issues of internal governance of key importance. And this, at two levels: the micro-governance of individual "base units" and the macro-governance of second and higher tier organizations.

• At the micro-governance level, questions are posed with respect to important governance issues such as "how would the bond of association apply" (page 9)? would individual credit unions "disappear" when merging their assets into a national Cooperative Bank or would they conserve a local governance structure? and so on.
• At the macro-governance level, the three proposed Cooperative Bank Models imply radically different approaches to organize the cooperative banking sectors. Some have well established historical precedents (e.g. the federative model) and some have almost no historical experience (e.g. the national model). They imply choices in terms of the relationship between the institutions and the members-owners at the bottom of the pyramid. These radically different choices of governance of the second- and higher tier organizations have crucial implications in terms of how governable the institutions will be.

In the remainder of this position, we will focus first on an analysis of the reasons for the very existence of FC: their competitive advantage. Then in Section 2 we touch on issues of economies of scale, governability of FC and the organization of networks. We will present models of FC organization that have successfully solved the problems of economies of scale and governance simultaneously. In Section 3 we focus shortly on the links between governance and regulation. There we will argue that the weaker the governance of the institutions created through a centralized government decision, the higher will a posteriori be the need for regulatory intervention often at high cost to member-clients and taxpayers. Then, in Section 4 we focus on the three models proposed in the CBCP, the strength of the governance structure of each of these models, to what extent they correspond to existing experiences of cooperative banking systems, and the level of performance demonstrated by each of these models. Finally, in Section 5 we argue in favor of protecting the legal, R&S framework of Quebec as a unique and balanced case of environment that promotes the development of highly dynamic networks of mutual financial intermediaries. The Appendix presents some results of a mini-study of American credit unions, between 1996 and 2001.

1. The competitive advantage of a FC

In order to develop an understanding of the specific needs in terms of regulation and supervision of FC it is useful to start by reviewing what FC are in the first place. In particular we want to present the competitive advantage of this institution vis-à-vis other financial intermediaries. This advantage is at the root of their successful expansion to almost every corner of the industrialized and developing world.

FC are institutions that successfully perform transactions where other institutions fail due to market imperfections, or perform transactions at lower cost and/or risk of expropriation (in the form of hold-up, a concept that will be explained later) for the principals. The reason why they are able to do that constitutes the comparative advantage of FC and the justification of their very existence. By necessity, the exposition will be compact. It is based on a well-established economic literature that explains the role of cooperation in economic life.

There are two central components to the competitive advantage of the FC. Without them, FC would most likely not exist, or would have their market invaded by successful competitors (something that would probably please regulators!). They are:

Information advantage:

FC possess an advantage in collecting the information needed to accomplish transactions that would for other institutions be too costly to obtain, resulting in either prohibitive prices or no transaction at all (market failure).^[3] The advantage results from the fact that all members of a FC, from the top manager to the last member, posses a knowledge of the community in which the FC is embedded and have an incentive to volunteer costlessly all supplemental information that will insure successful operation of the cooperative, of which they are co-owners. Given the idiosyncratic or "soft" nature (non transmissible) of this information, the pool from where it draws the information and to which it applies cannot be very large. Hence the classical and universal relative "smallness" of individual FC –not to be confused with size of FC networks!.

The advantage of being owner-client:

Investment in financial relations is highly specific. A reputation of creditworthiness and dependability with a financial institution, often accompanied by substantial collateral equity investment, is hard to build. Reputation, an attribute that is so important in financial transactions, usually has value in the eyes of only that institution with which the relationship has been built. In fact, the "scrap-value" of the relationship is near zero. Even the collateral equity investment may be lost if the relation is broken. Once lost it is lost completely regardless of the cost of building it up. This makes the client highly dependent upon the continued honoring by the institution of that trust: rain, hail or snow. Any opportunistic behavior that exploits that dependence of the client to the financial intermediary (a hold-up), be it a matter of institutional policy or attitude by an employee, will result in a loss to the customer. The lower the cost to the intermediary of the hold-up the higher the chance of occurring. Obviously, the risk of hold-up increases with smallness of the clients' position. Information asymmetries and principal-agent conflicts in share value maximizing joint stock bank (JSB) increases the risk of hold-up for clients, and thus reduce trust –because the set of decision rules used by shareholders to maximize their own utility, including those affecting the customer, are opaque to these. FC, due to the mutuality principle of owner-client, internalize this conflict. For agents operating in communities with which they share values and economic interests —and about which they have sufficient information—, membership with voice and vote to a FC will reduce the risk of hold-up. Smallness of the FC, again, plays a role. The larger the FC the less control over the decision process and the higher the chance of being exposed to groups or agents disposed to engage in opportunistic exploitative behavior.^[4]

1.1 Credit rating services and the erosion of the FC advantage:

Innovation, and in particular credit rating for individuals and small entrepreneurs –the main clientele of FC— that generates general or "hard" (transmittable) information, has dramatically reduced the advantage for FC. This has resulted in a strong competitive push of commercial banks into FC territory.

Modern rating systems, among other technological innovations, could reduce the need for the existence of FC in the market on two accounts. First, by generating more "hard" information and reducing the dependence of transactions on idiosyncratic knowledge. This is the strategy employed with brilliant success by MBNA (bank), among others, in the marketing of its credit cards. This enrichment and cost reduction of the information generation process has also allowed FC to operate comfortably in larger scale (gaining in scale economies and diversification) keeping risk constant. How large they can or should become is the million-dollar question for today's leaders of every major FC movement in the world.

Second, and in reverse direction, credit rating services also reduce the specificity of the investment in a relationship with a financial intermediary. To the extent that credit performance is reported to the rating services, the risk of hold-up of the principal is diminished. At the first attempt of opportunism on the side of the intermediary, the client can always "take" his/her credit report to the next financial institution and bargain for better rates and terms. This in turn reduces the need to create institutional mechanisms (in this case FC) designed to prevent this kind of hold-up.

Both these trends —increased production of "hard" information and reduced specificity of investment in relationship— are potent forces squeezing FC's markets and operation strategies. However, their continued albeit dampened success suggests that the competitive advantage is far from over. In fact, often FC accomplish transactions in absence of credit rating and even despite unfavorable rating. After all, the relationship with a financial intermediary can hardly be reduced to access to credit at satisfactory rate. While practically all networks of FC –including Desjardins--are encouraging merger and economies of scale, they are definitively not suggesting large scale consolidation into national institutions, an alternative that could appear as the most efficient from the point of view of economies of scale. It must thus be true that there are still comparative advantages related to information production and trust that prevent this step. And then again, there are the agency costs .... about these we will talk later on.

