Existential Threats to Credit Unions

[WizardDr]

This is now a better argued thread than previous.

About the Regulatory Reserve Ratio - I said previously that had Bank of Ireland had the same ratio of 3% that it would not have been bailed out so clearly when the Basle Ratio was being mooted despite all the ways of doing this such as risk adjusted weightings.

What I am saying is that the first thing the ratio causes the credit union to stop taking savings which I regard as ludicrous.
That limits its asset size because when shares / deposits are place in CU either Bank or Cash goes up so Assets rise as well as liabilities,

All the examples have to be viewed on the marginal case: If Credit Union A has total assets of €100m (all in Government Bonds) then it still has to have a 10% reserve ratio. Let us assume it has exactly that and it is break even. So it has reserves of 10%. Then it gets a Deposit of €1m and immediately invests in Government Bonds then its ratio should be €10,100,000. But it breaks even on operations all ready so it cannot come up with a €100k from anywhere.

It can switch some to lending so even if it accepted the deposit and lent out €1,000,000 @6% its earning would be €60,000 still €40,000 short.

It is still short. What the ratio does is in effect limits the size of the Credit Unions and has actually worried them all about a breach of the ratio rather than accept the funds as its a trusted brand etc.

As regards concentration risk its size and its common bond dictates that in essence it has concentration similar to a branch of a Bank. It could be argued that RR needs to reflect that but Basel rule of thumb was 3% - a ratio of three times that tells me that this was used simply because most credit unions before 2008 were at that level anyway. The average number of mortgages for a ban branch is 1 per week even at the height. Vanilla Equity Release that is paid back mortgages for the over 50s is where they should be heading. The central bank should revise the ratio before as it is unfairly calculated/

BB thinks you had the money back but that's similar to closing down and philosophically BB sees CU as having no worthwhile functions and has bought into the view that they are incompetent. So he wont wade into the issue.

I believe that some Government Borrowings should be sourced from here. I would prefer CU to do mortgages and I simply do not accept the competence piece I think its plain nonsense.

Lets have more on the Ratio please.

 

[Brendan Burgess]

Hi Wizard

The 10% reserve ratio does not stop the Credit Unions from lending.

It stops them from taking on more deposits.

The limit on the lending is just that there is no demand for it.

You seem to want the Credit Unions to take on more and more deposits. Why?

As regards concentration risk its size and its common bond dictates that in essence it has concentration similar to a branch of a Bank

That is a ridiculous comparison. If the Ballyhaunis branch of Bank of Ireland is hit hard by a closure of a huge local employer, it's one loss out of hundreds of branches of the same entity. BoI won't become insolvent as a result. But the Ballyhaunis credit union could easily become insolvent if many of its members are hit.

Brendan

 

[county]

In relation to Credit Union lending there is no one silver bullet to resolve this. Credit unions need to offer a mix of loans personal, small business, community loans and some home loans.
They need to seek out niche segments within each of these markets. There is scope for credit unions to do home loans but need to focus on specific elements of this market. It would not be advisable to compete for the ultra low margin business.
Looking at the loan portfolio's of credit unions at present tells me that they are highly concentrated (personal lending) and with a high churn rate. By offering other loans types it will reduce this concentration risk and offering longer term products will reduce the churn and make it a small bit easier to get the loan book to grow.
I much prefer to deal with a credit union for borrowing even if I have to pay a small bit extra. I find the staff extremely helpful and most importantly they are not trying to cross sell other products to me. I see the work they do for the community and how they have helped many who would otherwise not have been able to progress. There is a role for such an institution in our communities.

 

[Paul O Mahoney]

The threat is from people who want CUs to be competitors to the banks, the movement was never designed for that it was designed to promote saving and thrift.
I had the opportunity and took it, to cost up a 3 year strategic plan for a large community based CU, and after 4 months of analysing and understanding and presenting the results Ill guarantee you only 3 out 15 directors understood it, thats 15 years ago.

But and I said this during my presentation " the day CUs become banks or try and compete with banks is the day the spirit of the CU movement will begin to die, Personally I would prefer this credit union to have 1000 €500 loans out rather than having 1 €500,000 loan out "

And thats my view today, CUs are cooperatives and were set up to serve the community, but now many on this thread believe that they should go down the road of fractional reserve banking, fine but its the members who should be consulted on this not anyone else.

CUs aren't banks some may wish they were but those are the ones that will wreck it....

Newbridge, Enfield, Firhouse, Drumcondra, to name a few, there's enough evidence to support the way things have been done since the 50s, obviously modern technology and money laundering legislation needs to be used but the ethos, the community importance are more important than 3% ratios

 

[WizardDr]

Dear Readers

I have repeatedly asked BB to comment specifically and exclusively on the Ratio.

