Can looting - going bankrupt for profit - explain the gap between the haircuts suffered by Bank of Ireland and AIB versus the higher haircuts being applied to the two rogue operators Anglo Irish and INBS?
These two rogues are reckoned to cost the state close to €42bn in direct transfers of wealth from ordinary citizens to their bond holders and depositors. This figure may include billions looted through lending practices where bankers and borrowers colluded in doing deals they knew had no prospect of ever coming good - unless refinanced by others.
Such looters loans are near valueless and may be at the core of the vicious haircuts being applied. Many suspect the value of loans not transferring to NAMA may be in an even worse state.
While both recent reports into the banking crisis wrote of reckless lending, they did not differentiate between the differing types of recklessness engaged in by some but not all bankers. They did not address the difference between “looting” - going for broke at societies expense- and the more usual banking behaviour of “gambling for success”.
In 1993, the authors of “Looting: The economic underworld of bankruptcy for profit” in considering banking crisis in Chile and the US, found that in certain cases bank owners and their managers engaged in looting their banks to maximise current extractable value. As governments either directly insure deposits or explicitly insure bond holders and others, these people were incentivised to plunder the value of their firms leaving the default or bankruptcy costs to the taxpayer to carry. The authors argue this happens in the absence of proper accounting rules, lax regulation and low penalties for abuse. They also said that banker’s looting practices could symbiotically infect other sectors, causing some of their participants to loot their firms. It seems that a form of looting may well have been a facet of Irish banking and property sectors and may explain the significant, as yet unexplained, gap between the haircuts applied to our big two commercial high street banks and the two rogue banks.
For looting to work it takes two parties. A banker willing to go broke for profit and borrowers equally willing to go broke. Incentivised to maximise current value where a euro in dividends is worth more to a shareholder today than a euro of future earnings, bankers are drawn to lend money in ways that makes the current value of the bank higher than it actually is.
They may deliberately seek out opportunities to book deals that have no realistic chance of ever being repaid but on paper look highly profitable today. All that’s needed to make this work is a small group of borrowers who are willing to go broke for profit.
Following NAMA’s intervention, it is abundantly certain that many so called profitable loans were nothing of the sort. Many deals involved people borrowing to buy overpriced land and property in the hope that they would be able to offload it at a profit to someone else before their loans had to be repaid. Bankers converted interest they would normally have been paid over the life of the loan to upfront fees, booking them as immediate profits.
To make these deals tick over and work, the banker would advance more money to pay the interest bill, again banking spurious profits today. Meanwhile the actual true underlying value of the deal was negative. In short these loans could only have been unwound had they been refinanced. When the property bubble burst, the scale of looting had to crystallise. The looters loans could not be refinanced.
But bankers could not fess up to looting and continued to represent them as profitable. Only now as NAMA applies its haircuts is the enormity of looting becoming apparent. Of course there were many loans made honestly to fund honest developers who got caught out.
But how many were effectively looter’s loans are unknown. It could well be the huge additional haircut being applied to the two rogue banks is indicative of the scale of bank looting that occurred.
Did some bankers and speculative borrowers wilfully get involved in doing deals with no hope of ever repaying the money borrowed? Was this was a feature of the Irish relationship banking model which saw inexperienced lenders convince their customers to invest in the latest go- for- broke scheme?
Did bankers behave as if future losses were somebody else’s problem? In time maybe someone will prove looting was an aspect of Irish banking in the earlier parts of this century. For now the suspicion is that the, as yet unknown, final bill for bailing out banking probably contains billions in looters loans.
A version of this article appeared in the Irish Examiner Monday August 23rd 2010, Business Section
Monday, August 30, 2010
Monday, August 23, 2010
Urgent reform of debt laws needed
Faced with a consumer debt crisis, we need a legal system that allows people to pay what they can and earn the right to have what they cannot hope to repay, written off.
Advanced societies have long recognised the dire social costs of unaffordable indebtedness and provide debt resolution systems that allow people to once again become productive members of society.
