Address to the National Supervisors Forum - Frank Brosnan, Deputy Registrar of Credit Unions

Madam Chairman, members of the Executive, Charles Murphy, President of ILCU, ladies and gentlemen, I am delighted to speak here today at the 2017 AGM of the National Supervisors Forum. I want, first of all, to thank your outgoing Chair, Margaret and your Executive for their constructive engagement with us, on your behalf, over the last year.

 The theme of the today’s conference - ‘Working as a Team ’ - is particularly relevant. It refers, not only to harnessing the talent within the credit union at all levels, but also speaks to the importance of cooperation and collaboration between credit unions across the sector in terms of the prudent scaled growth of their business. Deriving the benefits of working as a team requires the clarity of a shared vision supported by considered and realistic strategies to achieve that vision. I will return to this important issue later.

Credit unions deservedly enjoy a positive brand, as highlighted in the recent CXi¹ rankings in which credit unions were rated for the third consecutive year as the top brand in Ireland when it comes to customer experience.  In the current environment, that accolade is not easily won by any financial institution and it reflects positively on the relationship of trust that exists between credit unions and their membership. The key challenge for credit unions is to translate this relationship to being the lender of choice. This is not easy.

In the course of this speech, I would like to set out some of the key issues in 2017, including

1. Credit Union Financial Trends
2. Business Model Issues
3. Credit Union Governance and finally
4. Policy Developments

Credit Union Financial Trends

In February this year we published “The Financial Conditions of Credit Unions 2011-2016”². This new publication is a statistical information release with the primary focus of assisting credit unions in analysing the performance of their credit union relative to peer groups and to provide insights to the sector on key trends that we see based on our analysis of the data submitted to us. While also highlighting a range of positive trends, in relation to reductions in the levels of arrears and provisioning required, it illustrates some of the continuing challenges for credit union business models.

In particular, it is of concern that the sectoral Loan to Asset (LTA) ratio, despite increases in nominal lending volumes, remains at 27%.  Declining investment returns and a persistently high cost base is putting significant pressure on Return on Assets (ROA), at 1.2% (gross average) and this limits the potential for dividend payment and further necessary investment in member services.

Whilst 2017 Prudential Returns indicate continued growth in lending volumes, it is insufficient to increase the underlying average LTA. The average cost income ratio of 73% remains stubbornly high, and is an area for credit union focus.

A further Central Bank publication, the Household Credit Market report³ positively notes that the size of the sub five year Irish household credit market, core to Credit Union lending (at 87% of your loan book⁴), is the segment of that market that has experienced greatest growth this year, increasing by some 14.3%. This is also a segment of the market that is beginning to see increasing competition from existing and new market entrants in search of higher yield. It is to be expected that as part of their strategic planning, credit unions are considering their strategies to protect and possibly increase their share of this market which is so core to their lending activity.

Business Model

Given business model challenges and aspirations, how credit unions prioritise investment of management time and financial resources becomes increasingly important. Decisions to proceed with investment in new services and/or expansion into new ventures requires critical assessment of the costs and benefits as they apply to the credit union and its individual situation in terms of membership profile, common bond, and financial capacity. In a scenario of limited resources (both human and financial), the credit union needs to prioritise, as seeking to achieve too much with limited resources can lead to unsatisfactory outcomes across the board, as opposed to strong performance in a small number of areas, including those where the credit union has demonstrated expertise and a differentiated proposition. 

The matter of longer-term lending and home mortgages as an increased proportion of total lending is topical and we anticipate further meaningful engagement in this area in coming months. The impact of increased longer term lending on balance sheet structure, liquidity, ALM and return on assets is material.  Clearly longer term lending covers a wide range of activity, some of which is a natural extension of existing core lending, while others have different dynamics, risk profile, profitability and legislative and regulatory considerations.

Depending on individual credit union profile, risk considerations can be considerable and in the case of mortgages, the credit union is subject to a range of additional domestic and European legislation from issuing its first mortgage and needs to understand product dynamics, compliance requirements, payout patterns, cost implications and impact on ROA.

In their analysis, the issue of scale economies needs to be considered and sectoral collaboration in the form of shared services or alliances with like-minded credit unions are an emerging trend. The capacity to access specialist services that would otherwise be unavailable or unduly expensive to an individual credit union is an obvious benefit of a shared services approach. 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.