The central idea to recover from this discussion is that the efficiency with which FC exploit their comparative advantages (information production and preventing hold-up) depend to a large degree on smallness. It should, as a result, not be a surprise that the largest and more successful systems of FC are built not by growth of a single unit into a large multi-agent institution but rather through vast strongly integrated networks of relatively small individual units. The degree of integration in the network, while conserving independence of individual units, appears to be important, as the working paper accompanying this position suggests.^[5]

2. Size, governance of mutual financial intermediaries and networks

A substantial body of literature with support in solid theoretical arguments and an equally impressive history of empirical testing suggests that dilution of control results in increased manifestation of "expense preferences" by managers. Using modern finance terminology, diffusion of ownership leads to increased exercise (or risk of exercise) of agency costs. In this analysis, managerial utility maximization that includes preferences for certain types of expenditures, such as staff, offices and perquisites, distort resource allocation. Imperfect monitoring of managers, accompanied by other imperfections in the capital and labor markets and poor regulation and supervision (R&S) facilitates this behavior by managers. Mutuals are institutions in which the rule of one-member-one-vote (and the fact that unbundling of votes and membership is not allowed) leads to high diffusion of control with no single individual possessing a substantial control. While the public corporation of diffuse ownership suffers of a similar problem, the market for shares and corporate control (both absent in a mutual) goes a long way to compensate for this "shortcoming". The larger the mutual institution the more diffuse is the control, leading to a worsening of the problems. Thus, theory predict unambiguously that growth in size of the FC will be accompanied by an increase in the expense preference behavior by managers.

To provide readers of this paper supporting evidence (in favor or against) we performed a mini-study of the American Credit Union system. Using United States data presented several advantages: i) The system of FC is very similar to the one existing in English Canada. ii) The data is available (which is generally not the case in Canada). iii) The sample is large, providing additional confidence to the results; iv) For whatever it is worth, we do not point the finger at any Canadian FC that is part of the debate. In Canada, large FC have a name and can easily be identified. The results of that mini-study are presented in the Appendix (with two further annexes) to this letter. As a quite revealing short summary we can say that the consistency of the statistical evidence with the theory provided by this mini-study is so clear-cut that it even surprised us! Whether the results can be extrapolated to the Canadian case is an open question--although we do not see why not.

Further, besides the simple fact that these theories count with a very solid empirical support^[6] ongoing empirical research being performed by these researchers in collaboration with colleagues from several countries yield the result that, with a remarkable consistency across countries, agency costs are a leading determinant of failure risk in FC. Further, crisis that have profoundly shaken the FC systems of several countries, particularly in Latin America —resulting in losses to millions of socially disadvantaged people-- consist mostly of the failure of the largest institutions in the system.

However, smallness presents its own set of problems. Economies of scale (lack of), credit risk concentration, narrow product and services offer to member, vulnerability to economic fluctuations, etc. are some of the problems associated with smallness. FC are pioneers in advancing an alternative to internal growth in size or mergers to exploit economies of scale and scope: networking. The concept was deployed by FC in Europe as early as the XIX century. Today, networking is an option of choice to manage inter-firm relationships (joint ventures) designed to exploit economies of scale and scope and accelerate learning of new technologies for a wide range of industries, such as: biotechnology, electronics and computing, airlines and banking (not in Canada) among others. While the economics of networking is still a hot subject of academic debate, we know that networks are used in situation where:

• Mergers may be too risky in view of the uncertainties of the project. In these cases networking allows to engage in reversible commitments (in this sense networks create valuable real-type options). Ex. Joint mining or technology development projects.
• Exploitation of economies of scale and scope in the production of inputs while conserving independence of the contracting parties (protection of residual property rights) is desired. Ex. Printing, banking, biotechnology.
• Providers of complementary services join in a long-term relationship to provide customers expanded value through coordination in the provision of the services. Ex. Passenger airline industry.

The second application is the one pioneered by FC (with the third becoming also important) with a huge success measured by the enormous scale and complexity of some of the European networks (including Rabobank and our local version that caught the eyes of the McKay Task Force: Desjardins). In effect, in several countries Canadians would be surprised to see that the largest institution is not some joint-stock commercial bank, but a highly integrated network of independent FC .... like in Quebec. That is, the primary financial institutions in the country are not the rich-man's banks but the poor-man's banks!

Whenever networks (or joint ventures/alliances) are created, governance structures become necessary. These governance structures insure that the alliances achieve their goal and at the same time that the contracting parties adhere to engagements and to fair play. Against popular perception, structures such as Desjardins (and Rabobank) are radically different from that of commercial banks such as Royal Bank or CIBC, and not only in that one is a cooperative and the other a joint-stock company. Networks are multi-firm structures that result from the subscription by all participating members of a contract that establishes the rights and obligations of each and all members. The institutions that result from these agreements are structures that have complex rules of operations designed to:

• Generate services for member FC,
• Insure a strategic coordination and leadership of the network,
• Enforce compliance of obligations by all parties under the subscription agreement (often combined with state supervision to yield what is known as "delegated monitoring," as practiced in Quebec), and
• Provide protection of member-shareholders residual property and control rights.

Now, as the members of the McKay Task Force correctly noted:

While it is of some importance whether the tiered-structure has two or three tiers, the fundamental question posed here by the Task Force is whether such structures should exist at all. In light of the discussion presented above, the response to the question posed by the Task Force is that in effect, the relatively complex multiple-tier structures play a specific role in the governance of a multi-firm network that is essential to the functioning of the system. They keep the balance of protection of principal residual property rights and strategic direction while at the same time generating the services required for the smooth functioning of the system. In particular, the layered structure of representatives and administrators of concern to the Task Force is there to insure that the decision process in the central nodes respects the interest and rights of principals at the base of the pyramid. This does not mean that efforts cannot be undertaken to reduce the cost of operating these structures (as Desjardins' experiment of reducing the number of tiers from three to two suggests), however, the fundamental role of the tiers in insuring protection of principals' rights must be kept. It would be a big mistake to attempt to introduce models of governance structure used in joint-stock banks into cooperative organizations, the role of the governance structure in one and the other case is completely different. In the first, it insures downward transmission of information and enforcement of decision-making. In the second it must do that and simultaneously insure that decisions are democratically taken and that upper bodies respect the interest of members of lower tiers of the organization.

The central message that one can extract of these observations is that, while there are, no doubt, large mutual financial institutions with a superb management, encouraging the formation of large multi-branch FC or CB is to invite troubles! The lack of checks and controls in these institutions, due to the dilution of ownership, is such that only the bravest of the hearts should be expected not to profit from the situation. Anything less and you can expect managers to engage in practices that, in a joint stock company, would be likely to deserve a hostile takeover bid from a bargain-hunting corporate raider. Unless, of course, the state, through its supervising authority, chooses to become the day-to-day watchdog of these institutions. On the other hand, an analysis of experiences worldwide suggests the existence of solutions –networking--that have such solid economic foundations that they have become a hallmark of modern inter-firm economic relations. These solutions conserve the competitive advantage of FC related to its smallness, avoid the governance pitfalls of large cooperative institutions and solve brilliantly —much better than most medium to large FC could-- issues of economies of scale and scope.

