Deposit Insurance and the Irish Credit Union Financial Safety Net
Public confidence in financial firms is dependent on their financial stability. Any loss of public confidence and risks of runs emerge. Financial stability arises from the effective financial safety nets - the combination of regulation, supervision, lender of last resort and deposit insurance provisions.
Irish credit unions have suffered considerable reputational damage of late. Consistent media stories of financial losses, loan delinquencies and regulatory investigations have undermined public confidence in what are increasingly seen as amateur bodies out of date and out of touch with modern society.
Worldwide the development of financial safety nets has resulted in the specification of state regulation and supervision twinned with state deposit insurance as being the preferred option.
Worldwide the development of financial safety nets has resulted in the specification of state regulation and supervision twinned with state deposit insurance as being the preferred option.
Proponents of the “let the markets self-regulate” view have been wholly undermined by the sub-prime crisis which has triggered calls for greater regulation and more robust and effective financial safety nets.
In Ireland the credit union sector holds over €14bn of household savings on deposit. There are 434 odd independent credit unions. Of these the top 100 control 80% of savings with the top 50 having about €6bn. Some of these hold well over €200m in savings of a local population living within the common bond area of ten square miles or so. This concentration of household savings is unparalleled anywhere else.
Despite this concentration of sectoral risk , the Irish state has failed to provide the necessary financial stability supports required of a modern credit union financial safety net.
Irish Credit Union Regulation & Supervision (R&S)
The adequacy of prudential regulation and the legal framework for enforcing regulations provides regulatory authorities with powers to set and enforce limits on risk taking by credit unions. Effective supervision and regulation is regarded as essential to ensure stability by limiting the amount of risk to acceptable levels. Just how effective is Irish credit union R&S?
Irish credit union R&S is hamstrung by legislation designed to reflect credit union risk profile of the 1980’s. It is a system derived from laws enacted in 1997 when credit unions had less than €2bn in consumer savings. Even when enacted, these laws failed to reflect modern regulatory guideline practices and failed to take account of risk based capital, liquidity and other issues. Changes to the few risk limits that exist require primary legislation, effected through a process fraught with trade body politics and lobbying.
It difficult to appreciate R&S effectiveness as the Regulator doesn’t publish any useful information. Transparency which is a cornerstone of financial safety net provisions is almost non-existent. People have no access to information that would inform them of the relative risk profile of their local credit union or the overall sectoral risk profile. Nationally it is impossible to tell the good from the bad. Yet the Irish regulator collects, through its prudential returns, risk performance benchmarking information that could be made public.
Worryingly the Irish Regulator has admitted that there is some way to go to ensure compliance which is seen as an admission of ineffective R&S since 1997 when the state adopted greater legal and regulatory powers.
The parallel existence of an alternative self-regulatory and supervisory body in the form if the ILCU and its Savings Protection system has meant that principal agent and moral hazard risks were not as limited than should have been the case. The continuing ambivalence shown by influencial credit union leaders to the State R&S is rooted in a regressive credit union ideology of self-help, self-regulation and supervision. Beneath the surface is a toxic and dangerous conflict between professional state regulators and amateur volunteers.
The Irish state strengthened credit union R&S in 2003 through the formation of IFSRA and the new statutory regulatory office of the Registrar of Credit Unions. But such was the regulatory and political capture in the decades prior its establishment that it has since struggled to contain credit union risk taking.
Such captivity was starkly highlighted in 2001 when on the enactment of credit union savings protection (deposit insurance) provisions the government announcement implied the ILCU scheme was an approved regulated scheme, when it wasn’t.
Since 2001, Irish credit unions are compulsorily required to participate in an approved regulated savings compensation scheme as a condition of authorisation. As no such scheme exists, every credit union in the state is carrying on business in non-compliance with the law.
This inherited legacy has given rise to regulatory tardiness in response to limiting risks. For example it took IFRSA until late 2006 to publish investment guidelines and 2007 to produce lending guidelines. These guidelines are voluntary as a credit union cannot be legally obligated to comply with them. The same is true of the planned publication of consumer protection and fitness & probity codes.
This inherited legacy has given rise to regulatory tardiness in response to limiting risks. For example it took IFRSA until late 2006 to publish investment guidelines and 2007 to produce lending guidelines. These guidelines are voluntary as a credit union cannot be legally obligated to comply with them. The same is true of the planned publication of consumer protection and fitness & probity codes.
The overall R&S system is quite unusual. On the one hand credit unions are subject to mandatory regulations in respect of non-core business (mortgage arranging, insurances etc) but remain outside the fold of effective R&S when it comes to their core risk business of savings and loans.
