Credit Unions to be allowed to charge 24% a year APR

[24601]

Credit Union's are restricted under law to charging a maximum of 12% per annum (1% per month). This effectively renders most small lending to those at risk of financial exclusion as loss-making - despite this credit unions are still, by and large, offering these loans to members.

Provident, to take an example, can charge 187.2% APR to loan someone 500 quid for a year, yet a credit union is limited to 12% for the same loan. Provident generates €653 in interest whereas the credit union generates €33. This is unlikely to even cover the costs of administration and underwriting, let alone facilitate the pricing of risk. This is madness. The Cabinet refused to approve a doubling of this APR limit for credit unions last week meaning that they are explicitly endorsing the extortionate rates charged by moneylenders whilst hugely restricting credit unions.

https://www.irishtimes.com/business...-to-expand-lending-by-credit-unions-1.3748083

 

[NoRegretsCoyote]

Credit unions source funds at close to zero, and rely on volunteer labour for much of their staffing. They are also supposed to know their client in a way that the big banks don't bother with any more.

So funding is close to free, labour is cheap and default risk should be reduced by their knowledge of their customers, and they are not expected to make a profit.


So why can't they break even when lending at 12%? I think it's down to really, really inefficient work practices and processes.

I've only been in a credit union once in my life and it felt like I'd stepped back into 1983.

 

[Brendan Burgess]

The Minister for Finance has said today is to amend the legislation to allow credit unions charge up to 24% APR.

https://www.finance.gov.ie/updates/cuac-report-implementation-group-final-report/

“I note that the Final Report contains a number of recommended actions which are the responsibility of my Department. While I will consider the majority of these recommendations in due course, I have asked my officials to begin preparations to make the legislative amendments required to raise the Credit Union interest rate cap from 1% per month to 2% per month, as recommended in the report and previously recommended by CUAC. This proposal will then be brought to Cabinet as part of the legislative process’.

Brendan

 

[Brendan Burgess]

Of course, the true APR is much higher than 24% if the borrowers are required to hold shares at the same time.

Brendan

 

[24601]

Credit unions source funds at close to zero, and rely on volunteer labour for much of their staffing. They are also supposed to know their client in a way that the big banks don't bother with any more.

So funding is close to free, labour is cheap and default risk should be reduced by their knowledge of their customers, and they are not expected to make a profit.


So why can't they break even when lending at 12%? I think it's down to really, really inefficient work practices and processes.

I've only been in a credit union once in my life and it felt like I'd stepped back into 1983.

They don't source funds at close to zero. All ILCU affiliated credit unions have to pay life protection premiums on savings. Regulatory levies are generally levied on the basis of total assets or savings. They must maintain a blanket total regulatory reserve of 10% of total assets (which can only be funded from the surplus/profit). Most still pay a dividend, however nominal. Many have been charged negative interest rates on liquid investments over the past couple of years. They also generally don't depend on "volunteer labour" for operations - nearly all volunteer roles are governance roles. There's pretty much no such thing as a volunteer teller any more and all credit unions are professionally managed now.

I'm not sure what you mean by the claim that they are not expected to make a profit. They may be co-ops but they still depend on generating a surplus or they wouldn't exist at all - they may not be particularly good at it, but that's a different story. Also, them knowing their members "in a way that the big banks don't bother with any more" isn't how things work anymore and was a significant part of why such high arrears presented post-crash. Character-based lending is a ticking time bomb.

So funding is not close to free. Labour is not cheap and loans have to be underwritten in accordance with far more stringent compliance and risk management requirements. The costs associated with small, short-term loans to a demographic that is at risk of financial exclusion far exceed the interest recovered at 12% APR.

 

[Monbretia]

Credit unions source funds at close to zero, and rely on volunteer labour for much of their staffing. They are also supposed to know their client in a way that the big banks don't bother with any more.

So funding is close to free, labour is cheap and default risk should be reduced by their knowledge of their customers, and they are not expected to make a profit.

Totally inaccurate for today's credit unions, might have had some relevance back donkey's years ago.

 

[24601]

Totally inaccurate for today's credit unions, might have had some relevance back donkey's years ago.

His/Her reference sample is probably unhelpful given there are c.250 of them and he/she has only stepped foot in one credit union ever.

 

[Feemar5]

Credit unions are like banks now - they have lost the personal touch and in our local credit union all staff are full time employees. I don’t agree that they should be allowed to double their interest rate.

