Credit unions et al: enhancing regulatory compliance systems to combat challenges

Overview:

Global financial regulations, standards and best practices have been around for many years, but never before has their application been of such value, or more pertinent, to maintaining financial stability. The collapse and near insolvency of large conglomerates in recent times has had negative repercussions on the economies of the Caribbean and the world.

These failures of major financial conglomerates have triggered mammoth reviews of the procedures used by regulators to identify, track and mitigate against vulnerabilities and threats to financial systems across the world, by international governing bodies. {{more}}These assessments resulted in the modernization of regulatory frameworks, to create a blueprint response to the triggers of economic fallout, in the hope of preventing future crises.

For the less advanced economies, particularly those in Caribbean region and more specifically, the business model of certain non-bank financial institutions such as credit unions, building societies and friendly societies, these new requirements undoubtedly challenge traditional principles and beliefs.

Notwithstanding the unique and commendable traditions set by the said non-bank financial institutions which still very much have their place in today’s world, consideration must equally be given to the composition of membership of these institutions, the interconnectedness of individuals to more than one of the three business types mentioned above and the likely impact on families, if internal structure, organization and business models do not evolve to meet the global regulatory minimums. A single adverse event, especially in a small economy, could very well shock our financial system and destroy economic balance. It is likely also that that failure to satisfactorily implement sound compliance standards, could significantly impede trade and adversely impact our already fragile Caribbean brand, where for many countries, financial services and tourism revenues are the main drivers of economic activity.

SVG’s Non-Banking Reality

In St Vincent and the Grenadines (SVG), credit unions, building and friendly societies collectively represent a significant part of the financial sector’s total assets, in part because they focus on providing retail financial services to low and middle income individuals. When their assets are collectively compared to commercial banks, their importance to the financial system of our island is amplified.

For example, statistics in 2013, obtained from the Eastern Caribbean Central Bank, showed that the total assets of the commercial banking sector were approximately EC$2.0 billion. Total assets of the credit union, building societies and friendly societies, collectively, were approximately 29 per cent of total commercial banking sector assets. The impact of these sectors on the economy can therefore be significant.

In the earlier years of development, the regulatory focus for these sectors was on basic functions such as licensing and registration. However, these establishments have matured, and today require standards for prudential behaviour to match the level of maturity and the risk exposure of the businesses. They have become systemically important to the economy of SVG and are now a known alternative to the commercial banking system. In addition to this, the population served is unlikely to be able to weather any unpleasant surprises that will adversely affect their funds. These facts have resulted in the re-engineering of the regulatory and supervisory focus of the Financial Services Authority (FSA), SVG’s regulatory authority, for these sectors.

Regulatory Regime

It appears that the greatest deterrent to embracing and implementing a sound compliance framework within these sectors is the actual and perceived cost of doing so. However, when weighed and carefully analysed, a less than optimal compliance structure inadvertently leads to loss for the members that far exceeds the cost of compliance. Sound systems of governance and documented operating processes mirroring the precepts of law, global standards and best practices provide comfort to depositors and investors that their funds are safe. This, in turn, builds the reputation of the sectors and leads to sound and sustainable business practices, with adequate internal triggers and mitigation strategies.

Modern regulatory systems are dynamic and thus their very dynamism challenges the structure of traditional indigenous sectors. This, intertwined with tremendous pressures from international organizations and individual sovereign nations for regulatory compliance to be demonstrated, will inevitably pose challenges to business operations that are unable to satisfactorily accomplish minimum compliance standards. Our recent past has clearly demonstrated that business conditions are becoming more volatile. De-risking, that is, the loss of correspondent banking relations with particular banks. Restrict local business as well as foreign business opportunities and strategies aligned to enhance the competitive advantage of credit unions and building societies. These developments and the limited responses that can be made to such predicaments have accelerated the need for vigorous embrace of comprehensive regulatory regimes for these sectors. The response must be designed to reconnect the financial systems of these institutions to international financial systems, foreign ex-change and trade, while continuously improving to meet evolving challenges.

In addition, to restore eroded trust, the regulatory and compliance framework of these sectors has to be robust, seamlessly adopting to changes and promptly and effectively identifying, assessing, managing and mitigating vulnerabilities and threats. Additionally, demonstrating resilience to the penetration attempt of launderers, aiding law enforcement in recognizing the placement of illicit proceeds into the financial system, and ultimately getting rid of money laundering are also a part of the compliance required.

Supervisory Initiatives for Credit Unions

To address compliance and maintain sound economic balance, both the regulator and the credit unions utilize various management and monitoring systems. Specifically, the performance of credit unions is monitored by using the PEARLS framework, Risk Based Methodologies and modernized legislation. These regimes guide the regulator and the institutions in the management of members’ funds.

The PEARLS framework makes use of forty-four (44) different ratios of excellence to measure a credit union’s performance. PEARLS focuses on the adequate protection of assets, the financial structure of the credit union and its overall financial strength, the quality of assets held, the rates of return and cost of doing business, the levels of liquidity and the rate at which the entity is growing. When used effectively, PEARLS allows both the regulator and credit unions to recognize deviations which threaten the safety of a member’s funds.

To strengthen the regulatory response to such deviations, the FSA complements its supervision practices by combining Risk Based Supervision strategies with PEARLS, focusing resources on deficiencies that may cause the most significant impact on the economy at any time. This approach is geared towards limiting continued exposure to risks and ensuring that supervisory action and resources are channelled in proportion to the nature and complexity of same. Ultimately, all efforts are geared towards lessening or mitigating the impact of threats posed to all members and the overall financial stability of the economy.

Way Forward

Being cognizant of the problems of the past and ever evolving risks, the FSA is moving towards the further enhancement of its risk based supervisory approach by consulting with and introducing stress testing techniques to the credit union sector. These techniques will allow both the regulator and the sector to mimic stressful conditions and determine the likely reaction of the balance sheet of these institutions based on different financial situations. The aim is to enhance the preparedness of the sector and to assist in the development of effective responses to unfavourable circumstances. This will be a valuable exercise in identifying areas of “stress” for early action by both the institutions and the regulator, thereby resulting in greater safety of depositor funds. The FSA will be engaging the credit union sector on this approach in the coming year 2017.

In conclusion, while regulatory compliance comes at a cost, it is vital to ensuring financial stability and safety for consumers. The regulatory landscape is evolving to match the risks of institutions and to improve efficiency of both the regulator and the regulated. The ongoing overall objective of the regulation and supervision of these sectors is to promote sound and prudential management, compliance with legislative requirements and best practices as well as financial stability at both the micro and macro level, in the best interests of all stakeholders.

Submitted by:Financial Services Authority