Overview of World Council of Credit Unions activities in Central and Eastern Europe with specific focus on projects in Romania and Poland

Normunds Mizis, Program Officer for Europe and Asia, World Council of Credit Unions, Inc. WOCCU

E-mail: normundsmizis@yahoo.com

It is a great pleasure to be present here at the COPAC Open Forum and I would like to take this opportunity to thank our hosts for the invitation to the conference and the opportunity to speak to this honorable audience.

My presentation today will provide a brief overview on WOCCU´s activities in the region, concepts and principals for successful development of credit unions in economies in transition and two case studies from Poland and Romania.

Someone has said: "A bank is a place where they lend you an umbrella in fair weather and ask for it back again when it starts to rain." Credit unions, in turn, are long known as institutions that assist their members to solve their financial problems in the shortest possible time and at fair cost.

WOCCU has been involved in credit union development in CEE since 1992 and has been working in the following countries: Poland, Ukraine, Latvia, Lithuania, Romania and Macedonia. We have finished our programs in Latvia in 1998 and Poland and Ukraine in 1999, but have just started new program in Bulgaria and have extended our activities in Romania for another 4 years. Lithuania project is scheduled for closure in year 2000 and Macedonia in 2001.

Why credit union support programs were necessary in CEE? As you know number of problems related to availability of efficient financial services to the population appeared and are still existing in the countries that are in transition from planned to market driven economies. Let me just mention few of them:

1. Inadequate financial system: the average citizen had great difficulty and quite often even no possibility accessing personal, small business or agricultural credit services.
2. Absence of market-oriented financial skills: it has resulted in too optimistic forecasts for development and financial strengths of newly established institutions, population´s unreasonable trust in institutions offering extremely high interest rates for deposits, fraud in financial market and inevitable bankruptcies.
3. Lack of people´s participation: individuals have had very little or no role in determining or evaluating the services provided by the financial sector.
4. Inappropriate and conflicting legislation: allowing establishment of various kinds of financial institutions without providing adequate regulation and lack of proper supervisory and monitoring capacity of state regulatory agencies.

World Council of Credit Unions has proposed the following solutions, ensuring provision of technical assistance in the countries that are trying to resolve the emerging problems mentioned above:

1. Development of savings and credit union system to provide consumers and small producers and traders with competitively priced, market-driven savings and credit products by using exclusively internal financial resources - member savings.
2. Transfer of skills and technology required for managing cooperative financial institution in the conditions of increasing competition.
3. Credit unions serving as models of private, member-owned, democratically governed financial institutions ensuring every member rights and possibilities to participate in decision making and management of credit union.
4. Policy and legislative reform encouraging greater reliance on market mechanisms in financial sector, providing for adequate regulation and supervision and eliminating subsidized credit, paying positive returns on savings and establishing sufficient reserves.

WOCCU is using the following methodology in building Model Credit Unions:

1. Ideology: credit union can only fulfill its social role if it is well managed and financially safe and sound institution. In the modern competitive world business orientation should prevail over social aspect of CUs activities and CU must attract diverse groups as members. Credit unions must be viewed as institutions for saving in the first place versus traditional appearance as a primarily lending institution.
2. Legislation: credit unions should be part of the formal financial sector with proper and adequate legislation in place, prudent regulatory environment and supervisory authority able to perform supervision of CUs.
3. Financial structure: main source of funds must be member savings deposits, while CUs capital must be formed by reserves rather than member shares.
4. Financial disciplines:credit unions must be both adequately provisioned for loan losses and capitalized and maintain appropriate liquidity levels at all times.
5. Credit services: all decisions must be based on 5Cs of the credit, Character, Capacity to pay, Capital, Conditions and Collateral. Ratio of unsecured loans to total loan portfolio must be carefully monitored and exposure to increased risks due to unsecured loans minimized. Information systems on delinquent borrowers must be up to date and follow up on past due payments immediate and collection procedures effective.
6. Marketing: CUs must be and have promote themselves as safe and sound financial institutions providing efficient financial intermediation services to its members and being competitive in the local financial markets.

Let me provide you with some information about the status of credit union development in countries where WOCCU has been active since early 90´s:

Romania

And now let me provide you with more detailed analysis of the conditions and status of CU development in Romania.

Credit union development history in Romania is almost 100 years old. It did survive times of planned economy but found itself unprepared for coming economic changes and fluctuations. Let me share with you some figures. In 1991 there were 5534 financial cooperatives with total membership of 3.6 million and $225 million in savings. At the year-end of 1998 there were 4653 CUs with 1.8 million members and $86.6 million dollars in savings. Decrease in membership has been 50% and decrease in savings 62% respectively. The reason for this dramatic decrease has been fluctuating economic environment combined with inability of management to adapt to the new conditions. Let me mention some facts:

Inflation. Year-end inflation for 1997 was 151% and 42% for 1998. CUs difficulties can be traced back to the high inflation, since 1991, and inappropriate pricing policies and lack of a strategy to minimize the effects of inflation on member savings and loan portfolios.