Rules based V Principles based regulation
There is a view that the most effective form of credit union regulation is rules based and not banking type principles based. Banks have the scale, resources, structures and professional competence to apply a principles approach.
Rules based V Principles based regulation
There is a view that the most effective form of credit union regulation is rules based and not banking type principles based. Banks have the scale, resources, structures and professional competence to apply a principles approach.
But given their size and relative governance, management competence together with limited resource capability, the adoption of credit union principles based approach would result in a multiplicity of inadequate applications and risks.
Some credit union leaders promote a principles approach, positing that credit unions should have maximum flexibility. They argue that they have the sophistication and competence in delivering on complex bank type risk governance and management support systems and structures. This of course is a rather naïve position espoused by some as an excuse for non-compliance behaviour by those who have deliberately ignored the law on the basis that it is out of date.
Some credit union leaders promote a principles approach, positing that credit unions should have maximum flexibility. They argue that they have the sophistication and competence in delivering on complex bank type risk governance and management support systems and structures. This of course is a rather naïve position espoused by some as an excuse for non-compliance behaviour by those who have deliberately ignored the law on the basis that it is out of date.
To be fair this position also reflects a wider credit unionist frustration with laws and regulations that hinder the introduction of more flexible products and services.
It is not at all certain if the Financial Regulator is attuned to principles based risks. A comparison with regulatory approaches in the UK, US and Canada highlights the depth of regulatory guidance versus the Irish system of high level guidelines unsupported by detailed guidance on effective implementation.
Culture of Regulatory Opacity
There is some justification in the view that considers the current regulatory system also reflects the circumspect opaque central bank culture.
It is not at all certain if the Financial Regulator is attuned to principles based risks. A comparison with regulatory approaches in the UK, US and Canada highlights the depth of regulatory guidance versus the Irish system of high level guidelines unsupported by detailed guidance on effective implementation.
Culture of Regulatory Opacity
There is some justification in the view that considers the current regulatory system also reflects the circumspect opaque central bank culture.
Certainly a reading of regulatory publications doesn’t inform people on R&S effectiveness. The Regulator is long on highlighting its activity but quite short on detailing its findings and responses. Consequently it is almost impossible to externally validate R&S effectiveness.
Recent regulatory public commentary has taken on a more strident tone where officials have highlighted concern over safety and soundness issues including investments, lending, credit risk, bad debts, IT and governance.
Delivering on modern credit union Regulation & Supervision
The Irish state must insist that effective modern credit union rules based R&S is implemented and must enact laws that empower IFSRA to deliver. The current state of credit union maturity with all its governance, management and operational challenges requires such an approach.
In time it may be possible to consider principles based regulation.
It is entirely possible to establish an expert group charged with developing and ensuring a modern system of credit union laws, regulation and supervision. There is an urgency required here that the current system of trade body procrastination and obfuscation prevents.
Meanwhile the regulator should improve its guidelines with comprehensive guidance notes similar to the FSA “CRED” and NCUA approaches. The regulator will also need to significantly improve transparency.
Deposit Insurance for Irish Credit Unions
High R&S standards are required for efficient deposit insurance (DI). Solving for a modern R&S system should go hand in hand with the establishment of a well designed system of credit union deposit insurance.
It should be designed based on sound international practice and experience. The preferred option of a state backed scheme is widely recognised as a requisite in all but the strongest of financial systems.
Therefore a credit union DI agency should be a statutory agency and governed as such. It should provide for a guaranteed level of savers compensation in the event of credit union failure and also provide for early stage intervention with high risk credit unions. Its mandate and legal powers, human and financial resources must be appropriate and its actions must be well coordinated with those of IFSRA. Credit Unions should be legally obligated to participate and their regulatory authorisation to carry on business dependent on continuing participation. Withdrawal of DI coverage should trigger regulatory action up to an including withdrawal of authorisation as a credit union.
The commitment to depositor protection should be backed by adequate funding. The arrangements should assure depositors that the guarantee will be honoured and they will be able to obtain rapid access to their funds.
Typically this includes both ex-post and ex-ante funding with credit union schemes. In recognition of the need to an adequate ex-ante protection, funding is in the range of 1.2-2% of insurable deposits. This recognises the concentration of risks inherent in credit union systems and is contrasted with a banks scheme which may require lower ex-ante funding of .2% (Ireland).
Deposit Insurance for Irish Credit Unions
High R&S standards are required for efficient deposit insurance (DI). Solving for a modern R&S system should go hand in hand with the establishment of a well designed system of credit union deposit insurance.
