Address by Registrar of Credit Unions Sharon Donnery to the National Supervisors Forum AGM

Introduction

Let me begin by thanking the National Supervisors Forum for asking me to speak at your annual general meeting. I know that you are discussing a wide range of topics today and events such as these are a really important opportunity for you to discuss current issues at what is a time of significant change for credit unions.

I would also like to add my thanks to the members of your executive, particularly your Chairperson Margaret Worrell, for their on-going positive engagement with me.

This is my first opportunity to address the National Supervisors Forum since I took up my post as Registrar earlier this year. It is certainly a busy time for credit unions and their boards and managers as they continue to deal with a number of significant challenges as well as implementing the new requirements from the 2012 Act. It is also a time of change for you as credit union supervisors as you transition into your new roles as Board Oversight Committees. This transition will, I am sure, raise some issues and challenges for you and no doubt you will be taking the time to discuss these over the weekend at your AGM. I will return to the role of Board Oversight Committees later.

Before that, I would like to reflect further on some of the challenges facing credit unions at present, governance and the various roles we all play in securing the protection of members’ savings. I will conclude with some thoughts on restructuring.

Current Environment

It goes without saying that there continues to be a very challenging environment for credit unions. As at June 2013, the total assets of the sector were just under €14 billion. Loans to members have decreased by 11 per cent from June 2012 and currently stand at €4.6 billion, with the sector average loan-to-asset ratio being approximately 34 per cent and it is notable that this ratio has decreased by close to 30 per cent since 2006. 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 is 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 2011, total interest income peaked in 2009 at over €600 million. Interest income will be a key figure for us all to watch for the end September financial year.

Average sector arrears at end-June 2013 were slightly over 20 per cent. However, it is worth noting that over 50 credit unions have arrears in excess of 30 per cent of their loan book. Loan write-offs continued to increase year-on-year from 2006 to 2011, by which time they had reached €125 million. It is important to note that the Insolvency Act had not commenced at that point and it is to be expected that loan loss experience will be amplified by the new debt settlement arrangements. 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 close to being 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.

Just a few weeks ago the new Insolvency Service of Ireland began its operations. While we cannot at this stage quantify the impact that the personal insolvency regime will have on credit unions, I think we must all have regard to the potential impact it may have. I have heard many different views about the state of preparedness of all lenders for this new and significant regime. To my mind, what is certain is that it will impact on all lenders both operationally and in terms of imposing losses. You should now be fully prepared for the receipt of proposed insolvency arrangements and boards should have policies and operational plans in place. It is clear that any unsecured creditor can expect to receive very little return in the insolvency process, be that through the debt settlement agreement (DSA), or a personal insolvency arrangement (PIA).

Maturing legacy books are reducing interest income, and investment yields are on a downward sloping trajectory at a time when the investment portfolio continues to grow. Total investments have increased by 8.6 per cent year-on-year and stood at around €9 billion as at 30 June 2013. And all of this at a time when embedded costs continue to rise. I think a key point here in relation to investments is that credit unions should not seek to replace loan income with investment income. Managing an investment portfolio can be a complex task and presents its own challenges to credit unions who need to have the appropriate level of expertise to manage the related risks. In addition, managing investment portfolios is not why credit unions were set up and is not what their members expect them to be doing. So the focus here needs to be on the loan-to-asset ratio and stemming its on-going decline to ensure that the business is viable for the future. Of course, this must be done in the context of a prudent approach to lending with strong underwriting and credit assessment.

All of these different elements lending, investments, arrears and provisioning combine to determine the overall strength of individual credit unions. When the Commission on Credit Unions published its report in 2012, it reported that 25 credit unions had total realised reserves to asset ratios of less than 7.5 per cent. While this figure has improved somewhat, it is based on figures reported by credit unions themselves. Through our work in the Registry we continue to identify cases of under-provisioning. Addressing such under-provisioning obviously impacts negatively on reserves levels. 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.

