System of stabilisation vital for credit union sector

Some twenty credit unions are said to be in serious trouble, writes Bill Hobbs

With the credit union system in trouble, the Government must be able to arrange for the crisis management required, which may well include liquidating non-viable credit union operations. What’s needed is a special resolution system called stabilisation.

Published last week, the Central Bank’s consultation paper on stablisation begins to close off a dangerous gap in the credit union sectors’ financial safety net. The Banks’ paper lists six options. Reading between the lines, it’s clear the preferred option is for a legally reliable system, closely integrated with prudential supervision and the deposit guarantee scheme. The bank is concerned that moral hazard - where risky credit unions trade off a stablisation system and savers guarantee - is carefully controlled through robust intervention and enforcement powers up to and including liquidation.

Credit unions can and do fail. Ten have been liquidated in the US this year so far. One credit union with assets of €185m and 45,000 savers was taken over by the US credit union regulator in April. Within a week its operations were transferred to a larger, more financially robust neighbour. Another credit union with €20m in assets was closed and its 5400 savers paid their money within seven days. Such is the nature of the US special resolution system that failure problems are dealt with rapidly and transparently. The same is true of the Canadian system.

Badly governed and managed operations are identified and weeded out to maintain savers trust in credit unions.

Effective and efficient resolution systems are wholly dependent on statutory intervention and enforcement powers vested in government agencies or their appointed, regulated agents. They are designed to protect people’s savings and to ensure the sustainability of credit unions themselves. To work, government agencies must be able to step in, take control and insist on a viability plan being implemented. More often this requires appointing an external manager and providing temporary solvency funding. This money is sourced from deposit insurance funds established to provide both stabilisation assistance and guarantee compensation to savers in the event of closure.

Stabilisation is one part of a two part system called Deposit Insurance. The other part is the, by now familiar, €100,000 deposit guarantee. While the guarantee works if a credit union is closed down, its principal role it to prevent people running to take their money out at the first sign of trouble. A stablisation resolution agent intervenes at an early stage to prevent such a crisis in confidence emerging. Because it’s cheaper to step in, liquidate and merge one with another, outright closures are infrequent. This approach works as people know their money is safe and are satisfied service is maintained in transferring to another credit union.

But for stablisation agents to succeed there must be robust laws allowing regulators to set rules and regulations to inhibit risk taking. Where regulators spot trouble they must be able to step in and if needs be, temporarily take over. Working with this regulatory process, stablisation agents decide whether the credit union; has a viable future on its own; should be merged with another; or closed down. In nearly all cases the decision is to enforce a merger.

But these safeguards are lacking here. Existing laws don’t allow the regulator to take early stage intervention and prevent failures. There is no reliable stabilisation agency with which the regulator can act in consort to step in and rescue viable credit unions. Some twenty credit unions are said to be in serious trouble with many more experiencing significant financial pressure. Regulatory stress tests require credit unions to face the impact of loan losses. High level analysis indicates significant adverse solvency impact particularly on those having higher loan to total asset ratios. In a sample of 32 leading credit unions, one of every three would incur solvency problems using the base line scenario. This rises to five of every six using the downside scenario.

The unapproved, unregulated stablisation scheme operated by the Irish League of Credit Unions (ILCU) has only about €110m to assist its 520 credit union members North and south. This voluntary scheme is not legally reliable, does not cover all credit unions here and is no longer considered fit for use. Some twenty two credit unions have over €100m in assets each, totalling €3bn of the systems €14.5bn in assets. The top 100 credit unions account for close to 80% of total savings and loans. A properly designed and funded deposit insurance system – integrating the savers guarantee and stablisation – should be mandatory, pre-funded up to about €230m and be capable of being topped up if needed by credit unions. It should be able to penalise high risk operations through charging a risk premium.

The run on a large credit union in early 2006, that threatened to become contagious, triggered calls for the Government to extend the banks deposit guarantee scheme to credit union savers. In early 2007, Senator Joe O’Toole, who helped found a teachers credit union, published a Private Members Bill to establish a modern, well designed, integrated credit union stablisation and a savers guarantee scheme. But it was rejected by the Minister for Finance, who responding to lobbying by the ILCU on plans for its own private scheme, instructed the regulator to conclude negotiations on approving it or not. Nothing happened until September 2008, when the ILCU’s plans were rendered redundant, as Government was forced to guarantee credit union savers funds.