3. The give and take of governance and regulation

Every enterprise consists of a bundle of contracts between stakeholders. In a JSB, the main stakeholders are: the shareholders contributing risk capital, the depositors, the bondholders and the borrowers. Other stakeholders exist (e.g. suppliers of inputs and services) but their role is relatively minor in most banks. For each type of contract, there exist a principal and an agent. For most principal-agent relationships, contracts exist that provide sufficient protection to the contracting parties from exploitation by the other. If the contracts cannot be specified in a sufficiently clear fashion for all possible outcomes of nature, governance structures are designed to compensate the shortcoming in the contract. One example of a contract that provides sufficient clauses and governance structure to protect the principal is the loan contract. While the banks (the principal) is exposed to risk by the borrower (the agent), loan covenants and rudimentary governance structures are designed to provide the bank a reasonable control over the use of the funds, thus protecting its interests. There are, however, a few situations in which this is not the case. That is, principals have no means to control the actions of the agents exposing them to substantial risk of expropriation by the agent. The bank depositor-shareholder relationship is one case in point. Depositors (mostly small ones) are considered sufficiently "unsophisticated" and void of tools to control bank shareholder behavior, that the state finds it necessary to step in in representation of the former. This is, of course, one of the two central economic arguments that justify the existence of bank supervision.

The importance of this notion is that, to a large extent, the purpose of regulation and supervision is to protect the interest of specific contracting parties (principals) that it considers important to protect and that are at a disadvantage in terms of controlling the actions of the agents. When contracts are well specified and governance structures are efficient, the need for state intervention will be less. On the contrary, when those structures are less efficient, the need for state intervention increases. The bottom line of this debate is the following: the weaker the internal governance structure of an institution or a structure, the higher the probability of instability in this institution or structure and the higher the probability that the supervisory authority may be forced to intervene, either to introduce corrective actions or to exit the institution. If a state-based deposit insurance scheme exists, the number of constituents represented by the supervisory authority increases to include the deposit insurance fund and taxpayers (as guarantors of the deposit insurance fund). Thus, it is in the best interest of the regulator to establish a governance and regulatory framework that insures the most efficient internal governance of the institution.

As we had the opportunity to expose with some length in the previous section, with respect to mutual financial intermediaries, the literature is absolutely unambiguous: compared to JSB, mutuals' governance is decisively weak and exposed to abuses by managers subject to incentives to engage in expense preference behavior. Further, the larger the institution the weaker the governance as the control over agents becomes increasingly diluted. This applies equally to first and second (or higher tier) institutions. The regulatory framework can either contribute to create cooperative institutions with weak governance structure or with strong governance structures. The choice is in the hands of policy makers facing the new regulatory environment for FC in Canada. The three models proposed in the CBCP have clear implications with respect to the strength of the internal governance structure that would result. This will be the focus of the next section. Specifically, we will analyze the differences between these models with respect to the strength of the governance mechanisms they create and what the existing experiences in the world suggest are efficient models of governance.

4. The existing and the proposed models

4.1 The existing models

For the purpose of clarifying the discussion we will attempt a rough classification of the different types of cooperative banks or financial cooperatives that exist around the world. This will help us to better understand the proposals contained in the CBCP. The classification, as usual, will not please everyone who might feel they are forced into categories into which they do not fully belong. But that is a risk taken by any taxonomist. Also, the description provided for each category will, by necessity, be concise.

For the purpose of the present discussion, it is useful to identify four different types of systems of FC or cooperative banks including, of course, the examples furnished in the CBCP. Let us call them Type 1 through 4.^[8]

We provide some details about each of these types in the following table. A quick perusal of the description in that table reveals that Types 1-3 represent systems with increasing degrees of integration, while Type 4 is of a completely different nature altogether. Often these "cooperative" banks are not even of cooperative ownership. Despite the low level of detail presented, what the table also suggests is that each Type has fairly well established and homogenous rules of governance that are found with a remarkable consistency across countries.

		Type 1 Dispersed FC	Type 2 Loosely-integrated networks of FC	Type 3 Federated strategic networks of FC	Type 4 Cooperative Banks as service organizations of other cooperative networks
Organization		Individually operating units with almost no coordination of business activity. Federation exists as syndicate, political representation and few other business functions (consulting, training, etc.).	Networks of independent FCs with cooperation of business activities with some pooling of inputs and some standardization of operations but absence of centralized strategic decision making and low-powered governance structures. Structures of 2 to 3 tiers of organizations with function of providing services to base units.	The "cooperative bank" is a network of independent FCs with intense cooperation of business activities in the form of pooling of inputs, standardization of operations, cross insurance, centralized strategic planning and high powered governance structures. Structures of 2 to 3 tiers of organizations with a highly developed set of subsidiary service organizations producing inputs and services for the network.	The cooperative bank is a service subsidiary typically of joint-stock type, owned by a network of cooperatives operating in other fields (typically consumption, commercialization or production) Often in parallel to this CB there exist an additional system of FC of Type 1 or 2. (*)
Governance		None. The federation acts as a syndicate and takes no (or very few) decisions for member institutions.	Low-powered governance structure with individual units maintaining strategic independence and central nodes with no or almost no authority over individual units.	High powered governance structures designed to control operations of central nodes and basic units according to strategic decision. Key elements of the governance structure are: Representation structures to facilitate democratic decision making and strategic planning compliance. Monitoring bodies to supervise operation of central nodes and basic units.	The governance structure of the network of non-financial cooperatives serves as control body of the CB. In this sense, the CB is not different of any other joint-stock subsidiary of any other corporation.
Examples		The most common model found in developing countries.	English Canada CU Irish CU Spain UK United States CU Many developing countries	Australia (***) Austria (2 networks) Credit Agricole (France) (§) Desjardins (Quebec) France (other networks) Germany (Raiffeisen) OKOBank (Finland) (§)(**) Rabobank (Netherlands) (§) South Korea (3 networks)	Banque Coop (Switzerland) (§) Cooperative Bank Group (UK) (§)
Notes:	(§) Examples proposed by the DF in the CBCP. (*) This is the case of both examples given in the CBCP: Banque Coop (Switzerland) and the Cooperative Bank Group (UK). (**) OKOBank is in reality an hybrid structure with features of Type 4 but essentially part of a system that is of Type 3. This Type of arrangement is common for non-banking subsidiaries in networks of Type 3 (e.g. insurance, portfolio management, etc.) but unusual as banking subsidiaries. Increasingly, networks of Type 3 have bought out interest of failing financial groups and thus have finished incorporating to the network a banking subsidiary. This is the case of Credit Lyonnais in France and Groupe La Laurentienne in Quebec. Thus, while corporate governance structures appear to be consistent with certain models, some path dependence will introduce variations among cases. (***) Australia was classically a Type 2 system but, since the crisis of the early 1990's has been moving rapidly into the camp of Type 3.

 

What is important to extract from this exercise is that the last 150 years of evolution of FC have generated a limited number, and clearly distinguishable, set of macro-organization of systems of FC. If they exist it is because they have survived the hostile world of evolution under competition and thus have proven that they are viable models of organization, with a market niche they, and only they, can serve, allowing transactions and value creation where no other institution can. English Canada credit unions, being already organized around one of the more advanced models (Type 2), if they wish to become more competitive and at par with the most competitive systems in the world, has just one way to go .... the federated strategic networks of FC (or, in the language of the CBCP, the Federated CBM)  la Rabobank or Desjardins. But let us look at this conclusion more carefully and why the other two models should be rejected.

