Access to finance through financial cooperatives

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Access to finance through

financial cooperatives

The role of financial cooperatives in creating access to financial

services in rural areas of developing countries

Master Thesis - International Economics and Business University of Groningen

September 2007

Supervisors University of Groningen: Dr. G.J. Lanjouw

Dr. C.L.M. Hermes

Supervisor Rabobank Nederland: Drs. I.C.F.W. Vereijken

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Executive summary

The United Nations (UN) declared 2005 as the International Year of Microcredit to get international attention for building inclusive financial sectors in developing countries. Although the media mainly focused on microcredit, the UN declared that it wants to build inclusive financial sectors. In many developing countries the financial sectors do not provide the financial services to the people with lower incomes at this point in time. Other organisations active in developing countries also focus on the broader concept of access to finance instead of just microcredit. Why do the UN and other organisations want to build inclusive financial sectors? Or, in other words, why is it important for people to have access to financial services? In a recent study of the World Bank, the authors state that little doubt remains that finance is one of the most important drivers of economic growth (Claessens & Feijen, 2006).

In this thesis the focus lies on access to financial services in rural areas. Not only do many people live and work in rural areas of developing countries, the poverty rates are in general higher than in urban areas. Moreover, the access to financial services is even less than in urban areas, because providing financial services in rural areas is costly: demand for financial services is dispersed, infrastructure is often poor, agricultural lending is more risky, agricultural prices are more volatile and the seasonality and diversity of income requires more complex products. In a list with tips for successful lending in rural areas membership-based organisations and the use of character-based lending techniques are mentioned. This raises the question whether financial cooperatives, which include both aspects, are a good alternative for rural finance. This line of thought is the starting point for this thesis and leads to the following theoretical framework with research question:

Possible solution: Financial cooperatives

Problem: Access problems

Goal:

Access to financial services in rural areas of developing countries

State variables Excessive Access Demand: Self-exclusion (H1a) Supply: Inefficiency (H1b) Research question:

Can a financial cooperative have a positive influence on the access problems that prevent the provision and use of financial services in rural areas of developing countries and if so, under which conditions can a financial cooperative enhance access to financial services?

Strengths & Weaknesses

(H2)

Internal & external factors of growth and

development (H3)

Influence of cooperatives on access

problems (H4)

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On the basis of the theoretical framework five hypotheses are formulated. These are tested with the help of several qualitative and quantitative methods, i.e. expert survey –followed by a group discussion with experts-, case studies, regression model and graphical analysis of a dataset. The combination of different methods was chosen to provide a complete picture with the limited data and information about cooperatives in developing countries. The result of the hypotheses testing is as follows.

The first hypothesis H1 focused on the main access problems in developing countries. The survey and the group discussion show that the access problems are too diverse to point out one or a few main problems. The local situation has much influence on main access problem and it can be concluded that all access problems can play an important role.

The strong points of a cooperative (H2a) are the low risk and low costs of operation. Besides, the fact that clients are members also played an important role. Combining these aspects with able leadership, the most important internal growth factor (H3a), gives a cooperative the right conditions to grow. Organisational structure with a central organisation does not play an important role in the growth process, contrary to expectations.

The most important weaknesses of cooperatives (H2b) are a weak governance structure and the conservative nature of cooperatives. As a result of the conservative attitude in many cooperatives do not invest in new technologies and products. The conservative nature of cooperatives is partly caused by the government influence, which makes them more bureaucratic. The role of the government goes beyond the bureaucratic rules and debt forgiveness schemes. The directive nature of the legislation in many countries restricts the choices that cooperatives have, which makes government influence an important external growth and development factor. This was not expected based on the theory (H3b) and can be considered as a major problem.

The information about access problems and financial cooperatives is combined to see whether theoretically financial cooperatives can help solve one or more access problems (H4). When asked to rate the positive influence that cooperatives can have in solving several access problems, the access problems related to supply inefficiencies were awarded the highest scores. Cooperatives are also expected to have some positive influence in solving the access problems that arise on the demand side, i.e. self-exclusion. Especially improving the knowledge about financial services and creating trust scored relatively high. The influence of cooperatives on state variables was very limited, as was expected.

The final hypothesis dealt with the question whether financial cooperatives have created and developed access in the past (H5). The trends show that more access was created in all four regions (Africa, Asia, Caribbean and Latin America). The development of access, in the sense of larger loans and more savings, is harder to see. The trends in Africa and Asia suggest that some development has taken place, but further research is necessary to confirm this.

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government influence is to use the cooperative principles under a different name. The second barrier is the conservative nature of cooperatives present in practice, which leads to less innovation and new products than should be expected based on the (theoretical) ability of cooperatives to assess the needs of clients. This is especially harmful since technology is expected to play a large role in providing rural finance in the coming years.

Four recommendations are given:

(1) The influence of governments is a major obstacle in achieving the full potential of cooperatives and should therefore be addressed. Development agencies and/or western governments could try to persuade or put some pressure on the governments in developing countries to diminish this influence. (2) A way to avoid the issue of government intervention and restrictive legislation is by starting an organization based on the cooperative principles but under a different name. For example, the FAO calls the cooperative-based organisations ‘farmer-owned businesses’ and ‘rural people’s organisations’. Although this is not an ideal long-term solution, it is a rather practical one if changing legislation is not possible in the short term.

(3) The structure of cooperatives, in which members have much say and which usually deals with members of the community, can become a liability if no checks and balances are in place. In cooperatives corruption –because credit analysts often deal with applicants they know-, inadequate accounting principles, mismanagement and conflict of interest are likely to occur at some point if no proper governance structure is put in place. Therefore this should definitely receive much attention. (4) The other issue for cooperatives is the lack of investment in technological innovations and new products. It is expected that technology will play a large role in the near future in the supply of rural finance. Moreover, without investment in new, more complex products many cooperatives will continue to be ‘graduation institutes’. The small size of some cooperatives may discourage these types of investment, but in those cases a common central organisation might be a solution.

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Foreword

Although writing many pages on a certain subject is no problem, writing a foreword is something different. It is a place to review the process of writing a master thesis and thank those that have helped to finish. Contrary to what many students may feel, everybody basically goes through the same process, as I noticed afterwards. Therefore, the thank-you part is much more interesting. Thus hereby I would like to say thank you to everybody who helped me to order the ideas, formulate the set up, find data and to everybody who gave new suggestions, read and reared the many pages and dealt with all my questions during the process: Economic Research Department of the Rabobank and especially Inez Vereijken, mr. G.J. Lanjouw of the University of Groningen, Henk, Jacob and other friends and family.

