Mind the Gap - Anne Marie McKiernan, Registrar of Credit Unions

02 March 2016 Speech

Address by Anne Marie McKiernan, Registrar of Credit Unions to CUMA Spring Conference  

Mr. Chairman, Members of the National Executive of CUMA, ladies and gentlemen. Thank you for inviting me to address your Spring Conference.

This morning I would like to focus on the ongoing restructuring of your sector and the importance of taking the steps necessary to reap benefits from mergers that are completed. I will also update you on where we at the Registry will focus in our supervision of merged credit unions and to also set out the Thematic reviews we have planned for this year. I will also comment on the latest position with the implementation of our new Regulations. Finally, I would like to give you some insight into developments with respect to the business model.

But first, I would like to pay tribute to you as credit union managers for your tireless work and determination in supporting your boards to achieve the necessary restructuring of your sector, embedding regulations and improving the financial and operational situation in your credit union. Credit unions have played a critical role in the financial sector and in communities across Ireland for over half a century. Your commitment to protect your credit union’s unique position in your community, while also supporting your voluntary ethos and continuing to serve your members to the best of your ability is highly valued and valuable, providing choice and access in the financial sector.

At the Registry we are committed to playing our part in the development of a resilient and development-focused credit union sector. We see four main requirements for this to happen : further restructuring; a substantial and sustained increase in the active borrowing membership; a marked increase in core lending, and business model development in a multi-step, well-managed way.

1: Restructuring

After a slow start, I think it is fair to say that the sector has moved significantly with respect to the need for, and momentum and activity towards, restructuring. Since its inception in 2013, the Credit Union Restructuring Board (“ReBo”) has worked tirelessly to advance the voluntary and incentivised restructuring of the credit union sector. I want to acknowledge the progress that has been made and significantly facilitated by ReBo. In 2015 alone, the sector restructured from 383 to 335 active credit unions, an important achievement.

ReBo has indicated that about 70 projects, involving potentially over 120 credit unions, are at different stages in the restructuring process. The Registry will continue to work closely with ReBo to assess each individual transfer project. The key risk parameters that are assessed include the current and projected financial position, governance standards and operational capabilities of the credit unions on both a standalone and combined basis.

As you are aware, ReBo will only be in a position to support those transfers where a high level business case has been approved and a letter of support has been issued by ReBo on or before the 31 March. From 1 April, credit unions that do not have this approval from ReBo but who want to progress a voluntary restructuring solution, should contact us at the Registry of Credit Unions. Our aim with restructuring is to help put the sector on a sounder footing and contribute to the maintenance of financial stability and well-being of credit unions generally. We will issue formal communication in coming weeks to the sector outlining our intended approach to the restructuring process post ReBo.

A key driver in restructuring is the willingness of financially strong and well governed credit unions with a strong operational profile to act as transferees. I would encourage potential transferee credit unions - not already doing so - to consider the strategic opportunities offered by mergers.

As you might expect, as we move along in the restructuring phase, we are now seeing some new trends and issues. More mid-sized credit unions are assessing merger opportunities, including with each other, and some proposed link-ups present special challenges regarding clarity of leadership, governance and strategic focus going forward. An important consideration in our on-going supervisory approach with credit unions will be to ensure an appropriate focus on viability and strategic planning, and to engage with both potential transferor and transferee credit unions to progress mutually beneficial restructuring projects, and also to address challenges as we see them.

We are often asked how much restructuring is needed, and what is the target number of credit unions? As I have iterated before, there is no target number. But there is an implicit target state, where credit unions are resilient and viable on a forward-looking basis, and are providing the services that members want via the channels that members expect. Clearly, we are some way from that target state, and I would continue to urge credit unions to consider whether restructuring – as a transferor or transferee – provides the prospect for a better future for their members.

