Address at the Credit Union Development Association's Annual Conference - Registrar of Credit Unions Patrick Casey

Introduction

Good morning Ladies and Gentlemen. I am delighted to speak at your 2020 Annual Conference in Killarney.

As a representative body, CUDA engages constructively with the Registry of Credit Unions.  In that regard, I would like to thank the Chair of your Management Committee John Grogan, the Chair of your National Council, Michael O’Mahony and your CEO, Kevin Johnson and his team. We look forward to the continuation of this cooperative approach - recognising both what we have in common and our differing mandates towards credit unions.

Your conference theme, Journey to the Model Credit Union, is highly topical. Indeed, it speaks to a key aspect of the sector’s sustainability – namely, the important journey for credit unions of business model change. Reaching your destination, in terms of measurable success, will require delivery of members’ needs on a basis that is financially sustainable.

I am conscious that I am addressing many larger credit unions today, including many credit unions engaged in business model change. My comments are intended to be particularly relevant to you. In my address, I will outline what we are doing in the Central Bank to fulfil our important statutory mandate towards credit unions, before considering your position and your activities, covering the following areas:

1. The tailored and proportionate nature of the evolving credit union regulatory framework;
2. The refinement of our supervisory approach;
3. The positive validation from a recent external peer review, of our work as regulator and supervisor of credit unions; and
4. An assessment of the sector’s overall financial health, and what steps are being taken to address it.

We, in the Registry of Credit Unions, have been clear regarding our vision for the sector of “Strong Credit Unions in Safe Hands”. That vision underpins our statutory responsibility to ensure 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.¹

Before I begin, I want to acknowledge the hard work and effort being undertaken by volunteer Directors across the country. Credit unions play a very significant role in the Irish financial sector, and they are positively recognised for a brand built upon member trust.² Such recognition is a very strong endorsement of the positive relationship that continues to exist between credit unions and their members. With that trust comes responsibility, not only in the protection of members’ funds today, but also in securing the sustainability of your credit union into the future.

I will now turn to the first topic I outlined earlier.

1. The tailored and proportionate nature of the evolving credit union regulatory framework.

Tailored and proportionate credit union framework.

For credit unions, the legislative and regulatory framework that applies has been tailored to reflect the unique nature of the sector. It is principally based upon the traditional savings and loans offering of credit unions. More recently, where it has been prudentially justified, it has accommodated the evolution of the business model into new areas.

The specific characteristics of the sector have been reflected in the recent evolution of the credit union framework:

1. A strengthened governance framework was introduced by the Oireachtas in 2013 in line with the Commission on Credit Unions’ recommendations³ - each of the six credit union failures since then, highlighted the importance of governance in preventing failure;
2. Changes to the savings framework in 2016 sought to protect members’ funds on a proportionate basis, with higher savings limits available to credit unions with total assets over €100M;
3. Investment framework changes in 2018 enabled credit unions to invest in social housing provision, as part of a wider package aimed at enhancing investment diversification; and
4. New Pre-approved Controlled Functions (PCFs) were introduced in 2018 for credit unions with total assets over €100M – taking the number of PCFs for such credit unions to five. By comparison, there are up to 46 PCF roles within large banks and insurers. The proportionality speaks for itself.

Some within the sector still view the credit union framework to be restrictive and disproportionate – suggesting, without any basis, that it is more onerous than the framework applying to banks. Savers, borrowers and investors expect regulatory frameworks to provide minimum standards to protect their interests. Seeking to dilute those standards, risks eroding trust.

Higher regulatory standards are expected for those operating more complex business models. For instance, as credit unions engage in mortgage activity, a range of additional domestic and EU level requirements apply - over and above the minimum standards already applying to all credit unions.

In evolving our regulatory and supervisory approach, we seek to ensure we have in place frameworks that are proportionate. In this regard, we welcome the recent endorsement of our approach in terms of the regulation and supervision of Irish credit unions, following an external peer review by a team of international experts – a point I will return to.

Recent lending framework changes

With an average sector loan to asset ratio of 28%, today credit union balance sheets can be characterised as under-lent. Why is this the case?

Some suggest it is because of regulatory framework constraints. Yet under the same framework, across the sector loan to asset ratios range from 12% to 73% - evidencing that some are better than others at fulfilling their members’ needs.

If the issue is not the regulatory framework, why are credit unions not lending more? One must look to the post-crisis reduction in credit demand, in the emergence of new/reinvigorated competitive forces in the household credit market and in how borrowers today prefer to source their credit needs. In other words, the challenges are commercial, not regulatory.

