Should the state continue to subsidise credit unions?

Should the state continue to subsidise credit unions?

Benefits such as state aid and exemption from corporation tax need to be reformed in this climate, writes Bill Hobbs
28th September 2009

In poor shape to deliver on their core purpose to generate credit in the economy and requiring fundamental reform, Irish credit unions may need to justify why the state should continue to subsidise their operations. Similarly the ILCU (Irish League of Credit Unions) may need to justify why its state subsidy should continue.

Ten years ago, Finance Minister Charlie McCreevy’s move to tax dividends on credit union savings accounts sparked an intense national lobbying campaign spearheaded by the ILCU during which activists threatened to run as general election candidates. Under pressure from Independent TD’s, then Taoiseach Bertie Ahern forced McCreevy into a climb down. Citing non-resident account abuses McCreevy warned that credit unions could become a haven for tax evasion.

Close to €9bn, has since accumulated in credit union non-DIRT “ordinary share” accounts, notwithstanding the availability of a DIRT account. As untaxed dividends are taxable at a person’s marginal rate many people may not have declared their credit union dividend in their tax returns. It is probably also the case that a sizeable amount of savings balances is undeclared income hidden away from the taxman. Should Revenue have a mind to investigate the use of these accounts it may well uncover a treasure trove in tax revenue. As a form of state aid, many consider the non-DIRT exemption distorts the market for savings with credit unions benefiting from higher savings balances.

But there is another, far more valuable state aid. Credit unions are exempt from paying corporation tax. It’s a discretionary exemption, wholly dependent on prevailing government policy, which has been withdrawn in other countries and never applied in others. The tax exemption is based on the notion that untaxed profits paid as dividends are taxable in the hands of savers. Such is the scale of this state subsidy that credit union reserves of €1.4bn arguably represents tax foregone by the state.
Credit union’s primary economic purpose is to advance credit using savings gathered from ordinary people. With less than 52% of assets in loans and the balance on deposit with Irish banks or held in investment portfolios, credit unions are not fulfilling this core purpose. Loans as a percentage of total assets peaked in the late 90’s and have been declining ever since. Pursuing a policy of maximising savers dividends and unable to generate enough profits from lending, credit unions adopted an ill-conceived investment strategy that ultimately led to large losses over the past two years. At the same time to bolster lending they also made more risky loans such as speculative property development finance which have led to rising bad debts. Far too many pursued a strategy of maximising profits for distribution as dividends to savers at the expense of building reserves and investing in improving products and services. It’s fair to say this dividend maximisation policy contradicts the intent of the state subsidy which was provided to underpin and support credit union’s economic and social function to provide affordable credit, bolster financial stability and fund development and growth.

Credit union leadership maintains that servicing the “financially excluded” justifies a state subsidy. In 2006, a Combat Poverty Agency research report estimated the number of financially excluded adults at about 180,000 and found that they did not use credit union services. With over 2m customers the vast majority of credit union customers are not financially excluded. Indeed a recent report commissioned by ILCU found that credit unions are predominantly servicing middle class customers. Whatever about community based credit unions, it can hardly be said customers of employer based credit unions, such as teachers, police, prison officers, utilities etc are financially excluded. And with a vibrant official licensed and regulated money lender sector, combating financial exclusion does not appear to be a dominant enough feature of credit union activity to justify continuing state aid.

Much is also made of “social finance” which is repayable financing of local community initiatives. The ILCU maintains about 10% of credit union lending or about €700m is for social finance purposes. This figure includes start up business loans to individuals. A narrower definition favoured by others would reduce this figure considerably below €100m or less than 2% of loans. While legally permitted to allocate profits to build social funds, credit unions have been criticised for not using these funds. A small number have funded successful local community initiates but the majority have not. An ad hoc approach to social finance does not support the case for a global tax exemption. Nonetheless a well designed national credit union social finance strategy would probably justify a degree of state aid.

Overall the case for a state subsidy is not at all compelling and requires a cogent rational justification if it is to continue. But there appears to be no compelling reason for the state continuing to subsidise the ILCU which is also exempt from paying corporation tax. When queried during a High Court case, the explanation provided for its tax exemption was it was “best to let sleeping dogs lie”. The ILCU has consistently declined to incorporate as its activities subjected to regulatory supervision or its commercial businesses exposed to tax. Yet it comports itself as a corporate entity, commercially engaging in regulated financial intermediary markets in which its competitors are not in receipt of state aid. Observers have commented in particular on how it capitalises its wholly owned insurance subsidiary ECCU using tax exempt profits earned through a management service agreement.

Credit unions should have the capacity to deliver valuable financial services to ordinary people and small businesses. But after a decade of pursuing an ill-conceived business strategy many are unable to deliver on what society requires of a vibrant, competitive and financially stable credit co-operative sector. As Minister Brian Lenihan deliberates on the future of the Irish banking system no doubt he will be concerned about reforming the credit union sector. The trade off for continuing state aid may well require credit unions to implement long overdue changes in structure, governance, management and operational competence.

A version of this article appeared in the Irish Examiner, Business Section, Monday 28th Sept 2009