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Chapter 1 Introduction

In this chapter first the subject of the thesis is introduced (§1.1). Then, I will formulate the goals and research question of the thesis (§1.2 and §1.3). After the research question is formulated, the relationships of the concepts are shown in the theoretical framework (§1.4).

1.1 Introduction to the subject

The United Nations (UN) declared 2005 as the International Year of Microcredit to get international attention for building inclusive financial sectors in developing countries.1_{According to} The Blue Book2_{, which resulted from discussions held during the Year of Microcredit, a financial sector} that provides ‘access’ to everyone can be called an ‘inclusive’ financial sector. An inclusive financial sector thus allows both the people with low-incomes and those with higher incomes to have access to credit, insurance, remittances and savings products.3_{During 2005 the attention was mainly on the} subject of microcredit, which are the many small loans given by institutions and banks to entrepreneurs in developing countries. Often the loans are only a couple hundred dollars, but are enough to help people start their own businesses. However, when looking at the statement of the UN within the framework of the International Year of Microcredit, it becomes clear that just focusing on microcredit is too narrow. The UN wants to build inclusive financial sectors. In many developing countries the financial sectors do not provide the financial services to the people with lower incomes at this point in time. Other organisations active in developing countries also focus on the broader concept of access to finance instead of just microcredit.4

Financial sector and economic growth and development

Why do the UN and other organisations want to build inclusive financial sectors? Or, in other words, why is it important for people to have access to financial services? In a recent study of the World Bank, the authors state that little doubt remains that finance is one of the most important drivers of economic growth (Claessens & Feijen, 2006). They investigated the statistical relationship between the development of a financial sector and the Millennium Development Goals (MDG)5_{of the UN. Their} results show that financial development and greater access to financial services lead to income growth, reduce poverty and undernourishment and are associated with better health, education and gender equality. On the other side, there are also authors that do not find a causal relationship between financial systems and economic growth. FitzGerald (2006) states that although financial development and economic growth are clearly related, the channels and even the direction of causality have remained unresolved in both theory and empirics. However, in general, authors agree with the statement made by

1_{UN, www.yearofmicrocredit.org, 7 December 2006.}

2_{Building Inclusive Financial Sectors for Development is the full title of the Blue Book. Published by the United Nations,}

2006.

3_{UN, www.yearofmicrocredit.org, 7 December 2006.}

4_{For example: Conference of Netherlands Financial Sector Development Exchange (NFX): Mind the Gap: Bankable}

approaches to increase access to finance (www.nfx.nl, 7 December 2007). Study of the Rabobank: Access to financial services in developing countries (Sjauw-Koen-Fa & Vereijken, 2005).

5_{MDGs are: (1) Eradicate extreme poverty and hunger, (2) Achieve universal primary education, (3) Promote gender equality}

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Claessens and Feijen that there is a positive, first-order relationship between financial development and economic growth (e.g. DFID, 2004; Beck, Demirguc-Kent & Peria, 2005; WSBI, 2006; Beck & de la Torre, 2006; Helms, 2006). Therefore, in the rest of the thesis I will assume that access to financial services is a means to improve the economic situation of people in developing countries and stimulate development6_{. Access to financial services is thus not a goal on its own for the UN and other} development organizations, it is just a means for a broader purpose. Eventually, the goal is development, which, as the name says, aims at helping people and regions develop and thereby increase their income and escape from poverty.

Focus on rural areas of developing countries

In this thesis I will focus on access to financial services in rural areas, which will stimulate the development of rural areas for several reasons. The first one is that the provision of financial services in rural areas is even less than in urban areas of developing countries. Access to financial services in rural areas is in general harder than in urban areas, because the rural areas are faced with several problems which make providing financial services costly. One of the problems is that demand for financial services is dispersed (Pearce, 2003). Low population density means that financial services have to be spread over large areas, which makes it harder to reach people cost effectively (Helms, 2006). Another problem is the high information and transaction costs due to poor infrastructure and lack of client information (Pearce, 2003). Moreover, lending for agricultural activities is widely considered more risky than industry or trade (Christen and Pearce, 2005). This is caused by the often large influence of weather, pests, diseases and other calamities on the harvest. Another issue is the volatility of agricultural prices. Because farmers often have little choice in the moment they sell their perishable goods, the price elasticity of supply is one of the causes of volatility. Finally, rural lending requires a greater variety in products than urban lending due to the greater complexity of rural households’ economies which arises from seasonality and diversified incomes (Buchenau, 2003). The diversified nature of the incomes is mainly caused by the inability to gain a ‘complete’ income from one activity.

The second reason focuses on the situation of rural areas. Not only is the level of poverty higher and development lower than in urban areas, there are also more people living in rural areas. In rural areas of developing countries poverty is a big issue, since some 70 percent of the poor in developing countries lives in rural areas (Pingali, Stamoulis & Stringer, 2006). Also the large number of people (both poor and non-poor7) living and working in rural areas shows the importance. Of the world population, little over half lives in rural areas (figure 1). With over 5 billion people in developing countries (World Bank), it suggests that at least 2.5 billion people live in rural areas of developing countries. Around 35% of the economically active population (EAP) worldwide works in the agricultural sector, although they earn only 5% of world income. Since around 4%8_{of the employment}

6_{For an -often cited- theoretical discussion on how the development of a financial system stimulates economic growth see Levine,} 1997.

7_{In this thesis the concepts of non-poor and poor are used to indicate the difference between the people that live below the}

poverty line (the destitute, extreme poor and moderate poor) and those that live above the poverty line (the vulnerable non-poor, non-poor and wealthy) (Helms, 2006). The poverty line is determined per country.

8_{Average for 2001-2003 is 3.9%. Source: World Bank, http://siteresources.worldbank.org/datastatistics/}

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in high income countries9_{is in agriculture, the percentage of employment in agriculture in developing} countries exceeds the approximately 35% shown in figure 1.

Figure 1: Agriculture in the Economy (June 2006) (percentage of world total) Source: Food and Agriculture Organisation (FAO)10

* EAP: Economically Active Population (//faostat.fao.org/Portals/_Faostat/documents/pdf/world.pdf, 11 December 2006)

Another point is that the development of rural areas could prevent mass migration to urban areas, which is seen as a major issue in many developing countries. Many migrants from rural areas are not able to find a job in the formal sector, because they do not have the necessary education (Ray, 1998). As a result they are bound to end up in low-earning informal jobs or unemployment and thus continue to live in poverty.

