Remarks by Registrar of Credit Unions, Patrick Casey at CUDA 2022 Annual Conference

Introduction

I am delighted to be engaging with you in person at your 2022 Annual Conference.¹ We have a regular interaction with CUDA, under CEO, Kevin Johnson’s leadership. I would like to extend our thanks to CUDA’s team for their constructive engagement.

Your conference theme - “Delivering the Credit Union Promise” - provides an opportunity for those in leadership roles across the sector, to pause for strategic reflection.

During the strained circumstances of COVID-19, credit unions showed their resilience in continuing to serve member needs. Building on that resilience is important to underpin credit union business model transition. It is central to your strategic future.

In November 2021 the Central Bank published our multi-year strategic plan for the coming period. It is aimed at ensuring we can continue to meet the challenges we face in an ever changing world, while delivering on our important public service mission. For those interested, further information on the plan can be found on our website², including on our connected strategic themes: Future-Focused; Open & Engaged; Transforming; and Safeguarding.

Credit union commercial challenges are well known. With a perennial sector focus on regulatory framework flexibility as a panacea to overcome the sector’s commercial challenges, it is important to focus on your ongoing resilience.

Governor Makhlouf recently³ referenced the role of long memories when it comes to regulatory flexibility in the context of recurring financial crises, by saying:

“We have seen the benefits of resilience over the last two years and we will continue to focus on it….. We certainly cannot lose focus on the risks that have brought down financial systems in the past: misaligned incentives and excessive credit growth, leverage and liquidity transformation.

…Financial crises are a recurring phenomena in market economies and I suggest there is an important role for ‘long memories’ in financial regulation. We need to guard against the swinging pendulum where regulation has tended to weaken during a boom and is then strengthened following the inevitable bust.”

With extensive regulatory framework change in recent years and a rapidly changing financial services landscape, now is the time for vision from sector leadership, informed by long memories. Now is the time for refocusing energies on strategic priorities connected with business model transition, in service of credit union sustainability. Now is the time for supporting credit unions to overcome their commercial challenges from the ground up – for instance by helping them to grow lending in newer, competitive areas, with scalable shared service supports.

In my address this morning, I will focus on credit union resilience, in the context of our statutory mandate towards the sector, and the protection of member funds. I will cover the following topics:

1. The sector’s current financial resilience and ongoing efforts to grow new areas of lending, which must be underpinned by required competence and capability;
2. An assessment of the quality of credit union risk management - a fundamental capability and a key business enabler;
3. Some critical areas of focus to strengthen resilience – including examples of where more proactive risk management is needed; and
4. The review of the credit union policy framework and our regulatory focus going forward.

I will now address the first of these issues.

1. The sector’s current financial resilience and ongoing efforts to grow new areas of lending, which must be underpinned by required competence and capability

Financial Conditions Report

In December 2021 we published the 8th edition of the “Financial Conditions of Credit" ⁴ were positive trends in reported data, reflective of a return to more normalised conditions.

Lending growth re-emerged as health restrictions were eased. However, the sector loan to asset ratio at c.27% remains close to historically low levels.

While savings continued to increase in 2021 (up 3% to €16.8 billion), the pace of growth slowed. This may reflect some reversal of COVID-19 effects as well as proactive steps taken by many credit unions to manage savings inflows.

Overall, income generation and return on assets remain an issue – two important measures of credit union financial resilience. At a time when savings growth continues to outpace lending growth, credit union sustainability remains constrained by low loan to asset ratios, low investment returns and high cost income metrics.

In such circumstances, capital adequacy - both in percentage and financial quantum terms - is paramount. The average sector total realised reserves ratio increased marginally from 15.9% to 16.0% over the year to 30 September 2021. Individual credit union capital reserves are key to underpinning member confidence, particularly in times of uncertainty and where sustainability challenges persist.

Lending Activity

Lending is the principal source of credit union income, and income is the only source of capital. Therefore lending is critical to sustainability and member protection. We support prudent credit diversification by credit unions towards a more balanced loan portfolio, recognising it will take time.

The Financial Conditions report shows many credit unions are availing of the increased flexibility to lend unsecured up to 10 years maturity. In the year to 30 September 2021, there was a marked increase of 27% in new credit between 5 and 10 years, now representing 23% of all new lending (compared to 9% in 2016). Such lending is not subject to regulatory limits, and while it commands less sector commentary than house lending, it is a far more significant contributor to income.

Our regulatory changes introduced in early 2020 provide combined house and business loans capacity of up to €2.5BN⁵. If this capacity was fully utilised for house loans, credit unions have scope to build up to a 3.2% share of the Irish mortgage market⁶.

