From Research

Liquidity risk and political instability in Northern Ireland banking

The banking industry in Northern Ireland (NI) mirrors the rest of the UK in its concentrated nature, with ten high street banks (Bank of Ireland, Danske Bank, First Trust Bank, Ulster Bank (RBS group), Barclays, Lloyds Banking Group, HSBC, Santander UK, Clydesdale and Nationwide Building Society) and a handful of banking businesses owned by retail groups (Co-operative bank, Sainsbury’s Bank, Tesco Bank and Post Office Money) who largely operating in the unsecured short term loans market1. Bank balance sheets in NI are facing some significant challenges as a result of the recent political instability. The EU exit and the assembly’s collapse (and subsequent polarised snap election results) due the mismanagement of the ‘ash for cash’ green energy scheme (RHI) 2 places real pressures on both business and consumer lending. The RHI scandal is likely to put pressure on a depleted small to medium enterprise (SME) lending portfolio adding further financial woes to the farming industry 3, while the economic fallout of an EU exit puts pressure on debt-fuelled consumer spending.

One way to understand these pressures better is to assess the liquidity risk of NI banks. Specifically, figure 1 presents an aggregate look at the funding liquidity ratio (borrowings a a proportion of deposits4) for individuals and a selection of SME business categories over the period 2013 Q3 to 2016 Q35.

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Over this period, lending to individuals averaged around 35% of the total loan book. Figure 2 presents the share of total SME lending by business category. The SME business categories investigated in figure 1 capture over 75% of SME loan book share and can be considered the biggest liquidity risk management. Finally, for comparison, figure 1 also includes a sector average.

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The calculated ratio approximates a bank’s liquidity position, with too high a value suggesting that a bank will not have enough funds available to absorb unforeseen funding shocks, while too low a value suggesting profitability issues due to a bank not earning as much as it could from its liquid assets. The data is sourced from the British Banking Association and captures over 95% of the banking business in Northern Ireland.

Some interesting points emerge. The large difference between quarterly SME (orange, light green, and dark green dots) and consumer lending (purple dots) ratios illustrates the stark differences in bank lending practices. SME business lending is secured against a combination of collateral, government backed income and EU subsidies. For example, EU and government backed income is purported to account for some 87% of farming income in NI 6. The SME sector has seen a reduction in the average liquidity ratio over the period, from 138% in 2013 Q3 to 82% in 2016 Q3, which is largely due to a depletion of the loan book size. This depletion has been driven by a deleveraging process in the real estate and construction industries7 due to large non-performing loan write offs and the sale of debt portfolios to investment companies such as New York investment fund Cerberus.

In 2016 Q3, liquidity risk in construction has now fallen below 100% while the real estate business remain well above the sector average at 181%. Agricultural business, while capturing a smaller portion of the SME lending stock (8% average for period), has remained a high liquid risk, well above the average liquidity ratio in every quarter.

This high liquidity risk position of agri-SME lending can be partly explained by the heavily subsidised nature of the industry. That said, a financial crisis in farming is an issue that has been raised a number of years ago when the big four banks were called to Stormont to give evidence8. A key concern for this SME category is the ‘ash for cash’ government backed scheme that has likely been used as lending collateral. In 2013, assurances by the finance department to the banks that the 12% rates of return on these scheme will be ‘grandfathered’ providing certainty regardless of future reviews, likely means that deleveraging in this sectors has been less of a concern to the banks over this period.9. With these guarantees now likely to be under review in a newly formed Assembly the high liquidity risk of agri-SME lending may be ossified by increased default risk if promised guarantees are now in doubt.

From a liquidity perspective, lending to individuals is increasingly well covered by more deposits, with the ratio falling from 73% in 2013 Q3 to 64% in 2016 Q3. That said, this may raise some profitability concerns as individual lending makes up a 35% of the bank lending in NI. GB and NI consumers have been largely unaffected by Brexit-induced economic slowdown or inflation pressure as UK consumer credit grew more than 11% in the year to December, an increase not seen since 2005 according to the Bank of England figures.

Banks in Northern Ireland, as in the rest of the UK, should be weary of such debt-fueled consumption as unsecured personal debt has historically made up 90% of the household loan losses in the UK. Mark Carney has cautioned on this type of debt-driven demand becoming more sensitive to income and employment levels. Another key concern is that UK households are saving at record low levels with saving rates as a proportion of disposable income dropping to 5% (20 year low). While employment levels are at their highest since records began in Northern Ireland, 70% according to the Department of the Economy, the real wage rate in NI has been falling steadily since 200910.

