Ewart S Williams: Some thoughts on a new regulatory regime for credit unions
Feature address by Mr Ewart S Williams, Governor of the Central Bank of Trinidad and Tobago, at the
Thirty-First Annual General Meeting of the Eastern Credit Union, St Joseph, 18 March 2005.
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I would like to express my sincere thanks to the Board of the Eastern Credit Union for inviting me to
address you on the occasion of your Thirty First Annual General Meeting. I am pleased that 2004 was
a very successful year and that you have very good news for your membership when you meet
tomorrow notwithstanding the low interest rate environment encouraged by Central Bank policy. I am
convinced that competition brings out the best in all of us and Eastern Credit Union is an excellent
example.
I understand that with us this evening, in addition to Eastern Credit Union members, are stakeholders
as well as officials of the national credit union leadership. Accordingly, I would like to take this
opportunity to talk a bit about some issues that have been the subject of much public debate in recent
months having to do with the prudential supervision of credit unions.
My point of departure will be the Government's stated position to work towards a "single" regulator for
the financial system as a whole and the announced decision to bring some credit unions under the
regulatory authority of the Central Bank. I will try to touch on some of the problems involved in the
approach and give some thoughts on an appropriate regulatory model for the Credit Union movement.
Obviously I am not making official pronouncements here since the choice of regulatory regime is not
the call of the Central Bank but of the Government.
But first permit me to recognize the tremendous contribution that the Eastern Credit Union has made
to the people of Trinidad and Tobago.
I was pleasantly surprised to read about the origins of the Eastern Credit Union. I grew up in San Juan
and I did not realize that Eastern started in my backyard ....out of the Bermudez Biscuit Factory and
the Aranguez Estates. From these modest beginnings in 1973, you now cover the East- West corridor
and have expanded to San Fernando and more recently to Tobago. I understand that plans are afoot
to expand to central Trinidad.
Your accomplishments have been impressive indeed and the Eastern Credit Union is now a major
player in our local financial system. The statistics that I have seen have you moving from an initial
membership of twenty-two, and a share capital of $1 million in 1978, to a current membership of some
(103,000) and a resource base of about $600 million. In terms of assets, Eastern ranks as the third
largest financial cooperative in Trinidad and Tobago.
But your influence in the cooperative credit union movement has been greater than could be
measured by your financials, as impressive as these are.
Eastern's main contribution has been as an innovator; stretching the boundaries of the cooperative
movement, in an effort to better serve its membership. Eastern was the first to move away from the
traditional model of share savings and consumer credit to provide a range of product offerings more
associated with commercial banks.
Eastern's innovative loan programmes have helped its members construct homes, create and sustain
small businesses, purchase land, and pay for advanced level education.
Among credit unions, Eastern has been a pioneer in the introduction of certificates of deposits, loan
protection and life savings programmes, and an ATM service.
Reading through the pages of your various annual reports, I was struck not so much by how many of
your members you helped to build homes, to buy cars, to start small businesses (and I am not saying
that these are not important achievements). What struck me more, as I could read between the lines,
was a certain passion for the fundamental principles of pooling, co-operation and mutual support.
I could see this passion and pride in the many references to La Joya, this jewel of a facility that so
aptly represents your trail-blazing success. I could see this passion for community and mutual support
in your education awards; the credit union management courses; the efforts to get youth involved in
the movement; and to get members to assist in reducing loan delinquency. I could see the passion for
the co-operative spirit in your alliances with other credit unions to pursue joint activities, and in your
strategic partnerships with credit unions in Barbados, Jamaica and Grenada.
That you could be true to your cooperative ideals even while you expand your range of financial
services; strengthen your business infrastructure to better compete with the rest of the financial sector;
all this, while striving to adhere to acceptable prudential and governance standards; that you can
accomplish all these things simultaneously, speaks volumes for the commitment of your management
and staff, your current Board of Directors and indeed the entire leadership and membership that built
this institution over the last thirty years.
