The Economics of Financial Cooperatives

Income Distribution, Political Economy and Regulation

Amr Khafagy

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781000703030
• Edition: 1
• Topic: Economía
• Subtopic: Política monetaria

Building on theories of finance and distribution, and the political economy of finance, this book explains the influence of financial cooperatives on wealth and income distribution, and institutional factors that determine the development of financial cooperatives. The book discusses the dynamics of income and wealth distribution with and without financial cooperatives, and defines the economic objective for financial cooperatives. Through explaining the influence of political institutions and regulations on the development of financial cooperatives, this book examines why financial cooperatives grew in some emerging economies and not in other similar ones.

The book is of interest to scholars interested in financial economics, political economy of finance, alternative banking and development finance, and banking regulation. The book also gives valuable output to central bankers and financial and monetary policy makers in underdeveloped economies. In addition, it will be of particular interest to practitioners in international development institutions, especially those engaged in development finance and rural finance.

1 Introduction

Why financial cooperatives matter now

1.1.Introduction

Financial cooperatives are financial intermediaries owned by the same people they intend to serve. Founded in the mid-nineteenth century, the focus on communal solidarity and unlimited liability of members enabled Raiffeisen’s and Schulze-Delitzsch’s cooperative models to overcome information asymmetry problems and provide credit, savings, and insurance services for low-income farmers and artisans at times when access to credit was nearly impossible. Financial cooperatives hold a significant market share in Europe and Latin America, as well as a few countries in Sub-Saharan Africa. They also have a strong presence in Asia, Australia, and the United States. According to the World Council of Credit Unions (WOCCU), there were 68,882 financial cooperatives in 109 countries in 2016, serving more than 235 million members, with total assets exceeding 1.7 trillion dollars. It is worth noting that the WOCCU’s data do not include some major financial cooperative networks in Europe, such as Germany, Finland, France, Denmark, and Italy. In many high-income economies, financial cooperatives hold significant market shares of the banking sector. The market share of financial cooperatives in the Small and Medium Enterprises (SMEs) credit market by the end of 2016 was 37% in Finland, 45% in France, 33% in Germany, 43% in the Netherlands, and 22% in Canada. In Germany, Volksbanken-Raiffeisen banks have a market share of approximately 21% of domestic credit and domestic deposits. In the Netherlands, RaboBank holds 34% of deposits, and in France cooperative banks (Crédit Agricole, Crédit Mutuel and BPCE Group) possess more than 59% of domestic credit and 61% of domestic deposits. In Finland, OP financial group holds 35% and 38% of domestic credit and deposits, respectively, and in Canada, Desjardins holds around 42% of domestic deposits and 22% of domestic credit (EACB, 2017; WOCCU, 2017). There are many types of cooperative financial institutions with different names across the world, including financial cooperatives (‘cooperativa financiera’ is the Spanish term used in Latin America), cooperative banks, credit unions, and savings and credit cooperatives (‘cooperativa de ahorro y crédito’ in Spanish or ‘coopérative d’épargne et de credit’ in French-speaking countries).

This book discusses the influence of cooperative financial institutions on income distribution and the institutional factors that determine the development of cooperative financial institutions. It responds to the following questions: does the ownership structure of financial institutions affect income inequality? If so, then how can member-owned financial institutions promote a more egalitarian distribution of income? If cooperative financial institutions have a comparative advantage over other banking models when it comes to micro, SME lending, and accordingly with regard to income distribution, then why did financial cooperatives grow in some emerging economies and not in other similar economies? The book addresses two institutional factors that may influence the development and growth of financial cooperatives. In particular, it explores how political institutions can dictate the development of financial cooperatives and the motives behind the behaviour of these political institutions. In addition, it explores the regulatory and supervisory approaches that would better support the growth and resilience of the sector in underdeveloped economies. This book contributes to literature on the political economy of finance (Nienhaus, 1993; Pagano and Volpin, 2001; Rajan and Zingales, 2003; Perotti, 2014), finance and income distribution (Greenwood and Jovanovic, 1990; Banerjee and Newman, 1993; Galor and Zeira, 1993; Aghion and Bolton, 1997; Piketty, 1997), financial sector regulations (Vittas, 1992; Brunnermeier et al., 2009), as well as the economics of cooperative financial intuitions (Münkner, 1986; Ferguson and McKillop, 1997; Poyo, 2000; Cuevas and Fischer, 2006; Ferri et al., 2014).

