Irish Credit Unions - Post Northern Rock and echoes of the Rhode Island crisis ?

Irish Credit Unions "Echoes of Rhode Island"

16 years on the Rhode Island crisis echoes chillingly down the corridors of Government buildings....

In 1991 the Rhode Island State privately owned deposit insurance company, RISDIC, collapsed due to severe liquidity shortfalls. As a result of the ensuing run, the Governor ordered the closure of every credit union in the State. At the time Rhode Island State had a population of 1m. Over half the households saved $1.3bn with credit unions.

What followed was a period when thousands of ordinary people were denied access to their savings, many experiencing severe financial hardship. Months later when credit unions finally re-opened some of the better ones stayed closed. The bail out cost Rhode Island State and its tax payers about $350m. It took Rhode Island officials nearly three years to return the full amount of principal to depositors at five credit unions, and about two-thirds of all insured deposits were frozen for the greater part of a year.

Reports into reasons why this occurred were scathing in their criticism of the way in which the legislature had become captive of trade body politics and had ignored consistent warnings that all was not well. More compelling was the evidence that the problems lay within the credit union system of private deposit insurance.

The primary element in the collapse this system were identified as:

“its incapacity to exercise sufficient supervisory authority to limit risks or to impose effective risk based deposit insurance premiums to make unwise risk-taking more costly for the insured institutions creating the largest risks. In the absence of effective restraints on risk-taking, and without adequate insurance reserves or assurance of replenishment following recognition of loss, any large loss was bound to undermine public confidence and to trigger rational runs by depositors on other institutions insured by the same fund if the solvency of those other institutions was also questionable. (Todd [1994])”

“Collectively and individually, RISDIC staff and directors lacked insurance experience, had little banking experience outside of the small world of Rhode Island state-chartered financial institutions, and possessed modest educational and professional credentials. Nevertheless, they were well compensated and had great confidence in each other's talents and integrity. RISDIC directors seemed generally oblivious to the complex risks for which they were responsible. Examination findings and problems noted at member institutions were filtered out or excused as they were communicated upward within RISDIC. The result was an uninformed board. (Gregorian [1991])”

It was a damning indictment of the system as it existed at that time. Since 1991 all bar one of the US private schemes have closed down. The remaining private deposit insurer has come in for some recent criticism :

“The overall system risk to the credit union industry that may be created by private primary share insurance appears to have decreased since 1990, although some concerns remain. The number of privately insured credit unions and providers of private primary share insurance have declined significantly since 1990. Specifically, in 1990, there were 1,462 privately insured credit unions—with $18.6 billion in insured shares—compared with 212 privately insured credit unions—with about $10.8 billion in insured shares, as of December 2002. This represented a 42 percent decrease in privately insured shares. Moreover, during the same period the number of private primary share insurers decreased from 10 to 1—ASI. Although the use of private share insurance has declined, some circumstances of the remaining private insurer raise concerns. First, ASI’s insured risks are overly concentrated in a few large credit unions and in certain states. Second, ASI may have a limited ability to absorb catastrophic losses because it does not have the backing of any governmental entity and its lines of credit are limited. However, ASI has implemented a number of risk-management strategies, including increased monitoring of its largest credit unions to help mitigate concentration risk. In addition, state regulation of ASI and the privately insured credit unions it insures provides some additional assurance that ASI and the credit unions operate in a safe and sound manner. One additional concern, as we recently reported, is that many privately insured credit unions failed to make required disclosures about not being federally insured and, therefore, the members of these credit unions may not have been adequately informed that their deposits lacked federal deposit insurance.” (CREDIT UNIONS :Financial Condition Has Improved, but Opportunities Exist to Enhance Oversight and Share Insurance Management US GAO Oct 2003 to Congress)

The ILCU is currently promoting a private all Ireland stabilisation and savings compensation scheme which is a form of private deposit insurance which it expects the Regulator to approve.

Despite the IMF preferred model of state backed explicit limited guarantees for all but the strongest financial systems it appears that the Irish Government may be satisfied with less ; that is a solution within "the context of the current legislative framework " and thus deny credit union savers state backed protection for their savings.

Are there echoes of Rhode Island ringing down the hallways of Merrion Street ?

