"Commercial change and member lending can deliver sustainability" Registrar of Credit Unions Patrick Casey

Address by Registrar of Credit Unions Patrick Casey, to the Irish League of Credit Unions Annual General Meeting - 24 April 2021

President, ILCU Board members, ladies and gentlemen, I am delighted to be addressing your 2021 virtual AGM.

The pandemic has resulted in unprecedented challenges. We have seen extreme measures taken to protect public health, triggering an extraordinary economic shock.

For credit unions, like others, this has presented many operational and financial challenges. Those challenges continue. The full impact of the shock will take time to unfold.

To date credit unions have been very effective in maintaining continuity of services to members. This is thanks to the hard work and commitment of credit union directors, managers and staff, as well as collaboration between credit unions.

Over the last twelve months we have had constructive and regular engagement with your representatives. For that, we thank your President Gerry Thompson, CEO Ed Farrell and all those involved.

The sector on aggregate reported a surplus for the 2020 financial year. Nonetheless, pre-pandemic commercial challenges continue to hamper credit union business model sustainability. Across the sector, many individual credit unions continue to face acute financial viability concerns.

In the face of this, all credit unions need to continue to strengthen their operational and financial resilience, supported by robust risk management.

For us - the emphasis on your resilience aligns with our statutory mandate. For you - it is important now given we are in a time of crisis, but also because many credit unions are already trying to manage the disruption caused by restructuring and/or business model change.

2021 is a pivotal year for all businesses, including credit unions. In my address this morning I will reflect on some key sector developments over the last year, before outlining our 2021 work priorities.

1. Recent sector developments  

Much of the Central Bank’s focus during the pandemic has been on mitigating its effects. The economic challenges posed have been met by extraordinary policy support. This has included a range of fiscal, monetary, macro-prudential and micro-prudential policy actions, to support households, businesses and vulnerable borrowers.

Financial Conditions Report

In December 2020, we published the 7th edition of the Financial Conditions Report[1].

Credit unions came into the crisis with a strong financial position - with sector average reserves of 16.5% and liquidity of 36.8%[2]. A year on, sector reserves and liquidity levels have remained relatively stable[3].

However, the full impact of the pandemic is still to be realised. This highlights the critical importance of all credit unions adhering to minimum regulatory requirements, and prudently taking capital and liquidity decisions, involving additional buffers. 

One of the most striking features of the trends in 2020 is the expanding gap between savings and loans. Managing savings inflows versus lending is a core part of your broader commercial challenge today.

The CEO Forum on Business Model Development

We initiated the CEO Forum in July 2018 to encourage greater collaboration between CEOs on business model change. We welcome the recent publication of the Forum’s workstream materials[4], as they offer a timely contribution to sector development.

With the CEO Forum now operational, as planned we have stepped away from our secretariat role. The Steering Group is currently commencing the next phase of the Forum’s development. We wish those involved well, and we look forward to continuing our engagement with them.

PRISM Supervisory Commentary

In September 2020, we published the fourth edition of the PRISM Supervisory Commentary[5].

We are encouraged to see instances of effective governance in some credit unions. The overall picture however is not so positive. We continued to identify examples of fundamental governance and risk management weaknesses in many credit unions. Recurring risk issues here are a prudential concern. They evidence a lack of maturity in the credit union risk management process.

Risk management is a central part of good governance, and is a critical line of defence in the protection of members. Our concerns here can only achieve so much – what we want is credit union boards to translate our findings into actions. Accordingly, enhanced risk management by credit unions is a key feature of our 2021 supervisory strategy.

The two other risk areas that stand out in our findings are credit risk and operational risk. During a time when so much sector advocacy has focused on credit union lending capacity, we continued to evidence basic, fundamental weaknesses in lending frameworks and underwriting practices (including examples of failure to assess the repayment capacity of members accurately). As lenders, this is not acceptable.  

From an operational risk perspective, credit unions have also become more reliant on increasingly complex IT systems, as well as on outsourcing to third parties. Deficiencies were identified in IT frameworks, IT risk management and oversight of outsourcing. In short, there are clear gaps in many credit unions’ operational resilience.