As part of our engagement on prudent business model evolution , we will shortly issue a considerations paper on Longer Term Lending for credit unions setting out certain key considerations that their analysis should address in selecting new business lines and product offerings.

Separately, the appropriateness of current longer term lending limits is an area of ongoing review within the Registry, and an area of focus for the CUAC Implementation Group and the Oireachtas Finance Committee whose reports are due shortly. Clearly of importance here is not just a recalibration of existing lending limits to address perceived short term business challenges, but also it also requires informed credit union consideration of the impact on balance sheet structure arising from such changes and developed consideration of products and approaches to address maturity gaps.

Ultimately, it is the responsibility of the credit union Board to ensure they understand the relative dynamics and complexity of new products and services and demonstrate that they are within the credit union strategy, risk appetite, competence and capability.  As Board Oversight Committee members you are in a position to evidence and challenge the quality of such consideration and debate by credit union Boards.

Governance

Successful delivery on business model change is fundamentally reliant on the key functions in credit unions operating effectively to support business model development. Sound governance and effective systems of control are an essential foundation to underpin development of the credit union sector and it is important that credit unions embed systems and controls to acceptable levels before considering significant business model development.

While standards of governance have improved across the sector, this is not uniform, and there is a need for continuous focus in this key area as it is fundamental to well run and strongly performing entities.  The absence of proper governance culture inhibits the credit union, not only from meeting minimum legislative and regulatory requirements, but also inhibits the credit union from effectively responding to emerging business challenges. It is notable that c 40%⁵ of the RMP findings arising from our 2017 PRISM engagements relate to Governance weaknesses, emphasising this as an area for continued focus.

The Credit Union Act provides significant detail on the range of responsibilities of the Board, the Management and Board Oversight Committee. These are minimum standards and while they support good governance, it is clearly calls for more than a compliance attitude but rather a governance culture. One of the better definitions of good governance I have found was not from financial regulation but rather from Sport Ireland:

“Good governance means that policies and procedures are in place to ensure an organisation is run well. Good governance is not all about rules and regulations. It is an attitude of mind. It is about the ethical culture of the organisation and the behaviour of the people on the governing body. An organisation with good governance should demonstrate transparency, responsibility, accountability and participation with all their stakeholders.”

So in credit unions with a positive governance culture, we tend to see open challenge and mature debate at board level which drives informed insight and an appreciation and understanding of the roles of all stakeholders under the current legislative framework. We see clarity in respect of their strategy supported by a well debated and agreed risk appetite, which is understood at all levels within the credit union. These boards are not reluctant to take ownership of risk and proactively move to understand and address known business model challenges. We see strategic thinking informed by a realistic understanding of the organisation’s operational capability to implement stated goals and objectives within prudent risk parameters. We see an appropriate oversight of the operations of the credit union including outsourced activities. Critically we see the risk management framework of internal audit, risk management and compliance embedded and utilised in supporting the Board in the discharge of its functions and seen as a value add rather than a cost overhead.

In turn, such progressive boards seek to prioritise the investment necessary to ensure strong and capable management teams with the necessary skillsets and expertise to deliver on the organisation’s strategy and where necessary, employ robust and reputable outsourced providers.

Fitness and Probity

In the context of governance, I would also draw your attention to the recent Consultation on Potential Amendments to the Fitness and Probity regime for Credit Unions CP113⁶, published on 8 September. It is considered that now would not be an appropriate time to align the credit union regime with the Fitness and Probity regime which applies to all other regulated financial service providers (RFSPs). CP113 instead proposes to prescribe an additional three PCF roles for credit unions. These proposed PCF roles are the:

1. Risk Management Officer (CUPCF-3);
2. Head of Internal Audit (CUPCF-4); and
3. Head of Finance (CUPCF-5).

In reviewing the Fitness and Probity regime for credit unions, the Central Bank’s objective is to ensure that the regime remains appropriate for the sector and to ensure that credit union members can have confidence that the persons holding key roles in credit unions are fit and proper to hold those roles. The Central Bank is of the view that current priorities should be around raising standards of competence and capability in key roles where supervisory engagement has identified weaknesses with a view to improving governance.

