The long-term well-being of Irish Credit Unions – turning aspiration into reality - Ed Sibley, Director of Credit Institutions Supervision

Introduction

Good morning ladies and gentlemen.

I would like to thank the Irish League of Credit Unions for the invitation to speak here today. I recognise and appreciate the importance and history of the Credit Union sector, the role of Credit Unions within communities and the financial sector, including financial inclusion, and the critical role that the League plays in the sector. I am therefore grateful for the opportunity to share some of my perspectives with you all today.

I will focus my remarks on three main topics:

The Credit Union Sector today

In supervision, as in life, it is important to consider both today's circumstance and the context and history that led us to this circumstance.  The financial services sector globally and especially in Ireland has endured a torrid decade.   The Credit Union sector in Ireland is emerging from this broader financial crisis arguably less bloodied than many other sectors (notably banking) and from what I can see, definitely unbowed.  You all can and should be proud of this. 

As a result of your efforts, alongside the work of the Registry, Credit Unions retain an important role in the domestic Irish financial system and deservedly have a strongly valued, well recognised and highly trusted brand¹.  This is a significant endorsement of the Credit Union ethos of putting members’ interests first, and is evidence that the Credit Union sector has a strong foundation built over the last 60 years from which to continue to evolve and thrive.

In considering the progress that has been made, I took the opportunity of referring back to the speech given at the height of the crisis by the previous Englishman from the Central Bank to address the League's AGM, almost seven years ago to the day today². The then Deputy Governor, Matthew Elderfield, outlined the changing approach to supervision and regulation of the Credit Union sector – emphasising the risk-based and proportionality principles of our approach, the role and importance of the sector, concerns regarding non-performing loans, lending limits and the strategic future of the sector. All of these topics remain relevant today, and I will touch on them all in my remarks.  

Coordinated efforts by all involved have delivered an unprecedented level of restructuring, resulting in 113 mergers³, which have reduced the number of weaker Credit Unions and materially reduced risks across the sector as a whole. Regulatory reserves have improved and in all but a small handful of cases are above regulatory minimums.  Loan arrears are falling⁴. The regulatory environment and requirements have also evolved and necessarily strengthened (and I will return to this topic shortly), and the sector has made progress in meeting these requirements.

Notwithstanding this progress, clearly significant challenges remain.  Return on assets for the sector as a whole continues to shrink; cost to income is high; and while loan books are starting to recover, they are growing at a significantly slower rate than the level of growth in unsecured lending across Ireland⁵, suggesting that the sector is facing challenges in responding to increased competition in one of your core product offerings. 

Restructuring has resulted in something of a bifurcation of the sector⁶ through the creation of larger Credit Unions. However, we are yet to see sufficient evidence of the business cases made for these mergers being realised.  In too many cases, we cannot see evidence of the hard decisions regarding cost efficiencies, embedding good governance and risk management and leveraging the mergers for business model development being made.  Looking at this from a glass half full perspective, it is clear that there are opportunities in all these areas.

Nonetheless, in too many cases in both large and small Credit Unions, minimum regulatory requirements, relating to governance, risk management and basic control requirements, are not being met - putting members’ funds at risk.  I will not go into detail here as our concerns are well documented (for example, recently by the Deputy Registrar, Elaine Byrne, in her speech at the recent CUDA AGM⁷). But I will emphasise that if the safe development and evolution of the sector is to be achieved, it needs to be built on solid foundations of strong governance and risk management arrangements, which at the very least meet minimum regulatory standards.

Business Model Development

Turning now to the future, it is clear that there is both a recognition and desire of all stakeholders that Credit Unions need to continue to develop and evolve to continue to serve members' interests and to secure the well-being of the sector as a whole, into the long term.

In common with other service providers in today’s market, the Credit Union business model is challenged on many fronts. Financial service providers are subject to an ever increasing range of internal and external challenges that go to the heart of their own business models.

Technology, is rapidly changing the way that customers interact with financial services institutions and in the way these institutions interact with their customers. Service delivery is now a multi-channel affair, spanning branch, telephone, direct internet channels, social media platforms, mobile devices and so on.

