Address by Registrar of Credit Unions Sharon Donnery to the ICCA 08 March 2014 Speech IntroductionChairman, members of the Institute Executive, ladies and gentlemen, let me begin by thanking you for inviting me to speak at your seminar. I have recently completed my first year in the role of Registrar and events such as this are really a great opportunity to meet people who are involved directly in credit unions and to hear your feedback on how credit unions are managing the many changes currently underway. There is a busy agenda for boards, managers, staff and volunteers in credit unions and for us as regulator and these events are useful to us in the Registry in understanding your perspective. In my various speeches and comments as Registrar, I have said previously that I am struck by the importance of credit unions to our society and communities and to how we undertake financial services. These are the critical elements of the role that credit unions play in their own localities and it is clear that while many things are changing for credit unions, they continue to have immense potential to deliver value for both their members and their local communities. As Registrar, I appreciate fully the immense changes that are underway and the impact that these are having on the ground in individual credit unions. Indeed, many of you are no doubt involved in delivering those changes and your role is critical to successfully embedding change in your own credit union. Those changes will support the delivery of strong well-run credit unions, which I’m sure you will agree is what we all want. The report of the Commission on Credit Unions, the new regulatory framework and the establishment of ReBo set out a blueprint for the development of the sector over the coming years. Sustainable development for the future at the heart of that blueprint. Strong credit unions as well as strong regulation are of benefit to members, to the credit union itself and to broader sector representatives. In summary a safe, secure, well-regulated sector benefits everyone. For my remarks today I would like to consider the current position of the sector based on our latest analysis of the data to hand, consider the various roles set out in the new governance framework and map out some thoughts on priorities for the year ahead. Current position of the sector It goes without saying that there continues to be a very challenging environment for credit unions. As at December 2013, the total assets of the sector were 13.9 billion euro. Loans to members have decreased by almost 13 per cent from December 2012 and currently stand at €4.3 billion euro, with the sector average loan-to-asset ratio being approximately 32 per cent and it is notable that 190 credit unions now have a loan-to-asset ratio of less than 30 per cent. Average sector arrears at end-December 2013 were approximately 19 per cent. As operating costs continue to rise, the pressure on net margins from falling loan interest income and declining investment returns is likely to continue into 2014 and beyond. While credit unions remain popular with and trusted by members, the average dividend paid for 2013 was below 1 per cent, based on the financial accounts for 2013 which we have analysed to date. Just as credit unions are concerned about declining returns on their investment portfolios, it is likely that members of many credit unions will become increasingly concerned about the dividend rates they earn. In this context, it would appear from our data that the payment of a dividend is necessary to retain member loyalty in the long term. On a review of sector-wide data, it is notable that for those credit unions that paid a dividend in at least three of the last five years, there was a minimal reduction in the total level of members’ shares and deposits from 2009 to 2013. However, for those credit unions that only paid a dividend to members in two or less of the last five years, there was an overall reduction in the aggregate level of members’ shares and deposits around one fifth in the same period. In the context of these business and financial challenges, we continue to focus on credit unions building reserves and provisions and maintaining a prudent dividend policy. Dealing with weakened credit unions is also an area of significant priority for the Registry and all of these credit unions are subject to a heightened supervision regime. Furthermore, where credit unions are in a weakened position and a solution such as a voluntary transfer or restructuring solution is not forthcoming within a reasonable time, we will avail of our resolution powers under the legislation. This was the case in the transfer which was ordered by the High Court in recent days. Of particular interest, in that case was the co-operation of the Board of the credit union who confirmed their view that a directed transfer was in the best interest of their members and ensured the protection of their savings. This co-operative approach resulted in clear and swift action under the resolution act and no disruption to members. The on-going stresses in the economy, growing arrears and the insolvency regime all create a climate of increased risk in relation to credit decisions. As I have said publicly previously most recently at CUMA’s Conference in February, I’m surprised and concerned that credit decisions and credit control continue to be issues in large numbers of credit unions we visit. I know that the regulator is publicly criticised on many occasions for the imposition of lending restrictions on individual credit unions. However, such restrictions are imposed in the context of our on-going concerns in relation to those specific credit unions. On many of our PRISM supervisory visits, we continue to find an