Developing Business Models - Patrick Casey, Registrar of Credit Unions

Credit Union Managers Association Spring Conference

Chairman, Members of the National Executive of CUMA, ladies and gentlemen. Thank you for inviting me to your Spring Conference. I am pleased to have the opportunity to address you as senior credit union executives and share some perspectives on current challenges and regulatory developments. 

First of all, I would like to thank your Chairman – Tim Molan and members of your National Executive, for their constructive and open engagement with the Registry over the past year.

The role of CUMA in providing professional development training and networking opportunities is very important. Evolving challenges in a rapidly modernising marketplace requires enhanced technical and managerial competence and collaboration. Indeed, in line with our statutory mandate¹, it speaks to our vision of “Strong Credit Unions in Safe Hands”:

• We see ‘strong credit unions’ as being financially strong and resilient, enabled by sustainable, member-focussed business models underpinned by effective governance, risk management and operational frameworks.
• We see that credit unions are ‘in safe hands’ when they are effectively governed, professionally managed and staffed by competent, capable people who appreciate and prudently manage risks, while successfully meeting members’ product and service expectations.

This morning I intend to share my perspectives on addressing sector sustainability by focusing on four key areas:

1. How strategic coherence and a clear articulation of risk appetite are fundamental to engaging in business model transformation, grounded in your members’ product and service expectations and in your capabilities;
2. How responsible business model change requires clear ownership by credit unions of the development of your business model, and where necessary, regulatory support by us through an earned flexibility approach;
3. How our supervisory priorities are designed to support your quest for future sustainability through a refined proportional-based approach to engagement, aimed both at assisting credit unions in taking action to strengthen core foundations and addressing viability issues as early as possible; and
4. How the regulatory framework - which is already tailored for credit unions and is proportionate - can continue to evolve in a responsive manner to support business model development.

Your theme “Developing Business Models” is particularly apt for the sector at this time when traditional banking models are being challenged by changing consumer expectations. In responding, the challenge will be to harness the advantages of your unique brand and personal interface, while seeking to evolve from being the deposit taker of choice to also being the lender of choice, for your members.

Business model transformation will require:

• A clarity of vision on your future credit union business model(s) and the strategic path to achieve it, informed by member engagement and aligned to your competence and capabilities;
• Strong core foundations of governance, risk management and operational capabilities to oversee and manage it; and
• Collaboration and investment in infrastructure and fulfilment processes (including delivery via shared service structures).

Defining your strategic path and risk appetite

Strategic coherence and a clear articulation of risk appetite are fundamental to engaging in business model transformation, grounded in your members’ product and service expectations and in your capabilities

Your vision for the future business model requires expression both at sectoral and credit union level. In the Registry we have frequently called for sectoral leadership in terms of defining the vision for the sector’s future, consistent with your unique ethos and the evolving needs of your members.

In the 1950’s, the founders of the Irish credit union movement had a compelling vision and story to tell to the Ireland of that time. Now is the time for you as senior sector executives to consider:

• What is your compelling vision and story for the future?
• What will the sector and the credit union business model look like in 2025?
• What will be my experience as a customer and member by then?
• What element(s) of my financial service needs will be met by my credit union?

These are questions for you as leaders to answer, plan for and execute.  To date there is limited clarity in terms of future vision and strategy. Discussion and engagement has been largely product-led, which does not always form part of a broader, coherent strategy to deliver on your members’ current and future expectations. In addition, a fragmented approach can emerge where a range of competing solutions are developed. This can result in confusion and potentially suboptimal outcomes, due to unnecessary dilution of resources. It also has the potential to undermine prudent development of the future credit union business model(s).

For our part, we are engaging and will continue to engage on responsive regulatory change. It is difficult however to appropriately calibrate a regulatory system for the future, where there is limited clarity of sectoral vision for that future.

Given the level of discussion it has generated², one could be excused for thinking that mortgage lending is the most important strategic issue for credit unions right now. I am not sure that this is the case, nor do I believe it to be fully reflective of sectoral thinking. We would encourage a broader perspective on business model opportunities as you seek to address credit union sustainability challenges.

