Turning credit unions around

Once a success story, credit unions are stuck in the past and in dire need of rescuing, writes Bill Hobbs

Unless credit union reform is on Government’s agenda for urgent change, the future for credit co-operative banking in Ireland is very bleak.

With the way credit unions continue to be operated here, being unable to pay a decent dividend is a sign of financial instability. One in every five is unable to pay any dividend for last year. And with only one in four paying a rate over 1.00%, three quarters of the state’s 412 credit unions are experiencing varying degrees of financial stress.

It appears that the Irish League of Credit Unions has almost exhausted its small stability support fund of €115m. So far it has committed €58m to supporting twenty nine credit unions. With another seven in the pipeline requiring upwards of another €40m, all too predictably, its small fund will soon run out of money.

Clearly credit unions are going to need state support. This could see the Government providing hundreds of millions in tax payers’ funds to stabilise the sector. As part of the IMF deal, the Central Bank is currently reviewing credit unions to establish the scale of support needed. The bank must also implement a strategy to stabilise the sector. Under the deal, new laws will give the bank a statutory resolution fund and tools to close credit unions or where they are viable, merge them with others including banks. But these crisis management responses have little to do with the future role of credit unions.

Something quite important is missing - a clear, unambiguous Government commitment to transforming credit unions into a modern, well run, credit co-operative banking network.

Once an international success story, Irish credit unions have been stuck in the past for the past two decades. Perfectly designed for an Ireland that doesn’t exist anymore, their methods and ways of doing business remain rooted in the 1950’s. Unlike their peers elsewhere, they have not developed as successful full-service banking co-operatives have in say Europe, Canada and Australia.

Instead of focussing on becoming full-service co-operatives, credit unions here pursued an ill-advised strategy of maximising surpluses (profits) to pay far too high dividends to their savers. This meant they did not invest in the modernisation required to provide better quality affordable products and services. Critically they did not set aside enough money to see them through bad times.

Financial stress cracks first appeared as early as 2005 when worrying levels of bad debts were reported on in the media. Their bad loans were far too high for booming economic conditions. And unable to make enough good loans, credit unions put over half of excess savers funds into risky investments that should never have been made.

Since 2008 two things have happened. Hundreds of millions have been wiped off investment values. And boom time imprudent lending along with an economic recession have triggered rising bad debt losses that could exceed over €1bn.

The fundamental problem is that Irish credit unions have not been led, governed and managed as they should have been.

As credit co-operatives, credit unions can be thought of reservoirs of community capital to be protected and enhanced by one generation of directors and managers to hand on to the next generation. By successfully providing affordable products and services to this generation, their managers maintain and build community capital to hand on to the next generation. Because their owners are also their customers, credit co-operatives are not driven by short term demands of the market, shareholders or bond holders. Their managers become expert at running co-operative banks. This notion of inter-generational community capital twinned with managerial expertise is why credit co-operatives elsewhere were able to weather their banking and economic crisis. Their ways of doing things can be adopted here in Ireland.

Here, 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 radically reform and change the way they do things. But for various reasons, they will be unable to make this change on their own. This is why many are convinced they have to be helped from themselves.

If the new Government considers credit unions of systemic importance to the any new banking system it must put credit union reform and modernisation firmly on its agenda for urgent and important change. Its starting point should be to establish a credit union reform authority with the power to design and deliver on the necessary changes.

A versions of this article appeared in the Irish Examiner, Analysis section, Friday 4th March, 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.