 

[Brendan Burgess]

The problem for the Credit Unions is that charging 24% on a loan of €200 is still only €48. It would cost them far more than that to process the paperwork.

24% on a performing loan of €10,000 would be outrageous but I don't think that this rate is being targeted at big loans.

Maybe the legislation should allow them to charge a €10 a month minimum processing fee?

Brendan

 

[24601]

It depends. For lower value loans a fairly straight forward application and approval process could be utilized. There’s no reason why loans up to €500 couldn’t be turned around in 15 minutes for many credit unions.

It’s more about pricing in the risk as loans carrying this rate are likely to be aimed at people who can only afford to borrow up to a grand or so and the cost of non-recovery across the product would need to be recovered as arrears are likely to run at 10% or so across the category. It’s surely preferable for a credit union to charge someone 30% than a moneylender charging 200%. It could be designed in such a way to be a breakeven option for credit unions and might have the added long-term positive of creating future borrowers of good standing that can manage money better and borrow larger loans with better margins for the credit union.

If they’re willing to cap the APR they could just as easily give the minister power to impose a max loan amount at which the rate can be applied which could be amended by statutory instrument as needed.

 

[NoRegretsCoyote]

@24601 ; @Monbretia

Perhaps I was being overly provocative with my post. I am not an expert on the CU sector. The one time I have ever been inside a credit union was recently enough, in late 2017, and they had not one but two volunteer tellers on duty. All I needed to do was lodge a cheque to a relative's account and the whole process took two hours and needed a second visit, and this was after I had called in advance. I've never been anywhere less keen to take my money

I appreciate that sourcing funds does not cost zero, but it is still pretty low and plentiful, judging by the fact that their deposit base exceeds their loan book by a factor of four. Obviously they are expected to generate a surplus, but they don't have analysts expecting a certain RoE that a commercial bank does.

I have no objection to lifting of the price cap per se. I just find it bizarre that they are looking to increase margins at a time when interest rates are much lower than they were when the cap was set twenty years ago. Maybe they've fallen into a bit of a space where AML and prudential requirements are squeezing players at the smaller end of the credit market. But if this is the case surely they should be trying to look at their own cost base, rather than just pushing up the cost of lending.

 

[RedOnion]

@NoRegretsCoyote
With respect, I think you need to do a bit of
research into the CU sector. Pick a large credit union, and check if their annual report is available online, and read that as a starting point to get a better understanding.

Credit unions don't need to charge higher margins per se. To survive, they need to lend more money. And the people they'd happily lend to at 6% to 12% per annum don't actually need to borrow from them. So CUs want to lend to the people who are turning to money lenders, but 12% is not enough to cover the risk in most cases. That's why they want the cap lifted.

 

[RichInSpirit]

But credit unions are meant to be the "nice guys".
So if one of these "small" short term high interest rate loans gets into difficulty or is totally unpaid they won't have the same fear inducing collection tactics of traditional money lenders. Also if a loan remains unpaid for a time does interest continue to be added?
24% interest rate is really attacking the poorest of the poor.

 

[RedOnion]

24% interest rate is really attacking the poorest of the poor.

The alternative:

Provident, to take an example, can charge 187.2% APR to loan someone 500 quid for a year,

But I agree. The ethos of the CU movement gets called into question. All you have to do is look at the CU sector in the UK where they are borderline moneylenders in some cases. 3% per month is typical.

 

[NoRegretsCoyote]

@NoRegretsCoyote
With respect, I think you need to do a bit of
research into the CU sector. Pick a large credit union, and check if their annual report is available online, and read that as a starting point to get a better understanding.

@RedOnion I am familiar with how banking works and concepts like adverse selection.

Credit unions were, inter alia, set up to provide smaller-value loans to people who banks were not interested in, probably more due to the cost to the banks of underwriting than default per se. Cost to credit unions was kept down as default risk on lending was mitigated by making borrowers hold on to shares, personal knowledge of borrowers' own circumstances, and also from the social pressure on borrowers of knowing that they were borrowing from your own community.

I think it is very odd that this business model worked well 20 years ago when interest rates were higher (with lower room for margins), but won't work now.

Should credit unions be actively seeking borrowers who are more likely to default? This seems to go against the traditional lending practices that they adhered to. I don't think that lending to higher risk borrowers by credit unions is Lehman 2.0, I just think it raises fundamental questions about the purpose of the sector.

