Tackling Sustainability - Patrick Casey, Registrar of Credit Unions

29 April 2019 Speech

Patrick Casey

Address by Patrick Casey, Registrar of Credit Unions, to the Irish League of Credit Unions’ Annual General Meeting

Mr. President, members of the Board, ladies and gentlemen, let me begin by expressing my thanks to the Irish League of Credit Unions for inviting me to speak at your AGM. I am delighted to have the opportunity to address those present and your broader credit union membership.

I will start by acknowledging the responsible way in which ILCU has helped member credit unions that experienced financial distress. 31 individual credit unions have been provided with SPS1 support in the form of permanent loss absorbing capital since 2015. Through transfers of engagement backed with SPS, many non-viable credit unions have been absorbed by financially stronger partners, ensuring today that over 200,000 members continue to avail of credit union services. This is an example of how credit unions can support one another to address viability, deliver enhanced choice, and importantly, maintain the trust of members.

Member trust is just one element necessary to tackle sustainability by delivering valued choice to members – clarity of vision and enabling strategies on your future business model are also key elements. I will cover four key areas in my remarks today, emphasising each credit union’s responsibility for its business model strategy and operational effectiveness. The four areas are:

  1. The importance of addressing your key commercial challenges in service of tackling sector sustainability.This requires directing your energies across revenue growth, operational efficiency and enhanced capabilities
  2. Building on this, the pressing need to re-orientate sector strategic thinking towards business-led rather than regulatory-led change, as a catalyst for business model development
  3. The necessity for all credit unions to meet minimum regulatory standards and to build strong core prudential foundations – which are designed to protect members’ funds and are necessary to support your change agenda
  4. How we communicate, engage and support the sector in fulfilling our statutory mandate

I will return to these areas shortly.

Clearly Brexit dominates current headlines and represents a very significant challenge for Government, financial institutions and consumers. The range of risk considerations flowing from Brexit will remain an area for continual assessment by all credit unions given wider economic and financial impacts. Central Bank analyis2 suggests a disorderly Brexit could reduce Irish economic growth by up to four percent in the first year. In addition to the direct disruption to international trade, adverse UK economic developments will have spillover impacts here. Our communications to credit unions therefore emphasise the importance of proactive contingency planning, in particular regarding credit, savings and investments. I also welcome ILCU’s recently issued Brexit guide, which is a support to member credit unions.

Importance of clarifying future vision

The impetus behind business model evolution has been widely understood for some time, and has been highlighted by previous Registrars since before the crisis. Indeed ILCU’s own 2003 Operational and Performance Review noted:

“The important concern for Irish credit unions is to examine their role, their capacity and ability to deliver quality services to members and to devise strategies to ensure they continue to remain a vital organ within financial services provision...” 

It is disappointing for all of us that some sixteen years later, there has not been any material repositioning of the credit union business model. Notwithstanding significant political engagement by the sector and support from legislators and regulators to facilitate prudentially-justified framework change, there has been limited delivery of business model transition within credit unions. In reality, business model transformation is neither inhibited by our prudential agenda, nor by the already tailored and proportionate credit union regulatory framework. Nor is it facilitated by rhetoric deflecting credit unions from facing the reality of their commercial and competitive challenges. What is required is meaningful action and delivery by credit unions in terms of business-led change.

Your conference theme “Greater Together” emphasises the importance of collaboration. We all recognise credit unions must focus collaboratively on the delivery of valued choice to members. They must do so on a operationally efficient basis cognisant of the cost to serve members, enabled via scale benefits that can only be derived through collaboration.

Our vision is of “Strong Credit Unions in Safe Hands”, where:

  • We see "Strong Credit Unions" as being financially strong and resilient, enabled by sustainable, member-focussed business models, underpinned by effective governance, risk management and operational frameworks
  • We see that credit unions are "in Safe Hands" when they are effectively governed, professionally managed and staffed by competent, capable people who appreciate and prudently manage risks, while successfully meeting members’ product and service expectations

Our vision underpins our statutory mandate to ensure each credit union protects the funds of its members and the maintenance of the financial stability and well-being of credit unions generally.

