Upcoming changes to credit unions have potentially negative consequences.
If you're wondering where your friendly bank manager went in the 80s, it wasn't to retire, but to be on the board of a credit union. There are over 600 credit unions in the UK, offering a fair and more democratic way to save than you'll find with both banks and building societies. We've written some positive things about them in the past.
The Government has been looking into credit unions for two years, searching for ways to make them more popular, more 21st century, and more accessible. However, these objectives lead to problems. I'll explain three of the changes that the Government is now very likely to make, having completed its consultations, and what I make of them. (This applies to Great Britain only. Northern Ireland and the Channel Islands mostly have separate legislation.)
1. Bigger credit unions
Credit unions offer savings accounts and loans, and some offer current accounts. Each union accepts members with a common bond only, such as sharing a profession, or sharing a city of residence. This binds the members together more than just financially. What's more, it keeps unions fairly small, making it easier for each member to be heard and to receive personal attention.
Most credit unions have just 1,000 members or so. The largest, Leeds City Credit Union, looks after £30m for just 20,000 members. Perhaps it's the size of this union that was the reason it created a £4m black hole in its accounts without realising it. (It was saved this year by the taxpayer, but credit union deposits are in any case covered by the Financial Services Compensation Scheme.)
However, the Government is looking to seriously reduce the requirements for a common bond. The new rules could see unions taking on more than 100,000 members, and possibly as many as 2 million. It's hard to see how credit unions can stay in touch with all those members.
Credit unions have been known to call people up in advance when they think they're in danger of going overdrawn. This warning helps people to avoid embarrassing situations, or bank-style penal charges. That sort of service isn't likely to happen with 1 million disconnected members.
On the plus side, existing members will be allowed to vote on changes to the membership requirements. Hopefully the possible consequences of the changes will be clear to them.
2. Pay interest on savings
Instead of receiving interest on savings, each member gets paid a dividend based on how much money is in the credit unions' coffers. Soon, though, credit unions will be allowed to pay an agreed interest rate instead of an uncertain dividend. If they do this, they will be required to hold a large chunk of money in reserve. Effectively, this means less money can be passed on to savers, because the pot available for paying either interest or a dividend shrinks by the size of the reserve. What's more, this reserve money could be put to better use for its members in other ways, not just as a dividend, but perhaps in cheaper loans.
If the union decides to let each member choose between interest or a dividend, it'll make saving with them more complicated. Simplicity is a key benefit of credit unions that distinguishes it from banks and building societies. This extra choice erodes that unique feature.
One plus point is that if unions can pay interest then they can begin to offer some other simple savings products, such as cash ISAs and Child Trust Funds. I would have preferred that this was handled differently though.
3. Abolishing the 8% dividend limit
Credit union members are currently not allowed to vote themselves a dividend greater than 8%, but the government will make the dividend size unlimited.
To pay themselves a higher dividend, the members must charge higher interest rates on loans to the members who are borrowing. If a union pays itself much more than 8% on savings then some of its members are likely paying a very high interest rate to fund that.
Just three years ago the interest that credit unions were allowed to charge on loans rose from an already high 12.7% APR to a shocking 26.8% APR. When you combine that with an unlimited potential dividend, it will encourage the savage treatment of members who are borrowing from the union.
My opinion is, if the union is treating all its members fairly, I don't see how they can generate a dividend greater than 8%.
The motive for increasing the limit is so that unions can offer a greater variety of savings products, but, again, this makes credit unions' products more complicated, and therefore less distinguishable from the minefield that is banks' products.
Becoming like the banks
Those are just three of several changes that bother me. Some of the changes proposed will reduce the cost of administration, which is of benefit to existing members, but more than half of the changes the Government is making could potentially erode the unique selling points of credit unions. It will increase their competitiveness and profitability, but it could come at the cost of loss of fairness to all members, loss of personal service, a diminished bond between members, and more difficult banking decisions.
Credit unions don't offer the best products. Under their existing structure they'll never have the best buy loans, savings or current accounts. But, whilst they have their communities' interests at heart, they're offering members a fairer deal compared to banks or building societies. I hope these changes don't end that. We don't need 600 more banks.
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