# Central Bank acts to control for credit union moral hazard risk



## kaplan (6 Oct 2011)

Three out of four credit unions have had their lending restricted. With 100 unable to pay any dividend for the second year in a row and another 100 at risk of not being able to, savers in one or two credit unions may withdraw their money and trigger a run that could become contagious. It won’t matter that savings are protected under the DGS. 

The Bank is not only the credit union regulator but also the deposit insurance manager. Under the DGS, should a credit union be closed down and savers made whole, the bank would levy the cost on other credit unions. The nightmare scenario is one where more than one is closed and credit unions cannot pay the levy. Three medium sized credit unions would trigger a levy call of about €200m and two large ones over €250m.   

Regulators and deposit insurance managers typically instruct the non-viable credit union to merge with a stronger one. They may provide temporary post-merger balance sheet funding.  

New legislation will give the Central Bank the powers it needs to deal with non-viable credit union operations and prevent calls being made on the DGS. These powers will include establishing a credit union funded stabilisation fund. 

While the Central Bank is prudently acting to contain moral hazard risk, credit union spokespersons have taken to the airwaves, print media and online forums to accuse it of driving people to moneylenders. 

Should credit union trade bodies, their managers associations, directors and managers consider what they can do to get credit unions working again rather than criticising their regulator?


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## dereko1969 (6 Oct 2011)

Is there a question here? Should this not be in Letting off Steam?

Do you post on anything apart from attacks on Credit Unions?


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## CU Manager (6 Oct 2011)

@kaplan : unsurprisingly your numbers are way off yet again. There is a massive difference between a liquidity call and a solvency call. Remember those CU's have capital reserves to deplete before a solvency call! 
Typical CU has over 30% solvency buffer against risky assets. Don't you just hate the way reality gets in the way of dramatic figures.


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## kaplan (6 Oct 2011)

@derek1969 edited and question posed.


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## CU Manager (6 Oct 2011)

kaplan said:


> Should credit union trade bodies, their managers associations, directors and managers consider what they can do to get credit unions working again rather than criticising their regulator?


 "emm, let me think, what can we do????"
"Oh, I know, try our damnedest to get sensible regulation in place that allows us to grow."
"But wait, isn't that what we're attempting to do?"
"Yes it is son, yes it is"


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## kaplan (6 Oct 2011)

@CU Manager : If you'd like to understand how ex-ante and ex-post deposit insurance and  reconstitution provisions work read here
You could also look at the NCUSIF site or any of the Canadian Provincial DGS systems. The DI call is typically on balance sheet reserves not solvency or liquidity. DGS systems are designed so that its members are cross guaranteeing ex-post funding.
In the case I have used above as currently there is nothing in the CU DGS fund a €250m call would be made on credit unions.


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## CU Manager (6 Oct 2011)

@Kaplan: your figures are way way off. €250M call would involve a lot of CU's. Your maths isn't working!


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## Brendan Burgess (6 Oct 2011)

dereko1969 said:


> Is there a question here? Should this not be in Letting off Steam?
> 
> Do you post on anything apart from attacks on Credit Unions?



Hi Derek

This forum is for discussing CU issues, so this is the right forum for it. 

Brendan


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## kaplan (6 Oct 2011)

@CU Manager : I'm afraid my maths do work. 

Most people are unfamiliar with how deposit insurance and the Irish DGS works. If a credit union were to be closed down then savers would be repaid their savings (net of loan exposure) by the DGS within a specified time period (20 days).   

A credit union having €100m in unattached insured shares and deposit balances would on closure create an immediate call on the DGS of €100m if all of its customer accounts were each under €100k. You can check how the DGS operates here. and [broken link removed]

As individual credit union DGS insurance exposure ranges from about €5m to just over €300m - you can see how two or three credit unions could create a call on the DGS for €250m. I can think of two credit unions which together expose the DGS to €500m.

Now imagine a scenario where four credit unions are closed due to a rational run - say the DGS compensation payout is €300m (€75m each). If the DGS was funded by credit unions the ex-post fund would be 0.20% of 11.5bn = €23m. The Central Bank would draw on the €23m and provide the balance of €277m to repay savers their money within the 20 days. It would then recoup the full €300m from the remaining credit unions - this is the reconstitution provision. So the failure of a small number of credit unions carries systemic risks for the credit union network as in effect they are co-insuring each other - they would recoup some but not all of the €300m in time from asset sales and loan workouts. 

