CONTINUOUS LEARNING. INDUSTRY ENGAGEMENT.

Ross McDonald 2021-02-22 Ross McDonald 2021-02-22

Proportionality in financial regulations. Asset size, business complexity & risk profile should matter.

Financial regulation is not national security. Edward Snowden alleged that 'collect it all' was a mantra of the US National Security Agency. But this seems rather heavy-handed for regulatory oversight of provincial credit unions. As a self-declared 'data-driven regulator', BC Financial Services Authority appears intent on data collection regardless of prudential supervisory risk or industry impact.

Financial regulation is not national security. Edward Snowden alleged that 'collect it all' was a mantra at the U.S. National Security Agency. But this seems rather heavy-handed for regulatory oversight of small provincial credit unions. As a self-declared 'data-driven regulator', BC Financial Services Authority (BCFSA) appears intent on maximum data collection regardless of its supervisory framework and industry consequences.

A formatted PDF of this article is available at https://www.bitly.com/rm-proportionality.

Following the 2008 financial markets crisis, regulators of major global banks duly turned up the heat. New mechanisms were designed and introduced to assess the capital, liquidity and risk profile of regulated financial institutions. Entities that regulators deemed 'too-big-to-fail' or 'globally systemically important banks' (G-SIB) were exposed to incremental costs, being higher compliance costs that were commensurate with their regulatory risk profile. These reporting requirements and supervisory expectations have steadily trickled down to domestic equivalents (D-SIB) and, in Canada, to provincially regulated financial institutions. The extent of due adaptation of G-SIB regulatory requirements for small community credit unions seems variable. Copy-and-paste can be a dangerous tool.

The regulatory environment for B.C. credit unions is wholly unrecognizable from a decade ago. Over recent years then BCFSA - and its predecessor FICOM - introduced numerous regulatory guidelines; escalated prudential supervisory expectations; and intensified regulatory reporting. The number, diversity and complexity of these new regulations are dizzying. By way of illustration, in late 2020, BCFSA launched an overhaul of regulatory reporting requirements for credit unions. The proposal seeks to expand data scope; introduce greater data granularity; on a more frequent basis; and from an increased number of credit unions. As regulated entities, B.C. credit unions have but three choices - comply, strategic transformation, or federal charter.

"The intensity of supervision will depend on the nature, size, complexity and risk profile of a PRFI.” - BCFSA Supervisory Framework

BCFSA appears to have discarded FICOM’s risk-based supervisory framework. Default prudential supervision, and regulatory reporting, was relatively modest. But credit unions of larger size, greater complexity and/or intervention stage rating should be subject to commensurately escalated intensity of prudential supervisory requirement and regulatory reporting. Following a flurry of new regulatory requirements then this approach - proportionality - is now being embraced by OSFI, a federal Canada financial regulator. BCFSA should take note. Instead, BCFSA seems intent on a wholly opposite approach - standardization. Vancity Credit Union (C$23 billion assets) and Vancouver Police Credit Union (C$18 million assets) have order-of-magnitude organizational differences, yet BCFSA proposed regulatory reporting would impose substantially similar regulatory reporting requirements. As would credit unions with scarcity or bountiful levels of capital or liquidity. As would credit unions with low-risk or high-risk intervention stage ratings. The objective of regulatory reporting should be to ensure legislative compliance and to assist prudential supervisory assessment of composite risk rating. This risk-based approach wholly aligned with its supervisory framework. No matter. Collect it all. Fill those databases.

"One of the key priorities identified in OSFI's Strategic Plan 2019-2022 is to further adapt its regulatory approaches to reflect the size, complexity and risk profile of financial institutions.’ – Source: OSFI ‘Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions'

BCFSA should stop and think. What is the purpose of the collected data? Why do the proposed changes fall disproportionally on credit unions with less than C$1 billion assets? How will the proposed changes have intended and/or unintended consequences on B.C. credit unions?

