Reflecting, Renewing and Reinvigorating - Patrick Casey, Registrar of Credit Unions

Irish League of Credit Unions’ Annual General Meeting

Mr. President, members of the Board, ladies and gentlemen, let me begin by thanking the Irish League of Credit Unions for inviting me to speak at your AGM. I am delighted to have the opportunity to address you as senior sector executives.

I intend to share my perspectives with you on where the credit union sector is today, what is required to overcome your key business model challenges and how we can support you in that regard.

Let me start by acknowledging the responsible way in which you have helped weaker credit unions in recent years, including through the provision of Savings Protection Scheme support. Since 2015, such support has been provided to 23 individual credit unions, which has consequently ensured in excess of 100,000 members are continuing to avail of services in financially stronger credit unions. This is an example of how credit unions have supported one another to underpin the stability of the sector, and importantly, to maintain the trust of members.

Credit unions deservedly have a highly respected brand and enjoy the loyal trust of members¹. This is a competitive difference upon which to build your business. While that trust has a disproportionate expression in terms of savings at present, your challenge is to grow your loan book in an increasingly competitive and rapidly evolving marketplace. The post crisis period can be characterised by:

• Heightened consumer and regulatory expectations of financial service providers;
• An increasingly technology-led change agenda; and
• Competitive market dynamics.

Whilst business model challenges are affecting all financial service providers, you are disproportionately affected by virtue of your individual size and scale, common bond profile, member demographics, as well as your financial and operational capability.

Transitioning your business model from being the deposit taker to being the lender of choice, will depend on your capacity to provide the products, services and delivery channels that members require of you today and into the future.

A vibrant sector requires initiatives that have broader sectoral appeal to underpin sustainability. The business model agenda should not be solely focused on individual product or service initiatives but embrace necessary balance sheet transformation, cost management initiatives, process efficiencies and collective arrangements. 

There has been limited evidence of this form of integrated thinking in our engagement with the sector to date. In that regard, we would highlight recent advocacy requests for one off changes to the regulatory framework such to facilitate investment in social housing or more recently long term lending. A broader perspective is necessary.

Your conference theme of “Reflecting, Renewing and Reinvigorating” your business model, should embrace this broader sectoral change agenda.  I hope the perspectives I share today will be a useful input for you into this important strategic assessment.

I will cover three key areas today:

1. In terms of your Reflection: the pressing need for you to set a broader coherent shared vision of the future credit union business model(s), designed to meet members’ current and future needs and expectations;
2. In terms of your Renewal and Reinvigoration: the importance of transforming your business model on a basis that addresses your financial fundamentals, through enabling strategies that are within your competence and capabilities, and by collaborating with others;
3. In terms of our Support and Engagement as sector regulator, how we can support your business model transformation in line with our statutory mandate²:
   • through supervisory proportionality in our engagement approach, designed to strengthen your core foundations;
   • through regulatory responsiveness, whereby we continue to evolve the credit union regulatory framework in a responsive manner to support your prudent business model development; and
   • by using our regulatory powers, where necessary, to facilitate stronger credit unions in safe hands in undertaking business model development through earned flexibility.

Taking each one of these in turn:

Your Reflection

The pressing need for you to set a broader coherent shared vision of the future credit union business model(s), designed to meet members’ current and future needs and expectations.

Where is the sector today?

I am conscious of the point at which the Irish credit union sector is at in its evolution. Informed observers highlight that your business model has yet to transition to the future business models required to meet changing member expectations. It is reasonable to ask why is this the case?

Looking at the sector today, there is:

• An absence of a shared vision and enabling strategies to transform your business model(s);
• Advocacy focused on one-off regulatory changes rather than a broader coherent sectoral roadmap, distracting from the sector’s leadership of the business model change agenda;
• An ongoing decline in your financial fundamentals of income generation and return on assets which, in the absence of business model transformation, has the potential to threaten your sustainability; and
• Insufficient action on the commercial collaboration needed to enhance member value and improve operational effectiveness.

