Failing credit unions must adapt for good of consumers

Only fit-for-purpose co-operatives can provide a viable alternative for consumers and small businesses.

With three out of four credit unions experiencing varying degrees of financial stress and the Central Bank undertaking a full assessment of their loan portfolios by the end of April, the new government faces making a policy decision on the sector’s future. Will the reformed domestic banking system include a co-operative banking network?

Having already lost hundreds of millions in imprudent investments, credit unions are reeling from boom-time poor lending outcomes. With arrears at 15% and heading for 20%, loan losses could amount to well over €1bn.

There’s also an elephant in the room: credit unions have Irish bank bond holdings of about €1.3bn of which €300m is in subordinated paper. If they sell now they will realise immediate losses, but if they hold on they may face haircut losses under new bank resolution rules.

The Irish League of Credit Union’s, having seriously dented its small bail out fund of €119m in supporting just 20 of its troubled affiliates, is now asking credit unions to double their contributions to its fund.

Recent regulatory requirements to rebuild capital buffers, provide for bad debts, restrict lending and manage liquidity have stripped the credit union dividend cupboard bare. Dividend rates are the key indicator of financial stability for credit unions. Three quarters of them are paying less than 1% with one in five paying nothing. There is a distinct danger that the combination of assertive regulatory medicine, liberally applied since 2008 and EU/IMF programme requirements could kill off even healthy patients.

Everywhere else, badly governed and managed credit unions are either shut down or merged with others. Whether as a strategic consolidation to create a working credit co-operative system or a haphazard crisis containment exercise, closures and mergers are inevitable. Either way tax payers' funds will have to be used. Depending on the severity of financial stress, this could amount to well over €500m. Should this money be used invest in building something that works or to try to fix something irreparably damaged?

In propagating the myth that they are not banks, credit unions are claiming their ways of doing business are not appreciated by government and the regulator. But neither are they appreciated by their credit co-operative peers elsewhere, who cannot quite understand why Irish credit unions have been incapable of maturing beyond their start- up business model.

The fundamental problem is that credit unions have not been governed and managed as they should have been. With only one in ten voluntary directors having a financial background, there are far too many badly run credit unions, providing poor quality expensive products to far too few people. If they are to play an important part in a working banking system, they will have to transform - radically.

A modern, fit for purpose co-operative system, could provide a nationally owned consumer and small business banking alternative. Examples already exist. They are called federated networks and they are the heart of successful co-operative banks across the world.

These networks are distinguishable by their many small independent credit co-operatives which, through contractual obligations and cross guarantees, are leveraging off a combined balance sheet. They own a central banking operation that provides the financial resources, operational capacity and professional competence to enable them to provide a full banking service to their customers who are also their owners. The Netherland’s Rabobank is one such network.

Federated networks treat community capital as an inter-generational endowment to be protected and enhanced by one generation of owners and managers to hand on to the next generation. As their owners are also their customers, they are not driven by the short term demands of external shareholder’. Expert at governing and running co-operative banks, their long term customer advocacy focus meant they were resilient in the face of recent global and domestic challenges.

Irish credit union’s dated business model and league system acted as value destroyers of community capital. Had they been structured, governed and managed as federated banking co-operatives, over the past decade they might have generated over €2 billion in additional surpluses which would have buffered them against the economic downturn, more than covered modernisation costs and critically, provided a working banking alternative today. Instead they are financially stressed and could will incur losses of close to €1.7bn, according to some estimates.

What could a federated model look like here? Let’s fast forward to 2020. The Irish credit co-operative banking system has consolidated from 412 down to 50 independently governed, professionally managed credit unions, each with its own multi-branch footprint, offering a full banking service to consumers and small businesses. These credit unions own a central banking facility providing wholesale market access, liquidity and loan securitisation.

The facility, originally constructed from redundant commercial banking resources, also provides a full range of corporate services, acts an outsourced regulatory agent, and provides IT and operational systems along with remote and internet banking channels.

Through contractual obligations and cross guarantees, credit unions have ceded autonomy to better serve their customers.

Can it be made happen? Yes, but credit unions will not be able to make this change on their own. They will need determined government intervention and funding through a suitably empowered change agent.

When warned of an urgent need to reform the sector as far back as 2006, the then finance minister, Brian Cowen, deftly kicked the ball onto the regulator’s pitch. Last year, his successor Brian Lenihan similarly abdicated responsibility for defining policy by requiring the Central Bank to carry out a strategic review instead. With the EU/IMF programme requiring the Central Bank to establish credit union capital adequacy requirements and implement a stabilisation plan, the review is now on hold.

For now it seems this government considers credit unions of some importance and is to set up a credit union commission. Who knows? Maybe will have the power to design and deliver on the necessary changes, which may even include transforming credit unions into modern working federated network.

A version of this article appeared in the Sunday Business Post, Markets Section on Sunday March 13th 2011