Address by Sharon Donnery, Registrar of Credit Unions, to the CUMA Seminar

‘The New Debt, Investment and Payments Environment’

Introduction

Let me begin by thanking the Credit Unions Managers Association for asking me to speak at this seminar. I would also like to add my thanks to the members of your executive, particularly your Chairman John Hickey, for their positive and constructive engagement with me since I took up my post. This constructive approach has been demonstrated very clearly in the recent discussions on the Framework on Multiple Debts where your colleagues have clearly advocated the position of managers in supporting credit union members.

As you known, I took up the position of Registrar a few months ago. In that time and particularly in recent weeks I have met many people involved in credit unions. It is clear that boards, managers, volunteers and staff are passionate about the sector and that many of them are prepared for the challenges ahead and the opportunities they present. During my remarks today, I would like to talk about some of those challenges and how we can face them in a way that secures the Registry’s vision for the sector of Strong Credit Unions in Safe Hands.

Before commencing my remarks, I just want to pause for a moment to congratulate Donal Coughlan, a former credit union manager, on his appointment as Chief Executive of the Restructuring Board. ReBo will play a central role in the development of the credit union sector over the coming years and both myself and my colleagues look forward to working with Donal over the course of ReBo’s life span.

Returning to the theme of your seminar today, the new debt, investment and payments environment is an extremely topical agenda and describes succinctly many of the challenging areas facing credit unions. I will address some of these challenges in my remarks. Before I do that I wanted to mention some key issues stemming from the recent legislative changes including the role of the credit union manager; fitness and probity; and the Credit Union Handbook.

Changing regulatory environment

There are a number of key principles behind the Credit Union and Co-operation with Overseas Regulators Act 2012, or what I might just call for simplicity the new Act, that support the development of a strengthened regulatory framework.

Firstly, the new Act provides for the development of an holistic regulatory framework for the credit union sector that incorporates prudential and governance requirements, addresses gaps in the existing regulatory framework and sets out clearly the requirements for credit unions, their boards and management. The new Act also contains provisions to support the development of a tiered regulatory approach whereby regulation can be applied to categories of credit unions (based on the nature, scale and complexity of the business undertaken) instead of what might be considered a ‘one size fits all’ approach for all credit unions regardless of size as currently exists. Finally, the Central Bank has been given regulation making powers in a number of areas and this moves us towards providing a more flexible and adaptable regulatory model whereby requirements can be changed over time, if appropriate, without needing changes to primary legislation. In this regard, as you will be aware, we issued a Consultation Protocol in November last which sets out our commitments regarding formal consultation with credit unions, their representative bodies and other relevant stakeholders prior to the introduction of new regulations.

Role of the Credit Union Manager

Managers play a key role within credit unions and this has been recognised by the inclusion of managers within the governance framework provided for 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, compliance and performance.

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

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;
• Implementing strategies agreed by the board;
• Updating the board on the financial position of the credit union;
• Ensuring financial reports required by the auditor are prepared;
• Managing and mitigating risks; and
• Implementing proper systems of internal control.

Many of you may be undertaking these responsibilities already or have commenced preparing for them. Delivering on these tasks will be a central pillar in making decisions about the future development of your own credit union and delivering on that plan.

Fitness & Probity

A major focus in designing the new regulatory framework is to strengthen governance in credit unions individually and the sector overall. Governance has been an area of concern in our onsite engagements and as you will be aware is something we, in the Registry, have been working on for a number of years now. We see 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.

The application of fitness and probity was a recommendation of the Commission on Credit Unions and is one of the first steps in the introduction of a strengthened regulatory framework. It will support and underpin other upcoming initiatives such as the governance framework which is set out in the new Act. The Fitness and Probity regime that is being developed and tailored for credit unions is aimed at individuals that hold board, management and supervisory responsibilities in order to focus on improving overall governance standards within the sector.

The proposed framework for the implementation of the fitness and probity regime has been the subject of a full public consultation. A number of submissions were received from credit unions and other stakeholders and the Registry has considered these in finalising the details of the regime. Most of the respondents were broadly in agreement with proposals in the consultation and the main areas of comment related to the guidance to be provided and the application of the existing Fitness and Probity regime to credit unions that also hold an authorisation as a retail intermediary. Based on the feedback, some amendments were made to the Regulations and Standards and the guidance we have developed has taken account of the feedback also. The proposed implementation date will be moved from 1 July to 1 August 2013 to facilitate more efficient communication with credit unions and to provide you with some additional time to prepare.

