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!


paul quigley said...


As usual, you are on the money. What could be more natural, or Irish, than the Cousin getting you a credit union loan when the bank won't pony up. That's probably where the SME sector is at these days.
What happens when the well runs dry ?

TrueEconomics said...

A Credit (Union) Crunch?..

Anonymous said...

I'm under the impression that the regulator(s) looked to stop all dividends last Autumn, but was in some cases convinced to allow a token amount to discourage a flight of deposits.

At the local union, dividends and lending were slashed back to achieve the recently increased reserve level, and now the regulator is pushing to go to 14% and beyond, effectively creating a credit union that cannot give credit for a year or so.
Loanbook in arrears earlier this year was about 3%.

Are they just applying blunt worst case rules or do those numbers justify this 14% reserve?

karl deeter said...

Credit Unions are just a smaller version of banking without the the sophistication. In the same manner that failure to regulate the shadow banking system was a mistake.

Applying lax rules to the CU's would also be an error, if you take deposits and lend them out you are essentially a bank either implied or de facto and all should be regulated the same.

bill hobbs said...

I have been writing of credit union problems for some time in the Irish Examiner and Sunday Business Post. See here:
A number of observations
Twenty are said to have solvency problems but these could be twenty of the top 100 which collectively control 80% of sectoral assets(loans) and household deposits. Of these some have > than €200m in savings of people living within a small cachement areas (the common bond of association) or association (trade union) or semi-state or ex-semi-state employment.
The regulatory reserve, introduced last year, for the first time linked risk assets to reserves albeit bluntly by requiring a non-distributable buffer of 10% which is low for credit unions - internationally 15% is reckoned to be about right. Irish credit unions do not use risk weighting.
The financial safety net is weak due (a) no lender of last resort (b) no stabilisation component of the DI scheme and (c) inability to issue mandatory and binding rules, standards and codes. This is unique to Ireland.
Underlent (credit unions should have at least 70% loans to total assets)they had seen steady decline from highs of c65% in 1998 to c48% by 2008Many were far lower some lower than 20%. The critical group the top 100 were between 20% and 62%, clustering around 42%. Unlent funds were (a) deposited in the banks and (b) invested in a range of risky assets including perpetual bonds, unit linked funds and equities. This is a unique feature of the Irish model. Elsewhere credit union investments are striclty limited to low risk investments with short maturites. The result were investment losses reckoned at c€350m.
Provisions escalated last year ranging 4-10% (top 100) and this year may reach 15% at the top end. There are two drivers (a) loan book unsecured consumer with a sub-prime pathology and (b) more robust provisioning rules. It's reckoned the latter will cause provisions to rise by 20-40% in c300 credit unions.
Regulatory stress tests being undertaken at this time look to stress unsecured lending at base case17.5% losses to 2012 and 25% downside risk. Secured are lower - development finance 30-40%. Yes some of the larger ones are remarkably exposed to small scale property development finance of dubious collateral value. One of the top 5 provided 10% last year - its net worth represented by the value of its expansive new banking hall premises which was valued at book value.
The outcome of the stress tests will mean that about 35% will generate operating losses at 17.5% rising to over 65% at 25% - in the top 100 group. Those with higher loan to asset ratios will show significant solvency strain.
The duration of a credit union loan book (before crisis driven loan modifications/rescheduling) is about 2.7yrs closing matching the duration of deposits. This means to stand still 33% of new loans have to be issued annually before any loa book growth occurs. Last year loan issues declined by an average of 27% - ranging +4% to -50%. Yet total loans only declined on average 4% - evidence of large scale rescheduling. The loan books is being hollowed out and shrinking - the adverse effect on interest income will feed into accounts this year.
To summarise: the 1950's dividend distribution business model still used here is bust: many credit union will not be able to generate the profits requited to maintain regulatory buffers, fund loan losses and remunerate savers. And as cost income ratios adjusted for dividends in 2007 averaged 80% on a banking comparitive basis - credit union basis 60% - they is little far to be trimmed in whct are banking operations that have not deployed modern IT and are using manual processes first designed well over 70 years ago.
The outcome: state funded rescue and enforced consilidation.