I am conscious that I am addressing you as the business leaders of the sector and again emphasise the importance of your strategic input into the formulation of the sectoral vision. You own your business model, your structured input needs to inform its future.

The 2012 legislation³, in addition to providing for an enhanced governance and risk framework, required credit unions to develop three-year strategic plans tailored to their individual circumstances. Fundamental to this is your articulation of your risk appetite and related risk tolerances. We expect the credit union’s risk appetite statement to provide clarity on its business activities and the level of assumed risk relating to each of them. This must be consistent with the capacity of the credit union to manage risks inherent in its activities. Of course your risk appetite should also inform your strategy for your credit union.

It is fair to say that some credit unions have applied this risk-based approach to greater effect than others.  The lack of an appropriate risk appetite can result in either excessive risks being incurred, or the potential for excessive conservatism. This can impact day to day trading performance in the short term, and the inappropriate calibration of business model proposals and strategic plans in the medium to long term.

When considering new initiatives, it is important that credit unions have a robust challenge process, the effectiveness of which will be a key determinant in good quality decision-making. In considering strategic options, some credit union boards will be able to identify the product and service mix they wish to target to meet member future expectations. They will be able to do so on a basis that is within their capabilities and is underpinned by their risk appetite.

Other credit union boards may end up questioning their financial and operational capacity to meet future members’ expectations. Indeed it may be that other stronger credit unions are better placed to offer that broader suite of products and services to their members. For those weaker credit unions, with emerging viability challenges, we would expect the strategic discussion to focus on solutions such as a transfer of engagement to a stronger credit union in the interests of all members. The earlier the decision is made by the board to pursue a strategic transfer in those circumstances, the higher the prospects of success for all parties, and most importantly, for members.

Taking ownership of your business model development

Responsible business model change requires clear ownership by you of the development of your business model, and where necessary, regulatory support by us through an earned flexibility approach.

Working towards a future business model involves attending to gaps in product range, introducing new services and embracing new delivery methods. Each represents a challenge, the scale of which will test your resources and capabilities. The manner and pace at which you undertake the transition in your business model must match your capabilities and expertise to deliver on it.

While change is inevitable and needs to be carefully managed, it is important that credit unions take the time to understand the uniqueness of the credit union offering and leverage the strength of the brand effectively. Your credit union’s strong local franchise remains a key strength and your relationship with members may well be a competitive advantage for some time to come. Whilst longer-term trends cannot be overlooked, it is important that in planning for the future, you seek to protect and enhance this competitive difference.

For many members, the speed of decision-making, electronic marketing and digitised distribution channels are becoming core expectations. Investment is necessary in back office processes and operational efficiency to support the speed of decision-making. Promotional advertising from banks with the capability to provide rapid credit approval of consumer loans, threatens the sub 5 year consumer lending area which is core to credit unions. Consumer loan demand has grown significantly in recent years⁴ and your business model consideration needs to include strategies to protect your core activity, in addition to new business lines.

Current ROA⁵ levels introduce a further challenge given declining income returns and weak operating cost metrics, which limits the potential for member dividend payment and necessary investment in member services. It is important therefore before proceeding with investment decisions regarding new initiatives or collective arrangements, that a critical assessment is undertaken regarding costs and benefits. Credit union assessment must consider membership profile, common bond profile and financial capacity. Choosing the appropriate business lines and developing new products/services for members are key strategic decisions that have financial implications that will differ by individual credit union.

Sectoral collaboration through a shared services approach can offer the benefits of access to scale and cost economies, unattainable for individual credit unions. Commitment on the part of the participants to implement correctly and deliver the benefits sought requires discipline and effective oversight, the absence of which can result in poor outcomes and possibly elevated cost. In considering the appropriateness for your credit union, your assessment must address the underlying net benefits and obligations of such collective arrangements.