In summary, political uncertainty has some clear liquidity risk management challenges for NI bank balance sheets. While a large deleveraging process in construction and real estate has significantly lowered liquidity risk in SME lending this is likely to squeeze profitability in these areas. More importantly, lending to the farming industry will require careful risk recalibration as RHI scheme guarantees may prove illusory after a review. Perhaps more encouraging is the well covered individual lending portfolio which is 35% of the total loan book. This low liquidity risk may also be a challenge for bank profitability as they struggle to on-lending some of these highly liquid deposits assets.

  1. Northern Ireland also has a well established credit union sector which, while more developed than its UK counterparts, operate mainly in the short term unsecured lending market
  2. 2017 “Green energy scheme fuels Northern Ireland crisis” FT
  3. In 2013, the largest four banks were called to the assembly to provide information and opinion on a perceived financial crisis in NI farming. For details of these briefings see (2013) Financial Crisis in Farming Northern Ireland Assembly Briefings with Banks 2013. Danske Bank , Bank of Ireland, Ulster Bank, First Trust Bank.
  4. Borrowings are defined as total loans and overdrafts while deposits includes all current account balances
  5. This is the complete period for which data is available
  6. (2017) Northern Ireland shows the risks of Brexit FT
  7. Over the three year period lending stocks has halved in real estate and fallen by three quarters in the construction industry
  8. (2013) Financial Crisis in Farming Northern Ireland Assembly Briefings with Banks 2013. Danske Bank , Bank of Ireland, Ulster Bank, First Trust Bank.
  9. http://www.bbc.co.uk/news/uk-northern-ireland-38466327
  10. http://www.nicva.org/article/what-ashe-tells-us-about-real-wages-northern-ireland

Me, HEC and Research 2B

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One of the many good things about working as a Finance lecturer at Queen’s Management School is the opportunity to research overseas.  As a senior research associate of the International Research Centre for Cooperative Finance (IRCCF) at HEC Montreal,  I have the pleasure of visiting this eclectic bilingual city each year. Over the academic year I have two visits as part of my sabbatical leave.  The visits are centred around three exciting projects:

  1. Banking Business Model (BBM) diversity and financial sustainability.
  2. Cooperative Traits of Mergers.
  3. Systemic Risk and Basel Regulatory Compliance (in collaboration with the IMF and Cass Business School)

This research hopes to provide evidence that enlightens the following research puzzles:

  1. What business model features have engendered resilience in the Canadian financial system ?
  2. Do credit union mergers enshrine membership benefits?
  3. How does compliance with core supervisory standards set by the Basel Banking Supervision Committee  affect systemic risk in developed economies?

Projects 1 and 2 are Canada focused while project 3 takes a global approach.  Each of these projects pose very different quantitative challenges which I relish as an card-carrying empiricist.

In project 1 we are using a data clustering approach to identify distinct business models based on an institution’s funding and activities.  This model-free approach reveals the BBM diversity in the Canadian sector over the period 2010-2015.  Following the seminal work on BBM global monitors by my co-author Professor Rym Ayadi  (Director of the IRCCF) in Ayadi et al (2011 2014, 2015 and 2016)1 this exercise will illustrate the unique architecture of the Canadian financial services industry and shed light on factors that promote resilience to globally systemic banking problems.

Project 2 uses a proprietary data set from Deposit Insurance Corporation of Ontario (DICO) to investigate 20 years of consolidation in this region’s credit unions. The analysis will use a flexible model which captures the uniquely cooperative objective of membership benefit maximisation. The project will empirically expose the cooperative traits of mergers/amalgamations in credit unions and hopes to reveal the nature of the membership value of such activity.

Finally, project 3 is a global exercise which uses a number of quantitative measures to capture systemic risk of a financial institution and identify to what extend regulatory compliance can mitigate this risk.  This is a follow on piece of work from Ayadi et al (2016) 2. We have used a large slice of data science to compile a unique sample representing global banking and its regulatory infrastructure.  Our key variable measures the compliance of a financial system with the principles of regulatory best practice proposed by the Basel Committee for Banking supervision.

In short I have my work cut out!  Watch this space for some interesting preliminary results from these projects.