absence of credit policies, inadequate processes surrounding income verification and credit worthiness and significant failings in relation to credit control and following up on arrears. While I fully accept the important role of credit unions within their communities and, of course, that many members have a demand for credit, I cannot emphasise enough the need for credit unions to be prudent in how they lend money. As we all know it is the money of the saving members that is ultimately lent to borrowing members. Ensuring that those borrowers can repay must be paramount in protecting those savings. Finally, on the issue of credit our own work on the multi-debt pilot, which I know led to a lot of debate, is also relevant. The pilot has now concluded its operational phase and has provided real solutions for members and borrowers in trying to resolve their debts. For me that is the key reason why we have started the pilot – the scale of indebtedness is simply so great that ordinary people – your members – need a way to manage their debts. I have to acknowledge great efforts on the part of the participating credit unions to bring forward a constructive approach and to try to deliver a solution for their members. We are now in a period of review, to understand the lessons from the pilot and to address these learning points by adapting the framework and the operating model with a view to taking it forward. As Registrar I would say that, in my view, it is critical that credit unions are at the table as we discuss these important issues to ensure the voice of the sector is heard and its interests protected. GovernanceIt is in the context of the current challenging environment I have just described that the new legislative requirements, particularly those improving governance standards and risk management need to be viewed. I am of the firm view that the new legislation and the related regulatory reforms we are introducing are an important support which can drive and enhance the ability of credit unions to address the current challenges and the rapidly-evolving market in which they operate. The requirements, including strategic planning, also support an important forward looking perspective where strategic direction and future viability are clearly articulated and understood within the credit union. A major focus in designing the new regulatory framework is to strengthen governance in credit unions individually and the sector overall. Governance has been highlighted as an area of concern in our onsite supervisory engagements and as you will be aware is something we, in the Registry, have been working on for a number of years now. The report of the Commission on Credit Unions also recognised that the issue of governance is at the core of strengthening the regulatory framework and the report set out detailed governance requirements for credit unions. In setting out those requirements, the Commission recognised that those who are entrusted with safeguarding members’ money must be skilled and experienced people of integrity with the necessary underpinning systems and controls to run credit unions in a verifiably prudent way. In the Registry, we see the implementation of proper governance as being a key element to bring about a financially strong and more sustainable sector which can continue to serve future generations of members. Management and oversight of a credit union has at its core responsibility for the money of other people. Too often, we find that despite our work to bring about an improvement in oversight, for example, relating to bad debt provisioning or poor underwriting, once we cease to have a close hands on approach credit unions revert to bad habits. In our view, good governance is central to addressing these concerns and good governance ensures that there is clarity about how authority and control are exercised within a firm or for our purposes a credit union. If we are all clear about who is responsible for decisions taken, it is much easier to ascertain who is responsible when things are going well but also when they go wrong. Directors and managers are accountable: firstly to the members but also to the law and to us as regulator. It is certainly fair to say that the responsibilities on board, managers and supervisors are significant and it is important that people who undertake these roles appreciate that. The board of directors shapes strategic direction and performance and has responsibility for the general control, direction and management of the affairs of the credit union. There are also a wide range of more specific responsibilities set out in the new Act including strategic planning, risk management, succession planning, and so on. In fulfilling these responsibilities, credit unions must have a clear organisational structure with well-defined, transparent and consistent reporting lines to the board. When establishing governance arrangements credit unions should take into account the nature, scale, complexity and risk profile of the business they do. This should be a key determinant in the level of oversight, extent of skills and expertise, and systems and control requirements. While boards may find it useful to obtain external advice and support in undertaking their role, it is the board that is responsible for strategic planning, risk management, internal audit and so on. We would expect credit union directors to fully own and understand all aspects of their credit union’s strategy. In developing strategy, boards need to understand and articulate the goals and objectives of the credit union and take into account the environment in which they operate, including considering economic, social and competition issues and indeed the many challenges I mentioned at the opening of