One issue to flag is that there may be some credit unions willing to merge but unable to find a suitable partner. In some cases, this may arise alongside viability challenges. In particular, I am reflecting on cases where a credit union is unlikely to generate a sufficient Return on Assets to deliver a return for members, or may be operating at a loss and actually eroding the capital reserves of the credit union. In such instances, where the credit union’s business model is no longer viable, it is not acceptable to wait until they are approaching regulatory reserve minima before prompting necessary action. For those credit unions, our engagement focus is on understanding their contingent strategies, including the trigger point at which a credit union may seek voluntary dissolution if there is no other viable strategy available. I appreciate that these are just some of the hard decisions that you and your Boards may have to take, but it has the benefit of bringing a focus on future viability and introduces clarity about the future. Without such clarity, some credit unions could drift into regulatory insolvency and potentially resolution, where decisions about their future would be largely taken out of their hands.

2: Post-Merger Supervisory Engagement

The motives for restructuring within the credit union sector are to support stability and to facilitate wider services for members facilitated by increased capacity and capability. At the Registry, we want to ensure that these potential benefits from mergers can be realised, so as to put the sector in the best position to deal with its financial challenges and focus on business model development opportunities.

We are, therefore, focusing a number of our supervisory engagements towards entities in a post transfer environment. We will seek to assess

  • Progress in implementation of the merger integration plan;
  • Progress in delivering the benefits and cost efficiencies which the transfer was intended to achieve;
  • Evidence of a shared understanding of, and action on, strategic and operational priorities;
  • Whether internal controls, policies and procedures are appropriate and are uniformly applied;
  • Strategic leadership of the board necessary to ensure a progressive and developmental orientation in the merged entity.

We recognise that embedding a new culture requires time and focus. However, I would say that, based on the sample of post-merger engagements we have undertaken so far, we are not – as yet – seeing the anticipated benefits of transfers and mergers coming through, to the degree expected or needed, in order to put credit unions on a sounder path forward.

It is critical that, post-transfer, there is continued focus on achieving the strategic and business model expansion goals, as well as the risk minimisation approaches, that are the target of the transfers. It is vitally important to use the potential for financial and operational efficiencies, and the broader capabilities of merged entities, to continue to attract younger active members and to facilitate business model development.

On the subject of involuntary restructuring, it is also worth taking stock of what has been achieved and what we have learned. Using our resolution powers, the Central Bank has undertaken three Directed Transfers and one liquidation since 2013. In the fourteen months since our last High Court action using our resolution powers, we have been able to avail of an alternative approach, using your sector’s private fund instead of taxpayers’ money. Under this approach, eight credit unions which failed to meet our minimum regulatory reserve criterion have been transferred with capital support, under legal agreements which provide appropriate safeguards to minimise risks to the greatest extent possible. The combination of these transfer and resolution cases was successful in removing the riskiest credit unions and at the same time safeguarding members funds, without disruption or contagion across the sector – a not insignificant achievement.

In reviewing the main causes of difficulty in these most problematic cases, three issues stand out : 

  1. The number of instances in which the credit union undertook major investment in its own premises during the boom period (which subsequently had to be written down substantially);
  2. The scale of losses on loan portfolios (sometimes up to half the loan book), and
  3. Governance and controls failings.

While these experiences were not unique to those entities - but symptomatic of the broader over-exuberance in the economy and especially the property/financial sector connection - there are important lessons to be taken from them. These include the need to continue to implement sound and cautious lending practices especially in an environment of heightened confidence, and the need to ensure that investments and development decisions in a credit union take account of the possible reversal of business conditions – whether cyclical or structural.

3:   Thematic Reviews

At the Registry we constantly review engagement with the sector to ensure it is appropriately aligned with our priorities for the sector and any emerging risks. As part of this process, we will, in 2016, embark on a number of thematic inspections. These reviews will supplement the bilateral onsite engagement we already have in place through PRISM and provide valuable information and guidance for credit unions. While narrower in focus, thematic reviews examine particular areas key to the proper operations of credit unions.

Our first two thematic reviews will be on Management and Oversight of Outsourced Activities, and Review of the implementation of Fitness & Probity due diligence requirements.

