Cooperative financial institutions: A review of the literature

Abstract

Financial cooperatives play an important role in the financial systems of many countries. They act as a safe haven for deposits and are major sources of credit for households and small- and medium-sized firms. A not-for-profit orientation (in many cases) and a focus on maximising benefits to members have ensured the enduring popularity and sustainability of financial cooperatives. This is particularly evident since the global financial crisis when financial cooperatives continued to extend credit to members as many profit-orientated commercial banks restricted credit to households and firms. The overarching theme of the first part of this review is the structural and behavioural characteristics of financial cooperatives. In this part we consider, the origin and diffusion of financial cooperatives, network arrangements, the business model, relationship banking, balancing the interest of members, tax treatment and regulatory framework. The second part has performance and contribution to the real economy as the overarching theme. In this part we consider, efficiency and sustainability, mergers, acquisitions and failures, the benefits (and challenges) of FinTech and the contribution of financial cooperatives to the real economy including during times of crisis. The paper concludes with a summary of what we now know (and do not know) about financial cooperatives and provides suggestions as to where future research may usefully concentrate.

Highlights

• •This paper reviews research on cooperative financial institutions in two parts.
• •The theme of the first part is structural and behavioural characteristics of financial cooperatives.
• •In the second part, the theme is performance and contribution to the real economy.

1. Introduction

Cooperative financial institutions comprise a variety of member-owned financial intermediaries variously referred to as credit unions/caisse populaires, savings and credit cooperatives, cooperative banks and Shinkin Banks. Credit unions/caisse populaires have a strong presence in North America, while cooperative banks are the dominant organisational form in many European countries. The institutional structure, legal and regulatory status, product offerings and business models varies across countries, and especially between advanced and emerging countries (Cuevas & Buchenau, 2018; Cuevas & Fischer, 2006). For example, credit unions/caisse populaires are not-for-profit entities, which provide services to members. Shinkin banks are also not-for-profit but restrict loans to members while accepting deposits from non-members. Cooperative banks are for-profit organisations that provide services to both members and non-members. However, unlike shareholder-based commercial banks, cooperative banks do not seek to maximise profits but rather generate profit in order to bolster capital and fund long-term growth.

Four cooperative principles shape the structure of cooperative financial institutions and set them apart from shareholder-based banks. Self-help: Cooperatives are member-owned and member-governed financial organisations that aim to achieve pre-determined economic and social objectives. Identity: A majority of cooperatives have a membership that is concentrated at a local or regional level and cater to the financial needs of individual members, community groups and small firms. Democracy: Each member has only one vote, irrespective of how many shares held. This reduces the ability of any one member or group of members to impose a controlling influence on the direction of the institution. Cooperation among cooperatives: Considered individually, financial cooperatives are often small. However, as they do not typically compete with each other (due to self- or regulatory-imposed limits on geographic spread), they have formed cooperative arrangements that have enabled them avail of scale and scope economies. In Europe, cooperative banks have developed prominent central institutions and formed network alliances. These networks range from loose associations to cohesive groups, and can be simple or complex multi-levelled structures (Bülbül, Schmidt, & Schüwer, 2013; Fonteyne, 2007).

The above principles confer a number of potential benefits on financial cooperatives. First, saving members and borrowing members, as owners of the financial cooperative, are inextricably bound to its fortunes. This may help mitigate the conflict (visible in shareholder-based financial institutions) between borrowers (who want as low cost credit as possible) and savers (who want as high a return on savings as possible). Second, as membership is structured around a common identity usually based on geographic location, information asymmetry (adverse selection) is reduced leading to better loan decisions, as borrowers are less able to under-represent risk. Furthermore, as borrowers have social and business connections through the common identity to other members there may be large informal costs of reneging on loan repayments thus enabling social capital to be used as ‘collateral’ in lending and in so doing reduce moral hazard (Fonteyne & Hardy, 2011; Guinnane, 2001). Third, depositors (as owners) are likely to maintain savings in periods of economic uncertainty thus ensuring retail funding stability. Fourth, given that employee remuneration is not linked directly to profits or share option arrangements, this may encourage management to be more circumspect in their behaviours relative to management in shareholder-owned banks (van Rijn, Zenga, & Hueth, 2019).

Arguably, there are also a number of disadvantages to the cooperative structure. First, transfers to reserves from profits are the main, if not only, source of capital accumulation for many cooperative financial institutions.1 Second, as there is no externally held capital and no tradable ownership rights, cooperative institutions face no (or weak) discipline from the market in corporate ownership and control. Third, the one member one vote system arguably means that members have insufficient incentive to engage in monitoring as their ability to exercise control is weak and potential rewards are low.2 In such circumstances, agency costs may be high and adversely affect efficiency and performance. In particular, management may have greater opportunity to indulge in discretionary expenditures and the pursuit of managerial emoluments (expense preference behaviour).

The remainder of the paper offers a review of the economics and finance literature on financial cooperatives published over the course of last five decades. The review is partitioned into two parts. The overarching theme of the first part is the structural and behavioural characteristics of financial cooperatives. In this part we consider, the origin and diffusion of financial cooperatives, network arrangements, the business model, relationship banking, balancing the interest of members, tax treatment and regulatory framework. The second part has performance and contribution to the real economy as the overarching theme. In this part we consider, efficiency and sustainability, mergers, acquisitions and failures, the benefits (and challenges) of FinTech and the contribution of financial cooperatives to the real economy including during times of crisis. We conclude with a summary of what we now know (and do not know) about financial cooperatives and provide suggestions as to where future research may usefully concentrate.

