Remarks by Deputy Registrar of Credit Unions, Elaine Byrne, to the CUDA AGM

Good morning Ladies and Gentlemen; thank you for inviting the Registry of Credit Unions here today to talk at your 2017 Annual Conference. We appreciate the opportunity to share our views with you on developments in the credit union sector, as well as to highlight some of the strategic issues which we will be progressing during the year ahead.

Before doing that, I would like to thank the Chair of your Management Committee, John Matthews, the Chair of your National Council, Jacqueline McCormack and your CEO, Kevin Johnson, for CUDA’s open engagement with us in the Registry over the past year. We have had many meetings and discussions and they have represented your views to us in an open and constructive manner.

As we set out on a new year of supporting credit unions to further develop as a strong, safe sector offering competition and choice to members, I would like to set out a brief overview of the sector informed by our supervisory review and analysis, to highlight some of the outcomes from our supervisory engagement during 2016 and outline some of the key strategic priorities for 2017 and how these will impact on credit unions. In terms of the key messages I want to highlight these are in the following areas:

1. Governance and controls - the importance for boards and management to embed the governance and control framework, as provided for in legislation and regulations, in their credit unions and to ensure that the risk management, compliance and internal audit functions are used to support you in your actions;
2. Restructuring/ Viability - for those credit unions that have merged - to track progress on realising the benefits and synergies set out in business plans developed prior to transfer, with a view to ensuring that their increased scale is delivering on meeting members needs and expectations and for those credit unions that have not yet taken action to address their future viability - not to postpone unduly taking actions; and
3. Business Model Development - credit unions should examine the potential within their current business model as an important first step towards growth and in looking at new areas of business development ensure a prudent and structured approach including risk focused business plans.  

Update on the Sector

Firstly – a brief update on the sector based on our analysis of the data. At the outset, I would like to highlight the important role that credit unions continue to play, at community and society level and also their place in the Irish financial sector. As we have highlighted on many previous occasions, for over 50 years, credit unions have served their members well and shown the necessary drive and determination to deal with the challenges and opportunities that have arisen.

At a sectoral level, in 2016 the financial position has shown some initial signs of improvement – reflected in some lending growth together with a decrease in the level of reported arrears. However, pressure remains on your business model particularly from the continued low level of total loans to assets, currently 27 per cent, and the low interest rate environment. A further challenge continues to be the need for credit unions to provide the services and products which your members want – delivered in the way they want.

More specifically, following a decline in total loans advanced over a number of years, since 2014 there has been some increase - with an increase of 16 per cent in loans advanced over the period September 2015 to September 2016 (up from €1.9bn to €2.2bn over that period). However, despite this increase in loan advances, in terms of the impact on total loans outstanding, there has only been a slight increase over the same period (from just under €4bn to just over €4.1bn). Average arrears reported, while still high, have shown a decreasing trend – falling from 13.5 per cent of total loans in 2015 to 9.7 per cent in 2016. On the income side, investment income has fallen and, given that investments represent the largest asset on the balance sheet, this represents a significant vulnerability to future income.

On the costs side, while over recent years operating costs have been increasing, the level of reported loan impairments has contributed to a reduction in the level of total costs. While return on assets (before dividend) is currently c1.2 per cent, taking account of the likely pressures on trends for both income and costs, it could be expected that this return will reduce. On the funding side members’ savings have continued to grow – up from €12.5bn at end-September 2015 to €13.3bn at end-September 2016 which, while an indication of member loyalty and trust in their credit unions, brings further business challenges in terms of the ability to provide a return to members on these funds.

So in summary, while the figures for 2016 show evidence of some recovery including growth in lending, the challenge remains that, without other changes including development of products and services, credit unions are unlikely to develop sufficiently to ensure a sustainable business model into the future.

2016 Outcomes

Moving on, I would now like to highlight some key outcomes from 2016 covering two areas – (1) supervisory engagement and (2) restructuring.

