Credit unions are paying a hefty price

With one credit union declaring losses of close to €5m on subordinated bank bonds, many more will be admitting to similar losses at their annual general meetings (AGM’s).

Understandably, the Irish League of Credit Unions (ILCU) has been reluctant to admit to scale of losses in bonds it once heavily promoted to its member credit unions. Estimates earlier this year put the scale of losses at €200m.

Including consumer loan write-downs, the sector is facing total losses of upwards of €1.5bn. While some of this will be covered by operating income, state bail-out funding will be needed to rebuild capital buffers.

The Government’s recent budget earmarked €500m in bail-out assistance -credit unions are to be advanced €250m in 2011 and €250m in 2012.

Just how taxpayer’s funds are to be made available is unclear. Presumably the state will not take an ownership stake as this would sunder the credit union co-operative structure.

It is probably the case that loan funding will be provided to support viable credit union balance sheets as non-viable operations are closed down and others are merged into better governed operations.

One question that looms large is why were Irish credit unions investing at all in long dated and perpetual subordinated bank bonds?

The root of the answer lies in 1998 when finance minister Charlie McCreevy relaxed the type of investments trustees were permitted to make. As credit union investments were also governed by these rules, McCreevy’s move had the effect of permitting them to invest in riskier assets. This was entirely out of kilter with other countries that insist credit unions invest in the safest of assets, principally government stock and top-rated senior bank bonds.

As consumer credit boomed from 2000 onwards, credit unions were left behind, causing a fundamental distortion in their balance sheets as loans shrank and investments grew.

Anxious to maintain high dividend pay-out rates to savers, boards placed excess funds in riskier investments, chasing higher yields.

Many credit unions unwittingly behaved as commercial for-profit enterprises, sweating their balance sheets to maximise dividends to savers. The irony was that they were funding both the cash and capital used by banks to finance the property bubble.

Realising the growing balance sheet distortion and inherent investment risk, the credit union regulator looked to have the law amended to reign in risk taking.

This was rebuffed by government officials as ILCU and its then investment partner Davy, aggressively lobbied against the change.

Eventually after two years of consultations, the regulator was able to publish non-binding guidelines in late 2006. While these limited risk taking, it was too late and many credit unions lost money from 2007 onwards. Indeed, many failed to unwind their holdings of subordinated bank bonds and suffered the consequences this year.

To date, there has been no official investigation or report on credit union investment activity during the boom years.

Hundreds of millions were invested in imprudent products and tens of millions lost in what has all the hallmarks of a mis-selling scandal. 

Easy targets, far too many credit union boards of directors and managers, were persuaded to invest in products their financial advisors barely understood themselves.

A small number of credit unions have sued their advisors with varying degrees of success. In some cases advisors have had to make good losses, in others they have not. Some credit unions are deemed to be “consumers”.

Whether a credit union is a consumer or not is defined by its turnover, which is hard to define for a credit institution. The problem is this: If a credit union is marginally under the threshold it is covered under consumer protection regulations. If it’s over the threshold, it is not.

But it’s not a matter of defining a credit union as a consumer or not a consumer.

A credit union board is charged with responsibility and accountability for prudent governance which means making safe and sound investment decisions.

As it is a responsibility that cannot be outsourced to a third party, it should be within the competence of a credit union’s board and management to understand balance sheet risks, including investment risk.

Competence, responsibility, accountability and fiduciary care are at the heart of good governance of all credit institutions. Fitness and probity means having the competence and experience to understand and control for all risks the enterprise faces. Bond losses are symptomatic of poor standards of care and indicator of why the credit union sector needs to be reformed.

As credit union members attend AGMs this year, they should be aware of one fact. Credit union bond losses arise from an ill-advised boom-time strategy to chase higher yields.

They might be mindful to ask searching questions and demand that their credit union insists that its regulatory authority investigates and reports on just how so much money was needlessly lost.

A version of this article appeared in the Irish Examiner, Business Section, Monday 19^th December 2011.

Vested interests stand in way of bank reforms

Has Government’s banking policy created a reformed regulatory system captive of banks vested interests? 

With its focus on just two dominant commercial banks, not only has its pillar banking strategy amplified the too- big- to- fail dilemma, it has also created an uncompetitive, anti-consumer banking environment.

If major banks are far too important to be allowed to fail, then is it not the case that executive government, public servants and the central bank become captive of banks vested interests? If so then we may have shifted from one form of political and regulatory capture to another.

The boom-time relationship between central banking, commercial banking, civil service bureaucracy and executive government was partially addressed in reports into the banking crisis. At best the reports hint at how mutually reinforcing vested interests literally brought the house down. Politician’s economic policy, public servants ideology and banking’s vested interest combined with regulatory captivity to cause both the banking and economic crisis.

In theory, banks should be regulated by independent authorities whose governing technocrats, guided by public interest considerations, should act free from political interference. While the reformed Central Bank addresses what was wrong with the previous regulatory system through its new structures and risk control approach, just who defines what’s in the public interest?

It appears at one level the bank’s new approach to banking regulation and supervision should act as an early warning system, allowing it to take prompt corrective action to head off problems. But it could be the case that intrusive engagement could result in even greater captivity as both banker and central banker focus on building functioning banks. Both will want to see a return to sustainable profitability. 

If the central bank’s consumer protection activity does not include product level regulation or price controls then how will banker’s marketplace behaviours be controlled for?

Is it in the public interest that banks exploit competition dynamics and engage in anti-consumer loan pricing behaviours? Is it in the public interest that so many people in debt are left on their own to negotiate with powerful institutions without any financial safety net?