On our part, the Registry in our engagement seeks to challenge that each credit union has considered the risk implications, understands the financial impact and has the resources and capability to manage change. Our focus through risk mitigation programmes (or RMPs) is to ensure that the risks your credit union is incurring are clearly understood, properly managed and subject to appropriate oversight. Effective implementation of  RMPs is central to ensure safe and sound business model development and balance sheet transformation.

Under our statutory and regulation making powers, we can facilitate changes to the credit union business model and balance sheet where prudentially justified. These powers enable us to set and amend prudential limits, and exempt low risk initiatives from needing approval. They also allow us to approve new services through our additional services framework for those credit unions with the capabilities and financial strength. We call this earned flexibility, which means facilitating strong credit unions in safe hands to develop their business models and transform their balance sheets. For example, the MPCAS⁶ enabling framework describes the services and sets out the conditions of approval including risk management expectations. It is a framework designed to ensure the safe and sound provision of full service personal current accounts.

As previously mentioned, the matter of longer-term lending and home mortgages is topical. The Registry is supportive of credit unions engaging in longer term lending as part of a balanced loan portfolio. In December last year, we issued a guidance paper on Long Term Lending⁷, highlighting the different risk and financial implications a credit union board must consider in developing its product offering in this area.

An individual’s mortgage is, for many, the most important financial decision they will ever make, and accordingly, it attracts the highest levels of consumer protection. From a prudential perspective, we have higher expectations in terms of governance, risk management and operational capabilities for those engaging in mortgage provision, reflective of the increased risk profile. In addition, the specific dynamics of mortgage provision - high volume, low margin activity; extended duration funded by member savings; payback pattern; governance requirements; and compliance considerations - would suggest that this is not a product for smaller or weaker credit unions.

Credit union mortgage provision internationally addressed the issue of scale economies through commercial collaboration in the form of shared services or alliances. In confirming the strategic rationale for engaging in mortgage provision, credit union boards must assess the financial and compliance impacts involved (including validating the net financial benefits of participation in collaborative structures), in the interests of their members.

The forthcoming review of lending limits presents a timely opportunity to assess the appropriateness of the regulatory framework to meet the needs of the future credit union business model(s). Therefore going beyond the request of the CUAC Implementation Group, we have decided to examine the overall lending framework for credit unions.

To inform our review, we recently issued a questionnaire to all credit unions. Its purpose is to gather additional data on sector lending. I would encourage all credit unions to take this opportunity to respond which will help to inform the development of proposals that will be contained in the formal consultation paper to be issued subsequently.

Our supervisory priorities supporting your sustainability

Our supervisory priorities are designed to support your quest for future sustainability through a refined proportional-based approach to engagement, aimed both at assisting credit unions in taking action to strengthen core foundations and addressing viability issues as early as possible.

Our supervisory approach supports business model development through onsite engagement designed to strengthen your core foundations of governance, risk management and operational capabilities.

In countries where credit unions have successfully undertaken business model transformation, a culture of strong governance and structured risk management is in evidence. Through our PRISM engagement credit unions are required to manage risks in a systematic and structured fashion, by setting out the mitigating actions to be taken to address them. The responsiveness to and quality of the remediation of these RMPs distinguishes progressive and risk-focussed credit unions from their peers.

Our thematic reviews are designed to address areas connected with your core foundations. Over the last year, the Registry undertook thematic reviews⁸ covering operational, credit and governance risk. In the operational risk area, reviews carried out included Prize Draws and IT. In terms of credit risk, we focused a recent thematic review on House Loans as a new business initiative for the credit union sector. Finally, in the context of governance risk, we are undertaking a thematic review focussed on transfer of engagements.

Our key findings from these thematic reviews are designed to help boards and you as CEOs/managers to address areas of weakness so as to strengthen your processes, systems and controls. Looking to the future programme of thematic reviews, we will be carrying out a review of internal audit, concentrating on the work undertaken within the credit union sector in that regard.

I want to briefly mention our recent Thematic Review on Prize Draws. This report has been the subject of significant media coverage, some of which contained factual inaccuracies. This was not helpful and distracted from the important messages contained in the report regarding governance, operational risk and transparency.

