Address by Registrar of Credit Unions, Anne Marie McKiernan, at the Irish League of Credit Unions AGM*

Good morning ladies and gentlemen. Thank you for inviting me to address your Annual General Meeting this year. I welcome this opportunity to talk to you about the important challenges which your sector faces at this juncture and some of our priorities as Regulator in this context. First, I would like to thank your outgoing President, Martin Sisk, and your acting CEO Ed Farrell, for their engagement with me and my team, since I took up my role last year.  I look forward to continuing this cooperative approach with your new President, as we work together to achieve a financially healthy and thriving credit union sector which protects members’ funds.

This morning I would like to take the opportunity to reflect on the progress your sector has made since the Commission of Credit Unions was set up.  I will also highlight the critical challenges still facing you, including the need to encourage and develop strong leadership while retaining your voluntary ethos, and the urgent need to restructure and develop your business model.  Then, I will discuss some of the key issues we are working on within the Registry, before closing.   

Progress since the Commission on Credit Unions 

When the Commission of Credit Unions was convened in 2011, there were very serious concerns about the possible outcome for credit unions, given the difficult economic conditions and the serious risks facing the sector.  At that time, many credit unions were at serious risk of failure and others required significant funding.  There was a possibility of outflow of funds and of extensive defaults.  Happily, the worst case scenario and the sudden failure of a significant number of credit unions did not happen. 

While there are many reasons for this, a very important factor is the tremendous efforts by your boards, management and volunteers, over a number of years, to strengthen the financial, governance and management position of many individual credit unions.  Your responses to the very severe challenges that your sector faced, and the scale of change dealt with, were exceptional.  These efforts – combined with some other factors which I will mention below – undoubtedly contributed to the avoidance of a worse downturn.  

So, what do we have now that we didn’t have when the Commission on Credit Unions reported? 

• A less financially weak sector, in aggregate, and fewer credit unions in immediate financial stress.
• Action and momentum on restructuring, which is a necessary starting point to address financial weakness and transform the business model.
• A resolution, restructuring and stabilisation framework and funding.
• A much strengthened regulatory framework.
• Better standards of governance, risk management and compliance across the sector. 

But what do we not have in place now, that the Commission on Credit Unions might have expected would be well underway, 3 years after it reported?

• First, I think it’s fair to say that the scale of restructuring has fallen well short of what is necessary to more fundamentally tackle the viability challenges to the sector.   
• Second, and related to restructuring, there has been very limited transformation on the credit union business model.  While the Commission noted that “there is scope for better and closer co-operation and co-ordination among credit unions towards shared services and standardisation of processes”,  overall there has been poor take up, at the sector wide level, of the challenge to deal with shared services and new service delivery.   

As well as your sector’s exceptional efforts on many fronts, what else contributed to the avoidance of the severe crisis that looked quite possible a half-decade ago? And what issues are a continuing risk to the sector?  

1. A key concern at the heart of the crisis was the risk of illiquidity and increased defaults. A fall in confidence towards many financially-weak credit unions, and the falling dividend income, could have caused an outflow of members’ funds. But, in general this did not materialise.  This reflected loyalty and confidence of your members, as many credit unions took action such as increasing provisions and decreasing dividends, to strengthen financial positions.  It was also helped by the extension of the deposit guarantee scheme (up to €100,000 for eligible deposits) to credit unions back in 2008, and the bedding-in of liquidity requirements introduced in 2010.   Defaults on the sector’s unsecured debt also evolved less severely than expected.  Many small  businesses and households prioritised their credit union small loan repayments, (sometimes at the expense of bank debt). This helped to limit the extent of credit union arrears and bad loans – although, of course, arrears still reached serious levels and remain extremely high at an average of 17%. And to date we have most likely not yet seen the full impact of the new insolvency arrangements. 
2. A second factor which helped avert a more serious crisis was the series of regulatory changes, both pre- and post- the Commission on Credit Unions, and the scale of credit union responses to these measures.  The introduction of the regulatory reserve ratio, the liquidity requirements and section 35 requirements – as unpopular as the latter may be – helped to reduce risks and vulnerabilities.  Later, the introduction of new governance and risk management regulations, and efforts to implement these in a period of stress, helped many credit unions to become more soundly-governed and better-run, and better able to demonstrably protect your members’ funds.  Lending restrictions also likely played a role in improving outcomes, by encouraging more responsible lending and focusing attention on the performance of existing loans. 
3.  A third factor was the resolution and restructuring undertaken in recent years.  The Central Bank’s resolution actions helped to remove the most problematic cases from the sector,  using - as efficiently as possible -  taxpayers’ funds to both limit the potential for spillovers to the rest of the sector and to retain credit union services as far as possible.  ILCU, for its part, used your sector’s private fund for restructuring to help some other specific credit unions in financial difficulty.  While we differ on the effectiveness of the respective approaches, it is clear that both interventions played a role in stemming the crisis, on both individual cases and on the overall sectoral financial position. 

