Net Savers Dominance - The Irish Credit Union experience

Net Savers Dominance – The Irish Credit Union experience

It is a commonly held view and wisdom that a net-savers dominance on a credit union board optimises financial stability.

This may be the case when the credit union is operating competitively and achieving the desired benchmark lending rates of 70% + in loans to total assets. But what happens when the critical ratio declines rapidly as it has in the case of Irish credit unions?

Well it seems another credit union phenomena occurs. That is the impact of boards dominated by savers and extremely low levels of lending.

Used to paying high dividend rates for demand type savings, Irish credit unions responded to historically low interest rates in recent years by maintaining a higher dividend than should have been paid.

In 1999 the Irish credit union loan to total asset ratio was somewhere around 64%. Today this figure has dramatically declined to below 46%. In some cases it’s as low as 18%.

Once lending volumes dropped credit unions did two things. The first is they invested surplus fund in high risk and illiquid portfolios chasing higher investment income and the second was engage in higher risk lending including business and speculative construction finance. In addition many credit unions ignored the loan term limits, issuing longer term loans in defiance of laws limiting the percentage of loan portfolios over 5 and 10 years. Thus the decline in loans to total assets resulted in a dramatic increase in credit, liquidity, investment and interest rate risks.

In many cases credit union lending is now so low it has led to the emergence of a new form of co-operative called the “savings club”.

Evidence of the shift in credit risk profile has emerged in worsening loan delinquency experience where over 73% of credit unions reported they were in excess of the 5% loan delinquency PEARLS threshold triggering regulatory intervention. The Regulator has consistently highlighted concerns over lending practices with regulatory language becoming increasingly robust and strident. Significant credit union investment losses have been regularly reported on in media.

Deeply concerned with the twin rise in investment and credit risks, the Irish regulator responded by issuing investment and lending guidelines. Moreover in agreeing to higher loan term limits the Irish Government insisted that higher limits had to be linked to key safety measures of capital (reserves) and loan delinquency issuing a warning that any further non-compliance with the law would not be tolerated.

What has been created is a vicious cycle since 2000. Faced with rising savings but low loans growth, many maintained high lending interest rates, credit worthy members went eslwehere, exacerbating the decline in lending. This triggered an increasing reliance on investment income and higher risk lending to plug the gap in overall income required to maintain dividend rates. Such behaviour has led to justifiable observations that many credit unions are exploiting their borrowers many of whom are the new working poor.

Unwittingly and in ignorance of the inelasticity of demand deposits to interest rate movements and buoyed up by special tax treatment of accounts (where tax is not deducted at source) savings mushroomed as Irish people became wealthy almost overnight.

It was a naïve and ill-thought out strategy that has dramatically undermined the Irish credit union movement and now threatens it existence. Indeed it hardly qualifies as a strategy as this means it was planned when it wasn’t. It was a result of the illusion of success that fooled many into believing and behaving as if credit unions were above competing in the market.

Why has this happened? As the Irish Tiger economy took off, credit unions were left trailing in the wash. A decade of apparent success from the 80’s and early 90’s blindsided the movement. Credit unions failed to invest in building the business competencies required to expand their core offerings to include credit cards, home mortgages and better savings & investment products. Though they could have acted as mortgage or insurance arrangers during the recent boom years, the first agency agreements where not announced until 2006 years after the Celtic Tiger commenced.

Allied to a failure to expand products and services is a failure to invest in modernising business operations. Consequently credit union operating costs now exceed core operating income. Credit Unions have also failed to create fee earning services, or look for some degree of cost recovery. Fee income is less than 1% of total income. Credit unions continue to finance free life insurance cover beyond reasonable limits and stubbornly refuse to move to member pay models.

The systemic risks of the dominance of aging boards of net-saver directors maintaining a high dividend rate, a declining loans ratio, higher risk lending, poor lending practices, worsening bad debts, uncompetitive lending rates, under-investment in IT and modernisation of operations, overinvestment in buildings and investment losses are such that many fear that a tipping point will soon be reached beyond which the movement will spiral into a serious crisis. This is a fear shared by people in Ireland and within the international credit union community.

Such a scenario would inevitably trigger external turnaround intervention with all its negative fallout for credit unions. It could well be that the social capital created by the movement will be frittered away and its one time success consigned to a historical footnote.