The final consideration here for the importance of rural development is mentioned by Pingali et al (2006) in their report for the FAO. They say that agricultural growth plays a critical role in enhancing food security and reducing poverty in developing countries. Development of rural areas can thus work as a driving force for poverty alleviation in both rural and urban areas.

Overall, access to financial services will increase the economic growth of a region, but is lacking is many rural areas. Of course, development consists of more than a higher income. A stable income, security, healthcare and education are all examples of things that are needed to achieve full development. However, economic growth of a region will usually stimulate things like education and employment. Therefore, since access to financial services can stimulate economic growth, it can be taken to boost the development of rural areas.

Financial cooperatives in rural areas

Christen and Pearce (2005) give several tips for successful lending in rural areas, which are based on the study of thirty successful agricultural microfinance providers. They mention that membership-based organisations can facilitate rural access to financial services and be viable in remote areas. Another point is that the use of character-based lending techniques can reduce the risk of default. This type of lending techniques includes group-based lending, peer-group information and peer-group pressure and can help to better select applicants and increase repayment rates. Since financial cooperatives incorporate both characteristics, it suggests that financial cooperatives might be a solution to part of the problems that exist in rural areas. This line of thought is used as the basis for this thesis.

9_{A high income country according to the definition of the World Bank is a country in which the GNI per capita is $ 10,726 or}

more (www.worldbank.org, 11 December 2006)

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1.2 Goals of the study

The Economic Research Department of Rabobank published a study in September 2005 with the title Access to financial services in developing countries (Sjauw-Koen-Fa & Vereijken, 2005). This study provides an overview of the financial services in developing countries, together with the activities of Rabobank in developing countries. After this study Rabobank wanted to expand its knowledge about the financial sector in developing countries. More specifically, their idea was to have a study about access to financial services with a solid academic basis. Besides gaining knowledge, Rabobank would like to get recommendations about how to stimulate access to financial services in developing countries, because the Rabobank is active in many developing countries. In the results of this thesis the Rabobank would like to see those ideas.

Besides the business perspective formulated by the Rabobank, the study has academic goals as well. The research on access to financial services in developing countries shows that several problems arise in rural areas. With this thesis I would like to add my point of view to the discussion about possible solutions by focusing on financial cooperatives. Moreover, since most research in this field is based on case studies, in this thesis the focus is on multiple countries. Although this may complicate the generalisation of the research, it is also an attempt to add new insights to the literature.

1.3 Research question

Based on the discussion above, the problem that forms the starting point of this thesis is the limited access to financial services in rural areas of developing countries, since it is assumed that access to financial services will stimulate economic growth and development. This problem must be seen as part of a bigger picture to help people in developing countries. It is expected that a financial cooperative can play a role in the different access problems that arise in rural areas of developing countries. If it can be established that cooperatives can play a role in filling the gap of access to financial services in rural areas, it is interesting to know how a cooperative can help more people to gain access and develop access. This means that the factors that influence the growth and development of a financial cooperative will also be investigated. This is based on the assumption that a larger cooperative or a cooperative network can serve more people than a small cooperative and can better serve the people than a small cooperative. This leads to the following research question for this thesis.

1.4 Framework and structure of the thesis

The research question of this thesis can be divided into smaller steps, i.e. into investigative questions. Figure 2 shows the relationship between the different concepts. To start with the access to financial services: to get a complete picture of the issues it is important to know what access is and what the access problems are. Why do financial institutions provide only limited financial services in rural areas? Why do people choose not to use financial services if they are offered? In figure 2, it is shown that access problems can be divided into four categories. In chapter 3 the theoretical background of these categories and a model of access are explained. Based on this theory two hypotheses are

Research question

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formulated about which access problems are the most important (H1a & H1b). Note that the ultimate goal is not only to create access for all (growth of access), but also to provide services that are affordable and desired (development of access). At this moment many institutions only offer standardised products, but if the inhabitants and firms of a country are to develop themselves more complex and tailor-made products are needed.

Financial cooperatives are the other main concept. In order to answer the research question it is necessary to know a little more about the background of financial cooperatives. What is a cooperative and why do people form cooperatives? What are the strong and weak points of a cooperative? Which factors influence the growth and development of a cooperative? This last question is important because if it is established that financial cooperatives have a positive influence on access problems, it is valuable to know how this effect can be increased. In chapter 4 the theory about cooperatives is described. Hypotheses H2 and H3 are formulated at the end of that chapter.

Figure 2: Theoretical framework (* These access problems are included in hypotheses H1a and H1b.)

The information about access problems and financial cooperatives is combined in chapter 5. It is explained how theoretically a financial cooperative influences the access problems. This leads to hypothesis H4. The final hypothesis (H5) focuses on whether financial cooperatives have created more access and stimulated the development of access in the past.

In chapter 6 the methods used to test the hypotheses are explained. The results are shown in chapter 7. The results form the base on which the research question is answered. The conclusions and recommendations can be found in chapter 8.

Possible solution: Financial cooperatives

Problem: Access problems

Goal:

Access to financial services in rural areas of developing countries

State variables* Excessive Access* Demand: Self-exclusion (H1a) Supply: Inefficiency (H1b) Research question:

Can financial cooperatives have a positive influence on the access problems and thereby stimulate growth and development of access?

Strengths & Weaknesses

(H2)

Internal & external factors of growth and

development (H3)

Influence of cooperatives on access

problems (H4)

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Chapter 2 Key concepts, methodology and assumptions

This chapter provides some background information about the definitions of the key concepts used (§2.1), about the research design and sources that are used (§2.2) and about the underlining assumptions (§2.3). A more extensive explanation about the empirical methods used to test the hypotheses can be found in chapter 6.

2.1 Key concepts

Two key concepts, namely access to financial services and cooperatives, will be discussed more elaborately in the next chapters. The choice for the definition is discussed in those chapters. For the other concepts the choice for a certain definition is explained, if necessary, in appendix 1.

Access to financial services11

The term ‘access to financial services’ can be split into two parts, i.e. ‘access’ and ‘financial services’. When the term access is used in this thesis, it covers both (1) the access and possibility to use financial services and (2) the actual use of financial services. Financial services are those products offered by the organisations that deal with the management of money, according to the Oxford dictionary, such as the possibility to lend, save, insure, receive/send remittances and make transactions. Rural areas and rural finance12

An area is marked as rural if the degree of concentration of population is low relative to other areas in a country (UN, 1998; FAO, 2005). Moreover, urban areas traditionally provide a different way of life and usually a higher level of living than are found in rural areas. However, these measures differ per country and are often subjective and therefore do not lead to a universal definition of rural areas. Luckily, for the purpose of this thesis the concept of rural areas does not need to be strictly defined. The main point is to understand the difference between financial services in general and in rural areas, i.e. rural finance.