We expect the findings of the 2020 PRISM Supervisory Commentary will be considered by all credit unions. I would also encourage you to read a recent speech by Central Bank Deputy Governor Ed Sibley to the Institute of Directors, entitled: “Governance and risk in a time of uncertainty and change”[6].

Liquidation of Drumcondra

In July 2020, we obtained a High Court liquidation order following Drumcondra Credit Union’s failure.  While the root cause of its problems ultimately lay in poor governance, they manifested as financial impairments and viability issues.

Drumcondra failed despite a 2016 standalone recapitalisation from ILCU[7]. Drumcondra’s board eventually accepted it could no longer operate on a standalone basis. Subsequent attempts to complete a transfer failed. We undertook an orderly and managed resolution to protect members’ funds and the sector’s overall stability. Recent developments will hopefully ensure alternative credit union access for members.

Our preference remains for troubled credit unions to address viability without formal resolution action. As Drumcondra demonstrates, it is difficult for failing credit unions to achieve sustainability on a standalone basis, notwithstanding external support. We therefore continue to encourage weak credit unions to seek a transfer solution as early as possible, including requesting funding support from ILCU if necessary.

Sector Engagement

COVID-19 has precluded any onsite activity at credit unions in the past year. Our supervisors instead engaged directly with credit unions more frequently on specific issues. To support this, we have also issued an increased number of credit union circulars on a range of topical issues[8].

In April 2020, we provided certain regulatory flexibility to credit unions on a temporary basis – in line with other regulated sectors – covering reporting dates and risk mitigation plans. 

Since the pandemic unfolded, we engaged even more frequently with representative bodies, often on a weekly basis.  In the interests of transparency, we also published detailed correspondence on a range of policy questions raised with us. In December 2020, we also held a virtual information seminar attended by over 250 people across the sector[9]. 

Regulatory and Legislative Developments

2020 saw a number of key credit union framework changes.

Last year we introduced additional house and business lending capacity, and published the application process for larger credit unions seeking regulatory approval for further lending capacity[10] at 15% of total assets.  

We also introduced further changes to the credit union investment and liquidity regulations[11] covering:

• Brexit transitional arrangements whereby credit unions - if they so choose - are permitted to continue to hold existing investments in UK credit institutions until maturity.
• Changes to the definition of “relevant liquid assets” to include excess minimum reserve account balances.
• An extension to the permitted maturity limit for Irish and EEA State Securities and supranational bonds.

The Central Bank also provided input on Oireachtas changes concerning virtual general meetings. Where credit unions want to ensure they continue to have the option to hold virtual general meetings in the future, they will need to pass a rule amendment at their 2020 AGM, or at an SGM held during the interim period which I understand has been extended until the end of June 2021.

So they are some of the key developments over the last year. I will now outline our 2021 work priorities.

2. Our Strategic Priorities for 2021

The Central Bank serves the public interest by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the wider economy.

Our vision for the sector remains: “Strong Credit Unions in Safe Hands”, where 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, and where they can be resolved when they get into difficulty; and
• Credit unions are ‘in Safe Hands’ when they are effectively governed, professionally managed and staffed by competent, capable people, who take ownership of and prudently manage current and emerging risks.

Our vision underpins our statutory mandate to ensure each credit union protects the funds of its members and the maintenance of the financial stability and well-being of credit unions generally. We seek to implement that vision through our four strategic priorities, which I will now refer to in the context of our 2021 work priorities:

A. Effective and Proportionate Supervision:

As supervisor, we expect credit unions to function with the benefit of strong governance and robust risk management.

Our 2021 supervisory engagement will include a thematic review of credit union risk management, in particular to assess its overall embeddedness. Greater ownership by boards of risk management is critical to overcome the recurring risk issues identified in our 2020 PRISM Supervisory Commentary.  

Enhanced data and reporting capabilities are essential to facilitate continual assessment of the range of credit union risk considerations. It aligns with our stated desire to enhance the use of data analytics in supporting effective supervision. Data is also an important resource for boards as they assess the financial resilience of their credit union, using key performance and risk indicators.

B. Managing disruptive change:

Credit unions are experiencing ongoing disruptive change through restructuring and business model innovation.

