August 2011

A CO-OPERATIVE BANKING STRATEGY FOR IRELAND

Conceptualising a Strategic Network Amongst Credit Unions Creating a national, community focused, citizen owned and governed federated co-operative banking system.

"The way we see things is the source of the way we think and the way we act"
Stephen Covey

A personal submission by Bill Hobbs to the Commission on Credit Unions 25th August 2011.

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A CO-OPERATIVE BANKING STRATEGY FOR IRELAND

1: Introduction and Summary...................................................................................... 3 2: 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 .............12 3: Network Rationalisation and Configuration............................................................13 4: The New Model Credit Union.................................................................................16 Savings Products ...................................................................................................16 Lending Products ...................................................................................................17 Operational Model..................................................................................................18 Governance Model & Strategic Orientation............................................................19 5: 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 ..............................................................................................32 6: Conclusion.............................................................................................................32 Appendix 1 : Note on Federated Co-operative systems ............................................33 Useful Referent Documents.......................................................................................37

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1: INTRODUCTION AND SUMMARY

This submission considers the concept and high level strategic business case for creating a national co-operative full service banking alternative for Irish consumers and small business owners through a strategic network alliance of consolidated credit unions. The credit union sector should adopt a federated strategic network as its core infrastructure for ensuring individual credit union financial stability and sustainability and strengthening the sectors financial stability. Such a network would be modelled on successful designs for centralised co-operation that have been key to the success of other co-operative banking systems globally but which have not yet been considered or implemented in Ireland. Given the success of federated credit co-operatives elsewhere and proven resilience of their business model during the recent global crisis, it would be unwise not to consider this viable and robust form of co-operative banking in the Irish context. Envisaged is a citizen owned and governed federated financial co-operative system, guided by credit union philosophy, values and ethos, offering a full range of consumer and small business banking products and services. Such a system would be modelled on the European style federated network, have a customer base of over 2m ordinary citizens who would also be its owners. Initially, excelling at providing savings and loans, it could in time provide full banking services through a 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 facility For many reasons the Irish credit union finance company business model and network structuration, with its emphasis on the independent, autonomous credit union and loose form League 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 cohesive centralist finance systems found in every other credit co-operative sector in mature financial service marketplaces. It also utilises a model of governance rooted in legacy part-time volunteerism that confuses non-executive director with executive management roles. Its proposed that a new model credit union be defined and credit unions required to transition to it within a defined period of time.

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Credit unions should focus on excelling at their core business and offer a wider range of updated savings and lending products that meet the needs of modern consumers. They should 1augment these core products with related fee earning products and services. The large scale now required for banking services to be competitive means that smaller players like credit unions must specialise to survive. It is just not possible for credit unions to be all things for their customers and still give them the best deal. However their basic business of consumer savings and lending can achieve scale economies at the size presented by the configuration of consolidated larger 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 savings and loans products and services to ordinary people. In short they have to be the best at delivering on generic category benefits which include choice, service and price elements. They will have to adopt market-based principles of pricing to ensure better rates and terms for customers. To do this they will need to upgrade their IT, operational systems and internal controls to achieve greater efficiency and safety. However in the absence of consolidation to realise scale economies and build human and operational resources competencies, credit unions will be unable to truly deliver on their economic and social objectives. Complexity requires scale economies to spread the costs of the more sophisticated technologies required to deliver modern financial services and products. The current operational model is one of high-cost, low-value transactions, mainly handled through manual processes. The costs of operating a manual delivery and service processes are unsustainable as they have eroded profits in many credit unions to a point where operating costs exceed core interest income. Routine transactions must be automated to keep down costs. People now want 365/24/7 service and their lives are too busy to stand in teller queues. ATM and internet delivery channels are now a given service feature required by almost all consumers. Furthermore the heterogeneous aspect of credit union operations, their varying size and restrictive common bonds prevents the best from expanding their operational footprint, allows poorly governed and managed operations to continue and inhibits the type of competitive merger activity that 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 its constituents would be of size capable of realising scale economies and participating in a federated network. 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, high quality services. Even when consolidated they would remain quite small operations with limited financial, IT and human resources. A central facility as envisaged here would employ the expertise required to deploy the technologies to enable credit unions transition to the new model credit union. More specifically the central entity would facilitate the design and implementation of a new operations model including enabling information technologies and management systems. Credit unions should establish or source a joint venture and co-own such a 2Central Finance Facility. It would operate as a corporate services centre and wholesale bank providing a range of shared services which, amongst others, would include treasury, central liquidity, MMR
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In so far as entering the current account market or providing basic banking accounts; it is not within the current organisational resource, capacity or competence of credit unions, regardless of size, to fund the operational costs associated with these products. Any consideration in this area should be secondary to the core objective of excelling at the savings and loans model for the time being 2 Central Finance Facility is a term used by international credit union trade body WOCCU to define central corporate entities owned by constituent credit unions

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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 constituent credit unions and would also provide a stabilisation mechanism based on contractual solidarity and cross-guarantees. In essence the central entity would leverage off its constituent owners' combined balance sheet. Such central facilities are found at the core of European credit co-operatives such as RaboBank (Holland) and Oko Bank (Finland). In a federated system, consolidator credit unions, whilst ceding some strategic and operational autonomy, would retain independent legal status, local governance, with each one having its own multi-branch network. Such multi-branch networks would be a consequence of the rationalisation of non-viable credit unions and those that opt to consolidate through mergers. Furthermore, in line with developments in other markets, credit unions would be likely to open new branches in underserved areas. Credit union network reconfiguration would be dependent on a number of variables including governance and management competence, financial strength and sustainability, geographic location and type (community, associational, employer based). The diagram below is a stylised design for the federated network organisational structure envisaged in 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 captivity of consumers and small business owners. It is unlikely that any new entrants will be attracted into the Irish marketplace for some time to come and existing foreign banks will respond to the demands of parent organisations having differing objectives. Pricing of products will be driven to repair their balance 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 of enabling 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 banking system could have seen a joint venture between a building society and credit unions to establish a central facility which would have incorporated the corporate support service capabilities and resources of the building society. However, exploring this opportunity appears to be no longer feasible.
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This submission proposes a movement strategy. Any further development would consider the strategic rationale in detail including funding implications.