Supervisory Engagement

Firstly, in terms of our onsite supervisory engagement with credit unions in 2016, we had a programme of engagements with about 155 credit unions (representing about 50 per cent of active credit unions) across a range of credit unions of differing asset sizes.

In terms of our findings and the messages that we can give at a sectoral level arising from these engagements, there are positive and negative findings.

On the positive side, there is some evidence of improvement in observed standards. Features observed in those credit unions that have sought to embed the regulatory framework include effective governance through boards having a strong strategic focus, displaying a good balance and mix of skills and experience on the board and demonstrating awareness of potential challenges facing their credit unions. Strong management teams were also evident in those credit unions with risk, compliance and internal audit functions embedded and carrying out their functions effectively in line with the regulatory requirements. There was also evidence of more robust credit underwriting and of credit unions addressing issues set out in previous risk mitigation plans.

However, on the negative side, we are concerned that we are still seeing an unacceptable number of credit unions that have failed to display strategic focus by boards, and we encountered limited financial skill sets and weak management structures - highlighting concerns around quality of governance and systems of control in those credit unions. Risk, compliance and internal audit functions were not well embedded and previous issues set out in risk mitigation plans had not been adequately addressed. In addition, weaknesses in credit underwriting practices were often apparent.

In 2016 we also carried out two thematic reviews covering the areas of "Outsourcing" " and "Fitness and Probity", ", the purpose of which was to determine the standard of compliance by credit unions with the regulatory requirements for each of these areas. The sample of credit unions selected for the inspections comprised a mix of large and small, industrial and community, and rural and urban credit unions.

The main findings in relation to "Outsourcing" " were that, while a number of material activities are outsourced by credit unions, the level of understanding and compliance surrounding outsourcing requirements has not kept pace with regulatory requirements – in particular in relation to the required level of governance and challenge over selection, analysis of contracts, quality control and ongoing oversight of performance. Clearly failure to have an appropriate framework in place exposes credit unions to increased risks in material activities that are outsourced.

From a supervisory perspective, key points to highlight are that, while credit unions may outsource services or activities, they remain legally responsible for ensuring the activities are carried out effectively, that the associated risks are adequately managed and for compliance with all requirements imposed under financial services legislation. Given the inevitable trend towards shared services in the future, outsourcing will be an increasingly important aspect for credit unions. From a Central Bank perspective, outsourcing will be the subject of increasing supervisory focus across all sectors in 2017.

In relation to "Fitness and Probity" " (which was referred to by the Registrar in her speech to National Supervisors Forum in November last) the main findings were that, while some credit unions demonstrated that they had fully engaged with the regime, at the other end of the scale there were examples of credit unions taking a minimalist compliance approach with limited demonstration of quality and completeness of due diligence undertaken on prospective role holders, lack of meaningful succession planning and failure to document processes and maintain full records of assessments. This type of approach means that the benefits associated with the Fitness and Probity framework, such as gathering complete information to inform planning and decisions for filling key positions and addressing skills gaps, were not being realised.

We will shortly be publishing reports on both of these thematic reviews which will set out the findings in more detail together with examples of good practice. These should be of benefit to all credit unions in seeking to enhance their own policies and procedures, so that they can fully embed the requirements and achieve the practical benefits for their businesses.

Restructuring

The second area I want to refer to in the context of 2016 is restructuring. A significant level of restructuring activity occurred during 2016, building on the increase in the pace of activity that had emerged during 2015. As of now there are 289 active credit unions which is a significant change from the start of 2016 when there were 339 active credit unions (and 377 active at the start of 2015). The Registry would like to acknowledge the important role played by the Credit Union Restructuring Board (ReBo) – in facilitating and overseeing this level of restructuring and the level of interaction they have had with individual credit unions to assist them in the process. We also acknowledge the significant commitment and work undertaken by individual credit unions in both the planning process as well as the subsequent undertaking of these mergers, with a view to ensuring the best outcome for their members in terms of ensuring continuation and expansion of services.

2017

Turning now to 2017 and some of the key activities we plan under each of our four strategic priority areas, namely supervision; restructuring; business model development; and policy development.