my remarks. The board of directors should also have full oversight of the credit union’s risk management system and should ensure that systems and controls are put in place to manage and mitigate risk. It is of concern that in a number of the credit unions we have visited as part of supervisory engagement, we have found a lack of strategic planning added to poor risk management frameworks and practices. Strategic plans must include a realistic appraisal of the business model, including analysis of income and expenditure and financial position as well as operational capabilities. This must also be orientated towards the future to ensure that the board is thinking about where the credit union will be in three to five years. The critical questions for boards are: where are we going; and how are we going to get there are. Boards and management alike need to look on the strategic planning process and development of their risk management systems as an essential element of their business rather than a simple tick box exercise to fulfill a regulatory requirement. So in summary, by getting the focus on the right issues, that is the general control and oversight of the credit union, boards can ensure that they take the right decisions for their credit union and at all times act in their members’ interests. The new governance framework emphasises the importance of a separation between these non-executive roles (performed by the board of directors) and the executive or operational roles (performed by the manager, management team, staff and voluntary assistants), with the manager serving as the main link between the board and the executive. Managers play a key role within credit unions and this has been recognised by the inclusion of managers within the governance framework in the new Act. It requires the appointment of a manager to be responsible for the day-to-day management of the credit union’s operations and for the manager to be accountable to the board for the performance of his or her functions. In addition to carrying out any responsibilities assigned to them by the board, key priorities for managers will include preparing and proposing strategies for the board of directors and indeed implementing the strategy which is agreed by the board and implementing proper systems of internal control. Credit unions are also required to have two other officers within the governance structures, namely the risk management officer and the compliance officer. While we are not prescribing how a credit union resources these positions, it is obviously crucial that those who fill them are competent for the role and can carry out the relevant functions. It is important to understand the reasoning behind having a risk management officer and risk management system, which is to promote a culture of risk awareness within the credit union to ensure risks are identified and mitigated. In a world of ever-increasing complexity, it is essential that boards of directors are aware of, understand and deal with the risks to their credit union. The role of the compliance officer is to ensure that the credit union complies with all statutory and regulatory requirements and indeed that there is monitoring of such compliance to ensure no conflict of interests arise. Essentially the role of the compliance officer is to foster and encourage a culture of compliance in the credit union. Significantly where compliance breaches occur, compliance officers must bring this to the attention of the board and the manager immediately and they should ensure that any matter is rectified a timely manner. The risk management officer and compliance officer support the board and management team in ensuring the credit union has an effective risk management system and a compliance programme. However, while the board, manager, risk management and compliance officers must work together the roles and related responsibilities are distinct and should be kept so. The governance structure in credit unions is somewhat unusual in that in addition to the board there is also a board oversight committee which has evolved from the former supervisory committee. The operational responsibilities that were assigned to the Supervisory Committee will now be transferred to the internal audit function. That function will be responsible for, as a minimum, evaluation of the effectiveness of the credit union’s risk management system, internal controls and governance processes. The internal audit function should make recommendations to the board on improving these processes and follow up on recommendations to ensure that effective remedial action has been taken. Some key elements in relation to internal audit include that it is independent of management and that the internal audit function adheres to professional standards and benchmarks such as those established by the Institute of Internal Audit. The role of the board oversight committee is to assess whether the board of directors has operated in accordance with the specific requirements set out in legislation including, for example, strategic planning and risk management. They will of course be required to meet with the board of directors at least four times per year and a member of the Board Oversight Committee should attend every meeting of the board and also report to the members at the annual general meeting. A key element of fulfilling this role is to determine whether any deviation from the requirements is material. In doing this, Board Oversight Committees need to consider the circumstances of each individual case and the matter should be reported to the board as part of the regular engagement between the oversight committee and the board itself. I know that the various roles that undertaken in the credit union bring