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2: BACKGROUND TO CREDIT CO-OPERATIVE BANKING

Credit Unions and Credit Co-operatives Internationally
Credit unions have historical roots in the credit co-operative movements that first appeared in 19th Century Europe. During times of industrial development and social disruption, small groups of people banded together to pool their savings and grant loans to one another. The primary economic and social purpose of these co-operatives was to provide credit to people who were financially excluded unbanked because commercial banks were not interested in serving them on an affordable basis. Credit co-operatives spread throughout Europe, crossed the Atlantic to Canada, and in turn were adapted in the U.S. in the form of credit unions. It was the U.S. credit union model that was eventually established in Ireland in the 1950s. Today, in developed countries other than Ireland, most credit unions and similar credit co-operatives have adopted the fractional reserve banking model and are regulated as authorised credit institutions. Although they typically operate under legislation specific to their unique mutual ownership and democratic governance, outside Ireland they are supervised under regulatory regimes every 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 has followed a different time line in each country. At first, the business model was that of a finance company or type of narrow bank in which members accumulated savings by purchasing withdrawable capital shares, thereby providing funds for making loans. Only after a member had purchased some minimum amount of shares could he or she then borrow. Shares formed part of the capital base and were exposed to the risk of the business. Tight common bonds of association acted as collateral for members loans. Lending was typically done at a simple interest rate of 1% per month on the unpaid balance regardless of market conditions.3 Instead of receiving interest on their savings based on market rates, members shared in the co-ops lending profits by receiving a dividend declared at the end of the year. Management was typically in the hands of unpaid volunteers. Initially credit co-operatives banded together loose form associations e.g. credit union Leagues, establishing some shared services and mutual stabilisation funds used to support growing balance sheets in particular providing early stage capital support. In the second stage, they evolved into savings and loans co-operatives, thereby shifting to the fractional reserve banking model, adopting market based pricing and offering a broader array of deposit and lending products to their personal and small business customers. Those were typically augmented with fee based services such as transaction accounts and simple insurance products, and credit unions in this stage were managed by professional staff. This stage also saw credit cooperatives establishing corporate central facilities through which they pooled excess liquidity, accessed liquidity support from one another and the wholesale banking market. In some cases these central facilities evolved into wholesale banking arms with devolved supervisory powers. Most operated as lender of last resort for their constituent members. This stage also sees the development of robust financial safety nets with developed legal frameworks, differentiated

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 earnings are sufficient. Although it is seen by some as having its roots in credit union philosophy, the practice is actually an obsolete carryover from the days when credit unions lacked even electronic calculators. On a paper-based system, even relatively untrained volunteers could readily calculate the interest due on a loan each month.

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regulation and supervision and deposit insurance systems closely mirroring or integrated with wider banking systems. Although Irish credit unions have broadened their product range somewhat, they remain stuck in transition between these first two stages of development. With deposit products largely limited to the member share account, their savers are still paid an annual dividend out of net earnings at a nonmarket-based rate. Lending is still done using the basic instalment credit loan first introduced in the 1950s. While the larger ones have paid staff, many of the smaller ones are still operated largely by volunteers. IT systems are relatively primitive, and Irish credit unions do not provide current account and only very limited electronic transaction services. Nor are they full members of the national retail payment system. Furthermore credit unions have not developed the central facility commonly found today in developed credit co-operatives elsewhere. In these countries, credit co-operatives have long since entered the third and final stage of development. This occurred earliest on the Continent with the evolution of full service co-operative banks offering a broad range of financial products. Credit unions in other major markets such as the U.S., Canada, and Australia have likewise become full-service consumer banks, while still operating as 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 unions when compared to their international peer groups full service models.

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Ireland
Payments Services Current account equivalent Debit cards EFT paym ents Proprietary ATMS Bank ATM network access Savings and Deposits Rates vary by type/m aturity Certificates of deposit equivalent Tax deferred or sheltered Lending Services Secured auto loans 30 Year 1st m ortgage Loans Open-end, revolving credit Credit cards Sm business loans all Wealth M anagement & Insurances Trust services Pensions Mutual funds Life Insurance General Insurance
No No No Y es No

U.S.
Y es Y es Y es Y es Y es

Canada
Y es Y es Y es Y es Y es

Australia
Y es Y es Y es Y es Y es

No No Y es

Y es Y es Y es

Y es Y es Y es

Y es Y es Y es

No No No No Y es

Y es Y es Y es Y es Y es

Y es Y es Y es Y es Y es

No Y es Y es Y es Y es

No Y es(PRSI) No No Y es

Y es Y es Y es Y es Y es

Y es Y es Y es Y es Y es

Y es Y es Y es Y es Y es

Today, credit unions and other credit co-operatives provide affordable financial services to hundreds of millions of ordinary people worldwide. Across Europe, co-operative banking systems represent a major force through which 140 million people, 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 combined market share of 20%. In five European countries they represent 40% or more of local banking services. 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.

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International Models for Centralised Co-operative Banking

A key characteristic of these successful credit union/co-operative banking systems internationally has been the existence of strong centralised support mechanisms. Development of these structures was essential to achieving the scale economies and professional management systems required for credit co-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 in The Netherlands and Raiffeisen Banks in Germany and Austria. OKO Bank, a central bank for Finnish co-operatives, has established a listed subsidiary for accessing equity markets. Some of the largest co-operatives, such as Rabobank, have expanded beyond retail banking into corporate and wholesale, and even international banking. In all cases, the European co-operative banks provide a full compliment of consumer and small business financial products. In Quebec, the Movement Desjardins followed the European model, whereas in the other Canadian provinces, 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 credit unions and credit union-owned service corporations for specialised functions such as IT, ATM network administration, and support for shared branching. CUNA Mutual Group, the dominant international provider of insurance services to credit unions, began life as a subsidiary of Credit Union National Association (CUNA), the U.S. trade body. CUNA also created U.S. Central Credit Union as a central liquidity and investment facility for state-level corporate CUs. Both CUNA Mutual and U.S. Central are now completely independent from the trade association. Australian credit unions receive central services from their national body, CUSCAL, which is itself an authorised depository institution. Recently, CUSCAL amended its charter to allow membership by building societies and friendly societies, and it also provides transaction services to superannuation (retirement) funds5. From their start-up in the early 1990s, Polish credit unions adopted a hybrid integrated model under the oversight of a central body, and they operate more like franchised branches than independent entities. Based on a system of mutual cross-guarantees, the Polish federated system fulfils EU capital standards by means of a consolidated balance sheet. Its central body provides payment system and insurance services through listed subsidiaries, and it now has more retail outlets than any other financial group in Poland.