4.2 The proposed models and assessment

Emulating or inventing

Before entering into a detailed discussion of the proposed models, a question that is worth asking is whether it is wise to emulate or to innovate inventing new structures. The proposals in the CBCP contain both: the Federated CBM is no doubt an emulation of Type 3 networks. However, the other two are largely an innovation in terms of governance with no operating example in real life. The question to ask is how wise is it for the regulator to innovate in corporate organization and governance. If the institution is a state owned enterprise, the government, as owner, can innovate as much as it likes with the governance structure and the way it protects its own residual property rights. However, attempting to impose corporate and governance structures on firms with private agents holding those property rights is tricky business. An example of regulatory restriction in terms of governance is the one existing in the banking sector, where shareholding is limited to 10% for major institutions. This is a relatively minor restriction on a corporate structure with proven performance: the joint-stock company. But this restriction does not modify the fundamental governance structure designed to protect the residual property rights of risk-taking shareholders from expropriation by agents (administrators, other shareholders, etc.).^[9] Would, for example, the government be willing to propose how the merger of say, two joint-stock banks, should be accomplished and what the resulting governance structure should be? If by any reason it chooses to do so, it most likely would adapt the proposed design to some reasonably well-understood corporate governance already existing in the market. It would probably be hesitant to create some new form of organization that does not resemble to some existing corporation. A substantial economic and business literature suggests that there are only a few types of corporate organizations that have carved their space in society, and each of them has its own internal logic of functioning and rules of governance to protect residual rights of owners. The tinkering is done mostly at the margin.

We do not think that the approach should be any different in the cooperative sector. Existing governance structures of cooperative institutions, including the ones described above (Type 2 to 4) are structures that have evolved over more than 100 years! There, even in the more integrated and complex ones (Type 3) property rights of owners (members in this case) are protected by a set of governance mechanisms that have evolved keeping a delicate balance between the protection of the property rights of owners (members) and the need for autonomous operations of agents (managers) in the different tiers of the organization.^[10] Thus, when considering to innovate by designing governance structures, the innovator should be quite clear that what is being proposed insures both: that the property rights of the principals are protected and that the agents are given the latitude they need to perform their job. Is that the case of the National CBM or the Individual CBM? Maybe. However, comparing the design proposed (to the extent that it has been made explicit) to the types presented above, it very quickly becomes clear that there is no living case of such types of organizations in the industrialized world and that those that exist in developing countries have been created for the wrong reasons. This fact alone puts a big question mark on these two models. They are certainly far from being just a tinkering at the margin.

Of course, if you ask a self-assured and ambitious managers of a FC whether he/she feels capable of building a national organization, the answer will be: sure! We just need to look at some of the submissions to the consultation to see that they are ready to take on the world. The message is clear: give them the regulatory space and they go for it. However, do the organizations they have in mind include built-in appropriate governance structures that insure protection of the principals (members) property rights including efficient mechanisms to control the managers themselves in the pursuit of their own agenda of interest? We doubt it! Personally, we would prefer to stay with our little CP Desjardins de l'Université Laval and Lévis, with just a few thousand members each, as part of a network, with a governance structure that has evolved over the last 100 years-- here in Quebec and elsewhere-- to protect our property rights. That structure, with established rules of the game, is there to insure that those huge upper layers of the organizations are there to serve us, the members at the base, and not just a big pool of perks where managers can dip at pleasure or engage into some outlandish corporate expansion plan that has little to do with the interests of principals (members) (not that it may not happen sometimes!).

The proposed models

Let us now focus on the proposed models. We start presenting a table that summarizes much of the arguments in favor or against the models. Afterwards we will engage in a detailed analysis of the three choices

	The "National" CBM	The "Federated" CBM	The "Individual" CBM
Likely development (crystal ball)	Creation of a few very large "federal" organizations coexisting with small FC. Possible development of competition between large CB and small FC in local markets. This as a result of expansion activity of large CB or simply as mechanism to force merger of small FC into large CB.	If successfully implanted, the system will approach the level of organization existing today in the Desjardins or Rabobabank systems, characterized by many relatively small –but relatively homogeneously sized--institutions with centralized strategic management and generation of inputs and services.	Not much change with respect to current situation (besides the appearance of a few large "federal" organizations) at best or a scenario similar to that of the National CBM at worst.
Governance	Highly problematic, due to dilution of control of agents. All empirical evidence internationally suggests that this is the worst possible model.	Well understood mechanisms of governance, developed over a century of evolution, that keep a suitable balance of centralized power and protection of property rights of members of FC	Mixed, depending upon the size of the institutions.
Existing experience to compare with	Some developing countries due to: R&S destined to make FC more "bank-alike" and reduce their number for ease of supervision R&S "vacuum" and relaxed bond restrictions.	A wide representation of systems and countries internationally (see Type 3 above)	None but could result in a system similar to many cases of FC in developing countries where bond restrictions have been weakened or are inexistent. Could approach the US case if bond restrictions are respected.
Expected performance	Impossible to assess. However, frequent failure due to massive agency costs of "very large" hierarchical cooperative organizations in the countries where they exist(ed) suggest risks are high.	Levels of performance that are equal or superior to any other form of cooperative organization elsewhere in the world suggests equally successful implantation in Canada.	Unimpressive performance of atomized systems (characterized by frequent failures of larger organizations) elsewhere suggest chances of an exceptionally good performance in the case of Canada are very low. If, on the other hand, bond restrictions conserved, no dramatic change beyond actual levels of performance should be expected.
Expected need of supervisory input	High due to weakened governance structure and diluted control of agents.	Relatively low due to role of internal governance and monitoring mechanisms needed for insuring respect of collective subscription agreement. These organs perform "delegated monitoring" for supervisory authorities.	High, due to proliferation of institutions and due to weakened governance and diluted control of agents in large organizations.

Why not the National or the Individual CBM

The "why not" of these two choices will become clear if we first outline a likely outcome of choosing either of these models. Creating a framework that would encourage the formation of "federal" CB by allowing two or more credit unions to roll over assets, implies in effect encouraging the merger of relatively small FC into larger inter-provincial organizations. At the limit is possible to arrive to a situation where several or a few "federal" CB expands either by absorbing local FC or by opening new branches. One cannot exclude the possibility that these "federal" mega-CB pressure small local FC into merger by first "dumping" a competing branch that makes use of the cooperative banner to undermine local affiliation (a practice known to have been applied by "national" FC, formed by internal growth or merger, in some developing countries).

Much the same scenario would occur in the case of adopting the Individual CBM. An individual FC would now draw its plans of expansion to go after membership in other provinces. There would be nothing wrong with this if the membership is limited to some well-specified bond, such as a national employer (e.g. the Canadian Government). But not much would be gained in this case. The United States has several of these large FC with federal charter (e.g. the Navy's CU). This does not make the United States CU any more competitive compared to other systems in the world. We would just end-up with a growth of a few of the FC into "federal CB" but this would not provide a boost to the rest of the system that would remain just as atomized as it is today. Instead, if these bond restrictions are relaxed so that this new "multiple-bond federal" CB would be able to get its membership anywhere, the result would be the same scenario just described for the National CBM. This "federal" mega-CB would most likely behave just as any other mega CB, competing with small local CU and often forcing them to surrender to a merger.