I appreciate that this media coverage has upset many of you and in particular those affected by association. While third party reporting content is not within our or your control, we sought immediate correction of those inaccuracies to avoid misunderstanding. Notwithstanding media coverage, I would encourage you to focus on the actual content of the report, in considering the adequacy of your own risk frameworks.

PRISM supervisory commentary 2017

In respect of our PRISM bilateral engagements, we recently published our Supervisory Commentary for 2017, setting out the current status of governance and risk management standards in credit unions inspected that year. Whilst governance standards have improved across the sector, governance remains one of the key risk areas for credit unions. It is concerning that almost 60% of individual risks identified during on-site engagements relate to governance or operational risks.

Sound governance and effective systems of control are an essential foundation to underpin the development of the credit union sector, and therefore it is important that credit unions ensure they have embedded systems and controls to acceptable levels before engaging in significant business model development.

Supervisory proportionality

For many years now we have adopted a differentiated approach reflecting proportionality in supervising credit unions of different sizes. All credit unions are required to meet minimum standards which are designed to protect members’ funds in a proportionate manner, aligned to their size and complexity. Despite some views to the contrary, our approach to supervision is commensurate with the approaches of international peers ^{9 10}.

From 2018, we are refining our supervisory approach to further differentiate on a proportionate basis between small (under €40M total assets), medium (€40M-€100M total assets) and large credit unions (over €100M total assets). We refer to this as supervisory proportionality:

• For smaller credit unions, we will adopt a desk-based supervisory approach, augmented with a number of targeted on-site engagements with those small credit unions with higher risk profiles. In addition, there will be scheduled bi-lateral engagements with key role holders in line with PRISM.
• We will continue our programme of onsite engagement with large and medium credit unions. Our expectations are highest for credit unions with more complex business models, and accordingly, we apply greatest intensity and depth of our engagement with those larger and medium credit unions with elevated risk profiles.

  Where we find viability issues we will challenge boards and in particular their key role holders, regarding the strategic options available aimed at protecting members’ funds and the fulfilment of members’ future needs. Early engagement on a transfer is critical. Where viability issues are allowed to deteriorate, transfers of engagement can ultimately become more difficult to undertake and strategic alternatives trend towards resolution. While regrettable, this may be inevitable if responsible strategic decisions are not taken at an earlier point in members’ interests.

Evolving a tailored and proportionate framework for credit unions through regulatory responsiveness

How the regulatory framework - which is already tailored for credit unions and is proportionate - can continue to evolve in a responsive manner to support business model development.

Tailored regulatory framework

The legislative framework that applies to credit unions has been developed to reflect the unique nature of the sector in Ireland. Credit unions benefit from a separate legislative framework and regulatory regime from banks and other financial service sectors.

Some within the sector view the credit union framework overall to be restrictive, burdensome and disproportionate. This is far from the case. For those familiar with the Capital Requirements Regime which applies to banks and large investment firms, or the Solvency II regime which applies to insurers, you will appreciate just how tailored and proportionate the credit union framework is by comparison.

The specific characteristics of credit unions have also been reflected in the evolution of the framework through Central Bank regulations. One example in that regard is the Fitness & Probity regime which was introduced on a phased basis for credit unions. The regime currently prescribes two Pre-approval Controlled Functions (PCFs) and two Controlled Functions (CFs). By comparison the regime applying to all other Regulated Financial Service Providers (RFSPs), prescribes a total of up to 46 PCFs and 11 CFs. The implementation of the tailored Fitness & Probity regime represents a clear example of a proportionate approach for credit unions, one where smaller credit unions were allowed further time to comply, and where the overall requirements remain less onerous for credit unions than for other financial service providers.

Accommodating a tiered approach

The issue of a tiered regulatory approach is frequently raised in the context of business model evolution. However tiering can mean different things to different stakeholders. We also await a paper from the CUAC Implementation Group on this topic. We are open to meaningful engagement on this issue with key stakeholders.