2. Part one: structural and behavioural characteristics

With the structural and behavioural characteristics of financial cooperatives as an overarching theme, part one of this review considers, under a series of sub-themes, the origin and diffusion of financial cooperatives, network arrangements, the business model, relationship banking, balancing the interest of members, tax treatment and regulatory framework.

2.1. Origin and diffusion

Cooperative financial institutions originated in Germany in the mid-19th Century as philanthropic self-help institutions designed to encourage workers to join resources and accumulate savings. Hermann Schulze-Delitzsch (1808–83), a politician and judge, founded the first urban credit cooperative in 1850. Friedrich Wilhelm Raiffeisen (1818–88), a mayor in Western Rhineland, formed the first rural credit cooperative in 1864. Raiffeisen emphasised Christian principles as the motivation for the establishment while Schulze-Delitzsch was mainly concerned with promoting economic self-sufficiency (Aschhoff, 1982; Guinnane, 2001, Guinnane, 2002). A principal purpose of early credit cooperatives was to draw outside funds into communities that needed them, not as charitable donations, but as loans to be repaid (Isbister, 1994). The model quickly spread to other countries in Europe. First to surrounding countries, namely Austria, Italy, Switzerland and the Netherlands then west to Belgium, France and Spain and eventually north to Finland and Sweden (Birchall, 2013b; Colvin & McLaughlin, 2014).3 Inspiration for cooperative ideals was also found in Great Britain where the Rochdale Society of Equitable Pioneers, a group of 28 workers, came together in 1844 to open their own cooperative store selling food items (Merrett & Walzer, 2004; Walton, 2015).4 A further example was in New Lanark, Scotland where Robert Owen (1771–1858) and other mill owners agreed to limit their returns on invested capital and to use residual profits that accrued for the benefit of the entire community (Royle, 1998).

At the beginning of the 20th Century, the financial cooperative concept spread from Europe to North America. The first financial cooperative (caisse populaire) was established in 1900 in Canada (Quebec). Alphonse Desjardins (1854–1921), first a journalist and then a parliamentary reporter, moved by the victimization of the poor by loan sharks established the first caisse populaire (people's bank) in 1900 in his home town of Lévis in Quebec. He proceeded to set up a further 150 over the next fifteen years (MacPherson, 1979; Mook, Maiorano, & Quarter, 2015). Desjardins helped establish the first US credit cooperative in Manchester, New Hampshire, in 1908. This was based around a Franco-American parish administered by Monsignor Pierre Hevey and it initially served French-speaking immigrants to Manchester from the Maritime Provinces of Canada (Moody & Fite, 1984; Walter, 2006). The mantle for credit cooperatives in the US was then taken up by Pierre Jay (1870–1949), the commissioner of Banks in Massachusetts, and Edward Filene (1860–1937), a Boston businessman and philanthropist. These individuals promoted and were instrumental in the passing of the Massachusetts Credit Union Enabling Act in 1909, the first credit union legislation in the US. A further person of influence in the US was Roy Bergengren (1879–1955) who along with Filene formed the Credit Union National Extension Bureau which was tasked with lobbying for credit union legislation at both State and Federal level. In 1934, the Federal Credit Union Act was passed. This Act encapsulated much of Bergengren's interpretation of what credit unions are, how they should be structured and how they operate in law (Kaushik & Lopez, 1994; Moody & Fite, 1984). During the remainder of the 20th Century, the model continued its spread and now extends to most of the Anglo-Saxon world and beyond (Fonteyne & Hardy, 2011).

Table 1 details a selection of size and market share metrics for cooperative banks. This information is for end year 2018 and concentrates upon European countries where cooperative banks originate and currently have significant market share.5 There are 2816 independent cooperative banks operating through 51,588 branches, with 712,700 employees and aggregate assets of €712.7 billion. Customer reach extends significantly beyond core membership (members to customers across countries averages 40%). Cooperative banks in Austria, Denmark, Finland, France, Germany, Luxembourg and the Netherlands have a sizeable share of the domestic banking market while in Finland, France, Germany and the Netherlands they are also an important source of funding for small and medium sized enterprises (SMEs).

Table 1.

Characteristics of cooperative banks by country.

The table displays characteristics of cooperative banks and national associations for cooperative banks by country for end year 2018.

European Union countries	Total assets (€ 100 mil.)	# employees (thou.)	# customers (thou.)	# independent cooperative banks	# branches domestic	# members (thou.)	Domestic deposit share (%)	Domestic loans share (%)	Mortgage share (%)	Market share SMEs (%)
Austria	326.2	30.1	4709	403	1746	2361	36.8	35.3	35.9	n.a.
Bulgaria	2.9	2.0	1785	n.a.	308	6.4	5.6	3.9	4.1	n.a.
Denmark	193.7	3.4	1159	56	42	493	5.1	31.4	41.3	n.a.
Finland	140.4	12.2	4282	156	365	1911	38.4	35.5	39.5	39.6
France	3981.4	327.9	113,500	86	21,055	27,000	62.7	60.3	76.9	50.3
Germany	1293.2	174.3	30,000	875	10,520	18,560	21.9	21.9	30.6	35.8
Greece	2.8	0.9	412	7	110	179.2	1.0	0.8	n.a.	18.0
Hungary	7.8	7.4	1390	19	1019	29.2	7.3	8.3	6.5	11.4
Italy	213.7	29.4	6000	268	4233	1290	7.8	7.2	10.1	n.a.
Lithuania	0.4	0.5	116	49	110	108.4	1.4	1.4	1.2	n.a.
Luxembourg	8.8	0.6	121	13	38	33.9	21.0	16.0	14.0	8.0
Netherlands	590.4	35.9	8300	101	409	1900	33.3.	n.a.	19.9	39.0
Poland	42.4	31.0	n.a.	549	4415	951.7	10.1	6.9	5.1	12.1
Portugal	18.8	4.1	1643	80	657	425.3	7.5	5.4	3.1	9.5
Romania	0.3	1.9	610	40	738	656.8	n.a.	n.a.	n.a.	n.a.
Slovenia	1.0	0.3	90	1	81	0.3	3.1	2.3	n.a.	n.a.
Spain	146.6	17.8	10,441	61	4273	2997.4	9.1	8.0	n.a.	n.a.
United Kingdom	453.2	32.6	25,000	43	1469	25,000	18.4	n.a	22.8	n.a.
Total	7423.8	712.7	209,560	2816	51,588	83,904	–	–	–	–

The data is from the European Association of Cooperative Banks: Key Statistics, December 2018.