While credit unions remain popular with and trusted by members, the average dividend paid for 2012 was below 1 per cent, based on the financial accounts for 2012 which we have analysed to date. It is also interesting to note that while credit unions have over 3 million members, the actual number of loans issued is only approximately 680,000. This demonstrates that many members see the credit union as a safe place for their savings but are not using the credit union to source a loan. While some of this mismatch can be attributed to the current state of the economy and depressed demand for credit, it highlights the critical importance for credit unions of understanding their members’ needs for services and ensuring that the credit union meets those needs in a prudent way.

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. Having taken at the role of Registrar only recently and given that we are now operating following a major financial crisis, I have to say that I’m surprised that credit decisions and credit control continue to be issues in large numbers of credit unions we visit. This is a matter of concern. 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 saver members that is ultimately lent to borrowing members. Ensuring that those borrowers can repay must be paramount in protecting those savings.

Our own work on the multi-debt pilot, which I know led to a lot of debate, is also relevant when considering the whole area of credit and insolvency. I know credit unions have made their decisions to participate or not for various reasons. The pilot has now moved to operation phase and is dealing with 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 is that many cases will be resolved by restructuring term or interest rate ultimately leading to full capital repayment. 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. I hope that we can ultimately take the pilot forward and that many more credit unions will see the benefits of participation.

Governance

It is in the context of the current challenging environment I have just described that the new legislative requirements, particularly those improving governance standards and risk management need to be viewed. I am of the firm view that the new legislation and the related regulatory reforms we are introducing are an important support that can drive and enhance the ability of credit unions to address the current challenges and the rapidly-evolving market in which they operate. The requirements, including strategic planning, also support an important forward-looking perspective where strategic direction and future viability are clearly articulated and understood within the credit union.

A major focus in designing the new regulatory framework is to strengthen governance in credit unions individually and the sector overall. Governance has been highlighted as an area of concern in our onsite supervisory engagements and as you will be aware is something we, in the Registry, have been working on for a number of years now. The report of the Commission on Credit Unions also recognised that the issue of governance is at the core of strengthening the regulatory framework and the report set out detailed governance requirements for credit unions. In setting out those requirements, the Commission recognised that those who are entrusted with safeguarding members’ money must be skilled and experienced people of integrity with the necessary underpinning systems and controls to run credit unions in a verifiably prudent way.

In the Registry, we see the implementation of proper governance as being a key element to bring about a financially strong and more sustainable sector which can continue to serve future generations of members.

Management and oversight of a credit union has at its core responsibility for the money of other people. Too often, we find that despite our work to bring about an improvement in oversight, for example, relating to bad debt provisioning or poor underwriting, once we cease to have close hands on approach, credit unions revert to bad habits. In our view, good governance is central to addressing these concerns and good governance ensures that there is clarity about how authority and control are exercised within a firm or for our purposes a credit union. If we are all clear about who is responsible for decisions taken, it is much easier to ascertain who is responsible when things are going well but also when they go wrong. Directors and managers are accountable: firstly to the members but also to the law and to us as regulator. It is certainly fair to say that the responsibilities on board, managers and supervisors are significant and it is important that people who undertake these roles appreciate that.

The board of directors shapes strategic direction and performance and has responsibility for the general control, direction and management of the affairs of the credit union. There are also a wide range of more specific responsibilities set out in the new Act including strategic planning, risk management, succession planning, and so on. In fulfilling these responsibilities, credit unions must have a clear organisational structure with well-defined, transparent and consistent reporting lines to the board. When establishing governance arrangements credit unions should take into account the nature, scale, complexity and risk profile of the business they do. This should be a key determinant in the level of oversight, extent of skills and expertise, and systems and control requirements.

While boards may find it useful to obtain external advice and support in undertaking their role, it is the board that is responsible for strategic planning, risk management, internal audit and so on. We would expect credit union directors to fully own and understand all aspects of their credit union’s strategy. In developing strategy, boards need to understand and articulate the goals and objectives of the credit union and take into account the environment in which they operate, including considering economic, social and competition issues and indeed the many challenges I mentioned at the opening of my remarks. The board of directors should also have full oversight of the credit union’s risk management system and should ensure that systems and controls are put in place to manage and mitigate risk.

