The Minister for Finance may now nationalise credit unions and transfer their business to a bank. Credit Unions have been included in the Government’s draconian new powers to restructure the domestic banking system, the Credit Institutions (Stablisation) act, because of worsening trends in financial stability due to both their current and potential loan and investment losses.
The minister may nationalise a credit union by requiring it to issue special shares providing him with overarching powers to direct a credit union’s affairs over those of a credit union’s shareholding members. It is how he currently controls the direction of the two building societies. The same approach with a credit union could see both the injection of tax-payer funds and subsequent transfer of its entire business to another credit institution. The Minister may also appoint a special manager to take over the running of a credit union, who may remove its board and management.
The act includes one important legal provision bound to upset credit unions and their trade bodies. The Minister will be able to direct the transfer of a credit union’s business to another credit institution, which may not only be a credit union but also a building society or a bank. Legal provision has been made to convert a credit union’s share accounts to deposit accounts where its business is being transferred. In essence takeover protection afforded to credit unions can be set aside to best protect people’s savings.
This sudden and unexpected development no doubt reflects concern for the stability of the sector’s 410 independent autonomous credit unions. Ranging in size from €1m to €350m in assets, they collectively hold €11.9bn of household deposits - mainly held in dividend earning share accounts. Early indications are that close to one hundred credit unions will be unable to pay a dividend this year, with close to two hundred paying less than 0.50%. As the ability to pay a dividend is a key financial stability indicator, these figures suggest some quite serious issues emerging.
Importantly then the EU/IMF financial support programme on restoring financial sector viability deals with credit union regulation and stability. Specific action steps required of the state include having a loan assessment (a structural benchmark) completed and comprehensive restructuring strategy in place by April 2011 and legislation on a strengthened regulatory framework including effective governance and stablisation requirements submitted to the Dail by December 2011. The Central Bank’s recent technical note on its Prudential Capital Assessment Review includes plans for the significant strengthening of the regulation and stability of the sector by the end of 2011.
Last June the bank invited submissions on its consultation paper on stabilisation - a resolution regime for credit unions. Unusually the bank has not published these submissions on its website. It said that they would be factored into its strategic review currently entering its second phase. This is an unusual development as, abiding with the principles for better regulation, it has undertaken to publish such submissions.
Perhaps the reason is contained in a recent speech, when in referring to stablisation the credit union regulator said that adverse trends emanating from the sector were suggesting “that even greater reform may be required than those envisaged in our recent consultation paper. We intend to bring forward proposals in this area early in the New Year”. He also warned of contagion risks to the sector.
What happened to change the bank’s view? Four significant things have occurred since last June.
The first is the bank’s stress test requiring credit unions to assess loan losses under differing risk scenarios. I wrote in this paper on the 15th November of how my own stress test analysis established a potential state solvency support funding of between €200m and €650m.
The second has been independent reviews reported to the bank of credit union loan books which have found they are on average 40% underprovided for bad debts.
The third relates to the strategic review’s first phase, financial stability analysis completed by Grant Thornton, a leading credit union audit firm.
While the bank has not published results of its stress test or the first phase of the strategic review, it’s clear it’s considered its June stablisation proposals are insufficient.
Finally and perhaps most relevant of all, credit unions have extensive investments in bank bonds which are or may become exposed to haircuts.
It shouldn’t come as a surprise, given the sector’s importance in the overall banking system, that credit unions have been included for in the banking stability bill or in the IMF/EU agreement. In ensuring it has the necessary powers to stabilise and reconfigure the banking system and to deal with the inevitability of some credit unions failing the Government has finally put credit union restructuring firmly on the table.
A version of this article appeared in the Irish Examiner, Business Section Friday 17th December 2010.
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