Table 2 details information on credit unions. It is estimated that for end year 2017, there were 85,400 credit unions operating in 120 countries across six continents (World Council of Credit Unions, 2018). These credit unions had total assets of $2191 billion and a membership of 274.2 million (population penetration of 9.38%). Africa dominates in terms of credit unions numbers (39,447; 46.2%) but they have only 13.0% of worldwide members, 0.5% of worldwide assets and a population penetration rate within Africa of 13.8%. In contrast, North America has 7% of credit union numbers, but 46.7% of worldwide members and 81.5% of total assets and a population penetration in North America of 48.88%. The credit union movement in Europe has a penetration rate of 9.16%. In Western European countries (with the exception of Ireland and Great Britain), credit unions have not emerged as a distinct group as their activities are captured by cooperative banks. While in Eastern Europe (with the exception of Lithuania, Moldova and Poland), credit unions are in a formative stage of development.

Table 2.

Characteristics of credit unions by country.

The table displays characteristics of credit unions in 2017 by region. The penetration rate is calculated by dividing the total number of reported credit union members by the economically active population age 15–64 years old. Data source, World Council of Credit Unions, 2018.

Region (number of countries)	# credit unions	# members	Savings (US$ mil.)	Loans (US$ mil.)	Assets (US$ mil.)	Reserves (US$ mil.)	Loans/assets (%)	Reserves/assets (%)	Penetration (%)
Africa (27)	39,447	35,783,426	9596	8133	10,780	1060	75.4	9.83	13.80
Asia (27)	33,004	57,450,343	147,233	138,187	180,826	5773	76.4	3.19	4.34
Caribbean (17)	374	3,427,989	6273	4996	7662	774	65.2	10.10	65.2
Europe (17)	3491	9,103,706	24,095	11,648	32,959	4069	35.3	12.35	9.16
Latin America (17)	2891	35,807,657	59,840	54,212	90,864	17,210	59.7	18.94	14.57
North America (2)	6010	127,970,072	1,485,178	1,326,185	1,786,602	170,219	74.2	9.53	48.88
Oceania (13)	183	4,683,829	70,026	66,764	81,392	6424	82.0	7.89	3.85
Worldwide (120)	85,400	274,227,022	1,802,240	1,610,125	2191,086	205,527	73.5	9.38	9.38

Data is from the World Council of Credit Unions (Statistical Data, 2018).

2.2. Network arrangements

Cooperatives banks in Europe developed prominent central institutions and formed network alliances. The level of integration ranges from the centralisation of common services (such as group representation, strategic advice, and basic support services) to more executive functions (such as risk and liquidity management, management of mutual support, supervision of local banks, and mergers and acquisitions (Ayadi, Llewellyn, Schmidt, Arbak, & De Groen, 2010; Karafolas, 2016)). Finland, France and the Netherlands have highly integrated and centralised systems. Austrian and German cooperative banks have delegated fewer functions to central organisations, while Italian and Spanish counterparts are almost entirely decentralised (Bülbül et al., 2013; Fonteyne, 2007; Hackethal, 2004; Stefancic, 2010). Desrochers and Fischer (2005) provides cross-country evidence which suggests that integrated cooperative banking systems reduces both performance volatility and expense preference behaviour at financial cooperatives. The authors conclude that integrated systems are more efficient and economise on bounded rationality.6

Network arrangements in credit unions are most commonly characterised by the so-called atomised model. This involves relatively loose integration of member credit unions, which is generally limited to representation, lobbying and public relations (Ayadi, 2019). A notable exception is the credit union movement in Canada where Desjardins caisses populaire operate along the lines of a complex federated model. The individual caisse are independent and autonomously incorporated entities, but operate in a structured, standardised and closely inter-connected environment (McMurtry & Brouard, 2015). The Desjardins federated structure provides significant economies of scale and both industry presence and profile in the marketplace (Levasseur & Rousseau, 2002). In other jurisdictions such as the US, credit unions form Credit Union Services Organisations (CUSOs) which are limited liability companies to facilitate shared services. Some CUSOs involve cooperation among a small number of credit unions, while others involve large numbers of credit unions that enter and exit the CUSO as circumstances change. CUSOs allow credit unions to achieve economies of scale and engage in activities that individual institutions may regard as too costly or risky, or that are prohibited by regulations (Wilcox, 2005). Campbell and Dopico (2016) describe CUSOs as the best example of ‘structural ambidexterity’ in the credit union system.7

2.3. Business models

In the context of financial institutions, the business model can be viewed as how institutions “…. manage their assets (activities) and liabilities (funding) over time to contribute to the financial system and the economy either by managing the risk (in their balance sheet and off-balance sheet) or by accumulating it and transferring it to the system.” (Ayadi, 2019, p31). The business model of cooperative financial institutions is shaped and will continue to be shaped through technological advances (FinTech, digitalisation of products and services and online provision). At a structural level, this reduces the need for extensive bricks and mortar branch networks commonly found in the traditional banking industry but perhaps more importantly it provides alternative opportunities for service provision to members and customers. The low interest rate environment that prevailed following the global financial crisis of 2007–2009 also influences the choice of business model pursued as profits from traditional interest-generating activities have been squeezed (Claessens, Coleman, & Donnelly, 2017; Meyer, 2018). In the short run, the negative effects on profitability may be mitigated through cost cutting and the generation of more non-interest income. However, in the longer term, capitalisation issues may encourage industry consolidation as institutions merge in the pursuit of scale economies (Altavilla, Boucinha, & Peydro, 2017; Bexley & Houston, 2016). More generally, regulatory, monetary and structural reforms are factors important in driving business model change (Köhler, 2014).