It is of concern that in a number of the credit unions we have visited as part of supervisory engagement, we have found a lack of strategic planning added to poor risk management frameworks and practices. Strategic plans must include a realistic appraisal of the business model, including analysis of income and expenditure and financial position as well as operational capabilities. This must also be orientated towards the future to ensure that the board is thinking about where the credit union will be in three to five years. The critical questions for boards are: where are we going; and how are we going to get there. Boards and management alike need to look on the strategic planning process and development of their risk management systems as an essential element of their business rather than a simple tick box exercise to fulfil a regulatory requirement.

So in summary, by getting the focus on the right issues, that is the general control and oversight of the credit union, boards can ensure that they take the right decisions for their credit union and at all times act in their members’ interests.

The new governance framework emphasises the importance of a separation between these non-executive roles (performed by the board of directors) and the executive or operational roles (performed by the manager, management team, staff and voluntary assistants), with the manager serving as the main link between the board and the executive.

Managers play a key role within credit unions and this has been recognised by the inclusion of managers within the governance framework in the new Act. It requires the appointment of a manager to be responsible for the day-to-day management of the credit union’s operations and for the manager to be accountable to the board for the performance of his or her functions. In addition to carrying out any responsibilities assigned to them by the board, key priorities for managers will include preparing and proposing strategies for the board of directors and indeed implementing the strategy which is agreed by the board and implementing proper systems of internal control.

Credit unions are also required to have two other officers within the governance structures, namely the risk management officer and the compliance officer. While we are not prescribing how a credit union resources these positions, it is obviously crucial that those who fill them are competent for the role and can carry out the relevant functions. It is important to understand the reasoning behind having a risk management officer and risk management system, which is to promote a culture of risk awareness within the credit union to ensure risks are identified and mitigated. In a world of ever-increasing complexity, it is essential that boards of directors are aware of, understand and deal with the risks to their credit union.

The role of the compliance officer is to ensure that the credit union complies with all statutory and regulatory requirements and indeed that there is monitoring of such compliance to ensure no conflict of interests arise. Essentially the role of the compliance officer is to foster and encourage a culture of compliance in the credit union. Significantly where compliance breaches occur, compliance officers must bring this to the attention of the board and the manager immediately and they should ensure that any matter is rectified a timely manner.

The risk management officer and compliance officer support the board and management team in ensuring the credit union has an effective risk management system and a compliance programme. However, while the board, manager, risk management and compliance officers must work together the roles and related responsibilities are distinct and should be kept so.

The governance structure in credit unions is somewhat unusual in that in addition to the board there is also a board oversight committee which has evolved from the former supervisory committee. The operational responsibilities that were assigned to you as the Supervisory Committee will now be transferred to the internal audit function. That function will be responsible for, as a minimum, evaluation of the effectiveness of the credit union’s risk management system, internal controls and governance processes. The internal audit function should make recommendations to the board on improving these processes and follow up on recommendations to ensure that effective remedial action has been taken. Some key elements in relation to internal audit include that it is independent of management and that the internal audit function adheres to professional standards and benchmarks such as those established by the Institute of Internal Audit.

The role of the board oversight committee will be to assess whether the board of directors has operated in accordance with the specific requirements set out in legislation including, for example, strategic planning and risk management. You will of course be required to meet with the board of directors at least four times per year and one of your members should attend every meeting of the board. You also have an important role in reporting to the members at the annual general meeting. A key element of fulfilling your role is to determine whether any deviation from the requirements is material. In doing this, you need to consider the circumstances of each individual case and the matter should be reported to the board as part of the regular engagement between the oversight committee and the board itself. The role of the board oversight committee is one which I welcome and which is clearly very important in the overall governance framework.

