Address by Registrar of Credit Unions, Anne Marie McKiernan, at the CUDA annual conference

Good morning ladies and gentlemen.

Thank you for inviting me to address your Annual General Meeting here in Cavan.  I welcome this opportunity to set out our views and priorities as Regulator regarding the credit union sector at this time.  But first, I would like to thank your chief executive officer, Kevin Johnson, and the team at CUDA for their constructive engagement with me and my team.  I look forward to the continuation of this cooperative approach as we work together to achieve a healthy and thriving credit union sector where members funds are protected and the sector faces a vibrant future.

At this early stage in the year – and given that it is a symbolic year for reflection – I will look back over some of the major achievements in the sector in recent years; the main outstanding challenges, and how we can all play our respective roles to meet these challenges. 

Improvements and Challenges

I would like to start by highlighting the critical role that credit unions play in the financial sector and in communities across Ireland. For over a half-century, credit unions have been serving members with drive and determination.  The combined commitment of the professional and volunteer staff and Boards in that time has been an extraordinary feature of credit unions resilience and their special place in society.  I know that all of you work tirelessly to protect your credit union’s unique contribution in your community and to serve your members to the best of your ability. You can rest assured that all of our efforts, as Regulator, serve the same end, although we may differ on the priorities and approach to get there.  We at the Registry are focused on ensuring that credit unions can be as critical to society in the future as in the past, and we call on you to deal with your major structural challenges as soon as possible, knowing that a vibrant future depends on it.

Turning to the current financial position of credit unions, it is fair to say that the picture is one of improvement in some areas and continuing concerns in others. Indicators of improvement include the growth in new lending volume, which has picked up again after falling year-on-year to September 14; the continued fall in arrears, and the fall in the number of credit unions reporting below our regulatory reserve ratio – from 11 at end-2014 to 7 at end-2015.  This reflects a combination of:

• huge efforts and commitment by credit unions’ boards, management and volunteers, over a number of years, to strengthen the financial, governance and management position of many individual credit unions;
• the improving economic situation, especially rising employment and incomes, and the spreading of the upturn more broadly, both geographically and sectorally; and
• accelerated restructuring as well as resolution, which have provided the opportunity for financial and operational strengthening of many  credit unions and removed some  weaker credit unions from the sectoral landscape.  

But are green shoots of recovery becoming broad-based in the sector, and do they provide enough of a basis on which to build structural change? This is the area where we as Regulator have most concerns.  Aggregate loans have fallen from €7bn in 2008 to €4bn in 2015, and total interest income fell 40%.  The increase in aggregate new lending volume disguises a continued downward trend in numbers of new loans; deleveraging remains an important constraint on loan recovery, and arrears remain unacceptably high at 13%.  While we welcome the fall in the number of credit unions below our required regulatory reserve ratio, this reflects restructuring and resolution efforts more than financial recovery.  Credit union members are not likely to take undue comfort from knowing that the number of credit unions failing to meet minimum standards is reducing – they rightly expect us, their Regulator, to ensure that all credit unions meet the appropriate standards, and that we take appropriate regulatory action when they fail to do so. 

At the same time, the structural challenges are considerable; the biggest challenge is the need to grow income from core lending.  This in turns leads to the need to address the ageing membership base, allied to the difficulties which many credit unions face in changing their product and service offerings to attract the younger members who will be the drivers of loan growth into the future.  The need to offer new services via different channels is a particular challenge, given the technology and other investment costs which smaller credit unions, in particular, struggle to meet.

For the sector’s future sustainability, we see four main requirements: further restructuring; a greater drive for new, active borrowers; a marked increase in core lending, and business model development in a multi-step, well-managed way.