Business model diversity within cooperative financial institutions has been investigated in a selection of countries. Canadian credit unions are found to operate one of three models, two are retail-oriented with different levels of diversification (focused retail and diversified retail) and one is investment-oriented which includes trading and derivatives (Ayadi, 2019). US credit unions operate one of three business model types although all are retail-oriented (Ayadi, Keoula, De Groen, Mathlouthi, & Sassi, 2017). Cooperative banks in Europe operate one of five business models. Three of these are characterised as being retail-oriented, a fourth wholesale focused and a fifth investment driven (Ayadi et al., 2016). In Japan, Shinkin banks adopt two forms of business model, which concentrate on the issuance of loans funded by deposits (traditional) and the investment and management of large investment portfolios (new) (Chronopoulos, Sobiech, & Wilson, 2020). Business model types differ in terms of their risk appetite and profit potential with instability in business models also adversely affecting bank soundness (Ayadi, Ferri, & Pesic, 2018).

2.4. Relationship banking

Financial cooperatives, as locally based institutions, are well placed to acquire specialized local knowledge through the cultivation of relationships between bank staff and the local community. These relationships facilitate the gathering of ‘soft information’ that can be used to mitigate screening and monitoring costs and more readily provide credit to informationally opaque borrowers.8 Large complex banks are not considered to engage in relationship lending because they are at a competitive disadvantage when information about individual investment projects is innately soft (Boot & Thakor, 2000; Stein, 2002). Transactional banking, commonly associated with large complex banks, places weight on ‘hard information’, and is consequently more conducive to borrowers with lower informational opacity. Hard information is defined as information that can be readily quantified, objectively collected, and easily communicated.9

Neuberger, Pedergnana, and ¨oppner (2008) find localism and cooperative ownership are positively associated with the relational orientation of financial institutions (see also Uzzi, 1999). Angelini, Di Salvo, and Ferri (1998) find that lending rates in Italy tend to increase with the duration of a relationship for banks other than cooperative banks. Cooperative bank members are also found to enjoy easier access to credit relative to non-member counterparts. Holmes, Isham, Petersen, and Sommers (2007) find that low-income households with strong ties to a credit union are more likely to receive loans, despite poor credit histories compared to those at a community bank. Uchida, Udell, and Yamori (2012) note that in Japan more soft information is produced by loan officers at smaller (Shinkin banks and credit cooperatives) banks. However, in contrast to conventional wisdom, they do not find clear evidence that loan officers at large banks are incapable of producing soft information and potentially underwriting relationship loans. Presbitero and Zazzaro (2011) find that where relationship lending techniques are already widely used by a large number of small mutual banks (credit cooperatives and savings banks) an increase in out-of-market competition drives the mutual banks to further cultivate their relationship ties with customers.

2.5. Balancing the interest of members

There are a number of models describing how credit unions set interest rates to compensate members (Flannery, 1974; Smith, 1984; Smith, Cargill, & Meyer, 1981; Taylor, 1971a). Taylor, 1971a argues that conflict may emerge because saving members want as high a return (dividend) on savings as possible, while borrowing members want as low a loan rate as possible. Taylor (op. cit.) demonstrates that in a ‘neutral credit union’ (where neither the interest of savers nor borrowers dominate) total benefits to members are maximised. This ‘neutrality’ also creates fewer incentives for the credit union to discourage new members (of a particular orientation) joining and therefore helps to maintain the vitality of the institution. A number of papers have empirically tested whether credit unions are borrower-, saver-, or neutral-oriented. Early studies of US credit unions find a majority of credit unions are neutral in their behaviour (Flannery, 1974; Kohers & Mullis, 1986; Patin & McNeil, 1991; Smith, 1986). Some identify US credit unions on average as saver-oriented, (Leggett & Stewart, 1999) while Goddard and Wilson (2005) find younger US credit unions more likely to be borrower-oriented and older credit unions are likely to be saver-oriented. Bressan, Braga, Resende Filho, and Bressan (2013), in an analysis of Brazilian credit unions, concludes that while borrower orientation was the dominating behaviour the deviation from neutrality was marginal.

Cooperative banks, unlike credit unions, also have non-member customers, which introduces new complexities in how to balance competing stakeholder interests. Emmons and Schimd (2002) show that both the distribution of member preferences and the amount of non-member business the cooperative does influences its optimal pricing and dividend policies. Catturani and Venkatachalam (2014) demonstrate that cooperative bank interest rate settings should include a premium determined by assessing partial elasticities for each type of customer, non-member (borrowers or depositors) and member (borrowers or depositors).

A further issue in the setting of loan interest rates and saving (dividend) rates relates to the fact that cooperative financial institutions in certain countries may be subject to loan interest rate and saving rate ceilings.10 Loan interest rate ceilings can be justified as protecting borrowers by offering access to credit at fair and reasonable interest rates. However, interest rate ceilings (or ceilings set at relatively low levels) may reduce product diversification, competition between institutions and risk pricing. The latter may result in institutions choosing not to lend to some high risk borrowers many of whom will have limited access to alternative sources of credit (Ferrari, Masetti, & Ren, 2018; Maimbo & Gallegos, 2014; Miller, 2013; Safavian & Zia, 2018).