Voluntary restructuring played a smaller role in avoiding serious crisis, not least because the financial incentive was less immediately available and in any case less attractive to credit unions given its terms and conditions.  But now, thanks to ReBo’s strengthened capacity and credit unions’ own focus on restructuring to secure a better future for their members, far more is being achieved. 

These are just some of the factors that helped to avoid the worst of the possible outcomes for the credit union sector during and after Ireland’s financial and economic crisis.  As I already mentioned, your efforts, and the efforts of all the officials and volunteers involved in the sector, were a critical factor in this outcome.  

But it is important to acknowledge that, while the eye of that particular storm has passed, it continues to leave its mark on the credit union sector.  We can see this is in the still-declining income growth and the high arrears rates, which put severe pressure on viability for so many credit unions.  We cannot have a false sense of security because the most severe possible outcomes did not in fact occur.  

Responding to the severity of the financial crisis took time, effort and focus away from dealing with serious underlying structural problems.  Those structural problems continue to impede the sector’s future stability.  

The critical challenge now for your sector is to address the shortcomings of your business model, your ageing membership base, your ability to grow and develop your product and services offerings and your lending business, and your ability to meet regulatory requirements.  As I have commented publicly before, we have yet to see a sufficiently structured and collaborative response, at the sectoral level, to the scale of business model transformation required to ensure a vibrant future. 

As our role is to support the sustainable and prudent development of the sector, we are concerned to ensure that proposed changes to the business model are prudently structured and implemented. With this in mind we intend to invite interested parties to a series of dialogues to discuss business model transformation expectations. Initial issues will cover consumer mortgages, small personal loans, personal current accounts and credit risk management best practice.  We anticipate these dialogues will provide stakeholders with a well-grounded basis to develop sound risk-based business model transformation initiatives.  We also intend inviting interested parties to a dialogue on exemplary credit unions’ risk management approaches, to inform the development of credit union risk management capabilities more broadly. 

When you reflect on the scale of change you have dealt with over the past half-decade, and the severe outcomes which you have helped to avoid, you can be confident that your sector can rise to this challenge.  Strong leadership will be key in this drive for future growth and development, while preserving your sector's voluntary ethos.  It is crucial to use the opportunity afforded by the economic upturn, the restructuring momentum, and the lowering of some financial pressures on credit unions, to tackle the difficult task ahead.  

I would now like to highlight some specific issues that credit unions need to tackle sooner rather than later, including lending growth and investment decisions. Then I will update you on our engagement in smaller so-called low impact credit unions, before summing-up. 

Lending Growth 

At the Registry, we agree on the need to grow income in the credit union sector 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 our review of lending restrictions.  As you know, we wrote to around 150 credit unions in February, inviting credit union boards to apply to have their restrictions reviewed, subject to carrying out the required remedial action to bring their credit control function to an acceptable level.  By the March 31st deadline, credit unions boards could either give us an expected date by which they would make a formal application for a review of their lending restrictions, or set out the remedial action required on their credit function to bring it to an acceptable level.

