Address by Registrar of Credit Unions Anne Marie McKiernan at CUMA Spring Conference 2015 04 March 2015 Speech Mr. Chairman, Members of the National Executive of CUMA, Ladies and Gentlemen. Many thanks for inviting me to your Spring conference to discuss recent developments and special challenges in your sector. First, I would like to say a special thanks to your Chairman, Sean Hosford, and your colleagues for your open and constructive engagement with me and my colleagues at the Registry. Your conference theme today - “Credit Unions: The New Model” – is a good opportunity to focus on developing a constructive and forward-looking approach to your sector’s challenges. I fully appreciate, and am committed to supporting, the critical role that credit unions play in your communities, and in the financial sector generally. Our view of a revitalised model for credit unions is one that is risk and compliance focused, financially resilient, well-governed and thereby capable of protecting members’ funds. In my remarks, I will highlight some of the issues which credit unions need to focus on to deliver this revitalised model. In the context of sector financial developments and challenges, I will highlight the importance of embedding the risk and compliance culture, drawing on the picture emerging from the Annual Compliance Statements and our requirements when reviewing lending restrictions. I will also highlight the change in our supervisory engagement model for 2015. Then, I will look at some of the challenges you face in developing your business model and the need for care in assessing possible new products and services. I will give a brief update on the development of our regulatory framework and, finally, I will set out some thoughts on restructuring and resolution in the sector. Sectoral Update and Challenges As managers of credit unions, you are acutely aware of main issues facing your sector today. We are undoubtedly in an environment of great challenge, ranging from revenue pressure, rising operational costs, increased regulatory requirements, and business model difficulties. The longer term challenge is to attract new, younger members and to identify and provide the services they want and which will provide viable growth opportunities for your business. While increasing membership is welcome, it is important to gain members who use their credit union, as part of a focus on stemming the decline in lending in a prudent fashion. The latest sectoral statistics starkly illustrate the financial challenges which the sector faces. Since September 2013, loans to members have decreased by almost 10%, to €4bn. While the sector average loan-to-asset ratio has continued to decline and is now at 30%, over 200 credit unions are below this ratio, some significantly so. Total interest income has fallen by almost one half since 2009. While average sector arrears at end-September 2014 were around 17%, almost 10 per cent of credit unions had arrears exceeding 30% of their loan book. The average dividend for 2014 is continuing to weaken and is below 1%. A little over half of all credit unions remain subject to some form of lending restrictions. There are some small positives in the sector wide picture which we welcome – total arrears as reported by credit unions have decreased, for example, and there is a slight increase in new lending volumes. But overall it is a picture of continuing business and financial pressure. It is clear that changes are needed, and needed quickly, to safeguard the future of the credit union sector. Credit unions need to improve their revenue-earning capacity by tackling weak loan-to-asset ratios and to offer the range of services that meet members’ expectations. Each credit union also needs to consider any threats to viability, be they operational inefficiencies, loan quality, governance issues, marketing weakness, or other issues. The boards and management of each credit union have to take responsibility for developing sound business models and infrastructures which will help to secure the future of their credit union, by building a risk-based, financially sound credit union in which the funds and savings of your members are protected. Lending Restrictions One of our particular supervisory concerns has been credit risk management across the sector. I have publicly referred to our May 2014 PRISM report on a number of occasions, to highlight our concerns at continuing weakness in lending practices, credit assessment and credit control. While the PRISM engagement process has shown some improvements in this area over time, it is clear that many credit unions have yet to adequately address weaknesses in credit policies and controls to meet regulatory standards. Given the level of our engagement and communication with credit unions on this core issue, and key documents setting out our expectations (such as the 2014 PRISM report and the Credit Union Handbook), we expect credit unions to have embedded significant improvements in relation to credit risk management. We have used lending and other restrictions as temporary measures to reduce risks until our concerns have been addressed. Our expectation is that the sanction of a lending restriction would motivate credit unions to take all necessary steps to effect its speedy removal. Regrettably, this has not been our experience across the sector. Accordingly, to bring a renewed focus on this issue, we have now launched a review of lending restrictions. We have contacted all affected credit unions, setting out the business case to be made, and the required content, to apply for a review of the lending restriction. We require internal audit validations and other documentation to certify that prudentially