"Credit union sustainability: the role of risk management, in sector restructuring and business model change" Registrar of Credit Unions Patrick Casey

Address by Registrar of Credit Unions Patrick Casey, to the Credit Union Managers Association’s Spring Conference, 3 March 2021

Chairman, members of the National Executive of CUMA, ladies and gentlemen, thank you for inviting me to address your virtual Spring Conference. I am delighted to have the opportunity to share my thoughts with you on topical issues affecting credit unions.

The pandemic has resulted in unprecedented challenges for everyone. We have seen extreme measures taken to protect public health, which have triggered an extraordinary economic shock. For credit unions, like others, 2020 was a very challenging year, both operationally and financially. Those challenges continue. The full impact of the shock to the economy and financial system will take time to unfold.

To date credit unions have been very effective in maintaining continuity of services to members. This is thanks to the hard work and commitment of you as CEOs, your staff, volunteer boards and board oversight committees, as well as collaboration between credit unions at local level.

As a representative organisation, CUMA’s role is vitally important at this time to support your CEO community. Since the emergence of the pandemic, we have had very constructive two-way engagement with your representatives. For that, we thank you, your Chairperson Therese Conway and all those from CUMA who engaged with us on a regular basis over the last 12 months.

The sector on aggregate has reported a surplus for the 2020 financial year, which is to be commended in the circumstances. Nonetheless,  the commercial challenges which existed pre-COVID-19, continue to hamper credit union business model sustainability. Across the sector, these challenges continue to manifest in acute financial viability concerns for many individual credit unions.

Given the continued risks and uncertainties associated with the virus, the near-term economic outlook remains uncertain. The prospect of an effective deployment of vaccines offers a path out of the crisis. However, recovery may not be even across all sectors or demographic groups, and the crisis may have lasting impacts. In addition, although no-deal was averted, new Brexit trade frictions will affect growth and household consumption going forward.

In the face of the uncertainty and given the key commercial challenges affecting so many in the sector, credit unions will need to continue to strengthen their operational and financial resilience, supported by robust risk management. Our emphasis here aligns with our statutory mandate towards credit unions, in particular the protection of member funds.

We view operational resilience as covering the full gambit of an entity’s operational durability, of which ongoing business continuity is just one aspect. We also emphasise the criticality of prudent balance sheet and capital management by credit union boards. This is prudentially important now given we are in a time of crisis, but also because many credit unions are already trying to manage the disruption caused by restructuring and/or business model change. I will return to this issue later.  

Your conference theme - “Spring Forward – Together, towards tomorrow” - offers an opportunity both for reflection and consideration of the path ahead. 2021 is a pivotal year for all businesses, including credit unions. As you reflect and consider your future priorities, in my address I will reflect on some key developments during 2020, before examining the Central Bank’s priorities for 2021.

1. Key developments in 2020

Much of the Central Bank’s focus in 2020 was on mitigating the effects of the pandemic. The economic challenges posed by COVID-19 have been met by extraordinary policy support. This has included a range of fiscal, monetary, macro-prudential and micro-prudential policy actions, to support households, businesses and vulnerable borrowers.

Financial Conditions’ Report

In December 2020, we published the seventh edition of the Financial Conditions Report¹. It provides a timely update on credit union financial performance and position.

Credit unions came into this crisis with a strong financial position - with sector average reserves of 16.5% and liquidity of 36.8%². A year on, and well into the pandemic period, sector reserves and liquidity levels have remained relatively stable³.

However, the full impact of the pandemic is still to be realised, and this highlights the critical importance of all credit unions adhering to minimum regulatory requirements, and prudently taking capital and liquidity decisions, involving additional buffers. 

One of the most striking features of the trends in 2020 is the expanding gap between savings and loans. Savings growth has continued, and at more elevated levels during the pandemic, up 7% across the sector in the 2020 financial year. Trends in lending have been more muted, with total sector loans falling very marginally over the period.

Managing savings inflows versus lending is a core part of the broader commercial challenges facing credit unions today. Credit union boards and management teams must therefore focus on the business risks that flow from this challenge.

The CEO Forum on Business Model Development

We initiated the CEO Forum in July 2018 to encourage greater collaboration between CEOs on business model change. The CEO Forum was established on an independent basis under Chairperson Donal McKillop and 15 Steering Group CEOs. 