While the fitness and probity regime will commence on 1 August it will be introduced on a phased basis with transitional arrangements. These arrangements will allow more time for smaller credit unions, essentially those with assets of less than 10 million euro, to comply with the regime. This approach will ensure that the impact of the introduction of the new regime is proportionate and will allow you time to ensure you have the necessary arrangements in place to comply with the requirements.

Information on the fitness and probity regime including the regulations, standards, the individual questionnaire and guidance will be circulated to you within the next week and seminars are planned to take place around the country in July. We have written to all credit unions regarding dates and locations and I expect that many of you will want to attend those seminars and my colleagues look forward to meeting you at them.

Credit Union Handbook

The new Act introduces a strengthened governance framework for the credit union sector and new prudential requirements in key areas including risk management, strategic planning and internal audit. In order to assist you in the implementation of these requirements our intention is to issue a Credit Union Handbook [which you might previously have heard referred to as the Prudential Rulebook].

The Handbook will bring together the new requirements along with existing requirements, supplemented, where appropriate, by additional guidance, for example in the areas of risk management and internal audit.

The Handbook is being developed and implemented on a phased basis also. The first phase will support the introduction of the fitness and probity regime and the prudential and governance requirements contained in the new Act. This phased approach will provide flexibility to add additional sections to the Handbook as regulations are made in specific areas, for example, on the introduction of the tiered regulatory approach.

We are currently conducting an informal consultation on key elements of the draft Handbook with the representative bodies and following this we will publish the draft Handbook. We will provide information on the draft Handbook at our information seminars and feedback received from credit unions will inform the final Handbook and assist us in developing relevant Frequently Asked Questions on the implementation of the new requirements.

Although the requirements in the new Act have not yet been commenced, credit unions should start planning and preparing for their introduction. Indeed, I am aware that many credit unions are already well advanced in preparing for the introduction of these requirements.

Coping with Change

Many of the new requirements being introduced in the regulatory framework reflect prudent and sound practices that would be expected in any well managed organisation. However, we recognise that the introduction of the framework may involve a substantial amount of change for some credit unions and welcome the work that many have been undertaking to comply with the requirements in advance of their introduction.

We will adopt a pragmatic approach to implementation. Our priority is to ensure financially sound and well managed credit unions and we will focus our regulatory resources on key prudential areas that support a strong credit union sector including governance, risk management, strategic planning, reserves, liquidity, lending and investments. While it is not our intention to establish resource requirements for you, or to tell you how to run your own credit union, each credit union will need to ensure they have adequate and appropriate systems and resources in place to meet their regulatory requirements and ensure that they have effective governance arrangements, risk management systems and internal audit functions.

While boards may find it useful to obtain external advice and support in undertaking their role, they should be mindful of their accountabilities and responsibilities and ensure they remain proactively involved in areas such as strategic planning, risk management and internal audit. For example, we would expect credit union directors to have a deep appreciation of all aspects of their credit union’s strategy and to be able to convincingly demonstrate that they fully subscribe to the appropriateness of the strategic plan and have full ownership of it. The board of directors should also ensure that any plans, policies or procedures they approved are appropriate and tailored to reflect the individual credit union’s circumstances. In this way, boards can ensure that they have a viable, well-managed credit union which can take the opportunity presented by the current challenges and upcoming change and in doing so ensure their credit union has a strong and sustainable future.

A key element supporting the introduction of the strengthened regulatory framework is the application of administrative sanctions to credit unions, and persons concerned in the management of credit unions. A regulatory framework must be underpinned by a credible threat of enforcement of the rules. A robust enforcement threat, assists in the creation and maintenance of high standards across all sectors.

Where there are breaches of regulatory obligations, the taking of enforcement action is discretionary, and the Central Bank will consider all relevant facts before commencing enforcement action. But where enforcement action is required, the Central Bank’s actions will be firm and robust. Y ou can be assured, however, that we will be proportionate in our approach, understanding the efforts that credit unions are making.

We appreciate that credit unions will be doing a lot of work to ready themselves for the new legislation, and the new regulatory framework. If a credit union is well run and diligent in respect of its regulatory compliance, and can demonstrate that it has taken clear steps to comply with its obligations, then this will be taken into consideration by the Central Bank in deciding whether to take enforcement action. We will be communicating further with credit unions on the sanctions process at the information seminars.

