I thank the committee for the invitation to appear today to discuss credit union finance for social housing. I am joined by Ms Elaine Byrne, Deputy Registrar of Credit Unions and Ms Anna Marie Finnegan, head of policy, Registry of Credit Unions.
I will start by acknowledging the important role credit unions play in Irish society and in the financial system. I also acknowledge the strong voluntary and community ethos of the sector. Both the role and ethos reflect the primary objectives and purpose of credit unions to promote thrift among their members by the accumulation of their savings and the creation of sources of credit for the mutual benefit of members at fair and reasonable interest rates.
Our statutory mandate is to ensure each credit union protects the funds of its members and to maintain the financial stability and well-being of credit unions generally. This informs our approach to all aspects of the regulatory framework for credit unions, including the investment and lending frameworks that are the focus of our engagement today.
My opening statement will provide some background information on the current position of the sector. It will also focus on the potential for credit unions to provide funding for social housing. Specifically, I will focus on three main areas: the current position of and main challenges facing the credit union sector, which is important in contextualising our approach, regulatory requirements and current standards and the potential for credit unions to provide finance for social housing through lending or investment.
In terms of the current position, over the past decade or so credit unions have dealt with the effects of the financial crisis, increased competition, major business model challenges, significant restructuring and increased regulation. Co-ordinated efforts have delivered an unprecedented level of restructuring, resulting in 116 mergers, which have reduced the number of weaker credit unions and reduced risks across the sector as a whole.
Notwithstanding this progress, clearly significant challenges remain. Return on assets for the sector as a whole continues to shrink and the cost to income is high. While loan books are starting to recover, they are growing at a significantly slower rate than the level of growth in unsecured lending across Ireland. Further work is required to fully embed mergers and deliver the cost savings and efficiencies anticipated in the business cases proposed for the mergers. This is critical in putting these credit unions in the best position to deal with structural challenges and to leverage increased scale to provide a broader range of products and services to meet the needs and expectations of members.
Investment income has helped offset declining loan income for a number of years but is falling. Between 2012 and 2016, annual aggregate investment income has fallen from around €300 million to €174 million. This happened at a time when total sector investments have increased from €8 billion to €11.4 billion. Our analysis highlights that if current loan, investment income and cost trends continue, an increasing number of credit unions could face serious viability issues in the future, thus highlighting the urgent need to now address the business model challenges the sector faces. In recognition of this, we established a new unit in 2016 with a mandate to engage with credit unions on business model changes in order to progress well-developed proposals supported by credible risk-focused plans.
I shall now discuss regulatory standards. At the registry we have prioritised regulation and supervisory changes that improve credit union safety and better position the sector for the future. Strong governance standards are a fundamental requirement to support strong, viable credit unions and are a prerequisite for credit unions seeking to expand their existing business models. Regrettably, standards of regulatory compliance are still well below those required to consistently safeguard the funds of members and to position credit unions to tackle business model development. We are still seeing an unacceptable number of credit unions failing to display strategic understanding and good governance. In too many cases we have encountered limited financial skill sets and weak management, poor systems of control, weak risk, compliance and internal audit functioning and weaknesses in lending practices. Significant further improvement is therefore required.
I shall now discuss finance for social housing. There has been much discussion on the potential for credit unions to provide finance for social housing with attention focusing on the sector's low loan-to-asset ratio and the resulting level of surplus funds, the majority of which is currently held in accounts in authorised credit institutions and bank bonds. The Central Bank is supportive of credit unions increasing their investment options, including through potentially playing a role in the provision of funding for social housing. Recently we have consulted on proposals to facilitate this and are analysing the feedback we have received. Nonetheless, it is important that there is realism on the proportion of the sector's surplus funds that could appropriately be allocated to social housing. This must be informed by the specific characteristics of funding for social housing and appropriate levels of risk for members' savings. Additionally, the sector's surplus funds are held across 277 credit unions. Each individual credit union would have to make an independent decision on whether to provide funding for social housing. The manner in which credit unions may fund social housing will also be driven by the existing legislative and regulatory framework that applies to credit unions. The Credit Union Act 1997 - the 1997 Act - and the Credit Union Act 1997 (Regulatory Requirements) Regulations 2016 set out the services that a credit union may provide to its members. These include savings and loans and a number of additional services.
