Notes From a Native Son: Pressuring Credit Unions to Shore up Foreign-owned Banks is a Missed Opportunity
There is a lot of back room chat about whether or not the Financial Services Commission has been putting one or more credit unions under pressure to move capital to foreign-owned commercial banks. Although this is wrong, based on the principles of financial regulation and financial management, the only legitimate exclamation has got to be political.
The other exclamation, of course, and one that neither the government nor central bank would entertain, is that the economy is in such bad shape that the ministry of finance, through the proxy of the FSC, has moved to capture all available institutional cash in the economy in order to meet its day-to-day costs. Whatever the official or unofficial explanation, it is simply wrong.
The key principle behind the creation of credit unions is to allow members to pool resources in order to provide alternative services to more commercial retail banks and at reasonable costs. They are not meant to operate in the same financial space as banks; their business models are different and their democratic decision-making may be cumbersome, but allows members to have a say in the management of the society. In Barbados, and indeed globally, they have been enormously successful, particularly so since the 2007/8 banking crisis, which has largely left mutual societies undamaged.
Regulating credit unions, however, presents new challenges to the two-pronged regulatory framework we have in Barbados, with the central bank overseeing conventional banks, and the FSC regulating and supervising the non-banking financial sector. This arrangement, however, presents enormous difficulties as was seen by the joint stress-testing regime in operation. Banks, insurance companies, credit unions, trusts, mutual funds, and other deposit-taking and investment institutions all have different business models which makes a single stress test almost impossible, unless, of course, it is simplistic, which means by definition, not fit for purpose. Avoiding the uniqueness of Barbadian financial regulation and concentrating instead on the more conventional universal regulatory and supervisory models, once again the local version – the so-called Barbados Model – is found wanting.
Why the FSC Intervention:
As suggested, even if there has been a misunderstanding about the FSC intervention, this is as good an opportunity as any to discuss the kind of regulatory structure and principles on which the FSC should be operating. As yet, the FSC has not given us any guidance as to how it intends to regulate those institutions that come under its remit. Is it going to be a principles-based system or a rules based one. The problem with rules-based regulation is that it plays right in to the hands of unscrupulous lawyers and clever executives who will use the rules to operate in the shadows of the law. Enforcing the law will become a constant relay between the disciplinary committee of the regulator and the high courts.
Given this, if the FSC intervention was perceived as lending risk, or even investment risk, there is any number of instruments that the regulator could have used to nudge the credit union, or credit unions, in to doing the right thing: it is simple behavioural regulation. But this is theoretical. So far neither the government nor the regulator has given a financial or regulatory case for compelling the credit union movement to move its cash on to the books of foreign-owned banks. In terms of regulation, the implication is that if the money remains in the non-banking sector it will be at risk. So, does this mean those non-banking institutions are not properly capitalised? Does it mean that cracks in their finances have been discovered during supervisory or regulatory visits? Is there a whistleblower?
Further, is this demand duplicating other regulatory requirements or is it just adding complexity and confusion to an already incompatible regulatory framework? Is one of the unintended consequences of this decision (at least I hope it is unintended) is to concentrate the banking sector in fewer foreign-controlled hands, rather than diversifying the sector to minimise risk and to promote a prudent and much-needed diversified financial sector?
Credit Union Bank:
Whatever the reason for the FSC’s intervention, with the ministry of finance and central bank pulling the strings, the more damaging outcome is that this narrow-view of financialisation is that, once more, the authorities have missed an opportunity to encourage the development of an alternative to commercial banks. A Barbados domiciled credit union bank would be in a position to fund households, small and medium enterprises and the micro-finance need for the self-employed. This is badly needed since the foreign-owned retail banks are just not lending to local people and businesses. It would also be a hedge against the oncoming financial tsunami crashing around Barbados. On top of this, the global banking convergence is sweeping down on us like a tornado and little economies like Barbados will be swept away like debris. The fundamental duty of our politicians and policymakers is to defend us, stand in the path of the oncoming giant and protect us.
A joint credit union bank, playing to its strengths by being restricted to simple relationship banking would provide an invaluable financial service to households and small businesses. In fact, by allowing credit unions to diversify their investments in to retail services, including supermarkets, farming and small manufacturing, would see a radical departure from traditional collecting of fees and warehousing that cash. This is the traditional credit union model and, in a low interest environment, will simply die a slow death. Instead of providing cheap capital for over-consuming people to go shopping for durables that will soon lose their value, should rightly be the drivers of micro-finance for the self-employed and small businesses, with proper planning, a credit union bank could be at the heart of the renewal of the Barbados economy.
