August 2011A CO-OPERATIVE BANKING STRATEGYFOR IRELANDConceptualising a Strategic NetworkAmongst Credit UnionsCreating a na...
A CO-OPERATIVE BANKING STRATEGYFOR IRELAND1: Introduction and Summary........................................................
1: INTRODUCTION AND SUMMARYThis submission considers the concept and high level strategic business case for creating a nat...
Credit unions should focus on excelling at their core business and offer a wider range of updatedsavings and lending produ...
participation, capital funding, loan securitisations, risk management, compliance, audit, legal, HR,IT systems and interme...
This submission proposes a movement strategy. Any further development would consider thestrategic rationale in detail incl...
2: BACKGROUND TO CREDIT CO-OPERATIVE BANKINGCredit Unions and Credit Co-operatives InternationallyCredit unions have histo...
regulation and supervision and deposit insurance systems closely mirroring or integrated with widerbanking systems.Althoug...
Ireland     U.S.   Canada   Australia                      Payments Services                           Current account equ...
International Models for Centralised Co-operative BankingA key characteristic of these successful credit union/co-operativ...
In each of these cases, the functions and structure of the central system reflect unique localcircumstances of history, ma...
Co-operatives were maximising stakeholder’s interest long before commercial banking began to talkof corporate social respo...
3: NETWORK RATIONALISATION AND CONFIGURATIONThe credit union movement should be realistic about the future of the smallest...
In the past, rationalisation was an inevitable consequence of success which for various reasons wasdelayed by the Irish mo...
based credit unions could be consolidated into just one central office to provide branded services totheir members from on...
4: THE NEW MODEL CREDIT UNIONTransitioning to the savings and loans model will require substantial changes to the balance ...
The share account should be retained only as an account denoting member’s ownership share in thecredit union. It should be...
Credit unions should partner with high quality, reputable mortgage lenders as loan originators. Overthe longer term, via t...
The sector should guard against IT projects driving the business strategy. IT should enable delivery ofthe business requir...
These findings show a result that most people will find surprising. Financial exclusion is not seen asthe primary orientat...
directors establish clear policies, expectations and goals, where results are objectively measured andrewarded – and where...
5: A FEDERATED NETWORK OF CREDIT UNIONSIt is a matter of historic record that while credit unions in Ireland have long rec...
survive and thrive. And collectively they demonstrate an inability to co-operate together and createthe central finance sy...
A Federated NetworkCreating a federated financial infrastructure and shared services alliance between credit unionswould s...
The creation of a comprehensive, centralised support system has been a long-term goal of Irish creditunions, and it has be...
The Federated Alliance – evaluation criteriaTo be achievable, any plan for an alliance must meet the following criteria:  ...
vibrant alternatives to banks through expanding products and services, delivery channels andnumber of branch outlets. In C...
of financial soundness and operational professionalism. This critical dimension is discussed in greaterdetail below.A prop...
Legal Simplicity. Participating credit unions would retain their current legal forms, pursuant to theCredit Union Act. It ...
Anticipated business advantagesNotwithstanding the logic of the proposed ownership structure, the likely success of the al...
Given their need for professional liquidity management, credit union access to current accountservices should be condition...
Anticipated business disadvantages and obstaclesThe potential disadvantages of the proposed structure come from the execut...
APPENDIX 1 : NOTE ON FEDERATED CO-OPERATIVE SYSTEMSAtomisation or FederationGlobally credit co-operatives have developed f...
The following diagrams capture the stages of development from atomised credit co-operatives(Ireland) to federated strategi...
A co-operative banking strategy for Ireland
A co-operative banking strategy for Ireland
A co-operative banking strategy for Ireland
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A co-operative banking strategy for Ireland

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Credit Unions in Ireland are facing significant challenges. This paper, submitted to the Irish Government's "Commission on Credit Unions", proposes that credit unions transition at pace to a modern co-operative banking system. Transitioning would require (a) sector rationalisation to a sustainable network of "consolidator" credit unions (b) transition of these consolidator's to a new business model - the savings and loans model and (c) consolidator's participate in a federated network having an apex organisation/central financial facility underpinned by contractual solidarity and cross guarantees.
In essence the resultant network would closely mirror those successful co-operative banking networks found in Northern Europe and North America.

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A co-operative banking strategy for Ireland

  1. 1. August 2011A CO-OPERATIVE BANKING STRATEGYFOR IRELANDConceptualising a Strategic NetworkAmongst Credit UnionsCreating a national, community focused, citizen owned and governed federatedco-operative banking system. "The way we see things is the source of the way we think and the way we act" Stephen CoveyA personal submission by Bill Hobbs to the Commission on Credit Unions, 25th August 2011. -1-
  2. 2. A CO-OPERATIVE BANKING STRATEGYFOR IRELAND1: Introduction and Summary...................................................................................... 32: Background to credit co-operative banking............................................................. 7 Credit Unions and Credit Co-operatives Internationally .......................................... 7 International Models for Centralised Co-operative Banking ...................................10 Structuring Irish credit unions as a modern co-operative banking system .............123: Network Rationalisation and Configuration............................................................134: The New Model Credit Union.................................................................................16 Savings Products ...................................................................................................16 Lending Products ...................................................................................................17 Operational Model..................................................................................................18 Governance Model & Strategic Orientation............................................................195: A Federated Network of Credit Unions ..................................................................22 A Federated Network .............................................................................................24 The Federated Alliance – evaluation criteria ..........................................................26 A proposed federated structure..............................................................................28 Anticipated business advantages...........................................................................30 Anticipated business disadvantages and obstacles ...............................................32 Government support ..............................................................................................326: Conclusion.............................................................................................................32Appendix 1 : Note on Federated Co-operative systems ............................................33Useful Referent Documents.......................................................................................37 -2-
  3. 3. 1: INTRODUCTION AND SUMMARYThis submission considers the concept and high level strategic business case for creating a nationalco-operative full service banking alternative for Irish consumers and small business owners through astrategic network alliance of consolidated credit unions.The credit union sector should adopt a federated strategic network as its core infrastructure forensuring individual credit union financial stability and sustainability and strengthening the sectorsfinancial stability.Such a network would be modelled on successful designs for centralised co-operation that have beenkey to the success of other co-operative banking systems globally – but which have not yet beenconsidered or implemented in Ireland.Given the success of federated credit co-operatives elsewhere and proven resilience of their businessmodel during the recent global crisis, it would be unwise not to consider this viable and robust formof co-operative banking in the Irish context.Envisaged is a citizen owned and governed federated financial co-operative system, guided by creditunion philosophy, values and ethos, offering a full range of consumer and small business bankingproducts and services.Such a system would be modelled on the European style federated network, have a customer base ofover 2m ordinary citizens who would also be its owners.Initially, excelling at providing savings and loans, it could in time provide full banking services througha national network of enlarged, consolidated credit unions and their jointly owned electronic,internet and call centre service delivery channels and special purpose subsidiaries.The shift to a federated model would require three important steps: 1. Network rationalisation through consolidation to realise scale economies 2. Transition to a new model credit union - the “savings and loans” model 3. Strengthening the financial infrastructure through contractual solidarity and cross guarantees, to be effected by the establishment of a central finance facilityFor many reasons the Irish credit union “finance company” business model and networkstructuration, with its emphasis on the independent, autonomous credit union and loose formLeague associational system, is inappropriate for the future development of the sector.The movement has not transitioned to the “savings and loans” model nor developed the cohesivecentralist finance systems found in every other credit co-operative sector in mature financial servicemarketplaces. It also utilises a model of governance rooted in legacy part-time volunteerism thatconfuses non-executive director with executive management roles.It’s proposed that a new model credit union be defined and credit unions required to transition to itwithin a defined period of time. -3-
