The Sour Spot

The hardest thing about financial institutions is having enough rigorous management and internal control to keep them both profitable and transparent. Large institutions can afford to pay for the MIS, the professional managers, and the external audits that are necessary, because they can spread the costs over a large enough base of revenues. Very small institutions - savings groups of 25 people and such - can fulfill those functions by having members watch every transaction, and keep a close eye on management. 

Of course, both very large and very small institutions sometimes fail, but it seems to me that medium size institutions - say, those between 50 and 5000 clients-or-members, or between $5000 and $500,000 in assets - are in the unfortunate situation of being too large to rely on member involvement, and too small to rely on professional management, and thus, sooner or later, run into trouble.   

It’s likely a small MFI will do well as long as a dedicated founder, or wise generous friend, is there to keep an eye on things, as a volunteer. I’ve seen SACCOs in East Africa that work because an old mzee has come back to his village to do something for his people and keeps an eye on the young person he chose to run “his” SACCO. 

But overall, medium sized institutions are destined to have trouble when the off-books subsidy of volunteer labor ends. These institutions are in the sour spot, not big enough, and yet too big. I suspect that hundreds or thousands of institutions in this category would do better to carry out purely social activities, and leave banking to institutions at the two extremes of the size scale. 

What do you think?

Reader Comments (1) 

This issue was debated extensively in the nineteenth century. Raiffeisen for example, eventually settled on the parish as the maximum size for a credit union (or village bank, as I think they called them in those days) in Germany. Two parishes meant two credit unions -- there could be no exceptions. After half a century of evolution, in 1910 there were 12,797 of these, with an average size of 95 members and average capital of £6,482. This was just enough to pay a salary to a part-time treasurer. Boards were fairly large (about 9-15 members), and volunteer work from board members filled gaps in the work. 

The solution to the problem of achieving economies of scale and scope was networks. If an institution relies solely on its own savings for capital, and is not receiving outside subsidies, its members will know when growth has become too risky. They will either stop saving in it, or put pressure on it for stronger controls. It was that pressure that triggered federations in Germany, and the work of the federations was oriented around meeting that demand for safety.

Some of the Raiffeisen banks grew to as much as 1,000 members, but most of those never joined the federations, considering themselves too advanced to need them. I'm not aware of any data on their relative success compared to the smaller, more networked ones, though failures were rare across the board.

In a system where externally subsidized organizations don't exist, such as the German case, the 'sour spot' is evidenced by the gap between the larger credit unions and the smallest federations. The range there was about 200-25,000 I think. So it probably varies somewhat from country to country.

Mon, April 4, 2011 | Brett Matthews