As Ireland has emerged from the recent crisis, some within the sector have advocated for increased longer term lending. In the Central Bank we have engaged with, listened and responded to those credit unions who want to prudently develop their business models to incorporate an increased level of longer term lending. Our December 2017 Long Term Lending Guidance⁴ highlighted the key risk areas involved.

The lending framework changes we have recently introduced followed an extensive review during 2018 and 2019.  This review was informed by detailed evidence we gathered directly from credit unions via our 2018 questionnaire, our data analysis of lending by category, public and statutory consultation processes and robust internal review and challenge.

As sector regulator, we view changes to the lending framework from the perspective of our statutory mandate. With that in mind, the starting point in reframing house and business lending capacity took account of:

1. The strategic planning goals of credit unions. This factored in the existing low level of capacity utilization⁵ in longer term lending, individual credit union risk appetites, member loan demand, the current funding model and common bond dynamics. Our 2018 questionnaire provided us with a credit union view in that regard, and an evidence basis to support the revised capacity proposed.
2. The prudential risk profile of individual credit unions, as summarised in our 2019 Supervisory Commentary paper⁶, which evidences material risk vulnerabilities across the sector, including in relation to credit underwriting.
3. The need to align house and business lending capacity with competence and capability, given longer term lending is a new activity for most credit unions.
4. The availability of key supports to credit unions through shared service type structures, which are still under-developed in an Irish context relative to international peers.
5. The Irish macro-economic outlook, given the cyclically advanced stage of the economy and well documented downside risks (including Brexit, elevation of global risk premia, international tax changes, etc.).

We recognise that for all credit unions, sustainable business models should include growth potential in short and longer term lending based upon member needs. In terms of capacity expansion, a stepped phased approach will allow time for credit unions engaging in a newer activity, to build the required competence and capability.

Our structural changes to the framework lay the groundwork for potential future changes. The recent revisions facilitate a lending framework that is responsive to enhanced competence and capability, and the development of shared service type structures.

So what does this responsiveness mean in practice? Where we see both credit union ownership of business model development, and conditions in the sector are such that there is an evidence basis to further adjust capacity in the future, this can be achieved by amending the level of the limits.

The conditions that would warrant a future change in the limits would require credit unions to have delivered a financially viable house or business lending proposition, including:

• Clearly articulated lending strategies;
• Full alignment between risk appetites and those strategies;
• Highly developed competence and capability for longer term lending;
• Fully embedded governance and risk management frameworks;
• Well established and operationalised shared service type structures; and
• Financial resilience.

Where prudentially-justified through evidence from credit unions, we remain committed to re-evaluating the capacity provided, and to making any appropriate adjustments. But to be clear, the bar for any capacity increase is a high one.   

I will now turn to the second area I wish to cover, namely the refinement of our proportionate supervisory approach. 

2. Refinement of our supervisory approach towards the sector, to reflect the changing risk profile of credit unions of differing sizes

Strengthening credit union core foundations across governance, risk management and operational capabilities continues to be a key focus of our supervisory strategy. Strong core foundations enable larger credit unions to engage in transfer activity, and to undertake prudent business model development in line with their strategy, capabilities and risk appetite.

In delivering our approach of supervisory proportionality, our expectations are highest for credit unions with more complex business models. Accordingly, we apply greatest intensity and depth of supervisory engagement to those larger credit unions with elevated risk profiles.

In 2019 we further refined our supervisory approach to differentiate on a proportionate basis between small and medium credit unions (up to €100M total assets) and large credit unions (over €100M total assets). Our supervision of the largest credit unions - many of whom are represented here today - continues to involve regular onsite inspections. Our desk-based supervisory approach was extended in 2019 to credit unions with total assets up to €100M. In addition to our minimum engagement activities, targeted on-site inspections occurred in small and medium credit unions with higher risk profiles.

Where our engagement identifies credit unions that face viability challenges, we continue to engage with boards on the strategic solutions available. If standalone viability cannot be demonstrated, we favour transfer of engagements to stronger credit unions capable of meeting members’ needs. In the event that no transfer is available, options tend towards resolution, to ensure members’ funds are protected.

Member-centric focus

All customers of financial institutions have an expectation that their funds will be safeguarded. For credit unions, effective safeguarding of member funds is built upon robust governance and systems and controls. The board of a credit union retains primary responsibility for these matters. Where minimum standards are not being met by credit unions, we have demonstrated that we will pursue those in breach by taking enforcement action. I will now turn to the third area I will cover.

