Concentration Risk

What does ‘proportionality’ mean? The term has been used frequently by credit union leaders and government over the last ten years and particularly in the run up to the major legislative changes in 2019. But small credit unions are being over-burdened with expanding requirements. Notably, the priority is set out to the BC Financial Services Authority (‘BCFSA’) by Minister Robinson:

• Advance the BCFSA’s risk-based and proportionate supervision of financial
services sectors and efforts to enhance consumer protection.

Mandate letter March 24, 2021

Appropriately, that phrasing is reproduced in the BCFSA Service Plan. However, since the terms ‘risk-based’ and ‘proportionate’ are not well defined, it is left to the BCFSA to interpret them. This is the rub. Many smaller credit union managers do not see the current approach evolving in a way that they had hoped or expected.

Regulatory burden is a primary concern among Community-Based Credit Unions. Smaller credit unions thought that “proportionate supervision” would mean they would get some relief. That does not appear to be the case. BCFSA Guidelines largely reproduce those employed by the federal bank regulator with little adjustment to ensure suitability to a much smaller local credit union. Recently BCFSA released a Regulatory Roadmap that gives notice of 7 new BCFSA Guidelines and 3 new BCFSA Rules, potentially introducing a host of new regulatory requirements.

bcfsa website

This is a more and more interventionist approach to regulation. The distinction between ‘business decisions’, those made by those managing an institution, and ‘regulatory decisions’ is growing less clear. A similar interventionist posture is set out in the recently revised BCFSA Supervisory Framework.

Further, in a recent online conference BCFSA senior management affirmed that ‘proportionality’ would continue to be determined based on ‘the nature, scope, complexity, systemic importance, and risk profile’ of the credit union, on an institution by institution basis, as has been the recent practice. But this model is not working well, as GM’s at smaller credit unions are having to negotiate all manner of things with BCFSA relationship managers instead of having a clear set of expectations. (I will expand on this in a coming post.)

Regulatory Burden is an issue to raise with government and legislators. Six of BC’s 30 small credit unions have completed or announced mergers this year alone. One of the big reasons for consolidation is Regulatory Burden. If it is government policy to force small credit unions to merge they should say so.

Where is the Risk?

I would argue that proportionality is rationalized on two grounds; first to recognize the greater ‘systemic’ risks presented by large credit unions (aka concentration risk) and, second, to provide appropriate regulatory programs for community credit unions (not to be overburdened).

Concentration Risk:  A serious liquidity event, or erosion of capital, at a large credit union could disrupt the entire system.  As a consequence of consolidation the very large credit unions may require closer “risk-based” attention from the regulatory authority.  The largest 4 credit unions represent @65% of total assets, the largest 10; 85%.

Most existing BC system resources are designed to cope with problems at smaller institutions.  Central1 may not be able to cover emergency liquidity needs at a very large credit union.  The regulatory authorities (BCFSA and Stabilization Central Credit Union) may not have the technical or managerial capacity to intervene if there is a significant information system or control failure at a large credit union.  The CUDIC fund could be substantially depleted by an insolvency at a very large credit union.  

Measures taken by BCFSA to reduce risk exposures, to introduce supplementary risk management practices, and to have operators report more frequently on potential risk exposures are likely needed for the larger credit unions.  However, they are not necessary for smaller credit unions where similar events pose little risk to the credit union system. 

Sustainability:  Many community-based credit unions (‘CBCU’) have expressed alarm at the growing regulatory burden.  The issues include expanded reporting, frequent information requests, new ALM monitoring, new guidelines, new consumer complaints processing, and added new performance targets (CUDIC risk indicators).  The BCFSA insistence on extensive reporting & policy controls at all credit unions puts a higher proportionate cost on smaller credit unions.  At the same time it is questionable if the risks are better managed or, perhaps, the new routines become ‘performative’, done to keep the regulator happy.  

The regulatory burden and costs make those CBCUs less competitive and more precarious. These pressures are inducing more credit unions to pursue mergers, and this path leads to greater concentration as opposed to diversification of risks to the system overall.  Over time, this path likely will result in fewer branches and services in non-urban BC.  In under-served and unserved communities vulnerable populations and small businesses will suffer.  This is should be a political concern of this government. 

Target the Risk

The above tries to reverse the discussion.  It is not so much that community credit unions need ‘less’ regulatory supervision, it is that large credit unions may require the ‘closer’ supervision.  

The BCFSA Service Plan appears to acknowledge its commitment to building a network of resilient community credit unions.  This is from the BCFSA Service Plan under Goal 1, Objective 1.1, ” A proportionate approach to supervision is required to protect the public while continuing to allow regulated entities and individuals to innovate and grow.”    That is followed by elaboration on Strategies:  • Develop a supervisory ‘playbook’ for supervision activities to enable a consistent methodology and approach to proportionate monitoring and on-site reviews, reflective of varying size, scope and complexity of regulated entities in BC.  

Within this framing by the BCFSA one can have another perspective, the regulatory requirements would be enhanced at the large institution end of the spectrum instead of being ‘relaxed’ selectively at the small end. Further, government or the BCFSA could clearly identify the two different types of credit unions that are subject to differing requirements.

Community-based credit unions (and the CCUA) should be making the case for a different regulatory approach that is risk-based, sensitive to the geography of BC, and consistent with BCFSA’s own stated intentions above.  One that recognizes the risk concentrations AND the different risk profile in CBCUs. I think community credit unions should  press for rules and guidelines with less complex policy controls, reporting that is simpler and less frequent, and other treatments that reflect the limited risk they pose to the public, the credit union system, the regulator, and the deposit insurer.  It should be noted that if a negative event does occur at a small institution, adequate stabilization resources and insurance provisions are in place. 

Add requirements for the complex and very large credit unions where they are needed!

At this point BCFSA is not targeting the risks, risks that are highly concentrated in the very large institutions, and community-based credit unions may be the collateral damage.

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