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Regional News>Credit unions - a case for credit ratingsWayne Dass - Guest Writer |
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Credit unions throughout the Caribbean have experienced strong growth over the last few years. Indeed, in Trinidad their asset base now exceeds TT$6 billion, approximately 14 per cent that of aggregate commercial bank deposits in the country.
The basic function of the credit union as a financial intermediary between savings and loans makes the institution not dissimilar to a bank. As such, credit unions need the same level of supervision and continuous monitoring as banks, to ensure depositors' funds are safeguarded against excessive risk taking and imprudent financial management. A credit rating of the credit union, similar to that of a bank, will reflect the institution's creditworthiness and its likelihood of defaulting on its debt or deposits at any point in time.
PEARLS
The prudential criteria to be followed by credit unions in new proposed legislation, is patterned after the PEARLS ratios. While these ratios are useful and extremely helpful in guiding financial management of the credit union, they are incomplete as a true gauge of the creditworthiness of the institution. The absolutely critical aspects of management quality and risk management strategies are missing. A credit rating as carried out by CariCRIS, would employ the more comprehensive CRAMEL framework as follows:
Capital Adequacy
Capital exists to protect a financial intermediary from unforeseen consequences of past actions. These consequences are an inherent part of the business as it entails revenue generation by predicting borrower behaviour over a period of time. Thus, higher levels of capital provide greater protection against risk in the existing asset book. Moreover, regulatory capital requirements mean that capital levels also determine the ability of the rated entity to expand the asset book.
Resource Raising Ability
Access to stable and low cost resources by the credit union (deposits, borrowings etc.) in adequate quantities is another crucial pillar of the financial intermediary business model. This factor not only impacts the availability of money to continue the lending cycle, but also the ability to lend at rates that are low enough to attract the targeted borrower profile.
Asset Origination Ability
Financial assets are the revenue engine for any finance entity. The strength of its business crucially depends on its ability to consistently generate assets that produce a positive return after expenses and write-offs.
This, in turn, is a function of the strength of existing borrower relationships, the ability to offer the services that the market demands to build new relationships and the quality of operating skills like pre-lending credit appraisal, post-lending account monitoring and problem asset resolution techniques.
Management Quality
This is perhaps the most important parameter in the analysis as it is a key determinant of all other parameters directly or indirectly. The competence, risk propensity and strategy of the incumbent management of any financial services entity have a profound impact on every aspect of its operations and consequently its credit quality.
Risk management refers to the use of proactive techniques and frameworks to ensure that, on an aggregate basis, present actions do not have unacceptable future consequences. Modern risk management techniques demand significant use of information technology and when effectively deployed can minimise the possibility of future capital shocks.
Earnings
Earnings are the end result of the rated entity's success in its core business of financial intermediation. Earnings are directly impacted by operational efficiencies and the skills of asset origination and deposit mobilisation.
Liquidity
The relative differences between the maturities of assets and liabilities are the primary determinants of liquidity cushion available to the rated entity to meet its need for funds. Other sources of liquidity in a contingency include access to capital or borrowed funds at short notice.
Assessing credit unions in the region against this CRAMEL framework and having this analysis and information in the public domain on an ongoing basis, reduces the information asymmetry that currently exists. Depositors and shareholders would for the first time have a true means of assessing the safety and creditworthiness of the institution they are placing their hard-earned cash in. The regulators would be comforted to know that the credit unions are being monitored on a real time basis, thereby freeing up some of their scare resources.
Benefits of a Credit Rating to the Credit Union
The immediate benefits of a credit rating to the credit union include:
1. Aligning with best practices in international financial markets
The rating is an indication not only of the relative creditworthiness, but also indicates the credit union's willingness to be transparent and speaks well of overall corporate governance.
2. Increased access to funding
By getting rated, the credit union will be able to convey its creditworthiness and peer group standing in the si
The rating as well as the accompanying rationale is an opportunity for the credit union to present its strengths to current and potential stakeholders, members, depositors etc, from the perspective of an independent third party.
As the financial sector increasingly gets consolidated, this will enhance the credit union's ability to address a wider audience of stakeholders and aid its growth strategies.
3. Leading the way in the context of potential trends in the credit union sector
Increased regulation and supervision of the credit union/co-operative sector has been on the cards for quite sometime now. In this context, transparency and good governance are key issues and institutions that take proactive measures will be positioned advantageously. A credit rating is a most appropriate way of showcasing good governance.
The local/regional perspective and benchmarking afforded by CariCRIS' credit ratings makes it even more relevant and useful as it will differentiate the credit union with respect to other financial sector players in the Caribbean, and bring it closer to mainstream institutions.
4. Likely Cost benefits
The likelihood of reduced cost of deposits is another benefit. As the region's capital markets become more sophisticated, credit rating based pricing is expected to become widespread.
By accessing a credit rating, the credit union can directly and clearly benchmark itself on a publicly recognised consistent basis of local/regional comparison for all depositors and lenders.
The rating can further facilitate initiatives such as issuing securitised obligations, and in that context may allow the credit union to negotiate favourable/lower cost debt either directly from the capital market or from any institutional lenders.
5. Encourages increased financial discipline
The process and the rigorous criteria employed in arriving at credit ratings have an embedded incentive for entities to adopt and maintain high standards of financial discipline and risk management in order to protect or even improve its credit rating.
6.Opportunity to contribute to the development of the region's capital markets
Capital markets are essential to the growth of any modern economy and credit ratings have been shown to be an essential ingredient for the development of capital markets. This development process can be accelerated only by the active participation of borrowers, lenders and their intermediaries.
Conclusion
Any legislation being crafted now in the region for credit unions should take cognisance of the tremendous value-added possible from a credit rating - to the credit union, its depositors and shareholders, the Central Banks themselves, and the wider financial system - and incorporate this into registration and licensing requirements.
The more proactive credit unions would do well, in the current environment, to get ahead of the curve and access a credit rating now.