29 Jan 2018 Speech
Good morning Ladies and Gentlemen; thank you for inviting me to speak at your 2018 Annual Conference. As you know, I took up the position of Registrar just over three months ago, and today’s conference provides me with a welcome opportunity to meet with people who are integral to the strategic direction of the sector, and the management and oversight of individual credit unions.
Firstly, I would like to thank the Chair of your Management Committee, John Matthews, the outgoing Chair of your National Council, Jacqueline McCormack and your CEO, Kevin Johnson, for CUDA’s open engagement with us in the Registry over the past year. I look forward to the continuation of this cooperative approach throughout my tenure as Registrar.
This morning I intend to share my perspectives on addressing sector sustainability and the importance of working together with a renewed focus on material challenges.
In this regard, I will address:
- The need for a clear sectoral vision and strategy for the future;
- How our vision and strategic priorities in the Registry of Credit unions support your efforts in building sector sustainability;
- How those credit unions that have the strong foundations of an effective risk framework and a culture of good governance, are best placed to deliver the sustainable business model of the future. This will require the capacity to develop diversified income streams and efficient management of operating costs, likely to be delivered through commercial collaboration; and
- Finally, how we in the Central Bank can support your efforts under an earned flexibility approach where necessary.
Your theme for today’s conference, “Credit unions making a difference” is timely and appropriate. The significant role that credit unions play in the Irish financial sector, the strength of your brand and the depth of member trust, is truly unique. That any financial institution could win an award1 for excellence of customer experience in the current environment is commendable, and to achieve it for the third consecutive year is a strong endorsement of the positive relationship that exists between credit unions and their membership.
Your challenge is to transition that relationship from being a deposit taker of choice to also being the lender of choice. While not easy, we all can agree that it is necessary to make the difference you seek.
In delivering on that difference, it is important to understand and be clear as to what your vision of the credit union business model(s) of the future looks like. There appears to be limited sectoral clarity on this important starting point.
Today, the traditional business models of all financial institutions are being challenged by changing consumer expectations. New, nimble market entrants are targeting specific business areas using disruptive, digital-based product offerings. The nature and form of customer engagement is changing as consumers increasingly expect to access products and services online, in real time. The retrenchment by retail banks from their branch networks, whilst in tandem investing in IT infrastructure and digitisation, is a striking example of the impact of current competitive dynamics.
Consumers expect choice, ease of access, efficient speedy decisions and service fulfilment across all delivery channels. Meeting their expectations requires business model and operational change, enhanced capabilities, new processes and investment in enabling technologies. The scale of investment and resources required can be significant and is likely to be beyond the capacity of many smaller institutions.
Shared service solutions through commercial collaboration are necessary to drive scale benefits and to deliver cost efficiencies. They require larger credit unions that have the necessary resources to lead the process of change. Experience elsewhere has shown that other less well-resourced credit unions, can then avail of such arrangements to support sustainable product and service provision to their membership.
In the Registry, we have regularly called for sectoral leadership on the challenges facing the sector, consistent with credit unions’ ownership of the development of their own business model. Sectorally, we are seeing some product development activity which is positive. However, these initiatives can be ad-hoc in nature and they do not always form part of a broader, coherent strategy to deliver on your members’ current and future expectations.
Without strategic coherence, a fragmented approach can arise where multiple competing solutions are developed. This can result in suboptimal outcomes, a dissipation of scarce resources, a failure to achieve scale economies and to develop the required capabilities. We caution against any such fragmentation risk, which has the potential to undermine a number of important new initiatives necessary for the prudent development of the credit union business model, and to underpin the sustainability of credit unions of all sizes.
Our Vision and Strategic Priorities
We, in the Registry of Credit Unions, have been clear regarding our vision for the sector of “Strong Credit Unions in Safe Hands”. This vision underpins our statutory responsibility to ensure the protection by each credit union of the funds of its members and the maintenance of the financial stability and well-being of credit unions generally.
- 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.
We seek to realise that vision through our four Strategic Priorities2 which support the ongoing change occurring within the sector, whilst ensuring appropriate management and mitigation of risks from a prudential perspective. In 2018, we will continue to implement our priorities in a way that supports sector sustainability to help you to overcome your challenges.