Since then full protection of savers funds remains incomplete. This is why the Central Bank has published its stablisation consultation document. It’s clear on a number of important things; any solution must be legally reliable, governed and managed professionally and be capable of providing the stablisation required of a modern, well designed financial stability system. The banks’ consultation process will be open, transparent and not inclusive to the point of political compromise. Such compromises in the past frustrated the regulator in preventing known risks from arising.

A version of this article appeared in the Irish Examiner Monday 28th June 2010, Business Section

A letter from the ILCU to the Editor of the Irish Examiner responding to this article is here

Financial Regulator embraces brave new world but can it deliver?

Yesterday the financial regulator published a paper setting out its stall for what appears to be the most comprehensive of behavioural modification programmes ever attempted in corporate Ireland.

Banks will be required to demonstrate how they will change their ways to behave and conduct themselves as good banks. Bad banks will be punished.

Having ditched the timid carrot of its own far too deferential past behaviours, the banking regulator is busy carving a big stick.

In one accompanying speech, there are twelve references to the behaviour of banks which will be intrusively policed by the regulator using its new approach to risk- scoring through which it will categorise banks as good or bad. The message is clear. If you are good then we won’t throw the kitchen sink at you.

It’s all encouraging stuff full of the strong vibrant robust language of the post-Lehmans chastened but re-invigorated banking supervisor. Bankers, lawyers and other professionals who would prefer to mutter dissent off stage were advised to desist and to engage transparently and publically with the regulator.

It’s sound advice, until that is you begin to consider the potential for a new form of institutionalised censorship through which dissenting voices are silenced in deference to the will and power of an all powerful banking policeman.

People will no doubt pour over what the regulators’ comprehensive strategy and tease out the implications for themselves and their firms. But some might ask can it do what it says it will do?

There is a danger in overpromising and under-delivering which could undermine trust in the new style unitary central bank – the remarriage of central banker and prudential regulator.

There is no doubting the ambition of the new leadership. It says it will intrusively supervise and second guess our banks business models and strategies to reform themselves as traditional intermediaries between savers and borrowers. It will also have a large say in the future structure of the domestic banking sector.

The new regulator is on a path which will take on vested interests of the regulated, their professional advisers, permanent government and political policymakers. Tellingly it has warned that its “actions will only be effective if they complement rather than run counter to Government economic and fiscal policy”.

Its “attentive, assertive supervision” brings to an end the Great Moderation when deregulation extended to relying on banks to internally control their own excessive moral hazard behaviors. The dogma that the markets were the best policemen has been buried along with the sullied reputations of some but not all of those who led the charge for greater recklessness. In its first installment the regulator has set out its stall for reforming and rebuilding trust in the nations banking system.

Just as it is asking banks to radically transform the way they do business, the new Central Bank has a mammoth task to transform itself. It is not easy changing organisational culture - the way things are done around year. Rolling back years of embedded behaviours, introducing new processes, information technology, new governance and management systems and maintaining employee motivation and commitment is not easy. It is harder still when faced with a deeply engrained, deferential hierarchy that believed in its own abilities. Banking is not known for its ability to successfully engage in major transformational change.

Organisational change requires a fundamental transformation into a fit for purpose modern regulatory system capable of policing system wide and individual bank risks including not only domestic Irish commercial banking, insurance and credit unions but also IFSC international operations.

In a short period, the new Central Bank has restructured into two major component parts with ten divisions and thirty one sub-functions. Thirteen senior managers will have a total of 31 managers reporting to them. With a staff of 1300 and plans to add up to another 200, the complexity of the structure reflects the need to supervise 15,000 firms operating here and internationally.

However, the plan doesn’t deal with its own strategic and business risks. In particular it doesn’t address the scale of its own organisational transformation and how it will mitigate the risks involved.

So who ensures that management and the board of the banking commission deliver on their own strategy? Who polices the policeman? It’s not that clear.

A version of this article appeared in the Irish Examiner Tuesday 22nd June 2010, Business Section

Safety rules must apply to financial products

Any comprehensive banking enquiry must seek to understand product safety and their use by ordinary people as there is nothing to prevent another bout of abusive marketing and mis-selling of consumer financial service products.

