Module 8 - Membership-Based Financial Organizations

Support to membership-based financial organizations, including relatively formal credit unions, savings and credit cooperatives, and less formal community-based savings and loan associations, has had mixed results. In some cases, sustainable institutions have resulted, successfully reducing transaction costs and collateral constraints. In others, donor support has created dependence and failed to address problems of weak governance, poor internal control, and capture by elites. This investment note describes lessons learned and good practice in supporting membership-based organizations that provide rural financial services for agriculture. Support to such organizations is recommended where rural financial markets are underdeveloped but social, geographic, and economic conditions nevertheless create a comparative advantage for this low-cost approach.

Membership-based financial organizations (MBFOs) are important long-term sources of financial services in rural areas. Credit unions and savings and loan cooperatives are the leading sources of financial services to the poor in Latin America and in Central and Eastern Europe, and they are found worldwide. The performance of MBFOs has varied greatly, however, with problems arising from weak governance, poor internal control, donor dependence, and—for those institutions focused on agriculture—covariant risks.

The term “membership-based organization” refers to a range of organizations that are member-owned and -controlled, with membership defined either geographically (a community) or by activity (farmer cooperatives). More formal membership-based organizations include savings and loans cooperatives and credit unions, whereas village-based savings and loan associations can be much more informal. The degree of formality depends on such factors as scale, resources, level of systems development, financial product range, management capacity, and level of legal recognition. This investment note covers only those institutions with a primary focus on financial service provision, not multiservice organizations with nonfinancial aims.⁹

Less formal MBFOs are low cost, relying on primary low-level institutional systems and infrastructure, and local, often volunteer, staff. They can therefore operate in less-favored rural areas that are underserved or not served by banks and formal MFIs. Their ability to access local information on potential borrowers lowers the transaction costs associated with screening and monitoring. Their membership-based nature can provide useful peer pressure in enforcing loan contracts. They often suffer from weak internal controls and monitoring, however, and they may be susceptible to deterioration in portfolio quality, capture by well-educated/influential persons, and even fraud. Some MBFOs are run for the benefit of a few members, who monopolize access to loans, or alternatively give loans to members as a “right,” with loan amounts simply multiples of member savings or shares. More formal MBFOs, such as savings and loans cooperatives registered with authorities that supervise financial institutions, are more protected from these weaknesses but have higher cost structures and are less suited to more marginal rural areas.

⁹ This investment note does not discuss community-based organizations that engage in financial services as their secondary or tertiary activity, such as churches, welfare, and development associations, or purely informal associations such as ROSCAs and CARE's Village Savings and Loan Model. These approaches will be discussed in a forthcoming Micro and Rural Finance Operational Note.