Address by Registrar of Credit Unions Anne Marie McKiernan to the CUDA Annual Conference 31 January 2015 Speech Mr. Chairman, Members of the Management and National Council of CUDA, Ladies and Gentlemen. Thank you for inviting me here today to talk at your 2015 annual conference. I appreciate the opportunity to discuss some of the more recent developments in the credit union sector and highlight some of the special challenges that we face as we work together to achieve a thriving credit union sector. First, though, I would like to say a special thanks to your CEO Kevin Johnson, for your open engagement and challenge with me and my colleagues in the Registry. We have had many meetings and the discussions have always been open and constructive. As we set out on a new year of working towards strong credit unions in safe hands, I would like to tell you today about some changes we have made in how we are engaging with credit unions and set out how these will work in practice. I will also outline the latest developments in the regulatory framework for credit unions and our plans to focus on ensuring good lending practices and strategy planning. Finally, I will comment on the importance of restructuring and resolution for the stability and growth of your sector and the need to keep momentum building in this area. Update on the Sector At the outset, I would like to highlight the critical role that credit unions play, at both the community and society level and also in their special place in the Irish financial sector. For over 50 years, credit unions have served their members well and shown drive and determination, by both their professional and volunteer staff and boards, in dealing with the challenges and opportunities you have faced. And the current environment is, undoubtedly, one of great challenge – from the financial strain that many credit unions face, to the pressure to reform your business model to be viable and thrive into the future. A further challenge is the need to attract new, younger members and provide the services and products which they want and which provide growth opportunities for your business. And we recognise the challenge involved for many credit unions in meeting the requirements of our regulatory framework, which is designed to protect your members’ funds and safeguard your business into the future. An important challenge is for you to also see the opportunities in today’s environment – including how efforts on restructuring can help develop more viable credit unions, and how developing the capability and systems of control to lend responsibly can help credit unions to avail of the opportunities of economic upswing without undue risk. The financial data on the sector tell their own story of the challenges which you face. Loans to members have decreased by almost 10% since September 2013, to €4bn, while the sector average loan-to-asset ratio is 30%, but just over 200 credit unions are below this ratio. Total interest income has reduced by approximately 45% between 2009 and 2014. While average sector arrears at end-September 2014 were about 17%, 31 credit unions have arrears exceeding 30% of their loan book. The average dividend for 2014 was below 1%, and a little over half of all credit unions are 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 at the sector-wide level, for example. But overall it is a picture of continuing business and financial pressure and it is clear that major rather than minor changes in approach are needed to stem this decline. Your leadership, and that of the other parties in the sector, is especially critical at this time, as you seek to safeguard the future of the credit union movement and its important place in the financial sector. Enhanced Regulatory Engagement Let me turn to the role which our supervisory approach plays in safeguarding the future of the sector, and where we are making some changes in view of the special challenges facing the sector and the important position of credit unions as deposit takers in the financial sector. As you know, the Central Bank’s risk-based framework for supervision is the PRISM framework, underpinned by a credible threat of enforcement through the Administrative Sanctions Procedure. The PRISM engagement framework focuses supervisory effort towards regulated entities which pose the biggest impact on the financial sector. As a result, our on-site presence with credit unions has focused on High, Medium High and Medium Low credit unions. The Low Impact credit unions – essentially smaller credit unions - have had very limited, mainly reactive onsite supervision, paired with desk based analysis and risk mitigation . We are now changing our engagement approach for a limited time to meet the specific needs of your sector at this juncture. We are taking a supervisory engagement approach that focuses on risk and restructuring of credit unions and the sector as a whole. What this means is that we will now apply resources, for a time, to direct on-site supervisory contact with the Low Impact credit unions, which were not previously subject to PRISM onsite engagement. Our focus now is to understand how these credit unions are assessing and addressing their key risks and how they can satisfy themselves, and their membership, as to their long-term sustainability and viability. Our onsite engagement now provides these smaller credit unions with the opportunity to demonstrate their prudent risk management systems, their compliance with legislative and regulatory requirements, and their ability to assess and address their capacity and their capability to maintain financial resilience and to be sustainable on a stand-alone basis into the future. Credit unions that are not in a position to satisfy these 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 should be considered, if those credit unions are to be a stable and significant part of the Irish financial system in the future. For Medium High and Medium Low Impact credit unions we will also have a targeted engagement approach. For these credit unions, our focus will be on ensuring they deliver on their risk mitigation obligations and provide evidence of continuing improvement in, and enhancement of, governance and risk management capabilities and operations. In line with our expectations of effective oversight of credit unions, we expect that Boards will have been provided with significant high quality reviews of governance and risk, with a particular emphasis on internal audit assessment and validation of how our risk mitigation requirements are being implemented. This work will be requested by our supervisors as part of their onsite assessment and will inform our risk-based dialogue with each credit union. With