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Chapter Four - page 1


High interest rates are not the only way people can get a healthy return on their savings. Organisations which recycle savings locally provide social dividends as well.

Every working day, every week of the year, the three banks with branches in Westport, the Irish town in which I live, send large converted lorries out into the surrounding countryside to collect money. "My branch is one of the most successful in the country in terms of the amount of funds we are able to remit to Head Office for use elsewhere" one of the banks' managers, now retired, told me proudly some years ago. "We take in very much more in deposits than we lend out."

This pattern is repeated throughout most of rural Britain and Ireland: the mobile banks go out and the cash comes in. "I know of branches in the west of Ireland where the ratio of local deposits to local loans would be 6:1, but that would be extreme" another retired bank manager told me. "Four to one would be quite usual and the ratio for the west of Ireland as a whole would be two to one because places like Galway and Letterkenny are expanding and spending more than they save."

Despite the ex-managers' evidence, there are few published statistics to indicate the extent to which financial institutions are draining resources from rural Ireland. The banks claim that this is largely because they do not keep their records in a way which would permit the data to be easily assembled. Since 1991, however, the Central Bank of Ireland has collected figures for bank deposits from the farming sector: it had been publishing data on bank advances to that sector for many years. In 1993, these figures showed that Irish farmers owed 1,225 million to the banks and were owed 946m. by them. But, as the Irish Farmers' Journal 1 pointed out when these statistics were published, the deposit total did not include farmers' money held by building societies, credit unions, pension funds and other investment institutions, a much greater sum in view of the better return. As a result, the agricultural sector was a significant net lender to other parts of the economy.

Professor Patrick Honohan of the Economic & Social Research Institute in Dublin, who has done considerable research into monetary flows between economic sectors, told me in a letter that although he had no data, he would expect to find that savings moved out of rural and depressed urban areas. "After all, financial institutions lend to borrowers who look as if they have plans that will result in a cash-flow sufficient to repay the loan. By definition, such borrowers are less plentiful in depressed regions"2.

This means that the economic system has positive feedback: prosperous parts of the world get more investment because better returns can be had from projects there, which makes them still more prosperous, while poorer areas have what capital they possess taken away. As a result, the poorer areas fall further behind and people living in them are forced to leave to seek work wherever investment is going on. They take up residence in the expanding areas and add their spending to its rising income flow, generating further investment possibilities. A major cause of the emigration of young people from rural Ireland is that their parents have allowed their savings to be invested away from home.

Economically, this population shift is an undesirable, inefficient outcome because it leads to vacant housing and under-utilised assets in declining areas, and overcrowding and congestion in the prosperous ones. Unfortunately, however, conventional economics is based on the assumption that there will always be negative feedback in the shape of diminishing returns and not a positive feedback like the investment-causing-a-population-shift-and-hence-more-investment case we are discussing. The discipline is therefore ill-equipped to recommend ways to stop the flow. W. Brian Arthur, professor of population studies and economics at Stanford University, is one of the few members of his profession to have tried to work out what happens when a positive feedback occurs. He described his results in New Scientist in 1993:

Increasing returns have interesting implications for the characteristics of economies. There are many possible patterns of world production and consumption, so it is not possible to predict which one will occur. The particular pattern that falls into place builds up organically - that is, new firms and industries grow on what is already there. This is partly the result of historical accidents - who set up what firms where and when. Once in place, such concentrations become hard to dislodge; they are 'locked in'. The resulting pattern probably does not coincide with the best allocation of resources. Even if all countries start with equal concentrations of each industry, the slightest tremble in the marketplace tilts the outcome to an asymmetric one. So with positive feedback in the form of increasing returns, the economy acquires very different properties: multiple potential production-consumption patterns, unpredictability, history dependence, lock-in, inefficiency and asymmetry.

