Credit unions must be reigned in for all our sakes, writes Bill Hobbs
Having funded boom time consumer spending, including first time buyer down payments, credit unions are experiencing rapidly increasing bad debts as their customers struggle with unaffordable debt. It’s a time bomb ticking in credit unions backyard which the Financial Regulator is trying to disarm. With only twenty eight staff to supervise 414 credit unions, the best it can hope for is to limit collateral damage when it goes off, as it inevitably will. But if credit unions and their trade bodies had their way, it would not be given the tools to limit the damage.
Last year credit union trade bodies lobbied for extended loan limits to reschedule short term non-performing loans into performing longer term ones. In the middle of one of the world’s worst economic contractions and consumer debt crisis, loan rescheduling is like treating a festering ulcer with a sticky plaster and a hug.
Yet the Central Bank Act 2010 includes a section which will effectively allow credit unions to apply the sticky plaster. It also provides their regulator with preventive tools to control for lending, liquidity and solvency risks. However credit unionists are now up in arms at the safety conditions attached by their regulator. They argue they should not have to make the bad debt provisions required. They maintain that once a non-performing loan is rescheduled the risk of non-repayment disappears. And true to form they are engaged in typical credit union political lobbying, refusing to deal objectively with substance but arguing instead from an emotionally charged subjective basis. The substance is quite stark – credit unions will not be able to trade their way out of trouble and the sector is on the cusp of a crisis it may not survive. It seems the regulatory cure may kill the patient.
As regulated credit institutions, credit unions are expected to set aside money in reserves as insurance against unexpected losses and to set aside money in bad debt provisions to meet current and anticipated loan losses. From last year they must set aside an amount equal to 10% of total assets in regulatory reserves. The regulator set this target to prevent them from raiding their reserves to pay dividends to savers and allowed for an interim target of 7.5% for struggling credit unions. It also wants them to set aside money to fund future loan losses. The problem is many can’t generate enough profit to fund reserves, pay for losses and pay a dividend to savers. Overall, solvency and liquidity levels may appear relatively healthy. But with a far too high cost base from failing to modernise over the 20 twenty years, individually a growing number of credit unions are in quite serious financial difficulty.
Should a large credit union fail, collateral damage will be hard to contain and the states creditworthiness, its sovereign debt rating, could be undermined. Recently news that Spanish authorities had to rescue one if its co-operative savings and loans outfits, called Cajas, undermined its sovereign debt rating. Luckily for the Spanish they had the good sense to have a special resolution system in place to manage the rescue. Elsewhere regulators and deposit guarantee managers intervene, taking prompt action to stabilise a troubled credit union. Frequently they order its amalgamation with another and fund its solvency stabilisation costs. Such prompt corrective action and stabilisation is required to manage a financial stability crisis. As is a reliable system raise funding and cycle excess cash and capital from one credit union to another. But here there is no statutory, legally reliable and effective resolution system for Irish credit unions.
Yet since September 2008, the state and taxpayer has effectively guaranteed every cent of the €11.5bn in household savings in credit unions under the revised deposit guarantee scheme which will compensate savers up to €100,000. With ineffective regulation, weak resources to effectively control risk taking, inability to set mandatory rules of business conduct and prudential safety standards and lacking a resolution system permitting prompt corrective action, moral hazard risk exponentially increased once the deposit guarantee was provided.
Some politicians do not appear to understand the nature of credit union hazard threatening the entire sector. During the Oireachtas ERA (Economic and Regulatory Affairs) committee hearing last week, the credit union regulator was upbraided for doing its job and asked why it couldn’t wait for the outcome of a strategic review before taking preventative action to control risks. It was a clash between rational prudential regulation and parochial credit union political lobbying. Despite the regulator revealing serious financial stability concerns, some members of the committee appeared to argue for a soft touch.
It is against this backdrop of rapidly worsening bad debts, failing business model and a badly designed ineffective, under resourced regulatory system that politicians are being asked to consider a soft touch response.
The regulatory cure for the festering sore may trigger a chaotic shambles as credit unions begin to fail. Similar crisis elsewhere led to orchestrated state and regulatory intervention that led over time to the ordered consolidation of credit unions which enabled them to professionalise, improve governance and expand their products and services. Time has run out here. What’s required is a policy response and resolution regime to rescue credit unions from themselves which may mean the tax payer will have to fund the costs.