Restructuring 

On restructuring, I would particularly like to acknowledge the progress that has been made in recent years, significantly facilitated by the Restructuring Board, ReBo.  The extension of ReBo’s mandate to end-March provides a welcome additional impetus to credit unions to appraise their strategic prospects and seek a restructuring opportunity that represents the best outcome for members and community.  The sector moved from 383 to 335 active credit unions in 2015 alone, a sizeable achievement, and we understand that there is a significant pipeline of cases with ReBo.  We are now seeing more mid-sized credit unions assessing merger opportunities, and while some proposed link-ups present special challenges, it is clear that restructuring has become widely embraced by credit unions as a strategic opportunity.  

Looking beyond the conclusion of the ReBo mandate, the Registry will continue to support restructuring as an important contributing factor to putting the sector on a sounder footing and contributing to the maintenance of financial stability and well-being of credit unions generally. An important consideration in our on-going supervisory approach for 2016 and beyond is to ensure an appropriate focus on viability and strategic planning, and to engage with both potential transferor and transferee credit unions to progress mutually beneficial restructuring projects.

Has the restructuring undertaken to date delivered the cost savings and efficiencies which put the sector in the best position to deal with its structural challenges? Clearly, many mergers are still in the bedding-in period, but nonetheless we would have concerns at the limited benefits becoming visible - as of yet - regarding cost efficiencies, service development and membership growth. I would urge all those involved in restructuring to keep focused on using the process to help their credit unions to drive for financial and operational efficiencies and to use those efficiencies, and the broader capabilities of merged entities, to continue to attract younger active members and to facilitate business model development. 

Business Model Development

On business model development, I have expressed before our concern at the slow pace of progress in achieving necessary transformation of the credit union business model.  I would like to acknowledge that, more recently, we have witnessed an increased focus by the sector representatives and individual credit unions on this area, and we in the Registry are now starting to see more – and more varied – initiatives or proposals for new products, services or link-ups with other bodies.   While some of the initiatives raised clearly have a way to go to be fully rounded proposals, your exploration process around your future business model and your specific proposals provide opportunities to further clarify thinking regarding what is – and what is not – beneficial for the long term viability of the sector.   

Overall, however, the sector-wide response to the challenge of developing shared services and new service delivery could be further enhanced.    This is a very significant challenge for the credit union sector and I would call on you all, both at sector wide level and individually, to focus squarely on developing prudent and sustainable business models critical for your sector’s future.  Leadership and commitment are essential components of success.  Equally important is the need to take cognisance of the current realities of the sector – both financial and operational –  that have to be dealt with to move forward.  This means that proposals have to align with capabilities and risk understanding, and can demonstrate how they support generation of surpluses into the future. Our challenge will also be rooted in ensuring that members’ funds are appropriately protected and are consistent with the nature and scale of credit unions.

There has been some criticism that the Central Bank is holding back the development of credit unions into new business areas, or that regulation is too restrictive.  We would dispute that.  In our view there is scope for credit unions to undertake significant development within the current regulations. Where credit unions can make a credible, well-constructed and prudent business case  and we consider that current  regulations may  be  restricting, we have stated that we will use our  powers where appropriate to amend or introduce new regulations. 

A recent example is the inclusion, in our recent Regulations, of explicit reference to our ability to prescribe further classes of investments which may include investments in “projects of a public nature”.  This would include, but not be limited to, social housing projects. 

For our part, at the Registry, we are committed to engaging and challenging for success and there have been important developments in a few areas.   Towards the end of 2015, as we had flagged in our feedback statement on CP 88, we initiated a Stakeholder Dialogue process aimed at discussing our business model transformation expectations and providing credit unions with a well-grounded basis to develop sound, risk-based initiatives. The first meeting was held in November and invited stakeholders to consider their priorities for the forum to deal with over the coming year. Issues raised included sustainability and viability, longer term strategic vision, longer term lending and the publication of sectoral data and analysis by the Central Bank.   Following a further meeting in January and additional discussions, we are proposing the following examples of  areas that  could be explored in more detail: longer term lending limits; additional services framework; sectoral data publications and analysis. 