Taking each one of our four strategic priorities in turn:
1) Inspection and Supervision
We regulate and supervise the sector to ensure that credit unions are financially sound and safely managed, so they can serve the needs of their members. As mentioned earlier, a credit union’s foundations are its governance, risk management and operational capabilities. Strengthening those foundations will enable you to address your challenges. Your risk management framework in particular will enable you to identify, manage and mitigate risks, ensuring the required foundations are in place to prudently deliver a sustainable business model for members.
While we expect all credit unions to meet minimum regulatory standards, our supervisory expectations are higher for the large and medium-sized credit unions.
Our PRISM system has been designed to accommodate differing supervisory approaches to facilitate proportionality. Since first introduced in 2012, we have adapted PRISM3 to drive our engagement process in line with differing credit union sizes and risk profiles. From 2018, we are refining our supervisory approach to further differentiate on a proportionate basis between small (under €40M total assets), medium (€40M-€100M total assets) and large credit unions (over €100M total assets).
For small credit unions, our supervisory approach will see us focus on viability risk, as many are struggling to respond to the operational and financial challenges involved in providing the range of products and services expected by members. We will continue to require that small credit unions meet minimum regulatory standards with a particular focus on financial, governance, credit and operational risks. In this regard, minimum standards are designed to protect members’ funds in a proportionate manner, aligned to the size and complexity of such entities.
In 2018, we will adopt a desk-based supervisory approach, augmented with a number of targeted on-site engagements with those small credit unions with higher risk profiles. Under this approach, credit unions will be subject to risk mitigation programmes (or RMPs4) and there will be scheduled bi-lateral engagements with key role holders in line with PRISM.
For medium and larger credit unions we will continue our programme of onsite engagements which will focus on their evolving risk profile. Such credit unions are likely to be involved in more complex business activities. Accordingly, we would expect they would have the resources and capabilities proportionate to that increased complexity. We will therefore deploy greatest intensity and depth of engagement with those larger and medium credit unions with elevated risk profiles for whom expected standards are highest in terms of governance, systems and controls.
A significant focus in 2018 will be on the credit union’s strategy, business model and risk appetite, along with its governance capability and capacity. The supervisory challenge presented by us in this approach is designed to ensure you are strengthening your governance, risk and operational foundations, so that you are better positioned to undertake more complex business activities, and further transfers of engagement in line with your strategy.
For all credit unions with viability issues, we will challenge boards and in particular their key role holders, regarding the strategic options available aimed at protecting members’ funds and the fulfilment of members’ future needs. After all, if you are not servicing your member needs and have viability issues, engaging at an early point regarding a transfer to a stronger credit union capable of serving those needs will be critical. Absent a suitable transfer being available, resolution may be required to protect members’ funds, an issue I will return to later.
Implementation of Risk Mitigation
We recognise the environment is challenging for credit union boards, who are volunteers, in seeking to navigate towards a sustainable future. It is important therefore that credit union boards fully leverage the key supports provided for under the enhanced governance framework5 of internal audit, risk management and compliance. These functions support credit union boards in seeking to identify, manage and mitigate risk in line with their risk appetite and strategic approach.
We will shortly publish an update on our PRISM supervisory findings for 2017 relating to credit unions of all sizes. Of the individual risk issues identified and mitigations agreed with credit union boards as part of RMPs, 35% relate to governance risks and 23% relate to operational risks.
Disappointingly, this PRISM update will highlight that many material risk issues are still in evidence across the sector despite being identified during our supervisory visits in prior years. This indicates a clear need for further risk remediation.
While standards of governance have improved across the sector, this is not uniform. Higher performing credit unions typically have moved beyond a mere ‘tick box’ compliance attitude to exhibit a more integrated risk governance ‘culture’, with a strong awareness and understanding of the impact of unmanaged risk.