Yet it could be the case that current banking policy may be embedding a different form of political and regulatory capture of vested interests. It’s clearly in the public interest that commercial banking functions again. But there’s a conflict within the wider public interest, as consumers are being asked to pay for banking rehabilitation costs in two ways. The first is explicit within the enormity of the taxpayer bail-out funding of banks. Billions in consumer derived tax revenues are being used to pay the interest cost of bank bail-out funding. The second is implicit within higher rates and fees being charged by banks. Not only have banks increased loan rates, they are also increasing fees on their utility banking services.

It’s fair to say that Government’s response has fallen well short of appreciating and responding to the impact of its own policy. It seems that it has quite deliberately rendered consumer protection absolutely subservient to banking profitability. In effect its banking policy is a shield protecting banks from competition and consumer interests. As the banking system has shrunk, consumers have become captive of remaining bank’s pricing behaviours. 

For example consumer mortgage captivity is particularly acute. People can no longer shop around as no one is open for business. Those that are open are rationing credit and cherry picking.

As Government has done nothing to balance vested interests, its banking policy is inherently anti-consumer by design. For example both the Cooney and Keane expert groups comprised bankers, regulators and public servants – three sets of vested interests. The groups did not include for consumer advocates with the reputational standing and professional competence to insist the consumer interest be accommodated.

Is it the case that both political and regulatory system capture has become more and not less embedded in the post-boom environment?

The evidence so far compels a closer examination and understanding of the relationship between banks, regulatory and executive government vested interests which have become a mutual re-enforcing survival compact. Insisting banks pass on interest rate reductions is simply a political reaction to public concern. 

All too often politician’s focus on near term gains comes at the expense of longer term sustainability of their social and economic policies. Recognising how large, dominant banks operating in an anti-competitive environment can exploit their “too big to fail status” will take more that political insistence on rate reductions.

How can a central bank technocracy effectively balance bankers and consumers vested interests when there is no consumer protection representation? 

A version of this article appeared in the Irish Examiner, Business Section, Monday 12th December2011

We need a National Debt Advice Service

The brutal reality of the impact of fiscal austerity measures means that thousands of households will slide into long term financial distress, joining over 100,000 others who have no hope of ever repaying what they owe in full.  

The consumer debt crisis is a unique event requiring a unique response that can only be provided by the Government. With over 150,000 people needing help, resolving billions in unaffordable debt will require hundreds of thousands of debt settlement agreements with multiple creditors such as  banks, credit unions, revenue, local authorities and utility companies.

No one existing service provider has the resources or operational competencies to do this and leaving it to the private sector is not a realistic option.

With no consumer protection regulations governing the provision of debt advice, resolution negotiation and settlement, current service offerings fragment across a state funded agent, not- for- profit services and a host of differing commercial operations.

 

MABS, through its national network of independent self-governing autonomous offices, is doing its best to respond. The demand for advice has spawned a plethora of commercial debt advisers. Some are charging fees of people in debt. Others are using free advice as a lead generation tool to sell life insurance and credit products.

Many are using exploitative tactics, baiting people with emotional marketing and misleading promises. Some are deliberately playing on people’s fears by falsely claiming they will instantly relieve psychological stress. Fabricating client testimonials to sell their services, they use suicide and clinical depression statistics to market free financial advice.

Debt advice, resolution and settlement services are regarded as high risk consumer protection activities as there is a heightened risk of exploitative business practices, including the provision of bad advice and predatory selling of unsuitable products and services.

Yet, exploitative marketing claims and misleading statements are being made by regulated financial intermediaries who are subject to consumer protection codes of conduct when selling financial service products. The very people who became quite skilled at getting people into unaffordable debt are now claiming they are skilled at getting them out of it. 

The provision of debt advice/resolution services is an expensive, inherently unprofitable business unless it’s paid for by creditors. No operator has the financial resources or capacity to deliver on the scale and scope of services required to deliver a comprehensive service.

Even if a private commercial operation could charge enough, it would need well over 50,000 customers to break-even. The likelihood of any private company having the resources to invest in achieving this scale is non-existent. Furthermore private operations cannot provide the scope of professional debt resolution services required.

It is also the case that the sheer scale of the need for advice and resolution is the result of a one off, non-recurring event. Any service response will have to have the capacity to deal with large numbers of customers and their multiple creditors using standardised, efficient and effective processes. Achieving this will need improved codes of conduct and protocols governing debt enforcement and resolution.

The principal of the “All Debt” approach has been widely accepted as the appropriate service model. All debt includes mediating resolution agreements with the full range of principal creditors-credit institutions, revenue, local authorities and utilities. The service should provide advice, financial affordability assessment, recommend solutions, draft multi-creditor settlement proposals, make representations and negotiate realistic settlements with creditors.

The only realistic solution is for the Government to establish an independent, all debt advisory and resolution service.

Designed to fit with whatever non-judicial mechanism and process is finally legislated for it should be governed and operated on a not-for-profit, commercial basis and should include for two components - secured home mortgage debt and other debt.  How the unaffordable element of mortgage debt is resolved is not really an issue. The key is that all debts are dealt with, through an integrated approach.

Working with other stakeholders, the debt resolution service should be empowered to improve the existing consumer protection framework, ensuring that people are afforded the professional representation they need, protection from abusive enforcement tactics and standardisation of creditor collection and settlement approaches.

The current situation with hundreds of debt advisors, offering varying degrees of service, in an unregulated market, is a recipe for consumer exploitation. 

As the scale of the crisis and scope of services required by people means that only one agent has the power and resources to respond to their needs, will Government act to create a national debt advice and resolution service and allocate the funding needed in the budget ?

A version of this article appeared in the Irish Examiner, Business Section, Monday 5th December 2011.