We welcome the recent publication of the Forum’s work stream materials⁴, covering: collaboration, revolving credit, intermediation, member engagement, operational effectiveness, balance sheet and capital and COVID-19.  They offer a timely contribution to sector development, and a support to you, as you refocus on business model development.

With the CEO Forum now operational, we have stepped away from our secretariat role as planned. The Steering Group is currently commencing the next phase of the Forum’s development. We wish the CEOs involved well, and we look forward to continuing our engagement with them.

PRISM Supervisory Commentary

In September 2020, we published the fourth edition of the PRISM Supervisory Commentary⁵.

We are encouraged to see instances of effective governance in some credit unions – evidenced, for example, in compliance and risk management functions supporting effective board decision making. Stronger credit unions see good governance and robust risk management as critical business enablers in this increasingly challenging environment.

The overall picture however in this area is not so positive. We continued to identify examples of fundamental governance and risk management weaknesses in many credit unions. Recurring risk issues here are a prudential concern. They evidence a lack of maturity in the credit union risk management process.

Risk management is a central part to good governance, and is a critical line of defence in the protection of members. Our concerns here can only achieve so much – what we want is credit union boards to translate our findings into actions. Accordingly, enhanced risk management by credit unions is a key feature of our 2021 supervisory strategy.

The two other risk areas that stand out in our findings are credit risk and operational risk. During a time when so much sector advocacy has focused on credit union lending capacity, we continued to evidence basic, fundamental weaknesses in lending frameworks and underwriting practices (including examples of failure to assess the repayment capacity of members accurately). As lenders, this is not acceptable.  

From an operational risk perspective, credit unions have also become more reliant on increasingly complex IT systems, as well as on outsourcing to third parties. Deficiencies were identified in IT frameworks, IT risk management and oversight of outsourcing. In short, there are clear gaps in many credit unions’ operational resilience.

We expect the findings of the 2020 PRISM Supervisory Commentary will be considered by all credit unions. I would also encourage you to read a recent speech by Central Bank Deputy Governor Ed Sibley to the Institute of Directors, entitled: “Governance and risk in a time of uncertainty and change”⁶.

Liquidation of Drumcondra

In July 2020, we obtained a High Court liquidation order following Drumcondra Credit Union’s failure.  This triggered a compensation event under the Deposit Guarantee Scheme⁷.

Drumcondra had faced difficulties since the last crisis. While the root cause of its problems ultimately lay in poor governance, they manifested as financial problems through asset impairments and viability issues.

Drumcondra failed despite a 2016 standalone recapitalisation from ILCU⁸. Drumcondra’s board eventually accepted it could no longer operate on a standalone basis. Subsequent attempts to complete a transfer failed. We undertook an orderly and managed resolution to protect members’ funds and the sector’s overall stability. Recent developments will hopefully ensure alternative credit union access for members.

Our preference remains for troubled credit unions to address viability without formal resolution action. As Drumcondra demonstrates, it is difficult for failing credit unions to achieve sustainability on a standalone basis, notwithstanding external support. We continue to encourage weak credit unions to seek a transfer solution as early as possible.

Sector Engagement

COVID-19 has precluded any onsite activity at credit unions in the past year. Our supervisors instead engaged directly with credit unions more frequently on specific issues. To support this, we have also issued an increased number of credit union circulars on a range of topical issues⁹.

In April 2020, we provided certain regulatory flexibility to credit unions on a temporary basis – in line with other regulated sectors – covering reporting dates and risk mitigation plans. Since then, as credit unions have demonstrated ongoing business continuity, we have normalised arrangements. 

Since the pandemic unfolded, we engaged even more frequently with representative bodies, often on a weekly basis.  In the interests of transparency, we also published detailed correspondence on a range of policy questions raised with us. In December 2020, we also held a virtual information seminar attended by over 250 people across the sector¹⁰. 

2020 Regulatory and Legislative Developments

2020 saw a number of key credit union framework changes - concerning both lending regulations and amendments connected with Brexit and COVID-19.

In January 2020, we introduced the revised lending regulations providing additional house and business capacity. In May 2020, we also published the application process for larger credit unions seeking regulatory approval for additional lending capacity at 15% of total assets¹¹.  