British Columbia and Ontario central financial facilities merger in 2008 creating Central 1 serving 164 member credit unions having CAD$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 between Maitland Mutual (building society) and Phoenix (credit union) in New South Wales. Australia has also seen the recent establishment of ABACUS as the combined national trade body for 99 credit unions, 8 building societies and 15 friendly societies, which collectively have AU$75 billion in assets and 5.5 million members.

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In each of these cases, the functions and structure of the central system reflect unique local circumstances of history, market environment, legal convenience, practical political compromise, and so on. Conceptually, however, these international models which are defined by their degrees of integration can be broadly categorised into the following basic types: Atomised: A system of autonomous and independent credit co-operatives where particular centralised services are provided on a contractual basis by specialised commercial firms owned by credit unions. (E.g. corporate credit unions, IT providers, ATM networks, insurance and brokerage companies in the U.S.) Typically credit unions or co-operatives remain autonomous in whats called an atomised system. Federated Network: Comprehensive finance, liquidity, and other services are provided through a federated structure led by a credit co-operative-owned central facility, which may itself be a wholesale credit union (Canada) or a commercial bank (Australia, The Netherlands). This system is referred to as a federated network. Integrated/Merged: Credit co-operatives share a consolidated financial structure, in which local outlets 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 all respects to a branch banking system. For the reasons discussed later, the appropriate model for Ireland is likely to be some variation of the second 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 business models as their longer term orientation and prudent focus on capital retention ensured resilience during the global crisis. The evidence highlights the need for legislators and regulators here to understand the difference between co-operative banking and commercial banking. That is to understand how the longer term co-operative orientation, unique governance structures, inherent focus on consumer value and capital retention policies differ from their publically quoted joint stock bank competitors. Whilst the co-operative model has evolved in many differing forms, they all have one thing in common; they are owned and governed by their members who are also their customers and all employ the empowering democratic principle of one member one vote. This defining democratic principle, allied to embedded customer advocacy ensures co-operatives remain culturally and operationally focussed on delivering affordable and valued financial services to meet their members needs along with educating them in the wise use of money. The inherent financial stability of the federated co-operative model has proven resilient during the global credit crisis due to its prudent levels of capital and longer term orientation. It is for this reason that many consider federated co-operative banking systems to be resurgent as regulators begin to truly understand how their unique organisational form helped to underpin financial stability and keep credit flowing when commercial banking had all but collapsed.

With the exception of the Co-operative Bank in the UK, the European and North American models do not involve consolidation of cooperative banking into a single, legal entity. Even systems such as Rabobank fall more into the second category. While Rabo has the outward appearance of an hierarchical bank, it is in fact a network of individual co-operatives. In that system, the emphasis is on local control over product quality, which in turn creates pressure on the central to compete on quality and price. Thus, a local Rabobank may offer the products of third party suppliers who compete with the Rabobank central subsidiaries.

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Co-operatives were maximising stakeholders interest long before commercial banking began to talk of corporate social responsibility, triple bottom line or recognise a wider stakeholder responsibility paradigm. In some respects the existence of co-operatives, their social contribution and successful enterprise model is focusing minds on alternatives to the joint stock bank model of banking with its singular focus on profit maximisation and shareholder value. Commercial bankers and stock market analyst critique of cooperative bankers prudence and strong capital positions has been silenced. In many countries, at national level, cooperative banking is seen as a customer champion and a vibrant, safe alternative to commercial banking.

Structuring Irish credit unions as a modern co-operative banking system

The strategy would see credit unions restructuring as a European style credit co-operative system in two phases. The first phase would require the rationalisation of credit unions into a reconfigured network of larger 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 credit union focussed on excelling at savings and loans. Consolidator credit unions would be required to be members of a federated network which would establish a central finance facility along the lines proposed in this submission. Alternatively such a central facility could evolve from a special authority established by Government charged with overseeing and implementing a rationalisation programme and transition to the savings and loans model. The authority would be empowered to create the federated network and establish the central finance facility. If required, state funding could be made available to the authority.

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3: NETWORK RATIONALISATION AND CONFIGURATION

The credit union movement should be realistic about the future of the smallest credit unions and those 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 about 7,500 credit unions, but their average assets are close to 50 times greater and nearly one third of Americans 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 small but healthy credit unions merging into larger ones. The office of the merged credit union often stayed 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 here as well. First, the smallest credit unions, with no employees and in which volunteers do all the work, are finding it hard to recruit the volunteers they need. This is understandable. When credit unions were the only reasonable source of credit for most people, there was a powerful incentive for volunteers to 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 deserve financial services that are delivered in a safe and reliable fashion, and the members of small credit unions are no exception. It will be difficult for a credit union to absorb the resulting costs of compliance 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 that todays consumers are demanding. The best strategy for many will be to join forces through mergers that can give the surviving credit unions the scale they need going forward. While these reasons for rationalisation have been acknowledged here, the negative impact of external forces (global and domestic) and internal financial stability shortcomings inherent within the business model have starkly brought the need to rationalise to the forefront as a sectoral financial stability and sustainability challenge.

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In the past, rationalisation was an inevitable consequence of success which for various reasons was delayed by the Irish movement. Today it has become an inevitable consequence of poor governance and 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 these numbers drive savings and loans volumes, data management requirements, transactions, operating costs and interest revenues. They also indicate the potential for add on sales of associated fee earning products and services. To achieve scale economies its possible to define the appropriate network size by the numbers of customers served. For example, whilst somewhat of an arbitrary number, 50,000 customers per credit union is useful to consider network reconfiguration. The chart below illustrates the resultant configuration should new model credit unions service 7 50,000 customers each.

Using this approach, the network would consolidate through a planned programme of mergers down to about 60 credit unions. In turn these consolidator credit unions would be required to transition to 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 current narrow 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 and services. Indeed consumers should be free to shop around credit unions for the best deal, in which case membership should be open to anyone who wants to join. In so far as occupational/employer based credit unions are concerned, they have generally provided a postal type service from a central office to their dispersed members. More recently, most have embraced the on-line or internet facilities. Some provide a branch/office/agent type location/facility to deal with their walk-in member transactions. Even immediately, these occupational/employer

Credit union total member numbers include active, inactive and dormant relationships. On current experience less than a third of the 50,000 would be active users of credit union products and services.