I am pleased to report that 92% of these credit unions replied to the original letter and 79% of credit unions indicated their intention to apply for a review of their restrictions by a specified date.  Some 28 credit unions, two of which are currently in transfer discussions, said they will not be applying for a review.  We are now writing to these credit unions requiring them to submit details of the credit remediation measures that they have undertaken.  

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.  Offering mortgages, for example, requires assessment of different financial and legal risks and the development of new expertise. In this regard there may be a role for a shared services model, for example in the areas of credit screening or legal expertise.  But the bottom line is, as you would anticipate, that the Registry will not expect to see credit unions with an unacceptable credit function adding mortgage or any other new lending to their product portfolios.  This is, of course, to ensure we meet our mandate of protecting members’ savings.

Increasing lending, in a prudent and viable way, is at the heart of growth and development for any credit union, whether merging or not. In this context, we expect credit unions to apply prudent lending standards for all new loans and top-ups of existing loans, and to have appropriate systems in place to be able to fully assess and confirm the member’s ability to repay the loan.

Investment Returns and Risk – the Financial Challenges 

On the subject of growing income at credit unions, I would now 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 has been pointed out in several fora recently, traditional investment returns are declining and will pose a threat to viability for many credit unions.  The boards of credit unions must ensure that any investments they make do not involve undue risk to members’ savings, particularly in the current low interest environment which is putting pressure on investment income.  It is very important that the drive to generate income for the credit union does not overshadow the need to be prudent and to understand very clearly the inherent risks that generally go hand in hand with the promise of higher returns. Credit unions must ensure that detailed analysis and careful consideration is undertaken before making investments, which should be in line with the investment policy and risk appetite of the credit.  I believe the key issues to focus on are the trade-off between risk and return and understanding the investments' costs and benefits for your credit union. In relation to capital protection, credit unions should ensure that they understand very clearly the level of capital protection provided by a prospective investment and that they take into account all potential risks to the repayment of capital, including circumstances where repayment of capital may be dependent on events in institutions other than the issuing counterparty.  We expect credit unions to be conscious of and learn from mistakes made in the past when investing surplus funds.  Our investment guidelines established 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 advisors have adequately explained why an investment is suitable for the credit union and that they understand the risk.   It is important that credit unions understand that they cannot outsource the judgement regarding investment risk fully to an external party such as an investment advisor and that the credit union remains responsible for both the decisions and the funds of their members.

Update : Engagement with Low Impact Firms 

I would like to give you an update on our recent engagement with smaller, so-called Low Impact credit unions.  As you know we narrowed our PRISM engagement with this group to focus on Governance, Strategy (Business Model Viability) risk, Credit and Market risk.  Although it is still in its early stages, so far this engagement has been very constructive.  While it is fair to say that we have found familiar weaknesses in business model viability and governance in some credit unions, we have also seen a strong level of analysis in other credit unions on their business model, while a number were actively engaged with ReBo or other credit unions on potential transfers of engagements, as the best way of ensuring continuation of member services. We have also seen instances of strategic analysis, challenge, and understanding of members’ needs which many of our larger credit unions could emulate.  For a number of the smaller credit unions, we have also highlighted viability concerns, particularly where the capacity to generate a surplus going forward is not apparent.  We encourage these credit unions to avail of the support offered by ReBo while it is still in operation and before there is further deterioration in the credit union position.

It is important to be clear also that our agenda is not to push all smaller credit unions to transfer to larger credit unions.  Rather, we want to see viable credit unions of differing sizes in the sector, with the governance and internal controls proportionate to the risks they are exposed to.  Naturally, this resilience and viability challenge is greatest for smaller credit unions but it is not insurmountable.  

I have acknowledged the significant work undertaken in credit unions to embed the enhanced regulatory requirements of recent years. But it is important to emphasise that many credit unions continue to face difficulties in meeting aspects of our requirements.  These requirements are the minimum standards required to ensure that your members’ funds are adequately protected.  Some of the issues we have identified are stagnant  business models, lack of clarity over how to grow income from loans, limited strategic thinking on attracting and retaining new and active members, and poor governance and risk management practices.  It is important that these issues are tackled sooner rather than later and that action is taken to remedy shortcomings, which will put the sector on a safer long term footing. 