Speed of decision making, electronic marketing and digitised distribution channels are now a core expectation. Existing and potential customers, young and old have different expectations and ways of interacting with financial institutions. Traditional customer loyalties are being weakened. New technology-based providers are emerging, aiming to take market share and cherry pick the more profitable business lines from traditional financial services providers in, for example, payment accounts, payment services, foreign exchange and consumer lending.

This is not a uniquely Irish issue.  In my role as the Irish member of the Supervisory Board of the Single Supervisory Mechanism⁸, I see these issues and threats impacting credit institutions large and small across the Eurozone.  But, I would suggest that Credit Unions have a particular vulnerability, given your size and scale, aligned to a significant decline in your core market of short term consumer lending, ageing customer base and high-cost product and service offerings.

All these factors mean that change is inevitable.  Financial institutions across the globe are having to face up to the challenges that change brings.  Some will be successful. Some less so. Some will fail altogether. As a regulator we must be ready for all these outcomes. 

The absence of a vision, and a plan with which to achieve this vision, will inevitably reduce the chances of success. Business model evolution requires coherence, a clear path towards sustainable viability, supported by realistic financial forecasting, assessment of operational capabilities, feasibility studies, cost benefit analysis and so on.

This is difficult.  It is difficult for a single institution to do.  It is hugely difficult for an entire sector. My view is that, to date, it has not happened effectively in the Credit Union sector.  Articulated thinking and engagement with the Central Bank has largely lacked this integrated consideration, and instead focussed on specific product provision in too narrow a way.

We do not see a sufficiently clear sectoral vision as to what the future Credit Union business model(s) will be, nor engagement on necessary balance sheet transformation to support achievement of that vision.  Developing and driving a strategic vision requires leadership.  Leadership at an individual entity level, and leadership at a sectoral level. The League and other representative bodies can and need to bring this leadership and vision to the fore. 

I do understand that Credit Unions are not homogeneous, that they vary greatly by size, can be rural or urban, industrial or community, have business models adapted to their specific membership, and so on.

Nonetheless, it is questionable as to whether even the largest Credit Unions are of sufficient scale to meet these challenges individually.  Some of you may disagree with this, which is fine.  Either way, collectively or individually, stronger leadership and a clearer shared vision are required to deliver the necessary business model changes to safeguard the long-term well-being of the Credit Union sector.

This vision needs to be grounded in realism, anchored by the needs of your current and potentially future membership, by what can feasibly be achieved and a broader scan of the landscape regarding opportunities and risks. Those banks whose activities you may be targeting for competition, are themselves reviewing how to deal with fierce competition from other providers, often with lower costs and greater agility.  Pursuit of a business model that is itself under threat may not be the wisest course. 

That is not to say that success is impossible. Internationally, there are highly successful models of church-spire / community-focused credit institutions, and examples within mature Credit Union markets, such as  Canada and the United States of America, where Credit Unions have been consistently developing their business models, investing in new technologies, delivery channels and product and service scope as they compete with bigger regional and national commercial banks.  I note that more Irish Credit Unions are placing an increased focus on digital marketing and delivery platforms, with a focus on social media. This is positive, but clearly a lot more needs to be done and ideally through greater sectoral coordination and collaboration.

It is clear that Credit Unions have significant strength within the Irish consumer finance market. Your common bond should maximise your knowledge of your customers, which could be translated into enhanced credit risk assessment, lower marketing costs and better servicing than your competitors.

In a Credit Union, there is no separation of interest between the customer and owner, which supports both transparency and accountability. These, together with the resilience of your brand, are significant strengths upon which to build. But Credit Unions are currently leveraging this trust and closeness to members disproportionately in terms of being a deposit taker of choice. Your challenge is clearly to better intermediate those savings into lending.

However, it is important to recognise that the size of the sub five year household credit market, which has been core to Credit Union lending (i.e., 87% of your loan book), has more than halved between 2011 and 2016⁹. This is also a market segment that is beginning to see increasing competition from existing and new market entrants in search of higher yield.