Figure 3 gives a good overview of how the concepts of rural finance, agricultural finance and microfinance relate to the whole financial sector (Pearce, 2003) (the size of the circles does not represent a relative size). Rural finance refers to financial services offered and used in rural areas by people of all income levels. Agricultural finance is a sub-set of rural finance dedicated to financing agriculture-related activities, such as input supply, production, distribution and wholesaling, and marketing. In this thesis the focus will be on rural finance for both the rural poor and the rural non-poor. It is important to recognise that the concept of finance in rural areas is thus more than microfinance and more than agricultural finance.

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Figure 3: Financial services in rural areas Source: Pearce, 2003

Developing countries13

In this thesis developing countries are those countries that are marked as low- or middle-income countries by the World Bank, since these groups are often referred to as developing economies. It is recognised that income does not give the complete picture, but this classification is straightforward, easily implemented and often used.

The World Bank classifies countries according to Gross National Income (GNI) per capita14_. The groups are: low income, $875 or less; lower middle income, $876 - $3,465; upper middle income, $3,466 - $10,725; and high income, $10,726 or more.

Cooperatives15

A cooperative is a form of economic organisation, in which independent economic actors, who do not consider each other as competitors, cooperate in the execution of one or more activities, with the aim of improving economic results of the actors concerned (Van Diepenbeek, 1990). In this thesis, if a cooperative is mentioned, a financial cooperative or savings and credit cooperative is meant, unless stated otherwise.

Rabobank and Rabobank Development Program

Rabobank Group is a full-range financial services provider founded on cooperative principles and is a global leader in sustainability-oriented banking. The Rabobank Group is comprised of 218 independent local Dutch Rabobanks, a central organisation (Rabobank Nederland) and a large number of specialised international offices16_.

Rabobank Development Program (RDP) is a part of the Rabobank Group that focuses on banking in developing countries. In 2004, Rabobank decided to combine its existing programs for developing countries into the Rabobank Development Program (RDP) to fully use its resources and experience of cooperative banking17_{. The RDP consists of three entities: the Rabobank Foundation,} Rabo Financial Institutions Development (RFID) and its subsidiary Rabo International Advisory Services B.V. (RIAS) (figure 4). The Rabobank Foundation has been established in 1974. It supports

13_{See Appendix 1.}

14_{World Bank, http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/0,,contentMDK:20420458~menuPK:}

64133156~pagePK:64133150~piPK:64133175~theSitePK:239419,00.html, 13 December 2006.

15_{See §4.1.}

16_{Rabobank, 14 December 2006, www.rabobank.com.}

17_{Rabobank, 4 April 2007, www.rabobank.com and www.rabobankgroup.nl.}

Financial sector

Microfinance Agricultural

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groups of people who are socially or economically disadvantaged. In approximately 70 developing countries, groups of small farmers, entrepreneurs and women are helped to set up cooperatives. RFID’s main objective is to create strategic alliances with and to provide capital to banks in developing countries. Through strategic collaboration with banks which also serve the rural areas, they aim to help transform them into modern financial services providers. Examples of their activities are the participations in banks and rural cooperatives in China, Tanzania and Zambia. RIAS offers consulting services and technical support to banks in the fields of rural banking, cooperative development and agricultural chain development. They are active in almost 50 countries.

Figure 4: Rabobank Development Program Source: www.rabobankgroup.nl

2.2 Methodology Research design

In this thesis a formal, descriptive and analytical study is executed (Cooper & Schindler, 2003). It is formal in the sense that there are research questions, which are answered in this thesis. The study is descriptive, because the research questions of the thesis lead to the description of phenomena, namely access to financial services and financial cooperatives. The analysis of the relationship between those two phenomena and whether a solution can be found for the access problems are also part of this thesis and make the thesis analytical.

Sources

The research includes an extensive theoretical framework about both financial cooperatives and access to financial services in developing countries. The sources of information for the theoretical framework are mostly secondary. In the orientation phase of the research interviews were held with several employees of RIAS, the Rabobank Foundation and the Economic Research Department.

The information about financial cooperatives and their history comes from scientific articles and books. Since the focus of many authors is on cooperatives in general and/or on sales and purchase cooperatives, there is only limited information about financial cooperatives. However, there is enough information to conduct a research based on secondary sources. Besides, the information found is checked with experts of the Rabobank, which have much experience on the subject as a cooperative bank. The Rabobank has also published several books, which focus specifically on financial cooperatives.

Based on the theoretical framework several hypotheses have been formulated, which were tested with the help of primary data. The data collection is hard because limited information is available about financial cooperatives in developing countries. Several international organisations collect information about cooperatives worldwide, but they all focus on their specific area. For example, the World Council of Credit Unions (WOCCU) mostly collects information about credit unions around the

Rabobank Development Program (RDP)

Rabo International Advisory Services (RIAS)

Rabobank

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world and the International Cooperative Alliance (ICA) mainly collects information about consumer cooperatives. To deal with the limited availability of data, surveys and case studies are also conducted. This is also valuable because not all aspects of cooperatives and access can be quantified. Therefore, both quantitative and qualitative research methods will be used, namely regression model, graphs, case studies and surveys. In chapter 6 each method of analysis is described extensively. The method of data collection for each method is also explained.

2.3 Assumptions

There are several assumptions that underlie this research. Since most could form the basis of a complete research, they are assumed to be constant in this thesis and are further beyond the scope of this thesis.

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Chapter 3 Access to financial services and access problems

The focus of this chapter is access to financial services and the access problems that can be distinguished. In §3.1 access to financial services and the way it can be measured are defined. Section 3.2 gives an impression of the current situation. The theoretical analysis of access problems is explained in §3.3. The hypothesis based on this chapter can be found in §3.4.

3.1. Access to financial services – definition and measurement The definition

The term ‘access to financial services’ can be split into two parts, i.e. ‘access’ and ‘financial services’, to ease the process of defining. The first part is the concept of access. Just as in other markets, the market of financial services has a supply and demand side. In the literature on financial services in developing countries the term access is often used for both the supply and demand side. The term ‘the outreach of the banking system’ is also used by authors (Beck, Demirguc-Kent & Martinez Peria, 2005). Outreach includes both (1) the access to and the possibility to use financial services and (2) the actual use of financial services. However, because in the literature the term ‘access’ is usually used for both sides of the market, in this thesis this will be done too.

