Regulatory Strategy - Strong Credit Unions in Safe Hands
1 June 2012
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Good evening ladies and gentlemen and welcome to the second year of the Credit Union Regulatory Forums. It is a pleasure for us to be here and we are looking forward to constructive discussions over the next few weeks at the various locations around the country, on the current and future regulation of the sector.
Last year the Regulatory Forum was attended by over 900 invitees and the feedback was tremendously positive. As you know the Forum is aimed at those who hold, what we consider, the ‘key responsible positions’ in credit unions. In our view, these ‘key persons’ – chairman, vice-chairman, treasurer, chair of the supervisory committee and manager - hold the greatest responsibility for ensuring the protection of their members’ savings and the financial stability of their credit union.
This year we have decided to hold the Forum earlier in response to feedback. We are looking to build on the positive discussions we had directly with individual credit unions last year and work together with the single aim of seeking to ensure that the credit union sector is put on a sound footing and remains viable in the long term.
Times are hard. The business environment for all credit unions is tough – you don’t need me to tell you that. Balancing the needs of member borrowers while protecting the rights of member savers – i.e. the right to expect that their savings are safe – is a challenging and stressful responsibility in these difficult times. But nobody should expect that running a financial institution is an easy task. Directors, managers and credit union supervisors are accountable for their actions and strong financial and business discipline is equally important – and even more so - in the bad times as well as the good.
This evening I want to talk about our regulatory strategy for the credit union sector. But first I would like to say a few words on why there is a need for this regulatory approach.
The credit union movement has been in existence in Ireland for over 50 years. The penetration into the Irish market is extensive with over 2 million reported members and the loyalty of the membership is unquestionable. Yet when we look at the current trends emanating from within the sector we must face up to reality.
We are concerned at the continuing sharp increase in arrears in many credit unions and the potential exposure of some to further investment losses in their portfolios. Falling income, a static cost base and downward pressure on dividends are all indicators that the sector remains under significant stress.
An increasing number of credit unions have migrated into the high-risk category and are on our supervisory watchlist. There are also an increasing number of credit unions showing signs of potential solvency problems. We are pro-actively dealing with these credit unions and are taking the necessary regulatory actions.
However, all of these trends are pointing to the likelihood that more credit unions could be heading into financial difficulties. Our strategy is designed to be ready to take pre-emptive remedial action to maintain member confidence and protect the financial stability of the sector should these trends continue. It is likely that many of these problems could crystallise at the credit union year-end as auditors take a closer look at the books than some might have taken in the past. We want to be ready to ensure confidence in the sector is not undermined.
It might be convenient to put the stresses now evident in many credit unions down to the difficult macro-economic environment we are now experiencing and there is much truth in that. However, this is only partly the reason. For those increasing number of credit unions who now find themselves in financial difficulty there is a recurring trend – they have been poorly governed by boards and management and effective oversight by the supervisory committees has been non-existent.
Many of the poor governance practices have come about in part due to the current loose legislative framework in place for the prudential oversight of the sector, but also because of the general poor compliance culture built up in many credit unions over the years.
It is pleasing, however, to see attitudes to compliance changing. Those directors and managers who have consciously upgraded policies, processes and controls in recognition of the ‘job to be done’ are to be commended. In order to build on this we now see the immediate introduction of statutory requirements in relation to governance and competency as being vitally important in putting a clear framework in place in relation to responsibility and accountability.
An appropriate fitness and probity regime for the credit union sector will help to strengthen governance and ultimately enable prudent development into other areas of business. We have asked the Department of Finance to commence the fitness and probity provisions contained in the Central Bank Reform Act 2010 for credit unions and will be bringing forward proposals to credit unions in this regard shortly.
So, turning to our strategy.
Our strategic vision is ‘Strong Credit Unions in Safe Hands’. The foundation on which our strategy is built is on the belief that strong, well-governed credit unions, led by volunteers and retaining their local identity should remain an important part of the financial landscape of Ireland.
There is opportunity for the credit union sector to take advantage in the current re-shaping of the financial sector and our strategy is designed to allow credit unions to develop. We will look to credit unions to be supportive of our regulatory strategy and we will accommodate the development of well-thought out proposals put forward by financially strong well run credit unions.