Differing in detail, the essential element is your right to earn forgiveness after a period of paying what you can. In this time you are expected to live off a basic income and pay the balance of what you earn to those you owe money to. The bargain is you pay what you can afford and the balance is written off.
Enacted during the nineteenth century, our debt laws are wholly out of step with our advanced society and its consumer credit economy.
Our laws protect creditors absolute right to recover money owed, enhance their ability to pursue debtors and can confine ordinary people to prison or consign them to bankruptcy for over a decade. They are by far the most draconian, antiquated and inequitable laws of any advanced society.
Published earlier this year, the Law Reform Commission’s proposal for a humane system has been sidelined by a politicised response yet to provide a meaningful solution to mass unaffordable indebtedness.
The recent interim report of government’s committee on personal debt and subsequent Financial Regulator’s proposals merely delay the inevitable decision – either we opt for wholesale home repossessions or introduce a debt resolution regime that deals with the totality of consumer indebtedness.
Recently while listening to one person’s debt story, I was struck by one observation. The individual relating the story seemed to me to imply that people would use Government’s twelve month stay on bank home repossessions to favour their other creditors over their mortgage lender.
Such thinking reflects a spurious, unfounded moral hazard argument that ordinary people struggling with unaffordable indebtedness will manipulate their financial situation to extract maximum benefit.
Moral hazard proponents ask us to believe, for example that a married couple with three children living on €600 a week having a mortgage of €200,000 and other debts of €50,000 will pay their other creditors first as they know their house can’t be repossessed for 12 months. Are we to believe that they will financially plan to do this and abuse the stay on repossessions?
Such thinking reflects the Dickensian creditor protection orthodoxy of an official Ireland that cannot yet accept or deal with the enormity of private citizen’s debt crisis. Moral hazard is a common thread in official commentary and expounded by those who hold themselves out as self-appointed gatekeepers. Some once advised people to maximise their use of personal credit and leverage into the boom time property market. Today they are purveyors of advice on how to manage unaffordable debt. Having made money advising people to over-borrow, many make money advising people how to manage their hopeless indebtedness.
Many act as if we are dealing with a run of the mill debt problem. We are not. Tens of thousands of people who have always earned reasonable incomes have suddenly fallen into debt through no fault of their own. They no longer have the income or repayment capacity to fund their loan repayments. And will not have for many years to come, if ever again. Some are so hopelessly indebted that only a humane personal insolvency regime will allow them to become productive members of society once again.
Most lenders know this but in the absence of the reforming system proposed by the Law Reform Commission and a solution to mass mortgage indebtedness, they use the current legal system to protect their rights to recover in full what they are owed – even where they realise they will never do so. Both lenders and borrowers need a way to work out what can be paid and what cannot.
Struggling to respond, the state funds a free to user, debt advice service originally designed to help the most financially vulnerable and marginalised in society. Provided with a mere €17m a year, MABS provides a valuable service to those dealing with their indebtedness. But it’s a service not designed to deal with the sheer scale of the problem and is hamstrung by its limited resources. At the very least it should be provided with all the resources it needs and its costs levied on those who benefit most – lenders.
Those who would treat people in debt as near criminals, accuse them first of wilfully over-borrowing and then likely to abuse a forgiveness regime, miss a fundamental issue. Modern societies realise that they cannot consign their citizens to decades of debt serfdom simply to protect the rights of those who should have acted with greater prudence in lending them money in the first place.
A version of this article appeared in the Irish Examiner Monday August 23rd 2010, Business Section
Advanced societies have long recognised the dire social costs of unaffordable indebtedness and provide debt resolution systems that allow people to once again become productive members of society.
Differing in detail, the essential element is your right to earn forgiveness after a period of paying what you can. In this time you are expected to live off a basic income and pay the balance of what you earn to those you owe money to. The bargain is you pay what you can afford and the balance is written off.
Enacted during the nineteenth century, our debt laws are wholly out of step with our advanced society and its consumer credit economy.