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based credit unions could be consolidated into just one central office to provide branded services to their members from one location. As mentioned above the scale of rationalisation would require an empowered body charged with its central 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 define and execute a rationalisation programme through which consolidator credit unions become founding members of the central.

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4: THE NEW MODEL CREDIT UNION

Transitioning 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 members needs. While customer value is embedded in why things are done this has not successfully translated into the way things are done which remain rooted in outdated, legacy business systems and 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 should rightfully 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, will have 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 to cost. At the very least credit unions should have some element of cost recovery rather than what is currently happening which amounts to the cross subsidisation by infrequent-users of frequent-users free services. In addition the practice or habit of paying or charging one rate for all accounts, whether savings or loans, should cease replaced with appropriate rates being paid or charged for differing product categories. For example a high transaction, low value savings account attracts the same rate as a high value, low transaction long term savings account. Similarly the same rate is charged on a short six month loan of 1000 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 to member-pay insurance coverage. The cost of insuring for free loans of upwards of 100,000 and savings balances to 13,500 is a crippling burden that given credit union member demography is unsustainable. Credit unions should as a matter of urgency significantly reduce the level of coverage and move to member pay models that effectively switches what is currently an operating cost to a fee earning revenue stream. To excel at their core business of savings and loans credit unions need to offer a much wider choice of modern savings and loans products along with learning how to ask for the business from their customers.

Savings Products
The 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 have closed it is a mechanism that has been exposed as an anti-consumer practice in the current climate.

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The share account should be retained only as an account denoting members ownership share in the credit union. It should be repositioned as being purely the means by which members have an ownership stake in their credit union. In good years, shares could pay a much better rate than savings deposits. But credit unions need to be straight with their members, making it clear that share dividends are not market based and that last years rate is no indicator of what it will be this year and that 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 the normal market environment. This is not the case today as banks fight for deposits to replace the high cost 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 of services which might carry a fee or unless a minimum balance is maintained no interest is paid. These accounts could also offer electronic payment facilities such as standing orders and direct debits and be the primary transaction account offered online and by ATM Regular savings accounts: regular savings accounts could be designed to encourage regular savings and pay higher rates for balances saved whilst allowing for infrequent withdrawals Term Deposits: for longer term lump sum savings would pay higher rates depending on the preestablished 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 where such collateral is required. The practice of nominated ownership in event of death should also cease. Instead the banking approach to joint accounts should be adopted. Credit unions would not offer current accounts, cheque books or overdraft facilities until such time as they and the central developed the technological capability, supporting architecture and assembled the resource capability required to provide such accounts and facilities.

Lending Products
A full range of consumer lending products should be made available shifting from the traditional instalment credit facility to fixed and variable term loan type structures. Additionally consideration should also be developing a revolving credit facility eliminating the cost of involved in the multi-issuance of small facilities. Given the numbers of customers, credit unions should have the collective strength to negotiate with product providers to offer white label fee-earning products offering attractive rates to their customers. These would include insurances, retail investments, debit cards, prepaid debit cards, credit cards, car leasing and other durable goods financing facilities.

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Credit unions should partner with high quality, reputable mortgage lenders as loan originators. Over the longer term, via the central finance facility, they could develop the competencies and legal authority required to act as mortgage producers. Credit unions should be required to comply with consumer protection codes and develop robust organisational competencies in credit assessment and risk management. In particular they should have the capacity to continue to provide loans to the less well off and financially marginalised to people of good character who cannot borrow elsewhere. Modern credit risk and lending assessment practices should be deployed including affordability assessment techniques and full membership of credit bureaux. Additionally in keeping with affording credit to marginalised borrowers, credit unions should develop specific credit assessment techniques using 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 pricing methodologies. This means setting rates at different levels depending on the service involved and rebalancing 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 stands credit union fee income to total income is less than 1%. In other advanced markets, fee income represents a substantial percentage of total income earned by credit unions.

Operational Model
Providing a modern range of high quality consumer savings and loans requires substantial upgrading of 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 of overheads on data processing and information systems. This false economy has driven up costs by limiting 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 responsiveness to increasing complexity in particular regulatory reporting and risk management requirements. It is unlikely that any of the current systems are capable of supporting a wider range of products or providing the operational flexibility required under the new savings and loans operations model proposed here. Deploying modern IT systems will be required to provide customers with the convenience they expect these days. For example customers should have access to their funds 365/24/7 via ATM machines. 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 as credit risk management and reporting processes. Credit unions need to employ more sophisticated tools for asset/liability management, investment analysis and product pricing and for monitoring and reporting on legal compliance obligations. Credit unions should have internal audit capabilities including appropriate systems for assessing and managing risk and testing for sufficiency of internal controls. More efficient and effective operations will require substantial expenditure on IT and IS as well as staff and director training. In many cases IT projects are being developed and implemented without a coherent supporting business strategy or business case. In some cases, individual credit unions have gone on solo runs implementing new systems at some considerable cost without it appears tangible business benefits being established or achieved.
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The sector should guard against IT projects driving the business strategy. IT should enable delivery of the business requirements and not define what the business is or isnt. It is highly likely the new model credit union proposed here will require an enabling modern core banking system, database model and architecture to support an operational model that excels at delivering savings and loans products. Even if consolidated as illustrated above, credit unions will not have the resources, operational capability or competencies required to transition to the new operations model. Their scale will remain small. All the more reason for a federated alliance and its central finance facility, which through its shared services delivery model, would provide the requisite upgraded technology platform, management information systems and delivery channels.