In the past, we have seen some instances where supervisory committees have raised issues with the board of directors. However, we have also seen many instances of limited oversight and no effective challenge. We have seen tendencies in some cases for conflict between boards and supervisory committees. This goes both ways with, for example, boards not providing the required information to supervisory committees or supervisory committees focusing on very small details. It is important that members of board oversight committees have a clear understanding of the new governance framework and have the courage of their convictions to raise material issues of non-compliance that are of concern to them. In doing so, they should focus on the facts and the evidence in relation to the concern and ensure the board of directors takes the matter seriously and takes the necessary steps to deal with any issues and mitigate risk. Members of board oversight committees should also think carefully about how matters are going to be escalated if they are not dealt with satisfactorily. As you embark on your new roles, I would encourage you to think about this.

It is important that each member of the board oversight committee has the relevant expertise, qualifications and background to undertake their role. It is also important to undertake relevant and comprehensive training and I would encourage you to avail of the support offered by the National Supervisors Forum and other representative and educational bodies in this regard. In considering your own roles, it is important that you understand the nature of the credit union’s business, the credit union’s financial statements, the legislative and regulatory framework, and, of course, the responsibilities that you undertake.

I know that the role that you will undertake is a challenging one and that it can be difficult to take on issues and to raise concerns with people that you know well and have to deal with on a regular basis within your own credit union. You need to ensure that you can deliver on your new mandate and that you approach your work in a clear and planned manner taking account of both the letter and spirit of the law. This is not about a box ticking or form filling exercise. We expect to see real change in relation to governance in credit unions and this will be evidenced in the way credit unions are run and operated and we expect the board oversight committee to play a key role in ensuring this. That is the responsibility that goes with your role and of course, overall, that role is all about playing your part in the protection of members’ savings.

Restructuring

As I mentioned earlier, one of the critical responsibilities the board has is strategic planning. This brings into focus the more medium-term needs of the credit union and thinking about where the credit union is going and how it is going to get there. This emphasis on strategic thinking is a critical element of the new legislative framework. Considering restructuring will be an important part of assessing those more medium-term needs for many credit unions.

Before I talk about some current issues in relation to sector restructuring. I think it is useful to take a moment to refer back to the report of the Commission on Credit Unions. In referencing the Commission report, I would also add that all stakeholders, including the credit unions themselves through your representative bodies were represented on the Commission and signed up to its report. A core recommendation of the Commission was that the credit union sector should be restructured on a voluntary, incentivised and time-bound basis. As we all know, a separate statutory body, the Restructuring Board has been established to support that restructuring. The Commission also recognised that some credit unions would continue to operate successfully on a stand-alone basis provided that they had a viable business model capable of meeting the Bank’s regulatory requirements. The Commission also recognised that restructuring could be viewed in two ways:

• as a way of addressing the current weaknesses in the sector; and
• as a business strategy for credit unions that want to achieve the scale necessary to move to a more efficient and sophisticated business model.

Overall, the report concluded that the Commission was, and I quote, “united on the guiding aims of restructuring”. These aims were the protection of credit union member savings; the stability and viability of credit unions and the sector at large; and the preservation of the credit union identity and ethos. It is interesting to note that two of these three considerations reflect the statutory responsibilities of the Central Bank to protect member savings and the financial stability and well-being of the credit union sector as a whole. In that sense, the Central Bank is entirely aligned with the views of the Commission in relation to restructuring.. These aims were the protection of credit union member savings; the stability and viability of credit unions and the sector at large; and the preservation of the credit union identity and ethos. It is interesting to note that two of these three considerations reflect the statutory responsibilities of the Central Bank to protect member savings and the financial stability and well-being of the credit union sector as a whole. In that sense, the Central Bank is entirely aligned with the views of the Commission in relation to restructuring.

I have been asked a number of times if we have some grand plan to reduce the number of credit unions or to force large numbers of mergers. At a high level, I would say that the Commission on Credit Unions has essentially set out a blueprint for the reform of the sector over the next few years and the Central Bank is committed to undertaking the work needed to deliver on our areas of responsibility. Part of that work obviously relates to restructuring and I think all of us would agree with the Commission that restructuring is necessary. The Bank will be working closely the Rebo and individual credit unions that see restructuring as part of their approach for delivering for their members.