Anyway I took your advice and looked at the annual report of a big credit union in a large town outside Dublin. They seem to only be generating surpluses due to large writebacks in recent years. On the expenditure side the regulatory costs and insurance are indeed very high for the size of balance sheet. I was also surprised by some of the ancillary spending though: €450k on IT, €165k on advertising, and €134k on sponsorship, AGM and convention expenses. These seem like a lot given net interest income of around €6m.

 

[RedOnion]

@RedOnion I am familiar with how banking works and concepts like adverse selection

Excellent. But we're talking about credit unions.

My point was more that 'typical' credit unions aren't run like 'Penny Banks' with volunteers recording transactions in a paper ledger. The experience you described is no longer typical of the sector, and most definitely not of those credit unions pushing for legislative changes.
I'm not sure which CU you looked at, but IT cost for most has been unusually high in the past few years due to mergers. However, their IT spend per customer is very competitive compared to banks.

 

[24601]

@RedOnion I am familiar with how banking works and concepts like adverse selection.

Credit unions were, inter alia, set up to provide smaller-value loans to people who banks were not interested in, probably more due to the cost to the banks of underwriting than default per se. Cost to credit unions was kept down as default risk on lending was mitigated by making borrowers hold on to shares, personal knowledge of borrowers' own circumstances, and also from the social pressure on borrowers of knowing that they were borrowing from your own community.

I think it is very odd that this business model worked well 20 years ago when interest rates were higher (with lower room for margins), but won't work now.

Should credit unions be actively seeking borrowers who are more likely to default? This seems to go against the traditional lending practices that they adhered to. I don't think that lending to higher risk borrowers by credit unions is Lehman 2.0, I just think it raises fundamental questions about the purpose of the sector.

Anyway I took your advice and looked at the annual report of a big credit union in a large town outside Dublin. They seem to only be generating surpluses due to large writebacks in recent years. On the expenditure side the regulatory costs and insurance are indeed very high for the size of balance sheet. I was also surprised by some of the ancillary spending though: €450k on IT, €165k on advertising, and €134k on sponsorship, AGM and convention expenses. These seem like a lot given net interest income of around €6m.

You do realise that this idea of "personal knowledge of borrowers' own circumstances" is one of the underlying reasons for the credit frenzy we had during the Celtic Tiger? Banks and credit unions alike lent to people who couldn't afford it but sure it was grand because Mary or John were "sound" and "good for it". Character based lending is a nonsense and doesn't mitigate risk but rather increases it exponentially. That's why some credit unions were carrying arrears of 30/40 or even 50% of their loan books around 2010/11.

The business model never worked particularly well. When credit unions were generating their "best" returns of assets it was very often on the basis of reckless lending coupled with the investment of surplus funds in risky products.

Credit unions already lend to people who are more likely to default and cater for this demographic insofar as they can as it aligns with their operating principles but prudent lending requirements and the cap on APR makes it a loss-making exercise and many are stopping it altogether so this development should be welcomed by anyone who would rather someone at risk of poverty borrowing to replace their washing machine for 3 or €400 at 16 or 17% rather than 200%! It's a no brainer. If credit unions could build up volume in this type of lending it might actually make them some money notwithstanding the larger than expected arrears. All other loan products are priced for risk so I don't really understand anyone's issue with this. The amount of interest earned on these loans at the minute doesn't cover the underwriting costs let alone the cost of arrears and provisions.

 

[24601]

@24601 ; @Monbretia

Perhaps I was being overly provocative with my post. I am not an expert on the CU sector. The one time I have ever been inside a credit union was recently enough, in late 2017, and they had not one but two volunteer tellers on duty. All I needed to do was lodge a cheque to a relative's account and the whole process took two hours and needed a second visit, and this was after I had called in advance. I've never been anywhere less keen to take my money

I appreciate that sourcing funds does not cost zero, but it is still pretty low and plentiful, judging by the fact that their deposit base exceeds their loan book by a factor of four. Obviously they are expected to generate a surplus, but they don't have analysts expecting a certain RoE that a commercial bank does.