  4. 4. Credit unions should focus on excelling at their core business and offer a wider range of updatedsavings and lending products that meet the needs of modern consumers. They should 1augmentthese core products with related fee earning products and services.The large scale now required for banking services to be competitive means that smaller players likecredit unions must specialise to survive. It is just not possible for credit unions to be all things fortheir customers and still give them the best deal. However their basic business of consumer savingsand lending can achieve scale economies at the size presented by the configuration of consolidatedlarger credit unions, an example of which is set out in this submission.To succeed in the future credit unions will have to excel at delivering low cost, high quality savingsand loans products and services to ordinary people. In short they have to be the best at delivering ongeneric category benefits which include choice, service and price elements. They will have to adoptmarket-based principles of pricing to ensure better rates and terms for customers. To do this theywill need to upgrade their IT, operational systems and internal controls to achieve greater efficiencyand safety. However in the absence of consolidation to realise scale economies and build human andoperational resources competencies, credit unions will be unable to truly deliver on their economicand social objectives.Complexity requires scale economies to spread the costs of the more sophisticated technologiesrequired to deliver modern financial services and products. The current operational model is one ofhigh-cost, low-value transactions, mainly handled through manual processes. The costs of operatinga manual delivery and service processes are unsustainable as they have eroded profits in many creditunions to a point where operating costs exceed core interest income. Routine transactions must beautomated to keep down costs. People now want 365/24/7 service and their lives are too busy tostand in teller queues. ATM and internet delivery channels are now a given service feature requiredby almost all consumers.Furthermore the heterogeneous aspect of credit union operations, their varying size and restrictivecommon bonds prevents the best from expanding their operational footprint, allows poorlygoverned and managed operations to continue and inhibits the type of competitive merger activitythat has been a positive aspect of other movements for at least two decades.The credit union sector of c409 independent credit unions should be rationalised to a size where itsconstituents would be of size capable of realising scale economies and participating in a federatednetwork. I refer to these larger credit unions as “consolidator credit unions” in this submission.On their own credit unions will struggle to deploy the technologies required to provide low cost, highquality services. Even when consolidated they would remain quite small operations with limitedfinancial, IT and human resources.A central facility as envisaged here would employ the expertise required to deploy the technologiesto enable credit unions transition to the new model credit union. More specifically the central entitywould facilitate the design and implementation of a new operations model including enablinginformation technologies and management systems.Credit unions should establish or source a joint venture and co-own such a 2“Central FinanceFacility”. It would operate as a corporate services centre and wholesale bank providing a range ofshared services which, amongst others, would include treasury, central liquidity, MMR1 In so far as entering the “current account” market or providing “basic banking accounts”; it is not within the current organisationalresource, capacity or competence of credit unions, regardless of size, to fund the operational costs associated with these products. Anyconsideration in this area should be secondary to the core objective of excelling at the savings and loans model for the time being2 “Central Finance Facility” is a term used by international credit union trade body WOCCU to define central corporate entities owned byconstituent credit unions -4-
  5. 5. participation, capital funding, loan securitisations, risk management, compliance, audit, legal, HR,IT systems and intermediated products and services.This central entity might in time be granted devolved supervisory responsibility for its constituentcredit unions and would also provide a stabilisation mechanism based on contractual solidarity andcross-guarantees. In essence the central entity would leverage off its constituent owners combinedbalance sheet. Such central facilities are found at the core of European credit co-operatives such asRaboBank (Holland) and Oko Bank (Finland).In a federated system, consolidator credit unions, whilst ceding some strategic and operationalautonomy, would retain independent legal status, local governance, with each one having its ownmulti-branch network. Such multi-branch networks would be a consequence of the rationalisation ofnon-viable credit unions and those that opt to consolidate through mergers. Furthermore, in linewith developments in other markets, credit unions would be likely to open new branches inunderserved areas.Credit union network reconfiguration would be dependent on a number of variables includinggovernance and management competence, financial strength and sustainability, geographic locationand type (community, associational, employer based).The diagram below is a stylised design for the federated network organisational structure envisagedin this submission.It is likely that the once dominant, cartel like, oligopoly of the two main commercial “pillar” banks,Bank of Ireland and AIB will re-emerge leading to a reduction in competition and the mass captivityof consumers and small business owners. It is unlikely that any new entrants will be attracted intothe Irish marketplace for some time to come and existing foreign banks will respond to the demandsof parent organisations having differing objectives. Pricing of products will be driven to repair theirbalance sheets, rather than for the benefit of the customer.The use of tax-payers funds to stabilise banking could have a wider economic and societal purpose ofenabling the creation of a viable co-operative alternative to commercial banking.One of the intriguing opportunities to fast track the creation of a federated co-operative bankingsystem could have seen a joint venture between a building society and credit unions to establish acentral facility which would have incorporated the corporate support service capabilities andresources of the building society. However, exploring this opportunity appears to be no longerfeasible. -5-
  6. 6. This submission proposes a movement strategy. Any further development would consider thestrategic rationale in detail including funding implications. -6-
  7. 7. 2: BACKGROUND TO CREDIT CO-OPERATIVE BANKINGCredit Unions and Credit Co-operatives InternationallyCredit unions have historical roots in the credit co-operative movements that first appeared in 19thCentury Europe. During times of industrial development and social disruption, small groups ofpeople banded together to pool their savings and grant loans to one another. The primary economicand social purpose of these co-operatives was to provide credit to people who were financiallyexcluded – unbanked because commercial banks were not interested in serving them on anaffordable basis.Credit co-operatives spread throughout Europe, crossed the Atlantic to Canada, and in turn wereadapted in the U.S. in the form of credit unions. It was the U.S. credit union model that waseventually established in Ireland in the 1950’s.Today, in developed countries other than Ireland, most credit unions and similar credit co-operativeshave adopted the “fractional reserve banking model” and are regulated as authorised creditinstitutions. Although they typically operate under legislation specific to their unique mutualownership and democratic governance, outside Ireland they are supervised under regulatory regimesevery bit as robust as those which traditionally governed commercial banks.The evolutionary path common to all credit co-operatives has been a three stage process, which hasfollowed a different time line in each country. At first, the business model was that of a “financecompany” or type of “narrow bank” in which member’s accumulated savings by purchasingwithdrawable capital shares, thereby providing funds for making loans. Only after a member hadpurchased some minimum amount of shares could he or she then borrow. Shares formed part of thecapital base and were exposed to the risk of the business. Tight common bonds of association actedas collateral for members loans.Lending was typically done at a simple interest rate of 1% per month on the unpaid balanceregardless of market conditions.3 Instead of receiving interest on their savings based on marketrates, members shared in the co-op’s lending profits by receiving a dividend declared at the end ofthe year. Management was typically in the hands of unpaid volunteers. Initially credit co-operativesbanded together loose form associations e.g. credit union “Leagues”, establishing some sharedservices and mutual stabilisation funds used to support growing balance sheets – in particularproviding early stage capital support.In the second stage, they evolved into “savings and loans co-operatives”, thereby shifting to thefractional reserve banking model, adopting market based pricing and offering a broader array ofdeposit and lending products to their personal and small business customers. Those were typicallyaugmented with fee based services such as transaction accounts and simple insurance products, andcredit unions in this stage were managed by professional staff. This stage also saw credit co-operatives establishing corporate central facilities through which they pooled excess liquidity,accessed liquidity support from one another and the wholesale banking market. In some cases thesecentral facilities evolved into wholesale banking arms with devolved supervisory powers. Mostoperated as lender of last resort for their constituent members. This stage also sees thedevelopment of robust financial safety nets with developed legal frameworks, differentiated3 The “1% per month” loan rate is still widely used by smaller Irish credit unions, which then may pay a year-end interest refund if earningsare sufficient. Although it is seen by some as having its roots in credit union philosophy, the practice is actually an obsolete carryover fromthe days when credit unions lacked even electronic calculators. On a paper-based system, even relatively untrained volunteers couldreadily calculate the interest due on a loan each month. -7-