Governance Model & Strategic Orientation

Consolidating to larger operations and transitioning to the new business model will require higher levels of governance and management capabilities to achieve the standards of operational excellence required to excel at delivering low cost, high quality consumer savings and loans products and services. A new form of governance will be required as boards should switch to the principles based strategic board 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 the training, experience and skills required for any institution that is holding peoples money. Current governance practices confuse the very different roles of non-executive directors and executive management. This results in part-time volunteers making management decisions and performing management roles for which they are neither trained nor qualified. Volunteer directors crucial leadership role should be to establish business goals and policies that advance the credit union ethos of fairness to members and service over profits and to ensure the safe and sound prudent management of the business. Directors should not be distracted from their real job by dealing with day to day operational decisions and routine matters. Management of the credit union should be the responsibility of a professional chief executive. The CEO should in turn be supported by full-time management team of qualified professionals with specialist skills in finance, operations, risk management, compliance, marketing, audit and so on. Most importantly the current short term strategic and business orientation focussed on maximisation of dividends to members will have to be replaced with a longer term orientation focussed on economic sustainability. Professionalisation of governance and management is a key feature of network maturity which is best illustrated in the strategic orientation of credit union boards and management. The diagram on the next page illustrates the stark difference in strategic orientation between Canadian and Irish credit unions:

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These findings show a result that most people will find surprising. Financial exclusion is not seen as the primary orientation for the majority of Irish credit unions. The Irish responses clustered within (2) and (3) starkly highlight the short term Irish credit union strategic orientation of the dividend distribution finance company business model - to pay the highest dividend - and lack of emphasis on competiveness and sustainability. In essence a credit union board is custodian of an intergenerational endowment represented not only by the credit unions financial strength its reserves, but also its capacity to achieve its economic and social objectives. Intergenerational handover of fiduciary care and responsibility can only happen where governance places the credit union itself front-and-centre and not on the periphery of strategic decision making. Indeed its the combination of the careful husbandry of the intergenerational endowment with its longer term strategic orientation, and embedded customer advocacy of the member/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 the strategic governance of the credit union, to establish and regularly review its top-level policies, to hire and supervise the chief executive, to set financial and other goals, and to monitor managements performance in achieving those goals. These are the essential functions of top level governance in a financial institution. They deserve the undivided attention of the board, whose energies should not be wasted on day-to-day decisions which staff are paid to make. There are two additional and very important advantages to this model of governance called the strategic board. The first is that it prescribes roles for volunteers that can be fulfilled without an undue commitment of time. By adopting a modernised model of board governance, credit unions discover that the challenge of recruiting capable directors diminishes considerably. Secondly, and even more importantly, effective governance is indispensable to attracting and retaining professional managers with the talents and skills that are needed to run excellent credit unions. Highly capable people gravitate to organisations where roles are well defined: Where
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directors establish clear policies, expectations and goals, where results are objectively measured and rewarded and where directors then get out of the way and let managers manage to achieve those goals to their best professional ability. Excellence in the boards governance of the credit union is key to 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 for their important roles. In which case a specific credit union fitness and probity regime should set out the requisite skills and experience required of directors. Given the increasing complexity of financial services providers generally and specific complexity envisaged with larger credit unions, directors should be remunerated accordingly.

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5: A FEDERATED NETWORK OF CREDIT UNIONS

It is a matter of historic record that while credit unions in Ireland have long recognised the need to develop a cohesive centralist system, they have been unable for a variety of reasons to transition and mature as credit co-operatives in line with their international peers. Furthermore the Irish credit union business model and network structuration within an atomised independent system operating within restrictive common bonds has meant that 8economies of scale and scope have not been achieved. Long before 2008 the business model in use contained a number of flaws which are exposed when credit unions grow and mature as they have in Ireland. Emphasising dividends paid from profits, the inclination of voluntary boards is to adopt risk adverse practices focussed on maximising dividends and to compete with one another to pay the highest rate. This behaviour leads to a strategy of dividend maximisation which eschews investment in improving products and services and adopting market based pricing mechanisms. It also comes at a cost of building the reserves required to ensure economic viability and sustainability and invest in improving operational competence. Moreover aging boards tend to represent a sectional savers interest and favour maximising dividends and minimising investment in building long term sustainable business capacities. The business model was at high risk to the possibility of an external shock which would have negatively impacted on both system and individual credit union financial stability. Both the global credit 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 of years. However it cannot be ignored in that we are now seeing an increasing number of credit unions coming under financial stress. The trend in arrears is continuing upwards and the opportunities for prudent lending are decreasing. Income is depressed and costs are either remaining static or increasing. Should these trends continue it is not implausible that a significant restructuring programme for the sector may be required. If the sector is to remain sustainable in the long term then the time for progressive solutions to the circumstances arising in the credit union sector may be coming soon if its not here already. Address by James OBrien, Registrar of Credit Unions, to the National Supervisors Forum, 6 November 2010 While significant stability intervention has been implemented by the Central Bank, there is a risk that the all too necessary regulatory cure may kill the patient, unless an overarching national policy and development framework is created through which restructuring is achieved. Such a policy and framework should ensure that the sector transitions at pace to a modern business model within a federated network. The sector faces significant issues that would challenge better resourced and competent credit cooperatives. On their own credit unions havent the resources to make the changes necessary to
8

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 excess funds. Operational efficiencies have not been achieved through the deployment of modern IT systems and automated processes. Adjusting for cost of funds (dividend rate) credit unions were operating at over 80% cost income ratio in 2007 which left little head room to finance investment losses and inevitable loan losses from unsecured consumer and small business lending.

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survive and thrive. And collectively they demonstrate an inability to co-operate together and create the central finance systems found elsewhere. Uniquely amongst developed credit union and credit co-operatives Irish credit unions have remained stuck 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 by an external forces. Transitioning to a savings and loans business model within a federated network is an urgent requirement if the sector is to deliver on its oft mentioned latent potential to offer a viable consumer and small business banking alternative to commercial banking. There is a need for a step change, creating the dynamic which will cause this to happen. Credit unions 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 must address one key question: is the future to be defined by the autonomous, independent, atomised credit union or is the future to be defined through a federated network of which consolidated credit unions are constituent owners. Deciding on the latter is the first step to beginning to craft a viable credit co-operative system that works.