The objective of restructuring is to provide the opportunity for stronger credit unions to develop a more sophisticated business model and to provide a mechanism to deal with financial stresses in the sector in an orderly way. In summary, to provide strong and sustainable credit unions that will deliver for members in the future.

As recognised by the Commission, and indeed a matter I have spoken about publicly previously, restructuring can be viewed in two ways. It can come about because of identified weaknesses in a particular credit union or because of a proactive strategic decision by a credit union or group of credit unions to undertake a re-organisation.

In terms of restructuring, we want to see well thought out plans that deliver synergies and benefits and of course, are in the best interest of members. As boards develop strategic plan, they should be considering the viability of the business and examining the options available to the credit union. Really, as I said earlier the key question is where you want to be in three to five years and ensuring you put plans in place to deliver on that strategy. While I understand many of you have questions about restructuring, and indeed concerns, I would urge you to see it as a positive with the potential to build a strong and relevant credit union sector for the future.

Restructuring plans also need to be 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.

We will require credit unions which we find to be below the minimum regulatory capital of 10 per cent to either recapitalise, or seek a restructuring solution under ReBo. The time allowed for recapitalisation to happen will be dependent upon the level of capital in the credit union requiring intervention. Our policy also provides, for the winding up of insolvent credit unions, where necessary. And of course if we believe there are matters of regulatory concern we may take action in the form of regulatory directions to restrict the business of a credit union or indeed administrative sanctions.

All of that sounds very formal and I can see why it may lead to apprehension on the part of many of you in the sector. However, I want to emphasise that the Bank’s actions are always taken in the best interests of members. If a credit union is in a weakened position and understands and acknowledges that it may not have a viable future, then the Central Bank is more than prepared to work with that credit union in a cooperative and constructive manner to find a solution that protects the members.

In my short period in the Registry, we have progressed a number of voluntary transfers both reactive ones which deal with weak entities and proactive ones where credit unions have taken the decision that it is in the interests of their members to amalgamate. I think it is fair to say that both the transferees and the transferors have found the process to be relatively straightforward and that we are open to working with them. Indeed in the year to date, we have concluded six voluntary transfers and a number of further transfers are in progress. This compares with four transfers in 2012 and four in 2011. In that sense, sector restructuring is already underway.

On that basis I would encourage any of you who are considering restructuring within your own credit union or those of you who have concerns about your future viability to face up to those challenges now and to engage at an early stage with us and Rebo. I can assure you that, for our part, you will find us to be receptive and constructive in our approach.

Conclusion

So in conclusion, we are in a time of great change and challenge for credit unions, as well as for your members. Credit unions must be alive to those challenges and ensure that they are proactively considering how to address them.

Board oversight committees will have an important role in the new regulatory landscape and in delivering on the governance and other regulatory changes underway. These changes are essential to delivering credit unions which are strong and sustainable and which deliver on their members’ needs and protect their savings. Restructuring will be an important element of strengthening credit unions for the future. Considering the longer-term future of your own credit union should be a priority for boards and managers. Whether that future is to continue as is or to engage in restructuring, it is incumbent on boards to have the debate about their own credit union and its strategy for the future and to consider the issues rather than simply remain passive.

The National Supervisors Forum which aims to assist supervisors in the execution of their duties will be an important support as you take on your new role as board oversight committees. I would encourage you to avail of the training and supports offered by the National Supervisors Forum and other representative bodies and also to use the materials we have produced in the Central Bank such as the Credit Union Handbook to assist you in your roles.

I look forward to engaging with over the coming years as we all strive to deliver strong and sustainable credit unions that meet members’ needs and most importantly protect their savings.

Thanks once again to the National Supervisors Forum for inviting me today and for your attention and I hope you have a thought provoking and productive AGM and an enjoyable weekend.