The ‘Brexit Risk’ to a Credit Union

What is the potential impact of Brexit on a credit union (CU)? To fully understand the question in risk terms, Brexit has to be viewed as an external context. Given the uncertainty surrounding the type of Brexit agreement that will actually materialise, let’s assume the worst-case and consider how that is likely to affect the objectives of the credit union.

There will be an economic impact and it could manifest in the following ways:

  • Longer supply chains
  • Wider exchange rate fluctuation
  • Tariffs on exported goods
  • Tariffs on imported goods
  • Job losses in some sectors
  • Skill shortages in some sectors
  • Border and customs associated headcount and capital cost increases
  • “Dumping” of lower cost / different quality standard surpluses through border outlets
  • UK competition pressure on border county retailers
  • Decline in visitor numbers from the UK
  • Many other unknown unknowns

Most of these manifestations represent cost increases for businesses and consumers. Depending on the sector a business is in, one or more of them could negatively affect it.

The objectives of a credit union are connected with the internal national economy and, as the economy is impacted, the CU’s loan book objectives, its credit risk objective and, by extension, its reserve requirements may be impacted. Brexit risks are dependent on location and on any wide concentration risk arising from the impact on the sectors that employ the borrowing members of the CU.

The ESRI are predicting a relatively low impact on the Irish economy. But, while the average downturn may be low, the sectoral impact could be quite severe. Credit Unions need to look at the source of income profile of their members to gauge the potential impact on the CU’s loan book objectives.

These are some examples of the Brexit risks CUs are monitoring and managing:

  • Credit unions close to or on the border are already dealing with foreign exchange risk; borrowers who work in the north and are paid in sterling may be impacted by a significant devaluation of sterling.
  • For staff that live in the north a hard border may well add time to a commute. Depending on how hard the border becomes or how technology may help, this could add up to 60 mins to a working day.
  • CUs with a common bond where a high percentage of the borrowing members are employed in agriculture or food production companies should watch out for concentrations. The WTO tariffs on food products can be as high as 33%. Any enterprise that is directly or indirectly dependent on exporting to the UK could see its product price to the UK consumer rise significantly.
  • Machinery producers also face tariffs, lower in percentage terms, but the cost per unit on machinery is higher so a 10% tariff is not readily passed on to a UK customer.
  • Imported raw materials or components from the UK will be more expensive increasing the cost base of some manufacturers, who will suffer on the double if they are dependent on sales back to the UK.
  • And much more…

Look for concentrations in your CU’s membership where income is dependent on sectors that may face tariffs post-Brexit – some of these firms will see job losses and the sector that could be most impacted by Brexit is the Agri / Food sector. Already we see Irish meat processors acquiring processing capacity in the UK, assuming that when Brexit happens they will export live animals and add value in the UK to retain existing markets.

Credit Unions whose member income is concentrated in tourism-related activity may be impacted by exchange rate risk. The assumption is that sterling will devalue in the period post-Brexit. There was a 7% decline in tourism from the UK in the aftermath of the Brexit vote and, while some of that has recovered, Brexit has the potential to result in further reductions in earnings from UK tourism. Here again, look for sector employment concentration in your borrowing membership.

At this point in your Brexit preparations the main issue is awareness. There is so much uncertainty around the issue that it is difficult to propose any concrete mitigation actions other than those described above. Look to the sector concentrations and make decisions to alter your risk appetite in areas where you have identified real concerns. Do mini stress-tests on the loan book. Some economists are suggesting that there could be as much as a 5% contraction in the Irish economy in a worst-case Brexit scenario.  In this worst-case scenario, Brexit will affect particular sectors more than others. Some of the impact may be experienced immediately, depending on the detail of the final outcome. One thing we can be sure about at this time is that the risk surrounding Brexit is still very much an unknown unknown.

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