Letters to credit unions: PRA annual assessment of the credit union sector – 2023

The Prudential Regulation Authority (PRA) has issued two supervisory letters each addressed at credit unions of varying sizes as regards the PRA’s annual assessment of the credit union sector and the PRA’s expectations of credit union actions in response to the current assessment. The key factors noted by the regulator are briefly outlined below; for more detailed comprehensive information, please refer to the following two letters:
1. Prudential Regulation Authority (PRA) Annual Assessment of the Credit Union Sector (Peer Group 4A)
2. Prudential Regulation Authority (PRA) Annual Assessment of the Credit Union Sector (Peer Group 4B
It shall be noted that the letters diverge somewhat in that additional issues and expectations are outlined for one Peer Group or the other. Wherever applicable, we will note the differences in the summary.
(1) The current macroeconomic environment: As most financial institutions involved in lending, credit unions (CUs) in the UK are currently faced with a challenging business environment marked by high interest rates, inflation, and economic uncertainty. While higher interest rates can benefit CUs‘ surplus funds in the short to medium term, they can also hamper their ability to lend as expected. Furthermore, the increasing cost of living is causing difficulties for borrowers, resulting in more loan defaults and arrears.
To deal with these challenges, it is essential that CUs are resilient and proactively assess how the evolving economic conditions affect their business model. Furthermore, the PRA notes that CU boards need to be forward-looking and continuously monitor their financial stability, adequately manage credit and interest rate risks, and address any emerging issues in a prompt manner.
(2) Liquidity: Over the past decade, favorable economic conditions and low interest rates have resulted in many CUs accumulating significant liquidity. Even during the pandemic, most CUs continued to see an increase in members‘ share balances and surplus funds. However, the recent external environment changes have introduced new challenges. Reduced affordability for new lending and higher returns on deposits outside the CU sector are creating risks that CUs haven’t had to deal with since quite some time. These risks are becoming apparent, such as unexpected member share withdrawals and mismanagement of investment maturity dates, negatively impacting CU liquidity. Therefore, it’s crucial for CUs to closely monitor their liquidity and review their cash-flow and liquidity forecasts to address these specific challenges. All CU boards must review their liquidity management statements and demonstrate how they have considered and addressed the relevant liquidity risks. Larger CUs in Peer Group A are expected to conclude this review by October 31, 2023.
(3) Corporate governance and succession planning: These issues are only addressed in the letter for smaller CUs (Peer Group B). Thereafter, either one is crucial for the stability and longevity of credit unions. Some CUs have faced closures in the past year due to their inability to recruit skilled and experienced volunteers. Many CUs are struggling to attract and retain new board members. In cases where a CU’s board of directors is not engaged and effective, it can lead to a decline in the CU’s safety and soundness. CUs must adhere to regulatory rules as well as their own internal requirements for board composition and key committees. If a CU’s board cannot implement a successful succession plan and faces the risk of losing key individuals, the existing directors should consider the CU’s future and explore options such as transferring engagements or closing in a solvent manner.
(4) Requirements pursuant to policy statement (PS11/23) and supervisory statement (SS2/23): On July 26, 2023, the PRA issued policy statement (PS11/23) which includes changes to the regulatory regime for CUs, along with a new supervisory statement (SS) 2/23. Both documents set out enhanced requirements and expectations of CUs that are deemed to pose higher risks to the safety and soundness objectives of the PRA. They also provides clarity on the PRA’s expectations in various areas, such as investments, capital, liquidity management, governance, risk management, operational risk, and internal audit.
According to the PRA, all CU boards are required to review SS2/23 by October 31, 2023 and develop a plan to ensure ongoing compliance with the specified requirements and expectations. This plan should be discussed and agreed upon at the board level, and the agreement should be properly documented.
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In the Annex to the letter, the new requirements under SS2/23 in each of the above noted areas are outlined for each Peer Group.