Want to avoid credit union risk? Get rid of credit unions
Financial regulator Matthew Elderfield and Kieron Brennan, chief executive of the Irish League of Credit Unions: could getting rid of credit unions be at the back of the regulator's mind? Credit unions will vanish from Ireland over the coming years. A familiar pattern will emerge of small credit unions transferring their business to bigger credit unions. This will continue until what is left is a small number of very large credit unions. These will eventually be sold to much larger international financial institutions until they no longer exist. History, they say, repeats itself. This is exactly what happened to the trustee savings banks.
This is going to come about because of one specific change introduced by the Registrar of Credit Unions in 2009. This requires credit unions to have a non-distributable regulatory reserve of 10% of total assets with effect from 1 October 2009. Currently, most credit unions can comply with this requirement, and because they can achieve the standard, it appears to be reasonable on the face of it.
With the financial panic that has gripped the throat of the nation, all sorts of regulatory medicine is being administered to financial institutions, whether or not there is any definite evidence of an illness. Even more is to follow and the news is full of it. Institutions that had sufficient capital came through the storm. One of the major remedies being applied is to ensure that institutions have sufficient capital as soon as possible. The regulatory world believes that, no matter what they do, there will be another crisis. Credit unions are not immune to these requirements.
There are two notable differences for credit unions. One is simply that there is no distinction regarding the assets. Loans to members, government gilts and dodgy investments are all assets. The 10% requirement applies equally to all. Are these assets all equally risky? The 'Anglo Irish' style of credit union – if there is one – has the same 10% requirement as the least risky.
The second difference is that the only capital that the regulator will accept is 'realised profits'. This means that, unlike every other institution, none of the share capital counts as part of the calculation. When you examine the combined accounts of credit unions, it is clear that most of them are over this hurdle already and their income is 6% of assets. The conclusion then might be that well-run credit unions will continue to pass the test and even if the regulator accepted the crudeness of the calculation, better safe than sorry.
Better safe than sorry could be extended to the conclusion that, if credit unions didn't exist, then there could be no failure. Could this be what is at the back of the regulator's mind? The cost-to-income ratio was about 60%, such that costs were about 3.6% of assets. This leaves 2.4% for dividends on members' shares and any transfers to reserves. Dividends averaged 2.02%, leaving 0.38% as retained earnings. The implications are therefore stark. A credit union will find itself in deep trouble if it increases its assets in any significant way. At best, it will take five years to achieve a 10% reserve on new assets – and that assumes no dividends.
Reducing the dividend from its current 2.4% to allow for growth may or may not be a price that members will pay. However, when new regulatory requirements on systems and risk start becoming evident, coupled to having to hire more professional staff, the cost base will simply rocket. The substitution of paid labour for voluntary labour is potentially fatal but is guaranteed with the 10% reserve requirement. Having no capital of members at risk – which is presumably the goal of the regulator – strips out the need to have me, as a member, involved. The dilution of members will stop the education of people towards achieving financial literacy, a cornerstone of people managing their own finances.
Anyone regulating the credit union business will suffer from continuous nightmares. First, there are 500 independent companies – most smaller than branches of banks and run by politically savvy individuals. Second, they are not computer literate, as evidenced by huge losses on a big system, so they will not co-operate on large systems. Third, they have been badly burnt by poor investment advice from experts. Fourth, most are, in fact, well-run.
The nightmares arise because, when you put a risk hat on as to what might happen, here are the matters that come to the fore:
- Bad lending;
- Money laundering;
- Lack of professionals in the business;
- Co-operation on new systems and practices will require combinations;
- Costs will rise and credit unions wont be able to maintain 10% reserve.
A much better approach would be to put in place what appears to be a reasonable reserve of 10%. Then sit back and let it happen itself. This will happen slowly and it will be appear to be voluntary euthanasia as the credit union movement itself will oversee it. The inevitability of this slow lingering death of what is currently almost an alternative banking system in the making has come about by the actions of the Registrar of Credit Unions – actions that seem reasonable.
On closer examination, this is similar to dosing your aunt with arsenic over a long period. She will die from poisoning but there will be no obvious trace to you, the person who administered the poison. The credit union movement is going to die slowly but not obviously. We will be safe from a credit union collapse because there won't be any credit unions. This is the best risk avoidance of all.
Greg Allen is a banking and finance consultant with GDA Consulting