  8. 8. regulation and supervision and deposit insurance systems closely mirroring or integrated with widerbanking systems.Although Irish credit unions have broadened their product range somewhat, they remain stuck intransition between these first two stages of development. With deposit products largely limited tothe member share account, their savers are still paid an annual dividend out of net earnings at a non-market-based rate. Lending is still done using the basic instalment credit loan first introduced in the1950’s. While the larger ones have paid staff, many of the smaller ones are still operated largely byvolunteers. IT systems are relatively primitive, and Irish credit unions do not provide current accountand only very limited electronic transaction services. Nor are they full members of the national retailpayment system. Furthermore credit unions have not developed the central facility commonly foundtoday in developed credit co-operatives elsewhere.In these countries, credit co-operatives have long since entered the third and final stage ofdevelopment. This occurred earliest on the Continent with the evolution of full service co-operativebanks offering a broad range of financial products. Credit unions in other major markets such as theU.S., Canada, and Australia have likewise become “full-service consumer banks”, while still operatingas mutuals and governed on the basis of “one member, one vote.”Credit co-operative evolution is illustrated in the diagram below:The diagram on the next page illustrates the gap in product and services offered by Irish credit unionswhen compared to their international peer group’s full service models. -8-
  9. 9. Ireland U.S. Canada Australia Payments Services Current account equivalent No Yes Yes Yes Debit cards No Yes Yes Yes EFT paym ents No Yes Yes Yes Proprietary ATMS Yes Yes Yes Yes Bank ATM network access No Yes Yes Yes Savings and Deposits Rates vary by type/m aturity No Yes Yes Yes Certificates of deposit equivalent No Yes Yes Yes Tax deferred or sheltered Yes Yes Yes Yes Lending Services Secured auto loans No Yes Yes No 30 Year 1st m ortgage Loans No Yes Yes Yes Open-end, revolving credit No Yes Yes Yes Credit cards No Yes Yes Yes Sm business loans all Yes Yes Yes Yes Wealth Management & Insurances Trust services No Yes Yes Yes Pensions Yes(PRSI) Yes Yes Yes Mutual funds No Yes Yes Yes Life Insurance No Yes Yes Yes General Insurance Yes Yes Yes YesToday, credit unions and other credit co-operatives provide affordable financial services to hundredsof millions of ordinary people worldwide.Across Europe, co-operative banking systems represent a major force through which 140 millionpeople, or one citizen in five, are customers and/or members. With over 4,500 individual banks,720,000 staff and 60,000 branches, European credit co-operatives collectively have a combinedmarket share of 20%. In five European countries they represent 40% or more of local bankingservices.In the U.S., credit unions serve over 90 million consumers and have total assets exceeding US$880bn.Their current share of the consumer savings and non-mortgage lending markets are 9.8% and 9.9%,respectively. Credit unions in Canada and Australia enjoy comparable scale and market shares. -9-
  10. 10. International Models for Centralised Co-operative BankingA key characteristic of these successful credit union/co-operative banking systems internationally hasbeen the existence of strong centralised support mechanisms. Development of these structures wasessential to achieving the scale economies and professional management systems required for creditco-ops to exploit the savings and loans model and to compete as full service financial institutions.For example, European evolution resulted in modern day federated networks such as Rabobank inThe Netherlands and Raiffeisen Banks in Germany and Austria. OKO Bank, a central bank for Finnishco-operatives, has established a listed subsidiary for accessing equity markets. Some of the largestco-operatives, such as Rabobank, have expanded beyond retail banking into corporate andwholesale, and even international banking. In all cases, the European co-operative banks provide afull compliment of consumer and small business financial products.In Quebec, the Movement Desjardins followed the European model, whereas in the other Canadianprovinces, credit unions developed federated networks around central (wholesale) credit unions.Two of the largest Canadian 4centrals have recently merged operations.U.S. credit unions evolved a more fragmented model using a blend of “corporate” central creditunions and credit union-owned service corporations for specialised functions such as IT, ATMnetwork administration, and support for shared branching. CUNA Mutual Group, the dominantinternational provider of insurance services to credit unions, began life as a subsidiary of CreditUnion National Association (CUNA), the U.S. trade body. CUNA also created U.S. Central Credit Unionas a central liquidity and investment facility for state-level corporate CUs. Both CUNA Mutual andU.S. Central are now completely independent from the trade association.Australian credit unions receive central services from their national body, CUSCAL, which is itself anauthorised depository institution. Recently, CUSCAL amended its charter to allow membership bybuilding societies and friendly societies, and it also provides transaction services to superannuation(retirement) funds5.From their start-up in the early 1990’s, Polish credit unions adopted a hybrid integrated model underthe oversight of a central body, and they operate more like franchised branches than independententities. Based on a system of mutual cross-guarantees, the Polish federated system fulfils EU capitalstandards by means of a consolidated balance sheet. Its central body provides payment system andinsurance services through listed subsidiaries, and it now has more retail outlets than any otherfinancial group in Poland.4 British Columbia and Ontario “central financial facilities” merger in 2008 created Central 1. Serving 164 member credit unions havingCAD$70bn in assets and 2.9m members, Central 1 has 500 staff and CAD$14bn in assets.5 The close association between Australian credit unions and building societies is illustrated in the merger between Maitland Mutual(building society) and Phoenix (credit union) in New South Wales. Australia has also seen the recent establishment of ABACUS as thecombined national trade body for 99 credit unions, 8 building societies and 15 friendly societies, which collectively have AU$75 billion inassets and 5.5 million members. - 10 -
  11. 11. In each of these cases, the functions and structure of the central system reflect unique localcircumstances of history, market environment, legal convenience, practical political compromise, andso on. Conceptually, however, these international models which are defined by their degrees ofintegration can be broadly categorised into the following basic types:Atomised: A system of autonomous and independent credit co-operatives where particularcentralised services are provided on a contractual basis by specialised commercial firms owned bycredit unions. (E.g. corporate credit unions, IT providers, ATM networks, insurance and brokeragecompanies in the U.S.) Typically credit unions or co-operatives remain autonomous in what’s calledan atomised system.Federated Network: Comprehensive finance, liquidity, and other services are provided through afederated structure led by a credit co-operative-owned central facility, which may itself be awholesale credit union (Canada) or a commercial bank (Australia, The Netherlands). This system isreferred to as a federated network.Integrated/Merged: Credit co-operatives share a consolidated financial structure, in which localoutlets operate in practical effect, if not legally, as branches of a central co-operative bank (Quebec,Poland).6 This system has been termed an integrated or merged system and is similar in almost allrespects to a branch banking system.For the reasons discussed later, the appropriate model for Ireland is likely to be some variation of thesecond category.Critics of credit co-operatives have long argued they are inefficient pointing out they hoarded capital.Those critics have been largely silenced since credit co-operatives proved the worth of their businessmodels as their longer term orientation and prudent focus on capital retention ensured resilienceduring the global crisis. The evidence highlights the need for legislators and regulators here tounderstand the difference between co-operative banking and commercial banking. That is tounderstand how the longer term co-operative orientation, unique governance structures, inherentfocus on consumer value and capital retention policies differ from their publically quoted joint stockbank competitors.Whilst the co-operative model has evolved in many differing forms, they all have one thing incommon; they are owned and governed by their members who are also their customers and allemploy the empowering democratic principle of one member one vote. This defining democraticprinciple, allied to embedded customer advocacy ensures co-operatives remain culturally andoperationally focussed on delivering affordable and valued financial services to meet their member’sneeds along with educating them in the wise use of money.The inherent financial stability of the federated co-operative model has proven resilient during theglobal credit crisis due to its prudent levels of capital and longer term orientation. It is for this reasonthat many consider federated co-operative banking systems to be resurgent as regulators begin totruly understand how their unique organisational form helped to underpin financial stability andkeep credit flowing when commercial banking had all but collapsed.6 With the exception of the Co-operative Bank in the UK, the European and North American models do not involve consolidation of co-operative banking into a single, legal entity. Even systems such as Rabobank fall more into the second category. While Rabo has theoutward appearance of an hierarchical bank, it is in fact a network of individual co-operatives. In that system, the emphasis is on localcontrol over product quality, which in turn creates pressure on the central to compete on quality and price. Thus, a local Rabobank mayoffer the products of third party suppliers who compete with the Rabobank central subsidiaries. - 11 -
  12. 12. Co-operatives were maximising stakeholder’s interest long before commercial banking began to talkof corporate social responsibility, triple bottom line or recognise a wider stakeholder responsibilityparadigm. In some respects the existence of co-operatives, their social contribution and successfulenterprise model is focusing minds on alternatives to the joint stock bank model of banking with itssingular focus on profit maximisation and shareholder value.Commercial bankers and stock market analyst critique of cooperative bankers prudence and strongcapital positions has been silenced. In many countries, at national level, cooperative banking is seenas a customer champion and a vibrant, safe alternative to commercial banking.Structuring Irish credit unions as a modern co-operative banking systemThe strategy would see credit unions restructuring as a European style credit co-operative system intwo phases.The first phase would require the rationalisation of credit unions into a reconfigured network oflarger consolidator credit unions of a size large enough to realise scale economies.The second phase would require these consolidator credit unions to transition to a new model creditunion focussed on excelling at savings and loans.Consolidator credit unions would be required to be members of a federated network which wouldestablish a central finance facility along the lines proposed in this submission.Alternatively such a central facility could evolve from a special authority established by Governmentcharged with overseeing and implementing a rationalisation programme and transition to the savingsand loans model. The authority would be empowered to create the federated network and establishthe central finance facility. If required, state funding could be made available to the authority. - 12 -