Our laws protect creditors absolute right to recover money owed, enhance their ability to pursue debtors and can confine ordinary people to prison or consign them to bankruptcy for over a decade. They are by far the most draconian, antiquated and inequitable laws of any advanced society.
Published earlier this year, the Law Reform Commission’s proposal for a humane system has been sidelined by a politicised response yet to provide a meaningful solution to mass unaffordable indebtedness.
The recent interim report of government’s committee on personal debt and subsequent Financial Regulator’s proposals merely delay the inevitable decision – either we opt for wholesale home repossessions or introduce a debt resolution regime that deals with the totality of consumer indebtedness.
Recently while listening to one person’s debt story, I was struck by one observation. The individual relating the story seemed to me to imply that people would use Government’s twelve month stay on bank home repossessions to favour their other creditors over their mortgage lender.
Such thinking reflects a spurious, unfounded moral hazard argument that ordinary people struggling with unaffordable indebtedness will manipulate their financial situation to extract maximum benefit.
Moral hazard proponents ask us to believe, for example that a married couple with three children living on €600 a week having a mortgage of €200,000 and other debts of €50,000 will pay their other creditors first as they know their house can’t be repossessed for 12 months. Are we to believe that they will financially plan to do this and abuse the stay on repossessions?
Such thinking reflects the Dickensian creditor protection orthodoxy of an official Ireland that cannot yet accept or deal with the enormity of private citizen’s debt crisis. Moral hazard is a common thread in official commentary and expounded by those who hold themselves out as self-appointed gatekeepers. Some once advised people to maximise their use of personal credit and leverage into the boom time property market. Today they are purveyors of advice on how to manage unaffordable debt. Having made money advising people to over-borrow, many make money advising people how to manage their hopeless indebtedness.
Many act as if we are dealing with a run of the mill debt problem. We are not. Tens of thousands of people who have always earned reasonable incomes have suddenly fallen into debt through no fault of their own. They no longer have the income or repayment capacity to fund their loan repayments. And will not have for many years to come, if ever again. Some are so hopelessly indebted that only a humane personal insolvency regime will allow them to become productive members of society once again.
Most lenders know this but in the absence of the reforming system proposed by the Law Reform Commission and a solution to mass mortgage indebtedness, they use the current legal system to protect their rights to recover in full what they are owed – even where they realise they will never do so. Both lenders and borrowers need a way to work out what can be paid and what cannot.
Struggling to respond, the state funds a free to user, debt advice service originally designed to help the most financially vulnerable and marginalised in society. Provided with a mere €17m a year, MABS provides a valuable service to those dealing with their indebtedness. But it’s a service not designed to deal with the sheer scale of the problem and is hamstrung by its limited resources. At the very least it should be provided with all the resources it needs and its costs levied on those who benefit most – lenders.
Those who would treat people in debt as near criminals, accuse them first of wilfully over-borrowing and then likely to abuse a forgiveness regime, miss a fundamental issue. Modern societies realise that they cannot consign their citizens to decades of debt serfdom simply to protect the rights of those who should have acted with greater prudence in lending them money in the first place.
A version of this article appeared in the Irish Examiner Monday August 23rd 2010, Business Section
Monday, August 16, 2010
Debt forebearance won't work
With the two big banks reporting worsening home mortgage loan quality and bond rating agencies highlighting worsening trends, Government’s policy to tackle the consumer mortgage debt crisis sees it waiting at the cross roads for Godot to arrive.
But Godot won’t arrive and homeowner distress will considerably worsen once the full extent of banks increasing mortgage rates bite. Headline figures are stark with well over 70,000 homeowners in trouble. In serious default, over a third of these face losing their homes. At current property prices, they owe over €85,000 more than their home is worth. It’s an amount they have no chance of every repaying yet are expected to under current laws. Tens of thousands of others have had their loan repayments adjusted downwards in the vain hope that they may at some future time be able to recommence full repayments. Indicative of worsening homeowner financial distress, electricity providers were cutting off 2600 homes a month earlier this year.
