Credit unions challenged by low-interest loans

Last week, members of the Irish League of Credit Unions celebrated International Credit Union Day. In nearly every country in the world October 15th was marked with outings and festivities. Many credit unions in developing countries have been set up with the financial and practical support of the Irish league. Yet amidst the celebrations, credit union officers and their members are caught in a debate which many feel needs to be addressed quickly and decisively: how much longer can a non-profit organisation, committed to low-cost borrowing, keep charging interest rates for loans that are 1 or 2 per cent higher than the rates charged by retail banks?

The credit unions are, in a sense, the victims of their own success. With over 1.2 million members in the 32 counties, the league was set up in Ireland in the late 1950s to help ordinary people secure low-cost borrowing through co-operative savings at the neighbourhood level. The savings capacity of its members has risen from less than £40,000 in 1958 to £2.55 billion at the end of 1997 - and the average annual dividend or interest payment on those savings (which the credit union calls "shares") is reckoned to be about 6 per cent, about 2 per cent above the best rates available from conventional banks. Once the latest interest rate cuts are taken into account, the credit union may have to change its title to the "Savings Union". Given that the average credit union continues to charge interest at a rate of 1 per cent per month, or 12.67 per cent annual percentage rate (APR), is it any wonder that many more people are saving with the credit union and borrowing with the banks, whose APRs are slipping below 10 per cent? At its annual general meeting this summer, the League of Credit Unions formally raised the issue of its high borrowing rate, an issue that has been taken up again in the autumn issue of its newsletter, Credit Union Review. A graph was produced at the a.g.m. which showed how drastic has been the fall in loans as well as how far savings have fallen since its highest levels in 1994. The graph projected that loans would continue to fall while savings - and this is a direct result of the high dividends the credit union pays out - would creep back upwards, at least to pre-1993 levels.

The gap is widening sharply between the amount of savings members have and the amount they borrow. Between 1995 and 1997, shares increased by an average of 19.5 per cent while loans increased by just 17 per cent. If these averages are projected, the league figures that the gap between shares and loans will widen to £764 million and £970 million this year and next; by 2000 it expects the gap to have widened to over £1 billion. According to Mr Noel Madden, the administrator of a large credit union in Ballinasloe, Co Galway, which has reduced its interest rate by 0.125 per cent earlier this year to 0.875 APR per month, the movement "is challenged . . . by low interest rate lending in competitive financial institutions. Let's not be coy about it - they are out to get our members and our business. Anyone who does not recognise this fact seriously underestimates our competitors." Just 30 per cent of members borrow from the credit union for personal loans, he estimates. Excess savings, writes Mr Madden in the latest Credit Union Review, "is a problem precisely because we have not loaned this money to our members at a rate that has kept pace with the market rate for loans". Comparing the low interest rate economy of today with the one during the 1960s, he notes that the rates then "did not impact on the fledgling credit union movement because credit union members would not be serviced in other financial institutions. We were in fact looking after a group in society that needed credit but could not get it other than from a moneylender or by hire purchase.

"The difference this time is that the banks are now prepared to lend to credit union members now that we, as credit unions, have established their creditworthiness." According to Mr Madden, and others within the movement, rebating interest in the form of dividends "can hardly be seen as being an equitable return of the surplus to members. How can it be equitable," he asks, "when the return is greater to one section of the membership than to another? Even among borrowing members, the greater return is to the greater borrower."

His solution is to lower the interest rate and distribute any surplus evenly to all members. If interest rates rise again, rates can be put back up to the 1 per cent per month rate, using it as a permanent interest rate ceiling. At his own credit union, he reports that the average loan growth for the past three years has been 23 per cent; this past year since the rate reduction, it has grown to 29 per cent. Criticism like this is now challenging the credit union movement to reassess its goals and purposes: is it to achieve spectacular surpluses and outperform the banks by way of refunded profits? Or is it to provide the cheapest form of finance to ordinary people in the geographic neighbourhood, whether that is a collection of streets in a town or city or an occupational "village" at a factory, hospital or office.

Given the attraction of credit unions to people with strong co-operative instincts it is no surprise that some members have focused on the investment "carpetbaggers" who have joined credit unions in recent years simply to take advantage of a much higher interest rate on savings. Such people's loyalty to the credit union, writes another Review correspondent, "is only to the return on their savings at any given time and their constant manipulation of funds could well make for enormous cash flow and liquidity problems for credit unions and their boards". As it now stands, unless more credit unions lower their interest rates to at least match, and preferably better the banks' interest rates, the credit union will increasingly be a place for people with money to include as an investment option for their portfolio or to be the bank of last resort for the less well off, or for people with a poor credit rating. (Judging every loan application on its own merits is a core value on which the movement was founded.)

Of course there are other reasons why many people still save and borrow from the credit union, despite its current interest rate position. It encourages good fiscal management by insisting that new members save regularly before they can borrow, and even then the level of borrowings is limited by the particular union's own multiple of savings and the person's ability to repay the loan. The credit union discourages debt while encouraging responsible borrowing and even as the loan is being repaid, the borrower is making small savings contributions into his or her share account. This sense of responsible borrowing is something that at least one bank - First Active - has decided to capitalise on with its recent launch of a new savings product, the First Active Savings and Loan Account in which you must save regularly for at least five months after which you can borrow twice the amount saved. The borrowing multiple increases with each loan. The repayment rate is 11 per cent APR and falling as interest rates drop. First Active said it launched the product as a direct response to its customers' demands for a borrowing facility that was directly related to their savings - exactly the reason many thousands of people like borrowing from the credit union. Unlike most banks, the credit union also provides life insurance benefits (subject to age) with every loan which will pay off outstanding loans on your death as well as modest death benefits to help pay funeral or other expenses. (First Active offers the same facility without the age restrictions.) The credit union also provides members with discount home, motor and travel insurances. Finally, the larger credit unions are moving towards a wider range of banking services as well, such as direct debit/standing order facilities and ATM machines.

Without the credit union, many individuals and communities would have been sorely pressed for the funds needed to buy homes, educate children, grow businesses, or to stay out of the clutches of moneylenders and high-price banks. Without a fairer interest rate regime credit unions may lose more than customers - they may end up losing their influence.