Growing savings is central to the Credit Union ethos and is that is stifled - then we should examine how this Ratio was put in place and apart from 10% being better than 3% what is the appropriate %. BB fails to engage meaningfully on that except he states it does not stop them lending at the moment.

@Paul mentioned a few noted failures - just remembering that the only Bank that did not go under was Post Office Savings Bank. Can anyone name another retail Bank?

 

[Brendan Burgess]

Hi Dr

It seems right to be putting about 10% of their loans aside.

It seems excessive to me to require a Credit Union to have to put 10% of their deposits aside for reserves.

But it's irrelevant, as it does affect their capacity to lend.

And anyway,they can release their reserves by returning the unlendable shares to their members.

I asked you to explain to me how the 10% stops the Credit Unions from lending?

Brendan

 

[WizardDr]

You see I already gave you an example. At the moment many CUs have to carefully attend to minding that their share balances do not creep upwards (a liability but then there is an asset Bank or cash) I gave you a fully worked example where it did stop lending but I will give you another.

CU A is right on the ratio of 10%. A new member wants to borrow three time his savings that he is bringing with him and has a tremendous savings habit. The CU receives €100k in savings (Debit Bank Asset Credit Shares Liability) The CU then lends €300,000 (Credit Bank Debit Loan so no change in overall assets as there is a swop from Bank to Loans).

H/ever the CU needs to put €10,000 aside NOW. Where and how will it get it? (assume only reserves are the Regulatory Reserve Ratio and its now reading less than 10%.

 

[24601]

CU A is right on the ratio of 10%. A new member wants to borrow three time his savings that he is bringing with him and has a tremendous savings habit. The CU receives €100k in savings (Debit Bank Asset Credit Shares Liability) The CU then lends €300,000 (Credit Bank Debit Loan so no change in overall assets as there is a swop from Bank to Loans).

H/ever the CU needs to put €10,000 aside NOW. Where and how will it get it? (assume only reserves are the Regulatory Reserve Ratio and its now reading less than 10%.

Has the 100k just been lodged in your example? I'm not sure what you're saying makes any sense. If the assets haven't changed the reserve requirement hasn't changed. If 100k has just been lodged then assets obviously have changed.

Brendan has clearly said he thinks the reserve requirement is probably a bit high but this is all moot given that the risk arises from credit unions not being able to lend the excess funds they have. In your example they should simply lend the member the money and refuse the deposit. The average reserve and loans to asset ratios are a pretty clear illustration that your issue is imagined. It would be bizarre for a credit unions to maintain average reserves of 16% if doing so makes it somehow difficult to lend.

The real issue is that loads of credit unions have older investments/deposits with reasonable yields maturing over the next year or so. It was fine when they were getting the money for free from members and going across the road to AIB/BOI/PTSB and getting 3 or 4% on that but it's a much different animal when they're going across the road and getting -1%. You don't seem to recognise this risk and you haven't illustrated how a credit union is limited in its lending because of the reserve ratio. They're about 25% lent, so this hypothesis is fundamentally wrong.

I think @county summarises the challenge pretty well. Credit unions have fenced off the small, shorter-term segment of the personal loans market. This is not a good long term strategy and exposes them massively to existential threats, but these threats are not the threats identified by @WizardDr , they're the normal macroeconomic ones. Low interest rates and limited demand for non-mortgage credit has exposed the current business model. This is particularly evident with something like COVID - if your loan book is turning over every 2 or 3 years it will drop like a stone when something like this happens. They need to address their loan book composition so that it trends longer-term but this needs to be done in a risk-appropriate manner and not by throwing caution to the wind on buy-to-lets or trying to compete with the banks on mortgages - that will only end in disaster.

A short term strategy that will have a meaningful impact is the return of savings to members. I don't agree with Brendan that it should all be handed back - such a solution doesn't really factor in the demography often served by credit unions and the importance on non-lending services offered in communities - but they absolutely should be cutting their cloth to measure and aggressively shrinking their balance sheets so that they can service the loan market that is there with an optimum level of funding. They need to revisit the business model in the mean time and either achieve the scale needed to make the non-personal lending markets viable or they need to use their excess funding to do things like Brendan has suggested, such as setting up CU-funded building society.

 

[Brendan Burgess]

All the examples have to be viewed on the marginal case: If Credit Union A has total assets of €100m (all in Government Bonds) then it still has to have a 10% reserve ratio. Let us assume it has exactly that and it is break even. So it has reserves of 10%. Then it gets a Deposit of €1m and immediately invests in Government Bonds then its ratio should be €10,100,000. But it breaks even on operations all ready so it cannot come up with a €100k from anywhere.