with them their own challenges and that it can be difficult to take on issues and to raise concerns with people that you know well and have to deal with on a regular basis within your own credit union. You need to ensure that whatever your role, you can deliver on your mandate and that you approach your work in a clear and planned manner taking account of both the letter and spirit of the law. This is not about a box ticking or form filling exercise. We expect to see real change in relation to governance in credit unions and this will be evidenced in the way credit unions are run and operated and we expect all parties to play a role in ensuring this. That is the responsibility that goes with running a credit union, overall, that role is all about playing your part in the protection of members’ savings. Looking aheadIt is now time to move on from the process of introducing the strengthened regulatory framework to the challenge of getting it working. A top priority for credit unions for 2014 must be embedding the new requirements and practices in the day-to-day operations of their own business. It is not enough to simply tick the box and say that we now have the requirements or indeed that credit unions have procedures written down in a manual. A number of important issues are on our regulatory agenda for 2014, including our next cycle of engagement under PRISM, the public consultation on the tiered regulatory approach, the commencement of further requirements under the new Act, enforcement and sector restructuring. I would like to speak about each of these in turn briefly. PRISM As many of you know, PRISM is the Bank’s framework for the supervision of regulated firms which delivers risk-based supervision underpinned by a credible threat of enforcement through our administrative sanction's process which now also applies to credit unions. To date, we have generally been pleased with the open and constructive engagement with the credit unions we have visited. There are a number of clear themes emerging from our engagement. You will not be surprised that it is in the areas of credit, strategic direction, risk management and governance that we have identified most areas of concern. In general, risk management competencies and capabilities in these key areas require significant improvement and these should be among the key priorities for credit unions. Many of the issues we have identified, while worryingly fundamental in nature, lend themselves to relatively easy remediation. Embedding these changes in policies, procedures, and risk culture takes longer and that is where the leadership of the board and management needs to be evidenced most strongly as champions of this necessary change. A credit union can only be sound if it is in safe hands and safe hands includes having the understanding, know-how and capabilities to prudently manage all the credit union’s risks. My final word on PRISM would be to emphasise that as we start our next cycle of engagement and begin visiting credit unions for a second full-risk assessment or one-day engagement, we expect to see significant progress in rectifying and closing out the issues raised previously. It is not acceptable to either identify risk yourself within the credit union or to have issues raised with you by your internal or external auditor or indeed your regulator and to not address them. Where we find this to be the case, further regulatory actions which may include business restrictions or potentially enforcement action will follow. Tiered regulatory approach The introduction of a tiered regulatory approach (TRA) was one of the recommendations of the Commission on Credit Unions. In developing the TRA, we are seeking to develop an approach that supports the operation of financially sound and well-governed credit unions and facilitates the prudent development of the credit union sector, within an appropriate regulatory framework. The consultation is an initial one and seeks views from credit unions and other stakeholders on the proposed approach to tiering; the high level operation of the tiers, including the activities and services proposed for credit unions in each tier; proposals on a provisioning framework for credit unions; and the appropriate timing for the introduction of a tiered regulatory approach. One of the key questions in developing a tiered regulatory approach is what is envisaged by the prudent development of the credit union sector. That is, for yourselves as credit unions that want to develop beyond the current credit union business model – what additional services and activities do you wish to undertake? Given the importance of addressing this question and indeed other issues in the consultation, we are proposing a two-staged approach with the first consultation seeking views on how the credit union business model should develop prudently, taking account of the objects and ethos of credit unions and the legal framework provided. Given the recent significant changes in the regulatory framework and the restructuring of the sector that is currently underway, we are also interested in obtaining views on the most appropriate timing for the introduction of a tiered regulatory approach. The consultation period is now open until end March and I would strongly encourage you to review the paper and to submit any views or suggestions that you may have. While I am sure the representative bodies will make submissions to the consultation, we also welcome submissions from individual credit unions. A further consultation and regulatory impact assessment will follow later in the year. A further consultation which will be of interest to you is that being undertaken by the Department of Finance on a statutory stabilisation scheme. The Commission on