Mobilizing Savings and Ensuring Their Safe Use
Lucy Ito, World Council of Credit Unions
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There are three benefits to savings mobilization from the credit union perspective. The first is that it strengthens the financial self-sufficiency of the institutions, and the second reason is that it reduces the dependency of the institution on external borrowings. Savings represent a stable and cheaper source of funds and allow an institution to engage in community-based finance as opposed to finance that may be subject to the priorities of government or donors. A last benefit of savings mobilization is that members/clients of financial institutions have savings needs as well as credit needs and savings mobilization gives them access to that much needed service.
But there are reasons why an institution might want to avoid savings mobilization. The three biggest dangers that we have identified in a savings mobilization program are the following:
First, losing members’ money. The second problem is losing members’ money, and the third danger is losing members’ money.
Brian Branch, World Council of Credit Unions
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When people are asked, “What do you look for in a financial institution?” people say they want to know their money is safe, convenient, and that they will receive a good return.
There are three principle strategies that we pursue in savings protection. One is to implement financial management disciplines. Once we mobilize savings there is the danger that if the institution runs into difficulty, fails and has trouble returning those savings to the member, you will impair the value of the savings. So one puts in place several lines of defense before impairing those savings. The first would simply be provisions for loan losses and expensing from the income statement a function of the risk to the institution that serves as a first line to absorb normal losses. The second line of defense would be the reserves, or the institutional capital. The surplus that we accumulate over time acts as a cushion against the extraordinary losses that the provisions aren’t able to absorb. Third would be the paid-in-capital or the equity, the shares that members invest as risk capital in their institution. We also highlight establishing standards for asset quality, delinquency, non-earning assets, and earnings for the institution that generate the surplus and the capital.
When we talk about provisions, we’re talking about expensing the amount of the provisions based on the risk to the institutions. We measure that risk by looking at the delinquency that the institution has in its loan portfolio and the aging of that delinquency. Normal standards would suggest that we provision off 100 percent of those loans which are delinquent more than 12 months. One can establish a number of different rules for those loans that are delinquent less than twelve months. The simplest rule in many countries is to say 35 percent of those loans should be delinquent less than 12 months. You can also find a number of tiered structures where you provision 30 percent of those loans delinquent up to three months, 60 percent, 3-6 months, 75 percent, 6-12 months. A number of strategies can be used. One charges off those loans which were unrecoverable, such as those delinquent more than 12 months.
We talked about capital. Here we’re talking about reserves and retained earnings as the second line of defense. Accumulating institutional capital, very often we suggest 10 percent of total assets as a target for institutional capital, which means the institution needs to capitalize its surplus so that as it grows, driven by its savings mobilization, the institutional capital will grow as well.
Institutions need to put in place standards for asset quality, measure the delinquency by the total amount of the outstanding loan portfolio that’s affected, keep delinquency below five percent, apply rapid and strict collection policies, and again identify those loans which are unrecoverable and charge them off with provisions (when they’re charged off it doesn’t mean that one forgets about them, but rather applies legal collection of those loans).
If one is mobilizing savings, then receiving savings that one is paying a financial cost on and channeling those savings into non-earning assets is a money-losing proposition to the institution. One wants to make sure that the non-earning assets don’t exceed the institutional capital, the source of funds that does not have an explicit financial cost to it, and then limit the non-earning assets to 5-7 percent of the total assets, again to maximize the earnings that the credit union will generate.
Setting targets for the earnings, one would calculate one’s loan interest rate policies to cover all the costs of the institution. The cost of the funds that we’d expect, the cost of operations, but again the cost of maintaining those lines of defense for the savings, provisions for assets losses and capital accumulation. Again, strict collections and delinquency control is important in order to maximize the earning potential of the portfolio and again limiting operating costs to less than 10 percent of assets.
In mobilizing savings, one wants to be sure that, when members come to the institution to withdraw those savings, that they will be able to access those savings and therefore maintain confidence in the institution. Maintaining a liquidity reserve of 10 percent of withdrawable deposits is a standard that one often uses. Taking in short-term savings, we don’t want to be lending those funds out on the long-term, so we’re maintaining an asset liability management policy.
We talked about these savings protection disciplines along the lines of protection, we talked about capital within the financial structure of the institution, we talked about asset quality and liquidity, and these are some of the indicators that the World Council uses in our PEARLS monitoring system. The PEARLS system measures these protection indicators. It also measures the structural indicators of the institution so that one can see how the institution evolves over time. It measures growth as well.
Lucy Ito:
Once we’ve put in place the protection controls and mechanisms necessary to assure that member savings are safe, under the Model Credit Union Program, we then move into identifying and offering demand-driven services to respond to members’ savings needs. What we have for you today are seven examples of savings services that credit unions offer and we’ll detail for you some of the advantages and disadvantages, both from a member point of view and an institution’s point of view.