Sector Restructuring

Restructuring plays a key role in sector sustainability:

• By addressing governance, solvency and financial viability issues in weaker, smaller credit unions;
• By providing members of such credit unions with access to enhanced products and services in larger credit unions; and
• By providing strategic growth opportunities and potential scale benefits to those larger credit unions.

The nature of restructuring continues to evolve. Whilst most transfers continue to see weaker, smaller credit unions being absorbed by stronger, larger peers, restructuring proposals are under consideration at all levels across the sector.

We recognise the critical role that ILCU plays in this area.  We ask that credit unions continue to assess the opportunities that restructuring may present to your credit union, and to contact us to discuss any potential transfer options that are under consideration.

Business model innovation and climate change

Alongside restructuring, business model change and innovation has an important role to play in sector sustainability.

Advances in technology are bringing rapid and transformative changes to the financial services sector. All users of financial services, including credit union members, expect innovation to offer them benefits as their needs evolve. Whilst others are embracing the process of innovation, it has yet to gain real traction in the credit union sector.

For 2021, we will continue to engage with those credit unions involved in the business model agenda, providing our regulatory input and challenge as appropriate.

Going forward, all financial service providers, including credit unions, will need to take account of other disruptive factors such as climate change. The issue of climate change will present new challenges, generating both potential risks, and opportunities, for the sector.

C. Tailored and Proportionate Regulation

Our expectation is that credit union framework change must slow. Perennial changes in legislation or regulation will not address your commercial challenges, you must tackle those yourself.

Reflecting this, our focus in 2021 will be on the implementation of recent framework enhancements. We are reviewing the impact of 2018 investment framework changes, guided by our mandate and risk appetite.

D. Sector Engagement

We engage proactively and transparently with credit unions, and value our bilateral interactions with the sector and its representatives.

In 2021, we will continue our extensive two-way communication and engagement with individual credit unions and sector stakeholders.

Conclusion

Pre-pandemic commercial challenges are contributing to the sector’s growing imbalance between savings and loans.  Whilst most credit unions have weathered the storm to date, uncertainty continues to cast a shadow over recovery.

The future is likely to contain low interest rates, reduced consumer credit demand and technology-led change. All of this will continue to force individual credit unions to evolve their business models to remain relevant to members.

Today credit unions retain the deserved trust of members. To retain this, members must remain confident that their savings are protected – strong, robust risk management is central to this.

Your real challenges are commercial in nature and are about finding ways to lend to your more economically-active members. While long term lending continues to feature in a lot of sector commentary, 2020 only saw an increase in house and business lending of c.€36 million and c.€2 million respectively.

Minimum capital requirements are not a barrier to increasing credit union lending – which is the principal driver of income, itself the only means of generating retained earnings to replenish capital.

Credit union boards have prudently chosen to hold capital above minimum levels, helping to underpin broader confidence in the sector in a period of crisis and change.

For those credit unions who struggle to generate capital, reducing minimum capital levels for everyone is simply not the answer – it would risk members’ savings and could significantly undermine confidence in the sector. For weaker credit unions, restructuring offers the best strategy to protect members’ savings.

Lending to more economically-active members offers a path to sustainability. It puts members’ savings to a productive use aligned to the objects of credit unions. It will ensure an ongoing funding need for growth in savings, and will help to mitigate the imbalance between savings and loans.

I will conclude there – many thanks for your attention.

[1] Financial Conditions of Credit Unions, 2020: I.

[2] As at 30 September 2019.

[3] The average sector reserves position was 15.9% and average sector liquidity position was 34.4% as at 30 September 2020.

[4] https://cuceoforum.ie/workstreams/.

[5] PRISM Supervisory Commentary 2020.  

[6]“Governance and risk in a time of uncertainty and change” - Deputy Governor Ed Sibley.

[7] The Irish League of Credit Unions

[8] March 2020, circular re COVID-19, April 2020, circular re regulatory flexibility, June 2020, circular re payment breaks in credit unions and November 2020, a circular was issued re a further update to supervisory flexibility measures.

[9] 2020 Information Seminar presentations.

[10] Application Form for 15% Combined Concentration Limit for House and Business Loans – representing 15% of total assets.

[11] Credit Union Act 1997 (Regulatory Requirements) (Amendment) Regulations 2020.