The common bond as underwriting

The lending problem that cooperative credit set out to solve is specific. A smallholder or a small tradesman needs money seasonally, in modest amounts, against no collateral a lender can practically seize, and with a repayment capacity that only a neighbour can assess. Commercial lenders faced with this either refuse or price for the ignorance, and the price for ignorance in small unsecured lending is very high indeed. The cooperative answer was to move the assessment to people who were not ignorant.

Two models, two temperaments

Two broad models developed and they differ in instructive ways. The rural model was built around a very tight membership — typically a single parish or village — with unlimited joint liability, little or no share capital, unpaid officers, and profits retained in an indivisible reserve rather than distributed. The point of unlimited liability was not to ruin anybody; it was to make every member personally interested in whether the society lent well, which converts the whole membership into a credit committee.

The urban model, aimed at artisans and small traders, took the opposite view on most of these points: substantial share capital subscribed by members, limited liability, paid management, and dividends distributed. It is a more recognisably commercial institution, and it could grow faster and further, at the cost of relying less on mutual scrutiny and more on ordinary banking discipline. The long argument between the two was, in effect, an argument about whether the common bond scales.

What the bond actually did

It is easy to sentimentalise the common bond, so it is worth being precise about its mechanisms. First, it gave the society information a distant lender could not buy: whether the applicant's land was in good heart, whether his trade was steady, whether the debt was for seed or for a wedding. Second, it gave the society leverage that had nothing to do with law: default was known immediately and locally, and the social cost fell on the borrower's whole household. Third, it aligned the borrower's incentives with the fund's survival, because he expected to need it again next season.

Where the bond was weak, all three mechanisms weakened together, and that is the pattern in the societies that failed. A membership defined too loosely produced applications the committee could not evaluate, defaults nobody heard about, and borrowers with no expectation of returning. The rule that the society should not lend outside its own membership, which looks like restrictive parochialism, is the rule that keeps the other three working.

Purpose-tied lending

A recurring feature is that loans were made for stated purposes and the purpose was enforced. This looks paternalistic and often was, but it also has a straightforward credit logic: a loan for a productive purpose repays itself out of the thing it bought, and a loan for consumption must be repaid out of income the borrower already did not have enough of. Societies that insisted on the distinction had lower losses, and societies whose members resented the insistence had a governance problem the accounts eventually recorded.

Growth and the branch

As these societies grew, the meeting room gave way to premises and unpaid officers gave way to staff, and the mechanism that made the model work began to thin out. A credit society with thousands of members cannot assess applications at a meeting, so it develops criteria; once it has criteria, its advantage over a bank is a matter of price and disposition rather than information. That transition is the subject of the page on professionalisation, and it is the same transition, arriving from a different direction, that the building societies made.