this group of credit unions, 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 and risk management. We will also challenge this group, as we challenge the Low Impact credit unions, to demonstrate their financial resilience and sustainability on a stand-alone basis into the future. Our risk assessment activities in recent years – which were summarised in our PRISM review, published in May last year - highlighted serious issues at some credit unions, including governance, business strategy and planning problems. As I have said before, I am very concerned at these findings and I expect credit unions to deal with these issues as a matter of urgency. It is not acceptable to have issues identified - whether by internal management, auditors, external reviewer or regulator – and not address them in a timely way, in the interests of the individual credit unions and the stability of the sector and importantly in the interests of your members. Taking Regulatory Action As Registrar, my statutory mandate is to protect the funds of credit union members and to maintain the financial stability and well-being of credit unions generally. As I have set out before, our strategic objective is “Strong Credit Unions in Safe Hands”. We believe that development, growth and restructuring are crucial to ensure that the credit union sector remains viable and sustainable and continues to hold a substantial place in local communities and in the Irish financial services landscape. We all have a role to play to ensure that credit unions remain relevant and important. Credit unions have a critical role to play in developing realistic strategic plans, founded on current capacity and capability, which ensure they are able to survive and thrive in a fast-changing financial services market and to provide the services and products your members want. As Regulator, our role is to develop and implement an appropriate regulatory and supervisory framework for credit unions which helps to deliver a safer, stronger sector. As you know, the process for strengthening the regulatory framework for credit unions recommended by the Commission on Credit Unions has been under way for a number of years. The latest development along that path has been our Consultation Paper, which we issued late last year, on a number of draft regulations, including savings, investments, lending, liquidity and systems and controls. We very much welcomed the large numbers of credit union officers who attended the information seminars we held to engage with you on these regulations. We received initial feedback at the information seminars on the draft regulations. That feedback included queries on the nature of related party lending regulations, the short term liquidity requirement and the savings regulations. In particular there was significant discussion at our Information Seminars in relation to a proposed cap on savings in a credit union, at €100,000. The measure proposed in our Consultation Paper, is two-fold: firstly, to ensure that members’ funds are protected, and second to ensure that funding at each credit union is sufficiently diversified to avoid sudden shocks and allow the business of lending to members to continue at a steady pace. This proposed measure needs to be seen in the context of the business model of credit unions, which is based on lending relatively small amounts to members who have built up a track record of saving. We have, at this stage, received a number of responses to the Consultation Paper and we look forward to receiving further submissions before the closing date of 27 February. We will then consider all the submissions and publish our response. Speaking of regulatory changes, this week saw an important milestone for the Central Bank with the introduction of new Regulations which will apply to mortgage lending in the Irish market, following a public consultation process. As has been well publicised by now, the measures introduce proportionate limits for loan to value and loan to income ratios for both primary dwelling houses and buy to let mortgages. These measures will of course apply to credit unions’ mortgage lending. The limits are in addition to individual lenders' credit policies and are not designed as a substitute for lenders’ responsibilities to assess affordability and to lend prudently on a case-by-case basis. The key objective of the Regulations is to increase the resilience of the financial and household sectors to the property market and to reduce the risk of credit and house price spirals from developing in the future. We will obviously take account of these new regulatory developments when we come to finalising our own regulations which I referred to earlier. Our focus, when putting regulatory requirements in place, is to protect the funds of your members and the stability of your sector. Each credit union must comply with the regulatory requirements to protect its members funds and, as I have said on a number of occasions, we will not hesitate to take action where there is non-compliance and where members’ funds or the stability of the sector is at risk. Lending Restrictions One of the necessary regulatory actions taken involves lending restrictions. As I alluded to earlier, a little over half of all credit unions are currently subject to lending restrictions. Where these are imposed, they tend to take the form of a restriction on individual loan size or on commercial lending activity and, in less than 10% of cases, a limit on the total lending permitted each month. For those with an individual loan size restriction, the level at which the limit is imposed ensures that the vast majority of those credit unions can continue to make loans significantly more than the average gross loans outstanding for the sector of just above €6,000, and indeed the evidence suggests that the majority of credit unions are not lending up to the amount of the restriction. The majority of restrictions enable credit unions to lend amounts of between €10,000 and €30,000. This reflects our aims to calibrate this regulatory tool to mitigate risk while recognising the core business of credit unions to lend to their members. Lending restrictions are intended to be short-term in nature and to be kept in place until the credit union has addressed the issues giving rise to the particular concerns. We always clearly advise the credit union of the reasons for our actions, and we – rightly - require evidence that the weaknesses in governance and systems and controls are properly remediated and solutions fully embedded by the credit union. Once we are satisfied on this point we are open to the removal of the restriction in question. We have clearly demonstrated this in our PRISM assessments, which