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A new approach to financial regulation - white paper and draft bill

Executive Summary

Credit unions are a sector of small, deposit-taking financial co-operatives.  To give a sense of scale, in a recent analysis of the size of ABCUL member credit unions in the year October 2007 – September 2008 (the most recent year for which complete figures are available to us) the following features were found:

  • 56% had less than 1,000 member customers
  • 53% had assets of less than £500,000
  • 32% had no staff at all and relied entirely on volunteers to operate
  • 82% generated less than £200,000 turnover
  • 56% generated a pre-tax profit of less than £10,000
  • 46% were unable to pay their depositors a dividend return on their savings

Under the proposed regulatory structure credit unions, as deposit-takers, are set to be dual-regulated by both the PRA and the FCA.  We support entirely the classification of firms by function as opposed to size and wish to remain under the same regulatory framework as the larger deposit-taking institutions.

Whilst we support our position within the new framework it is imperative that credit unions are regulated proportionately within that.  Even when taken as a whole, the sector poses very little systemic risk and could not cause a financial crisis as seen in 2008. It would be ironic if an unintended consequence of the new framework, designed to cope with those that caused the crisis, was to stifle the development of the firms that did not.  This would be at odds with the Government’s policy of supporting credit union development through both legislative reform and potential investment in the modernisation of the sector.

Despite this, we feel that the proposals as framed will have the unintended consequence of increasing the regulatory burden upon the credit union sector out of proportion with the benefits of doing so.  In our previous responses we have raised these concerns repeatedly. 

Nevertheless, the White Paper states in its impact assessment point 39:

The PRA will also be responsible for prudentially supervising much smaller firms which take deposits or effect and carry out contracts of insurance. Almost all credit unions and some friendly societies and building societies would fall [sic] to be considered as small firms; many credit unions would be very small by any standard. Some investment firms regulated by the PRA may also be small firms although it is likely that they will be parts of groups that include a bank or insurance company. The transitional costs for these firms seem likely to be relatively less depending on the circumstances of the individual firm.

And further at point 45:

Consultation respondents were concerned that dual-regulated firms would face significantly higher costs and that these would disproportionately on [sic] smaller dual-regulated firms. In practice, this probably means that the smallest dual regulated firms would (e.g. credit unions) would [sic] not be much affected while the largest banks and insurance companies would not face significantly higher compliance costs in comparison with their current compliance costs. The effect could be greatest in smaller banks or proprietary trading firms.

It is unclear on what grounds the Government feels that the proposals will not have a material impact upon credit union compliance costs.  In terms of compliance resource requirements we take the view that the smaller a firm is, the greater these costs are relative to the firm’s limited resource.  Very small credit unions may struggle to meet their regulatory obligations because of their over stretched resource and their lack of economies of scale which allow larger firms to deal more easily with such functions.  We disagree with the assertion that the smallest firms will not see a substantial increase in compliance costs.

Similarly, we are concerned with the escalating estimations of transitional costs for implementing the new regulatory framework.  In the second consultation, Building a Stronger System, these costs were estimated at £400 million, whilst the White Paper puts them at £770 million.  It appears to us that the new framework, by splitting the institutional capacity of the FSA between two bodies, is also likely to duplicate the overheads and back room costs on an ongoing basis.  The combined effect of the transitional and ongoing costs of implementing the new framework will be to increase the pressure to raise industry fees further than under the FSA.  Credit unions currently enjoy a reduced minimum fee framework because of their size and the social value that they create and we would like to see this retained.  With such pressure on the cost base of the regulatory system, however, we are concerned that this may not survive.

We support measures proposed to enshrine proportionality at the heart of the new principles of regulation as well as measures to ensure that any new regulatory development is assessed for its effect on mutuals as distinct from other corporate ownership structures.  These will go some way to ensuring that credit unions are fairly, appropriately and proportionately regulated and supervised.  We do, however, recommend a series of further measures which would embed proportionate treatment for small, dual-regulated firms under the new framework:

  • It is important that CREDS the specialist regulatory sourcebook which is to be implemented alongside the Legislative Reform (Industrial and Provident Societies and Credit Unions) Order which is currently before Parliament is retained.  This has been developed specifically for credit unions and is constructed in a rules-based format which is more suitable than principle-based regulations which are more suited to larger, more complex organisations.
  • We propose that mechanisms are not only retained but strengthened for smaller firms – such as credit unions – to hold the new regulatory bodies to account and have an input into decision making.  The Practitioner Panels should be retained for both bodies, the Smaller Businesses Panel should be put on a statutory footing for both and smaller firms should be given a voice in the governance structures of the new regulators.
  • A greater emphasis should be placed upon Cost Benefit Analysis (CBA) and this should be provided for in statute. Not only should individual regulatory developments be subject to CBA but regular, sector-wide assessments should be conducted to assess the overall impact of regulatory developments rather than ad hoc piecemeal assessments which only take account of one specific issue.  This would put the statutory obligation to proportionality on a directly measurable footing.
  • A single point of contact is needed for dual-regulated firms to deal with both bodies.  At present there are very complex proposals in place for different regulatory approvals and processes – approved persons authorisations, for example – which will be very difficult for small firms especially to negotiate without the creation of a single port of call through which all such issues are communicated and behind which the regulatory split is co-ordinated by the two bodies themselves. This would alleviate the resource-strain of dealing with two regulatory bodies.
  • Fees must not be allowed to rise significantly from the level that they are at present outside of reasonable incremental increases.  It should not be the case that fees increase more rapidly than they would have under the FSA.  Regulatory fees are one of the key expenditures credit unions are required to meet and major increases brought on through the division of the FSA and behind-the-scenes duplications of function would add no value but put significant strain on the financial position of many small credit unions.
  • The costs of funding the Financial Services Compensation Scheme must be kept under control and set up such that they are proportionate to the risk that various sectors pose to the stability of the financial system as a whole.  We have benefitted greatly from the FSCS’s protection but current proposals under discussion – such as the EU proposal to pre-fund guarantee schemes – could leave our sector facing very serious difficulties.

Whilst we appreciate that Government considers some of these proposals to be operational matters for the regulators to assess and implement as they see fit, we feel that it is important to embed such measures by legislation in order to ensure true proportional treatment of smaller firms – especially small, dual-regulated firms of which our sector is almost the only example.

Credit unions have an extremely valuable role to play in providing financial services to those otherwise excluded from fair and equitable access to the mainstream and, as they grow, in providing vital diversity and competition in financial services which will serve to enhance the stability of the industry in the UK.  We urge the Government to look again at our proposed measures which we feel would greatly reduce the burden of the new framework upon our sector; a sector which did not have a hand in the financial crisis and therefore should not be unduly burdened by the regulatory response to the it.

The full response is available to download on the right hand side of the screen.