BCFSA should consider alternative tactics. Perhaps there could be two sets of 'standardized' regulatory reports - a simple set and a comprehensive set. This may mirror efforts in accounting standards - small, private enterprises and large, publicly listed companies produce financial statements of differing complexity. The Financial Accounting Standards Board 'Simplifying Accounting Standards' is exploring various topics related to proportionality in application of accounting standards. Perhaps there are learnings from the U.S. Federal Reserve, that has four intensities of regulatory reporting for deposits based on financial institution size. Perhaps B.C. credit unions could have an opt-in approach with a distant date rather than a near-term effective date (hat tip to peer for this pragmatic idea). Such an approach would allow smaller credit unions to consider banking system changes, resourcing requirements and/or strategic viability of the proposed changes. Perhaps CUDIC excess capital could be rebated, say on an equal dollar value basis across B.C. credit unions, to help fund process improvements, system implementation or other necessary automation to satisfy elevated reporting requirements?

BCFSA should recognize that there are multiple, diverse & complex changes impacting B.C. credit unions. BCFSA-required transformation of statutory liquidity deposits. Central 1 and membership driven implementation of digital technologies. BCFSA new supervisory expectations, such as the January 2021 Liquidity Guideline. At this time, BCFSA has four active consultations with credit unions - regulatory reporting, CUDIC assessments, IT Security, Outsourcing. Some requirements may even be competitive. For example, if credit unions respond the proposed regulatory reporting by sharing expert resource then this may create resource dependency and outsourcing risk. But if credit unions respond by recruiting dedicated staff or investing in technology then this will impact prudential supervisory assessment of earnings risk. Credit unions less than C$1 billion assets face a lose-lose situation.

“It certainly seems possible that BCFSA consequences and Competition Bureau objectives, as they relate to credit union amalgamations, may be significantly misaligned.” - Ross McDonald

Collectively these, mostly BCFSA driven, changes will permanently impact the B.C. credit union system. Ultimately, ever-increasing baseline regulatory requirements must surely translate into fewer provincial credit unions and increased minimum efficient scale. Should BCFSA continue on its seeming path, there may be only a residual few B.C. credit unions with less than C$1 billion assets by 2025, and perhaps none by 2030. A torrent of amalgamations seems inevitable. Per related member website, the ongoing proposed merger by six B.C. credit unions has been referred to the Competition Bureau. It certainly seems possible that BCFSA consequences and Competition Bureau objectives, as they relate to credit union amalgamations, may be significantly misaligned.

Do-as-I-say, not do-as-I-do. As part of the Ministry of Finance, FICOM reporting to industry was negligible, if anything. As a crown corporation, time will tell if BCFSA complies with the B.C. government 'Performance Reporting Principles For the British Columbia Public Sector'. The related publication, approved by the Auditor General of B.C, frames eight principles of deemed best practice that seek to support an open and accountable government. BCFSA compliance with B.C. government reporting principles for crown corporations require it to provide comprehensive disclosures to industry and to taxpayers. People who live in glass houses shouldn't throw stones.

“BCFSA compliance with B.C. government reporting principles for crown corporations require it to provide comprehensive disclosures to industry and to taxpayers.” - Ross McDonald

BCFSA executive has the near infinite authority over its expanded empire. Oversight lies in its board of directors, and ultimately the B.C. Ministry of Finance. Under the Taxpayer Accountability Principles of the B.C. government state that ‘Board members act independently from the organization’s executive and have the best interests of taxpayers and shareholder as their primary consideration.' Hopefully this enshrines expectations of a principal-agency relationship. Approximately 40% of British Columbians are members of B.C. credit unions. Collectively B.C. credit unions provide substantial benefit to their members, employees, communities and the B.C. economy. BCFSA Board should ask difficult questions of the executive team; demand a business case for proposed changes; and consider the collective impact on British Columbians.

In the short-term, BCFSA may amass a standardized, NSA-worthy database about B.C. credit unions. Probably significantly more than that required to fulfil the needs of executive management, board oversight or risk-based prudential supervision. In the medium term, this database may become a museum relic. A moment in time record of an industry that was subject to accelerated transformation and proactive consolidation by its regulator. A priceless collector’s piece but a needless lament.