have resulted in a number of lending restrictions being removed. Overall, however, it is disappointing that our PRISM engagements have continued to highlight that the quality of lending standards and related risk understanding in many credit unions remain a cause for concern. The findings, reflected in our Risk Mitigation Programmes with a broad range of credit unions, echo the concerns which gave rise to the imposition of the lending and other restrictions in the first place. These include an absence of credit policies, inadequate processes for income verification and credit worthiness and significant failings in relation to credit control and dealing with arrears. It is particularly disappointing given that these are central functions of credit unions and it demonstrates a failure, by some credit unions, to take appropriate and prompt corrective action, since the restrictions were initially introduced, to properly protect members’ funds. All of these issues have been addressed repeatedly with many credit unions, through our onsite and offsite engagement, our communication with the sector through the Credit Union Handbook, and our PRISM review document, “Credit Union PRISM Risk Assessments - Supervisory Commentary”. We would expect, at this stage, to see significant improvement in this area in 2015. Accordingly, we intend in the near future to invite those credit unions, who should by now have embedded robust risk sensitive lending practices, to apply for a review of their lending restriction. Within the coming weeks, we will be communicating with credit unions who are the subject of a lending restriction, and we will set out our requirements regarding the case to be made to have the restriction lifted, and the information required to support that case. Internal audit validation, attesting to the quality of the process and controls, their level of embeddedness and their operational integrity will be a core component for the evaluation. Our priority is to ensure that credit unions can have the scope, the structures and the processes to prudently lend to their members. Credit unions who are currently engaged in remediation work, which may have been identified as part of earlier supervisory engagements, should not apply until the new structures, processes and controls are properly embedded. We encourage credit unions, which are subject to lending restrictions, to actively consider how they can strengthen their risk frameworks in relation to credit decisions and controls, to enable restrictions to be prudently lifted. This will help their members to have access to prudent lending, which will in turn support their communities and their own financial future. Continuing Restructuring Development, growth and restructuring are crucial to ensure that the credit union sector remains viable and sustainable and continues to play a substantial rule in providing financing and deposit-taking opportunities in local communities and society. At the Registry, we are fully committed to the development of a strong credit union sector meeting the needs of your members. That significant restructuring is required to develop a strong viable sector is clearly acknowledged, not least by the Report of the Commission on Credit Unions in 2012. This means change and I fully accept that change can be difficult. But I have no doubt that failure to make the necessary change, or to recognise the need for change, will further weaken your sector. What is really important now is that we increase the pace of the required change, particularly in view of the deterioration in many of the key financial measures of health for your sector, which I set out above. It is very clear that to achieve a stable and viable sector, each credit union must focus on its own viability and plan for its future. Each credit union must rise to the challenge of developing sustainable medium and long term business plans. Each credit union needs to develop its sources of income, to attract new active members by offering the services that people want in their area. Each credit union also needs to tackle its own threats to viability, be they arrears, governance or other issues. The boards and management of each credit union have to take responsibility to develop existing business models or structures, which are aimed at securing the future of their credit unions by building a risk-based, financially sound, well- governed, member-focused credit union in which the funds and savings of your members are protected. No plans and no clear vision or strategy for the future is not an option when you consider the challenges which your sector is facing and the need for a timely response to these challenges. A Credit Union’s Strategic Plan is the key to assessing and ensuring viability. This plan should express its medium term goals and set out in detail how it plans to achieve them. But significant weaknesses in strategic planning across the sector were highlighted in our 2014 PRISM review. We found in some cases a marked reluctance by Boards and management to confront business model constraints and address viability challenges. We also found many strategic plans which were generic or formulaic, and not reflected in either financial planning or day-to- day operations, with little or no ownership by Boards documented for these plans. We found financial forecasts which were based on unrealistic assumptions, or not linked to stated business objectives or proposed new business. Today, I would like to congratulate CUDA for putting strategy at the centre of your conference. The conference title of “Strategy in action and action out of strategy” is a very timely focus on the critical importance of strategic planning and I hope that all of you will leave this conference with important insights into issues which you can address, in reviewing your own strategic plans, which will secure the future of your business, either individually or as part of a restructuring. I am also delighted to see CUDA take the opportunity to learn from peers and bring an international perspective, by having a session on the factors which have made the credit union sector in British Columbia in Canada so successful. The change that is required to ensure the future viability of the credit union sector in Ireland can take different forms. In some cases, this may involve shared services models, voluntary link-ups or mergers aimed at strengthening financial positions, achieving economies of scale and the ability to provide new services to members. At the Registry, we support the growth and development of the Credit Union sector and we will support innovation where it is grounded in viable business plans. We will, as you would expect, challenge the