sound practices are fully embedded in the credit union. We also want those credit unions who do not intend to apply for removal of their lending restriction to set out the reasons why and, importantly, to declare the current state of their remediation work and likely timeline for completion. This “comply or explain” approach is to ensure that all credit unions with lending restrictions are actively working on getting their credit risk management framework to the right prudential standard, consistent with their obligations to protect members’ funds and lend responsibly. Credit unions who do not address this issue in a substantive fashion must expect that we will use our powers to reduce the risk to members’ funds. Annual Compliance Statement : A snapshot This is the first year where credit unions have been required to submit a compliance statement. The preparation and submission of this first annual statement was an important tool to assess credit unions’ compliance with the governance framework and other recent changes in the Credit Union Act. I would like to acknowledge the efforts that you, as credit union managers, have put into ensuring your returns were completed and submitted on time. I would also like to give you some initial feedback on the picture emerging from the annual compliance statements submitted. Firstly, important progress has been made in having compliance issues identified, assessed and acted on. However, the level of non-compliance is still too high for comfort and further work will be needed to properly embed the compliance culture. Just over half of credit unions who reported non-compliance had “material breaches”, and most of the relevant reports in those instances were signed off by boards of the credit unions. We welcome this high level of sign-offs by the boards of the credit unions, which holds the board accountable and focuses attention on the importance of the compliance culture. The largest number of outstanding compliance issues related to policies which credit unions are required to have but were not in place at that time or not being reviewed, approved and updated by the board of directors. This mirrors some of the findings in our PRISM review last May and highlights that further improvements continue to be needed to ensure that policies are in place and guide decision-making. Other issues reported relate to business continuity plans not being tested and risk management systems, internal audit functions and related policies and procedures not being in place. While the annual compliance statement is an important element of the overall compliance framework, it is only one part of that framework. As credit union managers, you will be particularly aware that compliance is an everyday obligation in your credit unions. Each credit union is required to have in place the oversight, policies and processes, systems and controls, expertise and reporting arrangements to ensure on-going compliance with legal and regulatory requirements. The annual compliance statement and the report of material non-compliance provide the framework for credit unions to identify, assess and act on compliance issues in a timely way. I note that, in the majority of cases where material issues were reported, credit unions indicated that they will be remedied by the end of this month. It is critical that proposed actions are appropriate and are completed and suitably embedded in a timely manner. Our supervisors will be following up with individual credit unions to ensure that these actions are completed within the time frames indicated. As these first Compliance Statements were submitted at a time when credit unions were implementing a significant number of changes in regulatory requirements, I would expect that the level of compliance will increase significantly and quickly. I urge all of you to keep the focus on ensuring that the appropriate compliance culture is built up in your credit union and that lessons learned from the 2014 process are used to develop improved practices, policies and processes which safeguard your members’ funds. At the Registry, we continue to monitor the progress of credit unions in addressing issues identified. We are also reviewing the information received in compliance statements to determine whether further guidance may be warranted and if there are particular issues to prioritise, in advance of the submission of the next annual compliance statement (by 30 November 2015). 2015 Supervisory Engagement As part of our 2015 supervisory programme, we have extended the scope of our onsite engagement to credit unions designated as Low Impact under PRISM. To date, our engagement with these credit unions was largely reactive, but we recognise that financial analysis, paired with reactive supervision, cannot give a complete insight into the standards in this group of credit unions. Our focus is to understand how these credit unions are addressing their key risks and how they can satisfy themselves, and their membership, as to their long-term sustainability. Our onsite engagement now provides these smaller credit unions with the opportunity to demonstrate to us their prudent risk management, their compliance with legislative and regulatory requirements, and their financial resilience. Our on-site engagement with these Low Impact credit unions will help us to better understand special challenges which this group may face, including capacity limitations associated with smaller size. We have already received key documentation from most of the Low Impact credit unions to whom this engagement will apply and my colleagues in the Registry have already commenced the initial round of engagements. This afternoon, my supervisory colleagues are