Our current thinking recognises the benefits of tiering can be achieved through:

• Our supervisory approach: which delivers a differentiated application of the tailored legislative framework in terms of our off-site and onsite engagement, where our supervisory expectations take account of the nature, scale and complexity of each individual credit union – an approach we refer to as supervisory proportionality; and
• Our regulatory approach: through the introduction of tiered provisions to achieve regulatory proportionality on a targeted basis – one example being the increased investment in Tier 3 AHBs for social housing permitted for credit unions with greater than €100 million in total assets.

We can further enhance this approach by facilitating prudent development in those credit unions that can demonstrate a clear vision and the capability to successfully implement that vision. As mentioned earlier, this approach of earned flexibility supports those stronger credit unions to deliver a broader range of products than is currently provided for in legislation or regulation.

We would caution that the introduction of pre-defined tiering has the potential to unduly restrict smaller and medium sized credit unions, and may in fact inhibit their future business model development. In particular, we would be concerned that it could constrain the flexibility and benefits of the current tailored regime.

Evolving regulatory framework

In supporting business model development based upon a responsive regulatory framework, we undertook two important reviews of aspects of the framework for credit unions in 2017. Proposals arising from these reviews reflect our continued commitment to ensuring the regulatory framework remains responsive, tailored in nature and proportionate. We call this regulatory responsiveness.

Investment Regulations

Following extensive consultation we published a feedback statement on CP109 with amending regulations on 1 February 2018. The changes introduced which commenced on 1 March 2018, include the introduction of three new investment classes for credit unions:

• Bonds issued by Supranational Entities;
• Corporate Bonds; and
• Investments in Tier 3 Approved Housing Bodies¹¹ (AHBs).

The revised investment framework allows for greater diversification in credit union investment portfolios, while recognising that it is not appropriate for credit unions to invest in riskier, more complex financial products. The sector’s desire to increase investment options has been facilitated, with a recognition that it is members’ savings that are being invested.

The amending regulations also introduce significant changes in the liquidity regime for credit unions including a broadening of the definition of liquid assets and a reduction in the short term liquidity requirement. These changes are in response to the significant level of feedback we received in relation to liquidity requirements from credit unions.

The revision to the investment framework underlines both the flexibility provided by the Central Bank’s regulation-making powers and the proportionality of the framework in terms of the introduction of a further practical form of tiering.

The sector brought forward detailed proposals around the provision of funding to AHBs. Following comprehensive engagement and consultation, this is now provided for reflecting our regulatory responsiveness and willingness to apply tiering on a targeted basis.

Fitness & Probity

Following a review of the Fitness & Probity regime for credit unions, we published a consultation paper in 2017 on proposed changes. We proposed to retain the tailored regime for credit unions. We also proposed to designate internal audit, risk management officer and finance functions as Pre Approval Controlled functions (PCFs). This reflects our view that these three functions can play a key role in strengthening core foundations necessary to support boards in embedding restructuring and undertaking business model development.

The designation of the new roles as PCFs for credit unions with total assets of at least €100 million is in acknowledgment of the increased scale and specific characteristics of these credit unions. There are currently 53 credit unions with total assets in excess of €100 million and over 65% of them have engaged in transfers of engagement since 2013, with a significant number engaging in multiple transfers of engagement. The introduction of additional PCFs for larger credit unions underlines the proportionality of the regulatory framework and represents another practical form of tiering.

New CEO Forum

We engage proactively and transparently with the sector and value our direct bilateral interaction with you as its business leaders. Indeed it is an experience from which I have gained important insights from since taking up my role as Registrar.

In addressing the business model agenda, we also intend going forward to set up a new forum to engage directly with credit union CEOs/managers. You will appreciate our role in that regard as regulator, will be to support and challenge proposals, given credit unions are the owners of their own business model development. The new CEO Forum will give those progressive credit unions with the capability and desire to undertake business model transformation, a mechanism to avail of practical regulatory support when seeking to address their commercial challenges.

Conclusion

To conclude, I am mindful that 6 years have passed since the Commission on Credit Unions Report¹² which called for action by credit unions to arrest the decline in their loan books, revitalise their business models and collaborate via shared service structures.

