SYDNEY: 21 November 2013 - As Ireland prepares to formally exit the EU-IMF-ECB bailout, underlying difficulties within the banking and financial sectors remain unresolved.  Despite substantial regulatory reforms introduced after Ireland’s economic collapse in 2008, significant challenges remain for regulatory authorities.

RSA Insurance Group Plc (RSA), Ireland’s biggest insurance group, suspended three senior executives in November pending the outcome of an internal accounting probe.  The Central Bank has also instigated an investigation into the Irish claims and finance functions of the insurance company. RSA’s UK parent company injected €100 million in capital as an emergency response.  

Danske Bank and ACC Bank, a subsidiary of Dutch lender Rabobank, both substantially reduced their operations in Ireland in October and November. The retrenchment in the Irish banking sector raises concerns about competition at a time when contraction in bank lending continues unabated. The Irish Bank Officials’ Association believe that Ireland may only have the service of three, if not two, banks in the near future.

As a consequence of a partial review by the Central Bank of the payment protection insurance (PPI) sector, €25 million was returned to customers of 11 financial institutions because they had been sold in breach of Central Bank rules.

Newbridge Credit Union

In an unusual move, the High Court granted an order to the Central Bank to transfer control of Newbridge Credit Union (NCU) to Permanent TSB bank, itself a state-rescued creditor. The High Court’s decision, which was delivered at 11pm last Sunday night in an emergency sitting, is the first time in the state’s history that a credit union has been taken over by a bank. The taxpayer will ultimately fund the €53.9 million loss incurred at NCU which Permanent TSB will receive from the Credit Institutions Resolution Fund, established by the government in 2011.

Mr Justice Eamon de Valera said that there were ‘two options available, either liquidation or transfer.’ The Central Bank told the judge that the average daily withdrawal from NCU since 28 July 2013 was €76,000 which meant that the lender would reach its liquidation trigger point by 8 December.

The Director of Credit Institution Supervision at the Central Bank, Fiona Muldoon, said there had been a history of issues at NCU which could be summarised as ‘atypical lending’.  In his affidavit to the High Court, the Head of Resolution Mergers and Acquisitions, at the Special Resolution Unit (SRU) of the Central Bank cited ‘poor governance and inadequate or lack of systems and controls’ going back several years as reasons for the nationalisation of NCU.

Patrick Casey pointed to failures in ascertaining borrower’s financial positions, overall exposures to NCU, absence of consistent loan application process and inadequate and deficit documentation.

The median loan across the credit union sector is €7,764 but at NCU, it was €17,300. In all, 7.7 per cent of loans which were outstanding by December 2011 were identified as problem loans, 26 of which averaged at €550,000 each. Other breaches included a loan of €3.2 million, which was in excess of the Credit Union Act's restriction of a maximum of 1.5 per cent of the total assets. Some 53 per cent of loans exceeded five years' duration as opposed the maximum set out in the Credit Union Act of 20 per cent.

Casey noted that governance deficiencies included an inadequacy of skills and resources allocated to the NCU credit function and credit control function and inadequate policies and procedures of both.

There are three concerns.

1. Central Bank Transparency

The Central Bank has not outlined specific details regarding the ‘governance deficiencies’ at NCU. No reference is contained within the Resolution Report from the Special Resolution Unit of the Central Bank of Ireland to the High Court. The public must take the Central Bank at its word. (See below for discussion on Maynooth Credit Union).

Independent MEP, Marian Harkin, has accused the Central Bank of adopting ‘jackboot tactics’. Gagging orders placed on directors of NCU ‘with threats of two years in prison or enormous fines to be imposed’ meant, she said, that ‘information on the issue was non-existent.’ Sinn Fein shared such concerns noting that ‘the secrecy and lack of information available to the members of the union was unsatisfactory from day one of the appointment of a Special Manager.’ The NCU campaign argues similar points.

2. Central Bank Intervention

The second concern is this. Why did it take the Central Bank so long to intervene given that it was aware for five years about alleged irregular lending practices at NCU? The Central Bank’s alarm was urgent in its “Memorandum on the intervention conditions” submission to the High Court on the NCU transfer order.  It believed that the collapse of NCU, one of the largest credit unions in the country with 38,000 members, ‘could lead to contagion in the credit union sector, which could contribute to instability in the banking sector… and seriously damage the financial system, the economy and the State.’ It was in the ‘public interest’ therefore to ‘intervene rather than let credit unions fail.’

The economy stability of the state apparently rested on the future of a credit union. Yet the Central Bank’s urgent intervention came after a five year process of cognizance of difficulties within NCU.

Since 2008, the Central Bank had engaged in extensive loan book reviews and audit management letters with NCU, raising concerns about the community lender’s lending practices including holding too many loans above €1 million and inadequate reserves for bad debts.  

