Co-operatives as the Key to Responsible Microfinance

By Najmul Hoda,

Microfinance Focus, April 3, 2012: The poor and the poorest have a right to be serviced affordably, appropriately and accessibly, reads the Millennium Development Goal campaign named end poverty 2015. There is no denial of the fact that microfinance has emerged as a key strategy in reaching the Millennium Development Goals and as an effective tool in the provision of financial services to the poor and the near poor. However, despite the claims of overwhelming success of microfinance in financial inclusion and poverty alleviation, the microfinance sector in India has faced some critical problems highlighting shortcomings in the institutional or functional framework.

Several reports suggest that the efforts of the existing microfinance institutions are directed mainly towards growth and outreach. The industry also lacks rigorous analysis of the institutional, incentive features and benefit-cost or statistical studies of impacts tends to be biased towards women, lack features of fund mobilization. The diagnosis of the crisis in Andhra Pradesh reveal similar problems like lack of credit discipline, rapid expansion of credit in highly concentrated markets, lack of proper incentives for sound underwriting or customer care, lack of internal controls, reliance on credit-only services, and dependence on basic bank debt.

Finally, the single biggest problem with conventional microfinance, and for that matter all interest-based finance, is that the borrower has to make his interest payments even if he is unable to meet them. At a time when a young business should be concerned with innovation and expansion, an interest payment looms unavoidably large at the end of the month. Further, interest based transactions tend to focus attentions on the process-oriented task of repayment rather than on the result-oriented task of increasing profit. Loans can also be taken for consumption or to fund special events such as weddings. The fungibility of money, which is routinely overlooked by microfinance proponents, blurs the distinction between investment and consumption borrowing. This results in increased problems for the poor rather than alleviating it.

The existence of co-operative based microfinance is rare and may provide remedy to the existing problems in the microfinance industry. The reason for the recurring problems of same nature across the industry is that a majority of microfinance models work on the same or an altered method of group lending. In a recent article David Hulme, an expert, suggested that the industry must strive to keep its costs as low as possible, expand incrementally and focus as much on savings services as on loans. Such features are deeply embedded in the co-operative structure. Co-operative has a long history and began nearly 150 years ago in Europe expanded across the globe as a movement.

The financial co-operatives usually non-profit and provides financial services: savings, checking accounts, loans, insurance, and fund transfer services (although the weaker and smaller ones are not capable of offering transfers). The reliance on the members’ own savings as the source of funds fills a major gap found in the case of other models. Cooperatives generally have higher levels of cost recovery and fund a greater proportion of their loan portfolios with mobilized deposits than NGOs with similar clienteles. The co-operatives may be grouped into federations at regional or national level to offer supervision, liquidity management, refinancing, and/or technical support that might be difficult to find at the local level. Even small financial cooperatives typically have the legal and institutional capacity to provide a wider range of more flexible financial services than NGOs, particularly if membership in a federation provides them with access to a liquidity pool. A cooperative has a huge potential for scale depending upon the nature of its common bond.

A really interesting model is that of Al Khair Cooperative at Patna. The model allows the member to engage in participatory finance. The system of participatory finance allows the members to decide on aspects like interest, transaction cost, loan disbursements, financial products and liquidity. The Al Khair experiment allows a great scope of innovation in terms of financial products. The members can decide on interest free borrowings and lending thereby reducing their transaction considerably compared to the prevalent market rates. Innovative financial products like micro-ventures may be introduced and the profit sharing may be used for cross subsiding the transaction cost incurred in the consumption loans.


The co-operative structure provides the requisite institutional structure for catering to these needs. A financing system based on profit sharing with the micro-entrepreneurs should be able to provide interest free consumption loan, while still leaving enough in the reserves to show as profit. There are indeed risks of non-repayment due to business failures but the same exists in any collateral free loan lest the institution resorts to any illegal means. The interest free deposits by members would come as a boon for the microfinance institutions that do not have any other option but to charge a higher interest rate from the poor clients to meet their cost. There is a strong need to study such institutions for more detailed insights and the potential for their mainstreaming. Hopefully, the interest free co-operative microfinance may provide the much needed change the industry is eagerly waiting for.

(The author is pursuing PhD from Birla Institute of Technology Noida and also heads the Research department of a microfinance institution in India)


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Believer in Coops and their members

Let the readers of this forum be assured that I am indeed a firm believer in Cooperative Societies as a legal form that has enormous potential in achieving sustainable services delivery for people and areas that are marginalised by purely commercial companies.