As Registrar, I want to see a vibrant credit union sector meeting members’ needs and expectations on a sound and sustainable basis. I therefore call for:

• Your shared vision of your future credit union business model(s), building upon the strong trust of your members in serving their current and future needs;
• The progressive approach to sector advocacy evident in credit union movements internationally, where business model transformation has been successfully acted on and delivered;
• Proactive leadership to deliver on your vision and strategy on a basis that addresses your financial fundamentals;
• A constructive culture within the sector that embraces regulatory engagement and a risk management mind-set, necessary in building stronger core foundations in terms of your governance, risk management and operational capabilities; and
• Inter-credit union commercial collaboration working in practice to deliver business model transformation.

Vision and Strategy

For a number of years now we have called for a clear vision for the credit union business model(s) of the future.  Clarity of vision and strategy would support more meaningful advocacy and engagement with us on necessary business model change.  This vision has yet to be articulated. We acknowledge individual credit unions are seeking to advance their business models and individual product proposals are being brought forward which is positive. However, the ad-hoc nature of the proposals highlights the lack of coherent enabling strategies necessary for business model transformation. Leadership from the sector is needed to provide that coherence and avoid fragmentation.

Current business model challenges are reflected in declining ROA³ across the sector driven by business factors such as depressed loan to asset ratios, low investment yields and rising costs. Changing member expectations and intensifying competition means that your traditional face-to-face branch delivery channel needs to be augmented with other channels.

Transitioning your business model to where it ought to be will take time, commitment and investment. It will involve significant transformational change not just at credit union level, but also between credit unions. The good news is that many of you are beginning to look at collaborative shared structures focussed on back office operational efficiencies and new products to enhance member experience. We welcome commercial collaboration, provided it realises benefits for participating credit unions and their members.

Overall however there is a worrying lack of urgency in setting out a clear and coherent path towards the future credit union business model(s). Key questions to address in this regard include:

• What will your credit union look like in five years time?
• What will your members’ needs and expectations be?
• What products and services will you be delivering to them?
• What delivery channels will you be using?
• What will commercial collaboration look like and with whom will you partner?
• These are questions you need to be addressing today, as only you can determine where your business model ought to be and the strategic road map to realise it.

For our part, we are committed to providing you with the regulatory support needed to enable you to transform your business model within the current legislative framework. This is in keeping with our strategic vision of ‘Strong Credit Unions in Safe Hands’:

• We see ‘strong credit unions’ as being financially strong and resilient, enabled by sustainable, member-focussed business models underpinned by effective governance, risk management and operational frameworks.
• We see that credit unions are ‘in safe hands’ when they are effectively governed, professionally managed and staffed by competent, capable people who appreciate and prudently manage risks, while successfully meeting members’ product and service expectations.

Our vision is aligned with our statutory mandate – to administer the system of regulation and supervision of credit unions with a view to the protection by each credit union of the funds of its members and the maintenance of the financial stability and well-being of credit unions generally.

Through supervisory proportionality, earned flexibility and regulatory responsiveness, we can provide ‘Strong Credit Unions in Safe Hands’ with the support they need to prudently develop their business models, and therefore build a strong and more sustainable sector.

Your Renewal and Reinvigoration

The importance of transforming your business model on a basis that addresses your financial fundamentals, through enabling strategies that are within your competence and capabilities, and by collaborating with others.

While many agree there is a compelling case for change and the process has started for some, there is also a worrying lack of urgency in defining and implementing transformational business strategies across the sector. Purposeful commitment and engagement is necessary to truly transform your business model(s), beyond individual product-led initiatives.

There is a recent trend through advocacy of requests for one off changes to the regulatory framework. Trade bodies sought for credit unions to engage in the provision of funding for social housing, which has now been accommodated. More recently, advocacy has moved to mortgage lending provision and revisions to the section 35 long term lending limits.

Is the future business model of the sector to be defined by singular regulatory framework changes? Is it to be defined by the provision of longer-term exposures funded by your members’ on demand savings - that themselves have cliff effect risks, given member demographics? 