Supervision

In 2017 we will continue our programme of regular risk/impact based supervisory engagement with credit unions, with the objective of seeking to continue to raise standards towards that expected of entities managing members’ funds. Overall we plan to undertake onsite engagements in about 50 per cent of all credit unions which will be prioritised on the basis of risk as well as impact (asset size). For larger credit unions (i.e. with assets of over €100m) the expectation is that the frequency of such engagements will be every 12 – 18 months.

Our engagements will take the form of full risk assessments (FRAs), which will cover a range of risk areas, and summary risk assessments (SRAs), which are shorter and more focussed on particular risk areas. While these supervisory engagements will provide us with significant insight into the financial strength, risks and controls in credit unions and the risk mitigating actions required to address issues arising, it is important to emphasise that it is the board of directors of each credit union that has responsibility for the general, control, direction and management of their credit union and for ensuring that risks are identified, monitored and mitigated on an ongoing basis.

We also plan to undertake some more thematic reviews to examine particular areas that are key to the operation of credit unions. While narrower in focus than our FRAs and SRAs, they will provide valuable supervisory information to us and enable us to issue sector-wide feedback on risks arising and our expectations for mitigating these.

Two of the thematic reviews for 2017 will be on ‘Systems and Controls’ and ‘Mortgage Lending’.

Thematic Review – Systems and Controls

Responsible governance at board and management level is fundamental to the protection of members’ funds and supporting credit union viability.

While the strengthened governance framework has been in place since 2012, as I referred to earlier, we are still seeing issues in embedding the requirements in a surprising number of credit unions and at a sectoral level governance standards are still not at the level that we would expect. While some credit unions have fully embraced the governance framework and requirements, we are concerned that changes in governance culture are taking longer to embed in other credit unions.

At an operational level we are concerned that we are still continuing to find weaknesses across a range of basic systems and controls in a number of credit unions – and not just confined to any size or type of credit union or a particular region. These have ranged from: failure to adequately segregate duties and responsibilities; deficiencies in procedures, systems and controls; and inadequate financial accounting systems. Such failures can result in instances of financial fraud and losses as well as uncertainty over the completeness and accuracy of the books and records of the credit union and the overall financial position. Our message to you as directors and management is to ensure that you are fully informed on the nature of risks and compliance issues arising in your credit union and that the functions set out in the regulatory framework, including risk management, compliance and internal audit are used as envisaged by the legislation to support you in your actions.

Where we have found weaknesses in systems and control, the remedial action required to be taken by the credit union, can often result in significant costs – both in terms of the credit union’s own resources needed to remediate the issues and bring the systems and controls to the appropriate standard and, where applicable, the need to engage external expertise, such as forensic accountants, IT specialists or other third parties, to determine and report on the extent of the issues that have arisen. In addition to the financial costs, reputational damages may arise for individual credit unions which also has the potential to impact negatively on the sector as a whole.

For this reason, we will undertake a thematic review of this area. The work will include reviewing and assessing systems and controls – including seeking evidence of establishment of systems, maintenance, review and reporting to boards supported by effective risk management, compliance and internal audit functions – with a view to providing sectoral feedback to assist credit unions in ensuring that the standard of systems and controls in place protects the financial stability of your credit union and the funds of your members.

Thematic Review – Mortgage Lending

At a sectoral level while mortgage lending by credit unions is not significant in terms of total lending (just under 3 per cent of total lending based on figures reported to us by credit unions), about a third of credit unions are reporting that they engage in some such lending. Given the characteristics of this lending (including maturity, loan size etc.), product oversight and governance guidelines and the specialist skills required for this business, we plan to carry out a thematic review of this area which will include a review of lending policies, underwriting, and asset / liability management. I will address the area of longer term lending / mortgages later on under Business Model Development.

Finally, in terms of our overall approach to supervision, we will continue to apply a proportionate approach. Our expectations on how an individual credit union implements requirements takes account of the nature, scale and complexity of the credit union. We supervise implementation of the requirements in a manner that is proportionate and appropriate to the scale, complexity and specific issues of each credit union. It must be pointed out though that in all cases each credit union must demonstrate their compliance with the standards set out in legislation and requirements.

