Tag Archives: credit unions

Thoughts on the future of banking in Ireland…

This is an extended version of a column published in the Irish Examiner, 21/1/12,
http://www.examiner.ie/business/co-operative-banks-may-be-the-way-forward-180948.html .

The news that the Newbridge Credit Union has been taken under care by the Central Bank is of course a source of great concern to depositors. However, things are not all bleak

Credit unions play a vital role in the Irish financial system. Total assets (loans outstanding in the main) as of the latest figures (2010) were. €21b, which amounts to c 5% of the total amount of loans outstanding to Irish residents as of that date.. If €1b is to be required to recapitalise losses that will, proportionally, be a good deal lower than for banks. Credit unions, despite the recent concerns, are as a body very different as compared to banks. The domestic banks as a whole, at end 2010, had a loan to deposit ratio for Irish residents of approx. 135%, while for credit unions this was only 45%. there would on the face of it appear to be room for Credit unions to engage in cautious increases in lending, if we wished to allow credit to grow (a whole other debate) but this is stymied by lending restrictions imposed last year. There is a good overview of the CU situation available in the report of the interm commission, available here.

There is long history of cooperative and alternative form banking, beyond shareholder owned models. Within Europe, cooperative banks have approx. 20% of the deposit and loan market, and account for in some cases up to 40% of all SME lending. The best known of the large cooperative banks include Rabo, CoOp (UK) and Credit Agricole. The academic evidence is that cooperative banks are similar or even slightly better when to other banks in terms of organizational efficiency, but provide lower returns on assets than shareholder owned banks. They typically are smaller than shareholder banks but the largest Cooperative banks are amongst the largest in the world, and have retained strong credit ratings, to date.

we also have evidence from world bank and other researchers on competition in banking. Recall that all financial services industry participants’ work within the same broad environment. in principle a cooperative bank can compete on the same range of products as one with any other ownership structure. If we now introduce a distortion, call it a blanket guarantee, for some but not all of the participants in the market, there will be consequences. We know the calamitous macroeconomic consequences. But at the level of the industry the non-guaranteed banks now face a perverse incentive. The subsidy that has been given to the guaranteed banks is not available to them. The unguaranteed banks have an incentive to increase risk in order to chase profitability, if they wish to remain in the market. Not only is the blanket guarantee an effective subsidy to the financing of the banks – however high the financing costs are to the covered banks they are much less than would be absent the guarantee – there is also a further subsidy from NAMA. Non-covered banks faced with poor loans are not in NAMA, therefore they have to either work them out themselves , costly in terms of time and effort and a continual ongoing drain on the operation, or they sell them which comes at the cost of an immediate bottom line hit. Given the date that was set for loan valuation in NAMA was November 2009, and that the commercial and residential values in Ireland are down 20-25% since then, were the non NAMA loans to be now sold off its reasonable to assume that this would be the additional hit to them. Finally bailed out banks have the ability to attract greater deposits or to pay more (perhaps even pay at a loss) for these deposits. Thus, the effect of the solutions has been to force the non-NAMA/Covered banks to either exit, to accept that they will be acting at a disadvantage, or to engage in more risky activities. Finally of course the bailed out banks themselves, having had a bailout once will expect another, have every incentive to increase their risk taking, which increases as public ownership increases. None of these findings are exactly conducive to good healthy banking.

The evidence is that more competitive banking systems, may in fact be less systemically risky, and show less signs of financial fragility. There is a meme in the Irish banking discourse that the crisis was caused by competitive pressures forcing what would otherwise have been good banks to loosen their credit standards. There is in fact little evidence of this. The share of the largest credit institutions in the bubble increased, not decreased; competition in the Irish market, as measured by the standard H index, decreased significantly; based on the quarterly survey of banks lending the competitive pressures, especially for home loans, were almost the same in terms of their effect on loosening or tightening credit standards as were perceptions of risk or ability of banks to access funds.

This gives us a possible route for Irish banking. When the dust settles it might be worth considering boosting the capacity of the credit union system as a whole, enabling one or two competitive but cooperative owned banks to emerge. Some encouragement of the formation of new cooperative banks would be useful as would be a consideration of whether or not we should cap the size (in order to foster competition) of domestic banks, to consider the winding down all majority state owned banks which have had moral hazard injected into them through bailing out and to encourage the transference of activities to new, clean, cooperative by preference banks which can compete on a new level playing field.