Risk Capital and Competitiveness

Irish credit unions are not obligated to provide for risk capital. The only legal requirement is for a credit union to provide 10% of its net revenues to statutory reserves. More recently under regulatory conditions for allowing higher lending limits to qualify a credit union will need to maintain only 6% statutory capital and 8% overall. These thresholds are extremely low by international comparison where credit unions elsewhere have been obliged to provide for risk based capital for some time.

As capital is the first line of defence against loan losses it is necessary to asses the relative exposure of credit unions. Here the news is far from good. The sector has reported loan delinquencies well in excess of safe thresholds. Yet this leading indicator of potential losses is not reflected either in bad debt provisions nor loan write offs.

Many informed observers consider this demonstrates that credit unions have not adequately provided for nor are willing to bite the bullet and write off bad loans. Delinquent loan restructuring and the manipulation of provisions and loan accounts is a known phenomenon.

There is evidence then that a bad debt mountain has built up and will need to be written down sooner rather than later. Some estimates put this as high as €200m which represents 1.4% of current reserves.

Surely 6% statutory reserve is too low a threshold in this environment ?

Failing to bite the bullet has undermined not only safety and soundness but also competitiveness. Many credit unions have invested reserves in expensive new building programmes which have only added to their cost base.

Simply catching up with current consumer expectations will take investments of millions. Credit union IT and operational capabilities require investment along with funding required for new products and services. The only source a credit union has are its current reserves and ability to sustain sufficient net revenues to maintain a safe and sound level of risk capital and finance for the investments required to modernise operations.

At a time when massive investment is required in the business infrastruture many will find their ability to generate the revenues and capital required severely impeded by declining margins, increasing costs, bad debt provisions and write offs.

One is reminded of Ozymandias:

I met a traveller from an antique land

Who said: Two vast and trunkless legs of stone

Stand in the desert. Near them on the sand,

Half sunk, a shatter'd visage lies, whose frown

And wrinkled lip and sneer of cold command

Tell that its sculptor well those passions read

Which yet survive, stamp'd on these lifeless things,

The hand that mock'd them and the heart that fed.

And on the pedestal these words appear:

"My name is Ozymandias, king of kings:

Look on my works, ye mighty, and despair!"

Nothing beside remains: round the decay

Of that colossal wreck, boundless and bare,

The lone and level sands stretch far away

Could it be that in years to come people will regard credit union buildings as remnants of the past ?