  1. Ayadi, R., Arbak, E. & Pieter De Groen, W., 2011. Business Models in European Banking: A Pre-and Post-Crisis Screening. Centre for European Policy Studies.

    Ayadi, R. & DeGreon, W.P., 2014. Banking Business Models Monitor 2014 Europe. Centre for European Policy Studies.

    Ayadi, R., Arbak, M. & GreonWP, D., 2015. Regulations of European Banks and Business Models: Towards a new paradigm.Centre for European Policy Studies.

    Ayadi, R. & De Groen, W.P., 2016. Bank Business Model Monitor for Europe 2015. International Research Center for Cooperative Finance.

  2. Ayadi, R., Naceur, S. B., Casu, B. & Quinn, B. 2016, Does Basel Compliance Matter for Bank Performance?,  Journal of Financial Stability. 23, p. 15-32

Credit Unions and Financial Stability

CUConcept

A credit union is one of the purest forms of cooperative banking, striving to balance both economic and social goals for the benefit of its membership.

Credit unions are a prevalent part of  society and have long been seen as a stable and risk-averse form of banking. In Canada, credit unions compete directly for market share with shareholder-owned banks, and dominate in some regions. Overall this heterogeneous banking system has been perceived to be relatively stable, especially since the recent financial crisis.

This research project aims to provide key insights into the dynamic contribution financial cooperatives make to the overall stability of a banking system. Focusing on the Canadian banking system, the analysis aims to assess key credit union characteristics that influence stability in a banking sector in periods of crisis and calm. The projects’ empirical design has four paradigms; business model heterogeneity; structural performance; survival, and viability.
This research project is part of my work as a Senior research associate of the International Research Centre for Cooperative Finance in HEC Montreal.

Tiered Regulation and Irish Credit Unions

Regulatory reform in Irish credit unions is a hot topic.  A recent Irish times article 1 highlights the juxtaposition of opinions of the various stakeholders in Ireland.

In this research project we investigate the existence of a tiered structure in Irish credit unions.  We let the data speak and provide some empirical evidence to help inform this current policy debate.

So far our findings conclude that a multi-tier system in terms of business model complexity is present.  This findings is based on a novel approach which endogenously identified an optimal tiered business model strategy based on key financial viability characteristics of Irish credit unions.

For more details of this work see   http://www.barryquinn.com/a-sustainable-business-model-strategy-for-irish-credit-unions/

 

  1. “Credit unions criticise ‘overzealous’ regulatory plans”-http://www.irishtimes.com/business/financial-services/credit-unions-criticise-overzealous-regulatory-plans-1.2443451″

A Sustainable Business Model Strategy for Irish Credit Unions

Introduction

One of my latest pieces of research investigates business model complexity within the Irish credit union movement using a novel technique which allows identification of a multi-layered system based on financial viability characteristics.

Study summary

This study examines the business model complexity of Irish credit unions using a latent class approach to measure structural performance over the period 2002 to 2013. The latent class approach allows the endogenous identification of a multi-tiered business model based on credit union specific characteristics. The analysis finds a three tier business model to be appropriate with the multi-tier model dependent on three financial viability characteristics. This finding is consistent with the deliberations of the Irish Commission on Credit Unions (2012) which identified complexity and diversity in the business models of Irish credit unions and recommended that such complexity and diversity could not be accommodated within a one size fits all framework. The analysis also highlights all tiers are subject to decreasing returns to scale at the sample mean. This may suggest that credit unions would benefit from a reduction in scale or perhaps that there is an imbalance in the present change process. Finally, relative performance differences are identified for each tier in terms of technical efficiency. This suggests that there is an opportunity for credit unions to improve their performance by using within tier best practice or alternatively by switching to another tier.

This study is part of the Not-for-profit and Public sector Research (CNPR) centre’s working paper series.  For a copy of the full paper please visit the financial institutions section of:

http://qub.ac.uk/schools/QueensManagementSchool/OurResearch/ResearchCentres/NotforProfit/AbouttheCentre/Publications/

How does web technology adoption affect the performance of Irish credit unions?

Irish credit unions are now entering a period of substantive structural change which will in part be based around technological improvements. One of the conditions of the EU/IMF/ECB financial support package for Ireland was the requirement that credit unions are restructured. A Credit Union Re-Structuring Board was established in 2012 to facilitate amalgamations and the creation of strong ‘anchor’ credit unions capable of developing more sophisticated and more sustainable business models. €250 million has been allocated for this process some of which will be used to enable ‘anchor’ credit unions upgrade their ICT systems.  It was against this back drop, in our forthcoming paper[1], that we assessed the performance implications of web technology adoption in Irish credit unions over the 2002-2010 period.

