Financial Cooperatives: A "Market Solution" to SME and Rural Financing

This paper analyzes the function of financial cooperatives (FC) to investigate whether they could finance small and medium enterprises (SMEs). It also analyzes the nature and role of the common bond in the decision making process by FC.

The paper argues that:

• FC are likely to be in a position to offer credit to businesses that may find it difficult to obtain financing through the stock banking system;
• They will be suitable financial intermediaries for SME financing.

The paper's analysis of the common bond confirms that FC, as forms of cooperative organizations specially adapted to specific niches of the market, may be able to resolve some of the information asymmetries and high transaction cost problems that characterize credit markets for SME enterprises.

The paper also finds limitations, which are:

• Success in promoting the establishment of FC is likely to be dependent on the spontaneous sociability that exists in the society. Societies with a high level of spontaneous sociability may find establishing a FC an easy task;
• Given that the common bond plays an important role in giving the FC the ability to limit the problems of information asymmetry, transaction costs and moral hazard, not every SME is likely to have equal access to cooperative financing;
• A close association to the community will be a necessary condition for accessing FC financing.

The paper concludes by listing regulatory and policy implications of the study.