Introduction
Since early 2022, Ireland's financial sector has faced a significant paradox, particularly in its credit union system. Despite a widespread network of credit unions, there has been a concerning rise in money lending activities across the country. Notably, credit unions are under-lending, with only 27% of their deposits currently lent out in loans, leaving an immense €15 billion un-lent and not deployed to maximum advantage. This situation has compromised the financial health and sustainability of credit unions and hindered their community service capabilities.
UK moneylenders have entered the Irish market, offering loans at rates exceeding 100% per annum, which has starkly contrasted with the more conservative offerings of credit unions. This trend has been exacerbated by the former restrictive regulatory cap of 12% per annum on interest rates for Irish credit unions, limiting their ability to cover operational costs and manage the predominantly unsecured credit risks effectively.
The Permitted Interest Rate
The former 12% per annum interest rate cap has significantly constrained the operational and financial flexibility of Irish credit unions. After covering about 2% for staff costs, a minimum of 1% for funding costs to depositors, and at least 2% for reserves, only a maximum of only 7% remained to address credit risks. This narrow margin was insufficient for the real risks in consumer lending, especially considering the unsecured nature of these loans.
In contrast, UK credit unions are authorised to charge interest up to 36% per annum, giving them up to 31% to manage credit risk (after similar operational costs), compared to the former Irish maximum of 7%. The lower earnings of Irish credit union depositors, resulting from unrealistic loan pricing, have also emphasised the need for this reform. It might now be argued that the new Irish limit of 24% could be raised to match the UK level to accommodate a more realistic level of credit risk and support better risk management.
Challenges in Loan Pricing
Irish credit unions face operational challenges due to the convention of charging one uniform interest rate for each broad class of assets, where 'class' remains undefined. This policy fails to address the higher risks associated with lower-earning, heavily indebted borrowers, as opposed to more financially stable members. It also prohibits differentiating between risks inherent in different loan types, such as long-term versus short-term or larger versus smaller loans.
The result is an averaging of pricing and the detrimental cross-subsidization of all lending. Empirical analysis shows a high concentration of risk in specific loan maturities, value bands, and certain assets like car models, with some loans charged interest rates even below their measurable credit risk. Credit unions should be encouraged to use credit risk analytics software to differentiate risk pricing, aligning better with the principle of mutuality.
Mutuality in Credit Unions
Mutuality in credit unions, also in building societies, requires members to support each other through the depositing and borrowing process. This principle implies that depositors will accept lower interest on deposits to facilitate lower rates for borrowers, with the understanding that sacrifices made today are repaid later.
The concept of mutuality is intended to operate across member classes, not between loan types. Therefore, mutuality requires an efficient operation to achieve mutual support for both depositors and borrowers, without resorting to unrealistic or indiscriminate risk pricing or the wholesale cross-subsidization of manifestly poor loans.
The Future of Irish Credit Unions
The story of the Irish credit union movement is one of impressive growth and valuable social investment. Credit unions have a vital role to play in the future, especially including participation in the mortgage market. However, to realise this potential, they need regulatory support, particularly in redefining policies of mutuality to encourage responsible and differential risk pricing.
Conclusion
Irish credit unions are at a pivotal juncture, facing challenges like competitive pressure from high-rate moneylenders and, following the withdrawal of Ulster Bank, more aggressive lending from the main banks. To navigate these challenges, a combination of regulatory reform, operational adaptation, and a reinvigorated commitment to the principle of mutuality is required. By undertaking these strategic changes, Irish credit unions can continue to thrive, offering vital and equitable financial services to their communities and playing a strong, relevant role in Ireland's evolving financial landscape.