It is understandable that some Credit Unions wish to get involved in longer term lending. The Central Bank is supportive of Credit Unions extending their loan product offerings, as part of a balanced portfolio, This is currently accommodated within your existing framework where you can lend up 40% of your loan book in excess of five years with regulatory approval. It is notable that only 12 Credit Unions are currently availing of these higher limits. In order to encourage more Credit Unions to apply for these higher limits we have revised our eligibility criteria to place a greater focus on the business case and more recent loan book performance. We will be formally communicating these changes to the sector shortly.

Regarding lending limits themselves, I do understand the argument that they potentially constrain upfront investment. This will form part of the Credit Union Advisory Committee Implementation Group discussions and the review of Section 35¹⁰. But I would caution that this review will need to go beyond a mere recalibration or relaxation of limits and consider risks and mitigants, individual and collective capabilities, and a broader based analysis as to where prudent growth opportunities exist.

It is also important to consider the impact of longer term lending on interest margins, return on assets and crucially on balance sheet structure – as the nature, complexity, and yield potential of longer term lending can vary greatly.  It is notable that within longer term lending, discussion to date has primarily focused on mortgage lending. While some Credit Unions do already provide mortgages, doing so in scale presents significant challenges.  Mortgage lending attracts a range of additional domestic and European legislation to which Credit Unions are not currently exposed but need to understand and provide for, prior to entering this market, as these are mandatory standards.

Furthermore, any material changes in lending will need to consider funding and the management of liquidity risks, as the necessary counterpart to longer term lending. If the intent is to change the maturity profile of the asset side of the balance sheet, be it in lending or investments, then there is a need to similarly address the maturity profile of your liabilities, while also accommodating your membership’s ageing demographic and Credit Unions lack of access to broader market funding. Credit Union liabilities are largely on-demand members' deposits, your sole funding source.

Funding stability is necessary for longer term lending and investment activity, to ensure liquidity risks are being managed appropriately. To date, there has been a singular lack of recognition of this aspect of balance sheet transformation and the associated need to term out funding profiles in engagements on longer term lending and investments. 

In relation to investment in social housing, the Central Bank will shortly be consulting on changes to eligible investments that Credit Unions can invest in. We have flagged already that investment in social housing is among the proposed changes. As with all longer term initiatives, be it lending or investment, Credit Unions need to fully consider and address asset-liability matching and liquidity considerations. Evidence of consideration of this balance sheet transformation and risks relative to prudent limits being set for this type of investment would enhance the credibility of any submissions being made to the Consultation Paper.

As I touched on earlier, these developments need to be aligned with an overall vision for the sector. I am very keen that we are engaging on this, and other issues in a mature, constructive and strategic way. The Registry’s creation of the Business Model Development team reflects the importance the Central Bank places on the strategic development of the sector and our engagement with you on it.

The Central Bank has created structures and fora to engage with both Credit Unions and your representative bodies to progress business model development. The avenues are there, yet we see a lack of developed proposals upon which to base meaningful engagement on the strategic direction and future for the sector.  

Regulatory Engagement and Requirements

Finally, turning to the role of the Central Bank.  We are responsible for administering 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. 

Our PRISM¹¹ supervisory engagement is familiar to you all and is designed to supervise Credit Unions according to their size and risk profile. It is assertive and risk-based, such that we aim to ensure that risks are not only identified but also managed and mitigated effectively. Far from being one size fits all, it is proportionate, bespoke and differentiated based on risk and impact. It provides for proportionality by dealing with smaller Credit Unions on a less frequent, more targeted model of engagement. Those Credit Unions who want to do more can do so but are correctly subject to more stringent requirements.

Our financial stability and well-being mandate focuses on ensuring that core business model changes do not undermine either financial stability or damage the well-being of your sector. It is why we insist that business model and balance sheet transformation must be underpinned by proper risk assessment, feasible plans and effective delivery capabilities.

Our regulatory and supervisory actions are taken to ensure that the sector can survive and thrive into the future, and through meeting necessary minimum standards, is better positioned to adapt to the changing environment and meet the needs of members in a modern and progressive way.

