Balancing the benefits and risks of member-owned credit cooperatives

In late 2021, India’s Enforcement Directorate, a law enforcement agency focused on economic crimes, arrested two people in connection to a scam at the Navjeevan Credit Co-operative Society that diverted funds out of the financial institution and into the pockets of its chairman and relatives.

The chairman and his accomplices had allegedly opened 200 branches of the credit cooperative, luring depositors with promises of unrealistic returns on their investment. The perpetrators then diverted depositors’ money to entities controlled by them. Board members were also later accused of taking interest-free advances from the Navjeevan Credit Co-operative Society, one of several such institutions set up to help facilitate financial transactions in the local community. (See “2 arrested in Navjeevan Credit Co-operative Society scam case,” The Statesman, Dec. 12, 2021; “Navjeevan society scam: SOG arrests 2,” by The Times of India, May 24, 2023; and “Credit Cooperative Society,” by Dinesh Mishra, Legal Service India E-Journal.)

And similar stories are playing out in other parts of the world. Take Kenya, where nine employees of the National Intelligence Services Sacco, a type of credit cooperative, were arrested after Sh160 million (over $1 million USD) allegedly disappeared. The arrested included the Sacco’s internal auditor, loans manager, an accountant, two system analysts and an NIS officer. In 2018, the director of criminal investigations (DCI) in Kenya, George Kinoti, warned banks and mobile service providers about the risk of fraud at the hands of their own employees, including an alleged case of theft against Harambee Sacco Limited as an example of the threat. (See “Sacco fraud: Nine arrested after NIS Sacco loses Sh160 million,” by Esther Nyambura, The Standard, Sept. 25, 2023 and “Vet staff, Kinoti warns banks, saccos over rising fraud cases,” by Augustine Sang, Nation, Aug. 19, 2018.)

The credit cooperatives in the cases above have become an important part of the informal sectors in developing countries. But they’re also vulnerable to fraud. In Kenya, for example, a significant proportion of the workforce operates in the largely unmonitored informal sector, which often lacks the social security benefits provided to formal-sector employees, such as health and disability insurance and retirement benefits. Formal financial institutions, such as banks, only provide financial services to a small number of people, particularly in rural areas.

This is where savings and credit cooperative societies (Saccos as they are called in Kenya) enter the picture. Saccos, which are member-owned, play a vital role by bridging the gap and providing an inclusive measure of financial security to individuals in the informal sector who may need access to formal financial institutions. They also serve as a platform for collective action among workers in the informal sector that helps to enhance their bargaining power, and their ability to advocate for better working conditions and social protections. As the Kenyan economy reopened in 2022 following the COVID-19 pandemic, Saccos experienced renewed growth, with a 4% annual increase in assets driven by gross loans. (See Figure 1 below.)

Source: SASRA

There are two sides to the Sacco coin, however. These cooperatives have inherent vulnerabilities, including credit, liquidity and operational risks. In this context, it’s essential to recognize the significance of Saccos in promoting economic development and financial inclusion in Kenya, while also addressing the vulnerabilities that a cooperative model faces in the digital era — and where fraud fighters can lend their skills and expertise to help shore up Saccos’ defenses.

Bridging the inclusion gap

A cooperative’s main goal is to benefit the local communities where it operates. Since co-ops are nonprofit organizations, the bulk of their revenue is used to meet the social, economic and cultural requirements of the community. As a result, the entire community benefits when a co-op succeeds. A successful and efficient cooperative model can, among other benefits, offer employment, investment opportunities, collective growth and even income equality. India’s Amul Cooperative is a prime example of the success that can be achieved through a cooperative model. Owned by members who are mainly small-scale dairy farmers, Amul was established with the aim of providing a sustainable source of income for them in the Gujarat region of India. Like a Sacco, Amul is also a member-owned cooperative that achieves economies of scale and is a testament to the power of the cooperative model in promoting economic development and improving the livelihoods of members. Amul is, to a large extent, responsible for the “White Revolution” that made India one of the world’s leading milk producers. (See “White Revolution in India, Objective, Impact, Phases & History,” by Lisa Roy, PW, Oct. 7, 2023.)