DI introduces moral hazard risk as members of DI schemes may trade off the guarantee - deposit insurance managers look to manage this risk by demanding higher payments from riskier members and implementing risk controls. This is another reason why for example lending restrictions will be imposed. Not only is the Central Bank concerned for savers funds it's also concerned that no call is made on the fund. In the same way credit unions should also keep a weather eye out for others who may be trading off the guarantee. 

The alternative to closure is merger which typically is the option of choice of regulators and deposit insurance managers as it's cheaper than closure. In these cases they are prepared to provide temporary funding to stabilise post-merger balance sheets. Either the deposit insurer does this or there may be a fund created for this purpose. A special stabilisation fund will be set up by the Central Bank here for credit unions with appropriate credit union contributions.


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## CU Manager (6 Oct 2011)

After the dust settles, the cost would be net of the liquidated assets of any CU. With solvency buffers of over 30% of "risky" assets together with the proceeds of the sale of a CU's assets being applied against the payouts to savers, it would take quite a lot of CU failures to reach YOUR figure of €250m.
The track record for the movement is that no CU has gone bust in the c. 50 years history of CU's in Ireland but you see the need to speculate on multiple failures and the possible effects of same - go figure!


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## kaplan (6 Oct 2011)

@CU manager - see my post. cu's would eventually recoup some but not all of the funds called on and committed to the central bank's protection account. These would not be losses rather the commitment (levy) would be made from credit union reserves which would not count as regulatory capital. The impact of a small number would decrease levels of regulatory capital across the system. You are not right to suggest that it would take quite a lot of credit unions to reach a figure of €250m. It's an understandable error made by those who do not appreciate systemic credit institution system risks 

On your other point - just because one has never failed doesn't mean one cannot fail. But that's not the issue. Any regulator be they a self-regulatory body or statutory body will act first to stave off closure through using amalgamations, transfer of engagements and other arrangements. The reason they do so is to limit the costs to the DI system and the systemic risk I have illustrated.

On this latter point regulatory commentary is instructive:

_"If individual credit unions don’t face up to their current business difficulties they are risking their future and possibly that of the sector overall, given the indistinguishable nature of the credit union brand between credit unions and so the potential for contagion to spread.... A failure of one or more credit unions could lead to a significant loss of confidence across the sector. This must be avoided. Part of our regulatory work will be concentrating on identifying weak, or non-viable, credit unions and taking pre-emptive action where necessary in order to sustain the financial strength and well being of the sector."_ Nov 2010

_"Credit unions that do not have the financial strength to weather the current difficulties – either because of a policy of running with low reserves, or because of the financial impact of poor management and business decision-making in the past – are now being severely exposed. ...We have been working over the past number of months towards the establishment of a statutory resolution mechanism to stand ready to help credit unions falling into financial difficulty. This is important to maintain member confidence and protect the financial stability of the sector."_ June 2011


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## dereko1969 (7 Oct 2011)

Brendan Burgess said:


> Hi Derek
> 
> This forum is for discussing CU issues, so this is the right forum for it.
> 
> Brendan


 
When I posted my comment there wasn't a question in the post just another rant. It has since been edited.


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## kaplan (11 Oct 2011)

As expected the Central Bank is to set up a stabilisation fund partly funded through levies on credit unions. The move brings to an end years of protracted,fruitless negotiations between the credit union regulator and ILCU to regulate its controversial scheme the SPS.

The development probably explains why ILCU is engaging in an anti-central bank media and lobbying campaign in which it has been joined by the Credit Union Managers Association. Obligatory membership of its SPS is the mechanism through which ILCU has sought to dominate the market for other credit union services for over two decades.


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## Gerry Canning (17 Jul 2013)

This is an old post. 
From me ,as a credit union member and without full knowledge I make the following points.I am more than prepared to be corrected.

1. Central Bank has a new found interest in Credit Unions and by Central Bank machinations, people are given to believe that Credit Union movement is in a similar position to Banks.
Pity Central Bank  didn,t have such an interest in Banks in the fluffy times.
To my knowledge Banks have cost us 60 Billion , Credit Unions have cost nought .
Central Bank now stand ready to help, I do not believe them.


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