The Registry should and does take proportionate action to address identified weaknesses where members’ funds are unduly exposed, where minimum legislative and regulatory requirements are not met. At this stage the new legislative framework has been in place since 2012 and should be well embedded at this point. But, as I have highlighted, we have concerns at the quality of implementation in certain key areas. These are minimum requirements which your members have the right to expect of their Credit Unions in protecting their funds.

I am seriously concerned by the clear dissonance between the articulation of our role and approach, and the views articulated by the sector's representative bodies.  Tension between the regulated and regulator is not unhealthy, but I am struck by the various accusations being publicly levelled at the Central Bank¹². I do not draw attention to this lightly; adversarial positions are, after all, part of the stock in trade of regulation and we are not seeking popularity or praise. 

Rather, I want to call out the difficulty in reconciling this rhetoric, particularly regarding our stymying of business model development, with the vast majority of interactions we have with individual Credit Unions, the lack of concrete grounds for such statements, or constructive suggestions for improvement, and most importantly the limited number of business model proposals received, developed or otherwise.

Moreover, I am concerned that this approach of blaming the regulator is deflecting attention and effort from the collective and individual leadership necessary to lead change in the sector, such that it can survive and thrive for the next 60 years and beyond.

I can assure you that our objectives never sway from seeking the best possible outcome for the Irish Credit Union sector, through the execution of our statutory mandate, and we will continue to challenge for improvement – be it on supervisory standards, business development applications, restructuring or other – as your members deserve. As I have mentioned, the teams within the Registry, the Registrar and I are keen to engage constructively and collaboratively on well thought through proposals. The safe delivery of the levels of restructuring achieved in recent years show what can be achieved through collaborative effort to a common purpose.

I will cover some of the specific points that have been raised recently. I have touched on lending restrictions already.  I would add that the restrictions typically were calibrated to prevent outlier lending activity until Credit Unions took the necessary corrective steps to address the identified credit weaknesses and remove the temporary restriction. The flexibility within those restrictions was such that there were few requests for their removal. It took a 2015 regulatory initiative to get proper engagement on this issue and reduce the number of Credit Unions with lending restrictions by nearly 75%. It was of concern that some Credit Unions had actually sought to have the restriction retained.

Sectoral limits, such as community lending and commercial lending have similarly been highlighted as representing a constraint, yet Credit Unions' regulatory returns demonstrate that usage levels are a fraction of the overall concentration limit (4% and 7% respectively)¹³.  If this is truly an area where there are opportunities for sustainable and prudent business growth then let us discuss specific proposals and what the barriers are to achieving it, because it is certainly not evident that the prudent concentration limits that are in place are a binding constraint.

And to return to mortgage lending. We have engaged over many months on the one high-level sectoral focused initiative that has been raised with us.  This has yet to crystallise into a proposal submitted to us, despite being first raised in 2014. Where our input was sought on this initiative, we have been demonstrably constructive throughout the process and provided formal feedback to support a more robust proposal - highlighting key risk considerations including lending limits and our preparedness to engage on these issues. We await commencement of this engagement. Nonetheless, we consistently hear that the Central Bank is holding back a sectoral solution to provision of  mortgages in scale, despite there being no credible proposal submitted to us. 

We take our responsibility regarding well-being very seriously, and for Credit Unions, we go well beyond any other regulated sector in terms of proactive support and engagement. But it is not the Central Bank's responsibility to develop implementable strategies, change and product development for the sector.

In my role, I have the opportunity to gain insights across the whole financial services industry.  For good reasons, the world has changed since 2007/ 2008.  Regulations have been enhanced.  Regulatory requirements and restrictions have increased.  For banks this includes Capital Requirements Directives, Capital Requirements Regulations, the Bank Recovery and Resolution Directive, Banking Union, technical standards written by the European Banking Authority, Payment Services Directives, Corporate Governance codes, Consumer and SME codes of conduct, and so on, running to tens of thousands of pages of requirements.  It is a similar story for insurance with Solvency II, for asset management with MiFIDII and numerous other requirements. 

I would not suggest that firms in these sectors are necessarily happy with the changes, nor are they immune from complaining about regulatory burden, but, in the main, large and small, they focus on working constructively to address the challenges they face within the regulatory envelope.