Turning to the first of the four key areas I will cover.

1. Importance of addressing your key commercial challenges

As highlighted in our recent guidance on business model strategy3, there are three core commercial challenges credit unions must address in repositioning their business models in service of sustainability:

a) Increase revenues via loan growth and non-interest income

Growing lending is a challenge today given the sector already has a c.34% market share in non mortgage consumer loans4. Of course that is not the full picture as each credit union faces a unique competitive landscape within its common bond.

Some advocate that mortgage and commercial lending are the answer. Whilst they may form part of a balanced loan portfolio, the challenge is to deliver returns on a sustainable basis recognising product cyclicality, maturity transformation and concentration risk issues. Credit unions should be cautious about engaging in new areas where established incumbents with size and scale advantages, have themselves encountered difficulties. A gradual stepped approach to new areas such as mortgages and commercial lending is considered prudent, until competence is developed.
 
Additional lending capacity is the subject of an ongoing consultation (CP125). Proposed changes would facilitate house and commercial lending on a prudent basis while appropriately managing duration and concentration risks.
 
While I appreciate the focus of many of you is understandably on loan growth, it is vitally important to ensure your credit union has a well-developed and embedded credit risk appetite. As our recent PRISM Supervisory Commentary 2019 highlighted, weaknesses in credit frameworks were noted during our 2018 engagements which included divergence between the stated credit policies and credit union underwriting practices. Such weaknesses can undermine credit union efforts towards sustainable growth.
 
As more credit unions become active in longer term lending, there may be a temptation for some to lend larger amounts, whether beyond their competence or outside of risk appetite. The recent crisis provided many such examples. It is inconsistent with the duty of care you owe to your members, not just as shareholders, but also as borrowers.
 
As a nation we are still dealing with the consequences of inappropriate bank lending, not just to developers but also to consumers. The crisis aftermath has shown the consumer detriment associated with irresponsible mortgage lending and its costly social consequences. This may make for uncomfortable conversation, but must be reflected upon in the context of each credit union’s calibration of, and adherence to, an appropriately developed credit risk appetite. It will serve your credit union and its members in the longer term.
 
Non-interest income, which is less than 3%5 of total sector income, contrasts sharply with international peers who generate up to c.30% of total income from fuller service, fee-earning offerings to members. They competitively price their services, offering lower cost alternatives6.
 
Credit unions can already offer a range of such services to members on a tied or introduction basis from which to generate commission income. We note increased interest recently from credit unions to provide insurance intermediation as independent advisers. For those credit unions with appropriate expertise, authorisations and systems and controls in place, we are currently defining the nature and scope of this expanded activity as an ‘additional service’7. For this we will expect credit unions to adopt a risk-based approach, and ensure appropriate consumer protections for their members. 

 

b) Address operational effectiveness

With an average cost income ratio of 74%8 across the sector, for many credit unions there is limited headroom to invest in modernising core processes. It remains a concern that we are yet to see strategic focus within the sector on transforming your operational model and the cost to serve members. Credit unions must prioritise this area given enhancing operational effectiveness is a critical component of future sustainability.  I urge you therefore to orientate your strategic thinking to include operational effectiveness. Otherwise seeking to automate existing manual embedded processes, while beneficial, may only produce limited benefits. Collaboration is key to a more fundamental re-design necessary to deliver material long term benefits.

Absent a cost effective process capacity to deliver on members’ expectations, achieving sustainability will be challenging for many. Similarly, as regulatory burdens grow in line with business complexity, you need to find ways to redesign processes and information systems to be operationally effective from a compliance standpoint. In view of average entity size, this is another area which lends itself to collaboration, and is a feature internationally.

c) Enhance capabilities to deliver for members

Credit unions need to develop delivery channels to keep pace with competitors and meet member expectations. Digitisation is central to this. As both new entrants and incumbents invest in digitisation, they are setting the service standards people expect. For you this is an area that will also require inter-credit union collaboration and investment, while protecting the safety and soundness of your core savings and loans systems.

