Regulators Shift to Approach Based on Principles and Data

As every executive and director knows, the way credit unions are regulated and monitored has changed dramatically over the last 20 years as the industry and the dangers it faces have shifted. 

Regulators have moved away from prescriptive checklists of do’s and don’ts that worked when credit unions provided limited services in limited ways, and shifted to an approach based on a broader overview of their actions and potential threats. 

For example, the Financial Services Regulatory Authority of Ontario (FSRA) focuses on what it calls a principles-based approach, while the B.C. Financial Services Authority (BCFSA) calls its approach risk-based. The approaches for the credit unions they regulate are similar. They provide reams of data from their banking systems that the regulators can analyze to spot any dangerous trends. 

George De La Rosa, Chief Executive Officer at $300 million Luminus Financial in Toronto, has been in the credit union system for almost 30 years and recalls the old approach when consultants would hold branch visits, interview staff, and look at the facility. “They’d spot a camera and say, ‘Where's your camera facing? Oh, no, that's not facing the right way.’ And you could get a negative point.”

Those visits are history, but FSRA is seeking far more data and information. 

“The shift has been a learning progress for everyone, the regulator and the credit unions as well,” De La Rosa says. “We’re having open discussions with the regulator, attending webinars, and talking to them and listening to them; it's great. We've gone through our first assessment with the regulator under this whole new principles-based, risk-based assessment, and it was intensive but useful. The results were very different, but it isn't prescriptive by any means.”

Seeking More Data

De La Rosa says FSRA is looking for lots of data from each credit union and working with them to understand what is available now. “They're working with each credit union to make sure that they understand, if all of these are the data points that we want, which ones do you have? Which ones do you not have? Can there be a plan for you to get them in the future?”

He says they review results in an action plan that the credit union develops in conjunction with its FSRA relationship manager. 

“I think a principles-based approach is very well suited to a diverse sector and to accommodating the needs of large, small, complex, and simple credit unions,” says David Maxwell, Head–Regulation and Strategic Initiatives, Credit Union and Insurance Prudential at FSRA. “So, I think going back 25 years, the sector would have really benefited from a less rigid approach, as comfortable as everybody got with checklists and the idea that the regulator is going to come in every year or two and look at exactly the same things.”

He points out that FSRA has gone to great lengths to explain the new process and ensure boards and executives understand the approach. 

“We've done a ton of work to socialize the idea of principles-based regulation and to talk about the core principles and ultimately what our approach is going to be. I think the more that people learn, the more comfortable they get with it,” he says. 

Maxwell says many credit unions have found the change is not as onerous as they feared. 

“Our approach has been to take a tailored approach to each credit union and to understand their processes,” he says. 

De La Rosa says that one challenge with the principles-based approach is that it leaves what is permitted up to interpretation by the credit union and the regulator. “So, if you don't have specific guidance on what you should or shouldn't do, it does become difficult to sort of say what am I being judged on.”

Looking at Viability 

Regulators are also concerned about the long-term financial viability of credit unions. “We're of the view that there is no right number of credit unions in the sector,” Maxwell says. “There's no ideal size for a credit union. We have some very strong and successful smaller credit unions in the sector that provide a model for their peers. We know some amalgamation is inevitable, some further amalgamation, but we're not pushing that in any way and look at each individual case.”

One of FSRA’s fundamental roles is promoting innovation in the sector. Maxwell says its goal is to be flexible and encourage the sector to develop its own solutions to its financial challenges.

He says FSRA is agnostic on the issue of federal continuance but is focused on “what’s in the best interest of credit union members and the best interest of the sector overall. The implications for the sector are always front of mind for us.”

The change in regulatory focus is not just a Canadian trend. 

In its 2020 paper A Regtech Manifesto: Redesigning Financial Regulation for the Digital Age, U.S. nonprofit Alliance for Innovative Regulation argues that there needs to be an “urgent redesign of the financial regulatory system to convert it from an analog approach to a “digitally native” framework – that is, to a system that will be rebuilt from scratch, over time, to leverage new digital technologies that can make regulation better, faster and cheaper, all at once.”

The report warned the financial system is changing dramatically and the regulatory system needs to keep pace. “The single most critical force that is driving all this change is the digitization of information.”

The report noted there are two trends that regulators must contend with: 

“One trend is the explosion in the volume of information generated by and about the financial system. The second is the sharp acceleration in the pace of change. Both trends present unprecedented challenges for regulators.”

Need to Use AI

The report also indicates regulators must turn to AI to keep pace with the mountain of data they face. “They will need to see and understand the full set of information, rather than relying on data sampling and summary reports. They will need to see it in real time, not in periodically submitted reports that lag months behind the present day. They will need new tools that enable them to respond quickly to information and indicators.”

For its part, BCFSA says in its regulatory roadmap for 2024-25 that it is studying technological innovations such as open banking, the regulation of digital currencies and crypto assets, payments modernization, and artificial intelligence so it can “understand how these technological innovations will impact consumers and what safeguards might be needed to ensure consumers are protected.”

BCFSA says its regulatory priorities are modernizing the regulatory framework, crisis preparedness, natural catastrophe and climate risk, and digitalization risk. 

In 2024-25, BCFSA will continue its modernization efforts, focusing on capital modernization, credit union lending, and the formalization of anti-money laundering requirements.

The regulator says it is working with credit unions to implement new loan-data reporting requirements to better monitor and assess risk in credit union loan portfolios. Analysis of collected data is a crucial component of BCFSA’s risk-based supervision.