Management and Oversight of Outsourced Activities

Our thematic review of the management and oversight of critical outsourced activities is to understand better where risks arise, are held, are managed and reviewed with respect to outsourced arrangements. A credit union is only as strong as the weakest link in its outsourced processes. Risks that can arise through outsourcing include inability to execute transactions; inability to confirm balances or financial positions; inadequate control systems or culture. We will seek to confirm that credit unions are meeting their members needs and evolving business offerings through their outsourced arrangements, and that the content of SLAs are appropriately challenged to ensure they provide the appropriate level and type of services required.

Review of Fitness & Probity due diligence requirements

With regard to a thematic review of the due diligence process with respect to Fitness & Probity requirements, our focus is to ensure that the governance of credit unions is strengthening in line with our regulatory requirements. We will include a focus on the role of the Nominations Committee, in particular the process for identifying suitable candidates, and the consistency of the criteria applied with special emphasis on Control Functions.

We will shortly communicate with you more formally on the scope and timing of these planned thematic reviews. These will consist of desk-based and onsite elements. The typical sample size will be such that lessons learned from the exercise can be extrapolated across the sector. While we will address any issues identified directly with the credit union(s) concerned, we will also communicate our findings in aggregate to the sector. This will outline the standards achieved and also our expectations in the areas examined. For the credit union sector and, particularly for you as managers and for your boards, this is intended to build a clear understanding of the nature of the particular risks and set out the risks that should be considered and, where necessary, addressed in the context of your own governance and control framework.

4: Business Model Development

We know that your credit unions are working to overcome the many challenges you face, especially the declining core loan income and ageing membership base and the need to attract new younger active borrowers by offering the services they want via the channels they expect. The key to overcoming these challenges will be the development of appropriate, viable and sustainable business models. At the Registry we are now starting to see more initiatives or proposals for new products, service s or link-ups with other bodies. As you explore options for your future business model and your specific proposals, this should help to further clarify what is – and what is not – beneficial for, and realistically achievable by, your sector.

It is important to be clear that it is not the role of the Registry to develop the future path for the sector. That is for the sector itself to decide. Whether that path involves wide scale consolidation, further restructuring and the development of a variety of business models or confederation, it will be up to credit unions to take the decisions and to manage the risks involved.

At the Registry we are not seeking to constrain your business models, but to ensure that proposed developments are carefully assessed. Where credit unions set out a clear path on how they wish to develop, we will consider any amendments to the regulations that may be appropriate.

With that as context, there are opportunities for sector representatives and the Registry to engage, in a beneficial way, to advance the business model development agenda. As you know, we are undertaking stakeholder meetings on business development, aimed at discussing our business model transformation expectations and providing credit unions with a well-grounded basis to develop risk-based and feasible transformation initiatives.

Three meetings have been held and the priorities identified for 2016 include 

  • Review of longer term lending limits;
  • Clarity on additional services framework, and
  • Publication of sectoral data and analysis. 

5. New Regulations

As you aware, we are continuing to work on the development of the application process for the retention and acceptance of new savings over €100,000. We will continue to engage with sector bodies - including CUMA – as we finalise these processes. Our objective is to ensure that the approvals are consistent with the adequate protection of the savings of members and are effective and proportionate. When the application processes are finalised, the Central Bank will provide credit unions with application forms accompanied with explanatory notes for each application process. We are also committed to review the savings limit three years from commencement of the regulations.

6: Conclusion

We have spoken before about the challenges facing your sector and the efforts which you and your Boards and colleagues have taken, in difficult circumstances, to achieve the best outcomes for your credit unions. The greater momentum towards restructuring has provided the basis on which to build significant improvements in the outlook for the sector, and we will work with ReBo to complete the proposals in the pipeline where they best protect members’ funds and sector stability.

Mergers are not an end in themselves, and I urge you to continue the work required to reap the potential financial and operational benefits of mergers, with the aim of putting the combined operation on a sounder footing to make progress into the future. You must decide the form that your sector’s future will take and satisfy yourselves that you will continue to be able to meet your members’ and community objectives, as well as your regulatory requirements, as you move forward in a multistep approach to develop sustainable business models for the credit unions of the future. I wish you success in the vital role you play as front line managers of credit unions, as you work to secure the future of your credit union and the overall sector.

Thank you for your attention.