It can switch some to lending so even if it accepted the deposit and lent out €1,000,000 @6% its earning would be €60,000 still €40,000 short.

Sorry Dr. I had not noticed that reply or the example in it.

I appreciate that you have a Ph.D. in Credit Unions, so clearly you are correct. But I do not follow it. Is this what you are saying. ( You say all in Government Bonds but I presume you mean all non loans in government bonds.)

It looks to me and I only did Credit Unions up to the Inter, that the 10% is stopping them from taking on more deposits rather than preventing them giving out more loans?

Now that you explain it like that, you have convinced me that the Central Bank is right to insist on 10%. It is their way of saying: Lend more and stop putting savings at risk by taking in money you don't need. But if you do want to be a deposit union, you will need plenty of reserves.

Brendan

 

[Paul O Mahoney]

This is a very complicated thread, If the ratio was dropped to 3% would the CU be able to lend out more? Who knows 10% doesn't stop them now.
In whos interest is it that the ratio is dropped to 3% ? Well certainly not the members, they couldn't give a toss if it was 30% because a, they won't understand it, and b, they are in general only concerned about having their savings secure, be able to get a loan for a car or holiday or college etc........and getting their death benefit to pay for the funeral.

The above would represent 90% of credit union members, and yes dividend was important to them, but after witnessing what the unfettered greed and illegal practices the global banking during the crash and how most banks were bailed out the average CU really wants a local community based financial service that they can deposit a bob into and also borrow a few more bob.

Its my opinion that the debate above is academic as the league wouldn't endorse it, if the league still exists, it goes against the ethos and if it was explained to members that the risk to the CU of having a lower ratio " like the banks" they'd tell any proposer to feck off. People are happy with CUs in general those who want bigger loans can apply to banks because CUs aren't banks period

 

[Paul O Mahoney]

CU funded co-op or mutual would work but the politics of getting agreement from all CU boards would be almost impossible, most don't even agree internally.
Imagine trying to explain "economies of scale, or ROI etc to volunteers directors and then Members

If its not broke don't fix it.

 

[Paul O Mahoney]

Whatever happened to CUDA anyway weren't they going to revolutionise who CUs were going to maximise returns for members, by all this new fangled dangled leveraging stuff, Newbridge gave a pretty clear answer.

 

[Paul O Mahoney]

Maybe there's a greater moral imperative to chase defaulters since they're effectively impacting their immediate neighbours in their communities by not paying?

Some regard defaulters as hero's and its a long process, years to get back €1500 easier to keep the savings and w/o the balance.

 

[Brendan Burgess]

If its not broke don't fix it.

Hi Paul

Do you not think it's very broke?

They have very few borrowers.
They are living off the returns on money put on deposit at fixed rates a few years ago.
They will have very little income over the next few years

And all those trips to Credit Union conferences around the World don't come cheap.

Brendan

 

[Paul O Mahoney]

Hi Paul

Do you not think it's very broke?

They have very few borrowers.
They are living off the returns on money put on deposit at fixed rates a few years ago.
They will have very little income over the next few years

And all those trips to Credit Union conferences around the World don't come cheap.

Brendan

Certainly there are issues, low interest rates elsewhere will always and has always reduced borrowing and I doubt that the movement ever experienced such a long period of low interest rates and yes it does reduce income, increases deposits and reduces dividend/ returns to members.

But, that wouldn't for me, classify the entire system broken. There is certainly much to improve the structure of the movement is outdated, deposits must be used to generate income, a step up to modern technology done properly and holistically.
I'm not sure if legislation has changed since 1997, but there are many factors and processes within the movement that need looking at to increase efficiencies to improve economies of scale for the whole movement.
Consolidation is inevitable and will continue, but again this needs to be seen as something that favours the members and the community as a whole, our local CU Maynooth was "merged " with the larger one Naas , people here still think it was a hostile takeover. When I pointed out to some the Maynooth CU had serious issues they simply didn't want to hear.
Now the annual budget saving type account is no more and home improvement loans of 20k plus apparently on offer, just seems that our "new" CU isn't interested in small loans anymore. And this is a mistake in my view

There is undoubtedly issues but CUs effectively becoming banks is not the solution in itself, I don't think that the 10% ratio is an issue , and from memory its always been in place, bad debts or a least their provision from memory was a weird calculation where any deposits were automatically taken off the provision.

Many things probably have changed since I was involved around 2005, but the principle of the movement shouldn't change , promoting savings and thrift is a good thing, dividends was also an attractive marketing tool, but thats not coming back anytime soon, CUs need to be creative for example rebate of some interest paid on loans or some other type of incentives to attract more loan uptake .