I have no objection to lifting of the price cap per se. I just find it bizarre that they are looking to increase margins at a time when interest rates are much lower than they were when the cap was set twenty years ago. Maybe they've fallen into a bit of a space where AML and prudential requirements are squeezing players at the smaller end of the credit market. But if this is the case surely they should be trying to look at their own cost base, rather than just pushing up the cost of lending.

There's 250 or so credit unions and some of them are backwards but the type you visited is a dying breed. How did you know they were volunteer tellers out of curiosity? I've worked with a huge number of credit union staff and I've never come across a volunteer teller but I also wouldn't be able to tell from looking at them!

Funds are plentiful, yes, and credit unions are in fact pretty keen to not take your money at the moment for that exact reason. They can't lend out enough money but savings are piling in which creates a huge pressure on their capital since they have to keep a blanket 10% of total assets in a regulatory reserve. A significant number of credit unions have introduced temporary caps on savings to try mitigate this problem (which is a total nonsense to begin with, but that's another debate)

Interest rates being low is also a huge problem for them since they have such excess funds. When you lodged that cheque to your relative's account for every €100 the credit union probably lent about twenty of it, had to insure it for life savings protection, had to reserve €10 of it and likely went across the road to AIB/BOI/PTSB etc. and deposited a large chunk of the rest of it a 0% with a small portion of it being invested in longer term products that are probably yielding, if they're very lucky, 1%. They literally don't have any want or need for your money and many are telling their members this but you know what happens, money keeps piling in. This is a serious medium-term viability pressure for some credit unions.

The cost of compliance is massive and this has to be paid for. I don't really know how they can look at their cost bases to any material degree in this sense. They all have to have a CEO, Auditor, Internal Audit Function, Compliance Officer and Risk Management Officer regardless of whether they have €1m in assets and 1,000 members or €500m and 100,000 members. They all have to have a core banking system and there's only two real players available creating a duopoly but IT spend isn't astronomical when compared with the banks. Then there's the additional compliance costs such as AML and GDPR both of which are becoming specific jobs in themselves.

 

[Protocol]

Interest rates being low is also a huge problem for them since they have such excess funds. When you lodged that cheque to your relative's account for every €100 the credit union probably lent about twenty of it, had to insure it for life savings protection, had to reserve €10 of it and likely went across the road to AIB/BOI/PTSB etc. and deposited a large chunk of the rest of it a 0% with a small portion of it being invested in longer term products that are probably yielding, if they're very lucky, 1%. They literally don't have any want or need for your money and many are telling their members this but you know what happens, money keeps piling in. This is a serious medium-term viability pressure for some credit unions.

Perhaps off topic, but why don't CU cut their lending rates to boost lending and income?

Why not compete against PCPs?

They are earning maybe 0%-0.5% on deposits and maybe 1% on bank bonds.

Why not earn 4%-5% on car loans?

Instead they seem to charge 7% on car loans, or more.

My CU is actually increasing rates, while PCPs are available at 0%-4%.

 

[24601]

They have cut their rates significantly but with varying results. In most cases it has been ill-judged. People generally aren't price sensitive for small-medium sized personal loans (a point illustrated by this discussion!). Lending is growing modestly across the sector and would be in any case given the economic environment so the credit unions that have embarked upon significant rate discounting have ended up running hard to stand still - loan books are up but loan interest is stagnant.

They can't compete with PCPs, obviously. They're generally close to zero APR and the costs associated with setting up the infrastructure to do HP type products are prohibitive and it's unlikely that there would be regulatory approval for such a product. There's also a huge amount of risk involved if you don't understand the autotrade market and regardless of all that, PCPs and car finance generally is sold at the point of sale - nobody can compete with that level of convenience. A PCP payment is always going to be small when compared with a straight-up loan on the same car so there's no getting around that cashflow USP for a credit unions.

They do earn 4-5% on car loans at them moment but the advent of PCP finance has reduced the market share considerably - this will likely rebound though. In any event most credit union loan books comprise of a significant number of car loans but there has been a shift towards the 2nd hand market and as a result the overall book tends average small/medium shorter term car loans which require an APR of 6-8% to make sufficient margin. The churn rate on credit union loan books is staggering.

PCPs are not comparable with a credit union car loan. They're not the same product. With a PCP you're financing the cost of the depreciation on what is someone else's asset whereas with the credit union loan you're buying the car day 1 and renting the money from the CU. The difference in payments on a new car worth 30k would be somewhere between 200 and 400 per month on any personal car loan vs PCP.