The Current Financial Challenges

Turning now to some of the challenges facing the sector and the matters under discussion at your seminar today.

Indebtedness

The financial position of the sector as reported at the end of 2012 highlights the key difficulties facing credit unions at the moment. The core lending business continues to decline with gross loans now only making up just over one third of total assets. Of these loans, on average over one fifth are in arrears in excess of nine weeks. These challenges for credit unions are in the broader context of arrears on other forms of credit also. For example, mortgage arrears of over 90 days now stand at over 11 per cent. So, the levels of indebtedness facing members of credit unions are, of course, more significant when considered in the context of their broader portfolio of loans. I am going to speak next about the recent Framework for the Co-ordination of the Resolution of Multiple Debts published by the Central Bank in early May.

As you know, the Bank is facilitating work on the problematic issue of burden sharing between lenders to deal with multi-borrowed personal customers (where there is secured and unsecured debt). It is clear that any unsecured creditor can expect to receive very little in the insolvency process, be that debt settlement agreement (DSA) or personal insolvency arrangement (PIA). It is also clear from our analysis of anonymous Standard Financial Statements data supplied by the banks, that many cases can be resolved by mutual effort before that difficult end-stage is reached. Indeed, there are many cases which will not be eligible for an insolvency arrangement as the borrower is in difficulty but not insolvent. Whilst requiring compromise and pragmatism from all creditors, an agreed framework would reduce costs and time for the lenders and provide peace of mind, sustainability and certainty to the borrower. An agreed creditor framework would facilitate burden-sharing arrangements that work sensibly for both secured and unsecured creditors as well as for the individual borrower without the need to proceed to a full PIA or bankruptcy. All lenders demonstrated a commitment to the discussions and there was a constructive engagement in working through the issues with us. In that context, it was disappointing that the Irish League of Credit Unions ultimately chose to leave the process at the final meeting to discuss the Framework.

Whether you agree with the Framework or not, the reality facing your credit union and many of your members is one coloured by on-going indebtedness.

The Framework represents the outcome of a negotiation or facilitation led by the Central Bank among banks, credit card providers and credit unions. It is aimed at dealing with two distinct cohorts of borrowers: those who are indebted but will not be eligible for the new insolvency arrangements and potentially those who are eligible for insolvency but may wish to choose an alternative which does not have some of the consequences of insolvency such as having their name published on the register. Importantly for your members there is no weakening of their rights, either under the Central Bank’s codes of conduct which apply to the banks or their right to ultimately choose insolvency if they wish to do so and are eligible. Recognising that the proposed Framework raises many questions about how it would operate in practice, the Central Bank is now overseeing a pilot or test of the Framework on 750 borrower cases. This is a prudent course of action which allows us to test the assumptions underlying the Framework to determine if it is effective or needs modification. It also represents an opportunity for a group of credit unions to come together and share experiences and learn from testing a new approach before it is potentially rolled out, if that is what is ultimately agreed for the Framework. I must say that as the new Registrar I find this approach, of a small group of credit unions working together to prudently explore a new way of doing things, very useful and I could see a model in the future where the Central Bank can work with small groups in this way. For the Framework pilot, we are pleased with the response to our call for participation in the pilot and we have a good mix of community and industrial, large and smaller, rural and urban credit unions on which to test cases. All the main banks and one of the State’s largest credit card providers have also signed up to participate. We will now engage with the participating lenders over the coming weeks to operate the pilot. We will also post some questions and answers on our website to clarify some the issues raised most frequently with us at our recent briefings.

In the discussions about the Framework, credit unions representatives raised a range of issues which in their view would impact on the ability of credit unions to operate the Framework or impact more broadly on credit unions ability to reschedule. These include issues which apply to all credit unions such as provisioning requirements under Section 35 and those impacting on individual credit unions such as lending limits. While I do not propose to address these in detail today, I wanted to mention them as they have been raised with us and our engagement with the representative bodies and associations involved in the pilot will continue in relation to these issues.