It is important to reflect at this point that PRISM has applied to credit unions for nearly six years now and most credit unions have had numerous onsite inspections. At a time when credit unions should have developed responsive risk management frameworks to address business model challenges, it is not acceptable that we are still identifying a range of fundamental risk issues. I would highlight that these issues were found in credit unions of all sizes, not just smaller entities, including in some of those eager to engage in new business lines. Accordingly, an evaluation of the quality of your remediation of material risks through underlying changes required under agreed RMPs will be a key focus of our 2018 onsite engagement programme.
Where we have cause for concern regarding the commitment of board and management to effect the necessary changes required under RMPs we will use the powers available to us – including direction and enforcement powers – to ensure that the required change is implemented, as well as pursuing individual accountability where necessary.
We supplement our bilateral PRISM engagement with a programme of thematic reviews. We recently published thematic review findings on IT Risk6 and on Home Loans. These documents emphasise the importance of improved risk understanding, governance and controls. They stress the need for proper risk ownership and, in the case of mortgage lending, appropriate understanding of specific product dynamics.
We expect credit unions to consider the findings and expectations outlined in these reports, to review the adequacy of their existing governance, risk management and operational capabilities, and to make any necessary improvements.
During 2018, we will also publish thematic review reports, based on reviews undertaken in 2017, including:
- Prize Draws;
- Bank and Cash Controls; and
- Post Transfer of Engagement Integration.
2) Business Model Development
Successful delivery on business model change is fundamentally reliant on the key functions in credit unions operating effectively to support it. Business model development is about more than changing prudential limits, or introducing new products and services. It is about ensuring that credit unions have a viable, sustainable and vibrant business model that serves members’ needs.
We expect credit unions to examine the potential there is within their current business model as an important first step towards growth. In terms of grounding your ambitions, your vision needs to be aligned to your strengths and your operational capabilities.
Competing directly with retail banks across the full suite of products and services is not realistic for most credit unions, and therefore your vision and strategy must clarify the product and service mix you wish to deliver. To move from a traditional savings and loans business model to a broader service offering will require careful risk management if member value is to be enhanced. Full service business models are likely to require significant change and investment in operational capabilities.
Internationally credit unions have incrementally evolved towards broader business models over a period of time during which they committed the resources, put in place the foundations and developed business model capabilities. They successfully advocated for business model evolution, obtaining regulatory approval to provide a fuller service offering to their members. This process of transformational change was led by larger, stronger credit unions that commercially collaborated to develop the structures and capabilities required to achieve regulatory approval.
In essence, this represents an earned flexibility approach where credit unions proposing to undertake transformational change, demonstrate that they have the wherewithal to transform their balance sheets and manage more complex risk profiles. There is much to be learned from the success of this approach elsewhere. It appears one of the key success factors was the ability of larger stronger credit unions to commercially collaborate using a variety of shared services structures.
It is widely recognised that commercial collaboration is a prerequisite to achieving scale economies, necessary to ensure sustainability7. As you know, we are supportive of shared service initiatives, and during 2018 we will explore regulatory considerations underpinning the safe and prudent development of collaborative approaches such as shared services and other forms of alliance.
Prudent business model change
Expansion of member services should always be considered in the context of the risk to members’ funds and to the financial wellbeing and stability of the credit union.
A robust risk-based approach is apparent from the manner in which applications for approval by us under Member Personal Current Account Services (MPCAS)8 has evolved over the last year. It is encouraging to observe the professional way in which all of the sector actors involved collaborated in approaching MPCAS. By the end of 2018, we anticipate through regulatory approval that in excess of 50 credit unions will have operational current account services for members. We see this risk-based approach and constructive style of engagement as a basis for delivering further business model transformation through a broader product/service mix.
Great care is required when considering new business lines. For example, our recent Home Loan Thematic Review showed findings which suggest that some credit unions have commenced mortgage lending without fully assessing and implementing a well-developed business plan.
Mortgage lending has its own unique risk characteristics. Any entry into the mortgage market requires careful analysis, planning and execution, reflecting the unique operational, risk and viability characteristics of the business of making long-dated loans to members to buy homes.
We recently published guidance on longer term lending9, including mortgage lending, and expect that credit unions will make the necessary changes to their operational model to meet our expectations. We expect that credit union boards and management will find our guidance paper of value as they seek to develop responsive business strategies to address the current challenges facing the sector.