From our perspective, we think the business model agenda should embrace broader considerations, not just covering social housing and long term lending, but addressing necessary balance sheet transformation, cost management initiatives, process efficiencies and collective arrangements.  A vibrant sector requires initiatives that have broader sectoral appeal to underpin sustainability.

Financial Fundamentals

The case for you looking more broadly across your income generating capacity is clear. The financial fundamentals of successful credit union movements internationally exhibit:

• Balanced loan portfolios generating loan interest income across a range of maturity bands;
• Diversified investment portfolios delivering broad-based returns, without undue risk to member funds;
• Non-interest income sources through broader financial service provision to members; and
• Competitive cost bases benefiting from scale efficiencies, including through collective inter-credit union structures.    

To overcome the commercial challenges you face today, will require you to consider a number of key questions concerning your financial fundamentals, including:

• Based upon your vision of the products and services that your members need into the future, what will be your revenue streams, your mix of interest and non-interest income?
• What will your balance sheet look like in five years?
• What will be the profile of your loan portfolio and your funding?
• Will you have the asset and liability management arrangements to support your long term ambitions?
• How efficient will your operating cost base be?

To address your financial fundamentals on a basis that delivers the products and services your members need into the future, will require you to answer these questions.  

Income Generation

The Central Bank published its “Household Credit Market Report – H2 2017"⁴ in 26 October 2017.  The report notes that the growth rate in 1-5 year loans became positive from early 2015 and reached 13.3 per cent in the twelve months to August 2017. This reflects increased demand for consumer credit in Ireland.

Such lending, which is your core activity, is a segment that is seeing increasing competition from banks and other market entrants. The Central Bank’s recent report: “An Overview of the Irish PCP Market”⁵ highlights the impact of personal contract plans (PCP) on the car finance market in Ireland.  In the past, this was an area of strength for credit unions.

As part of strategic planning, you therefore should be considering strategies to protect and grow market share in your core activity of unsecured consumer loans. This is fundamental to maintaining your income margins.

Despite much commentary to the contrary, it is important to recognise that the regulatory framework today does not inhibit you in extending unsecured credit to satisfy member demand.

Some credit unions are demonstrating that they can successfully meet members’ needs by delivering annualised growth in the 1-5 year loan category. For others, the situation is different, due to business rather than regulatory factors. Such business factors include member engagement, common bond demographics and competitive pressures. But to be clear, the regulatory framework today accommodates your growth potential in this core business activity.

Beyond core unsecured loans, there is also much commentary on the potential for credit unions to engage in long term lending. We support the provision of credit union lending across all maturity bands as part of a balanced loan portfolio, based upon a well-developed risk appetite within your competence and capabilities.  

Again, the current framework accommodates the provision of 5-10 year and beyond 10 year loans. Save for a very small number of exceptions, the existing lending limits present more than adequate headroom for your current growth aspirations⁶.

Notwithstanding this, the forthcoming review of lending limits presents a timely opportunity to assess the appropriateness of the regulatory framework to meet the needs of the future credit union business model(s). Therefore going beyond the request of the CUAC Implementation Group, we have decided to undertake a broader review of lending limits and related balance sheet structure, a point I will return to.

As part of our ongoing sectoral support, we provide insights on key financial trends. In December 2017, we published the second issue of The Financial Conditions of Credit Unions⁷, covering 2012 to 2017. This paper highlights some important positive developments, including stabilisation of lending levels, reductions in arrears and in provisioning. It also illustrates some of your continuing challenges, not least the pressure on your ROA.

Until recently, in the case of many credit unions, income has benefited from a reduction in bad debt write-offs, as well as loan provision write-backs. These non-recurring items are unlikely to continue to be a feature in future years. Needless to say, without an uplift in your lending activity, generating adequate surpluses will continue to be challenging for many of you.

