Credit Unions have an important role to play in our volatile times. We look at ways in which they can improve and adapt in order to survive into the future.
The recent failure of the Castle & Crystal Credit Union brought into sharp focus the vulnerability of these community institutions to both micro and macro challenges. Coming hard on the heels of the demise of the 6 Towns Credit Union and the Birmingham Inner Circle Community Credit Union, and the folding of some 85 other Credit Unions between 2002 and 2015, it’s clear there is a problem that’s not going away any time soon.
That Credit Unions are under pressure is not in dispute. Legal restrictions on their composition mean they are more dependent on depositors and exposed to borrowers with common risk profiles. This makes it difficult for them to diversify. Capital adequacy, asset quality, earnings performance, and liquidity are all factors that can ultimately lead to their failure.
Promoting financial wellbeing
Credits Unions can trace their history to the 1840s. A group of weavers in Rochdale created their own society, selling shares to members to raise the capital to buy goods at lower than retail prices. They then sold those goods at a saving to the members. The idea caught on, and the concept of a ‘Credit Union’ spread across the world. Their mission then, as today, is to promote the financial wellbeing of their members. They do so by providing a broad range of financial products, mainly loans, but also venturing into mortgages, bank accounts and ISAs.
Unlike banks, they’re not subject to market pressures for growth, earnings and performance, which begs the question: why do they fail? It’s also interesting to consider why they are failing now. Is it a trend? And are there are any common reasons why?
The Bank of England’s review of Credit Union failures five years ago highlighted many of the challenges they face. The biggest single pressure was one of regulation, and the onus placed on reporting. So that their performance can be monitored, every Credit Union is obliged to submit details of assets, liabilities, profit and loss and liquidity. The regulator requires them to maintain a minimum level of capital and liquidity, and a liquidity ratio (taking into account risk-adjusted capital and provision of bad debt) of 10%.
Vulnerability to shocks
Simply put, Credit Unions fail because their capital and liquidity fall below the minimum levels required, and lower capital ratios make them more susceptible to shocks. The most vulnerable of all tend to be the smaller, less well-capitalised and less profitable Credit Unions. These are not so able to withstand macro-economic factors such as increasing national unemployment rates and inflation.
This shouldn’t be a surprise. As far back as 2010, Liverpool John Moores University (LJM) wrote a paper summarising the principal reasons for failure as loan delinquency and bad debt, invariably in the context of a poor economic environment. Credit Unions just ran out of cash because they had insufficient income to meet expenditure. Losses were eroding their capital base, made worse by the end of local authority grants and government subsidies on which they’d once relied.
While those are the technical reasons for failure, they only go some way to explaining the ‘why’. LJM was quite brutal in its assessment. It cited a lack of financial discipline, a lack of financial control, and a paucity of financial information at board level. It called into question the boards’ ability to think strategically and adapt to changing environments, and their fitness to accurately and meaningfully analyse financial results.
The management factor
The paper went further, highlighting poor lending decisions that stemmed from weak credit administration, and inadequate management of the loan portfolio. These meant the Credit Unions were financially overexposed. It also cited an inability to diversify risk, which increased their vulnerability, and a lack of formal systems and controls to prevent potential problems or deficiencies from being highlighted sooner.
Macro issues were, of course, also a factor, as well as ‘regionality’. If a membership was reliant on a small number of regional employers, the failure of any one of those would negatively impact loan book collections. Poor economic conditions that bordered on recession also led to a reluctance by borrowers to take on credit.
Perhaps the elephant in the room as to why Credit Unions fail, but which LJM was bold enough to address, was the competence of the management. Did they have the right skill set to analyse financial data, ask challenging questions and hold employees and indeed other board members to account?
Many board members were, and still are, willing members of the community who want to do right by their local area, but don’t have the commercial culture and business instinct to make it work. A lack of succession planning and single points of failure (ie an over-reliance on one or two key individuals) also led to difficulties, as did gatekeeper founder members refusing to allow the Credit Union to evolve.
Priorities for success
LJM’s assessment, and the more recent Bank of England review, in many ways match what we have observed from working with Credit Unions in Administration. So it’s interesting to contrast a regulatory and academic view with the perspective of the directors themselves when they’re struggling with a potentially failing entity. There are lessons, too, that other Credit Unions could learn as a result.
In our experience in dealing with the Administration, default and wind down of Credit Unions the majority had all suffered with significant and recurring issues with their IT and operating systems, which could therefore be considered as a contributing factor to their failure. Therefore, investment in new technology, and better training for those who use it, would certainly help. That way, they would gain access to more accurate and timely information about loan book provisions and losses – which would in turn prevent them from breaching regulatory requirements. Focused investment to update operating software also means current platforms remain compatible with regulatory standards.
Though expensive, technology is a comparatively easy fix, as long as resource is also employed in the required training of staff to fully benefit from this significant investment. In addition, perhaps a bigger challenge is ensuring that Credit Unions receive appropriate professional advice and support when they need it. A good auditor, for example, will identify issues and shortfalls early, and provide the board with an accurate view of the actual financial position and underlying trends.
Procuring well is also important. Good outsourcing decisions can prevent a Credit Union from entering a contract (for the provision of new office equipment or third-party credit control, for example) that it cannot afford. Similarly, recruiting well, and making sure those employees are fully supported, should prevent critical members of staff from being overwhelmed and making mistakes as a result.
Marketing to attract new members is critical, as is ensuring the right products are being made available to the right people. Encouraging new talent to join the board is also vital. But it’s increasingly difficult in an age where many are time-poor, and balancing a voluntary role with their everyday work can be a challenge.
However, the future success of Credit Unions is dependent on having a new generation of executive-level board representatives with current industry knowledge. They will need to work with existing board members, with time served, to deliver the optimum blend of age and experience. It’s also important to ensure the board remains focused, energised and engaged. Fatigue can inevitably lead to poor decision making, however well-intentioned.
Adapting to shifting sands
Some of the challenges Credit Unions face are not of their own making. Take the pressure to offer ‘free’ services and apps, like the banks, difficulties with mergers to achieve economies of scale, and ongoing decline in the grants, reliefs and financial support available from local councils. The cost-of-living crisis and inflation mean many borrowers are unable to keep up with their repayments. This, combined with falling memberships, makes a difficult situation harder still. It doesn’t help that legislation makes it too easy now for individuals to escape unsecured borrowing through easy-to- access debt management offerings.
It’s no surprise that failing Credit Unions share common issues with any failing business. Their boards recognise they’re becoming increasingly vulnerable as the economic environment grows more uncertain. The successful Credit Unions of the future will likely be those that are quickest to adapt to a changing economic and political landscape. They’ll recognise that the old model of providing cheap finance to a narrow demographic only works if they are adequately funded. And since public sector funding is drying up, they’ll need to become more profitable by being more efficient and investing in technology.
This transition to a new state is not going to be easy, but it is essential. Credit Unions have a vital role to play in communities and their survival is important. They’re not simply symbols of ‘fair’ finance, but rather deliver tangible support to the people who most need it in a space that the Government does not currently support.
Even though they’re not for profit in structure, they will need to adapt their business model. And that means a potential shift in mindset. To prosper and grow, they will need to look and act like other commercial entities and diversify the products available to members where the business risk is reduced.