While the depth of the banking crisis took everyone by surprise, what’s frighteningly disappointing is the slow pace of response to the consumer debt crisis. Government began the crisis with wholly inadequate debt resolution laws and systems. And the pace of its response since has been snail like in comparison to other countries where all of the proposals outlined by the Financial Regulator in its consultation paper last week have already been implemented and haven’t worked.
Government’s tardy response is clearly designed to buy time to stabilise the banking system. Measures taken allow lenders to forebear, to cut balance sheet slack. It’s a carefully orchestrated response, obliging lenders to play ball with the banking regulator. Sold as benefitting homeowners, in reality it’s required to maintain the illusion that home loan arrears are being managed and not massaged. But as Government kicks the consumer debt can down the road, the can just gets bigger as it runs out of road. And it seems it will run out of road next year as the second round of its fiscal austerity measures, bank imposed interest rate rises and possible ECB rate increases erode struggling householders take home pay even further.
The classic mortgage default option of wholesale market repossessions and forced selling is not possible given the sheer scale of arrears and a moribund housing market with its massive oversupply of new homes and depressed demand. While the decline in housing values may be slowing down settling at 2001 values, right now the only people buying are cherry picking first-timers with decent jobs, who are buying homes at bargain basement prices in larger urban locations.
Just how many people are caught in the homeowner debt un-affordability trap is still unknown. Without hard, accurate and timely data we are left with the regulator’s quarterly reports. Figures for the second half of this year have yet to be published. They will undoubtedly confirm the trends noted elsewhere and we can expect some more bad news.
The sum total of measures taken so far, oblige mortgage lenders to look to negotiate favourable terms with people who are in arrears or who face arrears problems. The focus is on tackling arrears and fore-stalling repossession action in the courts. Government’s more recent proposals will obligate lenders to establish special arrears management units and use a standardised approach. They may also be required to offer an internal independent review process. It also seems that struggling homeowners may be given second chance to negotiate a second round of forbearance. The net effect of all these measures leaves all the power with the lender. US experience has not been good with its schemes even where they used independent state funded third party debt negotiators. There, lenders cheery picked the better cases and refused the poorer cases. Even when re-set at lower repayment amounts nearly a third failed to keep to their new repayment levels. The main problem it seems is lowered repayments must be affordable and the loan owing must also be adjusted downwards. In short without debt forgiveness, it won’t work.
Managing arrears merely deals with the symptoms. Here nothing is being done to address the underlying problem which is wholesale loan un-affordability. Tens of thousands of homeowners can no longer afford to pay off loans they owe in full. But many can afford to pay off a more reasonable amount. A proper loan modification programme should calculate what can be paid back and adjust the loan owing down to this level providing the new amount equates to the market value of the home. This adjustment could also allow for some homeowner equity. Those who want to sell and begin anew should be allowed to short sell – sell their home for what it’s worth with whatever is left owing being written off.
This will mean biting the bullet on loan forgiveness and finding equitable ways to fund the costs. It also means making the banks incur the lion’s share of costs.
But Godot won’t arrive and homeowner distress will considerably worsen once the full extent of banks increasing mortgage rates bite. Headline figures are stark with well over 70,000 homeowners in trouble. In serious default, over a third of these face losing their homes. At current property prices, they owe over €85,000 more than their home is worth. It’s an amount they have no chance of every repaying yet are expected to under current laws. Tens of thousands of others have had their loan repayments adjusted downwards in the vain hope that they may at some future time be able to recommence full repayments. Indicative of worsening homeowner financial distress, electricity providers were cutting off 2600 homes a month earlier this year.
While the depth of the banking crisis took everyone by surprise, what’s frighteningly disappointing is the slow pace of response to the consumer debt crisis. Government began the crisis with wholly inadequate debt resolution laws and systems. And the pace of its response since has been snail like in comparison to other countries where all of the proposals outlined by the Financial Regulator in its consultation paper last week have already been implemented and haven’t worked.
