New dawn

If credit unions are prudent about lending, they could prove to be more resilient than other institutions in the face of financial market turbulence, writes Caroline Madden

The credit union movement has taken a few body blows of late. Significant losses have been incurred on investments of surplus funds. The registrar of credit unions has expressed deep concern over the accounting practices of some credit unions. And certain observers have suggested that credit union savers are not adequately protected. However, the movement's luck could be about to change - thanks to the global liquidity crisis.

In recent years, credit unions have struggled to lend out funds to members, with the result that the ratio of loans to assets has declined dramatically. The target ratio for credit unions is 70 per cent, which means for every €100 held in savings, €70 should be lent out and the rest invested.

However, the average ratio is now approximately 50 per cent. Many credit unions would be more aptly named "savings unions" at this point.

The main reason for this trend is that, despite the historically low interest-rate environment, credit unions continued paying high dividend rates on members' share accounts (the most common form of savings with credit unions). In order to maintain these high-dividend levels, they have had to charge rates to borrowers that have been relatively high compared to those on offer from commercial banks. So, although there was an incentive to continue saving with their credit union, it made financial sense for members to go elsewhere for a loan if they could.

Now the tide may be about to turn. Unlike banks, credit unions fund their loans entirely through members' savings and are not reliant on the wholesale money markets, where the cost of funds escalated in the last six months. This lending model should now give credit unions a competitive advantage over other lenders that have greater exposure to the credit squeeze.

The chief executive of the Irish League of Credit Unions, John O'Halloran, agrees that developments in the international credit environment present an opportunity for credit unions to extend their loan books, pointing out that lending rates are already competitive. Interest rates vary, depending on the credit union, but the average rate at the moment on a personal loan is 9.9 per cent APR (annual percentage rate), which compares favourably to the rest of the market.

Rates are also competitive in different loan categories. For example, Gorey credit union has reduced its rate on car loans to 6.9 per cent APR; Tipperary credit union charges a rate of 6.6 per cent APR on its student loan package; and Youghal credit union now offers a home improvement package with an attractive rate of 6.2 per cent APR.

Credit unions have become more competitive, O'Halloran says. "Over the last four to five years, the average level of dividends has decreased and that is a corollary of credit unions deciding that they were going to individually decrease interest rates on loans. More than half of credit unions have now moved away from the top rate of interest that credit unions can charge."

Unlike other lenders, the amount of interest that credit unions can charge is capped at 12.68 per cent APR.

Apart from competitive interest rates, credit union loans have several other advantages of which borrowers may not be aware.

Loan protection insurance is provided free of charge, which means that the loan dies with the customer. There are no fees, transaction charges or early repayment penalties.

Also, a portion of the interest paid on the loan may be refunded at the end of the year. This isn't guaranteed, but O'Halloran recommends that customers check with the credit union to see what level of interest rebate was paid to borrowers in the previous year to get an estimate of what refund they might expect.

The biggest opportunity for the credit union movement, O'Halloran predicts, is that borrowers seeking short-term loans to finance holidays, car, education expenses and so on will become increasingly likely to turn to credit unions rather than consolidating the debt into their mortgage, as they might have done in the past.

"Banks have, over the last number of years, encouraged people to consolidate short-term debt into their mortgages, which we would consider as completely inappropriate," he says.

"A holiday loan should be paid off over 12 months; if you're consolidating that short-term debt into a mortgage over 20 years, you're actually paying more in the long run."

He predicts that, as the credit crunch hits and as equity in property begins to drop, there will be less encouragement from banks for borrowers to roll up debts into their mortgage. "I see that as an opportunity for credit unions as well," he says.

Another boost came last year when changes to legislation enabled credit unions to offer more long-term loans. O'Hal-loran expects this change will be reflected in increased lending volumes, although he notes that the majority of loans continue to be for amounts of less than €5,000.

There is already early evidence that the pick-up has started. According to O'Halloran, recent figures have shown a change in the trend of declining loan-to-asset ratios. In some cases the ratios are now stabilising and, in fact, have started to increase slightly as lending picks up.

Billy Doyle, chief executive of the Credit Union Development Association, a breakaway group that represents some of the largest credit unions in the State, says lending volumes in the association's credit unions are increasing and the average loan-to-savings ratio now exceeds 65 per cent.

Doyle agrees that the current credit environment could present opportunities for credit unions. "The not-for-profit, member-first ethos of credit unions allied with a funding model that sees funding for loans sourced directly from members' savings means that credit unions are largely immune from short-term money market shocks."

This differentiates credit unions from other lenders, Doyle continues, allowing them to focus on delivering competitive, value savings and loans packages to its members over the longer term. "In the current challenging financial environment, more and more ordinary people are coming to appreciate this credit union difference."

The fundamental purpose of the credit union movement is to provide cheap loans to ordinary people through co-operative savings at a community level.

If credit unions adopt a prudent approach to lending, this model could yet prove to be one of the most resilient in the face of current financial market turbulence.