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PRA – Introducing Risk-based levies for the FSCS deposit class

Response to the consultation

Credit unions are the third class of firm, along with banks and building societies, covered by the deposit class of the Financial Services Compensation Scheme.  We support the principle behind risk-based levies since credit unions are generally less risky institutions but we are keen to ensure that credit unions are not unduly disadvantaged by their implementation in the UK.  We are concerned that some aspects of the proposed calibrations and risk-weightings may not accurately reflect the risk profile of certain credit unions. 

Balance of risk-weighting

We appreciate the effort that the PRA has gone to to arrive at a simplified regime for risk-weighting in relation to credit unions given the discrepancies that exist between credit unions and other deposit-takers in terms of credit unions’ regulatory and reporting regime. 

In comparing the balance of different risk measures and the respective weight attached to each, however, we are concerned that the two do not reflect a balance with that applying to CRR firms.  In particular we are concerned that to give a 25% weight to Return on Assets (ROA) while the same measure in for CRR firms stands at 8.5% will unfairly emphasise this in respect of credit unions vis a vis other deposit takers.  We would suggest that a fairer approach would be to increase the emphasis upon the other three measures and decrease that in respect of ROA.  A split of 30-30-30-10 would seem fairer.  This is particularly true since many credit unions face tight profit margins as a result of serving hard to reach and excluded groups.

Bucket system for Return on Assets (ROA)

We are concerned that – both for credit unions and for other firms – a high ROA may represent a higher risk profile at the height of the credit cycle and that to reward firms based on the relative strength of their ROA may well reward risk-taking thereby militating against the logic of the risk-based system which should reward low-risk models.  As such we would like to suggest that consideration is given to discouraging overly-high ROA.

Grants and ROA

We would like to suggest that the PRA considers whether or not it would be possible to subtract the balance of grant income received in year from the total profit made by a credit union in the year in order to emphasise the vulnerability and risk that grant dependency generates among credit unions.  Where credit unions fail, a lack of exit strategy from a long-term dependency upon uncertain grant income to cover core costs is often a common factor.  Therefore, to adjust ROA figures to reflect this would be a better reflection of the risk profile of the credit union.

Leverage ratio metrics

We are also concerned that the leverage ratio metrics proposed – < 5%, 5% < 10% and >10% - are not reflective of the minimum capital requirements which the Credit Union Part of the PRA Rulebook requires.  In particular we would point to the vast majority of credit unions who operate with a 3% minimum leverage ratio.  These credit unions are generally very small organisations which present very limited risk in terms of their scale to the overall deposit-guarnatee framework and we see no logic behind punishing them for compliance with the minium requirements that the regulator demands. 

We would therefore suggest that a better approach would be to align the leverage ratio metrics based on the capital requirements to which each credit union is subject, as follows:

Minimum capital requirement of 3% -

<3% = 100 

3% <5% = 50

> 5% = 0

Minimum capital requirement of 5% and 8% -

<5% = 100

5% < 8% =50

> 8% = 0

The effect of this would be to more closely balance the burden of levies based on the requirements to which the credit union is subject.  The proposal as put out to consultation, on the other hand, would penalise many smaller credit unions unfairly.

Basis of liquidity ratio

We do not agree that measuring the liquidity ratio on the basis of total assets is a fair measure.  We would suggest that this measure is aligned with the overall liquidity ratio requirement as set down in the Credit Union Part of the PRA Rulebook which places “total relevant liabilities” as the denominator to the ratio rather than total assets. 

Total relevant liabilities takes account of the concept of “attached shares” which are those shares (deposits)  which credit unions secure against an outstanding loan balance.  Through being “attached” these shares are not able to be withdrawn during that time in which the loan balance exceeds the deposit balance.  This is a common practice set down in legislation and regulation and which is widely used by credit unions to secure their liquidity position.  Given that these shares are not withrawable, it would be unreasonable to require liquidity to be held against them.   The PRA Rulebook reflects this in its treatment of credit union liquidity and we strongly believe that the risk-based levy calculation should be consistent with this.

Banding of liquidity ratio

Finally, we would like to suggest that the inconsistency between the banding of liquidity for credit unions and that for other firms is unfair.  Given that the regulatory requirement placed upon credit unions is for them to have 10% liquidity, we do not understand why a higher standard of 15% is being suggested here as the optimum level.  For CRR firms the PRA proposes a dichotomous system whereby a firm is either out of compliance and therefore attracts the full risk weight or they are not and do not.  Our suggestion therefore is for those credit unions with less than 10% liquidity to be attributed 100 points and those above to attract 0. 

We would be happy to discuss our comments and suggestions further should you wish to.    

The full PDF version of the response is available to download on the right-hand side.


[1] Figures from unaudited quarterly returns provided to the Prudential Regulation Authority