holding an information session, to provide Low Impact credit unions with an opportunity to better understand the nature and focus of our onsite engagement process. Credit unions that are not in a position to satisfy our standards will be expected to demonstrate the planning that they are actively pursuing to both protect member’s funds and ensure continuity of credit union services to their members. Where viability cannot be demonstrated on a stand-alone basis, the need for restructuring clearly needs to be considered. For larger credit unions and for higher risk credit unions, we also have a targeted engagement approach. Here, our focus is to ensure that these credit unions deliver on their risk mitigation obligations and provide evidence of continuing improvement in governance and risk management activities. We also expect to have more developed risk-based conversations with Board and Management teams, in relation to the evolution of their business model and associated changes in governance, risk management and controls. We challenge this group, as we challenge the Low Impact credit unions, to set out how they can demonstrate financial resilience in the longer term. Strategic planning & Business Model Development A clear challenge is the reluctance of some boards and management to proactively address viability issues and develop new sustainable business models to deal with the current challenges. In this respect, we remain concerned about the quality of strategic thinking and planning in many credit unions. This is demonstrated in many strategic plans that contain generic or high level aspirations rather than a clear road map for the credit union’s future. Having no clear vision or strategy is not an option when you consider the scale of challenges which your sector is facing. One of these challenges is the need to ensure that credit unions remain relevant to current and future members. This involves analysing members’ needs and responding in a way that is feasible. It may also involve significant changes to the business model and the supporting operational models. While we do not underestimate the level of change involved, we have yet to see a sufficiently structured and collaborative response, at the sectoral level, to the scale of business model transformation required to ensure a vibrant future. Our role is to support the sustainable and prudent development of the sector. We will, as you would expect, challenge the developments which you propose, to ensure that business cases are soundly based, feasible and properly risk-managed. Provision of full service payment accounts and electronic transactions (e.g. mobile phone) have been mentioned as possible targets for the future. It is important to consider very carefully the business case for any such business activity and assess your credit union’s resource capability to develop the operational model, infrastructure and expertise to deliver such services, while recovering the costs involved and mitigating risks. Today, I would like to offer some guide to our thinking on such developments. Offering full service payment accounts requires quite significant expertise and resources to manage a sophisticated operational model, potentially dependent on integrating differing payment systems, instruments and channels such as direct debit, credit transfers, standing orders and payment cards and to be made available through branch, internet and/or mobile channels. It is a business that also requires continuous investment in marketing and operational capabilities, to ensure there is effective governance, oversight, compliance and risk management. Moreover, the rapid pace of payment systems evolution requires the effective risk management of outsourced activities and information technology systems, payment and settlement processes and regulatory and contractual obligations. It is a business recognised for having distinct legal, transactional, financial, reputational and strategic risks. It is important that credit unions wanting to offer such full-service payment accounts can do so within a regulatory framework that ensures an appropriate risk-based approach to a complex business activity. We intend engaging further with stakeholders on such a framework later this year. Meanwhile, we are currently seeing a number of third party payment card service propositions. As is our stated objective, we challenge the underlying business case and strategy for each proposition, to ensure it is appropriate for the credit unions involved and we require credit unions to determine if their proposed structures fit with all legislative and regulatory requirements. Restructuring Examining future options and building a viable strategic plan will, of course, show up the need for fundamental restructuring in some credit unions. There are a range of options that can be considered, from using shared services, to voluntary transfers or mergers with other credit unions to strengthen financial positions and enable a broader service provision. In line with the recommendations in the Report of the Commission on Credit Unions, a number of supports for voluntary, incentivised and time-bound restructuring have been set out. The Credit Union Restructuring Board (ReBo) was established to facilitate and oversee the voluntary restructuring of credit unions to support their financial stability and long term sustainability. We at the Central Bank support ReBo in its work to facilitate voluntary restructuring. Given ReBo’s time-bound mandate to the end of 2015, we encourage all credit unions who feel that restructuring may be an option, to engage proactively with ReBo as early as possible. The restructuring agenda is gathering pace this year, with a