I am sure that there are a few other credit unions which have evolved in ways broadly similar to
Eastern and which can boast of their own successes. And I congratulate them all and I urge them to
continue their efforts to keep the credit union spirit alive, as they continue to face the challenges
emanating from globalization and financial liberalisation and a more secular approach to community.
Ladies and Gentlemen, you know better than I, the tumultuous change that the credit union movement
has undergone over the past three decades. The movement saw a period of very rapid growth in the
decade to the mid-1980s; this was followed by stagnation up to around the mid-1990s: since then, with
the aid of some government support by way of tax credits, the movement has blossomed once more.
To survive, the credit union movement has had to adapt, and this is reflected in the considerable
consolidation that has taken place from around 400 credit unions in the early 1980s to about
130 today. Total credit union assets have increased sharply in recent years and are estimated at about
$4 billion currently. The recent growth has, however, been very lopsided and has led to much
concentration.
According to data available for 2003, the six largest credit unions with assets ranging from $200 million
to $800 million, account for about one-half of total credit union assets and the largest 17 credit unions
account for three-quarters of the industry's assets.
The smaller institutions raise resources from shares and savings deposits and make small loans for
consumer purposes; these are essentially run as co-operative societies and are based on principles of
volunteerism. In the case of the large credit unions, we have a new paradigm involving products and
services more readily associated with the commercial banks.
These larger credit unions, now offer certificates of deposits, make mortgage and commercial loans,
provide credit and debit cards to be used in automatic teller machines and also provide cambio and
travel agency services.
The expansion of the credit union sector over the last thirty-five years has taken place in the absence
of an appropriate legislative framework. As you know, the present legislation, covering the credit union
movement {The Co-operative Society Act} dates back to 1971 and does not adequately address
prudential issues. In an attempt to fill this gap, the Co-operative Credit Union League, over the past
few years, has been promoting a system of prudential management based on adherence to the
"PEARLS" system, which provides guidelines for capital adequacy, liquidity and non-performing loans.
The League's efforts have had mixed results. The preliminary data that I have been able to muster
suggests:
(i) that about 40 percent of the operating unions maintain a liquidity ratio below the 10 percent
suggested in the PEARLS system;
(ii) that non-performing loans in the industry average between 20 and 25 percent. If we calculate
this uniformly and according to internationally accepted standards, it is likely to be much
higher (the commercial banks have a delinquency ratio of 3 percent);
(iii) about 40 percent of operating credit unions maintain a capital adequacy ratio of under
10 percent (which is the recommended minimum ratio).
The need for the stricter regulation of credit unions was recognised several years ago. Indeed the
1993 Task Force Report recommended amendments to the Co-operative Act:
(i) to provide for the regulation and supervision of credit unions by a new supervisory agency
responsible to the Minister of Finance;
(ii) to give the regulator power to make regulations with respect to prudential criteria for credit
unions;
(iii) to grant full enforcement powers which should include the removal of directors and the
suspension of a license to operate.
Later in 1996, an IDB project implemented with participation of the Credit Union League, initiated a
review of the regulatory framework and established the Credit Union Supervisory Unit within the
Ministry of Finance with responsibility for the development and implementation of a system of
surveillance for credit unions. For various reasons this has not worked out as envisaged.
From my vantage point, the case for stricter credit union supervision is compelling. It is based on the
amount of resources now being intermediated and the business models of the larger credit unions
which encompass more complex and riskier operations. These factors require that greater attention be
paid to risk-management by the unions themselves and that there be a formal supervisory framework
for credit unions to protect members' savings and to help maintain the integrity of the financial system.
And remember that we are talking about an estimated 500,000 credit union members (about one-third
of the population) and largely lower and middle income people.
Some people have argued for self regulation to be done by an organization such as the Cooperative
Credit Union League. The fact is, however, that self regulation has never worked on a sustainable
basis anywhere because it is usually effective only with those who are inclined to obey the rules - not
for those that need it most. And, I can assure you that there are credit unions, both large and small,
that are not operating in accordance with sound prudential principles.