Financial services are those products offered by the organisations that deal with the management of money, according to the Oxford dictionary. Examples of financial services are the possibility to borrow, save, insure, receive/send remittances and make transactions. For this thesis the focus is on basic financial products, i.e. savings, payment and lending services. For example, the stock exchange and financial products for large corporate clients are beyond the scope of this thesis, even though some large farmers might use complex financial products.

Measurement

Access, and thus also exclusion, are both hard to measure (WSBI, 2006). One reason is that most financial institutions do not keep track of the number of people that are declined and the reason for declining. Secondly, the reasons for not applying for an account or loan are implicit and unknown. For these reasons organisations use proxies to measure access. Beck et al (2005) use the number of branches and ATMs relative to population and area as a measure for access. They use the number of loans and deposit accounts relative to population and the average loan and deposit size relative to GDP per capita as indicators for use. Claessens (2005) states that access can be measured by the percentage of households that saves and borrows. The World Council of Credit Unions (WOCCU)18_{indicates that} the amount of loans and savings and the number of member clients are a good proxy for access. Both CGAP19_{and MIX market}20_{use the number of loans and savings accounts as indicators. CGAP adds the} number of clients to that, if those numbers are available. MIX market also mentions the average

18_{WOCCU, http://www.woccu.org/development/md_main.php, 29 March 2007.}

19_{These measurements are mentioned in the disclosure guidelines for financial reporting by microfinance institutions and are}

published by CGAP (Rosenberg, Mwangi, Christen & Nasr, 2003).

Consultative Group to Assist the Poor (CGAP) is affiliated to the World Bank and consist out of a consortium of 33 public and private development agencies working together to expand access to financial services for the poor in developing countries (www.cgap.org, 27 April 2007).

20_{The MIX market (Microfinance Information eXchange) is a global, web-based, microfinance information platform.}

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loan/savings amount per borrower/saver and the average loan/savings amount per borrower/saver relative to GNI per capita.

To give an indication of the current situation of access in developing countries compared to developed countries (in §3.2), the standards of Beck et al (2005) are used. Later some measurements are combined in order to create the most complete picture about access with the available data (see chapter 6 for more on data selection and method of analysis).

3.2 The current situation of access in rural areas of developing countries

The access to financial services, i.e. availability and use, varies widely across countries (Claessens & Feijen, 2006). Figure 5a shows the use of financial services in several income groups. In high income countries like the Netherlands and the US, 90% of the population uses financial services. This is in contrast to low income countries where only 23% uses financial services. In figure 5b the distribution network of the banking sector per income quintile is shown. The figure indicates a pattern of increasing branch penetration in more developed countries (Beck et al, 2005). In the lowest quintile with countries like Bolivia, Botswana and Namibia there are 1.68 branches per 1,000 square kilometres. This is very limited compared to countries like Austria and the Netherlands (highest quintile), where there are 32.54 branches per 1,000 square kilometres. The question however arises whether branches and ATMs will continue to be a good measure for the penetration of banking services. Technological development, like banking through cell phones, will probably replace part of the brick-and-mortar branch network (see also §2.3). Especially in areas with low population density and weak physical infrastructure, these technologies are expected to have much impact. Nevertheless, for the time being, branches and ATMs give a good indication for the distribution of bank services.

a) Use of financial services per country (% of b) Banking network per income quintile population) (numbers are medians of each country)

23.0 34.8 49.0 90.0 Lower income Lower middle income Upper middle income High income 1.68 4.79 9.04 11.15 1.27 6.08 16.6 29.31 79.14 32.54 1 (lowest income quintile) 2 3 4 5 (highest income quintile)

Branches per 1.000 sq.km ATMs per 1.000 sq.km

Figure 5: Use and availability of financial services

Source: a) Adapted by Claessens & Feijen (2006) from Honohan (2006); b) Beck, Demirguc-Kunt & Martinez Peria (2005)

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moneylenders and friends/family (Helms, 2006). Also semi-formal finance21_{through organizations such} as microfinance institutions (MFI) and nongovernmental organizations (NGO) is an increasingly important source of finance in rural areas. Nevertheless, formal finance, mainly through banks, is still limited in rural areas. Below, I will take a look at why there is so little formal finance in rural areas of developing countries. The analysis is based on the literature and focuses on the general issues in rural areas of developing countries. Although there can be large regional differences, the issues discussed below are expected to be general to all developing countries.

3.3 Analysis of the access problems in rural areas The Access Possibility Frontier

As many markets, the market for financial services in rural areas of developing countries is imperfect. Although this is the precondition for creating a financial system (Levine, 1997), it also creates friction in the supply and demand for financial services. In their article Beck and De la Torre (2006) use modifications to the basic supply and demand model to show that these frictions lead to a suboptimal and thus lower access to finance. The general thought of the article by Beck and De la Torre is that potential supply and potential demand together determine the Access Possibilities Frontier (APF) of a country or region. The APF is defined as the maximum share of the population that could be served by financial institutions, for a given set of state variables22_{. In developing countries the APF is not} reached due to frictions in demand and supply.

The APF-model will be used here, because it is simple but effective to show the effects of the frictions in the supply and demand of financial services and thereby what is needed to increase the number of people who have access. In chapter 5, the model will be combined with information about cooperatives to show the effect of cooperatives on the share of population that has access to and uses financial services.

Beck and de la Torre split the theory about financial services into a model for payment and savings services and a model for lending services. The major difference is that they assume that risk does not play a role in the first category. In this thesis the model for payment and savings services will be used. The lending services are incorporated in this model by assuming that risk will increase the costs of doing business in an area and therefore affect the supply curve in the same way as other costs. For those interested in both models and the underlying assumptions I refer to the article of Beck and De la Torre (2006).

Access problems defined

The potential demand D* is determined by income and price (Beck & de la Torre, 2006), which are the same mechanisms at work as in the traditional supply-demand model23_{. The actual demand D is} determined by both economic (price and income) and non-economic factors leading to self-exclusion

21_{Organisations in the semi-formal sector do not have a bank license and are generally unsupervised by the formal financial}

authorities, but they may operate under particular laws and regulations (Sjauw-Koen-Fa & Vereijken, 2005). In general, MFIs and NGOs fall in the category of semi-formal finance. Credit unions are often also seen as part of the semi-formal sector.