As credit unions engage in more complex activities, operational risk naturally increases and requires careful management and mitigation, an issue highlighted in our recent PRISM Supervisory Commentary. Where you choose to seek outsourced service support, retaining necessary oversight and control over such third party arrangements is also critical.

I am pleased to note ILCU’s increased interaction recently with credit union CEOs. Internationally, CEO-led business model transition evolved through commercial collaboration, as the sector committed the resources, developed the required competences and built supporting infrastructure. We recognise CEOs, from an operational and technical perspective, are best placed to design and develop business model strategies for board consideration.  Indeed our 2018 initiation of the independent CEO Forum was aimed at supporting credit union sustainability through CEO collaboration. ‘Revolving credit’ is one of the CEO Forum’s workstreams – designed to enhance process efficiency in credit unions providing small recurring loans to members. While valued by members, the administrative workload involved in smaller loans can be significant. The challenge for CEOs is to design a solution which meets members’ needs and works for the credit union. I believe this CEO Forum workstream is progressing well, and understand that ILCU is providing some support, which is welcome.

Turning to the second key area I will address.

2. The pressing need to re-orientate sector strategic thinking towards business-led rather than regulatory-led change

Business model transformation can be complex. It involves offering real choice valued by members, attaining service quality standards, building new delivery channels, enhancing operational capability, establishing relationships with key service providers and identifying, managing and mitigating risks. Collaboration is key given scale limitations. Put simply it requires you to focus together on business-led change.

There are some who would have you believe your challenges are not commercial, but are regulatory in nature. This is misleading and distracts from market realities. Within the same lending framework today the loan to assets ratio ranges from 11% to 73% across the sector – confirming some are better than others at overcoming their commercial challenges.  Credit unions already have significant under-utilised lending capacity and regulatory flexibility9. Lending capacity will increase further under proposed changes outlined in CP12510. Therefore it is not your regulatory framework that inhibits your business model development.

Indeed, should you look to provide ‘additional services’ not specified within the credit union framework, there are established processes in place to seek required regulatory approval. With 51 credit unions approved for MPCAS11, commentary from some regarding regulatory inflexibility or that credit unions are more restricted than in the past, lack credibility. The evidence in front of us is clear. Since 2003, we have only received three proposals from credit unions to undertake ‘additional services’ not specified in the credit union framework12.

Given the limited business model change undertaken in the sector to date, it is reasonable to ask why? A focus on continual regulatory framework change as a perceived solution to addressing business fundamentals, distracts from overcoming the real commercial challenges you face. It does not serve members’ long term interests.

Turning to the third key area I will address.

3. The necessity for all credit unions to meet minimum regulatory standards

Minimum regulatory standards

Forward-looking credit unions today are focused on developing their business models to serve their members’ future needs. They distinguish themselves from peers by embracing a risk mind-set and recognising minimum regulatory standards to be what they are – the minimum of what is expected, not a target. The revisions under the 2012 Act13 strengthened the governance framework and embedding related changes has seen a focus since. The boards of these credit unions effectively leverage the support functions provided for of Compliance Officer, Risk Management function and Internal Auditor, to assist in discharging their oversight roles.

We have seen six credit union failures since 2013, which represent significant developments in the evolution of the sector. In each case, although financial difficulties precipitated failure, the root cause lay in weak core foundations and poor governance in particular. It clearly follows that there is a need for ongoing strengthening of governance to prevent failures from re-occurring, which can undermine member trust on a sectoral basis.

It is therefore surprising to us that we still occasionally hear references from some within the sector to over-regulation. It speaks to an outdated mind-set grounded in the past. The reality is that the regulatory framework applying to credit unions today is both tailored and proportionate. In fact, credit unions have frequently been excluded from the application of a range of EU and domestic regulation which applies to other regulated financial service providers.

As credit union business models evolve towards more complex products such as mortgages, credit unions automatically become subject to a broader range of mandatory consumer-oriented European and domestic regulation. This represents the price of participation.