The scale and intensity may differ, but we do recognise that Credit Unions have faced a range of new requirements and standards which have been necessary to strengthen the system and protect members’ interests.  Credit Union boards and management and the sectors’ representative bodies need to focus on ensuring they now meet these standards.

Conclusion

Credit Unions are an important part of the Irish financial sector and we share a common objective of ensuring sound Credit Unions that protect members’ funds’ and can thrive into the future, serving communities, households and businesses in the best spirit of the Credit Union movement.

As I have mentioned, this is a period of significant challenge for all credit institutions given the changing competitive dynamics driven by digitisation, new business models, new entrants, disaggregation of traditional delivery systems and changing consumer expectations.

Across the financial sector, and no less so for Credit Unions, business model vulnerabilities remain significant.  The coherence of strategic thought and planning, and business risk management remain key areas of focus, as are the risks of pushing out the risk envelope inappropriately in pursuit of yield.

Credit Unions also have a range of unique structural challenges impacting their current business model which require considered and constructive engagement. I would suggest that no one Credit Union will be able to deliver on the investment and resources required, which is why we agree with those who see the need for greater back office and middle office collaboration across the sector.

I encourage you collectively and individually to focus on real and pressing business challenges, which are common across the financial services sector, rather than being distracted by the suggestion that your problems are solely created by regulatory constraints.

I referenced Matthew Elderfield’s address in 2010 and the strategic challenges he highlighted are still relevant today, some seven years later.  Given the depth of the financial crisis experienced in Ireland, it is entirely understandable that the intervening seven years have seen a focus on survival, a degree of retrenchment, and significant restructuring. 

I sincerely hope that the next seven years see sustainable growth, business model development, and substantial progress towards a strong, resilient and thriving Credit Union sector that continues to play a key role in the Irish financial services sector and in the communities it serves long into the future.

I am sure that you would agree that it would be a singular disappointment to us all, if the same issues that are as relevant today as they were seven years ago, are the ones that are being focused on in 2024. The Central Bank is committed to working constructively with you on this journey and to try and ensure this is not the case.

I wish you well with your important work ahead and hope you have an engaging and constructive conference. Thank you for your attention.

References

¹ 'In its September 2016 report, across 170 brands, consumer insights firm CXi reported that Credit Unions were rated best by consumers for customer experience

² Speech to ILCU AGM 23 April 2010.

³ Registry of Credit Union statistics

⁴ From nearly €1 billion in 2011 to €360m in September 2016 - Central Bank Publication Financial Conditions of Credit Unions 2011-2016 (February 2017) 

⁵ Central Bank Money and Banking tables /Central Bank data based on credit union prudential returns Credit union market share of Total Personal Lending Market contracted from 34.9% to 34.2% December 2015/2016

⁶ Of the 281 active credit unions, the 50 largest credit unions represent 52% of sectoral assets (Central Bank December 2016 Prudential Return data)

⁷ Remarks by Deputy Registrar of Credit Unions, Elaine Byrne, at the Credit Union Development Association AGM

⁸ The Single Supervisory Mechanism (SSM) refers to the system of banking supervision in Europe. It comprises the ECB and the national supervisory authorities of the participating countries. Its main aims are to: (1) ensure the safety and soundness of the European banking system, (2) increase financial integration and stability and (3) ensure consistent supervision

⁹ Central Bank Money and Banking tables /Central Bank data based on credit union prudential returns

¹⁰ Review of Implementation of the Commission on Credit Unions

¹¹ Probability Risk and Impact SysteM is the Central Bank’s risk-based framework for the supervision of regulated firms

¹² For example, ILCU, CUDA and CUMA presentations to Joint Oireachtas Committee on Finance, Public Expenditure and Reform, and Taoiseach on 21 March 2017.

¹³ From the aggregated December 2016 Credit Union Prudential Returns (RRR of 11%)

• Community lending: Concentration limit at a sector level: €448m, sectoral usage €17m, (4% of limit)

• Commercial lending: Concentration limit at a sector level: €885m, sectoral usage €62m, (7% of limit)