Government’s tardy response is clearly designed to buy time to stabilise the banking system. Measures taken allow lenders to forebear, to cut balance sheet slack. It’s a carefully orchestrated response, obliging lenders to play ball with the banking regulator. Sold as benefitting homeowners, in reality it’s required to maintain the illusion that home loan arrears are being managed and not massaged. But as Government kicks the consumer debt can down the road, the can just gets bigger as it runs out of road. And it seems it will run out of road next year as the second round of its fiscal austerity measures, bank imposed interest rate rises and possible ECB rate increases erode struggling householders take home pay even further.
The classic mortgage default option of wholesale market repossessions and forced selling is not possible given the sheer scale of arrears and a moribund housing market with its massive oversupply of new homes and depressed demand. While the decline in housing values may be slowing down settling at 2001 values, right now the only people buying are cherry picking first-timers with decent jobs, who are buying homes at bargain basement prices in larger urban locations.
Just how many people are caught in the homeowner debt un-affordability trap is still unknown. Without hard, accurate and timely data we are left with the regulator’s quarterly reports. Figures for the second half of this year have yet to be published. They will undoubtedly confirm the trends noted elsewhere and we can expect some more bad news.
The sum total of measures taken so far, oblige mortgage lenders to look to negotiate favourable terms with people who are in arrears or who face arrears problems. The focus is on tackling arrears and fore-stalling repossession action in the courts. Government’s more recent proposals will obligate lenders to establish special arrears management units and use a standardised approach. They may also be required to offer an internal independent review process. It also seems that struggling homeowners may be given second chance to negotiate a second round of forbearance. The net effect of all these measures leaves all the power with the lender. US experience has not been good with its schemes even where they used independent state funded third party debt negotiators. There, lenders cheery picked the better cases and refused the poorer cases. Even when re-set at lower repayment amounts nearly a third failed to keep to their new repayment levels. The main problem it seems is lowered repayments must be affordable and the loan owing must also be adjusted downwards. In short without debt forgiveness, it won’t work.
Managing arrears merely deals with the symptoms. Here nothing is being done to address the underlying problem which is wholesale loan un-affordability. Tens of thousands of homeowners can no longer afford to pay off loans they owe in full. But many can afford to pay off a more reasonable amount. A proper loan modification programme should calculate what can be paid back and adjust the loan owing down to this level providing the new amount equates to the market value of the home. This adjustment could also allow for some homeowner equity. Those who want to sell and begin anew should be allowed to short sell – sell their home for what it’s worth with whatever is left owing being written off.
This will mean biting the bullet on loan forgiveness and finding equitable ways to fund the costs. It also means making the banks incur the lion’s share of costs.
Monday, August 9, 2010
Stable banking system still a long way off
Two years on and the gamble that pledged the nations wealth to shore up its banking system, the infamous banking guarantee is close to running its initially planned for course. Provided to buy time to stabilise banking, it will undoubtedly have to be extended. Banking stabilisation has not yet been achieved. And there is a complete lack of any business case from the main banks on how they intend managing through the next three to five years.
What’s more, no one has synthesised what type of banking system will be required to intermediate between savers and borrowers into the future. Everyone agrees it won’t be the one we have at the moment.
On current reckoning Anglo will cost the tax payer about €22bn in hard cash simply to retain its licence. Twenty billion will be consumed in its bad loans furnace – a mix of Nama and non-Nama distressed loans and about two billion will be needed to support it as a going concern, its good bank bit of about €15bn in residual performing loans. Just how Anglo intends functioning as a good bank is not yet clear. It says it may form a nexus around which others may consolidate or become a part of the mythical third banking force. It won’t be able to do this without the state guaranteeing those willing to provide it with funds.
Meanwhile AIB is struggling to show how it will raise the €7.4bn capital target set for it by the regulator. It might realise €2bn from selling its overseas assets. It may shave a bit from its operating costs and has hinted at swinging job cuts. It may convince shareholders s to pony up the balance. But it doesn’t stand a ghosts’ chance in hell of doing so unless the state continues to provide a guarantee beyond the end of this year.