2.6. Taxation

Not-for-profit financial cooperatives receive a tax exemption on earnings in some countries (Estonia, Ireland, Mexico, Romania and the US).11 Australian credit unions were granted tax-exempt status in 1974, subsequently rescinded in 1995. Canadian credit unions have been subject to federal taxation since 1972 but at a much lower rate than other financial institutions. The discount was abolished in 2013 (Ghosh, 2018).

Proponents of the tax exemption argue that credit unions provide subsidised services to members, many of whom are of modest means. The imposition of a tax on earnings would create pressure to eliminate some of these subsidised services (Feinberg & Meade, 2017). Others argue that the preferential tax treatment compensates for the capital accumulation problem faced by credit unions (credit unions rely on retained earnings to meet their capital obligations) (Emmons & Schmid, 1999). Theoretical models used to examine the implication of taxing credit unions suggest that, as closed cooperatives, credit unions are likely to respond to an earnings tax by raising the saving (dividend) rate and reducing the loan interest rate thereby reducing accounting profits and contributions to reserves (Cook & D'Antonio, 1984; Taylor, 1971b).

As the US credit union movement is the most developed in the world, it is no surprise that here the tax exemption has come under most scrutiny. Joint Committee on Taxation (2017) estimates that the tax exemption in the US results in a $2.9 billion annual loss of tax revenue. However, Feinberg and Meade (2017) estimate that requiring US credit unions to pay tax on earnings would result in a $38 billion decline in tax revenues over ten years due to reduction in credit, lost jobs, and other indirect effects from a shrinking credit union sector. Recently, economists at separate Federal Reserve Banks have asked whether the credit union tax subsidy remains justified given that recent changes in the structure and regulation of US credit unions has enabled them to compete more directly with commercial banks (DiSalvo & Johnston, 2017; Marshall & Pellerin, 2017).12 DeYoung et al. (2019) investigate whether the tax exemption passes through to members in the form of preferential saving and loan rates, or is consumed by management in the form of expense preference behaviour. The authors conclude that while some of the tax subsidy diverts away from credit union members (due to inefficiencies in non-loan investments portfolios and in the form of expense preference behaviour) most of the subsidy passes to members, with saving members benefitting most.

2.7. Regulation

Recent regulatory reform, captured by the Basel III Accord, have included revised capital and liquidity requirements, assets and activities restrictions, the introduction of supervisory stress testing arrangements and the identification and closer supervision of systemically important financial institutions.

In most European countries, cooperative banks are subject to Basel III. Some of the larger cooperative banks (in Germany, France and the Netherlands) are classified as systemically important institutions (EACB, 2018). The Basel III Accord does not apply to credit unions but some national and provincial credit union regulators have chosen to implement particular aspects of the Basel standards or have implemented regulatory changes inspired by Basel principles (WOCCU, 2012). More generally, as financial cooperatives in many countries are small and offer a limited product range, some form of proportionality is often embedded in their regulation either in the form of simplified rules, or different capital and liquidity requirements norms (Coelho, Mazzillo, Svoronos, & Yu, 2019; McKillop & Quinn, 2017). However, a trade-off often exists where adherence to simplified rules results in the imposition of higher capital and liquidity requirements (Cuevas & Buchenau, 2018; Hohl, Sison, Stastny, & Zamil, 2018).

The regulatory aspect that has come under most academic scrutiny is capital requirements. This is particularly so for credit unions which in most countries do not have the option to raise new capital in the form of equity and so are more likely to manage their capital cautiously over the course of the business cycle. Smith and Woodbury (2010) find that US credit unions are less sensitive to the business cycle than banks and should therefore be subject to lower capital requirements. Pana and Mukherjee (2010) find that higher levels of capital in US credit unions reduce their ability to create liquidity. Goddard, McKillop, and Wilson (2016) find that capital buffers for US credit unions vary pro-cyclically and until the financial crisis, credit unions classified as adequately capitalized or below followed a faster adjustment path than well-capitalized credit unions. This pattern reversed in the aftermath of the crisis. Hillier, Hodgson, Stevenson-Clarke, and Lhaopadchan (2008) find that capital adequacy regulations on Australian credit unions resulted in the use of accounting window dressing techniques to increase capital adequacy. While Australian credit unions are also found to manage their capital positions by setting a target profit rate, positively related to asset growth (Brown & Davis, 2009). Hessou and Lai, 2017, Hessou and Lai, 2018 find that Canadian credit union capital buffers behave counter cyclically and that they hold a capital buffer bigger than the maximum buffer advocated under Basel III. They also note that both the risk-based capital buffer and the leverage buffer are positively related to changes in loans and loan growth which underscores the importance of the Basel III conservation and the countercyclical buffer requirements in fostering credit.

3. Part two: performance and contribution to the real economy

With performance and contribution to the real economy as an overarching theme, part two of this review considers, under sub-themes, efficiency and sustainability, mergers, acquisitions and failures, the benefits (and challenges) of FinTech and the contribution of financial cooperatives to the real economy including during times of crisis.

3.1. Performance (efficiency, profitability and risk)

In North America, evidence for credit unions suggest the prevalence of economies of scale. Goddard, McKillop, and Wilson (2002) suggest that larger US credit unions grew faster than their smaller counterparts throughout the 1990s, suggesting advantages accruing to size. Wheelock and Wilson (2011) present evidence to suggest that economies of scale are available to credit unions operating across the entire size distribution. Studies for Australia (Brown & O' Connor, 1995; Esho, 2000); Canada (Kim, 1986; Murray & White, 1983); Japan (Glass, McKillop, Quinn, & Wilson, 2014); Ireland (Glass, McKillop, & Quinn, 2014); New Zealand (Sibbald & Mcalevey, 2003) and the UK (McKillop, Ferguson, & Nesbitt, 1995) also find evidence of increasing returns to scale.