In December 2020, we introduced further changes to the credit union investment and liquidity regulations¹² covering:

• Brexit transitional arrangements whereby credit unions - if they so choose - are permitted to continue to hold existing investments in UK credit institutions until maturity.
• Changes to the definition of “relevant liquid assets” to include balances in the minimum reserve account over ECB minimum reserve requirements.
• An extension to the permitted maturity limit for Irish and EEA State Securities and supranational bonds.

The Central Bank also provided input on Oireachtas changes concerning the deadline for 2020 General Meetings and the holding of virtual general meetings. Where credit unions want to ensure they continue to have the option to hold virtual general meetings in the future, they will need to pass a rule amendment at their 2020 AGM.

So they are some of the key developments in 2020. I will now outline our 2021 priorities.

2.Our Strategic Priorities for 2021

The Central Bank serves the public interest by safeguarding monetary and financial stability and by working to ensure that the financial system operates in the best interests of consumers and the wider economy. Deputy Governor Sibley recently outlined the Bank’s financial regulation priorities for 2021¹³, of which credit union priorities are a constituent part.

Our vision for the sector remains: “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, and where they can be resolved when they get into difficulty; and
• Credit unions are ‘in Safe Hands’ when they are effectively governed, professionally managed and staffed by competent, capable people, who take ownership of and prudently manage current and emerging risks.

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. We seek to implement that vision through our four strategic priorities, which I will now refer to in the context of our 2021 work priorities:

A. Effective and Proportionate Supervision:

As supervisor, we expect credit unions to have core prudential foundations including strong governance and robust risk management. We continue to focus on delivering effective supervision in the context of a sector that is undertaking restructuring, and has a stated desire to evolve its business model and to engage in innovation.

Our 2021 supervisory engagement will include a thematic review of credit union risk management, in particular to assess its overall embeddedness. Our review aims to identify best practice with the objective of improving risk management and the culture of governance across the sector. Greater ownership by boards of risk management is critical to overcome the recurring risk issues identified in our 2020 PRISM Supervisory Commentary.  

Enhanced data and reporting capabilities are essential to facilitate continual assessment of the range of credit union risk considerations. It aligns with our stated desire to enhance the use of data analytics in supporting effective supervision. Data is also an important resource for boards as they assess the financial resilience of their credit union, using key performance and risk indicators. Turning to the second strategic priority.

B. Managing disruptive change:

Credit unions are experiencing ongoing disruptive change through both sector restructuring and business model innovation.

Sector Restructuring

Restructuring plays a key role in sector sustainability:

• By addressing governance, solvency and financial viability issues, in weaker, smaller credit unions;
• By providing members of such credit unions with access to enhanced products and services in larger credit unions; and
• By providing strategic growth opportunities and potential scale benefits to those larger credit unions.

The nature of restructuring continues to evolve. Whilst most transfers continue to see weaker, smaller credit unions being absorbed by stronger, larger peers, restructuring proposals are under consideration at all levels across the sector.

We recognise the critical role that CEOs play in this area.  We ask that you continue to assess the opportunities that restructuring may present to your credit union, and to contact us to discuss any potential transfer options that are under consideration.

Business model innovation and climate change

Alongside restructuring, business model change and innovation has an important role to play in sector sustainability.

Advances in technology are bringing rapid and transformative changes to the financial services sector. All users of financial services, including credit union members, expect innovation to offer them benefits as their needs evolve. Whilst others are embracing the process of innovative business model change, it has yet to gain real traction in the credit union sector.

For 2021, we will continue to engage with those credit unions involved in the business model agenda, providing our regulatory input and challenge as appropriate.

Going forward, all financial service providers, including credit unions, will need to take account of other disruptive factors such as climate change. The issue of climate change will present new challenges, generating both potential risks, and opportunities, for the sector. Turning to our third strategic priority.

C. Tailored and Proportionate Regulation

Our expectation is that the flow of credit union framework change must slow. Why? We believe credit unions themselves need to urgently focus on their own future sustainability, by addressing the real commercial challenges to be faced. Perennial changes in legislation or regulation will not address them.

Reflecting this, our focus in 2021 will be more on the effective implementation of recent regulatory framework enhancements. In doing so we can support credit unions as they seek to utilise increased house and business lending capacity, as well as the investment capacity.

We remain available to provide regulatory input and challenge to support you. This will include for some, our ongoing regulatory approval of MPCAS¹⁴ and other additional service proposals, and for those who meet the criteria, the 15% lending limit for house and business lending. Since its introduction in early 2020, only one credit union has applied for additional lending capacity – which is disappointing when one considers the long stated desire of the sector to engage in this activity.  