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REFERENCES

OSFI January 2020 'Advancing Proportionality: SMSB Capital & Liquidity Requirements - Consultatitve Document' - https://www.osfi-bsif.gc.ca/Eng/fi-if/in-ai/Pages/SMSB20_cp.aspx

OSFI July 2019 'Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions' - https://www.osfi-bsif.gc.ca/Eng/fi-if/in-ai/Pages/smsb.aspx

FICOM/BCFSA June 2012 'Supervisory Framework' -https://www.bcfsa.ca/pdf/aboutus/FICOMSupervisoryFramework.pdf

FASB 'Simplifying Accounting Standards' - https://www.fasb.org/simplification

B.C. Government 2003 - “Performance Reporting Principles” - https://www2.gov.bc.ca/assets/gov/british-columbians-our-governments/services-policies-for-government/public-sector-management/performance_reporting_principles.pdf

Member website for potential amalgamation of B.C. interior credit unions - https://www.exploringstrengthandunity.ca/awesometogether.html

U.S. Federal Reserve Reporting Requirements for deposit reporting: https://www.federalreserve.gov/monetarypolicy/reserve-maintenance-manual-reporting-requirements.htm

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DISCLAIMER & COPYRIGHT

This article reflects the personal opinions of the author, Ross McDonald. This article does not represent the views of any financial cooperative, corporate organization, regulatory body, government ministry or other organization. All content is wholly based on information that is in the public domain. Where relevant, sources have been identified and referenced.

Although the author has made significant effort to ensure that the information in this submission was accurate at the date of completion then the author does not assume any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause.

Ross McDonald 2016-12-15 Ross McDonald 2016-12-15

Credit union intervention: an ERM failure?

John Lennon penned ‘we get by with a little help from our friends’. Credit unions can need help too, say when placed under regulatory intervention. Does such an act signal ineffective Enterprise Risk Management practices of the credit union?

John Lennon penned ‘we get by with a little help from our friends’.

Credit unions can need help too, say when placed under regulatory intervention. Does such an act signal ineffective Enterprise Risk Management practices of the credit union?

REGULATION

Regulators have the legislative power to impose an intervention on, or to ‘stage’, a credit union. A regulatory intervention seeks to minimize potential depositor losses and related insurance exposure. Dependent on the perceived severity of circumstances then there are multiple potential intensities of intervention. These can range from an early-warning to imminent insolvency. Specific information related to the number; identity; issues; and matters related to interventions are not in the public domain.

Just like their small business members then credit unions need to balance growth rate, cashflow and earnings. Over time then aggresive growth, capital investments or declining membership may strain capital adequacy, stretch liquidity, erode margins or surface other adverse effects.

Like their business members then credit unions need to offer a reasonable value proposition. Service offering, product range and operational footprint should be commensurate with the customer/member needs; economic climate; organization size; and competitive landscape. Over time then any related deficiencies may yield declined market/wallet share; elevated risk appetite; unsustainable operating efficiency; outdated management; inadequate governance practices and/or broader strategic challenges.

CREDIT UNION INTERVENTIONS

Interventions can be costly. The primary direct expense to a credit union is a higher premium for deposit insurance. This will impact the bottom line, potentially materially. Indirect costs may also be significant as executive and Board time is likely redirected to execute remedial requirements and to manage an elevated regulatory relationship.

Interventions are driven by specific perceived deficiencies. These may relate to a specific risk type (e.g. credit, liquidity); a specific inadequacy (e.g. oversight, policies); an atypical theme (e.g. growth, strategy) or other matters in the credit union.

There is no single remedy for interventions. Perhaps akin to a medical doctor appraisal of a patient then there may be various apparent symptoms and underlying causes. But there may be common themes, say based on historical ailments or current circumstances. Given the escalation to intervention then the remedial prescription will probably be more intense, and less palatable, than a hearty hot toddy.

Remedial resources vary by province. For example, BC credit unions may receive confidential consultative advisory services that are executed, and funded, by Stabilization Central Credit Union.