  13. 13. 3: NETWORK RATIONALISATION AND CONFIGURATIONThe credit union movement should be realistic about the future of the smallest credit unions andthose that have been poorly governed and managed.In the U.S., for example, the movement reached a maximum of over 24,000 credit unions in 1973,but that was at a time when only one American in seven was a member. Today the U.S. has about7,500 credit unions, but their average assets are close to 50 times greater and nearly one third ofAmericans belong. Canada and Australia had similar experiences.The chart below shows overall sector size and comparative data.Source: WOCCU Statistics (U.S., Canada & Australia 2010), CBI (Republic of Ireland 2010)In all these countries, the decline in the total number of credit unions was mostly the result of smallbut healthy credit unions merging into larger ones. The office of the merged credit union oftenstayed in place as a branch to serve the local community.There are three reasons why the number of credit unions could have been expected to decline hereas well.First, the smallest credit unions, with no employees and in which volunteers do all the work, arefinding it hard to recruit the volunteers they need. This is understandable. When credit unions werethe only reasonable source of credit for most people, there was a powerful incentive for volunteersto donate time to credit union service. That incentive is considerably lessened today.Secondly, the compliance burden on credit unions has increased over time. All consumers deservefinancial services that are delivered in a safe and reliable fashion, and the members of small creditunions are no exception. It will be difficult for a credit union to absorb the resulting costs ofcompliance unless it can spread those costs over a sufficiently large asset base.But most important, it will not be possible for many credit unions to offer the service levels thattoday’s consumers are demanding. The best strategy for many will be to join forces through mergersthat can give the surviving credit unions the scale they need going forward.While these reasons for rationalisation have been acknowledged here, the negative impact ofexternal forces (global and domestic) and internal financial stability shortcomings inherent within thebusiness model have starkly brought the need to rationalise to the forefront as a sectoral financialstability and sustainability challenge. - 13 -
  14. 14. In the past, rationalisation was an inevitable consequence of success which for various reasons wasdelayed by the Irish movement. Today it has become an inevitable consequence of poor governanceand management of many credit unions, an economic recession and a consumer credit crisis.One way in which to consider rationalisation is to focus on the number of customers served as thesenumbers drive savings and loans volumes, data management requirements, transactions, operatingcosts and interest revenues. They also indicate the potential for add on sales of associated feeearning products and services.To achieve scale economies it’s possible to define the appropriate network size by the numbers ofcustomers served. For example, whilst somewhat of an arbitrary number, 50,000 customers percredit union is useful to consider network reconfiguration.The chart below illustrates the resultant configuration should new model credit unions service7 50,000 customers each.Using this approach, the network would consolidate through a planned programme of mergers downto about 60 credit unions. In turn these “consolidator” credit unions would be required to transitionto the new model credit union – the savings and loans model.The resultant network is aligned on a loose form “county” common bond rather than the currentnarrow parish basis. It is likely that members would continue to perceive their credit union as being“local” and be persuaded by the promise of continuing access to improving quality products andservices. Indeed consumers should be free to shop around credit unions for the best deal, in whichcase membership should be open to anyone who wants to join.In so far as occupational/employer based credit unions are concerned, they have generally provideda postal type service from a central office to their dispersed members. More recently, most haveembraced the on-line or internet facilities. Some provide a branch/office/agent type location/facilityto deal with their walk-in member transactions. Even immediately, these occupational/employer7 Credit union total member numbers include active, inactive and dormant relationships. On current experience less than a third of the50,000 would be active users of credit union products and services. - 14 -
  15. 15. based credit unions could be consolidated into just one central office to provide branded services totheir members from one location.As mentioned above the scale of rationalisation would require an empowered body charged with itscentral planning and execution. No such body exists at this time.One option would be to establish an interim central facility whose immediate objective is to defineand execute a rationalisation programme through which consolidator credit unions become foundingmembers of the central. - 15 -
  16. 16. 4: THE NEW MODEL CREDIT UNIONTransitioning to the savings and loans model will require substantial changes to the balance sheet,and financial and business operations of consolidated credit unions.A credit unions competitive advantage lies in its relationship with and understanding of its membersneeds. While customer value is embedded in “why things are done” this has not successfullytranslated into “the way things are done” which remain rooted in outdated, legacy business systemsand processes. • The new model credit union exists as a constituent member of a federated network and outsources its non-essential operations to the central shared services provider. • It excels at servicing its customers and encouraging them to deepen their relationship with their credit union. • It distinguishes between the “member as owner” and the “member as customer/consumer”.As an owner, a member can expect to share in the profits but as a customer a member shouldrightfully expect to be paid a market based rate of return on their savings.The notion of providing fee-free services, particularly high cost over the counter transactions, willhave to end with credit unions charging a reasonable fee for the level of service they are providing –in many cases services that banks and others have ceased to provide or have priced according tocost.At the very least credit unions should have some element of cost recovery rather than what iscurrently happening which amounts to the cross subsidisation by infrequent-users of frequent-usersfree services.In addition the practice or habit of paying or charging one rate for all accounts, whether savings orloans, should cease replaced with appropriate rates being paid or charged for differing productcategories. For example a high transaction, low value savings account attracts the same rate as a highvalue, low transaction long term savings account. Similarly the same rate is charged on a short sixmonth loan of €1,000 as a longer term loan of say €10,000 over three years.The era of free life insurance came to an end elsewhere years ago as credit unions switched tomember-pay insurance coverage. The cost of insuring for free loans of upwards of €100,000 andsavings balances to €13,500 is a crippling burden that given credit union member demography isunsustainable. Credit unions should as a matter of urgency significantly reduce the level of coverageand move to member pay models that effectively switches what is currently an operating cost to afee earning revenue stream.To excel at their core business of savings and loans credit unions need to offer a much wider choiceof modern savings and loans products along with learning how to “ask for the business” from theircustomers.Savings ProductsThe traditional share account is manifestly outdated as the primary product and funding mechanism.Limited to paying dividends only once a year and then only in arrears after the annual accounts haveclosed it is a mechanism that has been exposed as an anti-consumer practice in the current climate. - 16 -
  17. 17. The share account should be retained only as an account denoting member’s ownership share in thecredit union. It should be repositioned as being purely the means by which members have anownership stake in their credit union. In good years, shares could pay a much better rate thansavings deposits. But credit unions need to be straight with their members, making it clear that sharedividends are not market based and that last year’s rate is no indicator of what it will be this year andthat in any event, non dividend on shares is ever guaranteed.A variety of deposit accounts should replace shares as the primary place for customer savings.Interest rates should track the market and exceed where possible what banks are paying in thenormal market environment. This is not the case today as banks fight for deposits to replace the highcost of funding from the interbank market.Products should expand to incorporate a full range of retail deposit accounts such as:Demand Deposits: for in-and-out money would pay a low rate reflecting the transactional nature ofservices which might carry a fee or unless a minimum balance is maintained no interest is paid. Theseaccounts could also offer electronic payment facilities such as standing orders and direct debits andbe the primary transaction account offered online and by ATMRegular savings accounts: regular savings accounts could be designed to encourage regular savingsand pay higher rates for balances saved whilst allowing for infrequent withdrawalsTerm Deposits: for longer term lump sum savings would pay higher rates depending on the pre-established period of time. These accounts would have limited if any withdrawal privileges.Zero rate deposit accounts: where set-off is offered against loan interest charges.As permitted by law credit unions might develop special retirement savings accounts.Linked accounts: the attached savings rule should end and replaced by assignment of deposits wheresuch collateral is required.The practice of nominated ownership in event of death should also cease. Instead the bankingapproach to joint accounts should be adopted.Credit unions would not offer current accounts, cheque books or overdraft facilities until such timeas they and the central developed the technological capability, supporting architecture andassembled the resource capability required to provide such accounts and facilities.Lending ProductsA full range of consumer lending products should be made available shifting from the traditionalinstalment credit facility to fixed and variable term loan type structures.Additionally consideration should also be given to developing a revolving credit facility eliminatingthe cost of involved in the multi-issuance of small facilities.Given their numbers of customers, credit unions should have the collective strength to negotiatewith product providers to offer white label fee-earning products offering attractive rates to theircustomers. These would include insurances, retail investments, debit cards, prepaid debit cards,credit cards, car leasing and other durable goods financing facilities. - 17 -
