From Bill Hobbs: Credit unions must be reigned in for all our sakes, writes Bill Hobbs
Having funded boom time consumer spending, including first time buyer down payments, credit unions are experiencing rapidly increasing bad debts as their customers struggle with unaffordable debt. It’s a time bomb ticking in credit unions backyard which the Financial Regulator is trying to disarm. With only twenty eight staff to supervise 414 credit unions, the best it can hope for is to limit collateral damage when it goes off, as it inevitably will. But if credit unions and their trade bodies had their way, it would not be given the tools to limit the damage.
Last year credit union trade bodies lobbied for extended loan limits to reschedule short term non-performing loans into performing longer term ones. In the middle of one of the world’s worst economic contractions and consumer debt crisis, loan rescheduling is like treating a festering ulcer with a sticky plaster and a hug.
Yet the Central Bank Act 2010 includes a section which will effectively allow credit unions to apply the sticky plaster. It also provides their regulator with preventive tools to control for lending, liquidity and solvency risks. However credit unionists are now up in arms at the safety conditions attached by their regulator. They argue they should not have to make the bad debt provisions required. They maintain that once a non-performing loan is rescheduled the risk of non-repayment disappears. And true to form they are engaged in typical credit union political lobbying, refusing to deal objectively with substance but arguing instead from an emotionally charged subjective basis. The substance is quite stark – credit unions will not be able to trade their way out of trouble and the sector is on the cusp of a crisis it may not survive. It seems the regulatory cure may kill the patient.
As regulated credit institutions, credit unions are expected to set aside money in reserves as insurance against unexpected losses and to set aside money in bad debt provisions to meet current and anticipated loan losses. From last year they must set aside an amount equal to 10% of total assets in regulatory reserves. The regulator set this target to prevent them from raiding their reserves to pay dividends to savers and allowed for an interim target of 7.5% for struggling credit unions. It also wants them to set aside money to fund future loan losses. The problem is many can’t generate enough profit to fund reserves, pay for losses and pay a dividend to savers. Overall, solvency and liquidity levels may appear relatively healthy. But with a far too high cost base from failing to modernise over the 20 twenty years, individually a growing number of credit unions are in quite serious financial difficulty.
Should a large credit union fail, collateral damage will be hard to contain and the states creditworthiness, its sovereign debt rating, could be undermined. Recently news that Spanish authorities had to rescue one if its co-operative savings and loans outfits, called Cajas, undermined its sovereign debt rating. Luckily for the Spanish they had the good sense to have a special resolution system in place to manage the rescue. Elsewhere regulators and deposit guarantee managers intervene, taking prompt action to stabilise a troubled credit union. Frequently they order its amalgamation with another and fund its solvency stabilisation costs. Such prompt corrective action and stabilisation is required to manage a financial stability crisis. As is a reliable system raise funding and cycle excess cash and capital from one credit union to another. But here there is no statutory, legally reliable and effective resolution system for Irish credit unions.
Yet since September 2008, the state and taxpayer has effectively guaranteed every cent of the €11.5bn in household savings in credit unions under the revised deposit guarantee scheme which will compensate savers up to €100,000. With ineffective regulation, weak resources to effectively control risk taking, inability to set mandatory rules of business conduct and prudential safety standards and lacking a resolution system permitting prompt corrective action, moral hazard risk exponentially increased once the deposit guarantee was provided.
Some politicians do not appear to understand the nature of credit union hazard threatening the entire sector. During the Oireachtas ERA (Economic and Regulatory Affairs) committee hearing last week, the credit union regulator was upbraided for doing its job and asked why it couldn’t wait for the outcome of a strategic review before taking preventative action to control risks. It was a clash between rational prudential regulation and parochial credit union political lobbying. Despite the regulator revealing serious financial stability concerns, some members of the committee appeared to argue for a soft touch.
It is against this backdrop of rapidly worsening bad debts, failing business model and a badly designed ineffective, under resourced regulatory system that politicians are being asked to consider a soft touch response.
The regulatory cure for the festering sore may trigger a chaotic shambles as credit unions begin to fail. Similar crisis elsewhere led to orchestrated state and regulatory intervention that led over time to the ordered consolidation of credit unions which enabled them to professionalise, improve governance and expand their products and services. Time has run out here. What’s required is a policy response and resolution regime to rescue credit unions from themselves which may mean the tax payer will have to fund the costs.
A version of this article appeared in the Irish Examiner, Business Section, Monday 31st May 2010
This post first appeared on Bill Hobbs’ blog
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