Academics and practitioners with experience and interest in financial services cooperatives in the region know about the challenges of their past in Cambodia, China, India, Indonesia, Laos, Pakistan, Vietnam and indeed also in Togo and the West African region.

Voluntarism based on full understanding and active control by members thus needs to be ensured and a basis for that is their own financial input in terms of working capital and loan capital. These founding principles would need to be included in the laws and regulations of Coops where they today are often not clear and coherent. Initiatives and Substantial funding from Government (regional and national) and from Donors will already represent visible, easy, firm indicators for potential risks.

If members discuss the interest and credit risk management in deposit and lending, a firm basis of education and vocational training is necessary. Here outside support can be helpful.

Finally, if interest on deposits, fixed term savings and on loans is not to be applied, but profit sharing instead, then the basis of the profit, the business, needs to be firmly discussed, and theoretic future profits should be dealt with as "selling pearls before diving"; as gambling and speculation. In particular in countries that face challenges with inflation (of at least 5-10% for instance), member-depositors need to understand well such losses to the little excess liquidity that they will entrust directly to borrowers.

Let us not call a comment un-academic just because it is criticising something that is trendy and attractive for support (in this UN Year of the Cooperatives). Let's look carefully at how we can defend and promote the interests of poor (often uneducated) unbanked people.

Respectfully, Peter


Well written article. It is the interest based system that is making poor more poor.
The whole purpose of microfinance is to help poor but with both Money and guidance and ensuring at the end that beneficiary overcome poverty

On the Financial Coops in Togo

Dear Najmul,

When I worked in Togo FUCEC was by far the largest MFI and a cooperative, which was under restructuring for years, helped and also-recapitalised with foreign support. It was a major concern for Togolese inspectors from CAS-IMEC and for the regional central bank BCEAO.

The smaller MFIs were also often coops, such as UMECTO, URCLEC, WAGES and TIMPAC.

As I regard it as extremely important that in these fora we discuss best practices as well as learn from weaknesses and challenges, it might be useful if you could explain to us the recent performance of the above financial services coops, maybe considering what I commented on Mr. Hoda's article.

Thank you, Peter

This is among the WORSE articles on Financial Cooperatives

This article is probably one of the worse I read world-wide on Financial Cooperatives.

It totally ignores the failures of (micro-) financial institutions that have been created for some hundred years as cooperative societies everywhere in the world, everywhere in Asia and everywhere in India.

The causes of these failures were often the following:-
- Creation of Cooperative Societies by government, national and government, thus not by members on a voluntary basis
- No full understanding of the members or government about the basic principles that make financial coops work (working capital by members, loan capital from voluntary member deposits and savings, effective control by members)
- Focus on Credit for socio-political objectives, for farming, micro-enterprise and for consumption in particular
- Is there own money is not really involved and because government is driven by socio-political motives (often providing guarantees for when things would go wrong), members do not undertake effective control functions
- No coherent and consistent framework of strategy, laws, regulations, supervision (by experts on coops and finance) based on the above principles.

The author claims to have a PHD and leads a Research department in an MFI. It is indeed very, very sad that a person with such an important responsibility seems to know so little about a subject and has so little interest in the history of his own country and that of the Asian region.

Peter van Dijk
FIQ Financial Inclusion advice

Microfinance Cooperative suuccess

I fail to understand the argument of Mr Peter and non-academic comment on the brief article of Mr Najmulhoda. Mr Peter is trying to highlight the failure of government managed cooperatives whereas Mr Najmulhoda is talking about voluntary groups under cooperative model and that too working basically on interestfree products with sole reliance on interestfree savings, profit sharing micro enterprise, cross subsidising the operative cost and experimentation freedom for innovative products under interestfree cooperative model. Perhaps, some sad experience of government funded cooperative has caused blurring the objective reasoning of Mr Peter.


Dear Najmul

This is a well written, well argued paper, coming in the year of the cooperatives.

I just wanted to mention that cooperative based microfinance are not so rare in other parts of the world. Although MIX data may show that only 10 to 15% of MFIs are cooperatives, my feeling is that cooperatives are smaller (number of borrowers) and normally do not need to report to MIX since they are self-sufficient and do not have the resources required to market themselves (unnecessarily). Therefore, there may be significant underreporting of cooperatives.

When we studied the history of Microfinance in Togo, we found not only that cooperatives were the dominant form of microfinance, but that during their internatinoal crisis, when donors from the West stopped giving donations, the cooperatives survived. The people from Togo that we interviewed were very proud of the fact that they had been able to resist the rest of the world, thanks to their mutual cooperation.

In any case, it was a pleasure to read your piece.


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