Our intention is to support business model development by providing more formal guidance regarding our requirements and thereby clarifying expectations and shortening lead-times for assessment and development of proposals.

Regulatory Framework

New Regulations  

At the end of 2015 we welcomed the commencement of the remaining sections of the Credit Union and Co-operation with Overseas Regulators Act 2012 (2012 Act), which included providing the Central Bank with powers to make regulations.  This enabled us to commence  signing new regulations aimed at ensuring that credit unions are more robust and viable and better placed to meet members needs and to deal with future challenges.

The biggest headline from the regulations was, of course, our decision to cap the amount of savings an individual member can hold in their credit union at €100,000.  This cap was put in place to ensure that members’ savings in their credit union will be fully protected in the event of a resolution, so no member would lose any of their funds. This also has the effect of helping protect the financial stability of the sector, given the wider potential negative impact of any credit union member losing any of their savings.  

It is our responsibility, as Regulator, to take measures at the sector-wide level to minimise risks or vulnerabilities, especially at times when the sector is going through major transition and facing structural challenges. We considered all of the arguments put forward, but we remain convinced that putting this cap in place is the right decision for the sector at this time and needs to be seen in the context of the business model of credit unions. In our view it strengthens members’ protection in a proportionate way, given that the figures show, at this time, that savings of over €100,000 represent a very small proportion (1%) of total savings, while many credit unions have self-imposed deposit limits well below our proposed cap. At the sector-wide level credit unions are holding unprecedented levels of deposits relative to their lending needs.   Taken together, these factors indicate that the business impact of the rule would be very limited relative to its value as a financial stability and member protection measure.

However, in a further example of our responsiveness to adapting aspects of our regulatory rules where there is a good business reason to do so, we have indicated that we will consider permitting credit unions to retain existing savings over €100,000, and, in certain cases, to take in new savings of over €100,000.  In the coming weeks, we will set out our application processes for retention and for accepting new deposits over €100,000 and will liaise with the main representative bodies on this matter.   In seeking either approval, credit unions must demonstrate to the Central Bank that the approval is consistent with the adequate protection of the savings of members and is effective and proportionate taking account of the individual circumstances of each credit union.  When the application processes are finalised, the Central Bank will provide credit unions with application forms accompanied with explanatory notes for each application process.  As you know, we  also  committed  to  review  the  savings  limit  three  years  from  the  commencement  of  the regulations.

Review of Implementation of CCU recommendations

We welcome the announcement by the Minister for Finance in December that the Credit Union Advisory Committee will review the implementation of the recommendations of the Commission of Credit Unions (CCU) during 2016.  To recap, the main recommendations in the CCU were:

• The introduction of a strengthened regulatory framework and a prudential rulebook covering key risk areas;
• Enhanced standards of governance and fitness and probity;
• Central Bank powers to make regulation and administrative sanction powers extended to CUs;
• Restructuring on a voluntary, incentivised, time-bound basis, overseen by a new Board (ReBo) with funding provided.

Clearly, these were all achieved to a significant extent, even if there are differing views over the choices made to implement them.

There have been calls for the Review to address a tiered regulatory approach (TRA).  I think it would be useful to set this call in the context of what has been discussed previously on tiering, and to acknowledge that tiering can mean different things to different people.

The CCU Report recommended TRA aimed at ensuring that the regulatory requirements for credit unions were proportionate to the nature and scale of the credit union.  In its final report, the Commission included an illustrative approach to tiering based on three tiers.  It recommended that where credit unions wanted to broaden the range of services they offered, this should be done within the tiered approach to regulation. It recommended asset size as the primary basis for the development of a tiered approach, given the additional risk that can arise from increased scale. 