Credit Unions recommended the establishment of such a scheme to be funded from the credit union sector. The consultation paper, which refers to mandatory contributions by credit unions, seeks the views of stakeholders on the amount of the fund and options for the structure of the levy and the consultation is open until 28 April. New requirements The introduction of the Fitness and Probity regime for credit unions was one of the first visible steps in the introduction of the strengthened regulatory framework. It supports other initiatives such as the new governance framework set out in the Act. The Fitness and Probity regime for credit unions with assets greater than €10m was introduced on 1 August last year. It is important to emphasise that credit unions themselves must have robust processes for carrying out fitness and probity assessments. The credit union must not permit a person to perform any role covered by the regime unless it is satisfied that the person complies with the fitness and probity standards and has obtained confirmation that the person has agreed to abide by the standards. Credit unions should also be in a position to evidence the fitness and probity validation steps and confirmations received and to provide these to examiners from the Registry in the course of any on-site inspections. On 1 August 2014, fitness and probity will have been fully implemented for credit unions with assets greater than €10m and will apply to all Controlled Functions. By this date, credit unions will need to have carried out due diligence to ensure that all those holding Controlled Functions positions both comply with the fitness and probity standards and have agreed to continue to comply with them Since last September, the majority of the new governance and prudential requirements contained in the 2012 Act, including the requirement for all credit unions to have a manager, have come into effect. The manager of a credit union, with responsibility for the day-to-day management of the credit union’s operations, compliance and performance, plays a key role in supporting the board of directors in the implementation of the new requirements. We have developed the Credit Union Handbook to assist boards, managers and other credit union officers in implementing both new and existing regulatory requirements, bringing together as it does regulatory requirements, supplemented, where appropriate, by additional guidance. On 3 March 2014, a small number of governance provisions that remained came into effect for all credit unions completing the comprehensive governance framework for credit unions that is introduced by the 2012 Act. These provisions relate to the board of directors, the requirement for credit unions to submit an annual compliance statement to the Bank and the requirement for the board oversight committee to report to members at the AGM. We have issued communications to credit unions and other sector stakeholders on these new requirements and have updated the Governance Chapter of the Credit Union Handbook and our Frequency Asked Questions. Looking back at the requirements introduced during 2013 and the remaining requirements introduced on 3 March, I would emphasise that the regulatory changes being introduced are in the context of operating a strong system of oversight which maintains the safety and soundness of the sector. As acknowledged in the report of the Commission on Credit Unions, since the enactment of the Credit Union Act, in 1997, the sector has changed significantly with credit unions growing both in terms of asset size and associated risks. As with all other financial institutions, credit unions depend on public confidence for their success and members need to be assured that their savings are safe. Enforcement The ability to take enforcement action is an important element of any regulatory regime. Those of you who’ve heard my colleagues from the Bank speak about regulation will have heard us talk about assertive risk-based supervision underpinned by a credible threat of enforcement. This sentiment encapsulates our approach to the supervision of the firms we regulate and, in our view, a robust enforcement threat assists in the creation and maintenance of high standards across all sectors. Since 1 August 2013, the administrative sanction's procedure is fully applicable to credit unions. We have in recent days published our enforcement priorities which sets out the areas of greatest concern to the Bank and for the first time we have published our priorities by industry sector. Certain priority areas have been identified across almost all industry sectors and these are fitness and probity obligations and anti-money laundering and counter terrorism financing compliance. Specifically in relation to credit unions we have also identified prudential requirements (with a focus on reserves, liquidity, lending and investments) ; timeliness and accuracy of information submitted to the Central Bank; systems and controls; and governance. We have highlighted these areas to ensure that the focus of our enforcement resources will help promote compliance in the areas that are of greatest importance to the Bank. I know that many credit unions are concerned about the approach that we will take to the exercise of our enforcement powers. Where there are breaches of regulatory obligations the Bank will consider all relevant facts before commencing enforcement action and ultimately the taking of an enforcement action under the administrative sanction process is discretionary. You can be assured that we will be proportionate in our approach, understanding the efforts that credit unions are making but where enforcement action is required, the Bank’s actions will be firm and robust. If a credit union is