The case for formal regulation also has to do with the sustainability of the movement and with
enlightened self-interest.
The financial environment is changing very rapidly - more so now than at any period in our history,
because of the proliferation of modern information technology. The credit union movement will have to
continue changing with the times to meet its members' needs, to fend off competition from other
financial service providers and to remain relevant. The sustainability of the movement will require
that credit unions get into increasingly riskier activities to survive and thrive. In these
circumstances, formal, rigorous supervision will become more critical and more urgent.
I should add that it is in everybody's self-interest to have effective formal regulation since poor
financial practices by one or two credit unions could undermine confidence in the entire movement and
could conceivably have contagion effects on the entire financial system.
I must concede that formal arrangements for the prudential regulation of credit unions are a relatively
recent phenomenon. We, in Trinidad and Tobago, are not alone in lacking adequate credit union
legislation. In fact, data published by the World Council of Credit Unions (WCCU) indicate that only
about one-third of 104 member countries surveyed, have credit union-specific legislation. In most
developing countries credit unions continue to be regulated under Cooperative Societies legislation.
The United Kingdom brought credit unions under the authority of the Financial Services Authority (the
regulator for the commercial banks) only in 2002.
In Jamaica, legislation shifting the regulation of credit unions to the Bank of Jamaica (the Central
Bank) was passed in 2004 but the operating details are still being worked out.
In Barbados, starting last year the five largest credit unions accounting for 80 percent of total credit
union assets are supervised jointly by the Central Bank and the Registrar of Credit Unions.
Recently, the Trinidad and Tobago Government announced the intention to amend the Financial
Institutions Act to bring large credit unions under the regulatory control of the Central Bank. The
rationale was that that these institutions were essentially conducting business of a "banking nature"
and should be regulated as banks, while the other credit unions involved in more traditional activities
would continue to be supervised elsewhere.
Having examined the FIA, it may indeed be more complicated than originally envisaged to
adapt this piece of legislation to the credit unions. Our research shows that legislation intended for
commercial banks is generally inappropriate for credit unions, whose purpose is to provide cooperative
financial services to members who are their depositors, their borrowers and their owners.
Credit unions are different from commercial banks because of a number of essential features,
including:
- their democratic control by members;
- their ownership structure through share contributions;
- their member savings contributions;
- the nature of credit union capital;
- the fact that their surplus is returned to members;
Because of these differences, credit unions have been most successful where they operate under
specific credit union legislation.
The part of the Government's proposal that prompted the strongest reaction was the proposal to split
credit union supervision between two regulators, based on institution size. It is difficult to disagree with
the Credit Union League (and many of you credit union leaders) that splitting regulation between two
regulators runs the risk of fragmenting the movement and stunting its development.
There was a similar situation recently in Britain. When credit union supervision was transferred from
the Registry of Friendly Societies to the newly created FSA, there was considerable concern that small
credit unions would not survive under the more robust regulatory regime. The FSA responded
pragmatically by adopting a two-tier system which perhaps may fit our circumstances.
It is my view that some kind of two-tier system is an appropriate regulatory approach for credit unions
in Trinidad and Tobago. In line with the views of the credit union movement, perhaps it makes sense
that all credit unions should be regulated by a single regulator - the Government has assigned the role
to the Central Bank. In these circumstances, the two-track regulatory regime should be based not
specifically on size but on the overall level of risk associated with the particular credit union. In
essence, the proposal is for a regulatory regime for credit unions which is essentially riskbased.
And what's the rationale?
Clearly there are different levels of risk attached to different types of activity that credit unions carry on.
The regime could be designed to take account of these different levels of risk. It will need to be
sufficiently flexible to accommodate the position of small credit unions while at the same time
responding effectively to the situation of large ones. The larger credit unions are likely to engage in a
wider range of activities, many similar to those provided by the commercial banks. This will expose
them to greater risk and a higher level of supervision. If smaller credit unions are engaging in risky
activities, they should also be subject to the more robust supervisory framework.