Operational Cost Competitiveness

While much focus of attention naturally has been on lending growth, not enough attention has been paid to operational efficiencies. This is reflected in unsustainable operating cost metrics in evidence across the sector. Proactive CEOs/managers review their cost structures with a view to ensuring costs borne are necessary to underpin sustainability. In addition, investment in the future business model can be undermined if your core processes are not supporting cost effectiveness.

Back office collaboration is also an important issue for you to consider. If properly structured and efficiently run, collaborative arrangements⁸ can result in, amongst other things:

• enhanced products and services;
• competitive operational efficiencies;
• enhanced risk management; and
• access to best-in-class expertise, which may not be accessible for many on a stand-alone basis.

While we support collaboration, we recognise that the benefits of it can vary greatly from credit union to credit union. In terms of entering such arrangements, key considerations include: 

• The need for a compelling business case, reflecting member expectations and demographic profile;
• The need to analyse the costs and benefits for your credit union;
• The need to articulate clear deliverables; and
• The need for long-term commitment, supported with investment and resourcing, as well as operational standardisation.

By their nature, collaborative arrangements have a unique risk profile particularly when they involve the outsourcing by a credit union of its material, but not core, business activities. Of course, some activities cannot be outsourced. Credit decision making would be an example of an activity in that regard.

For our part, we are currently considering the risk profile of such shared service structures with a view to setting out our expectations, as well as what, if any, changes may be required in terms of an enabling regulatory framework.

For your part, the challenge is to address your financial fundamentals and strengthen your core foundations in the interests of your members and in service of your sustainability, as you seek to Renew and Reinvigorate your business model.

Our support and engagement as sector regulator

How we can support your business model transformation in line with our statutory mandate²:

1. through supervisory proportionality in our engagement approach, designed to strengthen your core foundations;
2. through regulatory responsiveness, whereby we continue to evolve the credit union regulatory framework in a responsive manner to support your prudent business model development; and
3. by using our regulatory powers, where necessary, to facilitate stronger credit unions in safe hands in undertaking business model development through earned flexibility.

Supervisory Proportionality

From a supervisory perspective, we continue to focus our inspection activity on ensuring minimum standards are met by credit unions of all sizes.

To deliver on supervisory proportionality, we have further refined our engagement approach for 2018 to differentiate on a proportionate basis between small (under €40M total assets), medium (€40M-€100M total assets) and large credit unions (over €100M total assets).

For smaller credit unions, we have adopted a desk-based approach, augmented with targeted on-site engagements with those small credit unions with higher risk profiles.

We will continue our programme of onsite engagement with large and medium credit unions. Our expectations are highest for credit unions with more complex business models, and accordingly, we apply greatest intensity and depth of our engagement with those larger and medium credit unions with elevated risk profiles.

Our risk mitigation programmes support boards in ensuring they have necessary and appropriate governance, systems and controls to protect members’ funds. We find higher performing credit unions address their risk mitigation programmes beyond mere tick-box compliance, through effective embedding of necessary underlying improvements. This gives such stronger credit unions - of all sizes - the core foundations necessary for business model transformation.

Restructuring and Resolution

We support the ongoing restructuring that continues to occur within the sector, which we manage post ReBo as regulator. During 2017, we supported to completion and confirmed 19 transfers of engagement. Restructuring continues at a pace this year, and we have to date confirmed 6 transfers of engagement within the sector.

As has always been the case, for all credit unions with viability issues, we will challenge boards regarding the strategic options available. Where viability threatens the loss of member funds, our preference is to support a transfer of engagement to a stronger credit union to ensure continuity of services for members. If a transfer is not feasible, solutions trend towards resolution, and therefore early engagement in transfer discussions is critical to protect members’ interests and most importantly, their savings.

Thematic Reviews

We supplement our supervisory engagement with a programme of thematic reviews, which is an important communication tool in addressing prudential risks. The Central Bank publishes thematic reviews across all sectors that we regulate, in order to identify good and weak practices, to facilitate remediation and to issue further guidance or direction on risk areas, as appropriate.   

Our reports are provided to all credit unions, in order to support you when reviewing the adequacy of your governance, risk management and operational frameworks, and to make any necessary improvements. In doing so, credit unions are better equipped to protect your members’ funds. 