The Central Bank consulted the sector about tiering when, in December 2013, we published CP76. At that time we proposed the introduction of a two-tier approach, but one which facilitated the operation of the three types of credit unions proposed in the Commission’s illustrative example.  Our proposal envisaged allowing smaller credit unions to undertake a wider range of services and activities than was proposed in the Commission three tier model.  It also allowed smaller credit unions to have the flexibility to choose to retain their existing model, rather than be required to operate a more limited model (such as that proposed for Type 1 credit unions by the Commission).  In the Consultation Paper we highlighted the need to consider the timing of the introduction of a tiered regulatory approach in light of the significant changes then underway, especially sectoral restructuring and new regulatory requirements. 

A small number of responses to CP76 agreed with our proposed approach, but a large number of respondents did not agree with the two tiers we proposed. Some saw the proposals as too restrictive, while others reflected the expectation that smaller credit unions would be subject to reduced requirements under a tiered regulatory approach.  On the timing issue, a majority of respondents felt it should not be introduced at that time given the amount of change already underway.

Taking into account this variety of feedback and acknowledging the extent of change then underway in the sector, the Central Bank decided that further communication, engagement, clarification and consultation with the sector was necessary before a decision on the introduction of  a tiered regulatory approach for credit unions should be made. 

Debate on the most appropriate regulatory approach is welcome and the Central  Bank strives to  implement regulation in the most appropriate manner.  We are always open to change.

But I would highlight that tiered regulation can mean different things to different people. For example, while the requirements set out in legislation apply to all credit unions, our expectations on how a credit union might achieve these take account of nature, scale and complexity. We supervise the implementation of the regulations in a manner that is proportionate and appropriate to the scale, complexity and issues of each individual credit union. So, in effect, tiering is achieved via proportionality in approach and differentiated application of common rules. 

Our  2015 engagement with the low impact firms was a case in point, where our focus was predominantly on the most significant areas relating to business model viability - financial resilience, governance, credit and market risk and certain operational risks. We did not expect the sophistication of risk management and governance structures that we would see for our largest credit unions.  What we do expect is that credit union management can demonstrate that key risks are appropriately managed and member funds protected. Our engagement is tailored to have focussed discussions on these key areas.  Our communications and our workshop on our supervisory approach in Athlone last year emphasised this point.  Arising from this engagement, and to support clarity for smaller credit unions regarding our supervisory expectations going forward, we intend to issue a paper this year setting out our main findings from our cycle of engagements with low impact credit unions, highlighting common weaknesses for boards and management to consider and ensure necessary mitigation.

As  we  all  consider  the  issue  of  the  most  appropriate  regulatory  approach, the biggest challenge for the sector is to set out an  intended  future  direction: a  proposed  path  to ensure future viability; which  products  and  services  it  envisages  offering  to  members;  a  vision for  shared  services; and how credit unions will grow income and  membership.  While  the  sector  is  currently  in  a restructuring  phase, it  will be  useful  for  sector  leaders,   such  as CUDA,  to help  map  out  how  you  see  your  member  credit  unions  and  the  sector developing  in  the  future.   In addition,  we would welcome further challenge on where credit unions and sector representative bodies see  the existing  regulatory framework, or its application,  restricting their  plans for development, and whether tiering – either via proportionality of approach of common rules, or via differentiated rules – would make a difference in that regard.   

Lending Growth

Across the sector, we share the common view of the need to grow loan income in credit unions as a requirement for sector viability. While developing new products and services is necessary, it is important that credit unions ensure that they are in a position to grow their income from their traditional lending business first.

In this regard, I would like to update you on where we are with our review of lending restrictions. As a result of this initiative, and the important efforts made by credit unions to meet our requirements to validate their standards of credit risk management, we have now lifted 72 restrictions, with a further 11 still under review or other follow up.  26 applications were rejected and will be subject to special follow-up engagement.   From 199 lending restrictions at the start of this process, there are now 102 in place.  Overall, this represents an important step by a large number of credit unions to improve their credit risk management to meet their regulatory requirements.  I very much welcome this improvement and the fact that 80% of applicant credit unions under the initiative were successful in having their restriction removed.