Post the financial crisis, those providing financial services at retail level are subject to higher minimum regulatory standards than in the past. What some refer to as over-regulation in fact represents the minimum expectations of those placing their trust in their financial service provider. It is from this perspective that we must all view the need for minimum regulatory standards. After all, we all recognise the member-centric ethos of credit unions and share a common desire that members receive, at a minimum, the equivalent protections available to the customers of other regulated financial service providers. So what is the current position in terms of credit unions meeting those minimum standards?

PRISM Supervisory Commentary 2019

Our recently published Supervisory Commentary sets out our evidence-based findings from our 2018 supervisory activities, profiling identified risk issues by credit union size. Through our supervisory engagement we note some individual credit unions have through their actions improved their risk profile. These credit unions have moved beyond a mere “tick-box” approach in seeking to address their risk vulnerabilities, through board ownership of risk management and mitigation.

Nonetheless, there remains evidence in many credit unions of continued weakness in fundamental areas of governance and risk management. For instance, identified weaknesses in the three lines of defence of risk management, compliance and internal audit, are still being evidenced. Significant issues relating to credit have also been identified, including divergence between stated risk appetite, credit policies and underwriting practices. This is concerning given an increasing appetite within the sector for longer term lending. We also evidenced instances where operational risk is not being effectively managed and mitigated, which is concerning given growing operational complexity.

Our supervisors continue to identify vulnerabilities in these core areas which raise concerns about the ability of some credit unions, including some large credit unions, to transition safely to a more complex business model. We expect all credit unions to consider the findings in our PRISM Supervisory Commentary 2019, to support their own risk management.

Central Bank risk appetite

The Central Bank has different risk tolerances for failure of firms in different impact categories14. Our risk tolerance for failure is highest for low impact firms, while we have a very low tolerance for failure of higher impact firms. We recognise that some credit unions may fail. While we have a risk appetite for credit union failure, we have no risk appetite for unmanaged failure.

For weaker credit unions with viability issues who are not servicing member needs, engaging at an early point in a transfer to a stronger credit union capable of serving those needs is critical. As is the case with any business model, where recapitalisation is being considered on a standalone basis, we will challenge such proposals to confirm sustainability. History has shown that without fundamental changes to the business model, further demands for recapitalisation will likely follow.   Current financial trends underpin why transfer is the appropriate strategy for boards to pursue to protect members’ long term interests. Absent a suitable transfer, in line with our risk appetite for avoiding unmanaged failure, resolution may be required to protect members’ funds.

Turning to the final key area I will address.

4. How we communicate, engage and support the sector in fulfilling our statutory mandate15

We engage proactively and transparently with credit unions, and in fact undertake a far more extensive interaction with the sector than with any other sector regulated by the Central Bank. The variety of supports made available by us to credit unions through our multi-channel engagement include:

  1. onsite and off-site supervisory engagement designed to enhance the safety and soundness of credit unions, through proportionate supervision based upon the nature, scale and complexity of firms
  2. sector communications on cross cutting issues, including, our Financial Conditions publication, our PRISM Supervisory Commentary and our guidance and thematic reviews. Recent reports include our Business Model Strategy guidance16 and our “Thematic Review of Restructuring in the Credit Union Sector”17
  3. regular meetings with stakeholder representatives, including annual meetings with the Deputy Governor – Prudential Regulation
  4. presentations and speeches at representative bodies’ annual conferences on strategic issues
  5. engagement with individual and groups of credit unions on business model proposals through our dedicated Business Model Engagement team established in 2016
  6. engagement with credit unions on evolving an already tailored and proportionate regulatory framework, through regulatory responsiveness
  7. Information Seminars presenting on topical issues – in 2018 we held 5 seminars in Dublin, Athlone, Cork and Kilkenny, with 478 credit union registered attendees
  8. Credit Union Workshops, aimed at supporting directors in credit unions of differing sizes, in addressing risk vulnerabilities, and by extension, strengthening prudential foundations – in 2018 we held 6 workshops attended by over 200 credit union board members
  9. facilitation of a CEO-led Forum on Business Model Development aimed at supporting CEO business model collaboration – the outcomes of which should benefit all credit unions.

