Mr. Chairman, Delegates,
The financial and economic world which we now inhabit is a radically different place than that which existed when we met a year ago. Many of the old certainties are gone and we all have to adjust to the new realities which now exist and which will continue to emerge. The financial landscape is now somewhat analogous to the physical landscape which emerged a few years ago after the destructive Asian tsunami receded. Structures which once seemed impregnable lie in ruins and reputations have come crashing down. It is fair to say that the financial world has been changed irrevocably both nationally and internationally.
In speaking to you here today I have to acknowledge that my own organization has suffered criticism as a result of the banking crisis. However, I think you would agree, in hindsight, that at all times we have acted in best interest credit unions and their savers.
One part of the Irish financial industry which has stood up better than most to the battering which the financial system has taken has been the credit union movement. While credit unions have not escaped unscathed from the global storm that has swept over the financial system they have, so far, stood up very well to the stresses. Despite the damage done by investment losses in many credit unions, the movement itself, taken in consolidated form, remains robust. However, I would caution that the movement is facing a year of unprecedented difficulty in the economy which will require credit unions to make significant changes in how they do business. But more of that later.
It might firstly be useful to examine the strengths underpinning the movement that have buttressed its survival in the teeth of the financial storm and perhaps also to look at where it may have taken a wrong course in some situations.
The credit union model, based on member interdependence and mutual support is, to my mind, central to the strength of the movement. The ethos of self-reliance, prudence and thrift are, of course, an integral part of this model. The financial model arising from these underlying principles that is enshrined in the Credit Union Act (despite all its defects), is inherently robust. This is despite the fact that the apparent imbalance between funding from members, which is mostly on demand, and loans and investments which are not, seems to defy the laws of financial gravity. However, because of the checks and balances which are inherent in the model, especially those which moderate any tendency to a serious asset liability mismatch, (e.g. Section 35 of the Act) the model is inherently quite stable.
I believe that one of the key reasons for the strength and flexibility of the movement is a characteristic that cannot be described on a balance sheet. That is the fierce loyalty of credit union members to their credit union. I was very gratified to see that in the cases where credit unions were able to pay only a reduced dividend or no dividend at all for the year just ended, that members resolutely stuck with their credit union. In cases where serious losses or other problems arose this has also proven to be the case. This reservoir of goodwill or “Brand Loyalty” as a marketing guru might describe it, cannot be valued on a balance sheet but most definitely is the invisible pillar on which credit unions rest. The dedication and skill of credit union directors and supervisors and in particular the sound common sense and knowledge of local affairs of such people, is undoubtedly a critical component of the strength of the movement. Professional managers have also played an important part in steering the movement to where it is today.
I mentioned the word prudence a moment ago in relation to the ethos of the movement. I firmly believe that the historical culture of prudence in the lending function to which many, but not all, credit unions clung, also provided a stabilizing sheet anchor which kept the ship steady.
You could be forgiven for thinking that I am saying that the credit union movement is indestructible. This is clearly not the case for any industry, and the speed with which once household names can collapse has been amply illustrated over the past few months.
It is important to note where the movement has suffered damage in recent years but it is also now vital to look forward in an attempt to anticipate the threats of the future. It is not an exaggeration to say that the Irish economy has suffered a dramatic slowdown. Business collapses, job losses, cutbacks etc. are at a high level. Credit unions should prepare themselves for an extremely difficult year in managing their affairs. Unprecedented pressures can be expected in the lending and investment functions and credit unions will need to manoeuver carefully to maintain their stability and to protect their members’ savings. Consequently, this economic slowdown must also be matched by an appropriate application of the brakes in credit unions, where necessary, in the areas of lending and investing, so that a runaway situation can be avoided. A prudent application of the brakes as the road descends is preferable to waiting until it is too late to avoid going off the road when a sharp bend is encountered.