Irish Credit Union Financial Safety Net provisions

Irish credit unions are legislated for under the Credit Union Act 1997 which provides for their prudential regulation and supervision by a statutory office called the Registrar of Credit Unions. The office and function of the Registrar is within the ambit of the Irish Financial Services Authority (IFSRA), both created in 2003.

Whilst the Irish state enacted EC laws in 1995 establishing a deposit insurance (DI)scheme for credit institutions regulated in Ireland (banks etc) credit unions were excluded. However the 1997 CU Act requires credit unions to participate in an approved and regulated savings protection scheme as a condition of their authorisation to carry out the business of a credit union. But the state has not as yet made statutory provision to establish deposit insurance for credit unions. Whilst the Act refers to DI as "Savings Protection" the clear intention is for a scheme to pay out in the event of the collapse of a credit union.

The Irish League of Credit Unions (ILCU) is a trade body also offering commercial services to its member credit unions. It is the dominant trade body in the Republic of Ireland and the largest trade body in the North of Ireland. The ILCU operates what it calls as "Savings Protection Scheme" (SPS) which evolved from its provision of stabilisation assistance to its members in 1989. The SPS has been portrayed since inception as a form of deposit insurance however more recently the ILCU has reverted to referring to it as a stabilisation scheme. It is a discretionary scheme through which credit unions may be afforded financial assistance and savers may be afforded compensation of up to €12,700 in the unlikely event of a credit union failing.

"The SPS is not a true deposit insurance scheme because any payments to compensate savers are discretionary. The €12,700 indicated pay-out limit is simply a maximum figure. In contrast, the IMF’s favoured model is based on explicit limited insurance coverage (i.e. deposits formally guaranteed up to a maximum amount). Furthermore, the absence of any clear specification of savers' rights in relation to the SPS and the wide discretion given to the ILCU as operator of the SPS is in breach of the best practice guidelines..." (Dale/HC 2004)

In 2006 the ILCU stabilisation fund, publicly failed in its support of Monaghan Credit Union and a run started. It stopped only after the public assurances of the Irish regulator, which had the effect of providing an implicit government guarantee to savers.

DI Background since 1997
Under Irish law (CU ACT 1997), credit unions must participate in an approved and regulated deposit insurance scheme as a condition of carrying on the business of a credit union.

2001 - Government enacts savings protection provisions of the 1997 Act.
Yet it wasn’t until July 2001 that the section of the 1997 act dealing with savings protection was finally enacted. Minister Noel Treacy's press release implies the ILCU scheme was an approved scheme under the Act. But it was not approved then and hasn't been since.

“The introduction of the new provisions will also allow credit unions to participate in a savings protection scheme, which is approved by the Registrar of Friendly Societies. Most credit unions, who are members of the Irish League of Credit Unions already participate in a savings protection scheme. The main purpose of this provision is to give the Registrar sufficient powers to deal with the development of suitable and adequate savings protection schemes for those credit unions which are not members of the Irish League of Credit Unions. Under the Ministerial Order, sections 46 to 52 of the Credit Union Act, 1997 have been commenced with effect from 1 August 2001. Sections 48 to52 of the Credit Union Act, 1997 provide for the implementation by credit unions of additional services on approval of the Registrar of Friendly Societies. Section 46 of the Credit Union Act, 1997 provides that credit unions may participate in a savings protection scheme, which is approved the Registrar of Friendly Societies. The main purpose of section 46 is to give the Registrar sufficient powers to deal with the development of suitable and adequate savings protection schemes for those credit unions which are not members of the League of Credit Unions and which do not accordingly enjoy the protection afforded by the League’s own savings protection scheme. Section 47 requires credit unions to have in force, an insurance policy that insures them against loss suffered or liability incurred by reason of fraud or other dishonesty of its officers or voluntary assistants. It will be an offence for a credit union not to comply with this requirement.” (Minister Noel Treacy)[Emphasis added]

Why did this happen ? The regulator had already expressed reservations over the conduct of ILCU SPS affairs in using the fund to finance it's ISIS IT project in 2000.