It should be designed based on sound international practice and experience. The preferred option of a state backed scheme is widely recognised as a requisite in all but the strongest of financial systems.
Therefore a credit union DI agency should be a statutory agency and governed as such. It should provide for a guaranteed level of savers compensation in the event of credit union failure and also provide for early stage intervention with high risk credit unions. Its mandate and legal powers, human and financial resources must be appropriate and its actions must be well coordinated with those of IFSRA. Credit Unions should be legally obligated to participate and their regulatory authorisation to carry on business dependent on continuing participation. Withdrawal of DI coverage should trigger regulatory action up to an including withdrawal of authorisation as a credit union.
The commitment to depositor protection should be backed by adequate funding. The arrangements should assure depositors that the guarantee will be honoured and they will be able to obtain rapid access to their funds.
Typically this includes both ex-post and ex-ante funding with credit union schemes. In recognition of the need to an adequate ex-ante protection, funding is in the range of 1.2-2% of insurable deposits. This recognises the concentration of risks inherent in credit union systems and is contrasted with a banks scheme which may require lower ex-ante funding of .2% (Ireland).
In addition provision should be made for reconstitution where a fund is depleted. Emergency funding needs also to apply for example access to state guaranteed stand by lines of credit etc. Such funding is required in crisis situations where the fund is rapidly depleted and where reconstitution or raising additional funding from members is not feasible.
Clearly a private scheme may not have access to state supports and will either be limited in support up to its current fund level or reliant on commercial bank borrowings, if possible to put in place. For this reason the US GAO and NCUA reports to Congress were critical of the one remaining US private credit union deposit insurance agency. Both maintained it did not have the financial resources to sustain a systemic shock.
A Private Deposit Insurance Agency won’t work
The notion of the possibility of converting the current ILCU stabilisation scheme to a DI agency structured as an independent entity is fraught with risks.
Clearly a private scheme may not have access to state supports and will either be limited in support up to its current fund level or reliant on commercial bank borrowings, if possible to put in place. For this reason the US GAO and NCUA reports to Congress were critical of the one remaining US private credit union deposit insurance agency. Both maintained it did not have the financial resources to sustain a systemic shock.
A Private Deposit Insurance Agency won’t work
The notion of the possibility of converting the current ILCU stabilisation scheme to a DI agency structured as an independent entity is fraught with risks.
Indeed this proposal reflects the continuing ILCU ambition of statutory recognition of its role as a self-regulatory supervisor. It hardly qualifies as a financial stability or consumer protection ambition given the ILCU mandate is to represent its members who are regulated financial service firms. It is quite unusual to find a trade body insisting on a private scheme given the well documented problems elsewhere with such arrangements.
There is little encouraging evidence that such a private credit union trade body controlled DI agency will coordinate its activities closely with the regulator. Indeed the evidence points to a strong probability of interagency conflicts preventing the coordination required.
There is little encouraging evidence that such a private credit union trade body controlled DI agency will coordinate its activities closely with the regulator. Indeed the evidence points to a strong probability of interagency conflicts preventing the coordination required.
Credit union trade body mandates have recognised conflicts of interest with DI agency mandates. This is why schemes elsewhere are established on an independent statutory footing. Whilst such DI agencies typically provide for credit union representation, they are legally mandated to deliver on financial stability and consumer protection objectives.
ILCU's leadership maintain that as theirs is an all Ireland movement there must be an all Ireland DI agency. This is to argue that sovereign government has no role to play. Yet the ILCU only represents 60% or so of Northern Ireland credit unions.
Regulation and supervision of Northern Ireland credit unions remains considerably underdeveloped and thus arguably more overly exposed to financial stability risks than credit unions in the Republic of Ireland and Britain. Unlike credit unions in Britain they are not subject to FSA oversight or FCSC membership but could be brought within the remit of the FSA and the FSCS which is a legal provision HMG has provided for. Additionally membership of a private scheme cannot be made compulsory under current legislation in Northern Ireland. This means a private scheme would include some but not all of the insurable deposits and credit unions.
Whatever about the all Ireland dimension, the governance and operation of a private DI agency and interagency coordination problems with regulators and supervisors in two sovereign and differing legal jurisdictions will greatly increase complexity and risks. It is a recipe for interagency conflict that will undermine rather than enhance financial stability.
The truth of the matter of Private DI
The ILCU ambition is to evolve as a Canadian insystem type regulator and DI agency. This ambition flies in the face of Irish government policy underpinning the establishment of IFSRA. It is also at odds with HMG policy which includes credit unions within FSA and FSCS mandates.