Our recent thematic reviews have covered IT Risk, House Loans, Prize Draws and Post Transfer of Engagement (ongoing).

I want to briefly mention our recent Thematic Review on Prize Draws⁹. This report has been the subject of significant media coverage, some of which contained factual inaccuracies. This was not helpful and distracted from the important messages contained in the report regarding governance, operational risk and transparency.

I appreciate that this media coverage has upset many of you and in particular those affected by association. While third party reporting content is not within our or your control, we sought immediate correction of those inaccuracies – as you did - to avoid misunderstanding. Notwithstanding media coverage, I would encourage you to focus on the actual content of the report, in considering the adequacy of your own risk frameworks.

PRISM Supervisory Commentary

We recently published the PRISM¹⁰ Supervisory Commentary report¹¹, which sets out our 2017 inspection findings across key risk areas. This paper is intended to provide credit unions with useful insights to support the enhancement of their governance, risk management and operational frameworks, necessary for coherent and sustainable business model development.

Where we have cause for concern regarding the commitment of board and management to effect the necessary changes required under risk mitigation programmes, we will use the powers available to us - including direction and enforcement powers - to ensure that the required change is implemented, as well as pursuing individual accountability where necessary.

Guidance on Long Term Lending

We issued our “Guidance on Long Term Lending”¹² in December 2017 which sets out key considerations for credit union boards wishing to extend the maturity profile of their loan book.

We recommend that each credit union board undertake a rigorous internal challenge process, prior to committing scarce resources to any such long term investment. Mortgages in particular have unique product and risk characteristics as evidenced in our recent House Loans thematic review findings¹³. We are supportive of credit unions with strong core foundations expanding their longer term lending as part of a balanced loan portfolio. However, as our guidance illustrates, mortgage lending is complex and therefore may not be an activity for many smaller or weaker credit unions.

Review of Section 35 Lending Limits

I mentioned earlier that we are undertaking a review of the longer term lending limits in 2018. We do not view this review as simply facilitating the recalibration of a specific maturity limit, but rather a deeper examination designed towards accommodating the future lending growth ambitions of stronger credit unions, as part of a balanced loan portfolio.

Longer term lending needs to be considered in the context of broader balance sheet transformation. Consideration is required of asset and liability management and liquidity implications. Credit unions will need to consider how they can extend their funding profile, given challenges associated with a single funding source and membership demographics.

To inform our review, we issued a questionnaire to all credit unions at the beginning of April 2018. Its purpose is to gather additional data we do not currently hold on sector lending and funding profiles. The questionnaire offers an important opportunity for credit unions with the desire and capability to expand their range and level of lending, to set out their strategic expectations in that regard. I would encourage all credit unions to take this opportunity to respond, given it will help to inform the development of proposals which will be contained in the formal consultation paper that will issue subsequently.

Provisioning Guidelines

On 19 April 2018, we published Provisioning Guidelines for Credit Unions¹⁴. These guidelines are intended to assist you in developing sound loan provisioning frameworks, and by extension, assessing, measuring and mitigating credit risk.

Fitness & Probity

Following a review of the Fitness and Probity regime for credit unions, we published consultation paper CP113¹⁵ on potential changes.  From 1 July 2018, there will be three additional Pre-approval Controlled Functions required in credit unions with total assets of at least €100 million.  We will be issuing guidance and FAQs before commencement of the amending regulations.

Sector Engagement

As you know we engage proactively and transparently with the sector, and value our direct bilateral interaction with sector business leaders, an experience I have gained important insights from since taking up my role. Since becoming Registrar, I have been struck by the extensive level of engagement the Registry has with the credit union sector, by comparison with the other sectors regulated by the Central Bank.