When I first came upon these properties I was surprised - and fascinated - by them. They showed that there were theoretical reasons, not just practical ones, why the economy is unpredictable. But mere hints of these ideas alarmed economists of previous generations. In 1939, the English economist John Hicks warned what would happen if they tried to incorporate them into mainstream economics: "The threatened wreckage is that of the greater part of economic theory."3

Arthur points out that many parts of the economy - the high-tech sector in particular - do not run into diminishing returns. "To produce a new pharmaceutical drug, computer spreadsheet program or passenger jet, perhaps hundreds of millions of pounds have to be spent on research and development. Once in production, however, incremental copies are comparatively cheap" he writes. "Once a product gets ahead of its rivals it gains further cost advantages and can get even further ahead. High technology is subject to increasing returns."

Governments obviously need to counteract the effects of increasing returns, of positive feedback, if they wish to have an even spread of a wide range of economic activities throughout their territories and prevent the concentration of economic power in very few corporate hands. However, most mainstream economists are strongly opposed to such strategies and react to proposals to, say, subsidise emerging domestic producers facing competition from established giants overseas by warning that such a course would limit the workings of the free market and thus lead to gross inefficiencies. However, this response ignores the widespread evidence that gross inefficiencies are generated by the market itself and that intervention might be needed to correct them. It also ignores the historical evidence that the governments of virtually every continental European country provided protection for their infant industries to enable them to counteract Britain's head start during the Industrial Revolution.

The idea of intervening in the market by restricting capital flows is particularly unacceptable to many economists because it would prevent investors moving their money to wherever it can gain the highest return. "A standard view would argue that the greatest national benefit is achieved if savings are put to the most productive use" Professor Honohan wrote in his letter after making his comments about capital flows from depressed areas to prosperous ones. In the context in which he used it, 'profitable' might well be substituted for 'productive'.

The existence of positive feedback means it is not just movements of capital across national boundaries which are harmful. Substantial, continuing capital flows from one part of a country to another are destabilising too, leading to prosperity in one area and decline in another. However, in the absence of any political recognition of both facts, endangered communities are going to have to limit such flows themselves if they are to survive.

One way of doing so might be for a community group to attempt to draw up a league table of the financial institutions in its area, showing the proportion of the savings that each takes in which it re-lends locally. If such a table could be prepared it would allow people to move their savings to the institution with the best local-retention ratio, so putting pressure on its rivals to improve their performance by increasing the proportion of local loans they make. However, I used the phrase 'attempt to draw up' deliberately because, if the Irish Green Party's experience in the 1994 European Election is any guide, it would prove impossible to assemble one outside the US, where the relevant data is freely available under the Community Reinvestment Act. Elsewhere, banks are likely to refuse to supply the necessary figures arguing that, because accountholders do not necessarily live in the districts in which each bank branch is located, any statistics they supplied would be flawed and potentially misleading.

The counter-arguments, that their computers could quickly sort out accountholders' addresses and that even imperfect data would be better than nothing, are unlikely to change bankers' minds and, unless information can be obtained secretly from sympathetic (or disaffected) bank staff, the league-table project is likely to run out of steam. Nevertheless, it is well worth while attempting to compile one in order to alert people to the effects of money flows. Moreover, the near-inevitable refusal of the high street banks to tell savers what they are doing with their deposits will strengthen some people's resolve to set up a mechanism of their own through which their capital can be channelled to local projects without the intervention of secretive outsiders.

There are several reasons for wanting to end, or at least drastically reduce, the involvement of outside banks in one's community. One is that using an external bank's services to do a job which can be done within the community causes a significant loss of purchasing power which can only be restored if the community sells goods and services to the outside world and thus stays dependent on it. For example, the farmers who lent 943m. to the Irish banks in 1993 would have been paid about 10m. in interest, while farmers borrowing the same amount would have paid perhaps 113m. for the privilege, making a net loss of around 100m. to the farming community. Not all this difference would have left rural areas because some would have gone to pay the bank staff and thus been returned to the local flow of national currency. However, since branch operating costs are usually less than half a bank's income, using outside banks to effect a transfer from one group of farmers to another caused a substantial net drain from rural areas.