Many maintain that large organisations become captive of small groups of insiders who manipulate resources for personal gain under the guise of generating shareholder value. What’s good for the executive management cohort becomes good for shareholders.
In the name of the shareholder, AIB’s cultural inclination will be to fight hard to head off greater state involvement. It’s a bank with an interesting take on moral hazard – trading off the “too big to fail” doctrine. Its investment in buying ICI resulted in the nations foreign reserves being used to save the bank. It led the charge in selling tax-free non-resident accounts to residents. A rogue trader lost it close to $800m (€600m). It knowingly overcharged customers for years until publicly exposed.
Now facing regulatory demands for greater capitalisation and swinging Nama haircuts its core mercantile values are being tested. So far there’s been a lot of talk of selling the family silver but it has yet to publish a convincing business case demonstrating just how it sees itself becoming a soundly governed profitable commercial bank.
Two things are certain. Either, AIB will raise its capital target privately retaining its independence or the state will fund the money and it will end up nationalised. But what of other banks business plans?
At the heart of the crisis is the relationship between the state and privately owned commercial banking. Intent on pursing their own plans, powerful vested interests are forging a new relationship. Much has been written of Irish banks problems but little if anything about their future prospects. Just who is responsible for defining the future state of Irish domestic commercial banking and ensuring the state and its citizenry can access affordable financial services?
To date no one has had a stab at estimating the relative size or component parts of a new domestic banking system. There is talk of needing four national banks. Yet we have had a four bank national system for decades. Throughout, Bank of Ireland and AIB’s dominant market share remained relatively static even with the arrival of foreign competition much of which only a rebranding of existing domestic banks. Hoping for the arrival off shore of the banking version of the marines is wishful thinking. And spending too much time looking at the entrails of the past won’t define the future.
The creation of a working commercial banking system that intermediates prudently between domestic savers and borrowers can only happen if it is designed between Government, its agencies and what’s left of the national banking system after Nama and recapitalisation.
A version of this article appeared in the Irish Examiner Monday August 9th 2010, Business Section
What’s more, no one has synthesised what type of banking system will be required to intermediate between savers and borrowers into the future. Everyone agrees it won’t be the one we have at the moment.
On current reckoning Anglo will cost the tax payer about €22bn in hard cash simply to retain its licence. Twenty billion will be consumed in its bad loans furnace – a mix of Nama and non-Nama distressed loans and about two billion will be needed to support it as a going concern, its good bank bit of about €15bn in residual performing loans. Just how Anglo intends functioning as a good bank is not yet clear. It says it may form a nexus around which others may consolidate or become a part of the mythical third banking force. It won’t be able to do this without the state guaranteeing those willing to provide it with funds.
Meanwhile AIB is struggling to show how it will raise the €7.4bn capital target set for it by the regulator. It might realise €2bn from selling its overseas assets. It may shave a bit from its operating costs and has hinted at swinging job cuts. It may convince shareholders s to pony up the balance. But it doesn’t stand a ghosts’ chance in hell of doing so unless the state continues to provide a guarantee beyond the end of this year.
Many maintain that large organisations become captive of small groups of insiders who manipulate resources for personal gain under the guise of generating shareholder value. What’s good for the executive management cohort becomes good for shareholders.
In the name of the shareholder, AIB’s cultural inclination will be to fight hard to head off greater state involvement. It’s a bank with an interesting take on moral hazard – trading off the “too big to fail” doctrine. Its investment in buying ICI resulted in the nations foreign reserves being used to save the bank. It led the charge in selling tax-free non-resident accounts to residents. A rogue trader lost it close to $800m (€600m). It knowingly overcharged customers for years until publicly exposed.
Now facing regulatory demands for greater capitalisation and swinging Nama haircuts its core mercantile values are being tested. So far there’s been a lot of talk of selling the family silver but it has yet to publish a convincing business case demonstrating just how it sees itself becoming a soundly governed profitable commercial bank.
Two things are certain. Either, AIB will raise its capital target privately retaining its independence or the state will fund the money and it will end up nationalised. But what of other banks business plans?