Conclusion

Ten years on from the crisis, retail financial services continues to evolve and for too many credit unions, the gap is widening between where they wish to be and where they are. This is reflected in the financial position and performance of many credit unions. Meaningful business model transition has yet to gain sufficient traction. A failure individually and collectively to address business model change, has implications for sector sustainability.

Irish credit unions deservedly have a highly respected brand and enjoy the loyal trust of members18. This trust coupled with your co-operative member-centric ethos, is a competitive difference upon which to build your future business model. Some credit unions are seeking to move the business model agenda forward. Transformation may see them transition to a fuller service offering. Transformation in all its forms, will take shared co-operative leadership and collaboration.

In the face of sustainability challenges, members’ interests are best protected by leadership taking difficult decisions at a sufficiently early stage. We emphasise that all credit unions need to ensure there is greater clarity regarding their longer term sustainability, reflective of the competitive landscape, demographic impacts and the protection of members’ funds. For weaker credit unions with viability issues who are not servicing member needs, engaging at an early point in a transfer to a stronger credit union capable of serving those needs, is critical.

Minimum regulatory standards are designed to protect members’ funds and they must be met by all credit unions. They represent the minimum expectations customers have of their financial service providers. The reality is that the credit union regulatory framework is both tailored and proportionate.

Sustainability is highly dependent on credit unions utilising the flexibility that already exists within the regulatory framework today, to optimise their competitiveness. The key elements necessary for credit unions to undertake meaningful business model transition are in place. It now rests with credit unions to drive the required change process. Those who lead the sector will best serve the long term interests of members, by supporting a business-led change agenda.

Thank you for your attention.


1 Savings Protection Scheme administered by ILCU

2 The Brexit Discontinuity - Governor Philip R. Lane speech 13 February 2019. https://centralbank.ie/news/article/the-brexit-discontinuity-governor-philip-r-lane

3 Business Model Strategy – Guidance for Credit Unions, February 2019

4 Source: Central Bank Statistics – Private Households Credit and Deposits (Table A 18) and Financial Conditions of Credit Unions 2013-2018 December 2018

5 Source – Central Bank – Credit Union Annual Financial Statements September 2018 – Other Incomme/Total Income – average c.2.7%.

6 2018 NCUA data

7 As provided for under sections 48 to 52 of the Credit Union Act 1997.

8 Source September 2018 Prudential Returns, cost/income ratios range from 46% to 145%. Calculated as = Net Loan Protection (Life Savings Insurance) + Salaries and Related Expenses + Interest on Borrowings + Interest on Deposits + Other Expenses / Total Income

9 In terms of long term lending, sectorally credit unions can lend up to €1.5BN over 5 years and of this €517M can be lent over 10 years. Total utilisation of this capacity is €851M and €182M respectively. In terms of commercial loans, sectorally credit unions can lend up to €960M. Total utilisation of this capacity is €93M.

10 Changes proposed under Consultation Paper 125 which we are currently consulting on.

11 MPCAS provides current account functionality for credit unions

12 Three additional service approvals - mortgage intermediation (2007), MPCAS (2017) and multi-agency insurance intermediation (2018).  

13 Credit Union and Co-operation with Overseas Regulators Act, 2012

14 Under PRISM, impact indicates the degree of damage a firm could cause to the financial system, economy and citizens were it to fail.

15 Section 84 of the Credit Union Act 1997 (As amended)  

16 https://www.centralbank.ie/docs/default-source/regulation/industry-market-sectors/credit-unions/communications/reports/business-model-strategy---guidance-for-credit-unions.pdf

17 https://www.centralbank.ie/docs/default-source/regulation/industry-market-sectors/credit-unions/communications/reports/restructuring-in-the-credit-union-sector---thematic-review-findings---february-2019.pdf?sfvrsn=4

18 Survey carried out Amárach Research on behalf on behalf of the Cx Company http://thecxcompany.com/wp-content/uploads/2017/10/CXi-Ireland-2017-Report.pdf