22_{State variables are those factors that are largely outside the control of the managers of financial intermediaries and that}

change slowly over relatively long periods (Beck & de la Torre, 2006). Examples are market size, macroeconomic fundamentals, available technology, income per capita, quality of transport and communication infrastructure, contractual and informational frameworks, and degree of general security.

23_{For a complete overview of the workings of this model and the derivation of the demand and supply curve see}

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(e.g. illiteracy). The potential supply S* is the supply curve from the original model, based on price and costs. The potential supply S* differs from the actually observed supply S, due to several forms of inefficiency. The inefficiency is caused by a combination of state variables and cost variables of the financial service provider. The supply and demand curves are combined in figure 6. The vertical axis represents, as usual, the price. On the horizontal axis the quantity of transactions (Q) has been replaced by the share of population engaging in payments and savings transactions, since that is of main interest here.

Figure 6: Access Possibilities Frontier for payment and savings services Source: Based on Beck & de la Torre, 2006

The key points of figure 6 are the following (Beck & de la Torre, 2006). Point I indicates the Access Possibility Frontier (APF)24_{. The potential supply (S*) and potential demand (D*) curve} intersect in this point, thereby giving the maximum outreach point for payments and savings services that can be reached in a country’s financial system, given the state variables. Beyond this point it is economically irrational to offer financial services in a market-based financial sector. The difference between the full population (100%) and point APF gives the unbankable population. Although there is some discussion about the existence of an unbankable part of the population, in this model it is the part of the population that cannot be served economically in the current situation. The APF can be moved by shifts in potential supply and demand curves as a result of changes in state variables.

Starting from point I four different types of access problems can be identified (in the next sections the causes will be explained).

1. Self-exclusion: In point II the share of population with access is lower than possible due to the non-economic factors influencing the actual demand curve (D). People have access to financial services but do not use the services.

2. Inefficiency: The second problem is the inefficient (high cost) supply. This can be seen in point III (just inefficiency) and point IV (combination of inefficiency and self-exclusion). As a result no financial services are offered in certain areas.

3. State variables: The third problem is found if the bankable population (in point I) is too low relative to countries with comparable levels of economic development. This situation can arise if a country lags behind in certain state variables, such as low technological development.

24_{Note that the APF is a point and not a frontier in the economic sense of a series of possible combinations, such as a utility}

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4. Excessive Access: In the case of the fourth access problem more loans are granted than economically justified (point V). Curve S’ shows the supply of lending services beyond the rational (potential) supply curve (S*). This can happen when agency problems motivate more people to apply for a loan and financial institutions grant these loans, because their screening devices do not work well enough (Beck & de la Torre, 2006). It may also happen with subsidised loans (Cleassens & Feijen, 2006). The costs of a loan will be lower for the financial institutions granting the loan, which stimulates granting more loans than economically reasonable. When a financial sector grants more loans than are economically viable, the many ‘bad’ loans can increase the risk for default of a financial sector.

Now that the access problems are defined, it is interesting to look at what causes the access problems. This is necessary to see which factors cooperatives can influence in order to change the actual supply and/or actual demand curve. An overview of the different types of access problems and their origins can be given (table 2). Below the different causes will be considered closer (except excessive access (k), which has been explained above)

Table 1: Overview of the types of access problems

Source: Claessens, 2005; Beck & de la Torre, 2006; Claessens & Feijen, 2006

Self-exclusion

The following reasons for self-exclusion, i.e. the difference between the actual (D) and potential (D*) demand, are mentioned (Claessens, 2005; Beck & de la Torre, 2006; Claessens & Feijen, 2006). a. Financial illiteracy: Not everybody who can write and read basic statements is able to fulfil the information requirements the banks have, especially when dealing with slightly more complex products such as loan applications.

b. Cultural barriers (ethnic or religious factors): Some people do not demand financial services because they assume that they will be rejected anyway. Many women or people from ethnic minorities in developing countries do not apply for a loan for this reason.

c. Lack of trust: Households may mistrust banks based on their past experience; especially after financial crises trust will have to be regained. People may also distrust the financial sector because they do not trust the government and see the financial sector as part of the government.

d. Switching cost: As mentioned before, the main source of finance in rural areas is informal. Changing from a well-known product and procedures to the unknown banking system implies switching costs. The switching costs increase if households distrust the financial system and/or are illiterate.

Types of access problems

Caused by: 1. Self-exclusion a. Financial illiteracy

b. Cultural barriers c. Lack of trust d. Switching cost

e. Lack of awareness/need 2. Supply inefficiency f. Lack of economies of scale

g. Lack of competition h. Government intervention

i. Information asymmetry (need for non-price screening devices) 3. State variables j. Bad physical infrastructure; Weak contractual and informational

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e. Lack of awareness and/or need: If people make transactions in cash or in kind or they feel that using financial services does not provide something extra, they will not use financial services. The availability of well-suited products plays a large role in this. Another possibility is that people are not aware of the possibilities that financial institutions offer. The low penetration of the banking network in rural areas makes financial institutions less visible and, therefore, less well-known.

Supply inefficiency

The following reasons are mentioned for supply inefficiency, i.e. the difference between the actual supply curve (S) and the potential supply curve (S*) (Claessens, 2005; Claessens & Feijen, 2006; Beck & de la Torre, 2006):

f. Lack of economies of scale: Large volumes of (small) transactions are needed to spread the fixed costs of transactions. In regions with a small market size or low population density the economies of scale may not be reached. A solution to achieve economies of scale and reduce costs is offering standardised products. Although this strategy is often used, it might not work as well in rural areas as it does in urban areas. Rural lending requires a greater variety in products than urban lending due to the greater complexity of rural households’ economies which arises from seasonality and diversified incomes (Buchenau, 2003).

g. Lack of competition: The banks may have to work more efficiently in order to decrease or overcome the high costs and high costs of working in a rural area. However, if the competition in an urban market is low, there is little incentive to manage costs efficiently or to incur the switching costs in order to reach out to new clients, even if the profits are the same in the end. If competition in the rural areas is low, there are few incentives to set lower prices for those that do offer products in rural areas, such as moneylenders.

h. Government intervention: Unnecessary government policies, such as interest rate ceilings and targeted lending, often distort access (Claessens & Feijen, 2006). These interventions can remove incentives for banks to attract deposits and make good loans. Moreover, legislation often determines which financial institutions are allowed to offer savings accounts. Without savings accounts the institutions loose part of their transactions volume, making it harder to achieve economies of scale, and loose an important source of (relative cheap) credit.

