03 February 2008
Senator Joe O’Toole’s bill for safeguarding the public’s money is vital to ensure the national financial safety net, writes Bill Hobbs.
Events last year in Britain and here in Ireland starkly focused our attention on the safety of our savings. Whatever the cause of the run on Northern Rock, attention has zoned in on the effectiveness of what is called the financial safety net: that combination of prudential supervision, regulations and deposit insurance.
Governments know the only way to control a run on a troubled bank is to feed it with cash and public assurances. This is precisely what happened in Britain.
The cash backing was promised after a decision was made by Britain authorities to support Northern Rock. A decision it seems based on two considerations. As the bank was solvent, a work-out was possible and also there was a danger of a contagious run on other banks.
However, this support, public assurances and limited explicit deposit guarantees didn’t work, requiring an unprecedented blanket government guarantee for all deposits before the run abated.
A belt-and-braces review of the British financial safety net is well underway. It’s important to note that British authorities provided support through established statutory and legal mechanisms.
Here in Ireland, similar safety net mechanisms exist to provide support for troubled banks with a statutory deposit guarantee scheme in place since 1995. But this is not the case with Irish credit unions.
There are no mechanisms for state authorities to provide emergency assistance to troubled credit unions, compensation for savers in the event of closures, fully guarantee deposits or arrange for work-outs.
Despite a legal requirement for credit unions to participate in a state approved and regulated deposit insurance scheme since 1997, not one euro of savings is guaranteed.
Imagine if there had been no safety net for Northern Rock and its savers. Imagine instead an unregulated bankers’ trade body supervising its owner member banks having its own bail-out and crisis management fund. What if this bankers association also managed excess funds and underwrote life insurance for customers of its member banks and was almost entirely dependent on fee income generated from these activities?
Well this is the case with most credit unions. A trade body, the Irish League of Credit Unions (ILCU), continues to supervise its member credit unions. It runs a controversial stabilisation fund to provide discretionary support to troubled credit unions. It might, at its discretion, compensate savers up to €12,500.
The scheme, which is called Savings Protection, is unapproved and unregulated and only open to participation of its member credit unions. Some of the countries largest credit unions aren’t members and do not participate in the scheme.
Its subsidiary underwrites billions in life coverage. It co-manages, with a stockbroker, hundreds of millions of credit union excess funds. Yet the Financial Regulator has only direct prudential supervisory oversight of its insurance operations.
A rational mind would immediately recognise the systemic risks arising in a body that supervises, provides liquidity and solvency supports, is unregulated, co-manages excess industry funds and underwrites billions in life insurance risks.
To put it bluntly, the risks inherent in this mix of activities are not be permitted anywhere else, as the inherent conflicts of interest and risks are deemed untenable.
Credit union philosophy has never held that self-help means self-regulation or self-insurance, which is why credit union movements elsewhere are willingly supervised by government agencies with savers funds protected by government-backed deposit insurance schemes. These include bail-out supports and workouts for troubled credit unions, and guaranteed compensation for savers where they fail.
The Irish credit union self-regulation and stabilisation support system worked well in an era that was far less complex than today. It is perfectly designed for an Ireland that no longer exists.
It is true that no Irish credit union has ever publicly failed. But this does not mean that a credit union can never fail. It is also true there has never been a contagious run on credit unions.
But as Monaghan credit union illustrated in 2006, runs do happen. Its run was triggered by media reports of bad debts and the unreliability of the ILCU stabilisation assistance.
The run, which was close to becoming contagious, only abated following the public assurances of the Financial Regulator. So what lessons were learned and what action has been taken since?
In the face of mounting evidence of the need for urgent modernisation and reform, there is an ambiguous acceptance of state supervision and an outright rejection of state-backed protection for savers by a small number of influential credit union leaders.
In its recent annual report the Financial Regulator said: ‘‘During 2006, considerable progress was made in developing the system for the regulation of credit unions with a view to building compliance."
The implication is that state supervision has some way to go. But what of statutory deposit insurance for credit union savers ?
I’m sure the millions who save with credit unions and their voluntary directors would hardly agree they should not be afforded the same protection as savers with banks. Yet, the ILCU is pursuing a private scheme and all Ireland solution which would, in effect, deny savers statutory protection of their savings.
In 1991, a privately run scheme sponsored by the credit union league in the US state of Rhode Island suffered a spectacular collapse. Its failure resulted in a depositor panic that forced the temporary shut down of all the Rhode Island credit unions. Some never reopened.
In the end, the taxpayers of Rhode Island paid out over $350 million dollars to compensate credit union savers.
What makes the tale so chilling is that the credit union movement in that small state was less than one-fifth as large as the credit union sector in Ireland today. But like Ireland, close to half of Rhode Island households had credit union members.
Supervising those credit unions was the responsibility of state officials, so when the private scheme failed, political reality demanded that the state pay the piper. Since then, all but one of the US privately run schemes have shut up shop.
Politically, the glaring contradiction, where savers with banks have statutory protection but savers in credit unions have none, has been conveniently fudged. The government procrastination in facing down trade-body lobbyists echoes Rhode Island and a period of Irish solutions to Irish problems with all the usual vested interests.
Years after the introduction of government-backed statutory deposit insurance elsewhere, credit union movements continue to thrive. Credit union-owned deposit insurance is not a condition of continuing credit union success.
But government-backed deposit-insurance is part of a credit union sector financial safety net necessary to underpin financial stability and provide protection to savers.
Senator Joe O’Toole recognised this when he published a private members’ bill last year, addressing the statutory provision of protection for savers with credit unions.
His bill proposes a well-designed credit union deposit-insurance system reflecting best international practice. It preserves the unique status of credit unions and provides mechanisms for supporting viable troubled credit unions and guarantees savings in the event of the failure or one or more credit unions. At the time it received little media and public attention.
Post Northern Rock, I suspect that if reintroduced, the O’Toole bill will find significant support from all who are concerned with ensuring future of the credit union movement, its financial stability and protecting the savings of millions of ordinary people.
A version of this article appeared in the Sunday Business Post, 3rd February 2008