  18. 18. Credit unions should partner with high quality, reputable mortgage lenders as loan originators. Overthe longer term, via the central finance facility, they could develop the competencies and legalauthority required to act as mortgage producers.Credit unions should be required to comply with consumer protection codes and develop robustorganisational competencies in credit assessment and risk management. In particular they shouldhave the capacity to continue to provide loans to the less well off and financially marginalised – topeople of good character who cannot borrow elsewhere.Modern credit risk and lending assessment practices should be deployed including affordabilityassessment techniques and full membership of credit bureaux. Additionally in keeping with affordingcredit to marginalised borrowers, credit unions should develop specific credit assessment techniquesusing non-financial information to better manage and understand credit risks.Just as important as introducing a new high quality product is the adoption of correct pricingmethodologies. This means setting rates at different levels depending on the service involved andrebalancing rates on a regular basis to stay competitive in the market.As mentioned earlier, fees should be charged, where appropriate, for services provided. As its standscredit union fee income to total income is less than 1%. In other advanced markets, fee incomerepresents a substantial percentage of total income earned by credit unions.Operational ModelProviding a modern range of high quality consumer savings and loans requires substantial upgradingof IT, operational systems and internal controls to achieve greater efficiency and safety.Compared with the peers in other countries, Irish credit unions spend too small a percentage ofoverheads on data processing and information systems. This false economy has driven up costs bylimiting flexibility and increasing reliance on manual processes as well as amplifying operational risks.Non-standardisation of IT core systems leads to differing capacities, capabilities and responsivenessto increasing complexity in particular regulatory reporting and risk management requirements. It isunlikely that any of the current systems are capable of supporting a wider range of products orproviding the operational flexibility required under the new savings and loans operations modelproposed here.Deploying modern IT systems will be required to provide customers with the convenience theyexpect these days. For example customers should have access to their funds 365/24/7 via ATMmachines. They should be able to manage their accounts and effect transactions over the internet.There is an urgent need to upgrade loan underwriting and arrears management processes as well ascredit risk management and reporting processes. Credit unions need to employ more sophisticatedtools for asset/liability management, investment analysis and product pricing and for monitoring andreporting on legal compliance obligations. Credit unions should have internal audit capabilitiesincluding appropriate systems for assessing and managing risk and testing for sufficiency of internalcontrols.More efficient and effective operations will require substantial expenditure on IT and IS as well asstaff and director training.In many cases IT projects are being developed and implemented without a coherent supportingbusiness strategy or business case. In some cases, individual credit unions have gone on solo runsimplementing new systems at some considerable cost without it appears tangible business benefitsbeing established or achieved. - 18 -
  19. 19. The sector should guard against IT projects driving the business strategy. IT should enable delivery ofthe business requirements and not define what the business is or isn’t.It is highly likely the new model credit union proposed here will require an enabling modern corebanking system, database model and architecture to support an operational model that excels atdelivering savings and loans products.Even if consolidated as illustrated above, credit unions will not have the resources, operationalcapability or competencies required to transition to the new operations model. Their scale willremain small. All the more reason for a federated alliance and its central finance facility, whichthrough its shared services delivery model, would provide the requisite upgraded technologyplatform, management information systems and delivery channels.Governance Model & Strategic OrientationConsolidating to larger operations and transitioning to the new business model will require higherlevels of governance and management capabilities to achieve the standards of operational excellencerequired to excel at delivering low cost, high quality consumer savings and loans products andservices.A new form of governance will be required as boards should switch to the principles based strategicboard approach and empower senior employees to deliver on the business strategy.Larger consolidated credit unions will need to be managed by full-time professionals with thetraining, experience and skills required for any institution that is holding people’s money.Current governance practices confuse the very different roles of non-executive directors andexecutive management. This results in part-time volunteers making management decisions andperforming management roles for which they are neither trained nor qualified.Volunteer directors’ crucial leadership role should be to establish business goals and policies thatadvance the credit union ethos of fairness to members and service over profits and to ensure thesafe and sound prudent management of the business.Directors should not be distracted from their real job by dealing with day to day operationaldecisions and routine matters.Management of the credit union should be the responsibility of a professional chief executive. TheCEO should in turn be supported by full-time management team of qualified professionals withspecialist skills in finance, operations, risk management, compliance, marketing, audit and so on.Most importantly the current short term strategic and business orientation focussed onmaximisation of dividends to members will have to be replaced with a longer term orientationfocussed on economic sustainability.Professionalisation of governance and management is a key feature of network maturity which isbest illustrated in the strategic orientation of credit union boards and management.The diagram on the next page illustrates the stark difference in strategic orientation betweenCanadian and Irish credit unions: - 19 -
  20. 20. These findings show a result that most people will find surprising. Financial exclusion is not seen asthe primary orientation for the majority of Irish credit unions.The Irish responses clustered within (2) and (3) starkly highlight the short term Irish credit unionstrategic orientation of the dividend distribution finance company business model - to pay thehighest dividend - and lack of emphasis on competiveness and sustainability.In essence a credit union board is custodian of an intergenerational endowment represented notonly by the credit union’s financial strength – its reserves, but also its capacity to achieve itseconomic and social objectives.Intergenerational handover of fiduciary care and responsibility can only happen where governanceplaces the credit union itself front-and-centre and not on the periphery of strategic decision making.Indeed it’s the combination of the careful husbandry of the intergenerational endowment with itslonger term strategic orientation, and embedded customer advocacy of themember/owner/customer relationship that creates robust credit co-operative systems.Thus the leadership job of a board of directors should be to focus on formulating and directing thestrategic governance of the credit union, to establish and regularly review its top-level policies, tohire and supervise the chief executive, to set financial and other goals, and to monitor management’sperformance in achieving those goals.These are the essential functions of top level governance in a financial institution. They deserve theundivided attention of the board, whose energies should not be wasted on day-to-day decisionswhich staff are paid to make.There are two additional and very important advantages to this model of governance called thestrategic board.The first is that it prescribes roles for volunteers that can be fulfilled without an undue commitmentof time. By adopting a modernised model of board governance, credit unions discover that thechallenge of recruiting capable directors diminishes considerably.Secondly, and even more importantly, effective governance is indispensable to attracting andretaining professional managers with the talents and skills that are needed to run excellent creditunions. Highly capable people gravitate to organisations where roles are well defined: Where - 20 -
  21. 21. directors establish clear policies, expectations and goals, where results are objectively measured andrewarded – and where directors then get out of the way and let managers manage to achieve thosegoals to their best professional ability. Excellence in the board’s governance of the credit union is keyto excellent performance by its CEO and staff.Graphically the shift in governance emphasis is shown below:It is to be expected that the new model governance will require directors who are fit and proper fortheir important roles. In which case a specific credit union fitness and probity regime should set outthe requisite skills and experience required of directors. Given the increasing complexity of financialservices providers generally and specific complexity envisaged with larger credit unions, directorsshould be remunerated accordingly. - 21 -