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State variables

(j) The third access problem is an Access Possibility Frontier that is too low compared to similar economies. The state variables are seen as the reason for this problem. State variables are those factors that lie outside an organisation and usually even outside the market, often at country-level and which take a (relative) long period to change. A small market size and/or lack of technology to reduce costs sufficiently could hinder the introduction of new products (Claessens, 2005) and supply outreach (Beck & de la Torre, 2006). Besides low penetration of new technologies, rural areas often have to cope with bad (information) infrastructure, which makes the contact with customers more time consuming and expensive. No internet, telephone or even electricity makes solutions for areas with low population density even harder. State variables also play a role in the level of systemic credit risk25_{. This type of} risk is non-diversifiable within a given region and increases the risk for all financial institutions active within that area and results in less supply (Beck & de la Torre, 2006). Examples are economic and political instability. Overall, the state variables have a significant influence on the supply of financial services.

The change of state variables is often hard because the financial sector can be used as an instrument to retain power (Claessens & Feijen, 2006). An optimal allocation of capital in healthy financial sectors provides the best with opportunities to fund their ideas, not the wealthiest or best connected. The development of and access to a financial sector also promotes more equality. All this may give the wealthy and well connected a reason to prevent more access to financial services. Coincidentally, the wealthy and connected are often also those people who have influence on the allocation of budgets for the change of state variables, such as infrastructure.

3.4 Hypotheses

It is clear that due to the diversity of the sources, access problems can not all be solved at the same time nor can they be solved by one organisation. It is, however, interesting to see whether a ranking can be assigned to one or more access problems and see whether financial cooperatives are able to target those problems. It is recognised that access problems are dependent on the specific situation of a country or region. However, it is expected that one or two problems can be pointed out as common to developing countries.

Based on the theory two hypotheses are formulated. One hypothesis focuses on the demand side of the market for financial services. It includes factors which might explain why people do not use financial services even if they are available. The second hypothesis deals with the supply side of the market, including reason why financial institutions do not offer services. Factors of the access problem ‘Excessive Access’ are also included in this category, since excessive access has the same underlying problem as supply, namely information asymmetry. The factors representing ‘State variables’ are included in both supply and demand, wherever it was more suitable (e.g. illiteracy in demand and infrastructure in supply). This is done as a result of the overlap of state variables with the demand and supply issues.

25_{Claessens and Feijen (2006) and Beck and de la Torre (2006) give the following causes of systemic risk: (1) macroeconomic}

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A study by Kumar, Beck and Campos (2004) (cited in Claessens, 2005) shows that the reason for not using a bank by the unbanked differs per country. They studied five countries, namely the USA, Mexico, Colombia, Brazil and India. In Mexico, Brazil and Colombia the most mentioned reason was ‘supply limitations/bank barriers’. In India and the USA ‘demand limitations: no need/no savings’ have the highest score. Perceptions of service/safety and mistrust also score relatively high in several countries. Based on this research and theory in this chapter, the hypothesis about the demand side of the access problems should include the lack of knowledge and the lack of trust in the financial sector. Hypothesis 1a:

Lack of knowledge and lack of trust are the most important factors that create self-exclusion for the demand of financial services in rural areas of developing countries.

Looking at the supply side, in rural areas the economies of scale are likely to be very challenging for financial institutions due to the low density of population, which is typical of the rural areas. Achieving economies of scale in rural areas is extra challenging, because an often-used solution, i.e. standardisation of products, is hard in rural areas. Rural finance, after all, has to deal with seasonality and a variety of income sources. Information asymmetry is the other issue likely to pose a challenge to the supply of rural finance. Non-price screening devices, such as character assessment and group lending, require well-trained personnel and much monitoring, which are both costly. However, it is necessary to overcome the information asymmetry that is present in rural areas as shown in §3.3.5. If the costs of non-price screening devices can be decreased, this will make rural finance much cheaper too. The hypothesis about supply inefficiency therefore includes lack of economies of scale and information asymmetry.

Hypothesis 1b:

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Chapter 4 Financial Cooperatives

Before the analysis of the influence of cooperatives on the access to financial services can take place in chapter 5, it is important to have a good understanding of what a financial cooperative is. Therefore, financial cooperatives are the focus of this chapter. Section 4.1 and 4.2 provide background information on the definition and basic principles of the cooperative and the economic justification of the financial cooperative. An overview of financial cooperatives around the world can be found in §4.3. In § 4.4 the strengths and weaknesses of financial cooperatives in general are investigated. Section 4.5 includes information about the internal and external factors influencing the growth and development of financial cooperatives. Finally, in §4.6 hypotheses 2 and 3 are formulated with the information from this chapter.

4.1 Cooperative – the definition and principles 4.1.1 The definition of cooperative

The word “cooperative” already includes the main aspect of this type of organisation. People cooperate, i.e. work together, to achieve something. In the literature there are dozens of definitions for cooperatives. This variety of definitions is the result of the fact that cooperatives are formed in view of a specific market situation for a specific purpose. Depending on the origin of members (e.g. consumers or laborers) and the economic purpose of the cooperative (e.g. purchase, sales or services) cooperatives can take many shapes and forms (Ter Woorst, 1989). Although no definition is generally accepted, the general notion is that a cooperative is an association voluntarily formed by members with a common economic goal (Van Dooren, 1978). This goal is accomplished by the formation of a democratically controlled private organisation with a contribution of the members to the capital and a distribution of the risks and surpluses of the association over the members. Farmers or businesses stay independent, but each outsources a part of the production process to a commonly owned cooperative, for example the sale of products, purchase of raw materials or ‘storage’ of savings (Van Dijk & Klep, 2005). For this part of the production process the businesses do not see each other as competitors anymore, since the market has been replaced by a set of rules. All elements above can be found in the definition given by Van Diepenbeek (1990)26_{, therefore this definition will be used in this thesis:}

A cooperative is a form of economic organisation, in which independent economic actors, who do not consider each other as competitors, cooperate in the execution of one or more activities, with the aim of improving economic results of the actors concerned.