As your new Registrar, I reiterate our commitment to consider well-developed, achievable business change proposals aimed at credit union sustainability.
Our view is that credit unions with the ambition to do more, coupled with necessary risk understanding, should be facilitated, and that changes to the regulatory framework should be driven by well-developed and achievable business model proposals. This is consistent with the recommendations of the Report of the Commission on Credit Unions, and is in line with our earned flexibility approach that allows for safe and prudent business model development.
To facilitate both individual and collaborative business model change proposals, in 2018 we will publish a paper setting out our expectations of such proposals and our associated assessment approach.
3) Restructuring and Intervention
Through our Restructuring and Intervention activities, we facilitate ongoing sectoral restructuring. It had been envisaged that consolidation would lead to scale economies being realised along with the expansion of products and services.
Following significant consolidation to date, I am concerned that we have yet to see the envisaged benefits which should now be flowing. This is the subject of a thematic review by the Registry, and we will be publishing a report on our findings during 2018.
In accordance with our statutory mandate to ensure the protection by each credit union of the funds of its members, our intervention activities address those weaker credit unions through restructuring where possible, or failing that, resolution. As noted earlier, our preference is for such credit unions to be placed on a financially and operationally sound footing through a transfer of engagement to a stronger credit union capable of serving their members’ needs. Where this is not possible, we will seek a resolution solution that is consistent with the protection of members’ funds and sector stability. As is the case with undertaking business model development activities, we require transferee credit unions to have strong foundations before undertaking transfers of smaller peers in service of sector sustainability.
As a consequence of credit unions taking on greater risk under a growth strategy in line with their own risk appetite, potential outcomes for individual entities can range from success to failure. Should credit unions fail as a consequence of weak foundations and/or unmanaged risk in the future, this will inform the Central Bank’s risk appetite to undertake resolution actions to address such failure.
4) Regulations and Policy (Regulatory Framework Development)
In 2017, we undertook two important reviews of aspects of the regulatory framework for credit unions. Proposals arising from these reviews underpin our continued commitment to ensuring the regulatory framework for credit unions reflects an appropriate level of proportionality, and facilitates prudent business model development.
In relation to the investment framework, proposed changes demonstrate the flexibility provided by the provision of regulation making powers to the Central Bank. In this regard, the sector brought forward detailed proposals for the provision of funding by credit unions to approved housing bodies for social housing. Following a comprehensive engagement and consultation process10, we intend to shortly publish a feedback statement and amending regulations to facilitate this new investment class.
These regulations will also reflect our proportionate approach to regulation – having considered feedback received as part of the consultation process, we propose to amend the concentration limits for investments by larger credit unions in Tier 3 Approved Housing Bodies.
Fitness and Probity
In relation to the Fitness & Probity11 framework, our proposed changes would apply to credit unions with assets in excess of €100m. The changes recognise the importance of the key roles of internal audit, risk management and finance, and how they can strengthen systems and risk controls.
In terms of other significant developments impacting on the sector, I would highlight the recommendations of the CUAC Implementation Group12 and the second Payment Services Directive.
The CUAC Implementation Group has provided two papers to us for consideration in relation to the Section 35 lending limits and stakeholder engagement, and we intend to progress these matters as part of our work plan during 2018.
Lending limits are a topic which is central to many business model development discussions. We are supportive of greater credit union involvement in longer term lending. During December 2017 we published13 a revised application process for those credit unions that can demonstrate they have appropriate competence and capability, and who wish to lend a higher percentage of their loan book over longer time periods.
In terms of our assessment of prudential lending limits, we are open to considering any appropriate regulatory changes. However I would caution that this review will need to go beyond a mere recalibration or relaxation of limits, given the need to also consider broader issues such as balance sheet transformation, and associated risk considerations including funding and liquidity considerations.
Payment Services Directive
The European Union (Payment Services) Regulations 2018 (PSD2) came in to effect as of 13 January 2018. Credit unions should take the necessary steps to ensure that any obligations, including new reporting obligations, which apply are adhered to. This will be particularly important for credit unions who are more active in the payments area.
