Address by Registrar of Credit Unions Sharon Donnery at the Credit Union Development Association (CUDA) AGM

Introduction

Reflecting on recent changes

Current landscape of the sector

It goes without saying that there continues to be a very challenging environment for credit unions. As at September 2013, the total assets of the sector were just below 14 billion euro. Loans to members have decreased by 11 per cent from September 2012 and currently stand at €4.5 billion euro, with the sector average loan-to-asset ratio being approximately 33 per cent and it is notable that 180 credit unions now have a loan-to-asset ratio of less than 30 per cent. It is also worth noting that the decline in average loan-to-asset ratio is evidenced more so within community credit unions and that the average loan-to-asset ratio for industrial credit unions remains slightly above 40 per cent. The continuing decline in loan books across the sector is having a direct impact on the interest income generated in credit unions. During the period from 2006 to 2012, total interest income peaked in 2009 at over 600 million euro. Based on the September 2013 year end accounts received to date for 85 per cent of credit unions, this figure has reduced to just above 360 million euro which represents a 40 per cent decrease from 2009.

Average sector arrears at end-September 2013 were slightly above 19 per cent. However, it is worth noting that 47 credit unions have arrears in excess of 30 per cent of their loan book. Since 2009, the level of provisioning across the sector has increased as a result of the non-performance of loan books. Total arrears as reported by credit unions are now fully provided for when taken for the sector as a whole. However, of course, this does not recognise differences in individual credit unions, some of which remain under provided. Consequently, we continue to focus on credit unions building reserves and provisions and maintaining a prudent dividend policy. Dealing with these weakened credit unions is an area of significant priority for the Registry and all of these credit unions are subject to a heightened supervision regime.

As operating costs continue to rise, the pressure on net margins from falling loan interest income and declining investment returns is likely to continue into 2014 and beyond. While credit unions remain popular with and trusted by members, the average dividend paid for 2013 was below 1 per cent, based on the financial accounts for 2013 which we have analysed to date. Just as credit unions are concerned about declining returns on their investment portfolios, it is likely that members of many credit unions will become increasingly concerned about the dividend rates they earn. In this context, it would appear from our data that the payment of a dividend is necessary to retain member loyalty in the long term. On a review of sector-wide data, it is notable that for those credit unions that paid a dividend in at least three of the last five years, there was a minimal reduction in the total level of members’ shares and deposits from 2009 to 2013. However, for those credit unions that only paid a dividend to members in two or less of the last five years, there was an overall reduction in the aggregate level of members’ shares and deposits around one fifth in the same period.

I alluded to interest income a moment ago but I should say that more broadly credit unions need to consider both the current level of operational costs and income generation (irrespective of source) and the resulting implications for their business model. This goes to the very heart of viability and sustainability. Credit unions should be alive to these issues as they consider their strategic and business planning.

The on-going stresses in the economy, growing arrears and the insolvency regime all create a climate of increased risk in relation to credit decisions. As I have said publicly previously, I’m surprised and concerned that credit decisions and credit control continue to be issues in large numbers of credit unions we visit. I know that the regulator is publicly criticised on many occasions for the imposition of lending restrictions on individual credit unions. However, such restrictions are imposed in the context of our on-going concerns in relation to those specific credit unions. On many of our PRISM supervisory visits, we continue to find an absence of credit policies, inadequate processes surrounding income verification and credit worthiness and significant failings in relation to credit control and following up on arrears. While I fully accept the important role of credit unions within their communities and, of course, that many members have a demand for credit, I cannot emphasise enough the need for credit unions to be prudent in how they lend money. As we all know it is the money of the saving members that is ultimately lent to borrowing members. Ensuring that those borrowers can repay must be paramount in protecting those savings.

Owing to the scale of the issues and concerns identified within individual credit unions, approximately half of all credit unions are now subject to some form of lending restrictions.These restrictions range across the whole sector regardless of individual credit union size or impact category under PRISM. Where lending restrictions are imposed they tend to take the form of a restriction on individual loan size or on commercial lending activity and in some cases, a limit on the total lending permitted each month. Less than 10 per cent of all credit unions have a restriction which limits the total amount of lending within the month while close to 40 per cent of all credit unions have a restriction on commercial lending activity. And for those with an individual loan size restriction, the level at which the limit is imposed ensures that the vast majority of those credit unions can continue to make loans significantly more than the average loan for the sector of just above €6,000. This is evidence, in my view, that we have carefully calibrated our use of this regulatory tool to mitigate risk but recognising the core business of credit unions to lend to their members.

