Credit Unions - Increasing Interest Rates is this a wise move?

In the last blog we looked at reducing interest rates on loans mainly due to high levels of liquidity in the sector and to generate more income.

What would happen if interest rates were increased? Members could leave and the loan book could drop but how far can you go with price increases

Let’s take the same example

We have a Credit Union , CU Ltd, which has the following numbers:

CU Ltd

Key Numbers

Loans

2,500,000

Cash

500,000

Interest on Loans

500,000

Cost of Loans

300,000

GP%

40%

Overheads

150,000

Reserves b/fwd

100,000

Reserves for year

50,000

Net Reserves

150,000

CA Ratio

5%

CU Ltd, as before, is operating just at the minimum level for its size in terms of capital and is making 40% gross margin on the loans. Liquidity is healthy due to high levels of cash. Interest rates are charged at 20% on all loans.

Increase Interest Rates

If CU Ltd increases rates by 20% but this results in a 20% reduction in loans from new members what happens to the net profit position and capital adequacy.

CU Ltd

Key Numbers

Reduce interest rates by 20% Increase loans by 20%

Loans

2,500,000

2,000,000

Cash

500,000

1,000,000

Interest on Loans

500,000

480,000

Cost of Loans

300,000

240,000

GP%

40%

50%

Overheads

150,000

150,000

Reserves b/fwd

100,000

100,000

Reserves for year

50,000

90,000

Net Reserves

150,000

190,000

CA Ratio

5%

6.33%


As you will see the current position has changed first by increasing prices by 20% means interest rates have increased to 24% from 20%. With the increase this means 20% of the loan book is reduced and this therefore reduces income from £500,000 to £480,000.

Profit increases…

With 20% less in customers’/loans direct costs have reduced by 20% from £300,000 to £240,000. That’s £60,000 reduction in direct costs and this increases profit by £40,000 overall from the original position to generate a profit of £90,000. Not only that the margin on loans has increased making the credit union more efficient.

For CU Ltd to get back to the initial profit position it could afford to lose £834,000 of its loan book, that’s a 33% reduction.

Although liquidity is high the capital adequacy is better managed. Again though delinquency isn’t taken into consideration nor is the member mix.  The message however compared with reducing prices is that increasing prices is better.

Do however consider the following before increasing all the products rates

  • Be selective if you are considering an increase, take risk into consideration and do not do it for the whole loan book.
  • Having cash isn’t a bad thing even if the liquidity is high. It is easier to control a credit union’s finances with higher liquidity than trying to manage a loss making, low capital adequacy model.
  • Understand your loan book and the different products and always follow the loan policy
  • Understand how the cost of the loan is made up to ensure costs can be mitigated if the loan book is reduced.
  • Model the impact of the increases and to see how it will impact on the overall numbers before making the decision to go ahead.
  • Seek professional advice if you are unsure

If you wish to look at pricing in more detail for your credit union speak to:
Philip Jones at Hallidays 0161 476 8276
www.hallidays.co.uk/services/specialisms/credit-unions

Posted 20th May 2015

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