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There have been consistent warnings that some credit unions were managing their affairs was out of date with the requirements of a modern financially robust credit union system.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
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