Slimmed down credit unions should grasp reform opportunities

After delaying consolidation for years, credit unions are about to have it foisted on them.

Central Bank officials are making ready to apply regulatory triage by taking dozens of non-viable credit unions into care. Using its extensive resolution powers, the bank can appoint special managers to take over the running of credit unions, remove their boards and managers, order the takeover of one by another and where required, temporarily fund balance sheet rehabilitation costs.

While there’s mention of numbers shrinking from 409 to about one hundred, fewer than fifty are likely to be viable operations at this time. These numbers are the outcome of boom-time complacent sectoral leadership and poor governance when credit union balance sheets were increasingly exposed to risks. Concerned only to maximise saver’s dividends, their boards of directors and managers did not invest in building sustainable businesses and balance sheets capable of withstanding the economic recession.

 

Consequently, to prevent them pouring petrol on fires they built in their own backyards, close to three hundred credit unions have had their lending capacity restricted by the Central Bank. 

Last week, in what was probably an orchestrated campaign, trade body representatives and local politicians publically criticised the Central Bank, claiming it was driving people into the arms of moneylenders. They got their response in Taoiseach Enda Kenny’s robust defence of the Central Bank’s interventions to protect savers funds. Its interventions, which also include insisting credit unions account properly for asset values and come clean on losses, are driving the need to stabilise the network by consolidating it down to a viable and sustainable size.

Consolidation is an inevitable outcome of credit union maturity. In the U.S., Canada and Australia while numbers of credit unions have been declining for years, customer numbers and branches have grown. In these countries, induced by crisis events far less serious than here, consolidation was driven by governments and their regulatory agencies. And credit union leaders responded positively. Consolidation allowed them to realise scale economies to invest in modern technologies and establish the centralised shared services required to offer a full range of high quality financial services. The same is true of co-operative banking consolidation in mainland Europe.

Today we are seeing similar crisis induced, regulatory leadership by the Central Bank’s experienced credit union regulator the Registry of Credit Unions. It has acted to control investment and lending risks and while insisting on proper reserves, has permitted loan modifications and established a robust resolution system to enable the sector to survive and prosper. It has done so in the face of objections by credit union representative bodies who blame external forces and regulatory intervention for causing financial instability problems. The reality is that the root cause stems from credit union board rooms. An aging generation of long serving directors and their managers focused solely on maximising savers dividends and ignored the sustainability of the credit union itself.     

Crisis induced, regulatory imposed consolidation won’t work unless it’s framed within a broader strategic context. At a recent conference for managers and auditors, Professor Ray Kinsella spoke of the need to “bail in” credit unions as distinct to “bailing out” banks. At this conference, I illustrated one possible “bail in” approach when I presented on my paper “A Co-operative Banking Strategy for Ireland” recently submitted to the Commission on Credit Unions. It’s available on my blog, billhobbsie.blogspot.com.

Credit unions are economically important as they mobilise household savings as loans and socially important as they help create community social capital. Guided by a philosophy, which is best seen in their consumer advocacy values, the fundamental business purpose is to provide high quality financial services at fair prices to anyone who wants them. By excelling at this purpose they build the capital reserves needed for business sustainability, and realise their wider societal objectives. They are a vital store of intergenerational, monetary capital and facilitator of community social capital.  

As yet, credit union leadership has not come up with a “bail-in” strategy that makes sense. With the Government and Central Bank intent on stabilising the sector, credit unions need to stop looking at this as a threat and realise the opportunity it proposes.  

       

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

Credit Union Members need to toughen up on their act

With some credit unions in the red, members should attend AGM’s to get some answers, writes Bill Hobbs

With a worsening economic climate, many credit unions face serious challenges in funding day to day operations, paying dividends and maintaining prudent levels of reserves.

Significant regulatory interventions to control risk taking and maintain capital reserves have been put in place. More recently the Minister for Finance has ordered the Financial Regulator to review the sector. Heightened public concern may also result in large attendances and challenging sessions at credit union annual general meetings this year.