A segment of the literature has conducted comparative analyses of efficiency across cooperatives, commercial banks and savings banks. For example, Altunbas, Evans, and Molyneux (2001) find that savings and cooperative banks in Germany are more profit and cost efficient than commercial banks. Giradone, Nankervis, and Velentza (2009) find that cooperative and savings banks operating in EU-15 countries are more cost efficient than their commercial banking counterparts. Mäkinen and Jones (2015) find that in Europe cooperative banks are more efficient (less inefficient) than savings and commercial banks. For the US, Frame, Karels, and McClatchey (2003) compare the financial performance of US credit unions and US mutual thrift institutions. They find that credit unions incur higher costs than mutual thrifts.

A number of empirical studies have attempted to establish a systematic relationship between ownership form and profitability. For example, Goddard, Molyneux, and Wilson (2004) find little evidence that ownership type matters in explaining profitability differences across banks in Denmark, France, Germany, Italy, Spain and the UK. In a cross-country study, Fernández, Fonseca, and González (2004) find that public and mutual banks had higher interest margins but also higher non-interest expenses than shareholder-owned banks. Iannotta, Nocera, and Sironi (2007) examine the relationship between ownership form and the performance and risk of a sample of large banks from 15 European countries. In spite of their lower cost base, cooperative and savings banks exhibit lower profitability than shareholder-owned banks. Goddard, Liu, Molyneux, and Wilson (2013) find savings banks were more profitable than commercial banks in Germany, the Netherlands, Spain and the UK. Cooperative banks were more profitable than commercial banks in Germany, Italy, the Netherlands and Spain.

Financial cooperatives have different risk-taking incentives to commercial banks since they pursue social and economic development objectives rather than shareholder value maximization. Given a stable deposit base and business strategies that aim to build up capital for future generations, financial cooperatives may be less fragile than commercial banks.13 However, financial cooperatives are less diversified and have less option to raise capital at short notice. Consequently, financial cooperatives are less able to absorb demand-or supply-side shocks to their balance sheets (Fonteyne, 2007).

Results from extant empirical studies appear to suggest that savings banks and financial cooperatives are less risky than commercial banks. For example, Iannotta et al. (2007) in a study of banks across Europe find that mutual banks have better loan quality and lower asset risk than shareholder-owned banks. Using a large sample of commercial, savings and cooperative banks from 29 OECD countries, Hesse and Cihak (2007) find that while cooperative banks are less profitable and capitalized than commercial banks, they enjoy more stable returns. Chiaramonte, Poli, and Oriani (2015) find that European cooperative banks are more stable than commercial banks during stressed periods. The opposite appears to be true under normal economic conditions. Liu and Wilson (2013) find that when exposed to increasing competition Japanese financial cooperatives become riskier than commercial banks. In the US, Goddard, McKillop, and Wilson (2008) present evidence that revenue diversification does not reduce risk or enhance the performance of credit unions. Ely (2014) finds that credit unions with broader field-of-membership are less well capitalized and exhibit greater earnings volatility. For Australia, Esho, Kofman, and Sharpe (2005) find that the increased reliance on fee-income generating activities is associated with increased risk.

3.2. Mergers, acquisitions and failures

Analysis of credit union mergers have concentrated on the US (Bauer, 2010; Bauer, Miles, & Nishikawa, 2009; Fried, Schmidt, & Yaisawarng, 1999; Goddard, McKillop, & Wilson, 2009; Goddard, McKillop, & Wilson, 2014; Wilcox & Dopico, 2011); Australia (Ralston, Wright, & Garden, 2001; Worthington, 2004); New Zealand (McAlevey, Sibbald, & Tripe, 2010) and the UK (Goth et al., 2006). The majority of these studies conclude that members of target credit unions experience an immediate improvement in product cost, service provision and financial stability after the merger. However, limited evidence is found of enhanced benefits accruing to members of the acquiring credit union unless the credit union had prior experience of mergers. ‘Learning-by-doing’ spreads the overhead cost of successive mergers, and minimizes the loss of focus on managements' primary objective of serving members.14 Ralston et al. (2001) suggest that mergers do not generate efficiency gains greater than those that non-merging credit unions are able to achieve through internal growth. McAlevey et al. (2010) conclude that a major driver of mergers is not the usual reason of attempting to increase efficiency but rather enforced government action. Goth et al. (2006) argue that mergers may have negative consequences for the healthier of the two merging entities including a dilution in membership focus, increasing loan arrears, and reduced dividends.

Wilcox (2005) suggests that younger, smaller, and less well-capitalized credit unions are more likely to fail. Negative macroeconomic conditions are a likely contributory factor to failure. Smith and Woodbury (2010) find that credit unions are less exposed than banks to fluctuations in the business cycle. Goddard et al. (2014) find that smaller credit unions, those with a high proportion of assets in liquid form, those with low loans-to-assets ratios and those that are highly capitalized are at greater risk of failure. Pille and Paradi (2002) develop a failure prediction model to detect weaknesses in credit unions in Canada (Ontario). They find that the equity/asset ratio is a good predictor of failure and is not improved upon by more complex Z-score and Data Envelopment Analysis (DEA) models.