Risk and Compliance:
What is not clear, since it is not the practice of the central bank and the Financial Services Commission to publish details of their risk and compliance methodologies, is the nature of supervision, the processes, if each firm has a dedicated supervisor and, if the requirement to bank with the foreign-owned banks is a direct result of the failure credit unions’ risk models. The bottom line is that our regulatory architecture is flawed due to the inward-looking nature of policymaking in Barbados. Since the 2007/8 global banking crisis, almost the entire world has undergone financial regulatory and supervisory changes and, under normal circumstances, Barbadian regulators and parliamentarians had a enormous opportunity to craft a structure from the best systems in place in other jurisdictions. What makes the FSC directive so bizarre is that many of the foreign-owned banks are suspected of having capital adequacy problems and a long list of bad loans on their books, making them vulnerable to a disastrous run.
Analysis and Conclusion:
Typical of the ruling elite in Barbados, orders are issued from on high, but the ordinary people are not allowed to question them, to interrogate the authors of such orders or even to raise serious concerns. The minister of finance and the central bank governor had a opportunity to show some innovative thinking with the credit unions by legislating to create a single credit union bank, which all the credit unions would have been compelled by law to be affiliated to. Such a conventional balance sheet lender would have accounted for a fraction of the approximately Bds$1bn in credit unions and provide the financialisation that the economy so badly needs. They did not do this because their collective imaginations did not reach this far, or they were scared of failure. The governor of the central bank, and the government’s senior economic adviser, is a known fan of Canadian central bank policies. Therefore it is interesting to take a brief look at how Ottawa has prospered since 2007/8, so much so that the British chancellor George Osborne has stolen the Bank of Canada governor Mark Carney from his native country to head up the Bank of England.
About two decades ago Canada had one of the worst economic crises in post-second World War history. However, controversially, it cut government spending, balanced its budget and introduced a series of pro-market measures which collectively have been praised for dragging the North American nation out of its troubles. These included reducing corporate tax rates, large scale privatisation, and lowering trade barriers. Whatever the technical and political concerns some of us may have about some, or all, of these initiatives, the bottom line is that the 2007/8 crisis hardly affected Canada. What is more, the economy took off, jobs were created and the dollar reached parity with the Greenback. Yet, for reasons that have not been fully explained, either by policymakers, politicians or academic government cheerleaders, there have been no cutbacks in government spending by a defiant, almost obstinate minister of finance; so much so that even the Anglican Bishop of Barbados has joined the chorus of praise for the government’s stubbornness in keeping hundreds of under-productive civil servants in highly paid jobs while hundreds of teenagers and young men and women loiter on the block with nothing to do. Government, through the agency of financial regulation, has a moral duty to correct market failure or create the conditions for such a correction; However, it is not incumbent on government to use the shadow of market or risk management failure as a device through which to force through other monetary policy initiatives.
Of course, regulatory scrutiny, both of equity-based companies and mutual societies, is necessary as a protective consumer device, but fishing expeditions are disruptive and fear-inducing. This FSC intervention looks like a fishing expedition. Like any other business, the executives of credit unions must prove that their business models are sustainable by expertise, argument and persuasion, not just by emoting sentiment.
This blog is not the time or place for discussions on the technical aspects of investment strategy, however the regulator could use this opportunity to encourage (or preferably compel) credit unions to draft a strategy document on suitability for investments, detailing how they reach investment decisions. In fact, all fund houses, banks, trusts and other non-banking financial institutions should be compelled to produce such a document as part of their regulatory approval process. This should be a central plank of the ongoing joint stress testing apparatus with the central bank (even if stress testing a credit union as pointed out is totally different to that of a retail bank). One regulatory requirement should be that all credit unions should have an investment committee made up of suitably qualified members, excluding lawyers and accountants, unless they have had further training in the discipline of investment planning and advice.
This then raises other issues for the regulator, such as suitability guidelines, clients’ risk tolerance (even institutional investors have a collective risk tolerance) and appropriateness of the strategy. Does the regulator have the necessary professional expertise to challenge individual credit unions on their investment strategies? We must also bear in mind that the first duty of any deposit-taking organisation is wealth preservation; this includes the interest rates paid on a basic saving accounts. If the institution, be it bank or credit union or retail bank, is paying an interest rate below inflation (CPI or RPI), then the saver is a loser measured by purchasing power parity, which means that what a dollar can today will be much more than it would this time next year. Investment strategy is meant to provide a return above inflation.
In any case, at the same time, the board members of the national insurance scheme should also be compelled by law to produce a similar investment strategy document. However this regulatory intervention should not go down as a missed opportunity for a wider debate on the role of social enterprise in the future development of the economy and the role that mutuals such as credit unions could play in the economic development of the nation. Good corporate governance and mutual behaviour cannot be legislated, nor can a rules-based regulatory framework be the alternative, for reasons already stated.
Finally, bad regulation can undermine the competitive advantage of the credit union – and wider social enterprise – business model. While it is right to tightly regulate capabilities and performance, the regulator and government must be careful not to throw out the baby with the bath water.
Barbados needs well-run credit unions now more so than at anytime in their 50-odd year history.