The most important reason for wanting to short circuit local money flows, however, is that discussed in Chapter Two, namely, that once our savings have been passed over the mahogany counter of a outside bank, they will not return to our communities except at interest rates determined on world markets. These rates have nothing to do with local conditions or the rates of return we are able to earn by producing local goods for local sale at prices set by the lowest cost producers in the world. And, as we also discussed, these externally-determined interest rates are so extremely unstable that the cost of borrowing money can vary by over 100% within a short period, jeopardising the survival of every enterprise with an outstanding loan. During the ten years in which I ran a factory, the rate of interest the bank charged on its loans varied between 8.5 and 21%. What business, local or otherwise, can readily cope with so wide a variation?

In many places it is not necessary to start from scratch to set up a local banking system. Ireland and Britain already have almost a thousand independent, co-operatively-owned community organisations busy recycling their members' savings locally at stable interest rates - the credit unions.. The Irish movement began in 1958 and is much better developed than its British counterpart which started later - in 1964 - and only began expanding rapidly in the late 1980s. Now, however, a new British credit union is established on average every week. Internationally, the movement's stronghold is the United States where 66 million people, almost a third of the population, are members. Irish credit unions, with 1.33 million shareholders north and south in 1993 out of a population of 5 million have achieved almost as good a penetration rate. In Britain, 1993 CU membership was around 100,000, up an amazing 40% on the previous year.

The movement traces its origins to a loan bank set up by the burgomaster of Weyersbuch in Germany, Fredrich Wilhelm Raiffeisen, who was appalled by the activities of moneylenders who 'fastened like a vampire on the rural population' during a famine in 1846/47. Raiffeisen Credit Societies were set up all over Germany and were used by the founders of the Irish co-operative movement, Horace Plunkett and George W. Russell (AE) as the model for the agricultural credit societies or 'village banks' which they helped set up around the turn of the century. By the mid-1950s, however, of the 310 originally established, only 176 survived and their activities were very small scale. Roughly half of them were so disorganised and weighed down by bad debts that they even failed to meet their legal obligation to make annual returns.

The Raiffesen model was followed rather more successfully in Canada and the United States, however, and no US credit union defaulted as a result of the 1929 crash. By 1955, there were 16,201 credit unions with a total of about 3m. members in the US, most consisting of people employed by the same firm, and it was information, letters and encouragement from these, and from credit unions in Canada, that enabled a schoolteacher, Nora Herlihy, to set up the first Irish credit union. Similarly, the first British CU was set up in Wimbledon as a result of contacts with Nova Scotia.

New members join a credit union by applying in writing to its board or membership committee. Before being admitted, they must prove they share a common bond with the existing members, either because they live in the same area or, in the case of an employee credit union, work in the same firm. If their application is approved, they will then have to purchase at least a 1 share, although some CUs impose a five 1-share minimum. Any savings they then lodge up to maximum of 6,000 in Ireland, 5,000 in Britain, are also described as shares because they go to augment the union's working capital.

Shareholders receive dividends rather than interest on their money, the actual amount determined by the union's financial results. Shares can be cashed at any time but the manager has the right to require sixty days' notice in order to preserve the union's liquidity. In most credit unions shares are not cashed if the member holding them receives a loan but held as partial security. This can make support for that credit union expensive. Recently, well-established Irish credit unions have been paying tax-free dividends on shares of around 6%, and charging an annual rate of 12.68% on their loans, the same rate as in Britain. As a result, anyone needing access to their money but too loyal to insist on selling their shares pays their credit union roughly 6.5% to borrow their own funds. The only mitigating feature of this arrangement is that the borrowers are insured and, if they die, the loan is written off and their estate receives a gratuity of twice the value of their shareholding.

Click for 2002 update on the credit union movement in the UK and Ireland by Caroline Whyte.

