Information on Credit Unions
[ Last Updated 6 December 2005 ]
March 2000
Contents
Consultation on Credit Unions
The Ministry of Economic Development is seeking the views of interested parties on increasing the deposit limit for credit unions under the Friendly Societies and Credit Unions Act 1982 to $250,000. Closing date for submissions: Friday, 24 March 2000
Function of the Deposit Limit
1. The Friendly Societies and Credit Unions Act 1982 ("the Act") provides that a credit union may only accept deposits from members by way of subscription for shares in the credit union. The Act also sets a limit on the total value of shares that may be held by any member of a credit union. This limit may be amended from time to time by Order in Council. This limit is referred to as the "deposit limit".
2. The purpose of the deposit limit is to provide protection to the members of credit unions by limiting the level of risk of each member in a credit union and by limiting the dependence of a credit union on a small number of large depositors. A consequence of the deposit limit is that it also ring fences the business of credit unions and, therefore, any competitive advantage afforded by its tax exemption on income.
3. The current deposit limit is $40,000.
Background
4. Last year the (then) Minister for Enterprise and Commerce received a request from the New Zealand Association of Credit Unions to increase the deposit limit to $250,000. The (then) Ministry of Commerce undertook limited consultation with interested parties to sound out opinion on this request. This consultation revealed divergent views as to what the appropriate level for the deposit limit for credit unions should be. The Minister for Enterprise and Commerce decided in August 1999 not to increase the deposit limit for credit unions until:
- the Securities Commission had completed its review of the exemption under the Securities Act and all credit unions had signed a trust deed ( this exemption is discussed below at paragraph 6 below). This would address concerns about prudential safety of members' funds; and
- IRD had reviewed the tax exemption for credit unions taking into account competitive neutrality issues.
6. In September last year, the Securities Commission announced its decision to remove the exemption for credit unions from the requirement in the Securities Act 1978 to have a trust deed and an independent trustee. Credit unions now have a transitional period lasting until April 2001 after which all credit unions must comply with the trust deed and trustee requirements.
7. As a consequence, the New Zealand Association of Credit Unions has approached the new Government to reconsider its request to increase the deposit limit. A major driver for its request is a need for credit unions to meet the new prudential requirements under the proposed trust deed, which has increased the reserve asset ratio to 10% for all credit unions. The New Zealand Association of Credit Unions considers that this new requirement is best met by expanding deposits by new and existing members.
Discussion of Issues
Business Niche
8. Currently the deposit limit has the effect of segmenting the market in which credit unions can operate. For example, restricting savings to certain amounts may exclude credit unions from operating in long term investment and savings markets. It also has the effect of restricting the ability of credit unions to grow within their common bond of membership. This in turn limits the ability of credit unions to achieve economies of scale, and in association with other measures, it limits the amount of funds that can be lent to any person.
9. A significant increase in the deposit limit will facilitate credit union growth and may allow expansion into other savings and loan products. We understand from previous submissions that this may be a concern to some credit unions and interested parties. That is, that some credit unions may start to operate outside their traditional business niche and the essential character of credit unions may change.
10. The Ministry of Economic Development's ("the Ministry") preliminary view is that mandatory regulation should not be used for solely commercial reasons, such as to define market niche. If this is an important component of the character of credit unions, then each individual credit union can specify its own deposit limit within its rules or in the trust deed.
Prudential Safety
11. The intended purpose of the deposit limit is to act as a prudential measure to limit the funds at risk and a credit union's exposure to a large depositor. A substantial increase in the deposit limit will therefore increase the risk associated with members' funds, particularly for some of the smaller credit unions.
12. The Ministry considers that a substantial increase in the deposit limit should only be contemplated where the credit unions are subject to the trustee and trust deed requirements of the Securities Act 1978. This would allow the trustee and credit union to negotiate particular deposit limits for each credit union within the trust deed depending upon their size and risk.
Competitive Neutrality
13. Given that the deposit limit constrains the activities of credit unions, a substantial increase would facilitate growth and competition with other financial service providers. A potential problem that arises is that credit unions have a tax exemption on income, which is not available to other financial service provides. It is undesirable that regulation should distort competition.
14. The Ministry considers that there are two elements to this issue - one, the extent of the competitive advantage from the tax exemption relative to the other regulatory measures particular to credit unions; and two, timing issues for a review of the tax exemption.
15. The Ministry is interested in any comments on the extent of the competitive advantage held by credit unions as a consequence of the tax exemption. While credit unions have a tax exemption on income, they are also constrained by other factors under the legislation such as, the common bond of membership, the statutory limits on borrowing and the size of loans, which are not a feature of the regulation of their competitors. These factors may counter any advantage obtained as a result of the tax exemption.
16. In terms of timing, the Ministry understands that the Inland Revenue Department does intend to undertake a review of the tax treatment of credit unions and other mutual organisations sometime in the future. The details of this review have not been developed and, given the complexity of the issues, it is likely to take some time. Therefore, the Ministry is interested in comments on whether the problem of competitive advantage due to the tax exemption merits delaying any substantial increase in the deposit limit until this review is completed.
Proposed Level of the Deposit Limit
17. Given these issues, the Ministry has formed a preliminary view that the deposit limit for credit unions should be increased to $250,000. It is considered that a substantial increase in the deposit limit is necessary to facilitate credit union growth, and that the figure of $250,000 represents a suitable compromise figure between the different interest group views. If Option 1 is progressed further (see paragraph 19), individual credit unions would be free to set their own deposit limit under their trust deeds at the level they consider appropriate for their particular circumstances.
Options for Increasing the Deposit Limit
18. The deposit limit could be increased by Order in Council. However, a problem that arises is that not all the credit unions have acceded to a trust deed to comply with the Securities Act or will necessarily do so until the expiry of the transitional period on 30 April 2001. The Ministry considers that raising the deposit limit before the expiry of the transitional period could therefore expose members of credit unions who have not signed a trust deed to additional risk as the deposit limit is a key element of the current mechanism to safeguard the interests of members of credit unions.
19. There are two options for addressing this issue.
Option 1 - Increasing the Deposit Limit under the Act and Issuing a New Exemption Notice under the Securities Act
20. Under this dual regulatory approach:
- the deposit limit in the Act would be raised by Order in Council to $250,000; and
- the deposit limit for those credit unions that have not signed a trust deed would be fixed at $40,000 (i.e. the current limit) under the Securities Act. This could be achieved by the Securities Commission amending the transitional exemption notice under the Securities Act.
Option 2 - Increasing the Deposit Limit at the Expiry of the Transitional Period for Compliance with the Securities Act
21. An alternative option is to increase the deposit limit so that it takes effect at the expiry of the transitional period on 31 April 2001. By this point, all credit unions would have acceded to a trust deed and appointed an independent trustee or risk non-compliance with the Securities Act.
A Preferred Option
22. The Ministry's preferred option at this stage is option 1, but the Ministry is interested in the views of others before providing advice to the Government. Option 1 would allow the deposit limit for credit unions to be increased before 31 April 2001. This option would therefore facilitate credit union growth at an earlier date than option 2 and would ensure that the prudential risks to members of credit unions would be minimised.
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