SUMMARY - Characteristics of a Federated Network of Financial Cooperatives

Développement International Desjardins (May 2005)
http://www.did.qc.ca/documents/R%C3%A9seauFed(TAP)An.pdf

Abstract

This paper examines the rationale behind cooperative networks and compares two network models: federated and atomized-competitive. It then explains the key characteristics of federated networks: resource sharing, operations standardization, contractual solidarity, and strengthened governance.

Summary

Why networks? Financial cooperatives, like other businesses, have to adopt new practices in line with the following 3 trends:

1. Growing power of clients, who require tailor-made solutions
2. Intensified competition
3. Need for constant innovation

Among the advantages of a network are economies of scale, flexibility to adapt to market fluctuations, risk reduction, and access to additional sources of capital.

Two models of network organization are compared:

• the atomized-competitive network model, where entities have weak links and share resources minimally. This model is found in credit unions in the US, English-speaking Canada, and Australia.
• the federated network, where cooperatives are highly interrelated, with apex organizations and integrated supervision. The member cooperatives are owners and control the shared entity.

The authors assert that federated networks generally perform better than atomized-competitive networks, when measured by market penetration, stability, financial efficiency, range of services, and target clientele outreach (as evidenced by research performed by Klaus Fischer in 2000). This model is found in continental Europe, or where European immigration was strong (i.e. Argentina, Uruguay, Chile, Brazil and parts of central and West Africa). System reform in the US, Canada, and Australia is shifting toward federated networks for credit unions.

The key characteristics of a federated network are 1) resource sharing, 2) operations standardization, 3) contractual solidarity, and 4) strengthened governance.

1. Resource sharing
   Resource sharing is the main motivation for creating alliances. It allows for pooling of inputs which enables the base units to better negotiate with suppliers and expand their labor supply. It also allows for access to support services, such as combined training of staff. Moreover, federated networks engage in collective ownership of services which are complementary to their operations.
   
   
2. Operations standardization
   In standardized systems, base units present a uniform image to the public and operate according to certain norms. As a result, base units can easily be compared among themselves and within an industry. The overall advantages are economies of scale, growth, rigor, systematization, information management, and internal and external benchmarking. Standardization is most common in 4 areas:
   1. Operational systems – Affects financial systems, human resources and marketing; results in economies of scale
   2. Policies and norms – Can affect performance criteria, credit conditions, and hiring policies; base units must be committed to following policies once adopted
   3. Products – Even though base units may operate in different markets, they must draw upon a pool of products designed according to pre-established norms.
   4. Institutional image – By adopting a unified marketing image, each unit acknowledges that they are part of a system which is greater than they are.
   
   
   
3. Contractual Solidarity
   Formal agreements among members result in network solidarity and a positive image as a unified financial institution to outsiders. The advantages of contractual solidarity include balanced representation, internal and external recognition, access to capital markets, and protection of the network against weakness in certain units.
   
   The authors identify 6 elements of contractual solidarity:
   
   1. Control over opening service outlets – protects against encroachment on territory of one base unit by another base unit
   2. Balancing base unit size –network members err toward homogeneity, as the goal is balanced representation in network
   3. Dues – member coops are obligated to pay dues to the second-tier institution
   4. Communicating vessels – units with liquid surpluses may distribute excess liquidity to units with liquid fund deficit
   5. nternal security measures – security mechanisms (i.e. contingency funds, insurance funds) to cover base units from unforeseen circumstances and risks
   6. Central agency – manages liquidity exchange between members and raises funds in capital markets
   
   
   
4. Strengthened Governance
   The overall advantages of having network strategies for internal regulations to improve governance are: protection of member interests, protection against excessive centralization, and maintaining the functional independence of member coops.

   The authors identify 4 such strategies:

   1. Structure for democratic representation and centralization of authority - base units must continue to play a role in making decisions that affect them, even if certain powers are delegated
   2. Respecting principle of subsidiarity –the federation should not replace or take on base unit initiative and responsibility, but member cooperatives should subordinate their autonomy to the general good.
   3. Surveillance – internal supervision is a major function of federated networks
   4. Affiliation – is a voluntary act and an essential condition for belonging to network