The ILCU focus on statutory recognition and stabilizing R&S powers together with central liquidity and treasury ambitions is seen in its continuing ambiguous response towards state R&S and lies at the heart of its abject refusal to consider a state DI agency.
ILCU's leadership maintain that as theirs is an all Ireland movement there must be an all Ireland DI agency. This is to argue that sovereign government has no role to play. Yet the ILCU only represents 60% or so of Northern Ireland credit unions.
Regulation and supervision of Northern Ireland credit unions remains considerably underdeveloped and thus arguably more overly exposed to financial stability risks than credit unions in the Republic of Ireland and Britain. Unlike credit unions in Britain they are not subject to FSA oversight or FCSC membership but could be brought within the remit of the FSA and the FSCS which is a legal provision HMG has provided for. Additionally membership of a private scheme cannot be made compulsory under current legislation in Northern Ireland. This means a private scheme would include some but not all of the insurable deposits and credit unions.
Whatever about the all Ireland dimension, the governance and operation of a private DI agency and interagency coordination problems with regulators and supervisors in two sovereign and differing legal jurisdictions will greatly increase complexity and risks. It is a recipe for interagency conflict that will undermine rather than enhance financial stability.
The truth of the matter of Private DI
The ILCU ambition is to evolve as a Canadian insystem type regulator and DI agency. This ambition flies in the face of Irish government policy underpinning the establishment of IFSRA. It is also at odds with HMG policy which includes credit unions within FSA and FSCS mandates.
The ILCU focus on statutory recognition and stabilizing R&S powers together with central liquidity and treasury ambitions is seen in its continuing ambiguous response towards state R&S and lies at the heart of its abject refusal to consider a state DI agency.
The conclusion is that ILCU leadership believes that they have the competence, resources and professional ability to establish, govern and manage a deposit insurance agency. It sees control over a private DI agency as key to achieving it ambition to become an insystem regulator and supervisor. When read from this perspective, its “Strategy for the Movement” is a manifesto for its own trade body ambitions.
Public Confidence and Trust is vital
Public Confidence and Trust is vital
The key objective of DI is ensuring public confidence. The public have to trust their savings will be protected. Public confidence and trust will not be engendered through an ILCU controlled private scheme with its core mandate of self-regulation and supervision. The public will not have confidence in such an arrangement.
The financial stability of the Irish credit union sector is exposed to unnecessary risks mainly due to political inaction and a reluctance to face down trade body self interests. Providing for effective laws, efficient R&S and proper DI is the responsibility of government and its agencies. The only solution is a well designed statutory DI agency.
Despite heightened public concern over financial safety net provisions, Irish government policy continues to deny the millions who save with credit unions adequate protection for their savings. It is a form of constructive ambiguity resonant of political capture that exposes the state to full accountability for the safety of over €14bn of household savings held in credit unions. In the absence of an explicit limited state backed DI the publics’ rightful expectation is that its government will provide a 100% guarantee for all credit union deposits should a crisis emerge.
The financial stability of the Irish credit union sector is exposed to unnecessary risks mainly due to political inaction and a reluctance to face down trade body self interests. Providing for effective laws, efficient R&S and proper DI is the responsibility of government and its agencies. The only solution is a well designed statutory DI agency.
Despite heightened public concern over financial safety net provisions, Irish government policy continues to deny the millions who save with credit unions adequate protection for their savings. It is a form of constructive ambiguity resonant of political capture that exposes the state to full accountability for the safety of over €14bn of household savings held in credit unions. In the absence of an explicit limited state backed DI the publics’ rightful expectation is that its government will provide a 100% guarantee for all credit union deposits should a crisis emerge.
In 2006 Senator Joe O'Toole, a long time credit unionist, published a Bill which if adopted would deliver on a statutory DI agency with a well designed mandate for Irish credit unions and their savers. It is entirely possible for Government to adopt the Bill and ensure its enactment.
Those who are concerned with credit union financial stability should focus their attention on calling for a state backed DI and endorse the O'Toole Bill rather than meekly accepting an ILCU regressive in-system ambition and its private scheme.
Credit union leadesrhip has a duty of care to pass on to the next generation a strong, vibrant credit union system. This includes insisting that Government provides a robust credit union financial safety net of modern laws, effective R&S and statutory Deposit Insurance.
The alternative is an increasing irrelevance and a subsistence existence on the margins of Irish society where a 75th anniversary celebration may not happen.
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