1.2.Financialization, distribution, and the political economy of finance

The essential motive behind the interest in the economics of financial cooperatives is to explore aspects related to control over financial resources and how that influences the distribution of wealth and political power. Financial cooperatives can mobilise local financial resources and attract external funds for the benefit of local economies. In many low- and middle-income economies, deposits are channelled from small depositors, famers, pensioners, and workers to big banks outside the local communities of the original depositors (money owners). Original owners of these funds are rarely able to benefit from them, as the concentration of banks’ ownership serves the interests of a few large shareholders or narrow corporatists commonly linked to the governing political authorities. That makes financial cooperatives not only important for financial inclusion and economic growth, but their distinctive ownership structure also allows them to be practical instruments for redistributing economic resources and political bargaining power. This book aims to highlight and recognise the political and economic potentials of financial cooperative, as grassroot organisations owned by the people they are supposed to serve, and which have the ability to represent their interests and strengthen their political bargaining power.

While the financial sector should respond to the needs and interests of societies, especially low- and middle-income classes, the sector seems to be functioning for the sole interest of a narrow group of rentiers. There are growing concerns about unequal income and wealth distributions, especially in the current period of financial capitalism, and the rapid expansion of the sector is a heated topic at the heart of the current political and economic debate over wealth and income distribution. The 2007–08 financial crisis intensified criticism over the financialization of the economy and the role of the financial sector in causing a global economic crisis, with ruinous economic and political consequences that are still being experienced. Banks and capital markets became disconnected from their societies, pursuing short-term profits at the expense of the longer-term macroeconomic benefits, with privatised gains for a few financiers and shareholders and socialised losses that are disproportionately distributed on the rest of the society with lower classes bearing higher burdens. A number of recent studies suggest that too much finance harms the real economy and tends to have negative impacts on economic growth (Law and Singh, 2014; Arcand et al., 2015; Cecchetti and Kharroubi, 2015).

The allocation of capital by the financial system directly affects the rate of economic growth and the demand for labour, both of which have direct implications on poverty and income distribution (Demirgüç-Kunt and Levine, 2009). Economic theory and recent empirical literature provide contradictory results on the impact of the financial sector on income distribution. A number of theories suggest that financial sector growth would have a positive influence on economic growth and would reduce income inequality. In a perfect credit market, financial institutions channel money from agents who have surplus savings to agents who have high-return investment opportunities. The assumption of diminishing marginal returns on capital suggests that low-capital investments should be more preferable to lend as they yield higher marginal returns than high-capital investments, and consequently, low-income agents will have the opportunity to benefit from the capital channelled through financial intermediaries coming from wealthy agents (Beck et al., 2007; Ben Naceur and Zhang, 2016). But this is not how financial sectors work in the real world of imperfect credit markets. Financial institutions usually serve those who have sufficient collaterals or political connections to acquire credit, while low- and middle-income agents are more likely to be excluded from the credit market, especially in the early stages of economic development. Limited access to capital has long been recognised as a reason for persistent and increasing income inequality. Low- and middle-income agents are likely to be credit rationed from the credit market because information asymmetries and weak contract enforcement institutions discourage banks from lending to them and from exploiting potential high-return investments. Figures 1.1–1.4 show how domestic credit and capital markets as a percentage of Gross Domestic Product (GDP) have remarkably increased globally during the last 25 years, as well as the parallel growth in the share of the top 1 and 10% earners as percentage of pre-tax national incomes. These data were obtained from the World Inequality Database and the World Bank Open database.