At the heart of the crisis is the relationship between the state and privately owned commercial banking. Intent on pursing their own plans, powerful vested interests are forging a new relationship. Much has been written of Irish banks problems but little if anything about their future prospects. Just who is responsible for defining the future state of Irish domestic commercial banking and ensuring the state and its citizenry can access affordable financial services?
To date no one has had a stab at estimating the relative size or component parts of a new domestic banking system. There is talk of needing four national banks. Yet we have had a four bank national system for decades. Throughout, Bank of Ireland and AIB’s dominant market share remained relatively static even with the arrival of foreign competition much of which only a rebranding of existing domestic banks. Hoping for the arrival off shore of the banking version of the marines is wishful thinking. And spending too much time looking at the entrails of the past won’t define the future.
The creation of a working commercial banking system that intermediates prudently between domestic savers and borrowers can only happen if it is designed between Government, its agencies and what’s left of the national banking system after Nama and recapitalisation.
A version of this article appeared in the Irish Examiner Monday August 9th 2010, Business Section
Monday, August 2, 2010
Credit Union Sector faces independent review
Facing significant challenges that threaten its future viability, the credit union sector is to be independently reported on at the request the Minister for Finance. The strategic review, facilitated by the Financial Regulator, will see consultants Grant Thornton initially look at the current financial health of the sector as part of a wider process to ensure credit unions develop a robust and sustainable business model.
There have been consistent warnings that some credit unions were managing their affairs was out of date with the requirements of a modern financially robust credit union system. Comparisons with business models used elsewhere highlighted a worrying disparity in regulatory and legislative frameworks, prudential supervision, external support mechanisms, operational systems and governance and management competencies.
Lack of diversification and a heavy reliance on loan interest income augmented by investment income, has meant profitability was over-exposed to investment and loan loss risks. Both the global and domestic banking crisis crystallised these risks as real and substantial losses. They are losses that threaten the sectors financial stability.
Credit unions have been stuck with a business model that worked well in the past. But it’s now showing problems associated with years of underinvestment in improvements, poor governance and operating systems and insufficient bad debt provisions and low levels of regulatory capital. For nearly a decade observers warned of quite serious shortcomings which are now, as predicted, being exposed. Governed and managed to maximise profits for distribution as dividends to members at year end, the sector must now evolve a more robust and sustainable business model.
Initially incurring significant losses in inappropriate high risk investments, estimated in excess of €350m since 2007, credit unions may have provided for in full for these. As the scale of consumer indebtedness unwound, an increasing number of credit unions have been exposed to significant financial stress resulting from the impact of rising loan losses. Recently the Financial Regulator spoke of twenty credit unions experiencing serious solvency issues. In 2008, the regulator moved to ensure credit unions provide for adequate capital buffers and set aside money to cover bad debts and investment losses.
Loan quality has deteriorated dramatically with bad debts more than doubling from 6% last year to over 13%. It is highly likely that this figure will worsen as credit unions begin to prepare their year end accounts next month. With a financial year ending September, they must publish annual accounts and hold annual general meetings by the end of January next. Last year many of the larger credit unions, which control over 80% of total assets, made substantial additional provisions and write offs on their loan books. This trend is likely to be repeated this year.
More worrying perhaps is what is called the hollowing out of loan books. Last year credit union new loan issues shrank on average 27%. Unable to make enough good loans, their loan books and all important ability to generate interest income will be severely impaired. Under-lent, with less than 50% of assets in loans and reliant on thin investment margins, many credit unions are quite seriously challenged to generate the profits needed to cover bad debts, write off bad loans, fund regulatory reserves and pay a decent rate of return to savers. They are faced with some really tough hard decisions which will require strong governance and management skills to deliver on. Such decisions can’t be made in an information vacuum.
The first phase of the strategic review will look to establish the facts and report on the current state of affairs – the sectors risk profile. No doubt it will reveal the true scale of the financial challenges facing the sector. Its findings should be reported on publically, which will help resolve the contradiction between consistent regulatory warnings over financial strength and persistent representative body assurances of financial soundness.