In summary, credit unions are an important part of the Irish financial system. While significant challenges remain, there are also a range of positives, not least the trust of your membership. However, there is an increasing need for a clarity of vision and strategy to support future credit union sustainability. This leadership needs to come from the sector.
There have been significant developments in a range of key areas such as MPCAS and Cultivate15, which are good examples of credit union-led collaboration which can have a broader sectoral application.
I would also like to acknowledge CUDA’s work through its Solution Centre, which facilitates access to collaborative opportunities, and congratulate you in particular on those projects delivered including the Fintech White Papers. It is advancing areas such as this that will enable you as larger credit unions to make the difference.
Today, there are 53 credit unions with total assets of over €100M, representing 55% of sector assets and 50% of sectoral membership16 overall. Many of those large credit unions are represented here today. To those credit unions, we believe you are central to delivering on business model transformation and sustainability for the entire sector. Defining and delivering on a shared vision will need your commitment, collaboration and willingness to take risk with new initiatives, not to mention a sense of urgency and the importance of ensuring your risk and governance foundations are strong.
In this process, you will find the Central Bank a constructive and supportive counterpart, consistent with our vision of wanting to see ‘Strong Credit Unions in Safe Hands’.
Sustainability requires mature engagement from all stakeholders working together. For our part, the Registry’s own vision, implemented through our four strategic priorities is aimed at supporting your efforts towards building sector sustainability for 2018 and beyond.
For your part, we advocate that your focus moves towards strengthening your foundations, taking greater ownership of your business model and mapping a clearer path to a more sustainable future. For us, it is clear that:
- Stronger credit unions who embrace a risk-based approach and have a culture of good governance are best placed to implement their vision and enabling strategies in a prudent manner.
- To deliver for your members’ needs going forward will require having a balanced and sustainable loan portfolio, the capability to generate diversified income streams, whilst also managing costs to leverage operational efficiency through coherent commercial collaboration.
To conclude, we can support developed, risk-based proposals under an earned flexibility approach that has been successful elsewhere. Such an approach supports those firms with the strongest governance, risk and operational capabilities, through regulatory approval of new products and services. In this way, those who are most capable will have the necessary regulatory support to develop their business, and help the sector to deliver on its potential.
I thank you for your attention this morning and I wish all of you well for the remainder of your annual conference.
2 The Appendix sets out the vision and strategic priorities of the Registry of Credit Unions towards the sector.
3 The Probability Risk and Impact System (PRISM) is the Central Bank’s risk-based framework for the supervision of regulated firms.
4 Risk Mitigation Programme – Following our onsite inspections, supervisory teams issue a schedule of findings detailing material risk issues identified and associated corrective actions that must be undertaken by the credit union to reduce the risk to a more acceptable level. Each RMP is agreed with the credit union board before it is finalised for implementation.
6 IT Risk in Credit Unions – Thematic Review Findings (January 2018) Thematic Review
7 The authors of a recent research paper commissioned by larger credit unions, drew attention to the success factors of international peers highlighting their ability to collaborate commercially and engage in persuasive collaborative advocacy. The Irish Credit Union Business Model: Is it still fit for purpose? – Centre for Community Finance Europe Ltd. Centre November 2017 – www.cfcfe.eu/research
8 MPCAS is a suite of services allowing approved credit unions to offer full service personal current accounts – https://www.centralbank.ie/regulation/industry-market-sectors/credit-unions/applying-for-approvals
12 The CUAC Implementation Group, which oversees the implementation of the recommendations contained in CUAC’s review of the implementation of the Commission on Credit Union’s recommendations, was established in March 2017. The Implementation Group consisting of members from the credit union representative bodies, the Central Bank, the Department of Finance and a CUAC representative.
14 The Directive seeks to promote innovative services, provide improved consumer protection and enhanced security through the use of strong consumer authentication for electronic payments. PSD2 aims to open the payment markets to new entrants, which will lead to greater competition, choice and better prices for consumers.
15] Cultivate is a structured initiative of four Galway Credit Unions that provides short- to medium-term loan facilities addressing the needs of their farming members. The approach has been subsequently adopted by a number of Irish credit unions.
16 Central Bank Prudential Returns September 2017