In 2021, we expect to complete our review of the impact of the 2018 investment framework changes. We will approach this task guided by our mandate and risk appetite.

Turning to the final strategic priority.

D. Sector Engagement

We engage proactively and transparently with credit unions, and value our bilateral interactions with the sector and its representatives. Indeed, we undertake far more extensive engagement with the credit union sector, than with other regulated sectors.

In 2021, we will continue our extensive two-way communication and engagement with individual credit unions and sector stakeholders, across a broad range of channels.  

Conclusion

The pandemic has accentuated business model challenges for credit unions. Indeed credit union commercial challenges pre-dated COVID-19, and they are contributing to the sector’s growing imbalance between savings and loans.  

Whilst most credit unions have weathered the storm to date, economic uncertainty continues to cast a shadow over recovery.

As you turn to the future, you can expect historically-low interest rates to remain a feature, not to mention specific credit union challenges in terms of reduced shorter term credit demand and growing technology-led change. All of this will continue to force individual credit unions to evolve their business models to remain relevant to members.

Credit unions have an advantage in the strength of the brand and the deserved trust of members. To retain this trust, members must be confident that their savings remain protected as the business model changes – strong, robust risk management is central to this. Members also need transparency on all transactions with their credit unions, including clarity on fees and charges and on how interest is calculated on loans.

Your members’ needs are changing, and you must now compete with both existing and emerging fintech-led competitors, intent on innovating to gain market share. This will require effective collaboration.

While there continues to be a lot of sector commentary on long term lending, 2020 only saw an increase in house and business lending of c.€36 million and c.€2 million respectively. We welcome credit union participation in the Government Credit Guarantee Scheme, and we hope to see a stronger lending performance in 2021.

Minimum capital requirements are not a barrier to credit union lending – which is the principal driver of your income, itself the only means of generating retained earnings to replenish capital. Credit union boards have prudently chosen to hold capital above minimum levels, helping to underpin broader confidence in the sector during a period of crisis and disruptive change.

For those credit unions who struggle to generate capital given viability challenges, reducing minimum capital levels for everyone is simply not the answer – it would risk members’ funds and could significantly undermine confidence in the sector. As sustainability challenges persist for many credit unions, restructuring remains the best strategy to protect members’ funds.

Now is the time for larger credit unions in particular to lead the process of business model change and innovation, including using the increased lending capacity made available, to serve members’ needs.

This course of action offers a path to sustainability. It puts members’ savings to a productive use aligned to the objects of credit unions. It will ensure an ongoing funding need for growth in members’ savings, and will help to mitigate the imbalance between savings and loans.

For 2021 and perhaps beyond, we see credit unions needing to both manage through a crisis and manage disruptive change. Strong governance and risk management within credit unions is critical to managing the disruptive change arising from restructuring and business model change and innovation. Given the weaknesses we have identified across the sector in terms of recurring risk issues, our 2021 supervisory strategy will therefore focus on the embeddedness of risk management in credit unions. 

I will conclude there – many thanks for your attention.

[1] Financial Conditions of Credit Unions, 2020: I.

[2] As at 30 September 2019.

[3] The average sector reserves position was 15.9% and average sector liquidity position was 34.4% as at 30 September 2020.

[4] https://cuceoforum.ie/workstreams/.

[5] PRISM Supervisory Commentary 2020.  

[6]“Governance and risk in a time of uncertainty and change” - Deputy Governor Ed Sibley.

[7] Report of the Resolution and Crisis Management Division to the Governor of the Central Bank of Ireland

in relation to the Proposed Resolution of Drumcondra and District Credit Union Limited - 26 June 2020.  

[8] The Irish League of Credit Unions

[9] March 2020, circular re COVID-19, April 2020, circular re regulatory flexibility, June 2020, circular re payment breaks in credit unions and November 2020, a circular was issued re a further update to supervisory flexibility measures.

[10] 2020 Information Seminar presentations.

[11] Application Form for 15% Combined Concentration Limit for House and Business Loans.

[12] Credit Union Act 1997 (Regulatory Requirements) (Amendment) Regulations 2020.

[13]“Governance and risk in a time of uncertainty and change” - Deputy Governor Ed Sibley.

[14] Member Personal Current Account Services.