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
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