Ranging in size from less than €0.5M to over €370m, credit unions are accountable for the safety of €11.5bn in household savings. 100 medium and large sized credit unions ,having full time management and staff, control close onto 80% of all savings.

It appears that 50- as yet unidentified credit unions - will be unable to pay a dividend this year. If these are medium or larger credit unions then upwards of €4.5bn- the savings of tens of thousands of ordinary people- may earn a zero return this year. Due to a lack of public information, people can’t judge the financial performance and relative safety of their local credit union until it publishes its annual accounts. From now too early in the New Year, credit unions will publish annual accounts and hold their annual general meetings.
Credit unions are owned and governed by their shareholding members, who are also their customers. Electing directors from their membership, members empower a board to govern and manage the business. In turn directors are held accountable, principally through producing annual accounts and holding an annual assembly of members.

A study on the financial accountability of Irish credit union boards to their members, published in Financial Accounting & Management in 2004, found “accountability is not discharged in the most appropriate manner by credit unions in Ireland”. It also found that “users of credit union financial statements (in particular members) are not provided with appropriate financial information to make judgments and decisions. Given that the powers of direct interrogation by members of credit unions are limited, such weaknesses can disadvantage members.”

The study highlighted the absence of standards for financial accountability and also noted “ If low quality financial accounts are prepared and audited (without qualification), and members rely on these as a ‘health check’ of the financial performance and position of the credit union, then the potential for members being misled is high.”

Provided with only basic financial accounting information and limited commentary on performance what might credit union members look out for this year? There are four “health check” issues people should be concerned with. These are losses in investments (funds not lent out in loans), bad debts and loan losses, liquidity (sufficient cash to fund operations) and reserves (sufficient capital to cover expected and unexpected losses). All four are unlikely to be dealt with in credit unions annual accounts through detailed notes showing policy in each area, data comparing one year to the next and commentary on performance.

Concerned members might prepare questions and look for “plain English” explanations during the AGM. Questions might be asked on investment portfolios such as the type of investment’s made, with whom, the risks being incurred and expected or anticipated losses. They might ask for an explanation of the investment policy and whether or not the credit union is in compliance with regulatory investment accounting requirements and guidelines. If not, then the board should be asked of its plans to achieve compliance.

Recent media reports indicate at least 10% of credit union loans are in trouble but less than 1% may be written off. Yet banks are reporting far higher levels of loan losses on their troubled consumer loans. Members might ask of the number and amount of loans in default, considered at risk of default and what the expected losses are. As a credit union is legally restricted in its lending activities, the board might be asked if it is in compliance with these restrictions and if not, how compliance will be achieved. Last year 90 credit unions were found to have been in breach of legal lending limits by the Financial Regulator.

Credit unions are generally expected to maintain liquidity (cash) in instruments that can be encashed without delay or loss. Typically these include bank current accounts, short term bank deposits and government bonds. They should have at least 20% of assets held in this way. The board should be asked if it is satisfied liquidity is sufficient as some credit unions are borrowing from others to meet their cash needs. Some have had their lending restricted by the Financial Regulator. The board should be asked if the credit union has been or is being restricted in its lending and what actions it’s taking to resolve the issue. With loan default risk rising in a recessionary economy, questions might be asked of lending policy, in particular if the credit union is using repayment capacity lending assessment. If it is not a member of the Irish Credit Bureau, then an explanation should be given for this.

Credit unions are expected to maintain safe levels of reserves (capital) as a safety buffer against expected and unexpected losses. From September this year the Financial Regulator requires them to maintain minimum reserves of 10% of total assets. International best practice indicates a ratio of 15% as being prudent. This new requirement was introduced in part to prevent reserves being used to fund dividends to savers. Credit unions are only permitted to use reserves previously set aside specifically to pay future dividends. The majority did not create these reserves. Members might question their board to explain its reserve policy and what plans it has to achieve and maintain the regulatory reserve ratio.

Typically less than 2% of members attend the Annual General Meeting and few robustly question their board on credit union performance. This may be about to change as many people are deeply concerned that credit unions should continue to provide a safe place to save and make affordable loans.