Negative pressures persisted until 2015/2016, due to a range of internal and external factors. Returns on assets are currently at historic low levels, given prevailing low yields and weak operating cost metrics. Nevertheless, opportunities exist as evidenced by a recent recovery in consumer loan demand.

Looking forward to the time span of the next 6/7 years, the key question I pose to you is where the sector will be in 2025? As CEOs and managers of credit unions, you must help to shape the vision, and plan for and execute the strategy to deliver it. Drawing from international experience, business model change has generally been led by senior executives working together to realise a shared vision with a coherent strategy. Indeed, experience elsewhere highlights sectoral collaboration and leadership are critical to successful business model transformation. While we are beginning to see some signs of this emerging collaborative approach, we emphasise the importance of properly structured shared service initiatives to address cost and technical constraints.

Our vision of “Strong Credit Unions in Safe Hands” reflects our statutory mandate whereby we are  responsible for administering the system of regulation and supervision with a view to the protection by each credit union of the funds of its members, and the maintenance of the financial stability and well-being of  credit unions generally.  We take our responsibility regarding well-being very seriously, and for credit unions, have a higher level of proactive support and engagement than applies to any other sector. However, it is not, nor should it be the Central Bank's responsibility to develop your future business model strategies. That vision and related implementing strategies are for you as a sector to define.

I have set out how the Registry can help your business model development, by:

• Requiring you through our supervisory engagement and your remediation of RMPs, to strengthen your core foundations, through supervisory proportionality;
• Facilitating those credit unions who have the required foundations to engage in new products and services not currently provided for by the regulatory framework, through an earned flexibility approach;
• Assessing and evolving the regulatory framework to ensure it continues to be tailored for credit unions and that it remains proportionate, through what we term as regulatory responsiveness; and
• Challenging and constructively engaging with individual and groups of collaborating credit unions, on their business model development proposals.

Credit unions have many advantages from which to evolve your business model, not least the strength of your brand and the strong trust of your members. It is important that there is a coherent vision and strategy to deliver on your potential in the interests of your members and in recognition of your important role in the Irish financial system.

Credit unions must continue to strengthen core foundations by addressing key risk vulnerabilities through necessary changes. As owners of your business model, you need to develop and innovate to overcome the significant commercial challenges you continue to face.

For our part, the Central Bank will continue to provide you with the necessary support through supervisory proportionality, earned flexibility, regulatory responsiveness and through constructive engagement with you on business model challenges.

I would like to compliment CUMA on arranging this conference, which facilitates a collective examination of the challenges facing you as senior executives, as you evolve your future business model(s).  I welcome the opportunity to share our perspectives on this critical topic, and I would like to wish you well for the remainder of your conference.

Thank you for your attention.

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² Irish Independent “Credit unions to take on banks with mortgage lending offer”, December 2017. TheJournal.ie “Credit Unions want to shake up the mortgage market”, January 2017       

³ Credit Union and Co-operation with Overseas Regulators Act 2012

⁴ Household Credit Market report H2 2017 (PDF 5.14MB)

⁵ Return on assets as measured by net income after costs expressed as a percentage of total assets

⁶ Members Personal Current Account Services (PDF 1.05MB)

⁷ Long Term Lending – Guidance for Credit Unions (PDF 807.66KB)December 2017

⁸ Thematic reports

⁹ ICURN credit union peer review: “Central Bank Performance of its Regulatory Functions in Relation to Credit Unions” (PDF 2.06MB) July 2015.

¹⁰ “The Irish Credit Union Business Model – Is it still fit for purpose?“. (PDF 2.97MB)The Centre for Community Finance Europe November 2017  highlighted: “What is seen by some as overly restrictive supervision by the Central Bank is no more onerous than credit unions in other developed countries have successfully dealt with for years.”

¹¹ The regulatory code applied to AHBs divides AHBs into three tiers – Tier 3 refers to larger AHBs.

¹² Report of the Commission of Credit Unions  - April 2012