3. The outcome of an external peer review which validates the Central Bank’s work as credit union regulator and supervisor

The Central Bank is required to arrange for an international peer review of the performance of its regulatory functions for credit unions at least every four years.⁷

A peer review was carried out in 2019 by the International Credit Union Regulators’ Network (ICURN). A team of international regulators, drawn from the US, UK and Canada, assessed the Central Bank’s compliance with ICURN’s Guiding Principles.⁸ The Guiding Principles take into account the unique nature of financial cooperatives.

Following their onsite review in May 2019, the ICURN team issued a report setting out their assessment of the Central Bank’s overall performance against the Guiding Principles. The Report has been provided to the Minister for Finance and shared with all credit unions, and is available on the Central Bank’s website.⁹

In the context of my earlier comments regarding the tailored and proportionate regulatory framework in place for credit unions, and the proportionate nature of our supervisory approach, we welcome ICURN’s positive external validation of our work. In particular we welcome ICURN’s recognition that the Central Bank is effectively performing its functions in the regulation and supervision of the credit union sector, including the significant improvements noted since their last review in 2015.

The Report also provides recommendations to further improve regulatory and supervisory effectiveness, focusing on supporting credit unions in enhancing their risk management systems. In 2020 we will consider the findings and recommendations set out in the Report, with a view to enhancing our current practices.

Having addressed developments in terms of lending framework changes, the evolution of our proportionate supervisory approach and the positive external validation of the performance of our functions, as a final topic I will now consider the financial health of credit unions and associated sector developments.

4. The sector’s overall financial health, and the steps are being taken to address it

In December 2019 we published the 6th edition of the “Financial Conditions of Credit Unions”.¹⁰

Through voluntary transfer, the sector’s profile continues to evolve with a greater number of large credit unions and fewer small credit unions.

Positively, credit unions continue to demonstrate a strong reserves position with a sector average reserve ratio of 17%. This highlights that credit unions boards are choosing to prudently maintain capital reserves in excess of the 10% regulatory minimum requirement.

Of more concern, financial performance indicators continue to highlight significant sustainability challenges – reflected in low return on assets and high cost to income ratios across the sector.

Credit union balance sheets continue to grow. Last year total sector assets grew by 4% (underpinned by savings growth of 4%). While credit union lending grew at a faster pace (up by 7%), elevating loan to asset ratios across the sector will require continued lending growth well in excess of savings growth.

As competition intensifies, to grow credit union lending will require investment in your operational models to deliver on members’ expectations. As highlighted earlier, should you look to expand into housing and business lending, you will need to develop the competencies required.

Some credit unions are beginning to charge fees for servicing accounts and payments. Others are looking to grow non-interest income by offering third party products and services. In deciding to intermediate third party products, you should understand associated costs and risks. For example costs associated with regulatory compliance, technical competence and having risk management systems in place. What might appear to be a reasonable source of non-interest income upfront, may in fact be quite costly and risky to realise in the long run. Most of all, in pursuing these activities, you must ensure you protect members’ interests as consumers.

We have yet to see meaningful improvement in operational effectiveness metrics. Recurring cost income ratios, which average 80% across the sector, are unsustainable. The concern is that surpluses after operational costs leave little headroom to fund business model development and the maintenance of capital buffers. Given the prevalence of high cost income metrics, we continue to stress the need to tackle operational effectiveness, and the costs to serve members.

Overall, what does the recent Financial Conditions Report tell us about the sector? It is clear that many credit unions continue to face significant financial challenges which question their sustainability.  Whilst today many credit unions hold strong capital positions, sector sustainability requires meaningful business model change, and will likely involve continued sector restructuring.

For many of you, business model change in an imperative. Before considering what the sector and credit unions have been doing in that regard, it is worth setting out what we as regulator have done to assist and support you on your journey.

Regulatory initiatives

In the Registry we recognise the business model change imperative. We have sought to provide input and support within the confines of our regulatory role, clear that credit unions own their business model agenda. From a business model development perspective, examples of the support we have provided include:

Setting up a dedicated Business Model Engagement Unit in 2016 within the Registry. Through this we have undertaken numerous direct engagements with individual and groups of collaborating credit unions, advocacy bodies and their commercial arms, regarding a range of business model initiatives;

1. Granting regulatory approval to 53 credit unions to provide fully functioning current accounts as an additional service¹¹
2. Establishing a CEO-led Forum on Business Model Development under the independent chair of Professor Donal McKillop, aimed at facilitating business model collaboration between CEOs
3. Publishing guidance materials including our December 2017 Long Term Lending Guidance, our February 2019 Business Model Strategy Guidance and our recent circular on investing in and outsourcing to credit union owned service providers (CUSPs); and
4. Demonstrating regulatory responsiveness, through consulting on, listening to and engaging with you on a number of important regulatory framework changes in areas that you have advocated for.