But you will not be surprised to hear me say that 102 lending restrictions still in place - following our open and proactive approach to having them reviewed – is still far too high.  I would also point out that the existence of a lending restriction in any credit union will now convey meaningful information to members, that the particular credit union has failed to demonstrate to us that it is meeting the relevant regulatory requirements that are in place to best protect members’ funds.  It is unacceptable for the credit unions which have failed to engage meaningfully with this process to continue to do so. 

Clearly, only credit unions whose credit functions are at an acceptable level will be able to consider the introduction of new lending products. For the introduction of any new product, it is important that a credit union considers carefully its own key strengths and where it may need assistance or additional capital or expertise. In this regard there may be a role for a shared services model, for example, in the areas of credit control or legal expertise. But the bottom line is, as I am sure you would anticipate, the Registry will not expect to see credit unions with an unacceptable credit function adding any other new lending to their product portfolios. This is, of course, to ensure we meet our mandate of the protection by each credit union of the funds of its members’ savings.

Investment Returns and Risk – the Financial Challenges

On the subject of growing income at credit unions, I would also like to raise with you some concerns we have about investment returns and possible risk to the funds of credit union members. Investments now represent a significant portion of assets in the credit union sector and many credit unions rely heavily on their investment portfolios to generate sufficient returns.  But as you know, traditional investment returns continue to decline and will pose a threat to viability for many credit unions.

Boards of credit unions need to ensure that any investments they make do not involve undue risk to members’ savings, particularly in the current low-interest environment, and there should be realistic expectations about the future orientation of interest rates and investment returns.

The legislative requirements and regulations on investments establish boundaries, providing for a range of prudent risk appetites and attitudes with the underlying responsibility to ensure the protection of savers’ funds.  Where credit unions are dealing with an investment adviser, they need to ensure that the advisers have adequately explained why an investment is suitable for the credit union and they understand the risk. It is important that credit unions understand they cannot outsource the judgement regarding investment risk fully to an external party such as an investment adviser and that the credit union remains responsible for both the decisions and the funds of their members.

Following the signing of the new Regulations on 1 January, we now have the power to amend investment regulations in the future, following consultation, to facilitate new investments classes that may be considered appropriate and prudent.  

Conclusion

It has been a challenging period for the credit union sector and many significant challenges remain.  I want to acknowledge the strong and persistent measures undertaken by the majority of credit unions to achieve structural changes that have moved your sector onto a sounder financial footing.  These include broad-based moves towards restructuring, adoption of new regulatory requirements, conservative financial decisions on dividends and provisioning, higher standards of regulatory engagement and higher standards of compliance, focus on lifting lending restrictions, and increased focus on new business development ideas and proposals.  While I have focused today on the structural challenges that remain, it is important to take a moment to reflect on what has been achieved, all the more notable in a volunteer-led movement that continues to serve communities and members. 

I would also like to congratulate CUDA on showing leadership for credit unions in a number of key areas, including: the launch of the Solution Centre and its support for business model development across a large number of credit unions; the enhancement of your strategic supports, including on shared services; and your training and development programme. Your focus on leadership development, including the role of strategy and governance, is very welcome, given the need for strong leadership in the sector due to the challenges you face.  I would urge all credit unions to consider how you can increase capability. While this may incur additional costs, this should be considered in terms of the value this can bring to the successful transformation of your sector.

Strategic supports, leadership and focus - as well as the continued commitment of all stakeholders in the  sector - are all needed to deal with the challenges of:  further restructuring; the drive for new younger active borrowers; a  marked increase in core lending;  and  business model development in a multi-step, risk-managed way.  This will enable a thriving sector to emerge, with a viable future, which continues to meet the needs of members and communities in a new way for a new century.  The theme of your conference – “now seize the moment” – could not be more apt at this time. 

Thank you  for your attention.