Overcoming credit constraints would benefit the lower income classes, reduce wealth inequality, foster economic growth, and improve the efficiency of capital allocation (Banerjee and Newman, 1993; Galor and Zeira, 1993; Aghion and Bolton, 1997; Piketty, 1997). However, empirical studies on finance and inequality have focused only on the size and not the structure of the financial sector. Existing empirical literature on finance and income inequality tends to treat the financial sector as consisting of homogeneous lenders and does not account for the heterogeneity among financial institutions in terms of ownership structure. The influence of the financial sector structure and banks’ ownership on wealth and income distribution remains remarkably understudied.

Figure 1.1 Domestic credit and top 1% share of pre-tax income (global).

Figure 1.2 Domestic credit and top 10% share of pre-tax income (global).

Figure 1.3 Market capitalization of listed domestic companies and top 1% share of pre-tax income (global).

Figure 1.4 Market capitalization of listed domestic companies and top 10% share of pre-tax income (global).

Lenin (1999: 45 [1916]), building on Hilferding’s (1981 [1910]) seminal thesis on finance capitalism, argued that a key feature of the growth of capitalism is the expansion of the banking industry and the tendency to become concentrated in a small number of institutions. Banks underwent a transformation from simple financial intermediaries into powerful monopolies controlling a large proportion of money capital in the economy, which originally belonged to capitalists and small businesses, as well as wage and salaried workers. Concentration of the financial sector and concentration of ownership over these institutions placed a large proportion of the means of production and sources of raw materials in the hands of small elite that allocates financial resources according to its narrow interests, and there is no guarantee or incentive for banks to pursue social or communal goals. Existing literature that discusses ownership structures focuses only on the comparison between private and state ownership, or between domestic and foreign ownership, but the concentration of ownership and its influence on distribution is nearly neglected from current academic or political debates. Concentration of ownership is mainly discussed focusing on the efficiency and stability of banks and the financial sector. For instance, diffused ownership is thought to decrease the effective control of shareholders over the firm and transfers the control to the management because shareholders will not have enough incentives to monitor the management of the firm. Besides, conflicting interests between several controlling shareholders may affect timely and efficient decision-making. On the other hand, the concentration of ownership improves corporate control by strengthening monitoring over management because large shareholders bear most of the failure cost and they have a strong incentive to monitor the management (Berle and Means, 1933; Shleifer and Vishny, 1986). But large shareholders are also capable of expropriating minority shareholders if conflicting interests exist between both shareholding groups (Gomes and Novaes, 1999, 2005). Overall, ownership and management monitoring can be substituted by increased regulation. In comprehensively regulated industries, like the financial sector, managers may be efficiently monitored by the regulators, which in turn reduce the potential risks and benefits of controlling ownership (Demsetz and Lehen, 1985; Elyasiani and Jia, 2008). Iannotta et al. (2007) showed that concentrated ownership of banks is correlated with lower asset and insolvency risks and improved loan quality. Recently, Sawyer and Passarella (2017) developed an interesting Stock Flow Consistent model for the financial sector, based on the Monetary Circuit theory, presenting a modernised financialized economy with endogenous money creation by commercial banks. They divided the financial sector into commercial banks, which are able to create money, and other financial institutions that can provide financial services but cannot create money. They differentiated between ‘workers’ and ‘rentiers’ to highlight changes in income distribution and showed how financializat...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication Page
• Table of Contents
• List of figures
• List of tables
• Acknowledgements
• List of acronyms
• 1 Introduction: why financial cooperatives matter now
• 2 Finance, distribution, and the economic objective of financial cooperatives
• 3 Financial cooperatives and income inequality: empirical evidence
• 4 Political economy theory for financial cooperative development
• 5 Political institutions and financial cooperative development: empirical evidence
• 6 The origin and rationale for financial cooperative regulation in underdeveloped economies
• 7 Regulation, supervision, and deposit insurance for financial cooperatives: an empirical investigation
• Discussion and conclusions
• Appendix
• Index