Credit unions can expect further losses on investments in 2009, particularly those made before October 2006 – the date of the issue of our guidance note on investments. It is likely that further losses could arise from perpetual bonds, the Central Treasury Management Fund and equity based products. Credit unions should prepare for these losses and should try to anticipate the likely effect on solvency and liquidity. It is particularly important that very close attention is paid to the availability of liquid funds. Unless there is absolutely no risk to future liquidity, credit unions should limit their lending to a conservative percentage of their cash inflow on a monthly basis. It is no longer safe to assume that a liquid market exists for all investment instruments (other than bank deposits). Some investments, while retaining their inherent long term value, may now be difficult to realize at short notice.
Our circular of 13 January requires credit unions to give priority to the holding of surplus funds in liquid form. I know that some credit unions will consider that such a requirement is unreasonable due to the present prevailing low interest rates. However, we take the view that when an investment is being made that the decision pyramid must always prioritize capital security and liquidity over return. The chasing of return by credit unions in the past has been akin to a desert traveler chasing a mirage and this has led some credit unions into the quick sands. Please, therefore, beware.
With regard to the boards of those credit unions which have suffered investment losses, I would say the following – Promises about investment returns that appear to be too good to be true are, generally, just that. You should always read all of the investment contract material carefully and seek professional advice about its content and conditions prior to making any decision on such a matter. You should rely only on the written contract and not on verbal assurances provided by the broker or product producer.
In common with other lenders many credit unions drifted away from the strict lending criteria which traditionally set conservative limits to loan approval amounts on the basis of a member’s income, savings record and local standing. In addition, some credit unions ventured into business lending or even project finance, not always with a successful outcome.
Consequently, arrears in credit unions have been rising and this trend needs to be carefully controlled and reversed. Loan repayments including interest, constitute the most important cash flow source for most credit unions. Loan advances represent the largest channel for the outflow of liquidity and these must be carefully controlled.
Credit unions, especially their credit committees can expect a sharp increase in the demand for loans from existing and new members. It is of particular importance that the credit committee should be given clear monetary limits on the total funds available for the granting of loans, bearing in mind the availability of liquid resources. Close monitoring of liquidity inflows and outflows in the lending function must take place on a weekly basis. The extent to which loans may be made must be strictly related to the intake of cash from borrowers, and investments, adjusted for savings movements. Each credit union should examine its own cash flow to determine a safe rule of thumb in setting limits for the approval of loans for the credit committee. We have now introduced monthly reports for selected credit unions where we believe liquidity is lower than normal so that we can monitor such situations. Such reporting will be extended to other credit unions, as necessary.
To those boards which have been engaged in the provision of loans for purposes and for amounts which would never have been regarded as normal for the business of a credit union, I have this to say. Please stop trying to be banks. Borrowers have a choice of banks from which they can borrow. Lending for commercial property, project finance or main line business activity is not the business of credit unions and is not in the interests of members.
Taking Stock There is no reason why credit unions cannot survive and thrive in the present financial storm. There are however, a few provisos:
- Liquidity is now king and the focus of day-to-day management must be to ensure that adequate liquid resources are always available for operational purposes. All surplus funds must be held in liquid form.
- Lending criteria must become more restrictive and should be based on carefully researched criteria and on conservative estimates of the ability and commitment of the potential borrower to repay a loan.
- Strict cost control must be implemented. Capital expenditure (e.g. on premises) must be carefully evaluated and curtailed unless strictly necessary.
The rights of savers must be prioritized over those of borrowers.
If I wanted to summarize what I am saying here today it would be that credit unions must get back to basics – to their origins – to their real purposes. In that environment credit unions were safe and thrived and were insulated from the ups and downs of the outside financial world. They can thrive even more in these hard times and serve their members in the way that the founders of the movement intended if the few basis principles I mentioned just now are observed.
Should you wish to ask me questions about what I have just said or if you have any comments I would be happy to hear them.
Many thanks for your kind attention.