A functional community based/owned financial service is vital in an economy and does come with challenges but that shouldn't include fractional reserve banking.
And CUs shouldn't be simply compared with banks to see if they are maximising loans or ROI there are other/ substantial non financial benefits that accrue to people and communities from having a CU these will disappear and so will the movement.

Theres more to finance/banking than bottom lines, or lines of credit, or bonds, CDO........

The league if still as powerful as it was needs reform too, its a political launch pad, a place for ex- priests to earn 100k plus, as you mentioned Vegas isn't cheap, its monopoly on life assurance to members is another area if not changed should, drag it into the 21st century it won't come easily but come it must.

 

[24601]

Hi Paul

Do you not think it's very broke?

They have very few borrowers.
They are living off the returns on money put on deposit at fixed rates a few years ago.
They will have very little income over the next few years

And all those trips to Credit Union conferences around the World don't come cheap.

Brendan

I wonder how many credit unions cover their outgoings from loan interest income. Those credit unions are probably run well.

 

[Pinoy adventure]

Hi Paul

Do you not think it's very broke?

They have very few borrowers.
They are living off the returns on money put on deposit at fixed rates a few years ago.
They will have very little income over the next few years

And all those trips to Credit Union conferences around the World don't come cheap.

Brendan

Brendan I would of though they have loads of small too medium loans on there books Turing over good returns on the interest side ?

 

[Paul O Mahoney]

Brendan I would of though they have loads of small too medium loans on there books Turing over good returns on the interest side ?

They are struggling to an extent, "high street" interest rates are now probably lower, but , and I will stand corrected here, the interest on CU loans was/is a reducing balance interest calculation.
Additionally in the past CUs would help any borrower who was getting into or was in difficulty of course in times of old you had to be saving for 13 weeks before you could get a loan, AFAIK thats gone.
They aren't marketing properly in my view, communities want a functional alternative financial resource however now the focus is the same as the banks..
We all remember the S&L debacle in the US in the late 80s early 90s they never recovered and I can see our CU movement going down a similar road, unfortunately.

 

[Paul O Mahoney]

I wonder how many credit unions cover their outgoings from loan interest income. Those credit unions are probably run well.

Very few Id say I know when I was involved interest income from bonds, almost exclusively sold by Davy then contributed a fair ball of money to income.
Again this was 2004/05 just as the economy was going mental.
The idea of a co-op mortgage company is a good idea, and so is an investment type co-op .
CUs will have to start investing in community initiatives for example community based energy generation, they will also benefit from the profits and increase their presence in the community.
Of course there are lots more they could invest in .......

 

[WizardDr]

One of the reasons that Credit Unions were set up was to foster growth in savings.

Second was how to borrow carefully.

Third was Community.

Fourth was Financial Education.


The Financial Times recently highlighted how bad the public were at understanding basic financial maths such as Credit Card payments and interest.

BB - is against credit unions but he clearly is not concerned that the Credit Union saying NO to savings (or shares but they are classified by CBI as Deposits) dilutes and remove Pillar 1. Pillar 2 is heavily restricted - but has been opened and closed at the same time. Pillar 3 is getting remote as the CU take over smaller ones. Pillar 4 is most important and probably the lest understood but the one that CU can do best at. Simple provision of Budges account referred to by @Paul above where he laments its passing when one CU was taken over by another who didn't provide a Budget Account.

Actually @Paul probably realizes its importance because by setting out one's income and outgoings translating into peaks and troughs with the key result of understanding whether you were going to be over / under during the year and taking action accordingly. This was probably one of the cleverest product that some Credit Unions have (or haven't ) and @Paul is spot on. It spells out whether a CU member is living beyond their means with actions taking to rectify and is an outstanding product if used properly. BB has never known what its like not having the funds to pay household expenses.

BB makes the usual statement about paying back the excess. Where does the excess go when a member gets it back? So what happens the savings habit? Surely it is not a major step to allow CUs to place excess deposits with NTMA? Not necessarily paying anymore than what the Banks pay but recognizing Pillar 1. Just because they achieved the ratio by not paying out dividends in the past and could meet a ridiculous 10% when it has no support other that its higher than 3% is baloney. Many people save because of the Credit Unions. Savings is a good thing and should be encouraged .

The accounting equation where when CU receive payment for Shares (or Savings as the shares are treated as savings) that Assets and Liabilities rise is simply the case. BB makes the watery argument (totally ignoring Pillar 1) and says it does not stop them lending is true but its a weak argument. Indeed noting that the Mortgage to Rent scheme is financed by Local Authorities and by Bank lending - surely those borrowings by Housing Associations could be funded partly by Credit Unions? The dizzy lending is 66% approx. by banks it could be argued is funded by CUs but they lose the margin to the middle man. As these borrowings are in fact state guaranteed then why should CUs not fund them?