4.1.2 Cooperative principles

Contrary to what many people still think and what was common practice in the past, cooperatives should not be seen as socio-political organisations, but should be seen as being formed because people feel that they can gain economically from the cooperation (Van Diepenbeek, 2000). One of the first modern cooperatives was formed by Robert Owen (1771-1858), representative of the Utopian School (Rabobank Foundation, 2004; Van Dijk & Klep, 2005). Despite their failure, Owen’s

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‘villages of cooperation’ gave their name to the modern cooperative organisations and made clear that idealism was not enough and a set of rules (cooperative principles) was necessary.

For financial cooperatives the ideas of Friedrich Wilhelm Raiffeisen and Hermann Schulze-Delitsch were important (Van Diepenbeek, 2000; Rabobank Foundation, 2004; van Dijk & Klep, 2005). Schulze-Delitsch focused on urban entrepreneurs and small industrial businesses, while Raiffeisen aimed at small, rural communities. Schulze-Delitsch was an outspoken liberal and started savings and credit cooperatives based on the idea of self-help in the 1850s. His principles had much in common with Raiffeisen’s (see box 1), but have a different view on profits (dividend was paid to members) and the size (Raiffeisen cooperatives were smaller) (Banerjee, Beslfy & Guinnane, 1994; Rabobank Foundation, 2004).

Raiffeisen reformed his charitable organisation into a new association, the Heddesdorfer Darlehnkassen-Verein (Heddesdorfer Credit Bank), after realizing that self-help was an important condition for success. With this association he laid the foundation for the agricultural savings and credit cooperatives and cooperative banks. According to the International Raiffeisen Union (IRU), today more than 900,000 cooperatives with approximately 500 million members in over 100 countries are working based on Raiffeisen's principles.27

Box 1 Raiffeisen’s principles

Raiffeisen formulated five principles (De Boer, 2003; Rabobank Foundation, 2004): 1. Solidarity/unlimited liability

All members are liable for the debts of the cooperative, which should create moral cohesion between poor and non-poor members. It also gives the cooperation a financial basis, as unlimited liability signals savers that the cooperative is trustworthy.

2. Unsalaried management

Raiffeisen wanted the Board of the cooperative to consist out of the clergy and other educated members of the villages, but the Board was not to receive any compensation for its work. This is to prevent the creation of incentives for speculative activities and to save on overhead costs.

3. Local character

Each cooperative focused on a limited working area. Only in a small area the solidarity would be present to found a sustainable cooperative. Moreover, local knowledge played a large role in the assessment of creditworthiness. Since collateral was not always available and the members were liable for losses, a good assessment of the loan applicant was necessary.

4. Full reservation of all profits

Loans were provided to members against normal market rate, which was lower than the interest rates charged by usurers, but higher than cost price. All profits were to be put in a reserve, as a buffer to prevent a claim on the unlimited liability of members. Only a small percentage of the profit could be used for social and charitable purposes, such as education and health

5. Local autonomy should be accompanied by affiliation to a central organisation

Each credit cooperative has its own responsibility for the management of the cooperative and thus for its profits and losses. However, to overcome the disadvantages of small-scale operations, the local cooperatives form a central organisation. Common activities like marketing and, nowadays, ICT can be done at a larger scale. Moreover, the supervision of local banks can be done by the central organisation.

Although the principles of Raiffeisen and Schulze-Delitsch are too time and situation specific to hold as general principles for all financial cooperatives, cooperative principles still are the basis of every cooperative. However, it must be said that clear principles are essential for cooperative survival, but that there is a danger in attributing the success or failure of a particular cooperative, or cooperatives in general, just to the validity of principles (Cobia, 1989). Overall, the principles show what

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differentiates a cooperative from other types of business. In every principle the interest of the members is central, which shows the focus on maximizing the value for members as the distinguishing characteristic of cooperatives. Note that maximizing member value can include various options like maximum sale price, minimum purchase price, maximum overturn, a large variety of products and even maximum profit (Van Dijk & Klep, 2005). It all depends on the chosen direction.

4.2 Economics of cooperatives

The first cooperatives were formed in the second half of the nineteenth century. Adam Smith’s Wealth of Nations (1776) was the main economic theory at that time. He described the idea of the ‘invisible hand’, which makes sure that the most efficient allocation of production factors and thus the highest welfare is achieved when everybody is acting in his/her own best interest (Van Dijk & Klep, 2005). This notion of full competition in a perfect market is still found in textbooks. In reality, a perfect market does not exist in most situations. Through cooperatives part of the market imperfections can be solved (Van Roosmalen & Van Zanden, 2000). In other words, people can economically gain in this situation from cooperation.

The first market failure that can be solved through cooperatives is incomplete information. Financial institutions try to compensate the risk of default resulting from asymmetric/incomplete information in advance through a good selection method, by creating appropriate incentives or afterwards by (contractual) enforcement (Ray, 1998). Cooperatives have an advantage in selecting people through the availability of (free) information about applicants in a community (Van Roosmalen & Van Zanden, 2000). Monitoring is helped by the social ties in a community (peer monitoring) and by (un)limited liability present in many cooperatives (Banerjee, Beslfy & Guinnane, 1994). An appropriate incentive available to cooperatives is trust between the cooperative and the borrower. This can make part of the often used incentive, namely contracts, superfluous. The social cohesion and common values within a cooperative may create a sense of trust. If these things don’t work, collateral is often used to enforce repayment (Ray, 1998). However, in rural areas the use of formal collateral28_{is in many} situations impossible. In a cooperative, formal collateral can be replaced by informal collateral, such as social status and the possibility to borrow again. Since the possibility to get a loan at a different financial institution is often limited in rural areas of developing countries, the threat of not getting a loan from the cooperative in the future works as an enforcement to repay29_.

Market power is the second market failure that can be changed by cooperatives. By forming a cooperative members can create their own market power and thereby the possibility to change the market structure (Ter Woorst, 1989; Van Dijk & Klep, 2005). The sources of market power are economies of scale and market access (Van Dijk & Klep, 2005). Economies of scale can be created by clustering sales, transport, storage, etc. In the case of financial cooperatives, economies of scale lead to the idea that local cooperatives can gain by forming a central institute. The banking sector has many economies of scale, such as pooling risk, acquiring specialised skills and building reputation, which can

28_{In this case formal collateral is collateral which is valued by both the borrower and the lender, such as land rights. It shields}

the lender against the risk of strategic and involuntary default. Informal collateral are those things that are valued by the borrower, but are relative worthless to the lenders. It protects the lender only against strategic default (Ray, 1998).

29_{In a study of group lending, Wydick (2001) found that the credible threat by a lending institution to deny affordable credit to}

Access to finance through financial cooperatives