"In his letter dated 9th May, 2000, the Registrar set out in detail his position in relation to a range of issues including his strong objection in principle to the use of any further Savings Protection Funds for the Project per se and to his strong objection to the use of any further Savings Protection Funds for the Project in the light of the precarious state of the Project. The Registrar pointed out that the existing use of the Savings Protection Funds and the proposed further use of Savings Protection Funds was fundamentally imprudent ".(Registrar of Friendly Societies Report 2001)[Emphasis added]

The answer it appears points to political and regulatory captivity of ILCU trade body self-interest with all its Rhode Island resonances. Appeasement of credit union activists appears to have been necessary given the near collapse of Government as independent members threatened to withdraw their support unless the Minister for Finance withdrew attempts to tax savings interest of credit union savers.

Interestingly the then regulator did not subsequently approve the ILCU SPS. It is more than interesting to note that in 2001 a number of large credit unions were threatening to leave the ILCU. The wording of the press release carries an implied threat to non-ILCU credit unions. ILCU internal communications announcing the enactment linked its SPS with regulatory approval creating the impression that the SPS was an approved scheme under the Act.

Subsequently 22 credit unions left to form CUDA (Credit Union Development Association) riggering in turn Irish High Court proceedings by the Competition Authority against the ILCU for abuse of its dominant position in the provision of savings protection through its attempted exclusion from participation of those that had left.

2003- The creation of IFSRA and Registrar of Credit Unions (RCU)
Since taking up office in 2003, the RCU has not approved the SPS to date and has set out broad principles that must be met before approval will be granted. It's not unsurprising the ILCU is having great difficulty in agreeing to the Regulators principles as it would involve it losing control and ownership of a reformed scheme. Its control over its members would cease and the basis for its dominance as a trade body would be eroded. Released from the shackles of the SPS, it's credit union members would be free to shop around for better commercial deals than the ILCU is providing through its linked commercial operations which it is so dependent on for its financial survival.

Despite being legally required to participate in an approved scheme, credit unions cannot as there isn't one. It seems then that every credit union operating in Ireland is in breach of the law which could expose credit unions and their directors to severe legal sanctions.

Prior to the 1997 Act the 1966 CU Act made no mention of savings protection at all as it didn’t exist in 1966. But in 1989 the state regulator “approved of” the ILCU SPS scheme even though there was no requirement and the regulator had no legal basis in which to do so. A similar approval was provided by the regulator in NI where credit unions are not obligated to participate in a scheme even to this day.

"On 18th April, 1989, Mr. Sisk indicated he was prepared to give approval to the Scheme subject to some conditions. He gave approval as part of good regulatory practice without any statutory requirement or obligation to do so." (Irish HC 2004)

This allowed the ILCU to consistently state in its literature that the SPS has been approved by the Registrars in both jurisdictions. Yet it knows full well that these "approvals" are entirely worthless. It seems until recently many credit unions believed they were participating in an approved scheme under the 1997 CU Act.

A reading of the Dail transcripts of the debate on the 1997 act is quite telling indeed. This was 6 years after the Rhode Island crisis and two years after the Irish government had established the banks deposit guarantee scheme. The government at this time was a coalition between Fine Gael, Labour and Democratic Left. Fianna Fail were in opposition and were accused of an organised filubuster in representing the views of ILCU activists. Fianna Fail formed part of the a new government in June 1997 and have been in power since. One of the more lengthy contributions at the time in support of the ILCU case was by Noel Treacy TD, Fianna Fail.

The following statement by Michael Woods, Fianna Fail TD, during debate in the Dáil is particularly telling. Along with other Fianna Fáil deputies, Dr. Woods expressed concern that the bill did not adequately recognise the self-regulatory role of the Irish League of Credit Unions:

“In regard to self-regulation, the movement has two fundamental problems with the regulation proposed in the Bill. First, the Irish League of Credit Unions is not recognised as a supervisory body with the appropriate powers to set standards, carry out inspections and enforce the rules of the savings protection scheme, even though the league, on behalf of the movement, administers this scheme. Without such recognition, the movement will not be able to continue in the way in which it has operated for almost 40 years. That is a fundamental issue for credit unions. Second, while for the first time the Bill makes it obligatory for credit unions to be members of a savings protection scheme, it also removes control of the movement's scheme from itself and subjects it to the control of the registrar. That is a basic attack on the self-help, independent ethos of the credit union movement, about which it is very concerned.” Dáil Éireann, vol. 475, p. 1686 (5 March, 1997) [Emphasis added]

Tom Kitt, Fianna Fail TD expressed the same concern, urging Government to preserve the League’s control over savings protection:

"A key concern of credit unions is recognition of the Irish League of Credit Unions. The Minister rightly recognised the role of the league in presiding over the growth of the movement, but the Bill does not recognise the pivotal and central role the league plays in controlling and servicing credit unions. A new section should be introduced to allow such recognition by the Registrar of Friendly Societies so that the work currently done by the league is brought within the regulatory framework established by the registrar. The Irish League of Credit Unions has been subject to selfsupervision through a comprehensive self-regulatory system. The movement has its own savings protection scheme which has strict rules and procedures. That system has served members very well in protecting their savings over the years. It is vital that the savings protection scheme remains under the control of the movement in future." Dáil Éireann, vol. 476, pp. 40-41 (6 March, 1997) [Emphasis added]

At the time many other Fianna Fail TD’s actively lobbied for the ILCU position. It is noteworthy how strongly the Government resisted opposition calls for the ILCU to retain a strong self-regulatory role, including control of any savings protection scheme. As finally enacted, the 1997 law gives the ILCU recognition in only two places : it specifically authorizes the League to use the words “credit union” in its name and effectively enshrines the right of the League to be consulted by the Minister and the Registrar as “expert or knowledgeable in matters relating to credit unions” – while carefully making it clear that ILCU is not the only one presumed to have that expertise.

Why is it that a trade body is so intent on retaining its role in savings protection ? The answer perhaps lies within the nature of the ILCU itself. The SPS is the control mechanism, the glue, that binds its members to it and allows it to generate income from its linked commercial activities. Without the SPs the ILCU has to compete in an open market in which the real value of its offerings will be exposed.

ILCU Performance as a Deposit Insurer & Stabilisation provider

It is true that the SPS appears to have provided real support when required and that no credit union has ever publicly failed. But it does not mean that a credit union can never fail or that supports cannot fail. Monaghan has shown what happens when supports fail. It has also shown that credit unions can from suffer rational runs.

Furthermore the Northern Rock crisis had some serious as implications for the entire credit union sector.http://www.sbpost.ie/post/pages/p/story.aspx-qqqt=MARKETS-qqqm=nav-qqqid=27170-qqqx=1.asp (The UK government is considering an FSCS deposit guarantee of GBP100,000 in response to a need to shore its financial safety net. UK credit unions are covered under the FSCS but not in Northern Ireland. It is likely that the Irish government will be forced to increase Irish deposit guarantees to €100,000 to level the playing field.)

In the middle of this crisis of confidence in the financial safety net, the ILCU is arguing for a private scheme on an all Ireland basis over which it would retain significant control. The credit union sector had exposure of well over €100m to Northern Rock which could have had quite severe consequences at the time.

Should a credit union trade body ever be permitted to provide or exercise control over a deposit insurance scheme ?

Operation by the ILCU of the SPS

Serious questions have been asked concerning the operation and funding of the scheme which allegedly has in excess of €100m. This fund remains intermingled with the general funds of the ILCU, despite repeated recommendations of its auditors and others to separate it out and ring fence it from its commercial operations.

More enlightening is the manner in which the ILCU reported on the SPS in its 2005 published accounts which differ from other accounts later provided in 2006. In the latter case it seems that an amount of c€2.0m was written off monies owed to the fund. Why ? Because the ILCU had borrowed c€8m from the fund to finance one the biggest disasters in credit union history anywhere. That was its IT "ISIS crisis" in which c€40m was written off with nothing to show for it except a few lines of computer code and dusty manuals.

The ILCU also borrowed from the SPS fund to finance its headquarters. It has also made loans from the fund, to its member credit unions to finance their building programmes.

More alarmingly it appears the fund was exposed to investment losses where 10% of its fund was invested in open ended perpetual bonds:

http://www.ireland.com/newspaper/finance/2007/0507/1178204568602.html

Such investments would never be permitted of a deposit insurance scheme.

"Concerns about the adequacy of SPS resources are exacerbated by certain high risks and/or illiquid investments by the SPS. It is a core principle that an insurance fund’s assets should be liquid and therefore available at all times to meet unexpected losses. Yet, as noted above, the SPS fund has been used to fund (a) the purchase and development of League premises, (b) an ill-fated computer project (ISIS) and (c) the League’s Central Financial Service. The SPS fund’s combined exposure to these illiquid and/or high risk investments appears to be significant. " (Dale/HC 2004)

How is the SPS itself funded – a serious consumer issue ?