Regulation : Next Steps 

As you know the consultation period on new Regulations for Credit Unions on the commencement of the remaining sections of the 2012 Act closed on 27 February.  We issued Consultation Paper 88 (CP88) to consult you on the draft regulations that the Central Bank is proposing to introduce on reserves, liquidity, lending, investments, savings and borrowing. 

We held nationwide information seminars for credit unions late last year, to engage directly with you on regulatory policy developments and to provide an opportunity to get initial feedback on the draft regulations.  We received over 100 formal submissions on the consultation paper and are pleased to see the high level of interest in the draft regulations among credit unions and other sector stakeholders.  We are now reviewing all the submissions received and will publish a statement outlining the feedback received together with the Central Bank’s response and the final regulations by end-June. 

In August this year, we will introduce the Fitness and Probity regime for smaller credit unions.  This regime helps credit unions to focus on the need to ensure that individuals have appropriate skills and competence for the roles.  As you know transitional arrangements will apply with the changes being phased in from 1st August. The Fitness and Probity rules will also apply to credit unions authorised as retail intermediaries for the retail intermediary portion of their business from 1st August.  From 1 November 2015, the Standards will apply to all persons performing Controlled Functions for the first time and from 1 August 2016, the Standards will apply to all persons occupying Controlled Functions.

Peer Review

Finally, the first peer review of the regulatory functions in the credit union sector in Ireland is being carried out at present, and I would like to thank all the credit union representatives who have cooperated with this process.  The background is that the Central Bank must ensure a review of the performance of its regulatory functions is carried out once every four years. The International Credit Union Regulators’ Network (ICURN) agreed to carry out the first peer review on the regulation of the credit union sector in Ireland.  The review is based on the ICURN Guiding Principles for Effective Prudential Supervision of Cooperative Financial Institutions.  These Guiding Principles were developed in 2011 as guidance for supervisory authorities involved in the prudential supervision of cooperative financial institutions to establish an environment that facilitates effective supervision.  Our approach recognises the distinct and important role that credit unions play in Irish society and the financial sector.  This review is an opportunity for us to learn how we can best do so, to achieve our vision of a financially-strong, well-governed and managed sector which is providing the services that current and new members want.   The Peer Review Team was in Dublin earlier this month for an on-site visit and credit union representatives participated in some meetings with the peer review team.   In the spirit of learning and improvement, we appreciate the frank feedback which you provided in those meetings.  Regarding engagement with your sector, we are committed to continually keeping you informed of developments from our side, and we are considering what changes we can make to our engagement approach to best do so.  

Closing Remarks

To sum up, the credit union sector has come on a considerable journey in recent years, since it avoided the worst outcomes considered possible during the height of the crisis.  This reflected a combination of circumstance (resilience of liquidity, prioritisation of short term unsecured debts), fundamental transformative factors (enhanced regulations, resolution) and, not least, appropriately conservative responses by most credit unions (increased provisioning, cutting dividends, significant efforts to adopt new regulations).  

But significant vulnerabilities remain, including financial (especially loan arrears and falling loan and investment income), regulatory compliance and business model challenges.  Now is clearly not the time to unwind hard-won financial improvements by, for example, overly generous dividend payments (especially in an environment of historically low or even negative interest rates elsewhere) or less conservative provisioning (especially if there are any doubts as to asset values).  Now is the time to put restructuring and business model transformation to the forefront - to achieve better outcomes for members, to enhance the financial soundness of credit unions and to act as an enabler for future growth and development.

The old maxim “A lot done, a lot more to do” is hackneyed precisely because it is so often true, and never more so than at the current juncture. Developing the leadership required to drive sustainable growth while retaining the important voluntary ethos of the movement is a serious challenge.  But it is one I am confident that the sector, which has risen to so many challenges and none more so than in the recent past, has the capacity and the willingness to meet at this time.

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* These remarks were prepared for the ILCU AGM but due to circumstances beyond our control the speech was not delivered on this occasion.