greater acknowledgement within the sector of the role which restructuring plays in tackling the challenges you face. Voluntary restructuring is the preferred solution where this is possible. But it is important that, where a voluntary solution cannot be effected within a reasonable timeframe, an alternative approach, including directed resolution by the Central Bank, may be necessary. A number of financial supports are in place to help credit unions in tackling restructuring. Broadly they can be divided into public funds and private sector support. Public money can be provided to support voluntary transfers, and to give stabilisation support in certain cases where regulatory reserves have fallen below the required level. There are also resolution funds which are used to facilitate directed transfers. As you will be aware, funding for these public schemes is being raised through levies on the sector and terms and conditions have been set for the application of funds in specific cases. In addition to the statutory schemes, private sector support can come from the Irish League of Credit Unions’ Special Protection Scheme. Where ILCU provides SPS towards restructurings, we require this to be in the form of freely available and fully loss-absorbing funds which meet our conditions for regulatory capital. In all cases our objective is to ensure protection of members’ funds. Where a voluntary transfer or an action involving private money can not be effected within a reasonable timeframe, the Central Bank can use its powers under the law to seek Directed Transfers. In such actions, we are determined to find credit union-based solutions, that continue credit union services as far as possible and safeguard members’ funds, and that will continue to be our aim. Liquidation is a last resort, when other viable measures have been exhausted and where we have serious concerns that merit taking action in the public interest. It is our duty to ensure that the actions we take represent the best overall outcome, from the perspective of protecting members’ funds, safeguarding the stability of the sector and the cost to the taxpayer of resolution action if any. Consultation on Regulations As Regulator, our role is to develop and implement the appropriate regulatory and supervisory regime to support a safe and thriving sector. The latest development in strengthening the regulatory framework was our Consultation Paper, issued in November last year, on a number of draft regulations in relation to reserves, liquidity, lending, investments, savings and borrowing. At the launch of the consultation period, the Central Bank held nine nationwide information seminars with over 700 attendees to engage directly with credit unions on regulatory policy developments. The consultation period has now closed and we have received over 100 submissions. I welcome this high level of engagement on the draft regulations. The submissions are currently being reviewed and we intend to publish a Feedback Statement outlining the feedback received, the Central Bank’s response and the final regulations for credit unions in coming months. All submissions received will be made available on the Central Bank’s website at that stage. Learning and Improving - International Peer Review Just as we expect to see improvement in the way in which credit unions and, indeed, all regulated entities conduct their business and meet regulatory requirements, we in the Central Bank also have a focus on continuous improvement and higher standards. To that end, and in line with legislative provisions the Registry of Credit Unions is committed to undertaking a review of the performance of our regulatory functions every four years (peer review). The first peer review of the regulation of the credit union sector in Ireland will be carried out during the first half of 2015. It will be conducted under the auspices of the International Credit Union Regulators’ Network (ICURN), an independent international network of credit union regulators. The peer review assessment will be informed by the ICURN Guiding Principles for Effective Prudential Supervision of Cooperative Financial Institutions. The Peer Review Team will be in Dublin in April for an on-site visit. We will be inviting credit union representatives to participate in some meetings with the peer review team and we will be in contact with representative bodies to make arrangements in this regard. Conclusion In conclusion, it remains a particularly challenging time for the sector. I welcome the signs of progress in improving compliance with regulatory requirements, the increased engagement on and completion of restructurings and the emerging ideas on business model innovation. Clearly, however, we have much more to do to be at the point where the risks in the sector are soundly managed, the regulatory framework is well embedded, and restructuring has achieved the aims envisaged by the Commission on Credit Unions. I urge you all to continue to focus on bringing about the changes needed to put credit unions on a sound footing, both financially and organisationally and, thus, be best able to serve your members and communities into the future. In particular, ensuring prudent lending growth is critical to the financial recovery of your sector. Finally, I would like to thank CUMA for your invitation to speak at your conference today. Your focus on engaging with credit union management and boards to further develop the capability, capacity and professional standards in your sector is very relevant at this time. I trust you have had a constructive and engaging conference, which contributes to the development of further initiatives on Credit Unions – The New Model in due course. Thank you.