Pricing of savings. Under such a high inflation CUs continued to work according to the old methods, requiring obligatory monthly share contributions and paying low interest rates (around 3-10% per annum) and issuing loans at low rates 15-20% per annum. As a result of CUs not protecting the value of member savings against inflation members were leaving CUs and savings decreased dramatically.

The net result has been a loss of purchasing power of the CUs´ loans, amounts of CUs loans are now insufficient to allow members to purchase goods that were commonly financed before 1991, i.e., cars, houses, etc.

Privatization. Privatization involved increase of the efficiency of operations of privatized enterprises and loss of employment as state-owned enterprises went through the privatization process or downsized as a precursor to privatization. The impact on CUs, the majority of which are closed employer based, is a smaller field of membership. The employer based CUs expressed guarded willingness to expand their field of membership outside the work place.

Proposed solution for the current situation is to introduce savings and loan products priced according to market conditions.

Implementation of the new project includes two major components:

Modernization of CUs: in order to expand both the membership and the services of the CU system, the program is implementing the model credit union approach in 20 CUs. This methodology focuses on the areas of

1. institutional development,
2. savings protection,
3. a first round of credit administration (new credit policies and procedures, repayment capacity analysis, delinquency control, collections, risk analysis),
4. savings mobilization, and
5. a second round of credit administration (product and service diversification to meet members´ microenterprise and other credit needs). The methodology utilizes a financial performance monitoring tool known as PEARLS (Protection, Effective Financial Structure, Asset Quality, Rates of Return and Costs, Liquidity, and Signs of Growth).

Through this approach CUs will be able to move from traditional services to a more effective financial structure that emphasizes new, market-based services. Modernized CUs are being positioned to expand the range of financial products and services they offer to their members while improving their safety and soundness as financial institutions. This will lead to an improved public perception of CUs as a safe place to save and borrow and, thus, increases membership within the community.

2) Model CU Certification Program: A Model CU Certification Program will be instituted to recognize those CUs that meet international credit union prudential safety and soundness standards. Membership in the certification program will require that the CU adhere to the operating policies, financial disciplines, and performance standards established for Model CUs.

The goal of the Model CU Certification Program is to present an improved and consistent public image of CUs and to gain public confidence in CUs as safe and sound financial institutions. The Model CUs will seek to distinguish themselves from traditional CUs and will be marketed as a select group of financially strong, highly disciplined CUs which will help to accelerate savings growth in the certified CUs and provide an incentive for other CUs to emulate the certified CUs.

This Model CU rating and certification program will serve as the basis for a long-term regulatory framework for CUs. Given the possible amendment of Law 122/1996 WOCCU will undertake dialogue with agencies of the Government of Romania including the Ministry of Finance (MOF) and the National Bank of Romania (NBR) to develop a suitable regulatory framework for CUs.

The following results have been achieved by the end of July 1999:

184 CUs out of 4544 have introduced the new services, covering 33 Territorial Associations out of 42. Membership utilizing the market priced services grew from 42,361, at the beginning of the year, to 69,901 members by the end of June.

During the first six months of 1999 membership continued to decline and reached 5%, however, member savings largely due to the new services introduced showed a positive growth for the first time in past four years and reached the growth of 9%.

WOCCU has just started new program in Romania that will continue for four years and will be implemented based on the principals described above. We are certain that we will be able to tell you a good story of recovery of a large credit union system in years to come.

Poland

However, in CEE most of our activities have been working in countries were credit union systems did not exist or were destroyed during the communist era. One of the examples of building a new and rapidly growing credit union system is from Poland. Let me take a few moments to describe the experience of credit union development in Poland.

At Polish request, the World Council of Credit Unions (WOCCU) provided technical assistance funded by the U.S. Agency for International Development (USAID) to help create a credit union system after the fall of Communism in Poland.

In 1992, the project established a National Association of Savings and Credit Unions (NACSCU) and created a Central Finance Facility (CFF), a Stabilization Fund, and an Insurance Company. This technical assistance project did not focus on strengthening a number of primary level credit unions at the base, but instead had a top-down approach. NACSCU has directed and implemented most of the project initiatives. As of December 31, 1998, the following indicators were recorded:

The total cost of the entire seven years of USAID project assistance to Poland was 3.9 million USD. For every US Dollar that was spent on this project, over 40 USD of new assets were generated. Assets of 158 million USD render the Polish credit union system the fourth largest financial network in Poland. A survey of 604 credit union members in 21 credit unions completed in March 1998 in a qualitative sense reveals the depth of outreach of Polish credit unions. For more than 50% of the members surveyed, the credit union is the only source of formal finance available to them.