A threat in waiting?

While Saccos have shown post-pandemic signs of recovery, they’re sometimes described darkly as “ticking time bombs” because of the potential inherent risks that they face. One of these is credit risk, which arises when members default on loans, which can lead to significant losses that Saccos can’t absorb. Another factor is the liquidity risk the Sacco model faces when it’s unable to meet its financial obligations as they fall due. This happens when members withdraw their savings in large numbers or the Sacco is unable to access funding from other sources, as exemplified by the liquidity crisis that Stima Sacco members faced due to a technical issue. (See “Stima Sacco customers locked out of mobile platforms over system outage,” by Bonface Otieno, Business Daily, March 10, 2023.)

Operational risks, such as fraud and embezzlement, can also undermine Saccos’ financial stability and reputation. Some unfortunate members have learned painful lessons that illustrate these types of cooperatives’ vulnerability to fraud.

More recently, Saccos have faced increased high-tech risks. According to a recent news article, a 22-year-old was able to breach a Sacco’s IT systems and transfer Sh 900,000 (or $9,560 USD) to six M-Pesa accounts, a mobile-based financial service belonging to him. While the amount may not be huge by fraud fighters’ standards, the fraud demonstrates Saccos’ vulnerability to high-tech swindles, which has resulted in significant financial loss for their members. (See “Man accesses sacco’s IT systems, transfers Sh 900K to his MPESA,” by Magdaline Saya, The Star, Jan. 21, 2023.)

It’s important to note that the issue of cybersecurity and fraud prevention has become more critical than ever with the rise of financial technology and the increasing adoption of digital financial services, particularly for Saccos. According to the Kenya Financial Sector Stability Report 2022, Saccos face technological and regulatory vulnerabilities that may affect their operations. (See Kenya Financial Sector Stability Report.) The rapid adoption of digital financial solutions has introduced cybersecurity risks and frauds, leading to financial losses among some Saccos.

In terms of regulatory issues, failure to comply with regulations related to anti-money laundering, data protection and financial reporting can result in legal and reputational consequences, undermining a Sacco’s credibility and leading to loss of members’ trust. The Financial Sector Stability Report suggests Saccos also face compliance risks emanating from current and new legislation, which directly affects their business operations. As a preventive measure, the Sacco Societies Regulatory Authority (SASRA) in Kenya has signed a memorandum of understanding with the country’s Directorate of Criminal Investigations to establish the Saccos Societies Fraud Investigation Unit (SSFIU) to combat financial crime in Saccos. It’s also important that these cooperatives adopt robust risk management systems, including IT systems and data security measures, to protect them from data breaches that compromise sensitive member information — breaches that ultimately erode trust in the system. (See “SASRA forms Fraud Investigation Unit to quell theft in Saccos,” by Roy Hezron, Sacco Review.)

Strengthening the Saccos: The role of fraud examiners

At this juncture, fraud examiners have a unique opportunity to step up and help Saccos and other credit cooperatives identify and mitigate vulnerabilities through regular audits, training on data security and technology integration, and guidance on regulatory compliance. By working with management and regulatory authorities, we, as the advocates of fraud management, can help strengthen credit cooperatives’ governance and management practices, enhancing their ability to provide accessible, affordable and customized financial services to their members.

Durgesh Pandey, Ph.D., CFE, FCA, is a managing partner at DKMS & Associates, Chartered Accountants in India. Contact him at durgesh@dkms.co.in.

Collins Wanderi, MBA, CFE, PGD (HRM), is global vice chair for the Association of Certified Fraud Examiners (ACFE) Board of Regents and chair of the LSK SACCO Supervisory Committee. Contact him at wanderim@gmail.com.