A spotlight has been cast on credit unions and the vital role that they play in our communities, serving local members or people who share a common bond, such as the police or NHS workers. 2019 Bank of England figures show there are currently over 400 credit unions in the UK, with membership exceeding two million people.
Credit unions play an important social role in providing affordable credit to people typically excluded by mainstream lenders, who might then turn to loan sharks or other high-cost forms of credit. These people are increasingly under-served following the collapse of short-term lenders like Wonga and QuickQuid.
There is clear Government support to grow this sector. In October 2019 the Prudential Regulatory Authority (PRA) announced proposals to reduce the level of capital credit that unions are required to hold on their balance sheet, following two initiatives launched by the treasury to boost membership and visibility of credit unions.
However, this is against a backdrop of an increasing rate of credit unions collapsing in the UK, approximately one a month in 2019. This poses questions about the ability of the sector to continue to scale operations to fill the vital gap in the market for affordable credit, whilst managing higher levels of non-payment in an uncertain market.
What does the PRA propose?
Put simply, the PRA announced a consultation on cutting the level of capital that credit unions are required to hold. The changes would include:
replacing the current ‘cliff edge’ capital requirements system where firms have to suddenly hold 10% on their entire asset base if they grow a single pound over £10 million. In the new, graduated approach, larger unions would be required to hold 5% capital for assets up to £10 million, 8% for assets between £10 million and £50 million, and 10% for assets above £50 million
maintaining capital requirements at 3% for unions with total assets less than £5 million, but introducing a “monitoring zone” of 3-5%. If a smaller credit union’s capital falls below 5%, the PRA would step up their supervisory activity
simplifying the regime by eliminating other capital requirement thresholds linked to non-asset metrics, such as membership numbers and variety of business lines.
The effect of these changes is estimated to reduce overall capital requirements for the credit union sector by around 25%, which should have an overall positive impact on the sector.
Treasury initiatives to boost credit union membership
As well as reinvigorating the sector by reducing capital requirements, the government is trying to boost membership and competitiveness with two other initiatives:
In 2019, the treasury partnered with innovation charity Nesta to launch a competition for credit unions and other community lenders to link up with fintechs and develop new ways to access their loans. Credit unions have fallen behind in technology investment and often struggle to reach customers or compete with the speed and convenience offered by high-cost lenders. This follows the autumn 2018 launch of a treasury-backed savings scheme for credit unions – along the lines of the premium bonds model – designed to increase both awareness and membership.
Both of these initiatives were very welcome to the sector – and underline how important the government believes credit unions are in supporting the financially marginalised in our communities. However, given the high rate of administrations in the sector, there are still concerns around its ability to manage increased levels of lending and member numbers.
What are some of the concerns?
Credit union membership has doubled over the past 10 years and loans have increased by 22% in the past three. However, over the same three-year period, net profit declined by nearly 11% and the value of non-performing loans rose by 18%.
Credit unions have been doing excellent work in growing their membership and lending, but have so far been unable to translate that into the financial stability required to weather economic downturns. Indeed, in 2019, 12 credit unions have gone into administration - most recently Solent Credit Union in October and Mercat Cross and The Bruce Credit Union in December.
According to analysis conducted by the Bank of England, key drivers for credit union failures include:
smaller unions with low capital ratios and weak earnings
firms with a greater reliance on non-retail deposit funding
unions with fewer liquid assets to meet immediate outflows.
The PRA hopes their proposals will go some way to improve the resilience of smaller credit unions - allowing them to grow without the disincentives created by the current ‘cliff edge’ capital requirements system. This prevented credit unions from reaching the critical mass needed to survive in challenging economic times. The view is that unions with more scale will be able to invest to improve financial and operational resilience.
However, is there a trade-off between growth and maintaining healthy capital buffers, which allow credit unions to absorb increased loan defaults? With net profit declining nearly 11% over the past three years, unions may not be able to grow capital buffers and would be left thinly capitalised as a result.
Credit unions need to make sure that growth does not come at the expense of maintaining robust capital ratios, and to ensure that there is an ability to manage and absorb increased defaults in the lending book – especially at a time of economic uncertainty.
What should credit unions do?
With focus and impetus behind the credit union sector, now is a good time to examine your business models and focus on maximising both operational and financial resilience. By doing this, you can be fully prepared to take advantage of any potential opportunity to grow membership and provide new services to new members.
We understand that credit unions do not always have the resources or in-house expertise to address these challenges. Our financial services restructuring team has extensive experience in providing advice on financial resilience, loan book analysis, contingency planning, debt financing, recovery plans and addressing any areas of financial distress.
For more information and advice, contact Chris Laverty from our financial services restructuring team.