Of course, the Framework will not solve all cases, some will simply be too indebted and those cases will end in insolvency. One thing which is certain about the new insolvency regime is that it will impact on all lenders both operationally and in terms of imposing losses. I would urge you to ensure that your own credit union is prepared for those processes. This means having policies and procedures in place for dealing with proposals put to you by approved intermediaries as well as understanding your loan book to ensure you are provisioning adequately for potential losses. I would encourage you to examine the sample cases published on the Insolvency Service of Ireland website which outline some potential methods for dealing with cases. Also, remember that a member may be paying you but in debt to other creditors. As long as that member does not have an overall sustainable solution for their case there is a risk that you will ultimately not get paid. And so that brings me to my final remarks about the Framework, I have heard many different views about it in the last few weeks and I ask you to consider how your members can solve their indebtedness problems without some form of co-ordination among their creditors, essentially, what is the alternative? And for the wider credit union sector, what is best way to ensure that you can influence the outcomes?

Investments

Due at least in part, to the lack of credit being provided, credit unions continue to rely heavily on their investment portfolios to generate sufficient returns. Many of the investments currently maturing will be re-invested at much lower rates due to the current interest rate environment putting further pressure on the ability of credit unions to generate sufficient income. This pressure is intensified for some individual credit unions which are also facing issues regarding impairments that may be required to the carrying value of their fixed assets.

In the area of investments, I believe the key issues to focus on are the trade-off between risk and return and understanding the investments you are making. Essentially you need to ensure you have a clear understanding of the costs, risks and benefits of any investments. We have seen many cases over the years, where investors believed they were investing in something which had a level of security which did not come to pass. If you are dealing with an investment adviser, you need to ensure that they have adequately explained why an investment is suitable for your credit union and that you understand the risk. Boards should have clearly articulated risk tolerance statements which should be kept under review. It is important that the desire to generate income for the credit union does not over shadow the need to be prudent and to understand the inherent risks that generally go hand in hand with the promise of higher returns.

One particular issue of relevance in the area of investments is the potential impact on credit unions of the new capital requirements regime for banks. This is a topic you will hear more about from other speakers later today so I will only mention it briefly. From a Central Bank point of view, I can only comment on the treatment of deposits for regulatory reporting purposes which is, of course, different to the commercial treatment of deposits by banks. It is important to note that the issue of the return credit unions get from their deposits is not explicitly addressed in the new capital requirements.

Instead the regime introduces a new liquidity requirement for banks called the Liquidity Coverage Ratio (LCR). This sets out certain requirements regarding the quality and liquidity of assets. For the purposes of the ratio, credit union deposits are not classified as a separate stand-alone deposit type. Rather, it is our understanding that credit union deposits and interbank deposits will both be classified as ‘other liabilities’ and will receive the same treatment. So credit union deposits will essentially get the same treatment as interbank deposits. I am aware that this is a matter of concern for credit unions and that the representative bodies including those internationally are examining the potential impact.

While overall sector reserves remain relatively strong some individual credit unions are certainly in a weakened position. While the 10 per cent regulatory reserve requirement which we have set is a minimum requirement, credit unions are expected to operate with a level of reserves above the regulatory minimum. It is for the board of directors to decide on the amount of reserves to hold in excess of the minimum requirement taking account of the scale and complexity of the credit unions business, its risk profile and prevailing market conditions. Needless to say a lack of adequate reserves may threaten the financial soundness, stability and the future of a credit union while strong reserves enable a credit union to deal with future uncertainties and to act flexibly in adverse economic conditions. Poor investment decisions either in the past or the future and the impact of personal insolvency in dealing with members’ indebtedness could both have a potentially significant impact on credit unions future earnings and capital positions.

Payments

One the main issues raised with me since I took up my new position has been the issue of the payments landscape and in particular debit cards. It is a highly topical area right now following the recent publication by the Central Bank of the National Payments Strategy. At a high level the plan aims to provide more payment options for consumers and business, essentially so that modern forms of payments are widely accepted but acknowledging that cash remains an important method for transactions. At the launch of the plan, my colleague Deputy Governor Gerlach noted that “Ireland can and should be a leader in the payments area – Ireland has the youngest population in Europe and has shown itself to be a very fast adopter of new technology.” And new technology is one of the key issues in the payments debate.

While I can completely understand the desire of credit unions to offer debit card and other payment services to their members, I would note a few words of caution. The expansion of technology and increasing use of the internet and mobile devices mean that the future business of financial services is changing rapidly and fundamentally. People are moving on from carrying out their basic transactions over the counter, through the use of “plastic” and on to the rising use of mobile devices and indeed contactless payment technologies.