A version of this article appeared in the Irish Examiner, Business Section, Monday 31st May 2010
Thanks Bill for that inciteful but rather slanted commentary. There is no doubt but that credit unions members and by extension credit unions are feeling the pinch of the recession.The arrears figures being quoted does not take into account the effect of the "new" Resolution 49 Report recently implemented by the ILCU that makes more stringent provisioning for loans under pressure necessary. This new report has increased credit union reserves against default figures by an average of 33%. Therefore comparing figures of last year and the year before with the current year is not really a valid comparison. The new Credit Union Regulator is currently declaring that credit unions will suddenly have to be wound up if he does not get extraordinary new powers. I would question how many credit unions have had to be wound up with the powers that he currently has. I think the answer is none in over 40 years. The Regulator has already made credit unions increase their reserves to 10% of assets putting some credit unions under pressure to pay a dividend and therefore increasing their "liquidity" problems. Yes credit unions are under some pressures at present but history shows that these are the times that credit union members need their credit unions more than ever and hopefully without too much meddling they will be there for them
ReplyDeleteFintan
ReplyDeleteI take it insightful may be more apt. The regulator has quoted arrears >10 days at 13.47 does this mean new R49 will cause his figure to increase given the treatment of amortisation? There is no doubt the sector is facing consolidation which will be enforced by circumstance rather than desire. In which case the absence of a resourced and legally reliable resolution system, including stablisation elements, to manage consolidation in all its aspects is notable. It is a significant gap in legislative provisions and one which could cause serious problems. I don't buy the line that as a credit union has never failed one cannot fail. They fail all the time in the US, Canada, UK and NZ etc where there are well oiled systems to manage out problems - usually through mergers rather than outright closure.
Timothy O Sullivan Cork
ReplyDeleteExtending section 35 limits does not only apply to rescheduled loans. A Credit Union which had (say) 10% of its loans as long term over 2 years ago and then stopped issuing long term loans completely will find itself in breach of section 35 unless it can issue the same value in short-term loans as previously. With falling demand for short-term loans its percentage over long term increases (to greater than 10%) even though no new long term loan has been issued.
This scenario is much too complicated for most commentators who prefer to repeat the much simpler rescheduling issue which is not a problem for many Credit Unions.
Timothy O Sullivan Cork
ReplyDeletetimothyosullivan3@gmail.com
There are two other important points, which should have been included in your detailed article to keep a sense of proportion and balance.
1. Credit unions do NOT use ‘reserve ratio lending’ which makes them inherently much more solvent than banks. In fact Credit Unions can only lend money up to the amount they have in savings. In fact if they approach the 100% of savings to loans mark, the regulator will intervene. Not so for banks.
2. My sources tell me that the current average solvency ratio under the PEARLS system is 116% with a small standard deviation. While the 12 Credit Unions in CUDA do not use this system, the 414 ILCU Credit Unions in the Republic do. It also appears that the registrar uses a similar ratio. This indicates that there is no solvency problem with the vast majority of Credit Unions. Indeed McKillop et al’s research published in the recent CUFocus suggests that ILCU affiliated Credit Unions performed better in his study – possibly because of the use of this ratio system.
Tim
ReplyDeleteProportion and balance are a matter of subjective opinion which depends on a person’s point of view, informed or not.
Credit unions use the fractional reserve banking model – leveraging of capital using deposits to fund loans. While here they exclusively use retail deposits, they are allowed to raise funds using other instruments. In other countries they access wholesale markets to both sell and buy funds. For example a group of Aussie credit unions issued a bond part of which carried an AAA rating to raise capital. There is nothing in the credit union act to prevent credit unions lending more than retail savings. The problem is they aren’t lending enough – loans are less than 48% of total assets “on average” – many are trading at far lower levels including one major credit union which is below 20%.
But quoting averages and standard deviations is quite misleading as it hides individual problems. A growing number are facing severe financial problems – solvency is the real issue for them not degrees of standard deviation. ILCU, CUDA and Regulator will not identify who they are.
The McKillop study you refer to I believe relates to credit unions in Northern Ireland and not the South. And PEARLS is not being used as an aid to manage financial performance merely to report on it post facto. The core issue remains - there is no legally reliable system through which to manage a systemic financial stability crisis.
Timothy O Sullivan Cork
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You are correct in saying that mean and standard deviation will hide outliers but the outliers must not dictate to everyone else. Action must be taken on those immediately. I am reminded of the legal maxim "hard cases make poor law".
I have reread Mckillop,Glass and Quinn's article in CU Focus. The summary does not say how many Credit Unions were examined but it suggests that its all Ireland. It says that data were obtained from the ILCU and paper based accounts for non-ILCU credit Unions. Nowhere does it say that its confined to Northern Ireland. It does promise that the full paper will be available on www.creditunionresearch.com, a promise not yet fulfilled.
Bill, having read this article this evening I can see that you were on the money. I've read the number of failing credit unions is now 80. I do hope the credit union commission, central bank and this Government are up to the job of consolidation.
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