Despite two reports into understanding what went wrong with Irish banks and their regulation, little effort has been expended on understanding how the abusive promotion and marketing of consumer credit products created the credit bubble. Why did so many people participate in one of the world’s wildest and most reckless credit binges?

From about 2002 an explosive growth in banks’ foreign borrowings fed a voracious demand for consumer credit –principally to invest in bricks and mortar. Irish homes were marketed as financial assets to be used to fund a lifestyle choice to live life on cheap, abundant, flexible credit. Despite clear warnings, from multiple sources, no one in power bothered to heed how a clearly unsustainable growth in consumer borrowing was a weeping stick of gelignite primed to explode. Instead Government, its public servants and think tanks, our bankers and business people marketed the “soft landing” myth.

A national obsession with property as the investment asset of choice was manipulated by powerful vested interests that have yet to be fully investigated and reported on. It is certain that Government policy created the conditions in which credit product providers and brokers were able to abusively market credit products to people - encouraging them to effectively over borrow.

Bankers should have been well aware of the risks in relying on third parties selling their products. Mortgage and credit brokers made it all too easy for people to over-borrow. Some of the largest brokers were subsidiaries of estate agents. Will there be an enquiry into the all too obvious conflicts inherent in a business model which both represented sellers and arranged mortgage finance for buyers? At the height of the property boom, brokers arranged over 40% of all mortgages with car finance predominantly sold in car sales rooms.

In August 2009 the Irish Bankers Federation, in an EU consultation document on responsible lending, wrote “The current financial crisis is due to falling confidence and restricted liquidity and is not a result of irresponsible lending to consumers seeking residential mortgages.”

Irish banks were arguing against responsible lending rules that would, according to them, stifles innovation and increase costs. They are not alone; the Financial Regulator has said it also considers product regulation as inhibiting innovation and increasing costs.

Consumerists however point to drug companies which for decades have been required to produce drugs using simple rules and disclosures. Innovation has thrived with the cost of drugs declining. Similarly cars, televisions, baby seats etc. have become cheaper, not more expensive – yet their producers are all bound by product safety rules. Not so financial products, which bankers would have us believe are so unique a category as to preclude safety rules.

Yet many financial products are deliberately designed to confuse consumers, obscure costs and trick people into using more of them. During the boom structured investment products were made look safe and actively sold as “fit for use” by credit unions and other unsophisticated investors. Unsafe, they exploded causing significant losses. Their risks, if shown at all, were buried in pages of legalese. In the same way consumer credit products were sold as a safe means to enjoy a modern consumer lifestyle.

Expert US financial service consumerist, Professor Elizabeth Warren, convincingly argues that for too long policy makers and regulators charged with consumer protection have mistakenly believed in the principle that more disclosure promotes product competition. But more is not necessarily better.

Extra fine print provides product designers ample opportunity to fool unsuspecting consumers who are tricked into buying. The same is true here, where consumerists have argued against extensive disclosure that obscures rather than reveals what is really being sold.

Emerging from the credit wreckage of the past decade, the Central Bank Commission retains its consumer protection mandate. Yet its role as chief consumer protector has not been fully investigated. Nor has there been any public debate on how consumers might best be protected. It seems the traditional regulatory policy of educating people to become responsible, informed and logical consumers prevails. This notion of the educated super-consumer who shops around and whose choices force providers to behave themselves is embedded in the principle of our consumer education and information disclosure regulatory regime.

The Commission will ditch its consumer consultative panel - a legally hamstrung group unable to achieve much since 2003, it was the only formal forum for highlighting consumer protection concerns. Addressing its changing consultative arrangements, Mathew Elderfield recently said “I am committed to a close working relationship with representative consumer bodies who share our vision, take a constructive approach in engaging with us and work with us in appreciation of the trade-offs that need to be met as we set the priorities for our consumer work”. But consumerists and regulators are not necessarily happy bedfellows. What of consumerists who do not share the regulatory vision or agree with trade offs?