Analysis of cooperative bank mergers has focused primarily on Europe. Lang and Welzel (1999) considers mergers in German (Bavarian) cooperative banks and concludes that the primary motive is not the improvement of operational efficiency but rather regulatory pressure. Koetter (2008) considers savings and cooperative bank mergers in Germany and concludes that only one in two mergers prove a success. Coccorese, Ferri, and Spiniello (2017) find that mergers in Italian cooperative banks improve cost efficiency in only 5% of cases. Jones and Kalmi (2012) suggest that network arrangements confer on European cooperative banks many efficiency advantages that may be gained by way of merger and acquisitions. Harada and Kitamura (2016) investigate consolidation in Japanese cooperative banks (Shinkin banks). They conclude that much of the activity is driven by the regulatory authority's desire for banking stability. They find that large, but unhealthy and inefficient banks merge with small and inefficient banks in order to survive and benefit from a subsidised deposit rate.

Maggiolini and Mistrulli (2005) analyse a sample of recently established cooperative banks in Italy and conclude that the probability of failure is negatively related to the market share of incumbent banks and the absence of other mutual banks. Libertucci and Piersante (2012) find that the capital adequacy of cooperative banks is related to both the time to default and the likelihood of default. Fiordelisi and Mare (2014) find that the state of the economy affects the survival of cooperative banks. Iyer and Puri (2012) analyse the impact that a failure of a cooperative bank in India has on other cooperative banks in the same state. The authors find that the failure triggered runs across other cooperative banks in the same state. Deposit insurance only partially mitigated the runs. More important in the mitigation of runs were bank-depositor relationships and social networks.

3.3. FinTech

FinTech, refers to the interplay between finance and technology. Financial Stability Board (FSB) (2017) describes FinTech as ‘technologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services.’ While the interaction between finance and technology has a long history, the current FinTech phase (dating from 2008) has increasingly become defined by who delivers products and services rather than the products and services being delivered (Arner, Barberis, & Buckley, 2017). This latest phase is about the use of technology by new entrants to provide non-intermediated financial services directly to customers (Consumers International, 2017). The largest number of these new FinTech providers are in the payments, clearing and settlement sectors (mobile wallets, peer to peer transfers and digital currencies) followed by credit, deposit and capital-raising services (crowding funding, lending marketplaces, credit scoring, mobile banks) (Bank for International Settlements, 2018; Frame, Wall, & White, 2019; Frost, Gambacorta, Huang, Shin, & Zbinden, 2019; Stulz, 2019; Thakor, 2020).15

There are a number of implications of FinTech for cooperative financial institutions. First, several FinTech companies have now succeeded in successfully scaling a relationship banking technology which going forward may erode the relationship and soft information capture advantage of small scale localized financial cooperatives (Jaksic & Marinc, 2018; Lin, Prabhala, & Viswanathan, 2013). There is evidence in the US that ‘Peer 2 Peer’ lending activities have penetrated areas that are underserved by traditional banks (assets greater than $50bn) such as in highly concentrated markets and areas that have fewer bank branches per capita (Jagtiani & Lemieux, 2018). Secondly, many large commercial banks have taken a more active role in fostering technological improvements in transactional lending. A number of FinTech lenders have partnered with large banks to offer white label products.16 In some cases, FinTech lenders have been acquired by or have sold equity stakes to these banks.17 Partnerships between FinTech firms and small banks are less common due to the regulatory costs associated with them. However, there is evidence that by using FinTech solutions to process customer and application data some community banks have been able to restore profitability to some forms of consumer and small business lending after several decades of thinning and/or negative operating margins (Eckblad, James, & Oppenheimer, 2017; Kim & McKillop, 2019).

3.4. Lending and the real economy

In many countries, financial cooperatives via their role in mobilising savings and extending credit play a key role in fostering social capital and local economic development especially given their overriding mission to maximise the welfare of stakeholders that are located in the local community (Lang, Signore, & Gvetadze, 2016).18 Hasan, Jackowicz, Kowalewski, and Kozłowski (2014) find that local cooperative banks in Poland lend more to small businesses than large domestic and foreign-owned banks. Ferri et al., 2014, Ferri et al., 2015 analyse differences in lending policies across stakeholder and shareholder EU banks to detect possible variations in bank lending supply responses to changes in monetary policy. Following a monetary policy contraction, stakeholder banks decrease loan supply to a lesser extent than shareholder banks. A detailed analysis of the effect among stakeholder banks reveals that cooperative banks continued to smooth the impact of tighter monetary policy on their lending during the crisis period (2008–2011) whereas savings banks did not.19

Meriläinen (2016) finds that both the financial crisis and the sovereign debt crisis caused a negative shock in Western European lending growth. The shock was weakened by stakeholder banks whose lending growth either did not decrease during the two crises or decreased substantially less than that of commercial banks. Migliorelli (2018) notes that cooperative banks lent proportionately more than other banks in Germany and other European countries during the financial crisis. This was not the case for countries in Southern Europe. Ely and Robinson (2009) find that credit unions expand their small business lending activities in geographic areas significantly affected by bank consolidation. Smith and Woodbury (2010) and Smith (2012) suggest that credit unions are better equipped to withstand macroeconomic shocks to their balance sheets. They also find that while banks contract commercial lending during periods of economic stress the opposite is true for credit unions. Ramcharan, Verani, and Van Den Heuvel (2016) do, however, note that US credit unions most exposed to the failure of large corporate credit unions (because of declining investment values) reduced real estate and consumer lending during the great financial crisis.

Evidence suggests that financial cooperatives play an important role in the welfare of households and the economy more generally. Sfar and Ben Ouda (2016) present evidence that suggests that cooperative banks contribute to regional economic growth in France. Usai and Vannini (2005) suggest that (in contrast to larger commercial banks) cooperative banks play an important role in promoting regional economic development in Italy while Minetti, Murro, and Peruzzi (2019) show that cooperative banks play an important role in reducing income inequalities in local Italian provinces.