The risk that savings placed as shares in a credit union will be lost if lenders default or directors defraud is covered by insurance and no saver in Britain or Ireland has ever lost money. In any case, credit unions' experience remarkably few bad debts, in part because of the common bond, in part the character and ethos of the movement. In 1992, my credit union in Westport feared that loans totalling 8,826 might not be repaid out of a total loan book of almost 3m., a record many a bank would envy. Another safeguard is that in both Britain and Ireland, each union's accounts books are inspected regularly by the movement's own auditors and by staff from the Registrar of Friendly Societies.

Since it took an angel in Frank Capra's classic film It's a Wonderful Life to show the small-town savings and loan manager the difference his life had made to his community, we shall never be able to quantify the benefits credit unions have brought. Their contribution has undoubtedly been substantial, however, most notably in getting members out of the clutches of moneylenders and in building up the saving habit. A founder-member of the first Irish credit union to be organised for workers at a single company, Liptons, the grocers, wrote to Nora Herlihy: "It has done one good thing for our members. It has got them out of the moneylenders' offices and none of them will ever go back. Some of us were charged 2.10s. interest for a loan of 10 - the principal and interest to be paid back in 25 weekly instalments of ten shillings each. The credit union charge for a similar loan is about one-eighth of that amount and it remains in the credit union for our benefit."4 Even today, Graham Tomlin, the president of the newly-established credit union for employees of British Airways, talks of CUs' role in fighting loan sharks who are still a serious social problem in most British and Irish cities.5

In Britain, CUs also play another role - that of providing banking services to deprived communities after high street banks have pulled out. St. Columba's credit union, which operated from church premises after it was founded in the mid-1970s, responded to the closure of a local Trustee Savings Bank branch by acquiring its own premises in Tong Street, Bradford, in 1991. "For the low-incomed and pensioners on the estates here, the closure meant spending money to go into town to pay bills" the manager, Joseph Yewdall, told me in 1995. "We now have 720 members and 250,000 assets and are growing daily. We call ourselves a one-stop community bank."6 Southwark Council established South London's first high-street credit union to meet the same needs. In Birmingham, where five of the city's thirty-nine wards no longer have a bank or building society and a further six have only one branch left, the Birmingham Credit Union Development Agency has been set up to help establish credit unions to fill the gap. An estimated 28% of Birmingham's population does not have local access to banking services or is on the verge of losing it.

But can credit unions do more than fulfil the valuable role of 'poor man's bank'? Specifically, can they provide finance at interest rates low and stable enough to help community ventures using local resources to meet local needs to compete in their local markets with goods and services supplied from outside? Or should communities develop other financial intermediaries to perform that function?

At present, credit unions are not geared to lend to small businesses and most of their directors and members think in social-service rather than economic-development terms. Moreover, although their interest rates are not only usually lower than other sources of personal finance and amazingly stable - in Ireland they have remained at 1% a month on the outstanding balance (12.68% APR) since the first credit union opened - in 1994 they were unattractive for anyone seeking to borrow for non-speculative business purposes since they were about twice what the banks were asking large, established companies to pay.

The few credit unions which believe they should channel savings into local economic development have generally done so by providing premises from which small businesses can operate. One such is the Blessington Credit Union in Co. Wicklow which spent 90,000 in 1987 buying and restoring a derelict courthouse, the architectural centrepiece of the town, to provide offices for itself and to rent to others, and then, in 1992, invested a further 84,000 in building a five-unit enterprise centre in the overgrown garden at the back. However, the best Irish example is probably to be found in Tallow, a village with nine hundred inhabitants in Co. Waterford whose the credit union was set up by sixteen people meeting in a school classroom in 1968. The first honorary secretary was Sheila Ryan. "It took us five years to be taken seriously" she says today, "but what gave us real credibility was when we were able to buy our own offices in 1975 for 4,000. We only had shareholdings of 12,000 at the time, so we took out a five-year loan from the Kanturk Credit Union which we were able to repay within three months, so great was the impact of the opening."