  22. 22. 5: A FEDERATED NETWORK OF CREDIT UNIONSIt is a matter of historic record that while credit unions in Ireland have long recognised the need todevelop a cohesive centralist system, they have been unable for a variety of reasons to transition andmature as credit co-operatives in line with their international peers.Furthermore the Irish credit union business model and network structuration within an atomisedindependent system operating within restrictive common bonds has meant that 8economies of scaleand scope have not been achieved.Long before 2008 the business model in use contained a number of flaws which are exposed whencredit unions grow and mature as they have in Ireland.Emphasising dividends paid from profits, the inclination of voluntary boards is to adopt risk adversepractices focussed on maximising dividends and to compete with one another to pay the highestrate. This behaviour leads to a strategy of dividend maximisation which eschews investment inimproving products and services and adopting market based pricing mechanisms. It also comes at acost of building the reserves required to ensure economic viability and sustainability and invest inimproving operational competence. Moreover aging boards tend to represent a sectional saversinterest and favour maximising dividends and minimising investment in building long termsustainable business capacities.The business model was at high risk to the possibility of an external shock which would havenegatively impacted on both system and individual credit union financial stability. Both the globalcredit crisis and domestic recession have created these negative shocks and adverse conditions.Addressing trends emerging the sector in a recent speech the Register for Credit Unions said:“As yet it is unclear as to the level of restructuring that is likely to take place over the next couple ofyears. However it cannot be ignored in that we are now seeing an increasing number of credit unionscoming under financial stress. The trend in arrears is continuing upwards and the opportunities forprudent lending are decreasing. Income is depressed and costs are either remaining static orincreasing. Should these trends continue it is not implausible that a significant restructuringprogramme for the sector may be required. If the sector is to remain sustainable in the long term thenthe time for progressive solutions to the circumstances arising in the credit union sector may becoming soon – if it’s not here already.” Address by James O’Brien, Registrar of Credit Unions, to theNational Supervisors Forum, 6 November 2010While significant stability intervention has been implemented by the Central Bank, there is a risk thatthe all too necessary regulatory cure may kill the patient, unless an overarching national policy anddevelopment framework is created through which restructuring is achieved.Such a policy and framework should ensure that the sector transitions at pace to a modern businessmodel within a federated network.The sector faces significant issues that would challenge better resourced and competent credit co-operatives. On their own credit unions haven’t the resources to make the changes necessary to8 Lack of scale and scope is leading to rising costs and without a commensurate increase in income, margins are dramatically reducing.Undiversified, credit unions are wholly reliant on income from unsecured consumer finance augmented by investment income from excessfunds. Operational efficiencies have not been achieved through the deployment of modern IT systems and automated processes. Adjustingfor cost of funds (dividend rate) credit unions were operating at over 80% cost income ratio in 2007 which left little head room to financeinvestment losses and inevitable loan losses from unsecured consumer and small business lending. - 22 -
  23. 23. survive and thrive. And collectively they demonstrate an inability to co-operate together and createthe central finance systems found elsewhere.Uniquely amongst developed credit union and credit co-operatives Irish credit unions have remainedstuck in transition between a start up phase “finance company” business model and more mature“savings and loans” model. (For a discussion on this please see the appendix)Critical to transitioning to savings and loans co-operatives is the creation of central finance facilities,a robust flexible regulatory system, professionalisation of governance and management,considerable investment in IT and improving operational capabilities.Unfortunately Irish credit unions were never likely to make this transition unless driven to do so byan external forces.Transitioning to a savings and loans business model within a federated network is an urgentrequirement if the sector is to deliver on its oft mentioned latent potential to offer a viable consumerand small business banking alternative to commercial banking.There is a need for a step change, creating the dynamic which will cause this to happen. Creditunions will not be able to accomplish this step change on their own.If Government and the Oireachtas consider the sector of national importance then policy mustaddress one key question: is the future to be defined by the autonomous, independent, atomisedcredit union or is the future to be defined through a federated network of which consolidatedcredit unions are constituent owners. Deciding on the latter is the first step to beginning to craft aviable credit co-operative system that works. - 23 -
  24. 24. A Federated NetworkCreating a federated financial infrastructure and shared services alliance between credit unionswould solve for the strategic dilemma facing credit unions today. The sector doesn’t have thecollective resources, scale, scope or competencies to offer a viable savings and loans alternative tocommercial banking.A 9federated network structure consisting of a “10central finance facility” owned by credit unionswould have the potential to: 1. Fulfil the strategic economic and social objectives and needs of participating credit unions. 2. Improve scale economies and achieve broader market reach 3. Leverage synergies 4. Utilise capital more efficiently, while enabling more effective access to wholesale funding and capital markets 5. Enable credit unions to become a dominant provider of consumer savings and loans services in Ireland. 6. Have the potential to provide banking services to small business 7. Facilitate the orderly rationalisation of the credit union network 8. Through contractual solidarity and cross guarantees effect stablisation intervention where requiredCritically the central facility or apex organisation, would also serve as the basis for the long overduerationalisation of the credit union movement, as well as provide financial stabilisation for viablecredit unions.However, the facility would primarily operate as a wholesale commercial enterprise serving theinstitutions that own it. It would operate as a wholesale bank to the constituent members of thefederated network. It would not act as a trade association or representative body.Creating such a facility would be a significant undertaking, requiring a substantial commitment bycredit unions that join in its formation. For this reason, it would be sensible to begin with a relativelysmall number of larger qualifying credit unions. The idea, however, is to build a facility in which allIrish credit unions participate as both a co-owner and user.Rather than creating such a facility from scratch, it might be possible to source a commercialorganisation that would have a number of the skills, organisational structure and the ability to act asa contractor or in a joint venture operation with the credit unions that join the structure.A diagram depicting the high-level model of a federated network is shown below.9 See appendix for more detailed discussion on federated co-operative networks10 Central Finance Facility is a term used by international credit union trade body WOCCU to define central corporate entities owned byconstituent credit unions. - 24 -
  25. 25. The creation of a comprehensive, centralised support system has been a long-term goal of Irish creditunions, and it has been endorsed in principle both by Government and the Central Bank. However, itis an objective that credit unions and their trade bodies ILCU and CUDA have been unable to achieveon their own.Given current economic, political and financial market conditions, there is now a unique opportunityto facilitate the creation of such a network.The balance of this submission summarises the relevant international precedents and Irishenvironmental circumstances, discusses potential models for a credit union alliance, identifies aconceptual structure for such an alliance (including the potential advantages, disadvantages andchallenges in creating it), and suggests a roadmap for taking this visionary concept forward. - 25 -
  26. 26. The Federated Alliance – evaluation criteriaTo be achievable, any plan for an alliance must meet the following criteria: 1. A compelling and achievable business case for new model credit unions. 2. A compelling and achievable business case for a central finance facility 3. The plan must respect and preserve core credit union values, and provide for a degree of local autonomy. 4. The number of credit unions will need to consolidate considerably to realise the scale economies required to excel at their core business of saving and loans.While these conditions are necessary, in my view they will not be sufficient to achieve acceptance bya critical mass of credit unions.Over the past decade, several services providers have presented compelling commercial proposalsthat would have enabled Irish credit unions to achieve better scale economies or offer a broaderrange of products. For a variety of reasons, these have either failed to achieve sufficient credit unionsupport to be implemented or have generated only modest results.Furthermore the sector has long talked of centralist co-operative initiatives but has been unable toprogress these beyond publishing high level discussion documents. Long on talk and short on actionthe system and its constituents are demonstrably incapable of transitioning to higher level businessmodels or creating the centralist systems required to underpin financial stability and sustainability.Irish credit unions confront an imminent 11crisis which can only be addressed if they move quickly tomodernise their business model and rationalise the number of independent operations. And this willrequire a step change which can only be accomplished by Government intervention.Accordingly, an undertaking on the scale of that contemplated in this note is unlikely to succeedunless a fifth criterion is satisfied:There must be strong pressure on credit unions by Government and the Central Bank to participatein a federated alliance.Indeed such is the challenge, I would suggest that a special body be established by Governmentcharged with driving credit union rationalisation, transitioning consolidator credit unions to the newbusiness model and establishing the central facility.Evidence from other countries suggests that transitioning to higher level structures occurred only asregulators and government officials pressurised credit unions to adopt higher standards ofperformance in return for greater flexibility. This intervention was in turn used by small groups oflarger, progressive credit unions and their managers to effect change. Pushed from behind byconcerned regulators and pulled from the front by larger credit unions, change occurred over time.For example the modern day federated Australian credit union system arose from governmental andregulatory responses to the collapse of the Pyramid Building Society. Likewise US federal depositinsurance came about from credit union pressure to establish a federal guarantee over concerns theprivate system was insufficient. The concern in Canada has been to allow for the orderedconsolidation of the number of credit unions in particular those without a viable future. In all threecountries whilst the numbers of credit unions have dramatically declined they have evolved as11 New lending volumes have dramatically declined since 2008 which will cause a rapid deterioration in loan book quality and criticalinterest income stream. - 26 -
