CUDA shines a light on its philosophical approach to lending

Last week it was the turn of CUDA to promote its brand of credit unionism. It too appeared before the Joint Commitee on Economic Regulatory Affairs. Rather like ILCU, you can read it’s version of bread buttering here:
http://debates.oireachtas.ie/DDebate.aspx?F=ERJ20100216.XML&Ex=All&Page=1

There were no surprises. It said that it supported the single regulatory authority –the Central Bank Commission and the statutory function of the current Register of Credit Unions. But it went on to critique the regulator for its “one size fits all” approach to prudential supervision. Problem is the legislation only allows for a one size fits all approach.

It maintains that credit union member consumer protection should differ from consumer protection afforded the other forms of member owned banking – that of member owned and governed building societies. The ambiguity wasn’t missed on politicians who realise of course that outside of their core savings and loans business credit unions have to comply with mandatory consumer protection codes and minimum competency requirements.

CUDA’s promotion of longer term lending limits for credit unions was quite illuminating. It wants lending limits over five years of 30% and wants this calculated on total assets and not the loan portfolio. And it seems to have a problem with a prudential liquidity requirement complaining that it’s an arbitrary figure plucked from thin air. Makes you wonder where the arbitrary 30% loan limit is coming from? CUDA of course didn’t provide any cogent rationale why it wants a 30% to total loans lending flexibility.

One wonders how many of its member credit unions applied for and were approved for the increased lending limits allowed for under the Ministerial review of lending limits 2007 which resulted in legislation permitting credit unions lend 40% over five years and 15% over ten years subject to a regulatory application and approval process introduced in October 2007.

In quite an extraordinary unreconstructed pre-Lehman view CUDA said “One of our philosophical issues in using liquidity as the benchmark for longer term lending is that the level of capital is more important than liquidity. This has proved to be the experience with other credit union movements and in various banking sectors. Using liquidity is not best regulatory practice.”

To wit the response from a bemused politician was “I would always like to have cash in the bank. It is the best form of capital.”

CUDA's Version of Loan Flexibility
Here’s some maths to illustrate CUDA’s point of view. The average credit union is about 50% lent – some are far lower. So let’s take a 50% one and one at 42% which is closer to the median.

Say we look at a credit union with total assets of €100m:

(1) shows the effect of raising the current limit by 10% as a  percentage of total loans and (2) the CUDA version of relating the entire 30% limit to total assets.

The effect of (2) is quite dramatic. Is CUDA really serious about increasing the loan exposure over five years from €10m to €30m, an increase of €20m with 60% of the loan book lent out for over five years? Were a credit union to achieve 70% of total assets in loans under CUDA's version this would allow for 43% of lending over five years of more. This may be an achievable long term goal but the risk implications of the resultant asset/liability mismatch and required prudential safeguards were not addressed.

What’s the rationale for longer term lending – to be able to accommodate loan rescheduling for financially vulnerable borrowers? Or to make more loans between five and ten years? Well it says it’s to do both.

Maybe CUDA thought they could pull the wool over the eyes of the politicians by claiming that rescheduling wouldn’t really lead to higher risks or require adequate provisioning. Maybe it thought politicians would share its “philosophical” approach to liquidity not being as important as capital.

If you extend the duration of any loan portfolio then you widen the mismatch between assets and liabilities. In effect three risks are amplified: liquidity, interest rate and credit risk. Longer term lending is riskier. But CUDA doesn’t appear to think so ….

Enter the Mythical Member Argument .....

It seems what credit unions really need is to reschedule loans. An example was provided of a member of 40 years, married with two children who realising he cannot afford his repayments any longer approaches his credit union before he defaults to see what can be done. The credit union is now on notice the borrowers’ ability to repay within the terms of his contract is impaired and suggests rescheduling the loan over a longer term, thus reducing his repayments to a level he can afford. Thus the need for longer term lending limits.

Now according to CUDA this doesn’t necessarily give rise to a provision as loan repayments would be affordable under the new agreement. So what part of this is odd?

Well the insistence there is no increase in credit risk ! According this logic in all cases of rescheduling (a) because the new repayment is now affordable a provision doesn’t apply and (b) 30% of the loan book will be required to fund the rescheduling scheme. That’s unless there’s a huge demand for borrowings over five years from credit unions which contradicts the actual experience of a decline in demand for loans.