All the work involved in running the union was carried out voluntarily by the directors until 1984, when Mrs Ryan became its paid manager, a post she still holds. "The voluntary ethos is very important, but members also want a professional service" she says. Her employment left the directors free to fulfil their true role - setting the organisation's policy. "The board became seriously concerned about the growth of unemployment in the town and encouraged the establishment of the Tallow Enterprise Group. We offered them our office facilities and meeting rooms but they were never used because the unemployed just didn't have the confidence" she says.

Another approach was obviously necessary and so a solicitor, an accountant and three of the directors who had set up their own businesses reformed the enterprise group and began to run training courses on the top floor of the credit union building. Twenty-six people attended and, of these, half set up projects. But where were these new businesses to work from? By now it was 1989 and the organisation's 21st anniversary and, rather than mark it with a lavish dinner-dance as other societies might have done, the board decided to buy a derelict four-storey grainstore for 3,500 and spend a further 10,000 on doing it up so that it could be used by the enterprise group. Not that this meant that there was no anniversary dinner: a meal was prepared by credit union members and served in the refurbished building, Nora Herlihy House.

A playschool, a crèche and a picture-framing business started up in the new premises, along with a secretarial services company and a plastic display goods firm. "But it wasn't just used for economic development" Mrs. Ryan says. "We've had classes and exhibitions there and used it for Tallow's international sculpture festivals. You'd be quite amazed at the mess sculptors can make."

In 1993, with the old grainstore fully occupied, the CU board was keen to buy the premises of a motor dealer in the town which had gone into liquidation. "20,000 sq ft of space was being offered for 35,000" Mrs Ryan says. "However, we did not feel we could bid for it until the family which had owned it gave us permission. We don't profit from other people's misfortunes around here." Permission was given but a problem arose. The Registrar of Friendly Societies had visited Tallow three years earlier and expressed the view that owning and operating an enterprise centre was no part of a credit union's function. This, naturally, damaged some directors' confidence. "But he never put anything in writing" Mrs. Ryan says. "If he had found any legislation which we had infringed he would have certainly put it on paper. It was ridiculous - we had an Enterprise Centre worth 60,000 on our books for 10,000 and the Registrar was unhappy." Incidentally, Tallow’s purchase and conversion of the grainstore would have been illegal in Britain as the 1979 Credit Union Act prevents CUs buying property except for their own use.

So, instead of buying the garage itself, the credit union loaned the necessary funds to the Enterprise Group which bought it instead and got 100,000 in government grants and soft loans to do it up. "This solution made very little difference because the Enterprise Group operates more or less as a sub-committee of the credit union anyway" Mrs. Ryan continues. "However, it would have been better if the credit union had bought it directly as we would have had another very valuable asset on our books. I think the Enterprise Group will probably assign the credit union the title one day."

When the garage had been refitted, the businesses in Nora Herlihy House moved into it to allow an adult language-tuition centre to be established in their old home. By 1995, the Tallow Area Credit Union had a full-time staff of four, almost 3,000 members and savings of 3m. These statistics make it one of the smaller Irish credit unions, a fact which makes its achievements all the more remarkable. But it will not stay small for long. Its rate of growth has become exponential - it took it eleven years before it had 100,000-worth of savings, and 20 years to reach 1m. but the second million took four years and the third million two. Part of its attractiveness is due to its policies. "Although we have the right to require sixty days' notice, we've never asked anyone to wait longer for their money than it takes the time-lock on the safe to open. Nor have we required them to borrow against their shares" Mrs Ryan says. "It's not fair to do that and it's quite possible to avoid it if you have adequate liquidity. Normally, we keep between a quarter and a third of total savings in short-term investments or in other liquid assets."

Click for 2002 update on Tallow Credit Union by Caroline Whyte

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