Aside of the fact that a few annoying and regrettable situations like that just described may occur, is there anything wrong with these scenarios? Yes, there is:

• This model goes against the very principle that mutual financial intermediaries are best governed (by their own members) when they remain small. As already argued, when these institutions grow, internal governance weakens, agents (administrators) become more entrenched, and external principal-representative agents (the supervisors) must kick in to compensate and insure prudent management. If the federal government, by its legislation, becomes the ultimate responsible of the creation of these "federal" mega-CB, it will fall on the shoulders of federal supervisors to become the monitors of institutions that –unlike commercial banks-- lack any reasonably efficient governance. It is in the interest of no one to create incentives that will encourage the formation of institutions with a weak governance if the result will be higher instability in the system and more regulatory intervention later on. The costs of such a policy would be borne by members (with higher operating costs, lending rates, lower benefits and increased uncertainty) and by taxpayers in general that finance the government's implicit guarantees on the deposit insurance fund. This sort of problem does not exist in a federated-network model where federated bodies explicitly supervise management and administrative structures of member institutions!
• We know of not a single developed country where there exist institutions operating under these models, neither of a regulatory framework designed to encourages its creation. Certainly not among the great FC movements of the world. Despite appearances, the Cooperative Bank of England and Banque Coop of Switzerland (both described in the CBCP) are NOT examples of such structures. In both cases, the bank is a service organization of a cooperative network of other Type (the Cooperative Wholesale Society and Groupe Coop Suisse, respectively) where a clearly established governance structure insures that second tier bodies (in these cases the banks) serve principal members and control agent entrenchment. Besides, despite their relative success as institutions, they can hardly be counted among the world's great success stories of the financial cooperative movements.
• In those developing countries where the regulatory framework encourages the creation of mega-CB (e.g. Colombia, Peru) the result has been catastrophic! In these countries, the entire financial cooperative movement collapsed, with practically all large CB-FC falling under the weight of massive agency costs ... and disappearing as cooperative organization through liquidation, demutualization or nationalization. Only (almost all) small local FC survived the massive confidence shock caused by the crisis, having lost all their second-tier structure and the confidence of members, and being left with the difficult task of rebuilding a disseminated sector.

Federated networks: an attractive choice!

As members of Quebec caisse populaires (and one of us appreciative former-member of a United States based, English-Canada-styled educators' credit union), we would hate to see a regulatory reform that in anyway would distort or derail the achievements of the Desjardins federated network system. The tremendous diversity of services and products offered to us at the provincial, national and international level, the competitive rates we obtain on (most) products, added to all the particularities of a cooperative —such as the personalized and attentive service we obtain from its employees, the general assembly that allows us to intermingle with employees and managers sharing cheese and wine while discussing relationships of the FC with the community and, sometimes, influence decisions-- makes us firm believers of the Desjardins model. The range of services offered in that educators' credit unions was just a fraction to that we receive in our, much smaller but federated, caisse populaires (albeit with the same cordiality!).

As a researcher, having studied –and continue to study--the systems of financial cooperatives around the world, we face strong and multiple evidences that the model of federated-networks (or networks in general) is a model of economic organization ideally suited for economic units that want to keep their independence, smallness and nearness to customers but would like simultaneously to exploit economies of scale and scope equivalent to those of the largest players in the market. For example:

• We know that historically this is the--back then, not-so-evident--choice taken by Friedrich W. Raiffeisen in 1872, and since copied around the world, with the highest rate of success for those that adopted the federated-network concept he fought for.
• We observe that a federated network structure (rather than a centrally managed hierarchy) is the norm of organization of cooperative entities in all types of industries when they seek to promote growth and create economies of scale and scope through pooling of inputs and standardization of products and infrastructure management, while preventing "being imposed a foreign will"^[11] (i.e. protecting the residual property rights and particular needs of members of the individual cooperatives).
• We know that stock owned firms in some of the most fiercely competitive industries –such as pharmaceutics, electronics, printing, banking, passenger airlines-- increasingly adopt the network style of organization (rather than mergers and acquisitions or fighting in isolation) with equal partners to accomplish their strategic goals.
• We observe that even those systems of financial cooperatives that are not currently (or were not in the recent past) organized around the model of federated network are switching outright to (e.g. Australia, Korea), or gingerly approaching the model (e.g. the United States' through Credit Unions Service Organizations, CUSOS, mini-networks of limited purpose).^[12]
• In the transition to a more dynamic model, existing second-tier organizations, such as the CU Centrals, would be excellent candidates to play the role of representation of the interests of the member FC. Type 3 federated strategic networks of FC are organizations that have gone one step further in the integration. These structures are more dynamic and capable than Type 2 networks in responding to rapid changes in market conditions and to manage more efficiently the production of a vast array of services to be delivered to members through the primary organizations. All that, insuring that the property rights of members of those primary organizations are duly respected and protected. All systems of Type 3 have evolved from and built on the achievements of one of Type 2, with the democratic and business structure adapting to the new more advanced level of integration.
• The reorganization of the system would benefit the totality of the movement (and not just a few ambitious FC) as long as they choose to be part of the process. And they could do this without being forced to give-up their independence, closeness and control by the community in which they are inserted .... to some big manager, impossible to control, sitting in Toronto, Calgary, Montreal or Vancouver.

These observations, some mentioned before, and an additional list that we obviate for reasons of brevity, suggest to us that Canadians of all origins would be best served if their cooperative depository institutions would converge towards a federated network of financial cooperatives (or cooperative banks). That is if the system of credit unions and caisses populaires –other than Quebec, being already there--would organize themselves around the second of the models proposed in the CBCP: the Federated CBM. Whether it takes the exact form of Rabobank (Netherlands, originally a Raiffeisen system), Raiffeisen (Austria, Germany, Luxembourg, Switzerland), Desjardins (our domestic version of federated-network with an eminent success), Credit Agricole/Mutuel/Maritime or Banques Populaires (France), Okobank (Finland), the NACUFOK, NFAC or KFCC (Korea), or others, is of secondary importance. They are all fundamentally similarly organized federated-networks of financial cooperatives (or cooperative banks) but that offer a menu of idiosyncratic institutional variations on which we can sink our regulatory and managerial teeth and sort out those small variation we like best.^[13] Afterwards, it would be a matter of time for those provincial, or regional (multiple provinces) networks to start merging—once the regulatory framework allows it-- into larger national networks .... just as it happened in Netherlands (where the Raiffeisen and Boerelen Banks merged to form Rabobank) or in Germany (where the Raiffeisen and the Schultze-Dilitzsch Volkbanken merged), always conserving the federated network approach to governance and business organization.