While I have been told many times that the imposition of lending restrictions is the cause of the declining loan-to-asset ratio across the sector, the data shows that there is no material difference between the average loan-to-asset ratio of credit unions with and without restrictions. Furthermore, where individual lending restrictions are imposed, the evidence suggests that the majority of credit unions are not even lending up to the lending restriction amount with the majority of loans granted being at lower loan levels. However, the data for arrears over 9 weeks is more telling where credit unions with restrictions have an average arrears rate of over 23 per cent by contrast with those without a restriction where arrears over 9 weeks are around 13 per cent. This is a clear signal that on-going concerns about arrears in individual credit unions have been a key driver of the imposition of restrictions.

Restrictions are, in most cases, intended to be short-term in nature and kept in place until the credit union has addressed the issues giving rise to the concern and until we can evidence that the weaknesses in governance and systems and controls are properly remediated and solutions fully embedded by the credit union. We are motivated to remove restrictions once we are satisfied on these points. Central to any comfort on this issue is for us to see clarity around the credit union’s future risk appetite ideally reflected in an integrated risk-appetite statement supported by robust risk management and controls. In summary, credit unions that address our regulatory concerns and engage with us proactively in relation to mitigating identified risks will find that we are open to reviewing and, where appropriate, easing lending restrictions. However, restrictions are an important regulatory tool which we will continue to avail of where we find significant failings in individual credit unions systems and controls.

Finally, on the issue of credit, our own work on the multi-debt pilot, which I know led to a lot of debate, is also relevant. I know credit unions have made their decisions to participate or not for various reasons. The pilot has now concluded its operational phase and has provided real solutions for members and borrowers in trying to resolve their debts. For me that is the key reason why we have started the pilot; the scale of indebtedness is simply so great that ordinary people, your members, need a way to manage their debts. Our hope was that many cases will be resolved by restructuring term or interest rate ultimately leading to full capital repayment and the early results would suggest that there is potential for this in many cases. I have to acknowledge great efforts on the part of the participating credit unions to bring forward a constructive approach and to try to deliver a solution for their members. We are now in a period of review, to understand the lessons from the pilot and to address these learning points by adapting the framework and the operating model. As Registrar I would say that, in my view, it is critical that credit unions are at the table as we discuss these important issues to ensure the voice of the sector is heard and its interests protected. I hope that we can ultimately take the pilot forward and that many more credit unions will see the benefits of participation.

PRISM

As many of you know, PRISM is the Central Bank’s risk-based framework for the supervision of regulated firms. Since May 2012, much of our formal engagement with credit unions now takes place through the PRISM framework and I expect that all of you now have some experience of a PRISM assessment as we are nearing the conclusion of our first cycle of visits. Essentially PRISM is the bedrock of our approach to assessing and challenging all the firms we supervise, judging the risks they pose to the economy and to the consumer, and ensuring the mitigation of those risks where they are unacceptable. For us as regulator, PRISM delivers risk-based supervision underpinned by a credible threat of enforcement through our administrative sanctions process which now also applies to credit unions.

To date, we have generally been pleased with the open and constructive engagement with the credit unions we have visited. Overall, we have found credit unions to be appreciative of the interactions and feedback given by our supervisors, and supportive of the risk mitigation plans resulting from our assessments. However, there are a number of clear themes emerging from our engagement. You will not be surprised that it is in the areas of credit, strategic direction, risk management and governance that we have identified most areas of concern. In general, risk management competencies and capabilities in these key areas require significant improvement.

In particular we have been concerned to find that material risks were not being fully understood and consequently not being effectively managed by a significant number of credit unions. We have evidenced poor risk management standards and practices, supported by inadequate systems and controls, incomplete policy frameworks, insufficient board oversight and unclear and uncertain governance structures. Many of these governance and risk management issues were also reflected in our IT survey earlier in the year.

The culture of the credit union is very important in this regard. Where there is proactive management of these key areas, it is typically driven by a desire to better understand and mitigate the risks associated with the business in a manner which supports its growth and development. In other credit unions, we see a focus solely on meeting what is seen as a minimum legislative and regulatory requirement rather than evidencing any real understanding of how effective risk management supports the survival and growth of the credit unions business model. These latter credit unions inevitably face the greatest challenge in terms of long-term viability and business model development.

Many of the issues we have identified, while worryingly fundamental in nature, lend themselves to relatively easy remediation. Embedding these changes in policies, procedures, and risk culture takes longer and that is where the leadership of the board and management needs to be evidenced most strongly as champions of this necessary change. A credit union can only be sound if it is in safe hands and safe hands includes having the understanding, know-how and capabilities to prudently manage all the credit union’s risks.