Besides credit union-level achievements, the development of NACSCU as a financially sustainable second tier national association, is a remarkable project accomplishment. The National Association of Cooperative Savings and Credit Unions is the apex organization through which virtually all credit unions are allowed to do business in Poland. The development of NACSCU as a financially sustainable second tier, national association, has been one of the most remarkable accomplishments in the first seven years of the Polish credit union system. There are many national associations throughout the world that even after thirty years of existence are still not financially self-sustainable. NACSCU´s overall success and financial independence are largely due to its ability to attain: legal significance, commercial significance (as evidenced by income-generating services including central finance facility, stabilization fund, training seminars, SKOKOM computer software, equipment services, supervisory/audit services, insurance products), political significance, and supervisory significance.

As is the case in most successful projects, there are a variety of factors which, when combined together, produce a synergy that yields an output greater than the sum of the individual pieces. In the case of Poland, this synergy is readily apparent. The success factors in the development of the Polish Credit Union Movement include:

• successful national macro-economic reforms,
• political support from the Solidarity Trade Union and Solidarity political party,
• strong credit union leaders and competent employees,
• favorable credit union legislation,
• starting in the workplace,
• Polish economic and social underpinnings, and
• international credit union network and volunteer partnership agreements.

Considering that no credit unions had operated in Poland since before World War II, it seemed aggressively optimistic to assume that a credit union network could start from nothing in the early 1990s and build a large base of self-sufficient, primary level credit unions throughout Poland within seven years. Unbelievable as it seems, that is exactly what has happened. In addition the project has also created number of second tier organizations providing financial services present in virtually all of the developed credit union movements around the world.

Today credit unions in Poland offer a sophisticated variety of products and services ranging from short-term instant loans, medium term credits, long-term housing loans, share deposits, withdrawable voluntary savings deposits, systematic savings programs, fixed term deposits, automated teller machines (ATM), electronic payment of monthly bills, credit cards, to life insurance. Credit union interest rates are more attractive than those of commercial and state banks. Credit unions typically pay several percentage points higher on savings deposits and charge one or two points less on credit.

Let me mention second tier organizations operating in Poland.

Development of NACSCU was mentioned already. Something to be added is the fact that with the approval of the Credit Union Act of 1995, NACSCU assumed a preeminent role as the true axis of the entire Polish credit union network. Legally, NACSCU has been charged with the responsibility of establishing prudential standards and norms for credit unions, and then enforcing those norms through a comprehensive audit and supervisory role. This legal structure, in essence, guaranteed that NACSCU would always play a significant role in the development and supervisory control of the credit unions. At the center of its supervisory responsibilities are the prudential standards of safety and soundness that NACSCU imposes on all of the Polish credit unions. To effectively monitor the compliance of these standards, NACSCU requires strict monthly reporting requirements of all credit unions. The growing database of credit union financial data and statistics has become a powerful, centralized source of information for NACSCU, on the status of the Polish credit union system.

The key to the financial success of NACSCU has been the commercially-oriented products and services which it has offered to credit unions to help them provide better services to their membership base. The sale of these products and services has created sufficient revenues to cover the operating expenses and attain financial sustainability. The services listed below are offered either through NACSCU, or a subsidiary or affiliated organization through which NACSCU receives a financial benefit:

The Central Finance Facility (CFF). The CFF was created in order to provide liquidity protection to credit unions in the event of unanticipated member savings withdrawals. The current fund balance of 17,263,165 USD has grown as a result of the legal requirement that all credit unions maintain at least 5% of all savings deposits and external loans and 100% of their capital reserves (shares and institutional capital) in the CFF. The role of the CFF is to manage the liquidity of the credit union network. It is the only credit union entity that can borrow from banks, so base-level credit unions can only borrow from the CFF for their financing needs. It pays a competitive return to credit unions for the obligatory liquidity reserves that they must maintain in the CFF. Currently it is 12%, which is at the same level with Polish Commercial Banks.

This return is significantly better than that of the competition. For example the National Bank of Poland requires banks to deposit 11% of their risk-weighted assets as obligatory liquidity reserves, and pays 0% interest on those funds. Aside from the obligatory liquidity requirements, the CFF also offers a volunteer savings program which pays 1-2% higher than savings accounts in a bank.

The CFF has two investment options with its liquidity. It may either invest in government bonds which currently yield 14%, or it may loan funds to member credit unions in need of external financing. The loan interest rate varies between 16-20%, depending upon the term of the loan. The CFF has tried to "smooth out the highly volatile interest rates in the financial marketplace by not reacting immediately to rate changes. By lagging the market, the CFF provides greater stability to the credit unions still struggling with proper interest rate pricing.

Stabilization Fund. The Stabilization Fund was set up to assist credit unions that have experienced financial difficulties in the volatile economic conditions of the financial marketplace. Credit unions must deposit 1.22% of their total assets in the Stabilization Fund, at 0% interest, in order to help weak credit unions strengthen their financial position and protect their member savings deposits. NACSCU lends this money out to weak credit unions at preferential rates of interest (currently between 5-8%). As of December 1998, the balance of the Stabilization Fund was 2,045,000 USD. Of this amount, 250,000 USD is loaned out to financially-troubled credit unions while the balance is invested in government bonds.