The first savings product or service that’s offered is just a regular savings account. Often, in credit unions, members are accustomed to having had share accounts, where their shares weren’t accessible. They were encumbered if they had a loan or the share contributions were mandatory. A regular savings account is attractive to members because of the easy access, the withdrawability, the voluntary nature of the account, and lastly, that a minimal amount is required to open up such an account. From a credit union or institution’s perspective, regular savings is attractive because it mobilizes a large volume of funds that can be used for lending, but, the transaction costs can be high for many small accounts. The source of funds, these savings, because they are voluntary in nature, there is some volatility. There is no assurance to the credit union that the money will stay there.
A second example of a savings service is a programmed savings account. This is the kind of account that you would set up for a member so that he or she could save for a special occasion, perhaps a vacation. The agreement between the credit union and member would be that the member makes a set monthly contribution. For members, this is attractive because, given the decreased liquidity of the account, the credit union offers a slightly better interest rate, and that higher interest rate over regular savings is attractive to members. From a credit union perspective, these programmed savings accounts offer a stable flow of funds each month. These programs are easy to administer, with only one withdrawal at maturity. Its very easy for the credit unions to figure out what its liquidity needs are going to be. The cost is also very low, with a small number of withdrawals from one member. Lastly, there is no guarantee that a member will renew this service. If a number of members decide not to renew the service, this sends a message to the credit union about the quality of the service.
A third savings service that credit unions offer is something called a lottery savings account. This is a type of service where you offer a prize every time a member makes a deposit. A raffle is then held for a cash prize or home appliance. From a member perspective, this is an advantage, and from a credit union perspective, it allows a credit union to get a periodic stimulus of funds. The financial cost of this kind of product is much lower. Instead of returning a high interest on the deposit, the appliance or cash prize is the only cost to the institution. This is also attractive to institutions because such a product is attractive to those market niches that may have a lower capacity to save. This provides them with the incentive to make a small deposit. The only disadvantage for the credit union is that often there are many deposits before the date of the raffle, but once the drawing is held, the deposits for the program end.
A fourth service that credit unions offer are child/youth savings accounts. For the credit union, one of the biggest advantages to this program is that they’re providing financial education to their future market. It is also a way of accessing the parents of the children. If parents hear that there is a program available for their children, it brings them to the credit union and exposes them to other services. The disadvantages, from an institutional perspective, are that these accounts tend to be small, so the transaction costs are high, the total volume of mobilized savings can be low, and, for it to be effective, it requires direct marketing.
A fifth savings service that credit unions offer is the fixed terms savings account. The features of such an account are that it is a contract, offering a fixed interest rate for a certain period of time. Renewal of this program is at the discretion of the member and can be made automatic upon maturity. Part of the contract also is that if the funds are withdrawn before maturity, there are penalties, usually realized in the form of a reduced interest. From a member perspective, fixed term savings accounts are attractive because they offer a higher rate of return than other savings services and they can serve as a loan guarantee. For the credit union itself, the primary advantage of fixed term savings is that it is targeted at the market that has the capacity to save. A disadvantage is that the credit union has to repay a higher return to attract these savings that are going to be relatively illiquid for the member. The last disadvantage for a credit union is that these funds are susceptible to interest rates. If inflation increases, members won’t put savings into a fixed account and, depending on the term of the savings, the credit union is locked in to some kind of return. The credit union has to make sure that it adjusts its loan rates so that if the loan rates go down, then the margin that they can recover, relative to the fixed term savings, will be reduced.
A sixth service that credit unions offer assumes that credit unions are part of a network. The sixth product would be access to inter-credit union operations. The advantages to a member are that the member can make deposits, take care of transfers, or withdraw savings at an affiliated credit union no matter where that member is. This gives the member a sense of belonging to more than just a credit union. For the credit union, such inter-credit union operations are an advantage because they make the credit union very competitive relative to other financial institutions, with the possibility of realizing economies of scale. There are a number of reality checks, though, for a credit union. To be part of a network places greater demands on an institution, in terms of technology and communication. An alternative is that credit unions, if they don’t network in their own system, they can use existing infrastructure in the financial sector. However, they have to pay bank charges to facilitate the connection. The other reality check is that participation in such a network requires the credit union to meet very stringent minimum standards.
A seventh service is that credit unions have always offered share accounts. Credit unions do not abandon this, but we encourage them to modernize this product by offering a higher earnings rate than savings - often share capital has had no return whatsoever - and to minimize the obligatory amount. The challenge for the credit union of the long-term share credit is managing the length of that liability and matching that with the asset side of their books.