business models you propose, to ensure such proposals are strong, soundly based, well thought-through and properly assessed for risk. To remain relevant to a whole new generation of prospective members, credit unions need to identify and analyse members’ needs and respond in a way that is feasible and achievable. While we do not underestimate the level of challenge involved, we are not yet seeing from the credit union sector the extent of leadership that is required to drive the development of sustainable business models. Provision of full service payment accounts and electronic transactions (eg mobile phone) have been mentioned as possible targets for the future. In theory of course anything is possible, if it meets the test for viability and fits within the legal and regulatory framework. You need to assess if you can develop the infrastructure and expertise to deliver enhanced services while recovering the costs involved and identifying and mitigating the risk involved. At the same time the on-going challenge for credit unions is to increase your loan-to- assets ratio while lending prudently and finding ways to satisfy your members with returns on their savings. Examining future options and building a viable strategic plan may, in some cases, show up the need for fundamental restructuring. For some credit unions it will not be possible to continue in their present form. For these credit unions there are a number of restructuring options, ranging from using shared services, to voluntary transfers or mergers with other credit unions which would strengthen their financial positions, and enable them to provide new services to their members. The Report of the Commission on Credit Unions recommended a voluntary, incentivised and time-bound restructuring process where this is possible. The Restructuring Board, ReBo, has been working extensively to facilitate and oversee this aim and we fully support and engage with ReBo as it fulfils its voluntary restructuring agenda. Given ReBo’s time-bound mandate to the end of 2015, we would encourage all credit unions who feel that restructuring may be an option, to engage proactively with ReBo if they have not already done so. Our role in the restructuring process is to put the protection of member savings and the financial stability and well-being of the credit union sector as a whole to the forefront. Because the failure of any credit union can damage public confidence in the sector, and may impact negatively on other credit unions, we have - as you have seen - had to move to involuntary resolution to protect members funds and safeguard the financial stability of the sector. Our responsibility is to do the right thing in the right way to protect members funds. Where we have serious concerns about governance, business or financial issues, or systems and controls failures or weak strategic plans, we require credit unions to urgently undertake the changes necessary to deal with these problems. The solution may be a series of changes and / or financial injection to enable the credit union remain independent, or it may involve a transfer to another stronger credit union on a voluntary basis. ReBo has set out its plans for increasing the pace of restructuring in the credit union sector. We at the Registry have set reasonably high standards for approval of voluntary restructurings, but this is no more than is necessary to ensure that the new entity has the reserve base required for a solid future, to protect members funds and the overall credit union sector and is capable of delivering the benefits on which the restructuring proposal is based. Where a voluntary transfer within a reasonable timeframe proves not to be possible, we can, and do, use the powers set out in the Credit Institutions Resolution Act, 2012, to require a directed transfer. As you will have seen, I am committed to taking the appropriate resolution action where necessary. But it is also important to state that involuntary resolution comes into play only when it has not been possible to effect a voluntary solution within a reasonable timeframe. In the resolution actions we have taken so far, we have shown that we are determined to find credit union- based solutions, that facilitate the continuation of credit union services while safe guarding members funds, but that we move to action when it is prudent and important for the safety of members funds. That will continue to be our aim. Seeking the liquidation of a credit union is a last resort which we may use in situations when all other viable resolution measures have been exhausted and where we have very serious concerns for the safety of members funds. Resolution is a sensitive process which must be handled delicately to ensure an already-weak situation is not made worse. As you will appreciate, given that resolution actions may require the use of public funds, the actions must be taken in the public interest. It is our duty to ensure that whatever resolution actions we take - either involuntary transfer or liquidation - represent the best overall outcome, from the perspective of protection of members funds, the stability of the sector and the potential cost to the taxpayer from the resolution action. Conclusion Before I conclude, I would once again like to congratulate CUDA on showing leadership on the issue of focusing on strategy, and developing actions out of strategy and learning from international peers, which is your theme today. Further leadership will be required to deal with the challenges faced by your sector. I also welcome the valuable work you are doing to educate, inform and assist member credit unions, to understand and meet their statutory requirements. For example, your provision of handbooks and learning programmes in the area of risk and compliance is very welcome and is helping to develop the professionalism that is needed for the future. Your assistance to your members in the implementation of the enhanced governance framework is very important and I would like to invite you to join us in exploring how we could help support this model into the future. I would urge all credit unions to consider how you can increase your capability and, where this may involve additional costs, to consider the value that this can bring in enabling your credit union to deal with the many challenges you face. Training and development and learning from peers, both domestic and international, is a key part of enhancing capability, and I hope that today’s conference proves fruitful as part of that aim. I would like to thank all of you for your attention and I look forward to seeing and hearing about the actions out of strategy which you consider as a result of your deliberations today. Thank you.