Here are some key excerpts from the paper.

Figure 1 illustrates a steady increase in web adoption over the period although in 2010 53% of credit unions still did not have a web-based facility.  Further survey evidence from 2010/2011 suggests that these adopters are relatively unsophisticated technological capabilities, with less than 10% offering ATM and or phone banking. This could be related to two factors.  The first is that Irish credit unions have been unable to create a sophisticated integrated technology solution across credit unions and secondly credit unions are constrained by legislation and the regulatory authorities in the range of services that they provide

Figure 1

webadoptionCUs

Figure 2 presents a preliminary visualisation of some performance and cost metrics grouped by whether the credit union has adopted a website or not. The graphical analysis reveals some distinct difference with web adopters experiencing lower spreads on average (driven it seems by lower average loans rates), a marginally higher pay-out ratio and higher average labour and capital expenditures. The latter finding is consistent with the initial encroachment on costs of the adoption of a new technology, while the former finding suggests that credit unions are passing any benefit accrued from this new technology to their membership. The graphical analysis suggests that both saving members and borrowing members benefit but that the majority of the benefit accrues to borrowers.

Figure 2

Adoptioneffects

That said, care must be taken when drawing any causal inference on the effect of adoption from these graphs as to do so infers that the non-adopters and adopters have no other differences other than the adoption of a website.  Using an exhaustive econometric panel data analysis to account for both observable and unobservable difference between adopters and non-adopters, we find consistent statistical evidence of a reduction in spread ( driven by a fall in the loan rate) due to the adoption of web technology.  This effect is persistent over a two and three year period and translates into a cost benefit for borrowing members.

Overall our study highlights that the adoption of a website, even with limited functionality, can provide cost reductions and performance enhancement. This points to the potential of additional benefits accruing from more sophisticated levels of technological advance.  We feel this paper provides timely and important evidence to the Irish credit union sector, which is now entering a period of substantial structural change which is partly base around technological improvement.

1. McKillop, Donal G., and Barry Quinn. 2015. “Web Adoption in Irish Credit unions:Performance Implications.” Annals of Public and Cooperative Economics 86(3).

Investigating financial intermediaries’ performance determinants when ‘best practice’ rewards regulatory compliance to reduce bad debt

(J. Colin Glass, Donal G. McKillop and Barry Quinn)

 

 

 

 

 

 

 

 

Abstract

This study employs the Cuesta et al. (2009) translog enhanced hyperbolic distance function model to examine the performance of Irish credit unions. The modeling approach rewards credit unions for reducing undesirable outputs and for increasing desirable outputs and decreasing inputs. A number of findings emerge. First, credit unions are subject to increasing returns to scale with larger credit unions also more efficient than their smaller counterparts. Second, credit unions have secured technical progress via investment in interactive website facilities for product and service delivery. Third, regulatory pressure to reduce bad loans will have a beneficial impact on credit union output and performance.

JEL classification: G21

Keywords: Credit unions, Efficiency, Bad debts

Submitted to Journal of Business, Finance and Accounting April 2010

 

 

 

 

 

 

 

 

 

 

 

 

British Accounting and Finance Association April 2014

In April I attended the BAFA annual conference hosted by the London School of Economics.  My co-author, Barabara Casu (Cass Business School) presented a piece of work on regulatory compliance and bank performance.  We used a unique dataset including Basel Core Principle for effective banking supervision compliance data (BCPs) supplied by the IMF to ascertain if banks’ performance is influenced by compliance with these BCPs.  Using a global sample of banks and modern econometric techniques we find little evidence of an association between compliance and bank operating efficiency, suggestive of the inadequacy of such ‘one size fits all’ banking supervision principles.

Opportunity cost of financial regulation in English football

In collaboration with Ronan Gallagher (University of Edinburgh) I am investigating how financial fair play regulation (henceforth FFP) affects the relative performance of top flight professional football teams in Europe.  Using panel data from on the top two Tiers of English Football, we will use multi-dimensional benchmarking techniques to capture the heterogeneous nature of professional football teams and then retrospectively assess how FFP affect their relative performance.  Our goal is to shed light on the potential opportunity cost of such financial regulation in professional sport team management.