In terms of our engagement on strategy, our experience has been varied. As previously highlighted, we are looking for robust and thoughtful analysis of the credit union’s economic, social and competitive environment and a comprehensive realistic appraisal of its business model and capabilities. Under our PRISM framework a credit union’s strategy, as documented in its strategic plan, is a key evaluation component in our dialogue with credit unions. We would expect that directors and managers have a deep appreciation of all aspects of their strategy and can convincingly demonstrate that they fully subscribe to the appropriateness of the strategic plan and have full ownership of it. Given the many challenges to the credit union business model, we have been particularly concerned that a number of boards and managers have struggled in discussions regarding how their strategy will seek to address those challenges, and its relevance for their credit union. We had anticipated having more developed discussions with credit unions in this area but this did not happen in many cases. We expect a significant improvement in this position in the context of our 2014 engagement.

PRISM ensures that we have well-structured, forward looking engagement with the credit unions we supervise, with particular focus on understanding strategic developments and current and emerging risks as well as understanding how the credit union manages those risks. But while we now have the tools to engage with credit unions on the evolution and development of a sustainable business model, only credit unions themselves can cause this to happen.

While I have focussed on our on-site engagement which we have with our Medium High and Medium Low entities, it is also important to reflect on the low impact credit unions. These are essentially smaller credit unions, for whom our model is reactive supervision paired with strong enforcement. Given this model of engagement, it is important that there is clear understanding that if these credit unions do not comply with regulatory requirements, they must assume that we will use our enforcement powers effectively to achieve our supervisory objectives.

My final word on PRISM would be to emphasise that as we start our next cycle of engagement and begin visiting credit unions for a second full-risk assessment or one-day engagement, we expect to see significant progress in rectifying and closing out the issues raised previously. It is not acceptable to either identify risk yourself within the credit union or to have issues raised with you by your internal or external auditor or indeed your regulator and to not address them. Where we find this to be the case, further regulatory actions which may include business restrictions or potentially enforcement action will follow.

Looking Ahead

As we start the New Year, it is now time to move on from the process of introducing the strengthened regulatory framework to the challenge of getting it working. A top priority for credit unions must be to ensure they take the necessary steps to implement the new requirements fully taking account of the nature, scale and complexity of the credit union. As I said earlier, the new framework has governance, prudent management and sustainable development for the future at its heart. It is not enough to simply tick the box and say that we now have the requirements or indeed that credit unions have procedures written down in a manual. A top priority for credit unions for 2014 must be embedding the new requirements and practices in the day-to-day operations of their own business.

A number of important issues are on the agenda for 2014, including the public consultation on the tiered regulatory approach and sector restructuring. I would like to speak about each of these in turn briefly.

Tiered regulatory approach

Just in time for review over your Christmas dinner, we published a consultation paper on the introduction of a tiered regulatory approach (TRA). Its introduction was one of the recommendations of the Commission on Credit Unions. In developing the TRA, we are seeking to develop an approach that supports the operation of financially sound and well governed credit unions and facilitates the prudent development of the credit union sector, within an appropriate regulatory framework. The consultation is an initial one and seeks views from credit unions and other stakeholders on the proposed approach to tiering; the high level operation of the tiers, including the activities and services proposed for credit unions in each tier; proposals on a provisioning framework for credit unions; and the appropriate timing for the introduction of a tiered regulatory approach.

One of the key questions in developing a tiered regulatory approach is what is envisaged by the prudent development of the credit union sector. That is, for yourselves as credit unions that want to develop beyond the current credit union business model, what additional services and activities do you wish to undertake?

Given the importance of addressing this question and indeed other issues in the consultation, we are proposing a two-staged approach with the first consultation seeking views on how the credit union business model should develop prudently, taking account of the objects and ethos of credit unions and the legal framework provided. Given the recent significant changes in the regulatory framework and the restructuring of the sector that is currently underway, we are also interested in obtaining views on the most appropriate timing for the introduction of a tiered regulatory approach.

Having received requests to extend the deadline for the consultation to allow credit unions more time to consider this important issue, the consultation period is now open until end March and I would strongly encourage you to review the paper and to submit any views or suggestions that you may have. While I am sure the representative bodies will make submissions to the consultation, we also welcome submissions from individual credit unions. A further consultation and regulatory impact assessment will follow later in the year.