At inception the SPS stood at 1.5% of total savings with a stated minimum threshold of 1% below which it was not to be permitted to fall. Had the 1.5% funding been maintained it should now stand at c€210m. But today the fund is only c€100m which is c0.73% of savings. Why the shortfall of €110m+ ?

Until recently it was funded through a highly unusual mechanism. The ILCU has an insurance subsidiary called ECCU. This company is operated through a management agreement with the ILCU. It provides exclusive life insurance cover for credit union members of the ILCU and collects premiums of c€54m a year. But the rebates on these premiums due to credit unions were diverted and used over time to finance the SPS fund. Of course as the level of rebates fluctuated and the ILCU management charge and commission take increased, over the years the target of 1% eroded to where it is now at 0.73%. More recently the ILCU faced with its High Court case changed the way in which it funded the SPS requiring credit unions to pay directly on assessment. This is where it gets hairy yet again.

The ILCU is part funded by credit unions through an affiliation fee. Many credit unions continue to pay their dues by directly debiting their customers savings accounts. It’s a credit union league practice in use for years and appears to be legitimate although it’s likely that it contravenes consumer best practice. Indeed it’s a practice that has been eradicated elsewhere. Imagine if a bank debited customer accounts to pay for the its membership fees of the Irish Bankers Federation. Yet this is how many credit unions pay their dues.

As the ILCU switched its SPS funding basis, many of its member credit unions have used the same practice and passed their SPS funding cost directly to their savers by been debiting savers accounts. Whilst the amounts are individually quite small, the overall amount may total millions.

This means that at one time the cost of participating in the SPS was an operating cost to the credit union in foregone insurance rebates. But credit unions are now being paid these rebates. Instead of paying their way on the SPS many get their customers to stump up the cost. Imagine bank customers being asked not only to pay for IBF membership dues but also to pay for deposit insurance. Yet this is how the ILCU is funded and how its stabilisation scheme is funded.

For example, page 18 Tipperary CU annual accounts 2006 http://www.tipperarycu.ie/ : “That a sum of €3.50 be deducted from the shares of each adult member for payment of the Irish League of Credit Union annual Affiliation fee and Saving Protection Scheme fee, in compliance with Rule 170(6).” [rule 170(6) makes no mention of SPS deductions being permissible].

Where .73% funding level suddenly becomes enough !

Internationally credit union DI funding targets are between 1.5%-2.0%. This means that if properly structured as deposit insurance the SPS fund should be between €210m and €280m today.

For years the ILCU masqueraded the scheme as deposit insurance. And it clearly intended for everyone to believe it was. This is why all its members state “your savings are protected up to €12,700” and continue to do so. Derry Credit Union goes further and states "Your savings are guaranteed under the Savings Protection Scheme of the Irish League of Credit Unions" http://www.derrycu.com/content.asp?section=17

But as the ILCU got caught up in appealing the High Court ruling it changed tack and now refers to the scheme as only a stabilisation fund. Enter the external consultant who examines the scheme and finds that .73% is sufficient ! Of course it is, if all you’ve been asked to look at is funding a stabilisation scheme. But .73% is wholly deficient if it’s deposit insurance.

ILCU Accounting for the SPS

The SPS fund is hidden within its assets and only separated in a note to the accounts. It has also been funding risk capital in its insurance subsidiary ECCU. But where is this capital funding coming from? It seems ILCU revenues. But examining net revenues it's not all that clear. Could it be that some of the SPS fund is invested in ECCU ? The accounts are quite non-transparent. As it stands the fund is exposed to ILCU creditors.