It seems product providers have a ways to go before the lessons of the past ten years are applied. Only last month, a leading mortgage lender, said that people on €37,000 could borrow over four times that income to buy a house. Meanwhile some real estate agents and mortgage brokers are talking up home mortgage affordability.

There needs to be thorough investigation and report into the abusive marketing to and abusive use of credit by ordinary people. What caused so many to behave so recklessly? Just how dangerous is the mix of manipulative marketing of credit and the design of credit products?

While no one can ever hope to stop people overdosing on drugs or abusively using credit the important thing to ensure is that the products themselves are not the source of trouble.

A version of this article appeared in the Irish Examiner, Monday 21st June 2010, Business Section

Credit unions need to be saved from themselves

Are Irish credit unions safe? 42% of people participating in an online newspaper poll didn’t think so. The credit union system is suffering from a progressive illness that may become terminal for many credit unions. As a concerned member and customer, you have no way of knowing how ill your credit union is and whether or not it will survive the consumer debt crisis. Most directors do not know either, as they lack the business acumen to fully appreciate the risks to the business they are responsible for governing.

The credit union system is a part of the banking crisis. The scale is different but the outcome is the same. Having funded the consumer credit bubble, many are now facing unsustainable loan losses. This is why the regulator is demanding your credit union stress tests its loans using a base line estimate of 17% loan losses and downside estimate 25% over the next two years. Translated these would amount to system wide losses of between €1.2bn and €1.7bn. Such loan losses are not out of line with international historical experience of unsecured consumer lending during credit crisis.

Just as the banks denied the scale of their loan losses, credit unions are equally in denial and are lobbying hard to reverse the crisis prevention measures the new financial regulator and his experienced credit union regulator want to implement.

Despite prudent moves by Finance Minister Brian Lenihan to bolster safety standards, credit unions are up in arms. The minister is to allow them to modify troubled loans by rescheduling them over a longer term. Credit union trade bodies initially accepted the conditions attached, which would see the regulator issuing mandatory safety rules. The rules would require your credit union to set aside money to fund loan losses, maintain a higher level of cash safety, preserve its capital buffer and exercise care when assessing customer loan repayment affordability.

But having agreed to the conditions, credit union trade bodies and local activists have been lobbying local politicians to reverse the Minister’s proposed changes to credit union laws, contained in the Central Bank Bill 2010. They are not only disagreeing to the conditions but do not want their regulator being given powers to issue binding codes and rules. Yet credit union regulators everywhere else have been able to issue binding rules for decades. It’s fundamental to ensuring safety and soundness.

Objecting to the regulators’ new powers is nothing more than an argument for light touch credit union regulation, which does not bear scrutiny when compared to their regulation in other countries. The fact is your credit union is far less regulated than its peers internationally. It’s something credit union trade bodies would prefer local boards of directors, you and your local TD didn’t hear of.

The issue starkly highlights a dangerous fault line unique to the Irish credit union system which has a history of quite serious non-compliance with existing laws. Everywhere else credit unions are required to maintain minimum capital reserves, set aside money for bad loans and have enough cash to fund new loans, customer withdrawals and pay their creditors. In all cases these safety requirements are set by government regulators who issue mandatory binding guidelines, set rules and supervise them. What’s more, they also have powers and the resources to take prompt action to step in at an early stage to rescue troubled but viable credit unions, frequently forcing them to merge with others.

Without the capacity to do this, financial stability cannot be assured and savers funds cannot be properly protected. But credit union laws here do not provide the Regulator with the powers to regulate effectively and prevent financial crisis from happening. Had the Regulator been able to act in 2003 to issue binding rules to control credit union risk taking, they would not have lost the millions in investments they should never have been allowed make in the first place.

Credit union lobbying for light touch regulation appears to have been supported by backbench TD’s. Previous Fianna Fail-led coalition administrations were unduly influenced by grass roots political activism. And it appears it may be a feature of this coalition; last week a Green Party politician indicated that the proposed regulatory powers were to be watered down to appease credit union lobbyists.

Despite two reports into the origins of the banking crisis, it seems some politicians do not quite understand the lessons. Ineffective regulation and supervision of credit institutions was one of the principal causes of the crisis. The regulator was “captured” by the regulated and undoubtedly influenced by political lobbying.