ENTERPRISE RISK MANAGEMENT

Risk is the lifeblood of any financial institution. For credit unions then taking deposits, extending loans and executing other services inherently involves risk. Entity-level oversight of risk - or Enterprise Risk Management - typically assesses credit, interest rate, liquidity, transaction, strategic, strategic, compliance and other risks as appropriate. Just the sort of topics that are likely relevant to an intervention. Whether a credit union intervention signals an ERM deficiency, in my personal view, rests on two questions.

First, to what degree were management and the Board surprised by the intervention and regulatory concerns?

CEOs and Board Chairs may relish surprises delivered by Santa Claus. Not so much by their regulator. If intervention concerns draw gasps then there may well be misunderstanding of regulatory expectations; inadequate risk oversight; and/or poor ERM execution. Surprises may suggest challenges that extend beyond ERM. For example, if a Board first learns of statutory compliance breaches from the regulator then risk culture and governance practices may be awry.

Second, are the risk competencies and oversight appropriate for the current organization size and complexity?

Progressive organizations typically grow over time. Academics suggest that gradual evolution of organizational size is typically accompanied by periodic step-changes in capabilities. For credit unions then there are arguably levels of size and complexity that may trigger internal step-changes, and perhaps external expectations, in regards appropriate maturity of risk oversight functions. As a ballpark then a recently published Oliver Wyman report notes that in 2016 ‘risk functions will account for about 4 percent of the operating costs of an average bank’. This benchmark may not be appropriate credit unions of all sizes and complexities but peer comparison of the maturity of risk managment function may be insightful.

STAKEHOLDER ENCOURAGEMENT

To a Board Chair of a staged credit union then I urge due concern. The regulator may have identified one or more specific, material, time-sensitive threats to the membership that the Board is elected to represent. Board agenda should reflect this reality. As appropriate then seek advice or assistance. Related resources vary by province. Consider review of Board composition, competences and governance practices. And ultimately remember the arguably most important Board role is CEO selection.

To a CEO of a staged credit union then I encourage a deep breath. You are probably not going to enjoy this experience. The future will likely be required to be significantly different than the past. You may not agree with some perceived concerns. Expansive strategies and favoured initiatives may now deferred. Any ‘too difficult box’ may be prised open with gusto. The foreseeable future likely holds plentiful, potentially difficult, work; rather lower profitability; elevated levels of scrutiny; and no small measure of change. But it is hopefully an opportunity to question accepted norms, and to seek and embrace best practices that will - in time - yield organizational betterment and enhanced member service.

To regulators then I implore use of the motivation ‘carrot’ in addition to the penalty ‘stick’. Identifying the need for intervention is an important function, indeed duty, of any regulator. But as remedial actions are completed, trust is restored, and risk is demonstrably lessened then any onsite assessment and/or intervention appraisal should be undertaken in a timely manner. Incremental to risk-based prudential supervision then the motivational reward of successful betterment - and of normalized deposit insurance premiums - may be material indeed.

Unlike the Beatles then a staged credit union may not be feeling much love. But cooperation amongst cooperatives is a core credit union principle. And the industry is stronger together. So there are likely friends willing, even eager, to help. Let it be.

REFERENCES

Regulatory Guidelines

OSFI, federal regulator, ‘Guide to Intervention for Federally Regulated Deposit-Taking Institutions’ - Guideline: http://www.osfi-bsif.gc.ca/Eng/Docs/Guide_Int.pdf Overview & Process: http://www.osfi-bsif.gc.ca/eng/fi-if/rai-eri/sp-ps/Pages/gid.aspx Risk Management Assessment Criteria: http://www.osfi-bsif.gc.ca/eng/docs/11-risk_management.pdf

FICOM, BC provincial regulator, ‘Guide to Intervention - BC Credit Unions’ - Guideline: http://www.fic.gov.bc.ca/pdf/creditUnionsTrusts/GuideToIntervention.pdf FIA Review: http://www.fin.gov.bc.ca/pld/fiareview.htm