It is worth noting that the structure of the sector in terms of asset sizes has changed quite significantly over recent years – there are now more large credit unions and a lower number of small credit unions. 48 credit unions now have assets of greater than €100 million and account for 50 per cent of total sector assets (compared with a total of 30 credit unions with assets greater than €100 million - which accounted for one third of sector assets five years ago) and, given their impact, our supervisory expectations for these credit unions is higher. At the smaller end there are now 118 credit unions with assets under €25m compared to 231 such credit unions five years ago.

Restructuring

This leads me on to restructuring. Significant restructuring activity occurred during the period 2015 – 2016 and while the pace of activity is likely to change, it is clear that restructuring will remain an integral part of Irish credit union landscape. The Registry will continue to support restructuring as an important contributing factor to putting credit unions on a sounder footing and contributing to the maintenance of financial stability and well-being of credit unions generally.

For the Registry our focus in 2017 will be as follows:

Firstly, for post-merger credit unions – our supervisory engagement will include a focus on the embedding of governance, risk management and operational capabilities in the post-merger credit union. Also tracking of progress on realising the benefits and synergies that were set out in business plans prepared by the credit unions prior to the transfer – with a view to ensuring that their increased scale is facilitating the objective of meeting members needs and expectations.

It is important for all merged credit unions and for us to understand if the restructuring which has taken place to date has, or is likely to, deliver the cost savings and efficiencies to put those credit unions in the best position to deal with structural challenges and deliver on the strategic aspect of leveraging increased scale to provide a broader range of products and services to meet members needs and expectations.

Secondly, there will be a further pipeline of credit unions seeking transfers. In this regard we will be taking on in the region of 20 projects which had been commenced under ReBo and that are still at various stages of the transfer process. Handover procedures have been agreed between the Registry and ReBo to ensure an efficient and orderly process for the credit unions involved.

We also expect that there will be a further tranche of restructuring cases arising from those credit unions that continue to reassess their strategic future and viability challenges and may decide that, having tried other approaches, they now wish to seek a restructuring solution. We will continue to encourage those credit unions, through our supervisory engagement, not to postpone unduly dealing with viability issues as this will merely delay the necessary actions and have the impact of weakening their overall financial position including reducing the level of reserves they hold.

We will support further appropriate restructuring proposals as an important contributing factor for credit unions to put themselves on a sounder footing. A key focus on such proposals will be on ensuring strong credit unions post-merger. We will engage with credit unions on their individual proposals and details are available in our Credit Union Handbook on our website on the legal and operational steps of the transfer process.

Thirdly, in those cases where a credit union is not viable and / or there are egregious failures, as we have demonstrated in our actions on previous such cases we have taken, we are willing and prepared to take whatever action is necessary to protect members’ savings. In such cases we will work to ensure that any failure will be well-managed so that financial loss or loss of service for members is avoided as far as possible.

Business Model Development

As mentioned earlier, while restructuring is a means for some credit unions to seek to achieve the size necessary to realise the operational efficiencies needed to ensure viability, it is clear that this will not be sufficient on its own.

In 2016, in recognition of strategic importance of business model viability and sustainability, we established a new unit within the Registry with a mandate to engage on business model changes with credit unions (collectively, bilaterally or through representative bodies or other agencies) in order to drive forward well-developed proposals which are supported by risk focussed business plans and key financial analysis that includes implications for return on assets and balance sheet impact.

One new service approved during 2016 was the Member Personal Current Account Service ("MPCAS"). This represents a significant and positive development for many credit unions who wish to provide current account services and payment instruments such as debit cards to their members. Key lessons from the MPCAS credit union initiative include: the importance of open and transparent early stage engagement with the Registry; well-researched and targeted analysis by credit unions to support their business case; use of appropriate technical and legal expertise by credit unions; and effectively managed collaboration between credit unions. We have published details on our website on applying for such a service including an overview of the stages of the process, guidelines and an application form which should be a useful tool to inform those credit unions that may be considering provision of such a service.