3.5. The great recession

Evidence presented in the previous section suggests that following financial shocks, financial cooperatives decrease credit supply to a lesser extent than shareholder banks.20 The Great Recession has highlighted further differences between financial cooperatives and commercial banks.

Chatterji, Luo, and Seamans (2015) find that US credit unions on average gained market share from banks following the financial crisis. These gains primarily accrued to credit unions that embody traditional identities (such as philanthropic giving) distinct from traditional banks. Smith and Rothbaum (2013) note that financial cooperatives in the US, Canada, the Netherlands, the UK, and Taiwan have increased their deposits and loan portfolios in the midst of the global financial crisis. Stefancic (2016) find that Italian cooperative banks performed better than other Italian banks during the financial crisis. The quality of loans deteriorated less in these banks than in others while no significant differences were observed in terms of return on average assets and cost efficiency. Henselmann, Ditter, and Lupp (2016) find that cooperative banks (compared to commercial banks and savings banks) were the most stable during the years surrounding the financial crisis. Walker (2016) shows that credit unions have increased their business lending as a substitute for other lending during the crisis. Rauterkus, Ramamonjiarivelo, and Munchus (2018) demonstrate that credit union deposits increase in times of economic uncertainty suggesting that they are perceived as a safe haven during an economic crisis. Although, it is also observed that credit union members act as a disciplining mechanism by withdrawing deposits from credit unions engaged in overly risky lending activities (Gomez-Biscarri, López-Espinosa, & Mesa Toro, 2019). Less positively, Maskara and Neymotin (2019) find that during the financial crisis, credit unions were no more likely than other depositary institutions to extend a home equity line of credit either in areas experiencing housing price declines or to lower income households. They suggest that these findings provide an empirical counterpoint to those who have lauded credit unions for providing liquidity during times of crisis or for serving consumers who would otherwise be challenged to obtain funds.

4. Conclusion

The scope of this paper is vast but is by no means an exhaustive review of literature on financial cooperatives. Financial cooperatives play an important role in the financial systems of many countries around the world. They act as a safe haven for deposits and are major sources of credit for households and small- and medium-sized firms. A not-for-profit orientation (in many cases) and a focus on maximising benefits to members has ensured the enduring popularity and sustainability of financial cooperatives. This is particularly evident since the global financial crisis when in many cases, financial cooperatives continued to extend credit to members as many profit-orientated commercial banks restricted credit to households and firms.

The review has recognised the enduring nature of financial cooperatives from origin in Germany in the 19th Century to today where they have a presence in over 140 countries.21 It has identified the power of cooperation, in the form of network arrangements, in the attainment of their common goals. It has highlighted the importance of relationship lending as a feature of business model development although questions whether this comparative advantage can maintain in the face of disruption from FinTech companies. The review has confirmed the complexities involved in balancing competing stakeholder interests but confirms that financial cooperatives achieve this balance better than most other organisational forms. Whether mergers generate scale and scope economies and whether members/customers benefit post-merger have been the subject of many papers. Consensus opinion is that scale economies do accrue however, member/customer benefits are transitory.

The review also considered research areas in their infancy now requiring further investigation. Research on business models has concentrated on the identification of clusters based on product mix and funding source differences. Next steps in this research should be to develop and advance a more nuanced understanding of business models in terms of product and process innovation, finding and reaching customers and the design of new products for as yet unmet needs.

Research on FinTech demonstrated that FinTech solutions has restored profitability to some forms of consumer and small business lending after several decades of thinning and/or negative operating margins. However, the popularity of FinTech has caused disruption in financial services. Members/customers no longer feel tied to their traditional service providers. Instead, they prefer services that are quick, safe and offered remotely. Now is the time to connect practitioner-led and academic research to aid understanding of the challenges posed and opportunities offered by FinTech for both financial cooperatives and their regulatory bodies.

Recent research discussed (elsewhere) suggests that (as a consequence of informational asymmetries, limited collateral and a high proportion of intangible assets that are difficult to value) entrepreneurs can only start new businesses if they were born rich or accumulated capital over time (Brown, Cookson, & Heimer, 2019). Moreover, banking industry consolidation has led to a significant decline in locally based banks specialising in lending to small businesses. As banks have become in some cases less willing to extend credit to local entrepreneurs, financial cooperatives have started to expand their services to fill this gap. Future research could usefully explore the impact of financial cooperatives on access to finance and subsequent entrepreneurship, innovation and economic growth.22

The relevance and importance of financial institutions is illustrated only too aptly during crisis periods where households and firms often lack liquidity. During the financial crisis (and more generally during downward swings in the business cycle), evidence suggests that financial cooperatives play a crucial role in assuring the flow of credit to households (Ramcharan et al., 2016). At the time of writing the world economy is experiencing an unprecedented negative shock arising from the onset of the COVID-19 crisis. This crisis is having a significant and varied impact on businesses and households (Altig et al., 2020; Baker, Farrokhnia, Meyer, Pagel, & Yannelis, 2020; Chronopoulos, Lukas, & Wilson, 2020). Further research is urgently required to understand likely impacts of this crisis on financial cooperatives, and the role that these institutions can play in smoothing lending and liquidity to households and small firms.

Credit author statement

Donal McKillop and John Wilson were responsible for the conceptualization of the research and formulating the structure of the paper. Discussions with the other authors helped inform the topic area to be assessed in this review of the literature. Donal McKillop and John Wilson also undertook much of the formal analysis and the drafting of an initial paper.

Anna Sobiech contributed detailed insight to discussion around the section pertaining to business models and contributed to a number of revisions of the initial draft of the paper.

Barry Quinn and Declan French provided a detailed review of the original draft and contributed significantly to the construction of subsequent drafts and the final paper.