Apex Organizations

Yet another option is to develop a system of small-scale rural financial institutions, all linked through a central fund or 'apex organization', or second-tier or second-storey institution. Individually, the small-scale member institutions might be exposed to higher covariant risk in their portfolios, but in principle collectively they could disperse risk. Examples exist in Costa Rica, where the apex organization is a US-based nonprofit organization known as FINCA (Foundation for International Community Assistance), and in Colombia, where it is a local entity known as AGS (Asociación de Grupos Solidarios de Colombia). Apex organizations for microfinance programs can exist regardless of the structure of the programs of local affiliates. Apex organizations are regarded as 'brokers or wholesalers between banks and NGO-based programs'.110

The concept of second-tier institutions, like that of financial intermediation in general, has undergone a rapid evolution in recent years. They used to be conceived as sources of subsidized, directed credit; the Fondo Financiero Agropecuario in Colombia was an example of that approach. Now, their role is to assist with liquidity management of their affiliates, provide access to the interbank market, and sometimes also to provide technical assistance in financial management. Given that individual rural credit unions or 'mini-banks' are likely to be exposed to high covariant risk, their sustainability can be enhanced through linkages to a second-tier institution.

The new role of second-tier institutions has been summarized in the following way:

A second-tier institution is a financial intermediary or network that provides financial and institutional support services to retail intermediaries. .. . the second-tier institution needs to be autonomous, and free from political interference; have the capabilities to mobilize funding; know the retail institutions intimately; and be able to motivate retail institutions while being tough in the enforcement of standards and eligibility criteria for support.111

While an apex organization must have some supervisory control over its affiliates, with enforcement powers, it should not attempt to carry out banking supervision per se. This would put it in the untenable position of being a participant in the system and judge of it as well. In fact, the combination of supervision and technical assistance roles in a central organization has contributed to some of the problems experienced by credit unions.

Another critical issue concerns the ownership of the apex organization. The affiliates may be shareholders in it, but if collectively they hold a majority of shares, then it is virtually impossible for the organization to play the leadership role for the system that it should play. This issue has been raised in connection with the AGS in Colombia:

The governing structure of AGS, including the board, is in the hands of the affiliates' executive directors. This structure has been instrumental in ensuring that the services provided by AGS respond to the needs of the membership. .. .

Nonetheless, the fact that the directors are making decisions that directly affect their own organizations has had a negative impact on the objectivity of the process. The governing

109. R. P. Christen and R. Rosenberg, 2000, pp. 18-19. Options for a bank/NGO relationship are discussed further in that paper.

structure of AGS, like that of many membership organizations, is weak because the beneficiaries of the services provided by AGS are the same agencies that control the institution. The executive directors are both judge and jury. Policy decisions seldom take into account a larger vision beyond the parochial concerns of the members. A typical example is the strong opposition of some board members to increasing the interest rates charged by AGS and implementing fees for its services. The growth of the organization and its long-term sustain-ability have been sacrificed in favor of cheap money and free services for the membership.112

To help ensure good governance, such a second-tier institution can and should be owned at least in part by private investors, rather than by the microfinance institutions linked to it; they may be commercial banks for whom the small-scale intermediaries offer cost-effective ways to penetrate rural areas. A system structured in this way obviously bears certain similarities to a bank with many rural branches. A difference is that a federated system can have very low-cost local branches, to the extreme of some that are managed out of private homes and are open for business only two days a week. The possible role of such systems is becoming increasingly recognized:

.. . the most promising of recent strategies for financial market development is the linkage of member-controlled financial institutions with a liberalized banking and cooperative sector.113

Carefully designed to avoid the ownership problem and others, apex organizations can play a useful role in strengthening a group of small financial institutions. However, to date their performance has not always lived up to their potential. Ledgerwood has provided a summary of their potentials and weaknesses:

An apex institution can:

• Provide a mechanism for more efficient allocation of resources by increasing the pool of borrowers and savers beyond the primary unit.

• Conduct market research and product development for the benefit of its primary institutions.

• Offer innovative sources of funds, such as guarantee funds or access to a line of credit from external sources.

• Serve as a source of technical assistance for improving operations, including the development of management information systems and training courses.

• Act as an advocate in policy dialogue for MFIs.

The experience of apex institutions has been mixed. Apex institutions that focus on providing funds to retail MFIs, often at subsidized rates, have found limited retail capacity to absorb those funds. What MFIs most often need is not additional funding sources but institutional capacity building. Furthermore, by providing wholesale funds in the marketplace, apex institutions remove the incentive for retail MFIs to mobilize deposits.

There are other potential weaknesses of apex institutions:

• Vision and governance issues are made more complex by the number of parties involved.

• The level of commitment to expansion and self-sufficiency may vary among the members, affecting the pace of expansion and the ultimate scale achieved. The commitment to market-oriented operating principles may also vary, affecting the ability of the group to operate in an unsubsidized fashion.

112. Arelis Gomez Alfonso, with Nan Borton and Carlos Castello, 'The Association of Solidarity Groups of Colombia: Governance and Services', in M. Otero and E. Rhyne (Eds), 1994, p. 260.

113. M. Zeller, G. Schreider, J. von Braun and F. Heidhues, 1997, p. 4.

• Differential growth rates among the partners can also strain the relationship, especially when their needs for resources and technical support widen dramatically.

• Monitoring and supervision are essential to good performance but are made difficult by the number of partners. If there are weaknesses in financial reporting and management at the primary level, these can adversely affect the second-tier operation.

• Unless both the primary institutions and the apex are efficient, the ultimate cost to the client can be high. There needs to be constant attention to issues of productivity and performance.

While there are many disadvantages to apex institutions, if structured appropriately and set up with clear and market-oriented objectives, they can add value and aid in the development of microfinance.

For the most part, microfinance apex institutions provide more than just liquidity in the market. Usually the apex is set up when everyone agrees that there is a drastic shortage of retail capacity. The advertised objective of the apex is to foment the development of stronger retailers capable of reaching a much more substantial portion of the microfinance clientele.114 To define their roles more precisely, apex institutions may be particularly useful in the following situations (Von Pischke, 1996):115

• When they are lenders of last resort, not necessarily in situations of crisis but on the basis of cost. Retail lenders regard an apex institution as a good source of expensive funds and presumably use them sparingly and only for highly important and profitable programs.

• When the apex institution fills in seasonally. Agriculturally based retail lenders might want to borrow seasonally as a means of managing cash flow. Again, the funds should not have to be provided by the apex institution at anything less than commercial rates.

• When the apex institution becomes a shareholder in the retail MFIs, in the expectation that this would provide an attractive overall return. In this case, the apex institution would expect to add value by providing expertise and oversight as well as funds in the form of equity and quite possibly debt.

• When retail lenders are not permitted to take deposits. Apex institutions could then play a useful role if they added value through their terms and conditions and behaved commercially.

An apex institution appears to be most successful when a critical mass of strong MFI retailers already exists and when it is focused on working with existing formal financial institutions that are 'downscaling' to meet the demands of low-income clients.116

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