The history of credit union regulation here has been fraught with political captivity of trade body self-interest, which led to one of the weakest, most ineffective of financial safety net systems. Until September 2008 the Irish League of Credit Unions was lobbying against a state backed deposit guarantee for your savings. It took a banking crisis before this Government finally acted to extend the guarantee to you.

Before politicians react to lobbying pressure, they should consider one question. Which is more important, the survival of a sustainable credit union system or the support of a terminally ill system?

Rather than siding with trade body self-interest and ill-informed activism of a small handful of people who would threaten their vote, politicians should consider the silent majority of ordinary people who expect that the state ensures credit unions are governed and managed safely and will be around for years to come.


While regulatory medicine may well hasten the demise of lot of terminally ill patients, what’s really needed is urgent action to put in place a robust, reliable crisis management process through which a new co-operative structure and modernised credit union system can emerge. Credit unions do not have to be saved from the regulator; they have to be saved from themselves.

A version of this article appeared in the Irish Examiner, Business Section, Friday 11th June 2010

Myths peddled by leaders exposed for what they are

Government’s deceptive assertion the banking crisis was predominantly caused by external forces was blown out of the water yesterday by the two damning banking reports. Blame cannot be levelled at the feet of Wall Street. The Irish banking crisis would have happened without a global crisis.

It wasn’t complex – it was good old banking crisis caused by reckless property lending. Anglo Irish Bank and INBS were by September 2008 dead duck banks. Bank of Ireland and AIB may have just about survived without state aid. The banking guarantee, while inevitable, was far too generous.

Both reports illustrate how banking corporate governance failed miserably to prevent the crisis. No one was on watch. Everyone was busy partying below decks cheering on their well paid captains and officers. On auto-pilot, no one spotted the rocks until it was too late.

Bank boards, singularly focussed on maximising shareholder value, reneged on their responsibility to all stakeholders and wider society. Their greatest flaw was they did not understand or appreciate the risks they were running.

An all too cosy circle of friends, directors and senior management operated within a collective blind spot that first believed in the never ending wealth generating properties of residential and commercial buildings and laterally bought into the illusion of a soft landing to keep the party going. There is no evidence in the banking reports that any one at senior executive or board level challenged a collective wisdom that bankrupted the system.

Both reports write of a general systemic failure in governance – the one that resulted from herding behaviours and a myopic zeal to make money. They note that specific governance failures within certain banks were of world beating standards. Did these failures ever register on regulatory radar screens? It appears not. Would a code of corporate governance have prevented the crisis? Probably not.

Good governance is about stuff that can’t be captured in regulations or their supervision. It’s stuff such as ethics, honesty, integrity, vision and leadership. The latter two were singularly missing from Irish banking. Vision and leadership requires looking around corners and seeing risks for what they are.

Boards and senior managers shut out information that would have warned of the risks. Comforted by flawed, undeveloped internal risk assessment models, they did not perceive the risks in remunerating a buccaneering banking breed that drove a coach and four through tried and tested lending policies.

The Financial Regulator is currently consulting with the banking and insurance industry on corporate governance. It intends setting minimum standards it will insist on. The test of course is would these standards have acted as preventative measures in staving off the banking crisis?

Meanwhile some of the motley crew and directors who steered their ships onto the rocks remain in place. Some have even been elevated and promoted. New directors have been appointed mainly by the state. Within this melange of old and new blood, people are expected to forge a corporate behaviour based on standards of sound governance that will prevent reckless risk-taking. While good governance, minding the ship and ensuring the sustainability of enterprises is key to corporate leadership, it is also key to leading nation states.

Above all good governance and leadership is about individual courage; a willingness to listen to dissenting voices and to act, even if this means swimming against the tide.

The banking crisis was caused by governance failure in our banks, financial regulators, central bank and executive government. Taoiseach Brian Cowen, when finance minister defined a reckless national fiscal policy and oversaw its governance. His accountability and responsibility was clearly illuminated in the two reports.

Excuses built on “acting on advice” ignore a fundamental requirement of good governance and leaders. That is to listen and act even if this means leaving the party to steer the ship away from the rocks.

Good leaders also know that they are accountable for failing to act to prevent avoidable disasters. They step down without waiting to be told to do so.