Given the recent sector narrative on house lending, it is important to distinguish ‘available lending capacity’ from ‘actual levels of utilisation’. Sector house and business lending volumes remain muted. At 30 September 2021, the total of house loans outstanding was €260M (or 10% of maximum capacity), and the total of business loans outstanding was €128M (or 5% of maximum capacity).

The average credit union house loan advanced in 2021 was €100K (well below the market average of €249K)⁷. It tells us credit unions operate in a different segment of the market to competitors. It also tells us that our 2020 changes give credit unions extensive scope to provide members with a high volume of house loans.

Half of all credit unions (99) took the strategic decision not to engage in house lending. For those who do, activity is heavily concentrated in c.50 credit unions. The average capacity utilisation for all credit unions engaged in house lending is only 1.4% of total assets, a fraction of available capacity⁸.

Only five credit unions have notified us that they will utilise the 10% combined lending limit⁹, and only seven credit unions have applied for our approval for the 15% combined lending limit¹⁰. It is for credit unions to decide if they wish to avail of this increased capacity – when they do, we stand ready to engage with them.

Why are credit unions not engaging more in house lending? The answer is that as new entrants, credit unions are not able to build a large foothold in the market overnight. Other established and emerging lenders have commercial and competitive advantages - including brand reputation and awareness, scale and reach, product design, segmented pricing/offers and IT/operational efficiency.

House and business lending are specialist areas. House lending in particular is a high volume, low margin activity, which requires scale and a high degree of competence and capability (for instance engaging for the first time in liquidity transformation). As we introduced our 2020 changes, we did so on the basis of tiered lending limits to facilitate prudent credit union market entry over time¹¹, as competence and capability developed.

Recent calls for a substantial further uplift in house lending capacity bears no connection to market realities on the ground, including actual credit union house lending activity or future strategic growth plans.

For those within sector leadership calling for further capacity to be made available now, we suggest energies are instead dedicated to leading and supporting credit unions as they try to develop their new lending propositions. In doing so, it will be clear that the nature of the challenge is a commercial one and that given limited utilisation, there is extensive available lending capacity at a sector and a credit union level.

Other Market Developments

Irish retail financial services are changing, as new fintech providers grow their presence while some retail banks withdraw from the market. These changes present opportunities and challenges for you.

Credit unions have scope to provide a broad range of services to meet their members’ needs – including through the exempt services regime and the additional services regime. The provision of any new services should be undertaken prudently in line with a credit union’s strategy, capabilities and risk appetite.

Providing current accounts can help credit unions to become a primary financial service provider for members. As some retail banks withdraw, 2022 is likely to be pivotal for current account provision - now available through 68 credit unions following our regulatory approval.

Newly created vehicles are facilitating credit union investment in corporate bonds and Tier 3 Approved Housing Bodies (AHBs). Some AHBs are evolving their business models, including moving into ‘cost rental’ housing. If credit unions propose to invest in an AHB, it is vital that they undertake robust due diligence to fully understand the risk profile of the underlying investment.

In the pursuit of return, credit unions need to ensure that investments align with risk appetite. Boards need to carefully consider the risk/return trade-off, as elevated returns typically involve elevated risk.

This brings me to the second issue I will address.

2. An assessment of the quality of credit union risk management - a fundamental capability and a key business enabler

Risk management is a key line of defence for all businesses, including for financial service providers. We previously expressed our supervisory concerns regarding recurring governance and risk management issues in credit unions¹².

We welcome the progress made since the Oireachtas introduced the enhanced governance regime for credit unions in 2013. This does not mean that there are effective risk management frameworks in operation in all credit unions. Indeed, credit union risk management was highlighted by our international peers from ICURN during their 2019 peer review¹³. ICURN noted that while credit unions had put in place risk management frameworks supported by specialist staff, they needed to fully embed such structures and ensure that resources assigned were actively utilised to inform strategy and decision making.

Our 2021 supervisory engagement involved a thematic review of credit union risk management, to assess its overall maturity and embeddedness.

We found some credit unions continue to view the implementation of risk management frameworks as an exercise in regulatory compliance. On the contrary, it is a fundamental capability and a key business enabler, one that underpins informed decision making.

While it was encouraging to see examples of good practice during our review, risk management weaknesses were also identified. These included weaknesses in board oversight, stewardship and ownership, the structure and framework of the risk management function, risk reporting, engagement with risk management and training and culture.

I urge you to review our thematic review report¹⁴. You should consider how our findings can support you in embedding a strong risk management culture in your credit union.

Moving to the third area I wish to address.