Sector Restructuring

A further significant change brought about by the introduction of the new Act was the establishment of the statutory Restructuring Board. I hope our colleagues in ReBo will not mind me saying that the Central Bank and ReBo have established a solid and close working relationship. There is regular engagement both between myself as Registrar and the Chair and Chief Executive, as well as on-going interaction between our respective teams. As we all know, a core recommendation of the Commission on Credit Unions was that the credit union sector should be restructured and that this should be achieved on a voluntary, incentivised and time-bound basis. The Commission envisaged that restructuring would involve moving from the situation where over 400 credit unions act independently to one where there is some consolidation through mergers and the development of close networks and shared services. We encourage credit unions in a strong financial position to consider how they can best support their peers; this might be by sharing of knowledge and expertise or, ultimately, being open to the prospect of merging with a neighbouring credit union.

My own view is that some restructuring within the sector is essential if it is to be sustainable for the future and to deliver both for current and future members. As noted by the Governor in remarks he made towards the end of last year, this does mean some dilution of the very local control enjoyed by the members of some credit unions, but it would be more than compensated for by greater operational efficiency, range of services and solidity. And importantly, members remain members of the larger combined credit union with similar rights and benefits as before. So in restructuring it is certainly fair to say there will be changes in governance and control but members can expect at least the same, and in many cases can expect enhanced services delivered in a member-focused fashion.

Credit unions operate an increasingly complex range of services in an increasingly complex and fast-changing world and managing a modern credit union requires greater levels of skill and competence than in the past. It is also fair to say that there is a growing need to reduce overall operational costs and this can be achieved through consolidation while still retaining local presence. The provision of additional new products and services will certainly impose costs on credit unions and so to implement these credit unions will need a certain scale to their operations. For those credit unions who decide that they will remain as is and do not see their structure or model changing, we expect that they will have a clear strategy for the future demonstrating how they will manage the challenges of the external environment they operate in. While our credit union sector differs in some respects from its international peers, it is clear that credit unions in many other jurisdictions have benefited from consolidation. ReBo has a time-bound mandate and it is important that our credit unions seize the opportunity presented by ReBo to restructure and strengthen for the future.

The Bank and ReBo have worked closely to ensure that the process of mergers will be as straightforward as possible. At a high level, the process will involve appropriate due diligence on both credit unions. This is to ensure that the respective boards have an understanding of all factors before making any decisions. The due diligence process is complemented by an examination of the suitability of any merger and detailed integration planning. Ultimately ReBo will determine whether to recommend a proposal to the Bank. For our part, our strategy will be to support restructuring proposals, where they are sound and well thought out and supported by proper risk and control frameworks. We do not favour the merger of weak credit unions whose focus is on cost alleviation alone without a coherent vision for the future development and strength of their combined businesses. What this means in practice is that we will accommodate restructuring supported by well-thought out proposals put forward by financially strong well-run credit unions and we will take action to mitigate risk and deal with credit unions with a weak financial position including taking resolution action, if necessary.

Conclusion

I trust you will agree that the new regulatory requirements reflect prudent and sound practices that would be present in all professional and well-managed businesses, including credit unions. However, I do recognise that their introduction will require a substantial amount of change for some credit unions. I welcome the work that many have already undertaken to comply with the new requirements and indeed, I commend the work by some credit unions who could be considered leaders within the sector having already implemented governance and risk management changes even before they were a regulatory requirement. A critical focus for credit unions should be on ensuring they have clarity regarding their risk appetite and that this is aligned to the business and strategic plan.The Registry is not seeking to overburden credit unions with regulation. Rather, a pragmatic approach to implementation is being adopted and I would wish to stress that our priority is firmly set on ensuring financially sound and well-managed credit unions that protect the savings of members. In that sense, the goals of credit unions, members and those of the regulator are well aligned.

The culture of credit unions is distinct when compared with other financial services sectors. The role of the credit union in the community and with its members, the place of volunteers in supporting the smooth running of credit unions, and the alignment of members and shareholders’ interests through the member-based model is testament to that. As we go through a period of regulatory change and restructuring a positive, member-focused culture is even more important.The commitment of all involved locally within credit unions over the years is commendable and I am hopeful that this energy will continue to be harnessed to bring about the change that is necessary for future growth and development.

It is important that your AGM, and the on-going work of credit unions and all others with a key part to play, also stays focused on achieving the longer-term objectives of development, growth and restructuring which are crucial to ensure that the credit union sector remains viable and sustainable, and continues to hold its relevant and substantial place in the community, and also in the Irish financial services landscape. I look forward to continued engagement with both your credit unions individually as well as with the CUDA Management Committee and Executive.

Thank you once again for inviting me and for you attention. I trust you will have a lively and interesting debate over the weekend.