I said earlier that the Co-operative Societies Act was not a prudential tool and that the FIA was not
suited to the credit unions. It is my view that the draft Credit Union Supervisory Bill which was
prepared in the Ministry of Finance (under the IDB project) may be a useful starting point for new
credit union legislation. I noticed from its website that the Credit Union League had an opportunity to
comment on the draft bill and had many concerns. I understand this and I agree that the current draft
needs much work to be workable; but it's a good starting point. For one thing, the regulatory
responsibility will need to be shifted from a proposed Regulatory Authority to the Central Bank.
Without getting into details, it is my view that appropriate credit union legislation will need to address
the following areas, particularly with respect to the higher-risk (let's call it, Class A credit unions):
(i) It would need to define the classes of business in which credit unions could operate and
perhaps require that credit unions receive approval from the regulator before entering new
classes of business.
(ii) It would need to give the regulator authority to examine the business and affairs of a Credit
Union at least once every 18 months to ensure compliance, and to certify that it is in a sound
financial state.
(iii) As in the case of institutions under the FIA and the Insurance Act, the legislation will need to
provide for on-site supervision in which the risk management and governance systems (the
higher risk) of credit unions will be assessed.
(iv) The Act will need to specify prudential criteria on capital requirements, liquidity, investments,
and lending limits, as well as reporting requirements. These prudential criteria and reporting
requirements, could also, in principle, be tailored to meet the two-tiered risk-based
categories in which the credit unions fall.
(v) It would need to give the regulator enforcement powers to compel compliance with the
legislation. These powers could range from "close monitoring", to removal of officials, and
suspension of the credit union's charter. The regulator will need to have these powers so
that problem and/or insolvent credit unions could be managed and closed, if needed, to
protect members' deposits and the integrity of the credit union system.
If we are to take a more holistic approach to strengthening the credit union movement, in order to
support the new regulatory framework, we would also need to look at the developmental aspects of
the movement, including the supporting mechanisms. Thus, for instance, and perhaps over time, we
would need to give some thought to a strong effective Stabilisation Fund - my understanding is that
there are currently two such institutions (the Credit Union Stabilisation Cooperative Society and the
Central Finance Co-operative Society). I would imagine that there is need for a strong institution
capable of providing liquidity and investment support as well as training and various forms of technical
assistance to individual credit unions.
Moreover, in order to help the credit unions compete on broadly similar terms as the banks, for
instance, one may also need to give thought to a deposit insurance and a complaints mechanism
for the credit unions, similar to the Deposit Insurance Corporation and the Financial Services
Ombudsman Scheme.
These are just some preliminary thoughts which would need to be developed in greater detail and
refined.
I am aware that there is ongoing work to strengthen the present Co-operatives Act. This is important
and the new provisions should be complementary and not overlap with any new credit union
legislation.
To provide credibility to this regulatory approach there would need to be a process of intense dialogue
between all the stakeholders - the Ministries of Finance and Labour and Co-operatives; the credit
union movement; the Credit Union Co-operative League; and the Central Bank. The role of the
Ministry of Labour vis-à-vis the credit unions in particular and the co-operative movement in general
will need to be clearly defined. It is my view that the Ministry could still have an important
developmental role. There would also need to be a role for the Credit Union League in helping to
prepare its membership for the new regulatory environment.
I hope that these ideas contribute something to the ongoing debate about how to preserve the ideals
of the credit union movement, help the movement adapt to and thrive in the rapidly changing financial
environment, whilst we administer effective supervision to maintain a strong and robust financial
system.
I also want to underscore, contrary to the views that have been expressed in the media, the Central
Bank recognizes the important contribution that credit unions have made to our society. The Central
Bank also expects the credit union movement to continue to play a critical role in our diversified
financial sector. We feel strongly, however, that to achieve this, more robust regulation and
supervision are urgently needed.
Let me end by again thanking the Eastern Credit Union for inviting me. I trust that with your
commitment and team spirit you will continue to lead the way to positive change.