MPCAS is an example of the robust approach required of credit unions when proposing material change to their business model, balance sheet and risk profile. We expect that all proposals should adopt a similar approach.

Unfortunately, proposals of varying quality are being presented to us. We are seeing proposals that have not been grounded on a robust, comprehensive, evidence based business case, do not address risk implications, enabling business models and business sustainability. In addition to information already published on additional services, we propose to publish high level expectations over the coming months in terms of what a robust and developed business proposal should include.

The issue of business model evolution is a complex area and requires developed engagement. Challenges arise from the rapidly changing financial environment and realistically where credit unions seek to position themselves in that financial marketplace.

Clearly in a sector of currently just under 290 active credit unions of differing sizes and capabilities, there are different visions, and potential in that regard. To enable delivery, it is necessary to align your vision to your operational capabilities. One thing that is clear however is that the market is rapidly changing with increasing digitisation of product and service delivery, shifts in borrowing patterns, member expectation regarding speed of access and decision making and appropriate and evolving product mix to serve their needs over the long term.

These are significant challenges and the pace of change is continuously increasing requiring ongoing and significant investment to keep pace. Align to that the specific challenges facing credit unions – common bond considerations, size and related scale efficiency challenges, single funding source, ageing membership and generational wealth transfer, to name but a few, and it is clear that the scale of business model challenge cannot be underestimated.

We speak of change being a multi-step process. We encourage credit unions to examine the potential there is within their current business model as an important first step towards growth. One of the challenges facing credit unions is in seeking to convert members to "active" members availing of credit union products and services, and key to success in this is to ensure use of appropriate marketing and distribution channels to reach your membership.

One of the areas that is frequently referred to by credit unions as a way to expand their business is longer term lending, specifically consumer mortgages and the desire to change regulatory limits to facilitate such activity. Business model development is about more than moving certain limits, it is about ensuring that the credit unions have a sustainable and vibrant business model, with growth potential in short and long term lending, with cash flow and payback patterns commensurate with the nature of your funding and aligned to the credit union legal objects. It places a key focus on return on assets as a driver of future business sustainability, it is about providing your members with the range of products and services they seek and doing so on a cost efficient basis. It is about member responsiveness, and becoming the lender of choice within the area of your common bond.

It is important that business model transformation is carried out in a prudent and structured fashion supported by risk focused business plans, key financial analysis addressing future surplus generation and balance sheet impact and ensuring the necessary resources and capabilities are in place to deliver on the required changes. The use of a shared service approach to bridge technical, operational, risk management and knowledge gaps is a key feature of business model evolution elsewhere. Clearly, in order to deliver necessary scope and scale economies, such shared services need to demonstrate critical mass and resilience.

While we can see longer term lending as part of a balanced portfolio of total lending, in their analyses credit unions need to consider the impact of longer term lending on interest margins, return on assets and importantly on balance sheet structure – as the issue of funding longer term lending with short term funding is a challenge for the credit union business model with associated liquidity and asset and liability management considerations. In this analysis, the issue of scale economies need to be considered and as mentioned earlier sectoral collaboration through vehicles such as shared services, properly constituted, are important in that space.

Consumer mortgage lending is an activity that has its own success factors, unique risk profile and regulatory framework. In this regard any proposals to properly engage in this business must be supported by an evidenced based business case including realistic strategies, enabling business and operational models, risk considerations, balance sheet implications and set out the operational framework demonstrating how the activity will be viable, sustainable, safely established and prudently pursued.

Our reason for calling out these differences between short term and longer term lending is not to discourage those credit unions competent to do so from engaging in longer term lending. Rather, it is to highlight the importance of understanding the financial impact on projected surpluses, on balance sheet structure, both asset and liability considerations and emphasising the compliance and risk management considerations. In terms of the limits for such lending, we are keen to ensure that they remain appropriate. As we have previously stated, if there is clarity on how credit unions wish to develop longer term lending, taking account of risk appetites, pricing, funding capacity, asset and liability implications as well as the need for technical expertise to underwrite and manage such lending, we will consider changes to the limits.