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A Federated Network
Creating a federated financial infrastructure and shared services alliance between credit unions would solve for the strategic dilemma facing credit unions today. The sector doesnt have the collective resources, scale, scope or competencies to offer a viable savings and loans alternative to commercial banking. A 9federated network structure consisting of a 10central finance facility owned by credit unions would have the potential to: 1. 2. 3. 4. 5. 6. 7. 8. Fulfil the strategic economic and social objectives and needs of participating credit unions. Improve scale economies and achieve broader market reach Leverage synergies Utilise capital more efficiently, while enabling more effective access to wholesale funding and capital markets Enable credit unions to become a dominant provider of consumer savings and loans services in Ireland. Have the potential to provide banking services to small business Facilitate the orderly rationalisation of the credit union network Through contractual solidarity and cross guarantees effect stablisation intervention where required

Critically the central facility or apex organisation, would also serve as the basis for the long overdue rationalisation of the credit union movement, as well as provide financial stabilisation for viable credit unions. However, the facility would primarily operate as a wholesale commercial enterprise serving the institutions that own it. It would operate as a wholesale bank to the constituent members of the federated 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 by credit unions that join in its formation. For this reason, it would be sensible to begin with a relatively small number of larger qualifying credit unions. The idea, however, is to build a facility in which all Irish 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 commercial organisation that would have a number of the skills, organisational structure and the ability to act as a 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.

See appendix for more detailed discussion on federated co-operative networks Central Finance Facility is a term used by international credit union trade body WOCCU to define central corporate entities owned by constituent credit unions.
10

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The creation of a comprehensive, centralised support system has been a long-term goal of Irish credit unions, and it has been endorsed in principle both by Government and the Central Bank. However, it is an objective that credit unions and their trade bodies ILCU and CUDA have been unable to achieve on their own. Given current economic, political and financial market conditions, there is now a unique opportunity to facilitate the creation of such a network. The balance of this submission summarises the relevant international precedents and Irish environmental circumstances, discusses potential models for a credit union alliance, identifies a conceptual structure for such an alliance (including the potential advantages, disadvantages and challenges in creating it), and suggests a roadmap for taking this visionary concept forward.

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The Federated Alliance evaluation criteria

To 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 by a critical mass of credit unions. Over the past decade, several services providers have presented compelling commercial proposals that would have enabled Irish credit unions to achieve better scale economies or offer a broader range of products. For a variety of reasons, these have either failed to achieve sufficient credit union support to be implemented or have generated only modest results. Furthermore the sector has long talked of centralist co-operative initiatives but has been unable to progress these beyond publishing high level discussion documents. Long on talk and short on action the system and its constituents are demonstrably incapable of transitioning to higher level business models 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 to modernise their business model and rationalise the number of independent operations. And this will require 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 succeed unless a fifth criterion is satisfied: There must be strong pressure on credit unions by Government and the Central Bank to participate in a federated alliance. Indeed such is the challenge, I would suggest that a special body be established by Government charged with driving credit union rationalisation, transitioning consolidator credit unions to the new business model and establishing the central facility. Evidence from other countries suggests that transitioning to higher level structures occurred only as regulators and government officials pressurised credit unions to adopt higher standards of performance in return for greater flexibility. This intervention was in turn used by small groups of larger, progressive credit unions and their managers to effect change. Pushed from behind by concerned 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 and regulatory responses to the collapse of the Pyramid Building Society. Likewise US federal deposit insurance came about from credit union pressure to establish a federal guarantee over concerns the private system was insufficient. The concern in Canada has been to allow for the ordered consolidation of the number of credit unions in particular those without a viable future. In all three countries whilst the numbers of credit unions have dramatically declined they have evolved as
New lending volumes have dramatically declined since 2008 which will cause a rapid deterioration in loan book quality and critical interest income stream.
11

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vibrant alternatives to banks through expanding products and services, delivery channels and number of branch outlets. In Canada some centrals now have their own branch networks having bought them from banks. None of these changes would have been possible were it not for the creation of central finance facilities, 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 that only 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 services and service providers. The development of the US credit union service organisation (CUSO) model was only possible given the continental scale of its financial service marketplace. Proposing a fully Integrated/Merged structure in which credit unions become, in effect, local branches, the third model would be viewed as a takeover of the credit union movement. Even the suspicion that this was the goal would result in overwhelming opposition from the credit union sector. Conceptually, the three alternatives are diagrammed as follows:

Atomised Loose Alliance League

Representational/Development

Federated Network Coalition of the Willing Central Hub

Central Co-operative Wholesale Bank

Integrated/Merged Command Hierarchy Cooperative Bank

Members dominate Autonomous status A la carte membership Credit Unions

Balanced management Credit union drives local delivery

Centre Dominates Branch there to sell

Credit Unions

Branches

+ Good customer experience -Inefficient

+ Good customer experience + Efficient

+ Efficient Sales Machine - Poor customer service

Degree of Integration
Adapted from Mercer Oliver Wyman

The left hand column represents the current Irish credit union form of loose association through trade bodies and their business services. The far right column represents a mutual building society organisational system of a central head office and branch network. The best way forward, is for a federated network. In this model, credit unions would receive centralised support services from an entity they would both own and over which they would share joint control. Developing an appropriate governance structure for such a central federated body would be one of the most challenging elements involved in designing and implementing this concept. Needless to say, people would have to be convinced that the resulting central body would operate at a high level

Credit union ownership is crucial to the long term durability of an alliance. When U.S. credit unions entered the third stage of development 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 other service corporations to perform those functions. Credit unions did not want to remain dependent on actual or potential competitors for their core functions. CUNA Mutual preserved its position because it was always owned by its credit union policyholders. Similar considerations were also present in Canada and Australia.

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of financial soundness and operational professionalism. This critical dimension is discussed in greater detail below.

A proposed federated structure

The proposed structure for a credit union alliance involves creating a new central finance facility that would be owned by participating credit unions, who would also be its only customers. Although they would receive central support services from the new entity, credit unions would continue to trade independently under their own names. The facility would likely be incorporated as a commercial bank, although ownership might be held through a holding company organised as a co-operative. A diagram of the proposed structure is shown again below:

Fully implemented, the central banking facility would allow credit unions to collectively achieve greater efficiencies of scale in back office operations such as IT and payments systems, as well as obtain other services such as liquidity and investment management, regulatory compliance, internal audit, risk management, human resources, marketing support, and group purchasing. Depending on the final design, it is likely that a significant portion of operational capabilities would be centralised to the new entity. Some functions of the central might be conducted through one or more wholly owned subsidiaries. In addition a stablisation mechanism for credit unions based on contractual 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 optimal structure could be validated, it would appear that the structure above should confer the following advantages:

13

Some Canadian provincial central finance facilities provide a stablisation mechanism and funding under devolved authority and authorisation of provincial deposit insurers and regulators.