  27. 27. vibrant alternatives to banks through expanding products and services, delivery channels andnumber of branch outlets. In Canada some centrals now have their own branch networks havingbought them from banks.None of these changes would have been possible were it not for the creation of central financefacilities, professionalisation of governance and management, investment in modern technologies,adoption of the savings and loans model and in time transitioning it to the full banking model.Of the three basic models for credit union/co-operative cooperation mentioned above I believe thatonly the second, the Federated Network, is likely to meet all of these 12criteria.The Atomised model is dependent on a wide and deep markets for credit union outsource servicesand service providers. The development of the US credit union service organisation (CUSO) modelwas only possible given the continental scale of its financial service marketplace.Proposing a fully Integrated/Merged structure in which credit unions become, in effect, localbranches, the third model would be viewed as a takeover of the credit union movement. Even thesuspicion that this was the goal would result in overwhelming opposition from the credit unionsector.Conceptually, the three alternatives are diagrammed as follows: Atomised Federated Network Integrated/Merged “Loose Alliance” “Coalition of the Willing” “Command Hierarchy” League Central Hub Central Co-operative Cooperative Bank Representational/Development Wholesale Bank Members dominate Balanced Centre management Dominates Autonomous status Credit union Branch there drives local to sell A la carte delivery membership Credit Unions Credit Unions Branches + Good customer experience + Good customer experience + Efficient Sales Machine -Inefficient + Efficient - Poor customer service Degree of Integration Adapted from Mercer Oliver WymanThe left hand column represents the current Irish credit union form of loose association throughtrade bodies and their business services. The far right column represents a mutual building societyorganisational system of a central head office and branch network.The best way forward, is for a federated network. In this model, credit unions would receivecentralised support services from an entity they would both own and over which they would sharejoint control.Developing an appropriate governance structure for such a central federated body would be one ofthe most challenging elements involved in designing and implementing this concept. Needless tosay, people would have to be convinced that the resulting central body would operate at a high level12 Credit union ownership is crucial to the long term durability of an alliance. When U.S. credit unions entered the third stage ofdevelopment in the mid-1970s, they first obtained current accounts, card processing and investment services from commercial banks.Within a decade, they were abandoning those contractual arrangements, building credit union-owned corporate credit unions and otherservice corporations to perform those functions. Credit unions did not want to remain dependent on actual or potential competitors fortheir core functions. CUNA Mutual preserved its position because it was always owned by its credit union policyholders. Similarconsiderations were also present in Canada and Australia. - 27 -
  28. 28. of financial soundness and operational professionalism. This critical dimension is discussed in greaterdetail below.A proposed federated structureThe proposed structure for a credit union alliance involves creating a new central finance facility thatwould be owned by participating credit unions, who would also be its only customers. Although theywould receive central support services from the new entity, credit unions would continue to tradeindependently under their own names.The facility would likely be incorporated as a commercial bank, although ownership might be heldthrough a holding company organised as a co-operative. A diagram of the proposed structure isshown again below:Fully implemented, the central banking facility would allow credit unions to collectively achievegreater efficiencies of scale in back office operations such as IT and payments systems, as well asobtain other services such as liquidity and investment management, regulatory compliance, internalaudit, risk management, human resources, marketing support, and group purchasing.Depending on the final design, it is likely that a significant portion of operational capabilities wouldbe centralised to the new entity. Some functions of the central might be conducted through one ormore wholly owned subsidiaries. In addition a stablisation mechanism for credit unions based oncontractual solidarity and cross guarantees could be provided as a 13backstop to the DGS.While there are many legal, regulatory and tax issues that would require research before an optimalstructure could be validated, it would appear that the structure above should confer the followingadvantages:13 Some Canadian provincial central finance facilities provide a stablisation mechanism and funding under devolved authority andauthorisation of provincial deposit insurers and regulators. - 28 -
  29. 29. Legal Simplicity. Participating credit unions would retain their current legal forms, pursuant to theCredit Union Act. It does not appear that setting up this structure would require amendments toprimary legislation.Ownership. Credit union acceptance of this concept depends on the perception that it conforms toestablished international norms for credit union support organisations. Key to those norms is theconcept that credit unions should own the support structures that are strategically essential to theiron-going independence as a unique social movement. This structure would satisfy that requirement.Governance. Using a co-operative holding company as the vehicle for joint ownership allows for useof a capital structure that would recognise disproportionate contributions of its owners, whileaffording representation on the holding company board.Although governance is the most difficult aspect of designing a central facility, I believe that astructure can be set up that is acceptable if the governing board is constrained by certain agreedupon principles. Those should include, for example, that the central provides services to its ownerson a fair and equitable basis, with uniform pricing reflecting actual costs given the respective volumeof business each brings.Access to Capital. Whilst a co-operative holding company structure would be used to maintain creditunion control of the central banking facility, it would also allow for the facility itself to be 14publiclylisted. This would enable access to equity markets on a basis that could be advantageous to themajority owners.In-system stability. Through contractual solidarity and cross guarantees, credit unions wouldeffectively leverage off their combined balance sheets.Special Purpose Subsidiaries. To the extent desirable for tax or other reasons, the structure wouldpermit for the incorporation of subsidiaries for special purposes. Those might be owned by thecentral finance facility (as shown in the diagram above) or by the co-operative holding company. Conceptual Federated Model Members Credit Credit Credit Credit Credit Union Union Union Union Union Central Finance Facility Bank Asset Insurance Leasing Credit Cards Management14 OKO Bank (Finland) provides for public listing - 29 -
  30. 30. Anticipated business advantagesNotwithstanding the logic of the proposed ownership structure, the likely success of the alliancedepends on the business advantages it actually brings credit unions. From an overview perspective,the business case appears to be compelling:Scale Economies. Credit unions would be able to afford resources they individually lack the size toobtain affordably.The functions performed by the central body could start with payment systems, IT andinvestment/liquidity management, and they could grow over time to include most or all of thefollowing back office and support functions: • Regulatory compliance • Legal services • Internal audit • Risk management • Human resources (recruitment, training, payroll, etc.) • Group purchasing of supplies and equipment • Market research and analysis • New product development • Product support and developmentFunding and Liquidity Management. The central would have the capability to help credit unionsparticipate in the wholesale funding markets. The proposed facility would be designed to facilitatethis process and to manage more efficiently the liquidity and capital of its owner institutions.Specifically, this could be accomplished through the following mechanisms: • Through the central platform, credit unions would be provided with investment services. • Credit unions would be allowed to borrow from the central facility to meet their short term liquidity needs, such borrowing to be fully secured by the funds they hold on deposit with the central. • To the extent that any one party requires greater liquidity, the professional management provided by the central would be used to obtain funding from wholesale markets. As a bank in its own right, the central could also draw funding from the Central Bank of Ireland. • Participating credit unions could access ECB MMR support which is something they cannot do at present.The central could provide for stabilisation funding for credit unions similar to the system deployed inCanada where centrals working with deposit insurers are authorised by their regulators to stabilisetroubled but viable credit unions. Such a mechanism would be dependent on contractual solidarityand cross guarantees together with an appropriate relationship with the Central Bank and its DGS.It should be noted that in advanced markets stablisation funds are no longer utilised. Riskminimisation is effected through early state interventions, prompt corrective actions and enforcedmergers. Funding where required is frequently used to temporarily support the acquiring creditunion. For a more detailed consideration of stabilisation please see the attached submission to theCentral Bank on stablisation. - 30 -