5. On federal-provincial regulatory harmonization: protecting the Quebec legal framework

This is no doubt a complex issue, and we do not intend to address it beyond some few observations related to the value of Quebec's legal, regulatory and supervisory framework and the need to protect it. The current Quebec legislation (as in all other Type 3 model based countries) supports the functioning of federated networks. But it does so not only for cooperative depository but also mutual insurance intermediaries (e.g. the Promutuel Federation, a network of user-owned and locally controlled insurance mutuals offering a wide range of insurance products and operating under network principles similar to those of Desjardins). This framework has provided a fertile environment for the creation and development of advanced and innovative financial institutions based on the principle of mutuality, both as depository and insurance intermediaries, that are showpieces of network organizations of mutual financial intermediaries (depository and insurance). So much so that they are of interest to many countries in the world, who come to study it for its rich experience and innovative features, and a model the McKay Task Force saw as an example to follow.^[14] Our own experience in studying and working on legal, regulatory and supervisory frameworks for mutual financial intermediaries (depository and otherwise) tells us that the development of suitable frameworks that boost the chances of forming dynamic networks of these institutions is a tricky business. This development has been managed with great success in Quebec (although you may argue about one or the other feature here and there). This makes the Quebec legislative framework one of the most creative in the world, but certainly the most advanced in Canada. Equally remarkable is the fact that in Quebec, the legislation that regulates operations of networks of depository institutions (Desjardins) is very similar to that regulating the operations of networks of insurance mutuals (Promutuel), despite, again, independent development. What is undeniable is that the experience pioneered by legislators for Desjardins helped to build the one on which Promutuel was built. In both cases, the legislation evolved over many decades (not always contemporaneously), with periodic adjustments to changing conditions, in a continuous interaction and feedback between the evolving networks themselves and the legislative bodies of the government. Putting on our researcher's hat, we would say this could suggest that wherever federated networks appear because of the existence of legal or economic evolutionary forces, a long dialog between the networks and the legislative bodies develops. This dialog will remain open and changing continuously in order to adapt the legal, R&S framework for these networks with the evolution of the economic and legal environment.

Federal legislation that would weaken the Quebec legal framework by creating opportunities for regulatory arbitrage by individual FC would weaken the Quebec-based federated network structure and undermine the work of almost a century of legislative evolution that created that environment. In the process it would be likely to undermine the evolution of the institutions that currently exist. Thus Quebec's legal framework should be viewed as a case to study closer, to learn from and to protect, rather than an obstacle for the growth of the FC system of Canada.

We hope that with this position we have helped to shed some light on this all-important debate.

Yours truly,

Klaus P. Fischer

, Ph.D.
Associate Professor in Finance, and
Martin Desrochers, MSc.
Researcher.
Centre inter universitaire de la recherche en économie politique et l'emploi (CIRPÉE)
School of Business, Laval University
Quebec, G1K 7P4, Canada

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Appendix : Case Study of American Credit Unions

This annex presents some empirical results of a simple evaluation of performance of American Credit Unions. We tried to estimate whether some of our simple assumptions are effectively observed in the case of these institutions. We are particularly interested in exploring two specific issues:

• Do larger institutions manifest an enhanced preference for expense?
• Does the common bond help in controlling expense preference?

The first is related to our argument that the increase in size is accompanied by a weakening of the governance of a mutual intermediary, and thus with an increase in the manifestation of expense preference behavior (EPB) by management. The second is related to the fact that certain forms of common bonds provide a better control of expense preference behavior, and in particular that multiple common bonds in a large FC tend to weaken the governance of the institution.

Let us first review some arguments why larger cooperatives should display EPB. All members of a cooperative share a small and equal stake of social capital. No member is subject to strong incentives to act on defending its own interests against those of managers, as would be the case for large stakeholders in a joint stock bank (JSB). In fact, they rather have incentives to delegate monitoring of management to other members. This situation favors the "free riding on monitoring" behavior of members, who do not have adequate incentives to properly supervise the activities of their managers. Further, in contrast to JSB, no secondary market for shares or for corporate control exist and thus managers are not subject to a disciplining effect by these markets either, something that occurs with joint stock companies of diffuse ownership, large or small.

It can easily be understood that as the number of member increases, the "free riding" phenomenon accentuates. In effect, small cooperatives, comprising a few members only, will favor a strong relationship between management and members. The closeness of the relationship inevitably weakens when the number of members expands. This gives managers a greater scope to follow their personal agenda, at the expense of members. As noted, in the economic and finance literature this phenomenon is known as "expense preference behaviour", or "agency costs". Agency costs are defined as the preference of managers to incur into excessive expenses, or expenses that do not reflect the priorities of members, e.g. luxury offices, travel expenses for managers, excessive staff, holding of real estate properties, and so on. Agency conflict between managers and members is a frequently cited problem of corporate governance of institutions whose control is widely dispersed, such as large cooperatives.

In terms of common bond, single common bond offers the tightest relationship (and monitoring) between members and managers, due to a strong commonality of employer, religion, profession, etc. Multiple common bonds provides a weaker link and finally the regional (or no) common bond provides, generally speaking, the weakest link between members. In particular, when this latter grow in size, almost nothing holds those members together as they become just customers of a financial intermediary over which they have little or no control ... very much like a JSB.

We now proceed to test whether large American credit unions effectively manifested EPB, and if a more rigorously defined common bond among members can reduce the ability of managers to engage in this Type of behavior. To perform this analysis, we considered National Credit Union Association (NCUA) financial statements available on the internet, from December 1996 until December 2001. More specifically, we considered between 10 107 and 11 573 CU each year with a total of around 60,000 observations (data in panel). This data was partitioned using two criteria: Size of the institution and quality of the common bond. We use NCUA size categories,^[15] and three categories of common bond: single common bond, multiple common bond, and regional or absence of common bond.^[16]

We will present only seven key variables: Efficiency, total assets, number of employees, median salary, credit risk, the proportion of wages over total assets, and the proportion of fixed assets over total assets. The concept of efficiency is widely used in finance literature.^[17] We do not want to emphasize on technical aspects here, but only mention that we estimated a stochastic cost frontier approach, standard in the more advanced banking research literature. To compute this frontier we considered four inputs (real value of deposits and social shares, real value of financial obligations, labor, and real value of buildings and facilities), their respective prices, and two outputs (loans and remaining assets).^[18] The efficiency measure is presented as a percentage relative to most efficient observation.^[19] More specifically, the lowest cost is presented as the numerator of the ratio, while the cost of each credit union is the denominator. A 70% efficiency score means 70% of the costs of this specific credit union are used efficiently, while remaining 30% are wasted inefficiently. Obviously, the lower the score, the higher is the inefficiency. Credit risk is estimated by the ratio of pass-due loans over total loans. Remaining concepts are rather obvious.

We summarize the results of the analysis in the following table:

Characteristics of American Credit Unions Median Values 1996-2000 Single Common Bond
	Number of observations	Efficiency score	Total real assets (US$)	Number of employees	Wages /Total assets	Median salary (US$)	Non performing loans ratio	Fixed assets / Total assets
< $2 M	11 347	78,05%	857 064	2	1,88%	10 271	2,22%	0,19%
$2M-$10M	10 141	73,34%	4 377 986	3	1,79%	25 505	1,43%	0,45%
$10M-$50M	4 663	70,00%	16 677 677	8	1,62%	33 065	0,98%	1,07%
> $50M	1 646	69,89%	90 769 335	39	1,51%	36 416	0,66%	1,38%
Multiple Common Bond
	Number of observations	Efficiency score	Total real assets (US$)	Number of employees	Wages /Total assets	Median salary (US$)	Non performing loans ratio	Fixed assets / Total assets
< $2 M	3 259	76,86%	1 166 017	2	2,25%	15 530	2,41%	0,33%
$2M-$10M	7 925	70,98%	5 257 159	4	2,04%	26 087	1,39%	0,96%
$10M-$50M	8 848	67,99%	19 048 083	11	1,87%	30 674	1,01%	1,76%
> $50M	5 159	67,51%	98 669 483	53	1,75%	34 066	0,70%	1,87%
Regional or absence of Common Bond
	Number of observations	Efficiency score	Total real assets (US$)	Number of employees	Wages /Total assets	Median salary (US$)	Non performing loans ratio	Fixed assets / Total assets
< $2 M	1 895	73,28%	888 728	2	1,90%	9 760	2,38%	0,27%
$2M-$10M	3 104	69,64%	4 874 939	4	1,96%	24 533	1,28%	1,37%
$10M-$50M	3 641	65,98%	19 964 913	12	1,89%	29 294	1,00%	2,19%
> $50M	2 011	65,72%	91 340 302	53	1,78%	32 165	0,70%	2,25%
Source: National Credit Unions Association