The NCU loan book deteriorated by €1.5 in 2009, €0.9m in 2010 and €1.5 m in 2011. The period between September 2008 and September 2011 witnessed €3.9m of loan write-offs over that time. Bad debt provisions increased by €9m in 2009, €6m in 2010 and €21.3m in 2011, to an overall figure of €36.3m. This resulted in the provisions requirement on the NCU loan book increasing from 3.4 per cent of gross loans at 30 Sept 2008 to 30.5 per cent at 30 September 2011 and the total realised reserve ratio (TRRR) position deteriorating from 14.6 per cent to 5.4 per cent in the same period.

No less than three extensions were made by the Central Bank to a Special Management Order first granted in January 2012. NCU were the first beneficiary of the new resolution powers, including direct intervention within a financial institution through the appointment of a Special Manager, granted to the Central Bank under the Central Bank and Credit Institutions (Resolution) (No. 2) Act 2011.

3. Central Bank’s Approach to Credit Unions

The third concern relates to the extent of difficulties within the wider credit union movement and the Central Bank’s underlying approach to community lenders.

Credit unions argue that their ethos of community lending is being undermined by excessive Central Bank regulation which will force a rapid consolidation of the sector. The Credit Union Restructuring Board (ReBo) established in 2013 with the purpose of facilitating the voluntary restructuring of the sector. In the last ten years, the number of registered credit unions has fallen by 10 per cent from 437 in 2003 to 392 in 2013 with greater amalgamation anticipated.

The Central Bank’s desire to impose new regulatory oversight is understandable. With loans of €4.6 billion, Ireland’s credit unions have an arrears rate of some 20 per cent.

The Commission on Credit Unions (CCU), established by the government in 2011, recommended a strengthened regulatory framework to a sector which had witnessed limited supervision before 2010 and practically none before 2003. Since October 2013, credit unions have had to comply with new regulations, including new lending limits; the application of the Central Bank’s fitness and probity regime; and the appointment of a compliance officer, risk manager and internal auditor.

The extent of such supervision is in stark contrast to that pre-GFC. The Register of Credit Unions at the Financial Regulator had just two staff regulating the activities of 437 registered credit unions which comprised of two million member accounts with a total asset base of €11 billion. A culture shock within the credit union movement occurred after the 2010 reforms with 61.7 staff policing a credit union movement which had grown to 3 million members with assets of €14 billion.

The Tánaiste Eamon Gilmore told the Dail that the Central Bank ‘is working through a portfolio of approximately 100 credit unions on a case-by-case basis. This relates to issues that arise in those credit unions - levels of arrears, inadequate bad debt provision, high fixed asset to total asset ratios and other supervisory concerns.’ One in four of the 392 credit unions in the country are being assessed.

Maynooth Credit Union

This includes Maynooth Credit Union (MCU) which earlier this year took a judicial action with the Irish League of Credit Unions (ILCU) against the Central Bank after expressing concern about ‘the coherency and proportionality of its decision making in relation to regulatory directions’. They are ‘concerned that the Regulator is overstepping its function as Regulator and using its power to effect wide scale and significant consolidation of the sector.’

The Central Bank’s application to have the review heard confidentially (in camera) rather than in open court failed. The ILCU argued that this was an attempt by the Central Bank to ‘cloak the proceedings and the challenge to its decisions from public scrutiny.’ It also contended that ‘It is important that state regulators operate openly, clearly and accountably. They should not seek to scare the public or exaggerate risk for the sake of achieving unarticulated policy objectives.’

The Central Bank fears that the scale of arrears in MCU and NCU are representative of wider sectorial problems which will overwhelm the ILCU savings protection fund. In their affidavit to the High Court on MCU, they point to an asset review of MCU conducted by Deloitte which reveal that MCU was in breach of the 1997 Credit Union Act and regulations passed in 2009 in relation to the required minimum capital reserve level of 10 per cent.

The ILCU and MCU reject the Central Bank’s assertion that this breach impacts on the credit union’s ability to function and have entered a counter-claim that the regulator is being both overzealous and vague in its approach by requiring credit unions to take large provisions against losses but not spelling out the methodology behind its conclusions.

Enforcement

New regulatory powers over the credit union sector were introduced through the Central Bank Reform Act 2010 and the Central Bank (Supervision and Enforcement) Act 2013. The Central Bank was granted powers to extend its administrative sanction regime to credit unions. These measures included the ability to revoke registration, remove or suspend employees, officers and directors who commit prescribed contraventions, impose fines, suspend the board of directors, commence restitution orders and issue warning notices to alert the public to firms operating without authorisation. New requirements on governance, internal audit, risk management, lending, compliance and liquidity were initiated through a “prudential rule book” which set out a comprehensive framework of regulatory requirements for the sector. The Central Bank was also granted powers to inspect, investigate and gather information from the sector.

The Commission on Credit Unions contended that the ‘credibility of a regulatory regime rests in part on its ability to enforce its rules.’ Nonetheless, powers to sanction credit union directors for regulatory breaches under fitness and probity rules only came into force from August 2013, although they did apply to directors and managers of financial institutions.

The Central Bank is powerless to instigate enforcement action against the directors and managers of NCU for any alleged breaches which may have occurred. Enforcement action cannot be taken retrospectively.