Développement International Desjardins (September 2005)
http://www.did.qc.ca/en/qui-sommes-nous/positionnements/outil271.html
Abstract
Desjardins outlines the main forms of cooperative supervision through networks and describes situations when each type is most appropriate. The paper recommends implementing internal and external supervision simultaneously. This can either be done through a parallel approach or an integrated approach. The paper states that delegated supervision (a type of integrated supervision) works best when internal supervision fulfills conditions for success and network member coops operate in a standardized way.
Summary
The three elements of supervision are 1) an internal control system, 2) inspection, and 3) external audit.
Desjardins believes that supervision of all coops and MFIs should be the responsibility of government authorities. However, authorities such as the central bank or Ministry of Finance are often reluctant to take on this difficult task since little is at stake. MFI failure does not pose systemic risk to a country since total savings deposits in MFIs are small portion of total domestic savings. This is often used as a justification to delay the setup of appropriate regulation and supervision.
Networks: Networks provide internal supervision through an apex organization. They may do this either directly or indirectly.
- Direct - fees are paid by members to receive shared services (i.e. training, technical assistance, management of liquidity – surplus and deficits).
- Indirect - risk is shared by member coops because the performance of each entity impacts the others; apex organization exercises control, offers protection for all participants, results in interdependency that demands monitoring of member entities.
DID analysis finds that greater network integration, or greater delegation of supervisory authority to an apex organization, results in increased internal supervision.
External auditing: DID believes that this should be the first option, if possible, so long as supervision is done according to generally recognized principles. In some countries, external audits of community-based financial institutions suffer from poor quality because auditors are simply not well-acquainted with this sector. Usually lawmakers decide whether or not to impose external auditing as part of legal framework.
Conditions for successful supervision
The first step is self-regulation, which involves the establishment of an internal control system by the cooperative or network. Critical conditions for success are professional, legal, organizational, and operational:
- Professional – External auditors are hired based on knowledge, experience, objectivity, and training.
- Legal - The cooperative being supervised must agree to comply with recommendations made by auditors.
- Organizational – The internal auditing department does not report directly to the CEO, but instead to a surveillance commission, in order to avoid conflict of interest. Having audit reports reviewed by teams from different regions and holding joint training sessions may help ensure uniformity of audits.
- Operational – Since supervision relies heavily on the judgment of the auditor, proper review of the auditor inspection reports is vital.
Different models of supervision in federated networks
- Internal supervision – only by apex organization of network, no government involvement
- External supervision – only by authorities in charge of financial sector operation
- Parallel supervision – Internal and external but with no link between the two
- Integrated supervision – Linked internal and external supervision. There are two types:
- Auxiliary – apex organization supervises but uses tools from designated authorities
- Delegated – designated authorities rely on tools and orientation of apex, but maintain full control of supervision
Parallel supervision: DID believes that internal and external supervision should co-exist. However, initially it is preferable for both to act independently. Until external authorities are convinced of the quality of internal supervisory efforts and conditions for successful integrated supervision are met, parallel supervision should be implemented. After that point, integrated supervision may be utilized.
Integrated supervision: This should only be considered under certain circumstances, where internal supervision is already operating well. Other conditions favoring integrated supervision include:
- A federated network in place
- Agreement between authorities and network about expectations of supervisory tools and results to be delivered
- Clear definition of powers
- Independence between cooperatives and auditors
If these conditions are in place, integrated supervision can offer advantages for both the authorities and the supervised entities, including:
- Reduced cost of supervision
- Better synergy and less duplication of efforts
- Better knowledge of the entities supervised, which can improve quality of inspections
- Standardization of operations, which makes it easier to compare performance
In addition, integrated supervision offers specific advantages for the authorities and supervised entities. The advantages specific to authorities in charge include:
- A single point of communication, with the apex organization rather than all the cooperatives separately
- Fewer promotional or informational activities necessary
- Better ratio between energy devoted to sector and percentage of domestic savings represented
The advantages accruing specifically to supervised entities include:
- Less time spent by entities because inspectors have quick access to current information from the apex organization
- Follow-up procedure after the inspection reports are disseminated is assumed by the apex organization