Despite their significance in size and importance, publically available information and critical analysis of credit union financial soundness does not exist. This will be the first independent review and the start of a process that should lead to designing and implementing a more effective, sustainable and robust business model. Key to the success of the process will be the ability of all stakeholders to engage positively. Too often in the past change initiatives have unfortunately resulted in adversarial, politicised responses by credit unions and their representative leadership.
This time it may be different. By publishing the reviews findings, those genuinely concerned over the future of the sector will finally be informed of facts which have been hidden from view and obscured through a rhetoric that insists all is well when it is not.
A version of this article appeared in the Irish Examiner Monday August 2nd 2010, Business Section
There have been consistent warnings that some credit unions were managing their affairs was out of date with the requirements of a modern financially robust credit union system. Comparisons with business models used elsewhere highlighted a worrying disparity in regulatory and legislative frameworks, prudential supervision, external support mechanisms, operational systems and governance and management competencies.
Lack of diversification and a heavy reliance on loan interest income augmented by investment income, has meant profitability was over-exposed to investment and loan loss risks. Both the global and domestic banking crisis crystallised these risks as real and substantial losses. They are losses that threaten the sectors financial stability.
Credit unions have been stuck with a business model that worked well in the past. But it’s now showing problems associated with years of underinvestment in improvements, poor governance and operating systems and insufficient bad debt provisions and low levels of regulatory capital. For nearly a decade observers warned of quite serious shortcomings which are now, as predicted, being exposed. Governed and managed to maximise profits for distribution as dividends to members at year end, the sector must now evolve a more robust and sustainable business model.
Initially incurring significant losses in inappropriate high risk investments, estimated in excess of €350m since 2007, credit unions may have provided for in full for these. As the scale of consumer indebtedness unwound, an increasing number of credit unions have been exposed to significant financial stress resulting from the impact of rising loan losses. Recently the Financial Regulator spoke of twenty credit unions experiencing serious solvency issues. In 2008, the regulator moved to ensure credit unions provide for adequate capital buffers and set aside money to cover bad debts and investment losses.
Loan quality has deteriorated dramatically with bad debts more than doubling from 6% last year to over 13%. It is highly likely that this figure will worsen as credit unions begin to prepare their year end accounts next month. With a financial year ending September, they must publish annual accounts and hold annual general meetings by the end of January next. Last year many of the larger credit unions, which control over 80% of total assets, made substantial additional provisions and write offs on their loan books. This trend is likely to be repeated this year.
More worrying perhaps is what is called the hollowing out of loan books. Last year credit union new loan issues shrank on average 27%. Unable to make enough good loans, their loan books and all important ability to generate interest income will be severely impaired. Under-lent, with less than 50% of assets in loans and reliant on thin investment margins, many credit unions are quite seriously challenged to generate the profits needed to cover bad debts, write off bad loans, fund regulatory reserves and pay a decent rate of return to savers. They are faced with some really tough hard decisions which will require strong governance and management skills to deliver on. Such decisions can’t be made in an information vacuum.
The first phase of the strategic review will look to establish the facts and report on the current state of affairs – the sectors risk profile. No doubt it will reveal the true scale of the financial challenges facing the sector. Its findings should be reported on publically, which will help resolve the contradiction between consistent regulatory warnings over financial strength and persistent representative body assurances of financial soundness.
Despite their significance in size and importance, publically available information and critical analysis of credit union financial soundness does not exist. This will be the first independent review and the start of a process that should lead to designing and implementing a more effective, sustainable and robust business model. Key to the success of the process will be the ability of all stakeholders to engage positively. Too often in the past change initiatives have unfortunately resulted in adversarial, politicised responses by credit unions and their representative leadership.
This time it may be different. By publishing the reviews findings, those genuinely concerned over the future of the sector will finally be informed of facts which have been hidden from view and obscured through a rhetoric that insists all is well when it is not.
A version of this article appeared in the Irish Examiner Monday August 2nd 2010, Business Section
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