A version of this article appeared in the Irish Examiner, Business Section, Friday 11th June 2010

Debt forgiveness is not moral hazard

Our elite public servants are refusing to face up to the unaffordable debt crisis. Regulator Mathew Elderfied, NAMA chairman Frank Daly and Justice Minister Dermot Ahern, ruled out debt forgiveness for ordinary people. All three raised the spectre of moral hazard without providing any substance to it back up. It’s a Dickensian argument for penal debt servitude that once committed people to debtor’s prisons.

About 80,000 households are struggling with mortgage debt. Most also have personal loans they cannot afford to repay. They are the tip of an iceberg, barely visible within the opaque fog of sparse official data. If consigned to debt servitude a generation of enterprising business people -job makers - may never create another job.

Instead of arguing moral hazard, what’s needed is a just, equitable and humane system to order the scale of debt forgiveness required to write off, some but not all of, the billions recklessly lent to ordinary people. The bit that should be written off represents that portion people have no hope of ever repaying. It includes their unsecured personal loans, credit card debt, personally guaranteed business loans and unaffordable negative equity.

A recently reported court case starkly illustrates why there must be a just and fair debt settlement system. The case involved a credit union pursuing a customer for repayments on €36,000. She also owes another €103,000 in bank loans. Despite knowing she suffers from a terminal illness, her credit union subjected her to the ignominy and stress of this country’s draconian debt collection system. Unable to work, her only source of income is a meagre weekly disability payment of €200 and €150 a month children’s allowance for her young son. It’s far less than required to live life with dignity. Hamstrung by the law, a humane judge set repayment at €10.00 a week and noted it would take 69 years to pay off the loan. The credit union could have written off the debt but it didn’t.

Pursuing people for debts they have no means of repaying is not unique to credit unions. Some banks and finance houses engage in a ruthless race to grab their share of wallet first, which is why court lists are burgeoning from debt recovery actions. Many outsource debt collection to specialist agents who hound people dragging them in an out of court. It is an inhumane, inequitable system known to cause significant economic and social costs.

Alternative debt settlement systems exist in other countries where the principle of “earned debt forgiveness” applies. They have organised, regulated debt settlement processes permitting people to work their way out of near hopeless insolvency. Including for debt forgiveness, their settlement programmes are far from soft on borrowers but critics of such debt settlement systems here warn of moral hazard without being able to produce a shred of supporting evidence other than to allege that free riders will abuse debt forgiveness. They also say that “good” people who didn’t over borrow will not want to bail out the “bad” people who did.

The principle of debt forgiveness means a person pays what they can and the balance owing is written off. The deal is; if they pay what they can over a specified period of time, usually five years, their lenders agree to write off the balance owing at the end of the debt settlement period. They earn the legal right to be forgiven some but not all of their debts. It’s what happens during the five years or so of the agreement that matters. People are legally required to commit every cent earned above a basic living allowance to repay their debts. During the debt settlement period, families are forced to live on near breadline incomes. But they know that if they keep to their part of the bargain they can once again participate fully in society. Business people know they can build new businesses and once again create jobs. Lenders know they will not incur debt collection costs and can plan to fund their loan write downs. And governments know the economic and social costs of unaffordable indebtedness are minimised.

Moral hazard argument that people will abusively financially plan for debt forgiveness is nonsense. Who in their right mind would plan for five years of extreme debt servitude required to earn debt forgiveness? In any event such systems are carefully designed and supervised to mitigate moral hazard risks. They also ensure costs are equitably carried by reckless borrowers and reckless lenders. As lenders can better assess and manage credit risk they pay the most.

In other countries the principle of debt forgiveness underpins their entrepreneurial business class and whole economies. Their business people know that if they fail they will not be consigned to a life of penal debt servitude. This safety net of structured forgiveness is a fundamental requirement and necessary condition for risk taking which is wholly absent here. Our debt collection and personal insolvency bankruptcy laws commit people to 12 years servitude and longer if they cannot pay the costs involved.

The cost of living in modern society is the risk that a credit bubble will cause an eruption in unaffordable debt. The problem is bigger than our neighbour’s reckless borrowing. It cuts to the heart of economic recovery.

A version of this article appeared in the Irish Examiner, Business Section, Monday 7th June 2010