well-run and diligent in respect of its regulatory compliance, and can demonstrate that it has taken clear steps to comply with its obligations, then this will be taken into consideration by the Bank in deciding whether to take enforcement action. Sector restructuring A further significant change brought about by the introduction of the new Act was the establishment of the statutory Restructuring Board. I hope our colleagues in ReBo will not mind me saying that the Bank and ReBo have established a solid and close working relationship. There is regular engagement both between myself as Registrar and the Chair and Chief Executive, as well as on-going interaction between our respective teams. As we all know, a core recommendation of the Commission on Credit Unions was that the credit union sector should be restructured and that this should be achieved on a voluntary, incentivised and time-bound basis. The Commission envisaged that restructuring would involve moving from the situation where over 400 credit unions act independently to one where there is some consolidation through mergers and the development of close networks and shared services. We encourage credit unions in a strong financial position to consider how they can best support their peers – this might be by sharing of knowledge and expertise or, ultimately, being open to the prospect of merging with a neighbouring credit union. My own view is that some restructuring within the sector is essential if it is to be sustainable for the future and to deliver both for current and future members. As noted by the Governor in remarks he made towards the end of last year, this does mean some dilution of the very local control enjoyed by the members of some credit unions, but it would be more than compensated for by greater operational efficiency, range of services and solidity. And importantly, members remain members of the larger combined credit union with similar rights and benefits as before. So in restructuring it is certainly fair to say there will be changes in governance and control but members can expect at least the same, and in many cases can expect enhanced services delivered in a member-focused fashion. Credit unions operate an increasingly complex range of services in an increasingly complex and fast-changing world and managing a modern credit union requires greater levels of skill and competence than in the past. It is also fair to say that there is a growing need to reduce overall operational costs and this can be achieved through consolidation while still retaining local presence. The provision of additional new products and services will certainly impose costs on credit unions and so to implement these credit unions will need a certain scale to their operations. For those credit unions who decide that they will remain as is and do not see their structure or model changing, we expect that they will have a clear strategy for the future demonstrating how they will manage the challenges of the external environment they operate in. ReBo has a time-bound mandate and it is important that our credit unions seize the opportunity presented by ReBo to restructure and strengthen for the future. The Bank and ReBo have worked closely to ensure that the process of mergers will be as straightforward as possible. At a high level, the process will involve appropriate due diligence on both credit unions. This is to ensure that the respective boards have an understanding of all factors before making any decisions. The due diligence process is complemented by an examination of the suitability of any merger and detailed integration planning. Ultimately ReBo will determine whether to recommend a proposal to the Bank. For our part, our strategy will be to support restructuring proposals, where they are sound and well thought out and supported by proper risk and control frameworks. What this means in practice is that we will accommodate restructuring supported by well-thought out proposals put forward by financially strong well-run credit unions and we will take action to mitigate risk and deal with credit unions with a weak financial position including taking resolution action, if necessary. ConclusionAs I said at the outset, I do recognise that the introduction of the new regulatory framework requires a substantial amount of change for some credit unions. I welcome the work that many have already undertaken to comply with the new requirements and indeed, I commend the work by some credit unions who could be considered leaders within the sector having already implemented governance and risk management changes even before they were a regulatory requirement. I have no doubt that many of you here today have played an instrumental role in delivering those changes. The Registry is not seeking to overburden credit unions with regulation. Rather, a pragmatic approach to implementation is being adopted and I would wish to stress that our priority is firmly set on ensuring financially sound and well-managed credit unions that protect the savings of members. In that sense, the goals of credit unions, members and those of the regulator are well aligned. It is important that credit unions stay focused on achieving the longer-term objectives of development, growth and restructuring which are crucial to ensure that the credit union sector remains viable and sustainable, and continues to hold its relevant and substantial place in the community, and also in the Irish financial services landscape. I look forward to continued engagement with both your credit unions individually as well as with the various representative bodies. Thank you once again for inviting me and for you attention. I trust you will have an interesting conference and I wish you an enjoyable weekend.