3. Some critical areas of focus to strengthen resilience – including examples of where more proactive risk management is needed

While effective risk management must be deployed right across all of the credit union’s activities, we thought it would be instructive to consider a number of specific topical areas, where proactive risk management is critical to your resilience.

Operational Resilience

Credit unions continue to become ever more reliant on complex IT systems. This often involves outsourcing arrangements with third parties. Combined with expanding branch networks, this has increased the operational risk profile of many credit unions.

Your overall control framework must fully address IT and cybersecurity issues. Credit unions must understand and keep abreast of a range of specific IT-related risks to which they are exposed. IT and cybersecurity are good examples of areas where effective risk management is fundamental to strengthen your operational resilience.

The European Digital Finance Strategy aims to ensure that participants in the financial system have the necessary safeguards in place to mitigate cyber risks. This package includes proposed regulations on Digital Operational Resilience in the financial services sector (DORA). Irrespective of the scope of these requirements, it will be important for credit unions to consider how these regulatory developments can inform effective risk management of IT/cyber risks.

Regulated firms are also expected to have effective governance, risk management and business continuity processes in place in relation to outsourcing, to mitigate potential risks of financial instability and consumer detriment. In December 2021 the Central Bank published our cross industry guidance on outsourcing to assist regulated firms in developing their associated risk management frameworks¹⁵.

Accrued Interest

For a number of years now we have been highlighting the need for credit unions to take action regarding accrued interest issues. It is concerning that from our 2021 year-end engagement, accrued interest is not being proactively addressed in all cases. It is another risk area which boards need to be proactively managing and mitigating.

As previously indicated, where any credit union has determined that its members have been affected by accrued interest issues, we expect those members to be advised of planned actions and/or redress arrangements, in a timely manner.

Cost of Pension Benefits

Recent developments concerning a deficit in a pension scheme will have financial impacts for individual credit unions. It is important that there is full clarity and transparency for members in financial statements. Under section 108 of the Credit Union Act, 1997, boards must ensure the accounting records give a true and fair view of the state of affairs of the credit union.

In the context of sector capital levels, contrary to recent media reports, the scale of the pension deficit issue does not raise broader sector stability concerns. Nonetheless, we will continue to monitor the financial resilience implications on individual credit unions, and take appropriate action if needed, to protect members’ savings.

Boards should also be mindful of understanding the full implications of any new pension arrangements for their credit unions. Board risk management considerations should include financial, operational, legal and HR implications, as well as accessing third party professional advice where appropriate.

Climate Risk

Governor Makhlouf wrote to all regulated financial service providers on climate issues in November 2021. His letter sets out our supervisory expectations across five key areas – governance, risk management, scenario analysis, strategy and business model risk and disclosures. We encourage you to consider these issues in the context of your credit union, including associated risk management of climate risk.

Turning to my last area of focus.

4. The review of the credit union policy framework and our regulatory focus going forward

Policy Framework Review

Work is continuing on the Department of Finance-led review of the credit union policy framework, and we continue to provide input to this important process.

Separately, we are also focused on progressing work in relation to a number of regulatory framework areas.

Exempt Services

In January 2022 we published CP148, a Consultation on Credit Union Exempt Services¹⁶. We are consulting on technical changes to the regime¹⁷ and on the broadening of exempt intermediation services. Please note the closing date for feedback is 21 April 2022.

Minimum Competency Code (MCC)

The Central Bank published a consultation paper on Minimum Competency Code requirements¹⁸ for credit union core services (CP147)¹⁹. The aim here is to ensure that consumers have the same level of protection no matter where they source their financial services. Please note that the closing date for receipt of feedback is 19 April 2022.

Regulatory Capital

As recommended by ICURN in its 2019 Peer Review²⁰, we plan to undertake capital adequacy analysis on credit unions. This will assess the resilience of reserves under differing scenarios.

Some within the sector point to international credit unions where risk-based capital approaches have been introduced. Credit unions in these jurisdictions have transitioned their business models to more complex offerings, with much larger balance sheets, more advanced asset and liability management and more developed competence and capabilities. In many respects they are more akin to large retail banks.

The scale of financial viability challenges facing many Irish credit unions is reflective of low loans to assets, high cost income metrics and low returns on assets. Therefore any forward-looking scenario analysis we undertake on credit union capital adequacy will likely highlight those broader viability concerns.

Against that backdrop, we would caution against an expectation that introducing a risk-based capital approach would be appropriate here. After all, Irish credit unions are yet to transition the business model away from core savings and loans, on a basis that would warrant a complex, risk-based approach.

The sector faces a growing imbalance between savings and loans, which needs to be addressed through proactive asset and liability management by credit unions – not by reducing regulatory minimum requirements.

