Irish Finance Minister Orders Review of Credit Union Sector

Irish Finance Minister Orders Review of Credit Union Sector

Concerned over the financial stability of the sector, Minister for Finance, Brian Lenihan has ordered regulatory authorities to carry out a review of the sector:

http://www.sbpost.ie/news/ireland/review-ordered-of-credit-union-sector-45238.html

It appears that having dealt with banking stability, attention is now shifting to credit unions.

While credit unionists have been anxious to paint credit unions in a positive light the truth is their business model is under extreme pressure for some time. Lending less than 50% of assets, and rising costs, credit unions are non-diversified and wholly reliant on declining investment income to bolster operating income.

Worldwide credit co-operatives have proven to have been resilient during the global credit crisis. However the Irish credit union model has yet to demonstrate it is capable of weathering one of the worst domestic recessions in the developed world.

So far anecdotal evidence, League and regulatory communications point to problems of near crisis proportions emerging. Financial performance trends, worsening in recent years, are set to escalate as losses in imprudent investments and loans bite into balance sheets.

Exposed to unsecured consumer lending, largely advanced to marginalised borrowers, credit union loan delinquency has risen to 10% well in excess of the minimum safety levels of 5%. More worrying is the fact that loan write offs on a consumer loan book of €7bn are said to be less than 1% which bucks the trend seen in commercial bank accounting for their consumer loan losses. Credit unions do not operate in a bubble and they are highly exposed to rising consumer loan defaults.

Ireland has one of the highest levels of consumer indebtedness, with one in three home mortgagees said to be experiencing negative equity. Unemployment is nearing 500,000 with outbound migration rising. Fiscal budgetary arithmetic is forcing government to slash public spending and raise new taxes.

Most credit union lending can be said to have been sub-prime during the boom years as good credit risk customers forsook their credit unions. Much of the lending was also provided to first timers financing their equity participation in the home purchases.

Added to this is the nature of borrowing which selected against the credit union as it didn’t use credit bureau services. Irish credit unions are classic examples of borrower’s informational asymmetry power versus credit unions poor risk rating and affordability assessment processes.

Emphasising the safety of savers funds, the regulator now requires credit unions to maintain a minimum of 10% of reserves to total assets. The move was necessary to prevent credit unions raiding their reserves to pay dividends (interest) to savers as their profits collapsed. Cutting in some forbearance reduced the numbers of those expected not to be able to pay a dividend from over 200 to 50 or so. The move is indicative of the scale of the problems facing credit unions to ensure they remain economically viable regulated credit institutions.

The Ministers review may finally highlight for him the extent to which the sector needs to reform if it is to deliver on its economic and social purpose.

Are Irish credit unions fit for the future?

A telling study of Irish and Canadian credit unions identified four strategic orientations found in credit union movements. These were

1: A financial institution providing a full range of financial services in direct competition with other financial institutions and must generate sufficient profits to remain competitive.

2: That of a financial cooperative providing financial services for the maximum benefit of its members regardless of the level of profit generated.

3: Providing for the financial needs of its borrowing members while meeting operating expenses and maximizing the return to saving members.

4: Providing credit services for financially excluded individuals who would otherwise be unable to access credit.

Two out of three Canadian credit unions said they adopted the first orientation – but only 6% of Irish credit unions said they did. Over a third of Irish credit unions said they operated the second and over half the third. Only 5% said they operated the fourth.

Other studies have highlighted a short term planning horizon with less than 25% having a business plan and 70% making little or no provision for an intergenerational hand over of governance and management.

These findings are disturbing as they mean that most Irish credit unions have neither have any view of the future nor any plans to invest in long term sustainability. Nor are they planning to hand over the reigns to the next generation.

At EU level the importance of co-operative banking (including credit unions) is provided for under a laws that prevent current membership/owners raiding the co-operatives reserves for their own benefit. The view is co-operative capital represents an intergenerational endowment and current boards and managers are its trustees.

So what have Irish credit unions being doing to ensure economic viability and long term sustainability – the protection and enhancement of the intergenerational endowment?

Very little – the entire effort has been focused on competing with each other to pay the highest dividend which is a feature found when aging boards become captive of a savers mandate – they act to maximise dividends at year end.

With a strategic orientation focussed on the doctrine of dividend maxmisation and short term "year end" planning horizon, Irish credit unions will be sorely challenged to safely manage through the worst recession in Ireland's recent history.