  31. 31. Given their need for professional liquidity management, credit union access to current accountservices should be conditioned on their maintaining a substantial share (if not all) of their liquidity atthe central.As already noted, the proposed structure could provide access to equity markets if the central (orone of its subsidiaries) becomes a listed company. To the extent they need to free up their existingcapital to support growth, participating credit unions could transfer assets into the central; therebytaking advantage of the latter’s access to capital market funding and capacity to securitise assets.Broader Retail Reach & National Footprint. The proposed alliance would offer credit unions theability to offer products through a larger 15branch network, as well as conduct workplace affinitymarketing via employer credit unions.Broader Product Line. Credit unions would benefit from access to a broader array of financialproducts. Representing a primary retail distribution channel to millions of consumers, the centralwould have enhanced market power to enter into alliances with product providers 16unavailable toindividual credit unions at this time.Credit unions individually lack the size to be effective participants in the home mortgage market.However in line with developments in other markets the central could provide the resources,competencies and capabilities to enable credit unions to offer mortgages.Enhanced Financial Services to Small Business. Whilst credit unions provide limited financialservices to small business, they are not recognised as primary bankers to small enterprises. In othercountries, central finance facilities have developed competence and expertise in this important areaof co-operative banking.A central could assemble the resources required to allow credit unions to expand their small businessservice capabilities. Typically, centrals establish mobile small business lending teams who, operatingon a shared branch basis, are supported by dedicated central expertise. Some also provide internalloan syndication processes which pool and allocate loan assets to participating members. They alsoleverage their collective market purchasing power, building third party alliances to increase thescope of small business products and services offered.Social Finance. Effective social finance is a specialised form of commercial lending requiring expertisethat credit unions do not possess. A central could establish a special purpose finance facility andspecialist lending team providing social finance facilities through credit unions.Movement Stability and Rationalisation. The central facility could provide a platform forprofessionally managing the rationalisation of the credit union system. It is widely recognised thatthe number of credit unions in Ireland will need to reduce, but there is no vehicle currently availableto handle that process in an orderly fashion.In General. Credit unions have neither the scale efficiencies nor the operational competencies todeliver on a long standing objective to deliver a full banking service. An alliance along the linesproposed in this submission has the potential to create the roadmap to achieve this business andsocial objective.15 There are a significant number of underperforming credit unions in high density urban and provincial locations that would benefit fromrationalising with a larger neighbouring credit union and participation within the alliance structure.16 Alliances to provide consumer products (insurances, credit cards etc) require distribution scale in customer numbers which an alliancewould make available. - 31 -
  32. 32. Anticipated business disadvantages and obstaclesThe potential disadvantages of the proposed structure come from the execution risks of itsimplementation. Obviously, it would represent a major strategic initiative that would havesignificant implications for future operations.The primary obstacle to accomplishing this vision is in getting credit unions to participate. Creditunion decision making processes are notoriously slow. In the past, even where credit union boardsagreed to proceed with a joint initiative they have changed their minds at the last minute and failedto actually commit to and fund commercial joint ventures. Even in much more highly developedcredit union movements, volunteer boards are reluctant to fully embrace new business ideas. Thehistory of credit union modernisation in the U.S., Canada and Australia has been characterised bymajor new initiatives being launched by a handful of leading institutions, with the rest following intime once the concept is proven to work.Moreover, the process of developing an alliance would be complicated geometrically by the numberof credit unions initially involved. On the other hand, a structure that is developed and implementedby a founding group could be presented on a basically “take it or leave it basis” to those credit unionswho follow.It is likely the Central Bank will look favourably at credit unions participating in an alliance and affordthem the greater flexibility they have advocated for. This has been the experience elsewhere wherefederated centrals supervise their members under devolved powers from state regulators. In thiscase it is envisaged that credit unions anxious to grow and expand services to members will want tojoin a federated network system.Government supportAn important first step will be support for this concept from Government and the Central Bank.Although Government has been largely preoccupied with its rescue of the Irish banking industry,officials in both the Department of Finance and Central Bank are undoubtedly very conscious of thecritical need for reform of the credit union sector.6: CONCLUSIONIn conclusion the immediate future of credit unions should be defined by sticking to the knitting ofsavings and loans and excelling at their delivery. The current network should rationalise through aplanned programme of consolidation with resultant consolidator credit unions required to transitionto a new model of business operations. These credit unions could be required to be constituentowners of a central finance facility which is underpinned by contractual solidarity and crossguarantees. In effect what’s proposed is the creation of a European style community focussed, creditco-operative banking system guided by credit union operating principles and ethos.Bill HobbsAugust 2011 - 32 -
  33. 33. APPENDIX 1 : NOTE ON FEDERATED CO-OPERATIVE SYSTEMSAtomisation or FederationGlobally credit co-operatives have developed from individual loose form groups of individual creditco-operatives (atomised) to highly integrated networks coalescing around a central finance facility(federated). Frequently this facility is a wholesale bank providing a range of services to its constituentowners.The following diagrams illustrate the typology found in credit co-operative systems. Irelandregrettably remains rooted in the start up phase in all these models.This diagram illustrates the stages of development found in credit unions internationally. The Irishsystem has been stuck between Nascent and Transition for almost two decades. Nascent Industry Transition Industry Mature Industry Small asset size Large asset size Large asset size Tight Common Bond Adjusted common bond Loose common bond Serves weak sections of society Widened customer base Competitive environment Single savings and loan product Greater product diversification Electronic technology environment High commitment to traditional Weakening reliance on Professionalisation of self-help ideas volunteerism management Development of central services Well developed central services Need for greater effectiveness Organised progressive trade and professionalism of trade bodies bodies Diversification of products and services based on market rate structures Emphasis on economic viability and long term sustainability Rigorous financial management of operations Well functioning deposit insurance mechanism Adapted from “An Industry Approach to Classifying Credit Union Development” C Ferguson & D G McKillop 2007This typology of Nascent, Transition and Mature can be translated in turn into generic businessmodels deployed in each stage: Credit Union Business Models International Phases of CU Development Model A Model B Model C Co-operative Savings & Loan Full Service Finance Company Specialist Co-operative Bank Source Third Way Alliance 2009 - 33 -
  34. 34. The following diagrams capture the stages of development from atomised credit co-operatives(Ireland) to federated strategic networks seen in European style co-operatives such as RaboBank, TheNetherlands and OkoBank, Finland. Farther afield the Canadian Movement Desjardins and Australiancredit unions amongst others have also evolved strategic networks.Irish credit unions can been seen to be lying somewhere between atomised and cohesive networks. Cohesive Atomised Network Strategic Network Representation Pooling resources/ standardisation Separation of strategic and Cooperative operational management Education Market Sharing and control Advisory Standardised Image Services Prudential supervision delegated monitoring Delegation of strategic planning Contractual solidarity cross guarantees CIRPÉE Centre interuniversitaire sur le risque, les politiques économiques et l’emploi The Power of Networks: Integration and Financial Cooperative Performance Martin Desrochers Klaus P. Fischer May/2005 Characteristics of Networks Representation The central represents the system in issues of common concern (regulation) taxation, other cooperative movements etc Atomised Cooperative education Provides or supports cooperative education among members of the first tier System Advisory & Prudential services The central provides business and or/prudential management services for the members Voluntary pooling of resources and The central is responsible for the management of common standardisation resources and supports standardisation of operating procedures across the system Market sharing The network has rules eliminating inter member competition Consensual Networks Unique image The network assumes a unique trade mark and image to which all members adhere Delegation of strategic planning The central performs strategic planning for the network, function although there is no mandatory compliance with approved strategic plans Separation of strategic and operational There is a separation of strategic and operational decision decision management management between the central (strategic) and members (operational). The central and members are bound by network decisions. This includes mandatory pooling of resources and Strategic standardisation of operations in areas chosen by the network Networks Prudential supervision role The central assumes the role of prudential supervisor (or auxiliary supervisor) of the members Contractual solidarity The network adopts mechanisms of collective insurance designed to assist members or the central in difficulties Adapted from: CIRPÉE Centre interuniversitaire sur le risque, les politiques économiques et l’emploi The Power of Networks: Integration and Financial Cooperative Performance Martin Desrochers Klaus P. Fischer May/2005 - 34 -

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