DICO, ON provincial regulator, ERM - Framework and Guide: https://www.dico.com/design/Publications/En/ERM%202011/ERM_Framework_September_2011.pdf

https://www.dico.com/design/Publications/En/ERM%202011/ERM_Application_Guide_September_2011.pdf

Other References

Credit Union Deposit Insurance Corporation, BC government credit union deposit guarantor - Publications: http://www.cudicbc.ca/Publications.html

Stabilization Central Credit Union - Services: https://www.stabil.com/services/

Oliver Wyman Risk Journal - December 2016: http://www.oliverwyman.com/our-expertise/insights/2016/dec/oliver-wyman-risk-journal.html

Colorado Credit Union Working Group on ERM - White paper: https://mwcua.com/wp-content/uploads/2014/09/White_Paper_ERM.pdf

Harvard Business School, ‘Managing Risks - A New Framework’ - Article: https://hbr.org/2012/06/managing-risks-a-new-framework

Harvard Business School, ‘Evolution and Revolution as Organizations Grow’ - Article: https://hbr.org/1998/05/evolution-and-revolution-as-organizations-grow

Wikipedia, ‘Too difficult box’ - Article: https://en.wikipedia.org/wiki/Too_difficult_box

DISCLAIMER & COPYRIGHT

This article reflects the personal comments of the author, Ross McDonald. This article does not represent the views of any financial cooperative, corporate organization, regulatory body or government ministry. Comments are wholly based on information that is in the public domain.

Although the author has made every effort to ensure that the information in this article was correct at press time, the author does not assume and hereby disclaim any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause.

Ross McDonald 2016-10-23 Ross McDonald 2016-10-23

Coast Capital Savings: Federal credit union implications for the B.C. system

One member one vote. A core principle of cooperative organizations.

Coast Capital Savings Credit Union is currently conducting an important member vote. Its management and Board seek member approval to submit, and to progress, an application to the federal government for Coast Capital Savings to become a federal credit union.

This is a big deal for members of Coast Capital Savings. But it also has significant and diverse implications for the B.C. credit union industry.

One member one vote. A core principle of cooperative organizations.

This is a big deal for members of Coast Capital Savings. But it also has significant and diverse implications for the B.C. credit union industry.

Federal Credit Unions

First, context. In 2012, the federal government enacted legislation that permitted federal credit unions. Federal credit unions are authorized to operate branches in any Canadian province. Therefore they are subject to federal legislation and federal regulation. For example then any federal credit union would be subject to OSFI Guidelines, including those on the adequacy of their liquidity and capital that are perhaps more stringent than current provincial regulations. In July 2016 then Caisse populaire acadienne ltée (“UNI Financial Cooperative”) became the first - and currently only - federal credit union. UNI Financial Cooperative is a credit union, headquartered in New Brunswick, that has C$3.5 billion assets; 155,000 members; and 1,000 employees.

Coast Capital Savings Credit Union

Second, Coast Capital Savings. Per CCUA then, at end 2015, Coast Capital Savings was the third largest Canadian credit union with C$13.7 billion assets and 532,000 members. Management and the Board of Coast Capital Savings support the federal credit union strategy. Under its own Rules then Coast Capital Savings must secure 66.7% member approval to execute this strategy. To that end then Coast Capital Savings has recently published documents and videos to educate its members on related matters. Coast Capital Savings has also scheduled two member information sessions. Any approval by members of Coast Capital Savings would represent an important, and necessary, first step. Subsequent consent would be required from CDIC (federal deposit guarantor); FICOM (provincial regulator); OSFI (federal regulator) and the federal Ministry of Finance.

B.C. Credit Union system

Third, the BC credit union system. Now it gets complicated. Credit unions, while distinct cooperative entities, significantly operate as a system. This is partly driven by legal regulations - for example, the B.C. Financial Institutions Act requirement that B.C. credit unions hold certain liquidity deposits at Central 1 Credit Union. It is partly driven by collective commercial benefit - for example, centralized clearing and settlement of payments - that enable product innovation and provide cost economies that would be unavailable to any single credit union. And it is partly driven by cooperative principles (“cooperation among cooperatives”).