The first column of the table shows that the number of credit unions whose members have a unique common bond is not equally distributed among size categories. These institutions are usually much smaller than credit unions whose members have multiple common bonds or no common bond at all. In effect, 11 347 observations present assets below US$2 Millions, representing 23 percent of total observations. The respective proportions are 13% and 18% for credit unions having multiple common bonds or regional/absent common bond.

The second column displays a very interesting pattern: We observe that a stronger common bond is associated to a higher cost-efficiency score. Credit unions characterized by a single common bond present a median efficiency score between 70% and 78%. The median figures for institutions that favored a multiple common bond is slightly lower, between 68% and 77%. Credit unions with a regional or no common bond for their members are even less efficient, with median figures between 66% and 73%. To be clear, the decision to be a small and close institution, rather than a large and open one increases cost efficiency by 13% on average! Also interestingly, we observe important differences between size categories, and this for all common bond categories. The tendency is clear: The larger the institution the larger the inefficiencies. For single bond credit unions, the efficiency score passes from 78% for the smallest institutions to 73% for institutions whose assets are between US$2 Millions and US$10 Millions, and finally 70% for those whose assets are above US$10 Millions. Similar results are obtained for credit unions characterized by a multiple or regional/absent common bond.

The median size across categories is rather homogeneous. The median size of very small credit unions varies between US$0,9 Million and US$1,2 Millions. Size of small and medium institutions fluctuates around US$4,4 Millions - US$5,3 Millions and US$16,7 Millions-US$20 Millions, respectively. Median size of largest institutions varies between US$90,8 Millions and US$98,7 Millions.

Despite similar size of assets, credit unions characterized by a single common bond usually employ less people than credit unions characterized by a multiple or regional/absent common bond. One can say that the largest credit unions with regional/absent common bond hire 14 superfluous employees, to manage almost the same volume of activity than their single common bond equivalents. This is a very strong argument in favor of the EPB hypothesis. The reduced number of employees in single bond institutions is also reflected in a smaller proportion of wages in proportion of total assets, as can be seen in the fifth column.

Greater efficiency in personnel management does not necessarily goes at the expense of employees wages. Single common bond institutions present a greater median wage than credit unions without common bond, and this in all size categories. Small and very small multiple common bond credit unions offer better pay to their employees. Employees of medium and large institutions are better paid when a single common bond exists.

The next observation of interest is that a loosening of the common bond among members of U.S. credit unions seems to be associated with a higher pass-due loans ratio. This observation contradicts common belief that a wider geographical diversification reduces credit risk. The observation can be explained by a reduction of the strength of the relationship with clients, associated to a larger and more diffuse clientele.

Finally, very small credit unions in almost every year present the smallest ratio of fixed assets over total assets, in all common bond categories. This result goes straight up against common belief and often presented arguments that larger institutions will be more efficient. A growth of fixed assets is to be expected, but we do not believe a five or sevenfold increase of the ratio is uniquely associated to delivery of new and improved services to members such as an increase network of ATMs, more branch offices, etc. It is more likely that some of these fixed assets are acquired in response to the managers' own agenda. Most likely, managers of large credit unions prefer to increase the proportion of non-productive assets above the level achieved by much smaller institutions, exactly as the EPB theory proposes.

To conclude with these evidences about the U.S. experience, larger institutions are not more efficient than their smaller counterparts: They do not reduce the relative importance of fixed costs such as buildings and facilities or wages. Also, it is clear that credit unions whose members are closely associated through a common bond such as a common employer are more efficient, employ relatively less people, manage credit risk in a more efficient manner and waste less resources into non-productive assets than credit unions characterized by a multiple or regional/absent common bond. To review our initial hypotheses,

• Yes, larger institutions do display an accrued problem of EPB.
• And yes, a suitably defined common bond does help to control EPB.

Leggett and Strand^[20] obtained similar results using American credit unions. These empirical results, based on a very extensive data base of independent American credit unions operating in a somewhat similar environment, leave us to think that the option of creating a network of small, local cooperatives should be preferred to the alternative of creating large, nationwide cooperatives.

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Annex I : Categories of Common Bond

Regional or absence of Common Bond
00 = Community credit union
99 = State chartered natural person credit union
Single Common Bond
01 = Associational - faith based
02 = Associational - fraternal
03 = Associational - other than faith based or fraternal
04 = Educational
05 = Military
06 = Federal, State, Local Government
10 = Manufacturing - chemicals
11 = Manufacturing - petroleum refining
12 = Manufacturing - primary and fabricated metals
13 = Manufacturing - machinery
14 = Manufacturing - transportation equipment
15 = Manufacturing - all other
20 = Service - finance, insurance, real estate, trade
21 = Service - health care
22 = Service - transportation
23 = Service - communications and utilities
24 = Single common bond - other
Multiple Common Bond
34 = Multiple common bond - primarily educational
35 = Multiple common bond - primarily military
36 = Multiple common bond - primarily federal, state, local government
40 = Multiple common bond - primarily chemical
41 = Multiple common bond - primarily petroleum refining
42 = Multiple common bond - primarily primary and fabricated metals
43 = Multiple common bond - primarily machinery
44 = Multiple common bond - primarily transportation equipment
49 = Multiple common bond - primarily other manufacturing
50 = Multiple common bond - primarily finance, insurance, real estate, trade
51 = Multiple common bond - primarily health care
52 = Multiple common bond - primarily transportation
53 = Multiple common bond - primarily communications and utilities
54 = Multiple common bond - primarily faith based
60 = Corporate credit unions
98 = Multiple common bond - other
Source : National Credit Union Association.