Importantly - in the context of business model transition - the 10% minimum capital requirement does not represent a barrier to lending, with no additional capital required to grow loans.

Additionally, reducing minimum capital requirements in the face of pervasive financial viability issues, would be contrary to the interests of members and the financial stability of the sector.

Policy Implementation

Following the very significant credit union regulatory framework changes over recent years²¹, it is our expectation that the flow of such activity should slow.

We believe it is more important that the sector’s leadership - its energies and its strategic focus - are targeted at leading and supporting credit unions in overcoming their commercial challenges.

We will also be focused on engaging directly with credit unions - on the effective implementation of the existing regulatory framework. This will include assessing and processing credit union applications for various regulatory approvals, including for increased house and business lending, for current accounts and for new additional services. We see our role here as a key support towards their prudent business model transition.

Conclusion

Credit unions fulfil a central role in the Irish financial services landscape. That landscape is changing, and how you compete with others is a critical factor in your future sustainability.

Today the challenges to your commercial fundamentals are reflected in your key financial metrics, most notably in the growing gap between members’ savings and loans.
Those with long memories know regulatory flexibility cannot overcome your commercial challenges. Delivering sustainability depends on your capability to provide financial services to members - which they need, which they choose to obtain from you and which they are willing to pay you for.

The existing regulatory framework already accommodates your desired diversification away from short term personal loans. Your pursuit of lending growth in newer, competitive areas, must be aligned with competence, capability and risk appetite.

Risk management is a continuously evolving process designed to enable you to effectively address your risks. It is a fundamental capability and a key business enabler.

Building the necessary financial and operational resilience remains critical to safeguard your members, and deliver on your credit union promise. Thank you for your attention.

__________________

[1] I would like to thank Paul Stuart, Elaine Byrne, Paul Steinegger, Anna Marie Finnegan, Eamon Clarke, John Meagher and David Kielty for their contribution to my remarks.

[2] Central Bank of Ireland Strategy

[3] Speech

[4] Financial Conditions of Credit Unions

[5] Based on assumption that all credit unions utilise all available capacity based on December 2021 Prudential Return data.

[6] This compares to a credit union 4.8% share of the relevant domestic retail/SME loan market (consumer, mortgage & SME loans)

[7] Source

[8] Relative to maximum capacity of up to 7.5%, 10% or 15% of total assets, depending on credit union size.

[9] One of these credit unions has since been approved for the 15 per cent limit.

[10] As at 1 March 2022, four credit unions have been approved for the 15 per cent limit. Two applications from credit unions to avail of the 15 per cent limit are currently being assessed by the Central Bank.

[11] There are three tiers under our 2020 revised lending framework changes as follows:
• A combined concentration limit for house and business loans of 7.5 per cent of total assets for all credit unions.
• A 10 per cent limit, conditional on a credit union satisfying asset size (at least €50 million) and regulatory reserves qualifying criteria and notifying the Central Bank in advance.
• A 15 per cent limit for credit unions with total assets of at least €100 million, subject to Central Bank approval.

[12] Source

[13] Source

[14] Source

[15] Source

[16] Consultation on Credit Union Exempt Services – CP148

[17] As set out in the Credit Union Act 1997 (Regulatory Requirements) Regulations 2016 (2016 Regulations)

[18] Minimum Competency Code 2017 and the Minimum Competency Regulations 2017.

[19] Consultation on the Application of the Minimum Competency Code 2017 and the Minimum Competency Regulations 2017 to credit union core services.

[20] The 2019 ICURN Peer Review Report included an additional observation for consideration in relation to capital which encouraged RCU to “conduct additional stress-testing on regulatory reserves under the existing leverage ratio and risk-weighted reserve approach. This stress tests and impact assessments should take account of resilience to cyclical and structural vulnerabilities, long term demographic trends in the markets where credit unions generally operate, and the impact it has on loan demand, lower re-pricing of investments, the potential economic impact of a hard Brexit and the fact that retained earnings are the sole source of capital for credit unions”.

[21] In the past 6 years, the Registry of Credit Unions have issued five separate consultations in respect of important updates and reviews of various aspects of the regulatory framework for credit unions to ensure that regulations remain relevant and appropriate, in particular:
• CP88 Consultation on Regulations for Credit Unions on commencement of sections of the 2012 Act (2014/2015);
• CP109 Consultation on Potential Changes to the Investment Framework for Credit Unions (2017/2018);
• CP113 Consultation on Potential Amendments to the Fitness and Probity regime for credit unions (2017/2018);
• CP125 Consultation on Potential Changes to the Lending Framework for Credit Unions (2018/2019); and
• CP148 Consultation on Credit Union Exempt Services (2022).