There is much discussion currently on the surprising growth of Moneylenders in Ireland, in the presence of a vast network of Credit Unions throughout the country. It is also pointed out that Credit unions are seriously and very sadly under lent . Only 27% of Credit Union deposits are currently lent out in loans, with un-lent funds reaching some €10 billion! Credit Unions cannot possibly achieve profitability, or even survive, if this under lent situation is allowed to continue.
At the same time moneylenders, many freshly arrived from the UK, are entering the Irish market and offering Irish consumers loans at rates of interest ranging above 100%per annum. How can this be?
A large part of the answer here lies in the extraordinarily restrictive upper limit permitted by the regulations on Irish credit union rates of Interest, viz, 12% pa.
The Permitted Interest Rate
If one reflects that this 12%pa rate must pay also for credit union staff, say 2% pa, for any funding costs (a minimum of 1% to depositors would be appropriate) and a minimum of 2% for reserves, that leaves a maximum of 7% to cover credit risk. That 7% is impossibly restrictive to cover risk in consumer lending which, remarkably in the case of credit unions, is also predominantly unsecured! And being unsecured, Credit Unions understandably tend to seek guarantors and occasionally collateral for borrowings, slowing the credit evaluation process far beyond the urgent needs of borrowers, who turn to moneylenders. In consequence Credit Unions tend to rely heavily and unduly on ‘top up’ loans to existing borrowers rather than to new borrowers. This rate of 7% is sufficient to cover only quality borrowers, possibly as little as 25% of the available market.
In the UK, Credit unions are authorised to charge interest up to 36% pa. One may calculate that, assuming a similar cost structure, that 36% rate allows them up to 31% for credit risk (36%-5%), as compared with the Irish maximum of 7% for credit risk. Here it might be recognised also that Irish credit union depositors are entirely unhearing, because of the unrealistic pricing of their loans .
One might reflect also that the reason UK moneylenders are coming to Ireland is that, compared with UK Credit Unions the Irish market represents easier pickings! The Irish 12% limit should be immediately raised to that of the UK credit union level to accommodate a realistic level of credit risk and to fund them to resource for management at that higher level of risk
Same- Asset Loan Pricing
Another extraordinary and equally restrictive feature of Irish credit Unions is that requiring that Credit unions must charge one uniform rate for each broad class of assets. (Remarkably, ‘class’ is not defined). Accordingly, Credit Unions may not allow for the higher risk associated with lower earning, more seriously indebted borrowers, as against better endowed members. They may not even differentiate between the risk inherent in longer term loans versus short term loans, or in larger versus smaller loans. The result is the averaging of pricing and the fatal cross- subsidisation of all lending.
A simple analysis/autopsy of credit union bad debts shows a high concentration of risk in particular loan maturities, in specific value bands and in relation to particular car models, with some loans being charged rates of interest even below their measurable credit risk!
Credit Unions should be authorised to differentiate risk pricing for manifest risk; existing credit risk analytics software provides this credit risk intelligence. The current failure to differentiate credit risk is, arguably, based on a misunderstanding of the core credit union principle of mutuality
Mutuality in Credit Unions
Mutuality in Credit unions (also in Building Societies) requires that in transitioning through the depositing and borrowing process, members will support one another and take their turn between depositing and borrowing, hence the Credit union policy of requiring that members must build up deposits before accessing funds. The concept of mutuality is predicated on the idea that depositors will accept a lower rate of intertest on deposits to achieve a lower rate of interest for borrowers, so that sacrifices made today are repaid later. The principle of mutuality is intended to operate across classes of members, not between types of Loans.
Fundamentally, the principle of Mutuality requires that first and foremost, credit unions operate efficiently to achieve mutual support of members., both depositors and borrowers It does not require unrealistic or indiscriminate risk pricing, or the wholesale cross subsidisation of bad loans.
The Future of Irish Credit Unions
The story of the Irish credit union movement and its growth is an impressive one and one of which the movement can be proud. The organisation represents a highly valuable social investment, by very many people and it has an important role to play in future, including a role in the mortgage market. But it should first be supported by the regulations and enabled to get on with its current role, through relaxation of the upper rate of interest and redefinition of its policy of mutuality, to encourage responsible differential risk pricing