In banking, branches are changing too with more and more customers accessing services remotely and never visiting the branch and tellers and counter staff being replaced with help-yourself technologies. Already millions of transactions are being carried out remotely through online banking systems and over the internet. People are becoming more mobile, less loyal and more prepared to shop around for the best deal and demanding convenience, service and choice at a fair price. This is coupled with other changes in the market with new entrants from other industries, expert at retailing and marketing, offering new payment and other financial services outside of the systems traditionally provided by banks and other providers.

Competing in this market requires operational capability and expertise as well as deep pockets to provide the investment necessary to continuously keep up to date with changing customer behaviours, market developments and rapid technological advances such as smart phones, the internet - and other forms of technology that have yet to be developed.

Part of dealing with these challenges also relates to responding to peoples’ needs and expectations of your service. What do your members expect and need in terms of a payment service from your credit union? And given the rapid pace of change in the payments arena, what are the future needs and expectations of those members and indeed of the members of the future? To answer these questions credit unions must think carefully about their strategy and business plan for offering modern, responsive, accessible and affordable services. For example, specifically in relation to offering debit cards consideration needs to be given to the cost to members of such services to ensure they cover the operational and investment costs.

Another quite specific but crucial issue in the payments arena is the introduction of SEPA or the Single European Payments Area (SEPA) in 2014. This will standardise euro payments in over thirty countries. There are a number of important steps that providers of payment services must take to ensure they are SEPA compliant and fully ready for the introduction of this new method of handling payments. I would ask you to ensure that you are adequately prepared in this regard. I note that you have a presentation from IPSO on this topic later this morning.

While not directly related to the area of payments but certainly of relevance to the technology agenda, you will recall that earlier this year the Registry conducted a survey on IT issues in credit unions. We are very pleased with the

participation rates in the survey with almost every credit union we supervise responding. We will be writing to credit unions later in June on the findings and I hope you find it useful in dealing with some of these operational issues in your own credit union.

Conclusion

I don’t wish to rehearse an exhaustive list of the many real challenges being faced by credit union boards, staff, volunteers and members other than to say that the issues I have mentioned along with others are significant. You don’t need me to tell you that there are a lot of variables, risks and unknowns to take account of in the management of the day-to-day business of credit unions.

So all this means that now is a time of significant change for the credit union sector. However, in any process of development change is required – and so, in this sense, the change now happening should be seen positively. So rather than being fearful of change or having change forced upon you, I believe that the credit union sector must align that change with opportunity. In doing so an environment can be created in which prudent management of change can bring about prudent opportunities – opportunities that do not expose the credit union sector to undue risk. So as I have said before, it is about managing change and expectations, mitigating risk and failure and critically avoiding drift.

In conclusion, we all have a part to play in the future of the sector and you as credit union managers are integral to facing that change as well as to the introduction of the new regulatory framework which I spoke about earlier. For my part, as Registrar, I will continue to build on the engagement and interaction between the Registry and boards and management of credit unions to ensure that the regulatory environment is designed in the best interests of the sector and that in so doing we remain at all times alert to protecting members. This means establishing a regulatory environment which ensures strong governance and prudent management. Credit unions built on such pillars will have the ability to develop and grow their business over time. Our regulatory model which is built around a framework known as PRISM has three key elements: challenge, judge and mitigate. And so you can expect that we will demonstrate that we are willing to challenge you and your credit union about the issues facing you; we will require actions from you to mitigate those risks; or we will take regulatory action where necessary using directions, enforcement or through resolution. Ultimately, while we are prepared to enter into a dialogue with credit unions about the outcomes, as supervisors our job is to make a supervisory judgement and to mitigate risk in order to best protect the interests of credit union members.

In common with other financial services firms, credit unions are responsible for the money of others and the level of leadership needed to embed a prudent culture of compliance and decision-making in your credit unions is all important. That leadership is even more important now as you embark on a program of change that will take some years to conclude and embed. All of you here today are in a position to provide input to that change through your own credit union board or management. The commitment of you, the management and staff in credit unions, along with boards and volunteers can be harnessed to bring about the changes necessary for future development. My challenge to you is to deliver on that and to face and manage the challenges we are discussing here today. In doing so, you can deliver a strong and sustainable credit union sector which delivers a modern and relevant service to the members not just of today but of the future, while keeping the needs of those members centre stage and protecting their savings.

Thanks once again to CUMA for inviting me today and for your attention and I hope you have an enjoyable and thought provoking day.