Friday, May 28, 2010

Economics 28/05/2010: Welfare fun in the Credit Unions land

There are three things one must wonder about when it comes to the Credit Unions in Ireland:
  1. Why aren't we hearing more about the going-ons in these fine credit institutions that play a significant role in this economy? After all, credit unions have assets of ca €14.5bn per end of 2009 figures. €6.8bn of this is in loans and €7.3bn in investments. And they act as, in effect, second tier lenders (correcting per a tip from a reader: not in terms of quality of borrowers but in terms of types of loans), with most loans going to unsecured lending on cars, home improvements, personal spending, etc. Could they have miraculously escaped the fate of the banks in the current crisis? Highly unlikely.
  2. Why do we have a separate regulatory regime for these organizations, if their basic business model is virtually identical to prudentially justified banking?
Well, folks - in the land of endless quangoes (aka, Ireland) we have a financial regulator and a separate credit union regulator. The latter, James O Brien, now reportedly wants new additional provisions to be made by the 20 unions (out of 414 - a whooping 5%) operating in Ireland that face “serious solvency issues”. Oops. That was a sudden one. In effect, back in 2008 the Irish League of Credit Unions (yeah, I know, sounds like a Klingon gathering) issued annual report full of concerns for the Credit Unions' state of health on their investment side. Then there was a report into the impairments charges. Which promptly followed by a dramatic decline in the surprise spot inspections of the Credit Unions - the only real tool for assessing just how bad the loan books might be.

Now, we are being told that there are Credit Unions out there which have 'serious solvency issues' - or translated into common language 'might be trading in insolvent conditions'.
Apparently, arrears levels in the Irish credit unions rose from 6% in 2008 to 13.5% in 2009. The Credit Unions Klingon-styled response to this was to lobby Brian Lenihan to allow them continue lending for holidays in the sun to households, some of which can easily be on the verge of running into trouble with the banks. You see, credit unions provide credit after the banks provide secured loans to the punters (again, correcting per a tip from a reader: this does not mean that credit unions lend to a less worthy client than the banks, it means that they supply lower priority - in household budget terms - and largely unsecured loans. Neither does it mean that credit unions provide loans to people who were turned down by the banks. However, it is known that credit unions did provide top up loans for house purchasers who have exceeded mortgage allocation and borrowed to either supply a deposit or cover closing costs on property from the credit unions).

Credit unions do so by taking deposits from the same punters in exchange for the promise of a dividend - an annual payment that is there to replicate deposit rates paid by the banks. Alas, when a company runs into red, unless the company is AIB, the normal practice is to withhold the dividend and use the company earnings to replenish capital base. The credit union movement in Ireland disagrees, arguing that a dividends withdrawal for funding of higher reserves and offsetting losses on loans would damage their 'competitiveness' vis-a-vis the banks.

There is, of course, one major issue with the Unions operations - in effect, absent restoration of the proper functional business banking in this country, Credit Unions are now becoming more actively involved in small businesses operating capital management. This is a risky undertaking for all parties involved and we do not have much data on the matter. Small businesses - sole proprietorships in particular - can blend business cash flow management with personal banking, inducing risk spill-overs from business side to household finances. Increasing reserves requirements on Credit Unions will be likely to put the boot into this, rather atavistic, practice, made necessary by the lack of functional business financing in the core banking sector.

But one must be concerned about the end game here. If the regulator were to listen to the unions, what alternative ways can be found to cover the losses then? None other than a direct injection of cash from the taxpayers. So here we have it - welfare junkies in Ireland have reached a new high. We are being indirectly told that Credit Unions should be allowed to pay dividends out by keeping reserves low, even as they face mounting losses. Surely the taxpayers can provide a cover for these, should the trading environment continue to deteriorate into the future. Happy times, folks!
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