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Annex II: Definition of variables

Dependent Variables		Definition
Costs	Real costs, in millions US$, deflated by the Consumer Price Index (CPI) with 1995 as the base year.	Acct_350 + Acct_671
Independent Variables - Input prices		Definition
w1	Real annual, ex post interest rate on deposits and dividend rate on shares, in percentage.	(Acct_380+Acct_381) / Acct_018
w2	Real annual, ex post interest rate on financial obligations, in percentage.	Acct_340 / (Acct_014 - Acct_018)
w3	Real wage rate, in US$ dollars by full and part-time employee and deflated by the CPI.	Acct_210 / (Acct_564A + Acct_564B)
w4	Real occupancy expenses, defined as occupancy expenses divided by fixed assets, in percentage.	Acct_260 / (Acct_007 + Acct_008)
Independent Variables - Input quantities		Definition
x1	Deposits and shares, in millions US$, deflated by the CPI.	Acct_018
x2	Financial obligations, in millions US$, deflated by the CPI.	Acct_014 - Acct_018
x3	Number of full-time and part-time employees.	Acct_564A + Acct_564B
x4	Amount of fixed assets, in millions US$, deflated by the CPI.	Acct_007 + Acct_008
Independent Variables - Output quantities		Definition
y1	Loans, in millions US$, deflated by the CPI.	Acct_025B
y2	Other assets, in millions US$, deflated by the CPI (Total assets less loans and fixed capital).	Acct_010 - Acct_007 - Acct_025B
Accout Number	Description	NCUA File number
Acct_007	Land and Building	FS220
Acct_008	Other Fixed Assets	FS220
Acct_010	Total Assets	FS220
Acct_014	Total Liabilities and Equity	FS220A
Acct_018	Total Shares and Deposits - Total	FS220
Acct_025B	Amount - Total Loans	FS220
Acct_210	Employee Compensation and Benefits	FS220A
Acct_260	Office Operations Expense	FS220A
Acct_340	Interest on Borrowed Money	FS220
Acct_350	Total Interest Expense	FS220A
Acct_380	Dividends on Shares (Includes dividends earned during current period)	FS220
Acct_381	Interest on Deposits	FS220A
Acct_564A	Number of Full-Time credit union employees	FS220A
Acct_564B	Number of Part-Time credit union employees	FS220A
Acct_671	Total Non-Interest Expense (Sum of 210,230,250,260,270,280,290,300,305,310,320,360)	FS220
Source: National Credit Union Association.

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^1. The opinions expressed in this document in no way pretend to represent the official point of view of the institutions to which we are associated and that are mentioned in the text. These institutions have not been consulted in any way during the preparation of the text and therefore the opinions expressed are our full responsibility.   [Return]

^2. Task Force on the Future of the Canadian Financial Services Sector, September 1998, Background Paper #2, Chapter 5, p. 111.   [Return]

^3. There is still another section of the Canadian market, a population not even served by FC, where a modern equivalent to the proverbial moneylender operates, the pawnshop. This institution works on a combination of marketable real collateral and knowledge of the creditworthiness of individual dwellers of the community where they operate, and where customers obtain an around-the clock and reliable service they could not obtain in a bank, ... or a FC for that matter. It is not by accident that pawnshops are all placed right at the border of the poorest sections of towns.   [Return]

^4. It would be conceivable, however, that a large institution that operates with well-established rules to prevent expropriation and hold-up could be created. However, this represents a major institutional challenge. As we will see later on, the larger the mutual institution, the more problematic becomes its governance, giving rise to another problem: increased agency conflicts. In practice, there are no examples of successful large regional or national consolidated FC other than a few built around a single professional bond (e.g. medical doctors) or employer (e.g the U.S. Navy, General Motors). In the latter, the sponsor, as guarantor of the institution, often plays the role of additional "supervisor" in representation of members.   [Return]

^5. See Klaus P. Fischer. Governance, regulation and mutual financial intermediaries performance: the foundations of success. CREFA-CIRPÉE Working Paper No. 01-11 (2001), also posted on this web site.   [Return]

^6. See for example Srinivasan R. Akella and Stuart I. Greenbaum. "Savings and loan ownership structure and expense preference." Journal of Banking and Finance, 12:419–437, 1988.   [Return]

^7. Task Force on the Future of the Canadian Financial Services Sector, September 1998, Background Paper #2, p. 112.   [Return]

^8. Fischer (2001) classified Types 1,2 and 4 under the encompassing label "atomized-competitive" and Type 3 "integrated federated networks". In that paper, the purpose was a different one: to compare the performance of our Type 3 federated strategic networks against others.   [Return]

^9. Even this relatively harmless restriction, applied to another country where public and diffuse ownership is practically out of question (as is the case in many developing countries), could make life difficult for banks. They would risk languishing undercapitalized for lack of investors willing to take risk positions in an institution they cannot control.   [Return]

^10. We could provide a considerable list of examples where the tampering with those governance mechanisms, either by regulators or by powerful agents within the institutions, has simply and plainly resulted in the exit of the institution from the market .... through failure.   [Return]

^11. Book of Proceedings (1917-1953) of the Mutual Fire Insurance Company of the parish of Charlesbourg (Quebec), 8 of September, 1940.   [Return]

^12. It is interesting to note that Chris Langley, President of UniTrust Financial Services LLC, a CUSO that provides financial management advice, services and products, noted in a recent conference: "We wanted to develop a retail environment and reposition the credit union brand... the necessary economies of scale were nearly impossible to reach for a single credit union, but that a network of CUs provided the size and membership base needed to succeed." Further, "You look at what's going on in the CUSO world now and see this trend from wholly-owned to a shared or network model. It can work if all the partners are in sync. All that must be hammered out ahead of time, especially the sales philosophy and distribution of profit"   [Return]

^13. See for example the Submission by the Alliance of Credit Unions in this web site. The approach suggested by the Alliance is perfectly consistent with the "Federated" CBM and thus to applaud and worth careful consideration. However, at first sight, some important pieces are missing to make it workable. For example, once the members of the Alliance engage in the model, the appropriate governance structures must be created to insure that all parties in the collective agreement respect the terms of the same. Among the features of such a governance structure, it will be necessary to set up bodies in charge of prudential supervision of participating members and of the service organizations to insure that everybody adheres to terms of the contract, including the "cooperative bank" and other service organizations that may be created. The role of these bodies and their link with state supervisors (provincial and/or federal) will have to be established. Further, given that the business future of the members of the Alliance is now tied together and default of one can bring down the whole network, cross insurance arrangements will have to be set up, be this through central contingency funds and/or explicit cross insurance agreements. This, in turn, increases the need for cross supervision. We could go on noting some of the key features of a well functioning network that have received no attention in the submission of the Alliance.   [Return]

^14. To top the interest, it might be added that given the particular situation of Quebec with one foot in the "common law" and the other in the "civil law" legal traditions, makes it a particularly interesting case study for regulators and legislators interested in regulatory and legal frameworks for coops the world over.   [Return]

^15. Peer 1 (below US$2 Millions), Peer 2 (between US$2 Millions and US$10 Millions), Peer 3 (between US$10 Millions and US$50 Millions), and Peer 4 (more than US$50Millions).   [Return]

^16. Definitions of categories are presented in Annex I.   [Return]

^17. The reader is referred to Allen N. Berger and Lorretta J. Mester, "Inside the Black Box : What Explains Differences in the Efficiencies of Financial Institutions?" Journal of Banking and Finance, Vol. 21, 895-947, 1997 for a thorough review of these models. Readers interested in knowing more about the details of the methodology used in this work may approach either of the co-signatories of the position.   [Return]

^18. Definitions of variables are presented in Annex II.   [Return]

^19. After eliminating both 5% tails of the distribution.   [Return]

^20. Keith J. Leggett and Robert W. Strand, Membership growth, multiple membership groups and agency control at credit unions, Review Of Financial Economics Vol. 11 (2002), 37-46.   [Return]