It is proposed that these roles would initially be prescribed as PCFs in credit unions where the total assets of the credit union are at least €100 million. The designation of these 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 52 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. While this restructuring activity has presented opportunities for these credit unions, challenges have also arisen. These challenges have manifested as the resulting larger credit unions have sought to integrate governance, branch offices and systems & controls and develop cohesive risk management frameworks aimed at ensuring that they are on a strong footing and poised to reap the potential benefits presented from restructuring activity undertaken. 

The consultation is open for responses until 10 November after which the Central Bank will consider all responses received. A feedback statement and final regulations reflecting any changes to the Fitness and Probity regime for credit unions will be published in Q1 2018.

Other Policy Developments

The Registry’s consultation on the Review of Fitness and Probity Regime for Credit Unions  and the consultation on Potential Changes to the Investment Framework for Credit Unions contained in consultation paper CP109 are two examples where the Registry has reviewed the current regulatory framework and is consulting publicly on potential amendments to the framework reflecting proportionality in our approach.

Investments

In order to ensure that the investment regulations remain appropriate for the credit union sector, the Central Bank undertook to review the investment regulations this year to consider whether it is appropriate and prudent, at this stage, to facilitate investment by credit unions in other classes of investments.

Notwithstanding the current challenging investment environment for credit unions including the current low level of interest rates, the Central Bank’s overriding priority, in considering potential changes to the investment framework for credit unions, remains our statutory mandate and the legislative requirement under section 43 of the 1997 Act for credit unions to ensure investments do not involve undue risk to members’ savings.

The Central Bank is supportive of credit unions increasing their investment options, including through potentially playing a role in the provision of funding for social housing and published a consultation paper on 11 May[7] setting out the following potential additional investment classes for credit unions:

• Bonds issued by Supranational Entities;
• Corporate Bonds; and
• Investments in Tier 3 AHBs .

The consultation period closed on 28 June and we have received over 70 submissions from a broad range of respondents.  The majority of submissions are from individual credit unions, with additional submissions received from representative bodies, AHBs, investment firms and TDs. We welcome this feedback, which is an important input into the policy development process. Following completion of review and analysis of the submissions received, a feedback statement will be published on the Central Bank website. As per the timeline outlined in CP109 we expect to publish the feedback statement and final regulations in early 2018.

Thematic Reviews

Turning to our supervisory engagement. In 2017 we continued to supplement our bilateral engagement under PRISM with a number of Thematic Reviews concentrating on emerging areas of potential concern, in order to better explore sectoral standards and as appropriate, highlight risks and articulate expected standards.

In the course of 2017, thematic reviews were conducted on

• Members Prize Draws 
• IT Risk Management
• Home Loans
• Bank Reconciliation and Cash Controls
• Post Transfer Of Engagement integration

The onsite work is scheduled for completion in Q4 2017 and reports including key findings and recommendations will be issued. Thematic reviews present important insights for credit union Boards and Management to consider in respect of the adequacy of their existing governance, risk management and control frameworks.

Conclusion

In conclusion, 2017 has been a busy year for the sector and Regulator alike. Given the current business environment, the challenges for responsive business model strategies is significant. This emphasises the need for clear and structured decision making at Board level, grounded in realistic assessment of capabilities and capacity and informed by a strong understanding of financial considerations and risk appetite. These are important considerations for each Board in defining the business model for their credit union. Your role, as Board Oversight Committee is especially important in observing whether key decisions are informed by appropriate risk analysis and mature consideration at Board level.

In the last year, the Central Bank established a dedicated Business Model Unit to engage on business model changes with credit unions in order to drive forward well-developed proposals which are supported by risk focussed business plans and key financial analysis that includes implications for return on assets and balance sheet impact. While we welcome bilateral engagement, we encourage in particular proposals that have wider application and potential benefit across the sector.

Credit unions have strong foundations from which to evolve their business model, not least the strong trust of their members, and the challenge for many credit unions now is how best to intermediate this trust into more responsive, viable and substainable business models.

It is a matter for credit unions and their sectoral leadership to develop how this may best be achieved and, for our part, the Central Bank is available to engage constructively on any proposals.

Finally, I would like to thank all of you for your attention. I trust you will have an interesting and engaging conference and wish you well with the important challenges ahead.