The SPS was always meant to be a sort of deposit insurance scheme. It has been impaired in value due to (a) ILCU dipping into it and (b) under-providision of funding contributions over the years. It is all too convenient to switch late in the day to calling it a stabilisation scheme. The reasons why the scheme never incorporated a guarantee was set out in the High Court in 2004:

“the company would have to be capitalised EEC solvency margins would have to be maintained - there would be a liability to corporation tax - the company would have to operate at arms-length from the League, with consequent difficulties in the League retaining control. In those circumstances, it was agreed that the Scheme should be designed so as to: - retain the present taxation advantage - avoid the creation of a full insurance-type operation with its attendant risks avoid the need for statutory authorisation” (Irish HC 2004)[Emphasis added]

Trade body self-regulation, supervision and member credit union compliance

"The league and the regulator have been at loggerheads for a while now. Mr Logue [RCU] has repeatedly publicly questioned corporate governance practices at credit unions. The league has hit back that the regulator has been loath to publicly criticise the banks." (Irish Independent March 24th 2007)[Emphasis & title added]

Since inception the Financial Regulator (IFRSA) has consistently highlighted credit union governance and compliance as a major problem within the sector. Writing in its most recent report it said :

“During 2006 considerable progress was made in developing the system for the regulation of credit unions with a view to building compliance." (FR Annual Report 2006) [Emphasis added]

This is an indictment of the failure of self-regulation and supervision to build compliance.

It is widely known that some credit unions have adopted a lassez faire approach to compliance with the very standards they themselves agreed to adhere to. Yet the ILCU relies on compliance with these standards as part its stabilisation fund risk management.

It appears that some credit unions have become quite skilled in practicing "optional" compliance with the law over the years. This is frequently manifested in activists claims that credit unions are over-regulated, the law is too prescriptive and hindering their development. They reason that they can ignore the law as it is "out of date".

The ILCU stated policy in relation to the administration of the fund is:

“In the event of a credit union not complying with procedures, the Administration Committee is given the power to recommend to the League Board its disaffiliation. The Committee also has the power to propose the amalgamation of any member credit union, which is considered to be in default with procedures, with another credit union. This, however, will be a discretion since in many cases it might be necessary to provide temporary support to a particular credit union for the good of the Movement even though compliance was not being secured or had not been secured in the past.” (ILCU - SPS Administration) [emphasis added]

The final sentence is illustrative of forebearance; the fact that the credit union is focus of support even where "compliance was not being secured" . And shows why trade bodies should not be permitted to exercise control over deposit insurance schemes.

Northern Rock and Rhode Island

On the face of it, the ILCU has done a reasonable job with its SPS. But the day has long gone since stabilisation funds were in vogue. They dissappeared in the US in the early 70's. So far the ILCU has been lucky but not so lucky with Monaghan. The next time its SPS may well suffer a Rhode Island type collapse. Critically the Northern Rock crisis showed just how close Irish credit unions came to being embroiled in a contagious run. The time of private credit union controlled stabilisation and deposit insurance is well and truly over.

One of the key questions that arises is just who should be responsible for the governance, operation, regulation and supervision of any new Irish credit union DI scheme ?

Credit Union trade body control or influence over deposit insurance is fraught with forebearance and moral hazard risks. The conflict of interest is almost irreconciliable and untenable.

Clearly the Irish government needs to stand up to its responsibility and see to it that a properly consituted independent statutory scheme is established along the lines of the O'Toole Bill. One of the more interesting benefits of this Bill would be the retention of the SPS fund by the ILCU as it would not be required to fund the new scheme. The ILCU could continue to provide assistance to its members or use the fund for whatever purposes its members decide on.

The UK government will need to bring credit unions in Northern Ireland within the FSCS even if this means they are regulated by the FSA. This is all the more urgent post Northern Rock where the banks deposit insurance scheme is under scutiny.

Alternatively an all Ireland statutory solution may be possible as DI is operated on a cross border basis elswhere.

It will take political resolve to face down the threats of a small handful of credit union leaders and die hard activists who cannot distinguish between between credit union philosophy (which would never deny citizens rights to a proper savings guarantee) and credit union league self-preservation rhetoric. It will also take the resolve of credit union leaders to convince their colleagues and their trade body to let go "savings protection" and focus on the critical task of modernising credit unions.

The ILCU claim that an all Ireland private solution would best protect their member credit unions rings quite hollow. Years after the introduction of government backed statutory DI elsewhere, credit union movements continue to thrive. Credit union owned deposit insurance is not a condition of continuing credit union success. But government backed deposit insurance is part of a credit union sector financial safety net so necessary to underpin financial stability and provide protection to savers.

The resonating echoes of Rhode Island must be silenced and the seismic shock waves of Northern Rock prudently dealt with. Credit Union savers deserve to have their life savings properly protected.