It is clear that a lot has been done. Our input from a regulatory standpoint is designed to support credit union boards as they seek to determine and implement business model changes. So what has been happening at credit union and sector level?

Sector business model developments

We have consistently drawn attention to the importance of credit union collaboration in addressing business model change. It is fundamental to addressing scale efficiencies and accessing technical expertise not available to all.

There is an increasing level of collaboration emerging amongst credit unions. The launch by 30 PAYAC credit unions of a current account service in October 2019 is one interesting and practical example. Another is the Metamo joint venture arrangement.

Collaborating credit unions continue to bring forward initiatives with their business partners, including CUDA’s Solution Centre. I understand that the CEO Forum steering group will shortly publish a paper on collaboration best practices.

We also see an increasing level of shared service supports emerging, involving both established and new entrants. Indeed many of you are supported by the Solution Centre’s SAM framework and its new digital transformation programme.

I am also aware that CUDA’s Solution Centre is heavily engaged in the CEO Forum workstream on Revolving Credit. Revolving credit can help to meet specific member credit needs, enhance the lending offering and improve operational effectiveness. Given the operating cost challenges referenced earlier, we welcome efforts to improve efficiencies where credit underwriting standards are not compromised.

All of these activities are important steps forward in the right direction. Whilst they represent an early stage emergence of business model development at credit union level, they have yet to meaningfully deliver on members’ needs, generate sustained income or contain operating costs. In short, business model transition is still at an early stage, and will undoubtedly bring challenges over the course of the journey.

Conclusion

Credit unions fulfil an important role in the Irish financial services landscape, where you have built up a strong level of trust with your membership.

Challenges to your commercial fundamentals remain, reflected in your key financial health metrics.

Some in the sector continue to suggest that the regulatory framework is the barrier to business model development. However, the real challenge for credit unions relates to commercial fundamentals. Meeting this challenge requires credit union ownership of business model development. The framework already facilitates growth, and encourages strong governance and risk management standards, to protect members’ interests.

The level of change and competition in financial services continues to increase at pace. Credit unions must determine their role in this rapidly evolving financial services market.

Collaboration is key to prudent business model development, both as credit unions seek to avail of scale benefits and access technical expertise not currently available. I acknowledge the work of the Solutions Centre, CUDA’s commercial arm, which facilitates access to collaborative opportunities for many credit unions represented at the conference today.

While I congratulate you on those projects delivered to date, I think we can all agree that much more needs to be done, to reach the destination of your Journey to the Model Credit Union.

Although there are a number of initiatives underway, there are dangers in fragmenting efforts and resources across too many opportunities. Reaching your destination, in terms of measurable success, will require delivery of members’ needs on a basis that is financially sustainable.

The recognised trust and regard of members is a strong basis from which to grow new products and services. In transitioning, credit unions must retain the valued member-centric ethos they are recognised for. Members’ trust that has been built up over time can be lost very quickly if their best interests are not protected – which presents food for thought as you seek to pursue a more complex business offering.

I would like to thank you for your attention and I wish all of you well for the remainder of your conference. Thank you.

¹Section 84 of the Credit Union Act, 1997.

² Amarach Research, Ireland's CX Champions 2019

³Department of Finance, Report of the Commission of Credit Unions, 2012

⁴Central Bank of Ireland, Long Term Lending Guidance for Credit Unions

⁵While there was no specific concentration limit in relation to house lending under the previous lending framework, at a sectoral level credit unions, based on June 2019 Prudential Return data, could lend up to €1.63BN over 5 years and, of this, €566M could be lent over 10 years. Total utilisation of this capacity was €997M and €210M respectively. In terms of commercial lending, as at June 2019, at a sectoral level credit unions could lend up to €991M; total utilisation of this capacity was €113M (capacity utilised is taken to include all commercial loans). 

⁶Central Bank of Ireland, Credit Union PRISM Supervisory Commentary, 2019

⁷Section 32M of the Central Bank Act 1942 sets out the requirement for an international peer review to be carried out every four years.

⁸ICURN, Guiding Principles for the Effective Prudential Supervision of Cooperative Financial Institutions, 2011 and ICURN, Enhancing Governance of Cooperative Financial Institutions

⁹ICURN, Central Bank of Ireland's Performance of its Regulatory Functions in Relation to Credit Unions, 2019

¹⁰Central Bank of Ireland, Financial Condition of Credit Unions, 2019:II

¹¹In accordance with section 48-52 of the Credit Union Act, 1997.