Common bond restrictions in the Credit Union Act 1997 limit the potential for credit unions to provide funding for social housing via lending, as credit unions may only provide services to their membership that is characterised by a common bond. The common bond is based on a pre-existing social connection such as belonging to a particular community, industrial or geographic group. Therefore, for a credit union to lend to an approved housing body, AHB, the body would have to fall within the credit union's common bond. The potential impact of the common bond on business model development was a matter raised as part of the review by the Credit Union Advisory Committee, CUAC, of the implementation of the recommendations of the Commission on Credit Unions. CUAC has recommended that further consideration be given to the common bond. As a result of common bond restrictions, sector-wide approaches to lending for social housing have not come to pass and consequently, focus has turned to investment-based proposals.
While the primary purpose of a credit union is the provision of loans to its members, the regulatory framework also provides for credit unions to invest surplus funds. Under existing regulations, credit unions are permitted to invest in a range of specified investment classes, which includes government securities, bank deposits, bank bonds and collective investment schemes made up of these instruments. The Central Bank's ability to make regulations on investments in projects of a public nature is specifically referenced in the regulation-making powers provided for under section 43 of the 1997 Act. Therefore, such investments can be facilitated by regulations, where appropriate.
Additionally, the 2016 regulations make reference to the fact that the Central Bank may prescribe, in accordance with section 43 of the 1997 Act, further classes of investments for credit unions that may include investments in projects of a public nature.
The regulations state that investments in projects of a public nature include, but are not limited to, investments in social housing projects.
In order to ensure that the investment regulations remain appropriate for the credit union sector, the Central Bank undertook to review the investment regulations this year to consider whether it is appropriate and prudent at this stage to facilitate investment by credit unions in other classes of investments, including investments in social housing. The Central Bank published a consultation paper on 11 May setting out the following potential additional investment classes for credit unions: bonds issued by supranational entities, corporate bonds and investments in tier 3 approved housing bodies, AHBs.
As for investments in approved housing bodies, the consultation paper identifies potential risks and risk mitigants for such investments and asks for feedback on the appropriateness of credit unions undertaking such investment and the level of such investment that could be undertaken. An important issue highlighted in the consultation paper is the need for credit unions to take account of maturity considerations and the balance sheet impact of undertaking investments in approved housing bodies which, by their nature, are likely to be illiquid and significantly longer term than existing investments and could result in an increase in the existing maturity mismatch on the credit union’s balance sheet. Consideration will also need to be given to the interplay between a possible move to longer-term lending and longer maturity investments, which could also exacerbate this issue. If credit unions wish to significantly shift the maturity profile of their assets, they will need to consider how they can extend their funding profile, particularly if it requires the longer-term tie-up of funds belonging to ageing members.
The consultation period closed on 28 June and we have received more than 70 submissions from a broad range of respondents. The majority of submissions are from individual credit unions with additional submissions received from representative bodies, AHBs, investment firms and Deputies. We welcome this feedback, which is an important input into the policy development process. We are in the process of examining the submissions. The majority of respondents have commented on the potential for credit unions to invest in approved housing bodies and broadly welcome the potential for credit unions to do so. The submissions, however, also demonstrate some divergence in views on the level of risk associated with such investments and appropriate levels of exposure for credit unions. The Central Bank will consider the entirety of the submissions received prior to finalising changes to the investment framework for credit unions and will publish a statutory instrument amending the investment regulations for credit unions.
Finally, on longer-term lending, it is important to note that under the 2016 regulations, credit unions are already permitted to lend up to 30% of their loan book over five years and up to 10% of their loan book over ten years - subject to a maximum maturity limit of 25 years. In addition, credit unions can apply to the Central Bank for an extension to their longer-term lending limits of up to 40% over five years and up to 15% over ten years. Currently for the sector overall, total gross loans over ten years amount to approximately 3% of overall loan books.
In conclusion, by way of background I have set out the current position of the credit union sector and identified a number of challenges the sector faces. This is important in the context of this discussion. I have also provided some background on the regulatory framework for credit union lending and investment, the consultation process on investment in social housing and our intention to amend the investment regulations later this year.