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Legal Simplicity. Participating credit unions would retain their current legal forms, pursuant to the Credit Union Act. It does not appear that setting up this structure would require amendments to primary legislation. Ownership. Credit union acceptance of this concept depends on the perception that it conforms to established international norms for credit union support organisations. Key to those norms is the concept that credit unions should own the support structures that are strategically essential to their on-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 use of a capital structure that would recognise disproportionate contributions of its owners, while affording representation on the holding company board. Although governance is the most difficult aspect of designing a central facility, I believe that a structure can be set up that is acceptable if the governing board is constrained by certain agreed upon principles. Those should include, for example, that the central provides services to its owners on a fair and equitable basis, with uniform pricing reflecting actual costs given the respective volume of business each brings. Access to Capital. Whilst a co-operative holding company structure would be used to maintain credit union control of the central banking facility, it would also allow for the facility itself to be 14publicly listed. This would enable access to equity markets on a basis that could be advantageous to the majority owners. In-system stability. Through contractual solidarity and cross guarantees, credit unions would effectively leverage off their combined balance sheets. Special Purpose Subsidiaries. To the extent desirable for tax or other reasons, the structure would permit for the incorporation of subsidiaries for special purposes. Those might be owned by the central finance facility (as shown in the diagram above) or by the co-operative holding company.
Conceptual Federated Model
Members

Credit Union

Credit Union

Credit Union

Credit Union

Credit Union

Central Finance Facility Bank

Insurance

Leasing

Credit Cards

Asset Management

14

OKO Bank (Finland) provides for public listing

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Anticipated business advantages

Notwithstanding the logic of the proposed ownership structure, the likely success of the alliance depends 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 to obtain affordably. The functions performed by the central body could start with payment systems, IT and investment/liquidity management, and they could grow over time to include most or all of the following 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 development

Funding and Liquidity Management. The central would have the capability to help credit unions participate in the wholesale funding markets. The proposed facility would be designed to facilitate this 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 in Canada where centrals working with deposit insurers are authorised by their regulators to stabilise troubled but viable credit unions. Such a mechanism would be dependent on contractual solidarity and 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. Risk minimisation is effected through early state interventions, prompt corrective actions and enforced mergers. Funding where required is frequently used to temporarily support the acquiring credit union. For a more detailed consideration of stabilisation please see the attached submission to the Central Bank on stablisation.

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Given their need for professional liquidity management, credit union access to current account services should be conditioned on their maintaining a substantial share (if not all) of their liquidity at the central. As already noted, the proposed structure could provide access to equity markets if the central (or one of its subsidiaries) becomes a listed company. To the extent they need to free up their existing capital to support growth, participating credit unions could transfer assets into the central; thereby taking advantage of the latters access to capital market funding and capacity to securitise assets. Broader Retail Reach & National Footprint. The proposed alliance would offer credit unions the ability to offer products through a larger 15branch network, as well as conduct workplace affinity marketing via employer credit unions. Broader Product Line. Credit unions would benefit from access to a broader array of financial products. Representing a primary retail distribution channel to millions of consumers, the central would have enhanced market power to enter into alliances with product providers 16unavailable to individual 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 financial services to small business, they are not recognised as primary bankers to small enterprises. In other countries, central finance facilities have developed competence and expertise in this important area of co-operative banking. A central could assemble the resources required to allow credit unions to expand their small business service capabilities. Typically, centrals establish mobile small business lending teams who, operating on a shared branch basis, are supported by dedicated central expertise. Some also provide internal loan syndication processes which pool and allocate loan assets to participating members. They also leverage their collective market purchasing power, building third party alliances to increase the scope of small business products and services offered. Social Finance. Effective social finance is a specialised form of commercial lending requiring expertise that credit unions do not possess. A central could establish a special purpose finance facility and specialist lending team providing social finance facilities through credit unions. Movement Stability and Rationalisation. The central facility could provide a platform for professionally managing the rationalisation of the credit union system. It is widely recognised that the number of credit unions in Ireland will need to reduce, but there is no vehicle currently available to handle that process in an orderly fashion. In General. Credit unions have neither the scale efficiencies nor the operational competencies to deliver on a long standing objective to deliver a full banking service. An alliance along the lines proposed in this submission has the potential to create the roadmap to achieve this business and social objective.

There are a significant number of underperforming credit unions in high density urban and provincial locations that would benefit from rationalising 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 alliance would make available.

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Anticipated business disadvantages and obstacles

The potential disadvantages of the proposed structure come from the execution risks of its implementation. Obviously, it would represent a major strategic initiative that would have significant implications for future operations. The primary obstacle to accomplishing this vision is in getting credit unions to participate. Credit union decision making processes are notoriously slow. In the past, even where credit union boards agreed to proceed with a joint initiative they have changed their minds at the last minute and failed to actually commit to and fund commercial joint ventures. Even in much more highly developed credit union movements, volunteer boards are reluctant to fully embrace new business ideas. The history of credit union modernisation in the U.S., Canada and Australia has been characterised by major new initiatives being launched by a handful of leading institutions, with the rest following in time once the concept is proven to work. Moreover, the process of developing an alliance would be complicated geometrically by the number of credit unions initially involved. On the other hand, a structure that is developed and implemented by a founding group could be presented on a basically take it or leave it basis to those credit unions who follow. It is likely the Central Bank will look favourably at credit unions participating in an alliance and afford them the greater flexibility they have advocated for. This has been the experience elsewhere where federated centrals supervise their members under devolved powers from state regulators. In this case it is envisaged that credit unions anxious to grow and expand services to members will want to join a federated network system.

Government support
An 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 the critical need for reform of the credit union sector.

6: CONCLUSION
In conclusion the immediate future of credit unions should be defined by sticking to the knitting of savings and loans and excelling at their delivery. The current network should rationalise through a planned programme of consolidation with resultant consolidator credit unions required to transition to a new model of business operations. These credit unions could be required to be constituent owners of a central finance facility which is underpinned by contractual solidarity and cross guarantees. In effect whats proposed is the creation of a European style community focussed, credit co-operative banking system guided by credit union operating principles and ethos.

