State will need to rescue credit union sector

Solvency funding and state intervention will be required to stabilise and reform the sector, writes Bill Hobbs

CREDIT Unions may need tax payers’ funds of upwards of €650m over the next three years should a realistic loan loss scenario materialise.

At the very least they are likely to require well over €200m in state solvency support. In the past two years having struggled to fund loan and investment losses from collapsing profits, many are now experiencing serious solvency issues.

Currently the only solvency support fund available is ILCU’s unregulated €125m scheme which it may use at its discretion to support its 400 affiliates in the Republic and 110 in Northern Ireland.

It seems that it has already committed €45m in support of fifteen credit unions, according to a recent media report.

Last June the Central Bank published a consultation document on its proposals for a stablisation system, a resolution and funding mechanism for insolvent but otherwise viable credit unions. But credit unions affiliated to ILCU voted in support of its outright rejection of the bank’s stablisation proposals.

This month the bank said that “trends emanating from the sector are suggesting that even greater reform may be required than those envisaged in our recent consultation paper”.

It seems then its original stablisation proposals will not be robust enough to deal with risks no doubt surfaced by both its own loan loss stress testing and strategic review initiated by the Minister for Finance.

Having provided billions in largely unsecured loans to fuel boom time compulsive consumerism, credit unions are acutely exposed to the consumer debt crisis. As well as traditional loans to marginalised borrowers, their lending included financing first time house buyers’ down-payments, lending to small businesses and small scale speculative property developers.

For the past two years they have all been heavily rescheduling troubled loans. Equating to between 15% and 22% of boom lending, loan losses could amount to between €1.0bn and €1.5bn over the next three years. Depending on how well they have been governed and managed, losses will vary by credit union.

Applying regulatory loan loss stress test ratios together with likely financial performance criteria to thirty one leading credit unions, representing about one fifth of the sectors total assets, my results showed one in two incurring impaired solvency under optimistic conditions.

Under high stress loan loss and realistic financial performance conditions, thirty showed varying degrees of impaired solvency.

Extrapolating these results to the entire sector, results in a state solvency funding requirement of upwards of €200m under optimistic conditions. This rises to upwards of €650m under more realistic stressed conditions. The likely figure is probably somewhere in between.

With a moribund banking system unable to make enough good loans to ordinary people, credit unions are an important alternative source of consumer credit. Yet with an inability to mobilise household savings over the past decade, they have close to €3.5bn on deposit with the banks which should be used to make good loans.

Credit union’s ethos to be of service to their customers who are also their owners, within their local community by offering them affordable financial services is just as relevant today as it was fifty years ago. But the business model used is not. Years of poor leadership, insular governance and management, political captivity and lethargy have combined with a consumer debt crisis resulting in an inevitable and predictable outcome.

Significant state intervention and solvency funding will be required to stabilise and reform a sector that has failed to keep pace with what’s required of modern, fit-for-purpose credit co-operatives.

In return for state aid, the Government will undoubtedly insist the sector be consolidated to a smaller network of larger, viable, better governed and managed credit unions. The outcome could see a robust, financially strong, national network of modern independent credit co-operatives participating through a centralised finance and corporate services facility. While the number of credit unions may shrink dramatically from 414 to less than 100 or so, merged unions could retain some independence, remaining open to provide a better range of affordable financial services.

Everywhere else credit co-operatives have long since consolidated, modernised and expanded their services to offer a valued alternative to high street commercial banks. Key to their success is their professional centralised finance and corporate facilities.

These provide essential services such as liquidity, access to wholesale funding markets, securitisation, internal audit, staff development, information technology platforms, process standardisation and automation, expert credit and operational risk management, legal services along with products, services, call centers and online delivery channels.

Long on the rhetoric of change but short on action, credit unions have run out of time to effect such change on their own. If the sector is to be reformed it will need a purposeful state empowered change agent to order and facilitate reform or else a crisis led enforced consolidation could result in a chaotic shambles.

A version of this article appeared in the Irish Examiner, Business Section, Monday 15th November 2010.