As I mentioned earlier, during 2016 we established a unit within the Registry, headed by Frank Brosnan Deputy Registrar, which is the point of contact for engaging with the Registry on well-developed business proposals, which, proposals ideally, may have a broader application within the sector. We look forward to engaging with you during 2017 on various initiatives arising.

Policy Development – Investment Regulations

The final area that I wish to mention in the context of our strategic priorities for 2017 work is in the area of investment regulations.

As a result of the continued level of surplus funds available to credit unions through members’ savings and the low loan to asset ratio, investments represent a significant portion of assets in the credit union sector and many credit unions have become heavily reliant on investment portfolios to generate sufficient returns. But as you are aware, investment returns continue to decline. Other changes, including those arising from the EU Bank Recovery and Resolution Directive ("BRRD") which impact on the risk characteristics of certain investment instruments, will also influence the investment environment for credit unions.

In line with ensuring that regulations are kept up to date and appropriate, in 2017 RCU will review the investment regulations for credit unions. Under the existing regulations credit unions are permitted to invest in a range of specified investment classes which includes government securities, deposits and bank bonds and collective investment schemes made up of these instruments. Investments in these classes of investments are subject to specified maturity and concentration limits. We will review the regulations to consider whether it is appropriate and prudent to facilitate investment by credit unions in other investments, such as for example social housing, by broadening the permitted investment classes in the regulations.

Notwithstanding any potential changes that may be made to the regulations, the legislative requirement for credit unions to ensure investments do not involve undue risk to members’ savings will remain the overriding factor which must inform all credit union investment decisions. All investments must be in line with the risk appetite of the credit union and there is a need for credit unions to fully understand the risks associated with all investments including the level of capital protection.

As was the case when the regulations were first introduced, and in line with our published consultation protocol, once we have completed our review and analysis and developed proposals, we will undertake consultation with credit unions and your representative bodies and associations. This will be in the form of a public consultation on draft investment regulations, which will provide a framework for us to seek, receive, analyse and respond to feedback on our proposals prior to finalisation and publication.

Summary & Conclusion

In summary, as I set out at the outset, my key messages to you this morning in your roles as directors/management of credit unions, are (1) the need to embed governance and controls in line with required standards, (2) for post-merger credit unions to focus on assessing and realising the operational and other efficiencies and synergies from restructuring and for credit unions that have not yet done so/or have not done so recently - to consider the actions they need to take to ensure their viability and sustainability and finally, in the area of business model development to take a planned and structured approach in order to bring forward well-developed and risk focussed business proposals.

For our part at the Registry we will continue to engage constructively with you and, in addition to the range of supervisory materials already available on our website, we will continue to update and add to these during 2017.

In conclusion, I would like to congratulate CUDA for putting credit union members as the focus of your 2017 conference. The conference title of "happy members and sustainable credit unions" is appropriate in providing a focus to ensuring that credit unions seek to develop in the interests of servicing their members needs in a safe and prudent manner.

I also want to acknowledge the initiative that CUDA has developed to enable a group of credit unions to come together through the Solution Centre, whose purpose is to act as a vehicle for building scale and scope to their individual business operations and which facilitates access to collaborative opportunities for credit unions through a variety of initiatives including product development, digital marketing and procurement and most recently the launch of the mortgage support framework including assessment and standardised administration processes and access to specialist expertise to support credit unions own internal resources.

I hope that all of you will leave this conference with important insights into practical steps you can take in reviewing your own strategic and business plans, which will help to secure the future of your businesses in order to serve your members.

Finally, I would like to thank all of you for your attention. I trust you will have interesting discussions for the rest of the conference. For our part at the Registry of Credit Unions, we look forward to continuing constructive engagement with CUDA as your representative body and also directly with you through your individual credit unions, on a broad range of regulatory and supervisory topics over the course of 2017.