Therefore, it would be remiss of me not to address the variety of supports provided by us already through our multi-channel engagement with you. These include:

• our onsite and offsite engagement designed to enhance the safety and soundness of your core foundations through supervisory proportionality;
• our important sector communications on cross cutting issues, including guidance and thematic reviews, which support you as boards and managers, in addressing key risk vulnerabilities;
• our regular meetings with trade bodies and other stakeholders;
• notwithstanding the absence of your strategic roadmap, our engagement with you on continually evolving an already tailored regulatory framework for credit unions, through regulatory responsiveness;
• our annual information seminars and other engagement channels; and
• through earned flexibility, our facilitation of stronger credit unions on business model development proposals by using our additional service powers where necessary.

New CEO Forum

We have recently announced that we intend going forward to further engage with credit union CEOs/managers through a new CEO Forum. This is designed to address key constraints and enablers concerning business model development. You will appreciate our role in that regard will be as regulator, recognising credit union ownership and responsibility for their own business model development. We will shortly be writing to credit unions in relation to this initiative.

New Credit Union Workshops

Through our PRISM engagement, our sector guidance and our programme of thematic reviews, we continue to support you in strengthening your core foundations. To augment this and further support sectoral development, we plan to host new Credit Union Workshops to assist you to better understand and meaningfully address key governance, risk and operational vulnerabilities.

These new workshops, underpinned by a clear articulation of our supervisory expectations, should support improved risk understanding by boards and managers, and by extension compliance standards across the sector.

Strength in core foundations is not necessarily a function of size, and therefore all credit unions also need to focus on addressing their governance, risk management and operational capabilities. It is intended that the workshops, reflective of our supervisory proportionality, will differentiate between small, medium and large credit unions.  In this way, we want to help credit unions of all sizes, to strengthen their core foundations, necessary for sustainable business model development.

Conclusion

In order to transition to being the lender of choice as well as the deposit-taker of choice for your membership, you need to provide the range of products and services to meet their future needs.

Credit unions today retain a strong brand from which to build your future business model. However, you face many challenges by virtue of individual size and scale, common bond profile and membership demographics. These issues represent critical challenges to both your business and financial fundamentals.

Some would have you believe that the regulatory framework is at the root of your current business and commercial challenges. This is not the case. This serves only to distract you from developing solutions to the challenges you face today.

There is a compelling impetus for change and for action. Leadership and purposeful energy are required to drive forward the change agenda by mobilising your collective efforts to overcome the commercial challenges you face. This is the only way you will address your financial fundamentals and deliver sustainability.

It is not for the Central Bank to define your future business model(s). What we are doing and will continue to do is to help you build strong core foundations. As regulator of the sector, we will support your efforts in undertaking business model transformation, consistent with our statutory mandate and our vision of ‘Strong Credit Unions in Safe Hands’. 

To deliver on that vision and support your quest for sector sustainability, as I have highlighted, we are introducing four important changes to our approach in 2018:

1. A refinement of our supervisory approach since the start of this year to strengthen your core foundations, through supervisory proportionality;
2. A broader review of lending designed towards accommodating the future lending growth ambitions of stronger credit unions as part of a balanced loan portfolio;
3. A new CEO Forum aimed at supporting your advancement of your business model development agenda; and
4. New Credit Union Workshops, aimed at supporting credit unions of differing sizes, in addressing key risk vulnerabilities, and by extension, strengthening core foundations.

We are introducing these initiatives as further avenues for engagement in service of your quest for sector sustainability. As regulator, clearly there are limits on how far we can support you in overcoming your commercial challenges. The success of these initiatives therefore depends on all of you.  We believe they represent important enablers as you seek to address your financial fundamentals.

We emphasise that the business model agenda should not be solely focused on individual product or services or one off changes to the regulatory framework, but requires a more broad based approach embracing the necessary balance sheet transformation, cost management initiatives, process efficiencies and collective arrangements. 

In your deliberations on your conference theme of Reflecting, Renewing and Reinvigorating, we urge you to take the opportunity to undertake a broader coherent sectoral assessment of the future credit union business model(s). This should help you to clarify your future vision and necessary enabling strategies, to deliver sustainability for all your members.

I wish you well and hope you have an engaging and constructive conference.

Thank you for your attention.