De La Rosa said the shifting regulatory approach puts more pressure on boards because they have a higher duty of governance. FSRA wants to ensure that board members either know the answers to key questions or know where to get them. 

“I think governance and in particular governance at the board level is foundational to a principles-based approach,” Maxwell says. “The way that we articulate our expectations for directors has been a big part of this process. We emphasize the fundamental role that boards play in all of this, setting the direction of the credit union, setting the risk appetite and making sure that they have appropriate oversight. We’re very focused on engagement and we're focused on education.”

For example, FSRA has started an annual directors’ conference for both the credit union and insurance sectors. 

“Drawing your directors from your membership certainly places restrictions on some credit unions,” Maxwell says. 

The Challenge to Get Skills

“If you're a small community-based credit union, the reality is it's difficult to get people that are qualified in all of the areas that you need on a board to govern a modern financial institution,” says Michael Hatch, Vice-President, Government Relations, Canadian Credit Union Association. “That is a challenge that the regulator is increasingly focusing on.”

Marc-André Pigeon, assistant professor at the University of Saskatchewan and Director of Canadian Centre for the Study of Cooperatives, says that in the 1950s and ‘60s, Canadian credit unions were closely regulated, but that shifted as they developed, were allowed more autonomy, and worked together. 

Changes started in the 1980s and ‘90s with the international Basel agreements that set capital requirements for large banks and looked at system-wide problems. Then, after the financial crisis in 2008 made clear the growing dangers of systemic risks, more rules were put into place. 

Pigeon says that as credit unions grew larger it became apparent that the collapse of a large one could have extreme consequences for the entire system.

The size disparity “invites more regulatory scrutiny, more government involvement, less self-regulation,” Pigeon says. In the past, when a credit union ran into trouble, it was usually merged with a stronger partner, and the problems were absorbed. 

Pigeon notes that in the past, credit union regulators had close relationships with credit unions, and their boards were intertwined. That’s changed, with provinces such as Ontario and British Columbia creating new organizations that regulate other financial players, including credit unions. 

Pigeon says when there are fewer entities the relationship can develop into what is known as responsive regulation. “It can transcend formal written rules because you have relationships,” he says. This has been the federal government’s approach with the handful of big banks. 

Hatch of CCUA says many provincial regulators “are grappling with the medium and long-term vision of what the sector is going to be like in 2030 and 2040. How much consolidation has to take place in the next five to 10 years to continue to produce a viable credit union sector? Is the federal option viable for a critical mass of institutions? Can we get to a place where it's feasible to do interprovincial mergers? These are all big open questions that they don't have answers for.”

Want Stable Systems

One challenge is that many provinces “are actively opposed to credit unions in their jurisdictions going federal because they want to maintain a stable, provincially-regulated sector,” Hatch says. 

Pigeon suggests that provincial regulators may not oppose federal continuance but will 
have concerns. 

“My sense is this is probably not motivated by outright opposition, but about by, how do you do this transition in a way that's not disruptive? They like things to be orderly; that word is important to banking. They don’t want a disruption that is destabilizing.”

Regulators are changing how they regulate smaller credit unions, he says. “There are certain requirements that are more onerous on bigger institutions, or there are certain things where there's a threshold where you don't necessarily need to do a certain thing if you're below, let's say, a billion dollars in assets.”

For example, Ontario has introduced “enhanced data collection by the regulator over the past few years where they're really going in and asking credit unions to provide hundreds of lines of very detailed data on their lending activities and their membership in an anonymized way.”

That has been onerous for smaller members, so they have been given more leeway, Hatch says. 

As a leader of one of the smaller credit unions, De La Rosa says it has been a lot of work to provide the data that FSRA seeks. Luminus is looking at data warehousing options or at suppliers who can help pull together the information that FSRA requires, but all these approaches come at a cost.

It can also impose a need for greater caution with third-party providers to ensure they have proper security and processes. “Even that reliance on those third parties to manage all of that data has been a key point that the regulators look at,” he says. 

Hatch says many regulators are taking a closer look at smaller credit unions to determine “what their strategy is, what their plan is, and how they're going to compete. How are they going to keep up with investments in technology?”

Climate Change Risks

One place where there have been some regulatory differences is in the response to climate change. The Office of the Superintendent of Financial Institutions (OSFI), the federal regulator for banks and federally chartered credit unions, has issued guidelines warning FIs that they face dangers from physical changes due to climate change and transition changes due to the cost of moving to a low greenhouse gas economy. It warns executives and boards to consider these risks and report their plans. 

BCFSA has issued a discussion paper and says it will release a report outlining its proposed approach to natural catastrophes and climate risk this year or next. 

“This approach will signal alignment with national initiatives and a commitment to begin working with industry and key stakeholders to address issues and challenges specific to financial service providers in B.C. It is anticipated that specific regulatory measures will be implemented beginning in 2025-26.”

Ontario has taken a wait-and-see approach. 

“Our view right now is that we take an evidence-based approach to issuing rules guidance, and there’s not enough evidence for us right now that there would be a benefit to giving credit unions explicit direction in this regard,” says Maxwell of FSRA. “I would say that across all of our sectors, we are very much engaged in understanding how the implications of climate risk feed their broader risk-management processes.

“Credit unions have been resilient and I'm confident that they will continue to be,” he said. 

Based in Campbellford, Ontario, Art Chamberlain has written about credit unions for more than a decade and has been a member for more than 30 years.