The federalization of Coast Capital Savings would have numerous indirect implications for the B.C. credit union industry.

No stress event is likely. The press release of UNI Financial Cooperative noted that its federal charter was secured ‘nearly 18 months after having received a merger approval from its members’. Any similar schedule for Coast Capital Savings would likely allow significant time for members and stakeholders to consider implications and to execute actions.

Central 1 Credit Union would face broad and material impact. If federal then Coast Capital Savings would likely lose its class A membership of Central 1. Cascade effects include share capital, liquidity deposits, governance representation, and potentially profitability and service pricing. Any change in the level of utilization of cooperative centralized products - such as for payments, trade or treasury - by Coast Capital Savings may impact the scope and/or pricing such services, both to Coast Capital Savings and other credit unions.

The residual B.C. credit union industry would still have significant scale and be larger than in any other province. Per CCUA, at December 2015, Canadian credit unions collective reported assets of C$188 billion. B.C. credit unions represented 35% of this, with C$66.4 billion assets. A federal Coast Capital Savings would remove C$13.7 billion assets from the B.C. system. For context then Ontario credit unions held C$40.0 billion assets at end 2015.

Individual B.C. credit unions may receive a short-term boost. High-value member deposits, say amounts larger than the federal deposit guarantee, may migrate from Coast Capital Savings to other B.C. credit unions. Some current members of Coast Capital Savings may also seek an alternative credit union. There may also be medium-term benefits. In time then credit unions may have an incremental intermediary for securitization, through a debt-rated Coast Capital Savings. Residual credit unions may enjoy lower deposit insurance premiums - Frank Chong, Acting Superintendent FICOM, 7 October 2016 Public Accounts Committee draft minutes “A credit union opting to continue into the federal jurisdiction would not be able to bring their funds that were provided to CUDIC to the federal jurisdiction. Those funds would be retained by CUDIC.”

But B.C. credit unions, collectively and individually, would face negative impact too. Industry fragmentation - between large commercial and small community credit unions - may accelerate. Competitive forces could increase as a federal Coast Capital Savings could offer product types, funding sources and cost economies that could attract members from BC credit unions. But the B.C. credit union industry would lose the ideas; expertise; experience; and contributions of a major current stakeholder. B.C. system-level initiatives, such as the FIA review or liquidity stress test, would be have one fewer voice. But Coast Capital Savings may add its voice to federal-level credit union issues. Stronger together, perhaps, but at a federal rather than provincial level.

Were Coast Capital Savings a federal credit union then the BC provincial government would face lower deposit guarantee risk; a smaller mandatory liquidity pool; a lesser regulatory footprint; and the potential for consumer confusion, initially at least, in regards market conduct. Both the federal transition and residual circumstances may impact FICOM, CUDIC and other government entities.

One member one vote may be a compelling principle. But in practice then only a small proportion of members typically vote for credit union resolutions. This one is unprecedented. I encourage members of Coast Capital Savings to read the documentation, to attend an information session scheduled by Coast Capital Savings, and to vote.

http://www.coastcapitalsavings.com/vote

REFERENCES

CONTINUOUS LEARNING. INDUSTRY ENGAGEMENT.

Proportionality in financial regulations. Asset size, business complexity & risk profile should matter.

REFERENCES

DISCLAIMER & COPYRIGHT

Credit union intervention: an ERM failure?

REGULATION

CREDIT UNION INTERVENTIONS

ENTERPRISE RISK MANAGEMENT

STAKEHOLDER ENCOURAGEMENT

REFERENCES

Regulatory Guidelines

Other References

DISCLAIMER & COPYRIGHT

Coast Capital Savings: Federal credit union implications for the B.C. system

Federal Credit Unions

Coast Capital Savings Credit Union

B.C. Credit Union system

REFERENCES

Coast Capital Savings Credit Union

OSFI - Federal Regulator

UNI Financial Cooperation - Federal Credit Union

OTHER

DISCLAIMER & COPYRIGHT