Credit Union to Credit Union Loans

Wednesday 10 January 2024

Why do you need to know?

A robust funding strategy is an integral part of a credit union’s strategic planning, risk management and business continuity planning processes and central to its security and sustainability. The funding strategy should be underpinned by an ambition to ultimately achieve self -sustainability through self–generated income from loan interest.  However, this is an ambitious goal, and in the interim, the funding strategy will need to incorporate various forms of income generation. In the current economic climate established sources of financial support from the public sector are no longer certain. Credit unions need to look to more creative ways to secure income and attract investment.  The Credit Unions Act 1979 has permitted credit unions certain options to both make investments and to borrow. In addition, the anticipated Legislative Reform Order (LRO) will offer new opportunities for investment from corporate members (companies, partnerships and local community groups).

Credit unions also need to be familiar with the New Credit Union Sourcebook (CREDS), which replaces the Credit Union Sourcebook (CRED, relevant rules within the Senior Management Arrangements Systems and Controls Sourcebook (SYSC) and the new Credit Union Regulatory Guide (CURGS,) which now contains the guidance on relevant legislation. Both CREDS and CRUG together reflect the FSA new regulatory regime and the new provisions of the Credit Unions Act introduced as a consequence of the Legislative Reform (Industrial and Provident Societies and Credit Unions Order 2010 (LRO).

The Key Issues

Section 10 of the Credit Unions Act 1979 deals with transactions between credit unions.

CREDS 3.2.1 allows a credit union to invest its surplus funds as deposits or loans to another UK domestic firm with Part IV permission to accept deposits. This allows credit union to credit union loans.

Whilst a credit union cannot issue shares or take deposits from another credit union but they are permitted to issue either a senior loan or a subordinated loan.

An inter – credit union loan can benefit both the participating credit unions; it can provide a convenient option as part of the wider funding strategy for a credit union to raise additional capital ore revenue to support expansion, staffing or operations, whilst at the same time the loan interest can provide a small but welcome income for a friendly credit union with significant capital.

However, a credit union loan should not be used for lending to members as the risk of repayment shortfall would be too great.

When considering any borrowing or investment option, credit unions must ensure that they remain compliant with the key new prudential standards stated within the new regulations. These are:

  1. to maintain a capital-to-assets ration of at least 3% (A period of 3 years will be allowed to phase this in);
  2. All credit unions (version 1 & 2) will be required to hold at least 5% of total liabilities, not falling below 10% on 2 consecutive quarters. (There will be a transition period for version 2 credit unions).

Putting into Practice

When considering this option the lending credit union (lender) should ensure that they continue to be compliant with the FSA threshold conditions of having adequate sufficient resources to maintain its regulatory activity.

  • Similarly, the borrowing credit union (borrower) should consider carefully the financial implications of this arrangement and in particular that the repayments are manageable and still allow them to remain compliant with the same FSA threshold conditions of having adequate funds to support their regulatory activity.
  • Both parties should consider and clarify whether they are setting up an ordinary (senior) loan arrangement or a subordinated loan arrangement. Each of these options has different conditions and implications. Subordinated loans are dealt with in detail in a separate technical bulletin

The Topic in Detail

The lender should only do so if they can still maintain their minimum reserves and comply with the new FSA minimum requirements pertaining to liquidity and the capital-to assets- ratio.

  1. The lender should be mindful to keep the aggregate of loans to other credit unions at a moderate level to minimise the risk.
  2. The lender should consider the implication of late/ or non – repayment of the loan as the worse case scenario.
  3. A loan agreement should be drawn up with clear terms and conditions and a clear repayment schedule and for the loan repayments.
  4. The Board must check that the borrowing by the credit union (including the borrowing from another Credit union) remains compliant with CREDS 3.34 /5 i.e. the total borrowing by a version 1 credit union does not exceed 20% of the non – deferred shares over 2 consecutive quarters and does not exceed 50% of the non – deferred shared by a version 2 credit union on the same short term basis.
  5. If the loan capital is to be used to increase lending capacity the Board should be confident that demand for loans will be consistently sufficient to cover the increased costs of any interest paid to the lender.
  6. The Credit Union board must establish, implement and review a Financial Risk Management Policy; which details the organisational arrangements, details and controls relating to the credit union’s investments and borrowings. (This is dealt with in more detail in the technical bulletin on Regulations on Borrowing). This must be reviewed at least once a year (CREDS 3.3.7)
  7. All version 2 credit unions must send a copy of their Financial Risk Management Policy to the FSA.

Checklist

Has the Board completed a risk analysis of the impact of lending/ borrowing the proposed sum?

  1.  Is the Board confident that by entering into this proposed agreement that the credit union will remain compliant with the regulations?
  2. Can the Board of justify the need to borrow this sum and be confident of its prudent use?
  3. Does the Board need to seek specific management data (e.g. A report demonstrating un-met loan demand and/ or anticipated future member needs) to assist a decision to go ahead with a loan arrangement.
  4. Are both Boards clear and in agreement as to whether they are entering into an agreement for an ordinary (senior) loan or a subordinated loan?
  5. Are the repayment terms affordable and realistic within the borrowing credit union’s business plan?
  6. Has the advice of a solicitor been sought in the drawing up of the loan agreement?
  7. Is the maturity date or last date for repayment of the loan clearly stated?
  8. Has the lending credit union considered the impact of late/ non – payment of the loan?
  9. Has the Board implemented a Financial Risk Management Policy? Does this need to be reviewed? Has a copy been sent to the FSA?

Definitions

  1. non–deferred shares is the new term to describe a member’s shares (savings)
  2. New Credit Union Sourcebook (CREDS) replaces the Credit Union Sourcebook (CRED) and reflects the new provisions of the Credit Unions Act 1979 as a consequence of the introduction of the Legislative Reform (Industrial and Provident Societies and Credit Unions Order 2010 (LRO).
  3. The Legislative Reform (Industrial and Provident Societies and Credit Unions Order 2010 (LRO).
  4. A senior loan is ordinary funding that is not regarded as regulatory capital
  5. Short Term Basis is suggested within FSA guidance as 2 consecutive quarters (CREDS 3.3.4/5)
  6. A subordinated loan differs from other senior loans as it has specific terms and conditions. The loan agreement specifically stipulates that the loan debt is subordinated to the interest of the members i.e. in the event of liquidation; repayment of the debt would be made only after the repayment of members’ shares. There are also specific minimum repayment and accounting terms for these kinds of loans. A subordinated loan is regarded as regulatory capital.
  7. Surplus funds are those funds not required immediately by the credit union for “accepting deposits, lending and ancillary purposes.” (CREDS 3.1.3 (2))
  8. The Senior Management Arrangements Systems and Controls Sourcebook (SYSC) sets out the rules for small firms (including credit unions) regarding senior management arrangements, systems and controls as summarised in (CREDS 2.1.4)