How has the seriousness of credit union arrears gone little noticed until now? The answer here is one of a poor credit risk management reporting system and the dynamics of a challenging business model, starting with the risk reporting system. Until very recently the country’s credit unions used, and broadly relied on a seriously inadequate and out-of-date credit risk matrix – ‘Resolution 49’ – to indicate what the level of credit risk was for any given level of arrears. This credit risk/provisioning matrix is shown below:
This matrix – introduced to credit unions during the ‘boom days’ of 2002 but not revised, even during the years of the ‘Celtic Tiger’ collapse – misled credit unions and, to some extent, their accountants and the regulator, by suggesting that there was no risk whatever where loans were either up-to-date, or even one or two months in arrears. Only when a loan was 10 weeks in arrears did the Resolution 49 model allow that there might be a degree of risk of loss, estimated then at 10% – a manifestly inadequate loss probability rate.
However, as simple objective testing of local experience against these arrear rates might have demonstrated at the time, this rate and the other risk rates shown above shared similarly serious inadequate rates. Testing of one credit union’s experience in 2007 showed that the Resolution 49 model was then capturing no more than 29% of measurable credit risk.
The inadequacy of these rates was then inevitably compounded by the credit union business model, including, firstly, the ‘topping up’ of loans, thereby deferring the emergence of real arrears and secondly, rescheduling/refinancing arrears, which further delayed recognition of, already understated, exposures.
Consequences of Resolution 49
In consequence of the Resolution 49 matrix, credit union loans were variously: underpriced; recognition of arrears was lagged by up to three years; losses were under-provided for and a seriously misleading profit illusion was created for credit unions over many years, only recently and recognised. In the meantime credit union management was misdirected as to new lending, arrear management, resource management and reserving policy. It is a truism to say that you cannot manage what you cannot see!
Other systemic reasons for the credit unions’ problems include:
Absence of loan security: A further acknowledged cause has been the credit union business model of lending typically without any loan security. This has had a double impact. In the absence of risk transparency mentioned, arrears were neglected until too late and credit unions were then placed in an inferior position to motor and other lenders which had the benefit of relevant asset security.
Failure to differentiate loans for risk–pricing and management: In the absence of proper risk measurement, credit unions shared an almost universal policy of common loan pricing, failing to distinguish certain high-risk loan types and maturities for appropriate higher pricing and closer management. This egalitarian, but arguably misplaced, policy was sponsored by their wish to treat all members equally, regardless of risk.
The impact of the €100,000 government guarantee: Arguably a further reason for the rapid escalation of arrears has been the unique impact on credit unions of the Irish government’s guarantee on savings. As the great majority of savings in credit unions are below €100,000 and are fully guaranteed, the normal run on savings which might be triggered by escalating arrears, and which operates as a discipline on lenders, does not come into play, permitting a higher indulgence of already delayed and understated arrears.
Ireland’s credit unions are staffed by highly responsible, dedicated professionals and by volunteers who have given generously of their time over many years. They have provided a valuable service to the community over almost six decades; a service which, unfortunately, is now being increasingly filled by predatory money lenders.
Credit union management deserves to be supported by a greater transparency of credit risk. When this has been achieved, the other aspects of the business model might also be reviewed.
* At the author’s request, this article was subsequently revised on 6 February 2014 to emphasise common systemic difficulties.
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