Suppose there is a demand for loans over five years then it begs the question what are the loans for? Cars? Houses? Holidays? Rescheduling other debts? Probably the latter.

So there you have it: an argument to increase lending risk, lesson liquidity, lower provisions for rescheduled loans and increase the default risk on loan portfolios. Widening the asset liability mismatch appears to be an acceptable moral hazard dimension of a philoposphical approach to prudential management.

It would have been a Punch and Judy show had the issues not been so serious. CUDA was claiming that the current and proposed 10% increase in current lending limits were undermining the dividend based business model without providing a scintilla of proof why this was the case. Strangely there was no mention at all of its own previous identification of the core problem:

“ it is incorrect to blame the decline in key credit union metrics on action or the lack of action by Government or the Financial Regulator. Instead, the central thesis of this paper is that the challenges now facing credit unions result, to a large extent, from the reluctance of many in the movement to accept a fundamental reality: The business model still employed by many credit unions is largely unchanged from the one that was developed – and worked very well – in an Ireland very different from today…… The reality that must be confronted by credit unions is this: Their products, delivery systems, marketing approaches, and methods of management and governance – all the elements of the credit union business modelwere designed for an Ireland that barely exists any more. It is not that credit unions failed to change in the past 20 years. It is that Ireland has changed so much more, and so quickly, it has almost left them behind.” CUDA 2006

ILCU demands fall on deaf ears?

Joint committee on Economic Regulatory Affairs hears of ILCU fears that regulation may become too robust

Murphy’s Law dictates that a buttered slice of bread will invariably land buttered side down should you drop it on your lap. On the 2nd February last, the ILCU brought the entire loaf and proceeded to butter both sides before dropping it on its lap.

You can read of its bread buttering episode here: http://debates.oireachtas.ie/DDebate.aspx?F=ERJ20100202.xml&Node=H2#H2

It’s once again a story of unreconstructed Irish brand of credit unionism combining with a trade body’s corporate ambition to become an in-system regulator. ILCU wants to become the central governing corporate body for every registered credit union. This ambition bears some resemblance to federalist systems found at the heart of European credit co-operatives, Canadian Des Jardins and to a lesser extent Canadian Credit Unions. Key to these systems working is the notion of devolved supervisory authority from state regulators -a form of state and private system supervision and regulation.

Rather than argue for a proper Irish federalist co-operative system, ILCU wants to turn the clock back to the good old days when it held the credit union regulator captive of its corporate designs. The days when under the Department of Enterprise Trade and Enterprise (DETE) it almost managed to get its savings protection scheme – an ad-hoc insystem regulatory process – approved under section 46 of the 1998 credit union act.

(In 2001 on announcing the enactment of section 46, the departmental press release says that only non-affiliates of ILCU need comply, implying of course that ILCU’s scheme was an approved one. Which of course it wasn’t and it remains unapproved to this day.)

Promoting a return to the past, ILCU built its argument on fears that the Central Bank Commission will regulate and supervise credit unions as banks. There isn’t a scintilla of factual evidence to back this assertion.

At this time the Financial Regulator is engaging consultants to produce a report:

The Minister for Finance has directed the Financial Regulator to carry out a strategic review of the credit union sector in Ireland. This will involve an examination of the structure, operation, regulation and legislation of the credit union sector with a view to providing a report making recommendations, including specific proposals to strengthen prudential soundness, which will advise and inform an assessment of the future strategic direction of credit unions. CBFSAI 22nd December 2009.

In fact ever since the establishment of IFRSA in 2003, the experience has been of an effective regulatory approach being executed for credit unions - appreciative of their organisational form. For example fitness and probity, consumer protection, minimum competency codes are to be developed specifically for credit unions whose core business is not regulated under codes of business conduct applying to banks.

In referring to separate regulatory authorities ILCU said : “All large developed countries of the Western world that have credit union movements have separate regulation for them.” They do of course have separate “regulations” but not all have separate “regulators” for example Australia and the UK.

It seems the only argument ILCU could make related to “some” volunteers experiencing an overzealous approach by the regulator. Is ILCU dealing in rhetoric and perceptions rather than facts or reality? It appears so.