Credit union movement’s business model is beyond fixing

There are no support mechanisms to deal with the crisis facing the sector, writes Bill Hobbs

The way in which Irish credit unions are individually and collectively governed and managed- the movement’s business model- is so broken it cannot be reasonably fixed. With one in two of the nations 419 credit unions experiencing financial instability, a sizeable number may not survive as independent operations beyond 2010.

Some of these may have to close but most will probably have to be merged into stronger operations. The problem is there is no official government policy or supporting central corporate mechanisms to deal with what is quickly becoming the greatest financial stability crisis ever faced by any credit union movement.

Last week saw the publication of the Financial Regulator’s annual report. Reading between the lines it is struggling to ensure the stability of the business model. The problem is the model, or way things are done, is spectacularly and all too predictably failing. The Regulator will only uncover the true scale of financial instability when the nation’s credit unions produce their annual audited accounts later this year.

With half of all credit unions apparently unable to pay a decent dividend to savers, their trade body representatives are said to be looking for state aid. They want Ministerial dispensation from legal, regulatory and accounting rules along with state guarantees underpinning liquidity.

Any state aid or prudential dispensation should require that credit unions individually and collectively change the way they are governed, managed and operated. In other words the credit union movement needs to mature.

There are three empirically supported documented stages through which credit union “movements” mature or grow up. For nearly two decades Ireland’s movement has been stuck in a start up stage and it is now considered by international credit union observers as a basket case, posing reputational risks to the international credit union movement.

In their nascent or start up stage credit unions use a “finance company” model through which loans are funded by “shares” gathered from shareholding members who are in turn rewarded by way of a discretionary dividend declared by the board from annual profits.

Products are basic, with limited- if any- choice. The board of directors exclusively represents the savers’ shareholders interest and seeks to limit lending risk and maximise profits for distribution as dividends and build reserves. They form lose collaborative associations typically trade bodies called “leagues” and zealously protect their autonomy and independence.

The next stage sees credit unions grow to become “savings and loans” co-operatives with loans funded by deposits and not dividend bearing shares. Interest accrued on a deposit account is a liability that must be paid and not a discretionary dividend declared from profits.

International prudential standards indicate a target of 70% deposits, less than 20% in shares. Over €7 for every €10 in savings should be out in loans to members. Last year Irish credit unions had over 95% in shares, less than 5% in deposits and loans were less that €5 for every €10 in savings. The balance of funds was invested in financial instruments credit unions in other countries are not permitted to invest in.

Savings and loans co-operatives offer a wide choice of products augmented by additional fee earning services. They generate profits from loan interest income and fee income. Typically income is made up of 80% interest income and 20% fee income. In contrast Irish credit unions generate less that 1% in fee income and are entirely reliant in income derived from risky investment portfolios to fund dividends to savers.

Typically during this stage central supporting corporate structures are created through which credit unions cede some independence in return for enhanced financial stability, better IT systems, products, services, governance and operational capabilities.

Finally stage three sees the development of full scale banking services including current accounts, credit cards, mortgages, business banking, wealth management, investments etc. as credit unions become robust alternatives to high street banks. US, Australian and Canadian credit unions compete aggressively in this way.

For over two decades Irish credit unions have been stuck in a start up time warp unable to mature. Elsewhere maturity has been instigated by three forces; government intervention, regulatory effectiveness and credit union professionalisation. In every case central supporting credit union corporate bodies have been created under specially designed legislation and regulation. Movements have also rationalised and consolidated with unsustainable or financially troubled credit unions merged into stronger operations.

Ireland’s credit union movement should have developed into savings and loans co-operatives by now. Instead of blaming external forces, credit unionists have only themselves to blame for failing to respond to the needs of a modern society. Faced with demands for financial bail out assistance along with legal/accounting derogations, Finance Minister Brian Linehan should empower and enable a task force to ensure the sector matures, creates the central supporting stability systems and consolidates numbers down to a financially sustainable and realistic number.

Vibrant federal structures where credit co-operatives have coalesced around a central corporate body have been developed for example in Canada and mainland Europe. One of the most intriguing possibilities is an alliance between what remains of the Irish co-operative mutual building society sector and credit unions. Such an alliance is eminently possible should Minister Linehan decide to explore the public interest, policy and practical implications of designing and executing on a robust co-operative alternative to Ireland’s zombie banks.