Credit Unions' Roots

Cooperatives were created during the 19th century in Europe, following the industrial revolution, in an attempt to improve the appalling social, economic, and working conditions experienced by workers at that time. While the first cooperatives were organized and owned by groups that had something in common, such as artisans and farmers, it didn't take long for the groups to realize that these institutions could expand their activities. Around 1850, 'loan societies' started to be developed in Germany, mainly to provide credit to farmers at reasonable rates.

The first credit union in Brazil was founded in 1902 in the southern state of Rio Grande do Sul, which German immigrants settled. The credit union, that still primarily grants agricultural loans, is now part of Banco Cooperativo Sicredi S.A. (Sicredi; BB-/Stable/--), which is currently the largest financial cooperative in the country. Sixty years later, the Brazilian government passed laws that formalized operations of credit unions, and the central bank was tasked to supervise and regulate these entities.

While in Germany and France, cooperatives have average market shares of 25%, their Brazilian counterparts control a much smaller share. As of June 2021, Sicredi had a loan market share of 2.6%, Sicoob 2.3%, and the cooperative sector granted only 5.1% of the country's loans. Despite such a low number, credit unions' market share almost doubled in Brazil between 2016 and 2020. Growth stemmed from robust performance of the domestic agribusiness, a segment in which cooperatives specialize, as well as the more attractive rates and fees offered to members, given that business stability, rather than short-term profitability, is a higher priority for credit unions.

Additionally, considering the number of members, Brazilian credit unions are closer to their European peers: Sicredi and Sicoob have together approximately 11.5 million members, while Group Crédit Agricole in France has 11.2 million and the cooperative sector of Germany has 20 million.

Chart 1

Recent Trends

If in terms of total loans, Brazilian cooperatives have lower market share than those of private and public-owned banks, a different picture emerges if we look at the agricultural lending sector. As of December 2020, credit unions extended 22% of personal agricultural loans.

Chart 2

Sicredi is the sixth-largest financial institution in Brazil in loans, holding a market share of about 2.6%, while Sicoob is the seventh largest with a 2.3% share. On the other hand, in the agricultural financing segment, Sicredi and Sicoob are the second- and third-largest players, respectively, with 10% and 7% market shares.

Chart 3

Additionally, not only is agricultural lending among credit unions outpacing that of other lenders, but the cooperatives' share of total loans is surging as well. As we previously stated in our report, "Growing Digitalization Of Brazil's Financial System Will Foster Efficiency And Intensify Competition", despite strong recent growth, Brazil's digital banks are still primarily offering credit cards and are not yet taking market share from traditional banks. However, credit unions are in fact doing so, as exemplified in data in charts 1 and 4 show.

Chart 4

Credit unions are known to have broad networks of branches, including presence in nonprofitable and rural areas, prioritizing proximity to members and their communities. Over the past years, while traditional commercial banks have been closing branches and focusing on digital operations to cut costs and expand their product offerings, cooperatives not only kept their physical presence, but expanded it, and started operating in what is called a "physital" model, which is the merger of physical and digital models.

Chart 5

Such a trend broadens the cooperatives' role in pulling unbanked Brazilians into the formal financial system across small municipalities. We expect this factor and credit unions' expertise in serving local communities to remain a competitive edge for them.

Moving Forward

Part of its initiative to stimulate innovation in the financial system, the Brazilian central bank launched in 2019 "Agenda BC". Under this program, the central bank is working with credit unions to increase access to financial products, competition, financial education among the population.

In addition, to widen the credit unions' role in the financial system, the regulator launched a program, "2022 Challenges", the following goals that the cooperative sector is to achieve by year-end:

• Increasing the cooperatives' loan market share to 20% of;
• Lifting the share of loans taken out by cooperative members. Currently, they account for only 24% of loans in the cooperative system, with the remainder granted to various financial institutions;
• Raising the share of cooperative members from lower-income brackets to 50% from 33% currently; and
• Broadening the presence of cooperatives in the country's northern and northeastern regions from the lenders' traditional concentration in the south, by expanding services to 25% of cities from 15% in 2019 in those two regions.

Another plank is to amend the law regulating cooperatives in order to improve governance rules of these lenders and expand the range of products and services from credit unions. Currently, Brazil's Senate is reviewing this amendment.

We view favorably these initiatives because, once approved/implemented, they will not only strengthen the sector but help accelerate the country's economic and social development, the latter of which serves as one of cooperatives' main goals since their founding.

Main Challenges

Despite the promising prospects for Brazilian credit unions, the global and domestic economies are currently grappling with a large number of shocks. First, the inflationary pressures in the country can weigh on cooperatives' asset quality. While they usually have lower risk profiles than those of commercial lenders, credit unions are not immune to market downturns. In addition, funding costs for the entities are increasing because of the rising policy interest rates in Brazil. Although cooperatives benefit from very stable funding bases, given that depositors are members of the cooperative system, these lenders still must make the efforts to reprice their loan portfolios.

Furthermore, despite efforts to expand their presence around the country, credit unions offer services in 94% of the municipalities in the southern region, but only 27.6% of those in the northern region and 11.8% in the northeastern region.

Finally, competition in the Brazilian banking industry has intensified over the past few years, given the implementation of open banking initiatives, the digitalization of the industry and the growth of fintechs. We believe that in response to these trends, cooperatives need to raise their competitiveness in order to meet members' rising demand for digital products and services and broaden their range of offerings, while not eroding bonds and proximity to their members.

Ultimately, we don't expect the economic hardships and rising competition to affect the ratings on one cooperative that we rate, Sicredi. We expect credit unions to continue strengthening their business model, widening and diversifying their product offerings, as they seek to compete more against traditional banks, with the advantage of having a loyal base of clients, given that they're also members of the cooperative system. We also expect them to keep expanding both the number of members and the geographical scope of operations, despite Brazil's deep economic malaise. On the other hand, factors related to the system's operational complexity, faster lending growth than the industry average, and correlation of its businesses are not excessively problematic but can generate additional volatility for credit unions.