Bill Hobbs August 2011

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APPENDIX 1 : NOTE ON FEDERATED CO-OPERATIVE SYSTEMS

Atomisation or Federation Globally credit co-operatives have developed from individual loose form groups of individual credit co-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 constituent owners. The following diagrams illustrate the typology found in credit co-operative systems. Ireland regrettably remains rooted in the start up phase in all these models. This diagram illustrates the stages of development found in credit unions internationally. The Irish system has been stuck between Nascent and Transition for almost two decades.

Nascent Industry
Small asset size Tight Common Bond Serves weak sections of society Single savings and loan product High commitment to traditional self-help ideas

Transition Industry
Large asset size Adjusted common bond Widened customer base Greater product diversification Weakening reliance on volunteerism

Mature Industry
Large asset size Loose common bond Competitive environment Electronic technology environment Professionalisation of management

Development of central services Need for greater effectiveness and professionalism of trade bodies

Well developed central services Organised progressive trade 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 2007

This typology of Nascent, Transition and Mature can be translated in turn into generic business models deployed in each stage:
Credit Union Business Models

International Phases of CU Development

Model A Model B Model C

Co-operative Finance Company

Source Third Way Alliance 2009

Savings & Loan Specialist

Full Service Co-operative Bank

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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, The Netherlands and OkoBank, Finland. Farther afield the Canadian Movement Desjardins and Australian credit unions amongst others have also evolved strategic networks. Irish credit unions can been seen to be lying somewhere between atomised and cohesive networks .

Atomised
Representation Cooperative Education Advisory Services

Cohesive Network
Pooling resources/ standardisation Market Sharing Standardised Image Delegation of strategic planning

Strategic Network
Separation of strategic and operational management and control Prudential supervision delegated monitoring Contractual solidarity cross guarantees

CIRPE Centre interuniversitaire sur le risque, les politiques conomiques et lemploi 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 Provides or supports cooperative education among members of the first tier The central provides business and or/prudential management services for the members The central is responsible for the management of common resources and supports standardisation of operating procedures across the system The network has rules eliminating inter member competition The network assumes a unique trade mark and image to which all members adhere The central performs strategic planning for the network, although there is no mandatory compliance with approved strategic plans There is a separation of strategic and operational decision management between the central (strategic) and members (operational). The central and members are bound by network decisions. This includes mandatory pooling of resources and standardisation of operations in areas chosen by the network The central assumes the role of prudential supervisor (or auxiliary supervisor) of the members The network adopts mechanisms of collective insurance designed to assist members or the central in difficulties

Atomised System

Cooperative education Advisory & Prudential services Voluntary pooling of resources and standardisation Market sharing Unique image Delegation of strategic planning function Separation of strategic and operational decision management

Consensual Networks

Strategic Networks

Prudential supervision role Contractual solidarity

Adapted from:

CIRPE Centre interuniversitaire sur le risque, les politiques conomiques et lemploi The Power of Networks: Integration and Financial Cooperative Performance Martin Desrochers Klaus P. Fischer May/2005

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In a more recent document published by Oliver Wyman the following typology was illustrated:

Atomised Loose Alliance League

Representational/Development

Federated Network Coalition of the Willing Central Hub

Central Co-operative Wholesale Bank

Integrated/Merged Command Hierarchy Cooperative Bank

Members dominate Autonomous status A la carte membership Credit Unions

Balanced management Credit union drives local delivery

Centre Dominates Branch there to sell

Credit Unions

Branches

+ Good customer experience -Inefficient

+ Good customer experience + Efficient

+ Efficient Sales Machine - Poor customer service

Adapted from Mercer Oliver Wyman

The following diagram illustrates a typical federated European co-operative network:

Stylised organisational structure for a co-operative bank

Members

Local Co-op

Local Co-op

Local Co-op

Local Co-op

Local Co-op

International arm

Central bank

Listed Arm

Insurance

Leasing

Mortgages

Asset Management

As owner members of the central bank, local co-operatives are provided with a range of corporate services, central liquidity, treasury, loans securitisation, monetary system participation, IT systems, access to national payment systems, operational platforms and products and services. These products are either intermediated from external providers or provided through subsidiaries e.g. life insurance, fund management etc. The centrals may also have devolved regulatory responsibility to ensure compliance by local co-ops. Using cross guarantees, centrals participate in wholesale markets obtaining a rating none of the local co-ops would ever achieve. For example RaboBanks AAA rating is based on the underlying cross guarantees of the local Rabobanks. Many have grown in line with their members needs and have international subsidiaries providing corporate banking services, capital markets services and in the case of Rabo, own banks in other countries. In one case OkoBank (Finland) has a listing allowing it to raise equity funding but its member co-operatives own and control the central. Canadian provincial credit unions have evolved a similar approach using central credit unions. From a standing start in the 90s the Polish credit union movement adopted a federated system and now offer a broad range of products and services through the largest network of retail outlets in Poland.

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Taken together these illustrate the transition required of Irish credit unions. Indeed to survive they will need to make a step change as they do have the luxury of the time taken by systems elsewhere which have evolved since the 1950s save for Poland.

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USEFUL REFERENT DOCUMENTS

Call to Action - Re-inventing Credit Unions for the 21st Century Ratonalisation Report Strategy for the Movement An examination of the key factors of infuence in the development of credit unions The Power of Networks: Integration and Financial Cooperative Performance CUDA (2006) ILCU (2006) ILCU (2007) Sibbald, Ferguson, McKillop Desrochers and Fischer Annals of public and cooperative economics 2002 Cipree

Investigating diversity in the banking sector in Europe: The performance and role of savings banks Ayadi,Schmidt,Valverde Co-operative Bank: Consumer Champion UK Building Societies: Deregulation change myths A study of the initial returns and the aftermath of initial public offerings of demutualised building societies in the UK An industry approach to classifying credit union development Can mergers ensure the survival of credit unions in the third millenium Ethical banking: The case of the Co-operative Bank Governance, regulation and mutual financial internmediaries performance Financial cooperatives: structure, conduct and performance Cooperative banks in Europe - Policy Issues Oliver Wyman 2009 Tayler, Shiwakoti,Hudson, Short Ferguson, McKillop (1997) Ralston, Wright, Garden Harvey Fischer McKillop Fonteyne

Centre for European Policy Studies 2009

The Service Industries Journal, Sept 2005 Applied Economics Letters, 2005

CAFI, University of Queensland Journal of Business Ethics, 1995 CREFA (2002) Annals of public and cooperative economics 2005 IMF Working Paper (2007)

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