Co-operative banking under attack in Europe

In 2013, one of Italy’s 371 small co-operative banks, Banca Romagna Cooperativa (BRC), failed due to heavy losses. It was placed into administration by the Bank of Italy and in July 2015, it was wound up.

The course of this resolution was not exactly smooth. Like many banks in Italy – and like the UK’s Co-operative Bank – BRC had sold bonds and preference shares to its retail customers as a higher-interest alternative to deposits. The original plan was for BRC to be bailed out with funds from Italy’s Deposit Guarantee Insurance Fund, thus ensuring that retail bondholders would not have to take losses. But the European Commission ruled this out on the grounds that this would constitute illegal state aid. So the Italian co-operative banking network, the Banche di Credito Cooperativo (BCC), stepped in. It transferred BRC’s assets to ICCREA Banca Sviluppo, a specialist entity within the BCC which manages and resolves distressed banks, while BCC’s Institutional Guarantee Fund reimbursed both depositors and retail bondholders in full.

This sounds like a happy ending, doesn’t it? Italy’s co-operative banking sector, like its German counterpart (on which it is modelled), managed the resolution of a failed co-operative bank all by itself without any public funds being involved.

Not so fast. Questions are being asked about the manner of this resolution. The think-tank Bruegel, for example, complains that it undermined the principle of creditor bail-in:

“The Institutional Guarantee Fund is technically not public money (it’s financed by contributions from banks), but this still looks like a circuitous way to do what was initially planned, i.e. to avoid placing losses on private creditors.”

This completely misses the point. Bailout by the Italian Deposit Guarantee Fund should never have been considered. The BCC has its own deposit guarantee scheme, which unlike the public deposit guarantee scheme is fully funded by contributions from BCC member banks. It also has a bond guarantee scheme, again fully financed by its member banks, which makes bail-in of bondholders unnecessary. And in 2008, it established a new fund, the Institutional Guarantee Fund, which can provide liquidity and solvency support to distressed co-operative banks. This last fund effectively makes the co-operative banking sector fully self-sufficient. The BCC was always able to resolve Banca Romagna. The only question is why it didn’t do so earlier.

Despite the evident capability of Italy’s co-operative banking network to sort out its own problems, several other co-operative banks are still in administration, yet to be resolved. As a result, some people are now questioning the resilience of the co-operative banking sector.

This is more than slightly unfair. Italy has a large, long-established and highly successful co-operative banking sector which is stable, well-capitalised and resilient. Failure of a handful of its members is not going to cause it a serious problem. I suspect that there may be another motive for delaying resolution of the other failed co-operative banks.

Italy’s co-operative banking sector is split into two parts – the credit co-operatives, and the popular banks. The credit co-operatives are not-for-profit, local, mutually-owned organisations which collectively form the BCC network and own the specialist service organisations within it, such as Banca Sviluppo. But the popular banks are not part of this model. Indeed, they are not true co-ops at all, as my Co-operative News colleague Anca Voinea explains:

“In the early 2000s popular banks split from the co-operative model, adopting a joint stock companies model, but preserving certain characteristics of shareholder democracy such as the one member, one vote principle. This means that shareholders of those banks have one vote regardless of the size of their stake.”

Unfortunately, both types of bank are routinely described as “co-operative”. In January 2015, the Italian prime minister announced that the one member, one vote principle would be ended for the largest popular banks, effectively converting them to commercial joint-stock banks. Some have mistakenly interpreted this as the beginning of the end for Italian co-operative banking. Reuters, for example, said that the recent failure of one of the smaller popular banks, Banca Etruria, would “shine a light on the more vulnerable of Italy’s co-operative, or popolari, lenders”. And Euromoney said that the conversion of the large popular banks into commercial banks was meant to trigger a consolidation across the entire co-operative sector.

So to add to unnecessary delays in the resolution of failed co-op banks, we now have confusion over the relationship of the Popular Banks and the co-operatives. And there is an even more worrying development.

In a speech given in March 2015, the Deputy Governor of the Bank of Italy severely criticised the governance of co-operative banks:

“Now the need is to reduce the fragmentation that prevails in the system of co-operative and mutual banks, allowing for forms of integration that preserve these institutions’ local roots and capitalise on individual banks’ membership of banking groups. The solutions must be guided by the essential aim of enabling these banks too to turn readily to the market in order to raise capital, as well as by the purpose of improving the quality of their management.”

“The co-operative banking systems of other European countries are much less fragmented than the Italian system. The prevailing models centre on banking groups, in which the parent company exercises functions of direction and oversight over the banks in the group and, where necessary, can recapitalise them by recourse to the capital market. This model does not denature the co-operative form of the individual banks but allows them to maintain their characteristic mutuality and their community roots.”

It seems that the Bank of Italy is looking for consolidation of Italy’s co-op banks into quasi-commercial banking groups under something akin to holding companies. This is the model adopted by Austria’s Raffeisenbanken and Volksbanken, and by other large European co-operative banking groups such as France’s Crédit Agricole and the Netherlands’ Rabobank. And it does not work.

If there is one thing that I have learned from my study of European co-operative banks, it is that they get into trouble when they abandon their co-op principles. Italian banks are no exception: the reason why the popular banks, as a group, are in trouble is that they stopped being co-operatives. And the worst possible arrangement is one in which the central “hub” of a co-operative banking network becomes a commercial bank, accessing the commercial markets for capital and therefore forced to deliver a commercial return on equity.

The carnage among those co-ops that have diluted their principles in order to chase capital and profits has been terrible. The UK’s Co-op bank is all too familiar to readers of Co-operative News, but there are others too. For example, Austria’s Volksbanken AG, the hub for its Volksbanken co-operatives, failed in 2008 and is currently being wound up.

The most stable banks in Europe are Germany’s Volksbanken and Raiffeisenbanken networks, neither of which have commercial banking hubs. They are not particularly profitable, but they survived the financial crisis considerably better than commercial and public sector banks, and – importantly – continued lending to businesses. Surely that is what we really want from banks?

Some co-op bank “holding companies”, such as Rabobank, did weather the financial crisis successfully. But they too are under pressure. Their co-operative structure is being questioned by investors on grounds of “complexity”. As Euromoney says, “co-operative ownership of some of Europe’s biggest banks is under siege, largely because it is seen as hindering their capacity to raise public equity.”

The profit motive does not deliver financial stability, and access to capital markets does not improve the resilience of banks. The best sources of capital for banks are contributions from members and retention of low stable surpluses. But the prevailing view is that what matters in banking is delivering profits to shareholders, not providing services to the real economy. Since the financial crisis, the imperative to deliver profits at all costs has been dressed up as a need to raise more capital for financial stability. But the underlying driver is still the same. The co-operative principle in banking is under attack because it does not deliver what private sector investors want. Carpet-bagging is alive and well – in Europe.