Many of you will also be aware of the keen interest the external authorities have in the financial strength of the credit union sector in Ireland and the establishment of a strategy to enhance the viability of the sector is one of the key commitments made under the EU/IMF ‘Programme of Financial Support for Ireland’.
Our strategy is based on the following three key pillars:
- Resolve weak and non-viable credit unions quickly and efficiently to protect members’ savings and maintain the financial stability of the sector;
- Establish an adequate legislative and regulatory framework to protect the financial stability of individual credit unions and allow the sector to develop; and finally
- Bring about longer term restructuring of the sector to ensure its long-term sustainability.
The first two elements in this strategy come under a short-term regulatory agenda designed to address deficiencies in the current prudential framework for credit unions. The third is part of a longer-term reform agenda to ensure that the credit union sector can remain viable in the long term.
The delivery of this strategy is dependent upon the passing of legislation to provide the necessary regulatory toolkit, leadership in the development of a co-ordinated strategic vision for the future and a willingness on the part of all stakeholders to urgently address the issues arising in the sector in a constructive and collaborative fashion.
Resolution of credit unions
Turning first to the resolution of weak, or non-viable credit unions.
Credit unions that do not have the financial strength to weather the current difficulties – either because of a policy of running with low reserves, or because of the financial impact of poor management and business decision-making in the past – are now being severely exposed.
We have re-designed our supervisory framework to provide for the early identification of weak or non-viable credit unions. We have carried out loan book reviews for all credit unions and are in the process of finalising a stress test of the sector in order to make an assessment of the likely impact for a given stress scenario on the capital buffers of all credit unions. The purpose is to provide us with the necessary regulatory information to concentrate our supervisory focus.
We have also established a framework to allow for pre-emptive intervention in the case of weak or non-viable entities. This process is designed to allow us to act early and bring about resolution in a speedy and efficient manner.
In all cases we will engage fully with those weak or non-viable credit unions to seek an agreed solution. However, where this is not possible we will use all of the legal and regulatory tools available to us to bring about speedy resolution. Sometimes this will involve a transfer of engagements of the weak credit union to a strong one. It is important for credit unions to understand that where this is the solution, we endeavour to ensure that the process is as seamless as possible from the member point of view. The offices of the transferred credit union remain open and carry on business as usual, albeit under the control of the acquiring entity.
We have been working over the past number of months towards the establishment of a statutory resolution mechanism to stand ready to help credit unions falling into financial difficulty. This is important to maintain member confidence and protect the financial stability of the sector.
We welcome the recent announcement by the Irish League of Credit Unions in relation to initial discussions with us regarding the establishment of this statutory resolution mechanism. An important feature of the mechanism is the need to establish a statutory fund to support the resolution work and we will be engaging with all stakeholders in the sector on this matter shortly.
Legislative and Regulatory Framework
Moving on to the establishment of an adequate legislative and regulatory framework.
We have for a long time now pointed out the inadequacy of the regulatory framework for credit unions. In the Grant Thornton Strategic Review Phase 1 report, the risk profile for the sector reveals that a significant proportion of credit unions fall into the ‘high and medium high risk’ categories. Grant Thornton concluded that Ireland has too many credit unions that are functioning at an inappropriately high-risk level. This corresponds with our own analysis of the sector and we believe that that a proper legislative and regulatory framework built on responsibility, accountability, compliance and above all prudence, must be put in place immediately to prevent further migration of credit unions through the risk categories into the ‘higher risk’ end.
The regulatory framework, in the first instance, will need to be tightened considerably to rein in the risk appetite of individual credit unions to match their capabilities and realign the overall risk-profile of the sector to a more appropriate level. Fitness and probity requirements, lending rules, investment rules, sectoral and concentration risk limits, standards for IT and risk management systems are all among the suite of regulations that must be established to protect the financial stability of the sector. Any new regulatory framework must of course allow those credit unions better able to manage a wider range of services, to do so.
The introduction of a ‘Prudential Rule Book’ would also have the advantage of ensuring that credit unions were in no doubt as to the parameters in which they are permitted to operate and perhaps more importantly for some, what was required should they want to increase their business and operational risk profile.
