THE news that Newbridge Credit Union has been taken under care by the Central Bank is a source of great concern to depositors.
However, the situation is not all dire
Credit unions play a vital role in the Irish financial system. Total assets (loans outstanding in the main) as of 2010 were €21 billion, about 5% of the total amount of loans outstanding to Irish residents as of that date. If €1bn 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 to banks.
The domestic banks as a whole, at end 2010, had a loan-to-deposit ratio for Irish residents of approximately 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.
Credit unions have a long history of co-operative and alternative form of banking. Within Europe, cooperative banks have approximately 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 co-operative banks include Rabo, CoOp (UK) and Credit Agricole. The evidence is that co-operative banks are similar to other banks in terms of operational efficiency, but provide lower returns on assets than shareholder-owned banks. They typically are smaller than shareholder banks, but the largest co-operative banks are amongst the largest in the world, and have retained strong credit ratings.
All financial services industry participants work within the same broad environment. In principle a co-operative 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.
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 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, 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 commercial and residential values in Ireland are down 20%-25% since, were the non-NAMA loans to be now sold off it’s 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 for these deposits. Thus, the effect of the solutions has been to force the non-Nama/covered banks to either exit, to accept they will be acting at a disadvantage, or to engage in more risky activities. None of these are conducive to good healthy banking.
The evidence is that more competitive banking systems may 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 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, enabling one or two competitive but co-operative owned banks to emerge.
Some encouragement of the formation of new co-operative banks would be useful, as would be a consideration of whether or not we should cap the size of domestic banks, to consider 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, co-operative by preference banks which can compete on a new level playing field.
— Brian M Lucey is Professor of Finance, School of Business Studies, Trinity College
© Irish Examiner Ltd. All rights reserved