This would effectively mean a ‘tiered’ approach to regulation and allow for those credit unions that have the capacity to expand to do so in a prudent and controlled manner. Without such a framework, better and stronger well-run credit unions will continue to be at a disadvantage to the detriment of the sector’s development.
Under the EU/IMF financial support programme there is a commitment to submit legislation to the Oireachtas to provide for a strengthened regulatory framework by the end December 2011. We are working to this timeframe and we will be consulting with the sector shortly in this regard.
Turning finally to the issue of re-structuring.
The Government is committed to establish a ‘Credit Union Commission’ to review the future of the credit union sector. We welcome the establishment of the Commission and look forward to playing our part in this work.
The current negative financial trends for a large proportion of credit unions are a clear indication of the need for change to the current operating model for the sector. Four hundred autonomous entities competing in a relatively small market is no longer sustainable.
There is a slide accompanying this speech which shows the level of individual credit union penetration by county. By any stretch of the imagination even if the numbers of credit unions were significantly reduced in each county, every one would still be well served.
If the sector is to develop in any significant manner then re-structuring will be required to build economies of scale and provide for the necessary support and control frameworks and IT systems to drive such development. A major challenge for the sector now is how to drive out inefficiencies in the credit union cost base and for the majority of credit unions this can only be achieved through co-operation and coming together to build strength in unity.
Currently, the level of co-operation among credit unions can range from the simple sharing of back office functions right through to transfers and amalgamations. While this is happening to some degree, the pace of change is slow.
If the credit union sector is to be sustainable and play a significant role in a new financial services structure in Ireland, then the existing operational model must change, but in a planned and co-ordinated manner. This calls for ‘joined up thinking’ and we want to avoid any chaotic rush to amalgamation as credit unions play for position. Before any decision is made on a new operational structure significant analysis would need to be carried out on how to mitigate the risks involved and set out in detail a formal plan on how to manage the migration from the existing position.
So what are the options?
Let me first say that any proposals for a new operational model for the sector must consider how to:
- Firstly, retain the character and identity of the sector taking account of the ‘not for profit’ and volunteer ethos;
- Secondly, improve the level of services available for members; and most importantly
- Maintain the level of local penetration and membership by providing for the retention of local knowledge and day-to-day oversight.
So how can this be achieved?
There are many international models as examples. The basic premise is that functions are centralised to provide support for the local credit union, strengthen its financial position and enable a better service offering for its membership.
There are many ways this can be achieved – for example a starting point may be the sharing of services among two or more credit unions. This could then develop into:
- A planned mergers/transfers consolidation programme; or the development of;
- A Hub & Spoke model – where the ‘hub’ controls and services a locally operated ‘spoke’/branch, in which there can be any number of ‘hubs’ with any number of ‘spokes’; an alternative model for consideration is;
- A centralised model – where one central body controls all of the ‘member entities’ – a la Rabobank; and of course a combination of some, or all, of the above is also possible.
In the day to day operations there is little difference from the current position. There are fewer balance sheets but the same number of ‘outlets’ in the sector. The member is not disadvantaged in any way and local presence continues to be maintained.
While the Commission is the rightful place for this discussion to take place, I would be very interested to engage further on your initial views on this topic.
We believe that a financially strong, well governed and viable credit union sector has an important role to play in the future financial services landscape. However, the road ahead will continue to be difficult. Hard and in some cases un-popular decisions will have to be made by the leader stakeholders to meet the challenges ahead for the good of the sector’s future. We are ready for this challenge and I get a sense from talking to many of you that there is a growing appetite in the movement to ‘put shoulders to the wheel’. We welcome this.
Our strategy is built around a short term regulatory agenda to stabilise credit unions and allow the sector to develop prudently and a longer-term reform agenda to put the sector on a sound footing and ensure it is sustainable in the long term. Changes to the operational model must happen in a planned and co-ordinated fashion if the sector is to develop.
For all this to happen, strong leadership will be required. I believe that leadership is there in the movement. I am calling for it to stand up and be heard for the betterment of the sector and the members you are serving now and into the future.
That’s all I have to say at this point. I would like to ask that you hold any questions you may have until later in the discussion session and I will be happy to answer them then.
Thank you for your attention.