A Trick Question
Volume 12, Number 6
June 29, 2022
Advocacy News You Can Use
During my first job working for a prudential bank and credit union regulator, one of my early training classes posed the question of whether a credit union would prefer to be in a rising interest rate environment or a declining interest rate environment. We went around the room with various people offering their arguments as to which situation was better for a credit union. Strong views were offered on both sides of the issue. At the end, the teacher said that they were going to give us the answer but warned us that it was a trick question. To this day, I remember the answer clearly.
“Neither—a credit union should be prepared for either situation,” said the instructor.
It is a lesson that stuck with me because it really helps to focus on the fact that a credit union leader should focus on the skills and the actions necessary to properly manage the credit union based on the situation before them. Worrying or hoping for economic factors that are beyond the control of the credit union really does not help manage the institution in the most prudent manner. This lesson is really important now more than ever, with regulators focused on inflation, stagnation and a weaker outlook for growth. This, and the many new regulations coming our way on climate resilience, sustainable finance, payments, cryptocurrencies, etc., means we must be prepared for all situations.
WOCCU Advocated Proportionality Included in Climate-Related Financial Risks Standard
The Basel Committee on Banking Supervision published its Principles for the Effective Management and Supervision of Climate-related Financial Risks. The document forms part of the Committee's holistic approach to addressing climate-related financial risks to the global banking system and seeks to improve banks' risk management and supervisors' practices in this area.
The document outlines numerous principles for addressing climate-related risks that will form the bases of requirements from national-level regulators when addressing climate-related risks for financial institutions and credit unions. The principles outline numerous elements that should be in national-level rulebooks, including:
- internal control framework.
- capital and liquidity adequacy requirements.
- a risk management process.
- management monitoring and reporting requirements.
- comprehensive management of credit risk requirements.
- comprehensive management of market, liquidity, operational and other risks.
- scenario analyses.
WOCCU commented on this document during the consultation process by noting that the principles may result in a significant increase in regulatory burden for smaller, community-based deposit taking institutions such as credit unions. The principle of proportionality is key to allowing credit unions to address climate-related risks, but in a manner appropriate for their size and complexity.
The Committee included its strong support for the principle of proportionality by including the following language:
- The principles seek to accommodate a diverse range of banking systems and are intended to be applied on a proportionate basis depending on the size, complexity and risk profile of the bank or banking sector for which the authority is responsible.
- Supervisors should set expectations in a manner proportionate to the nature, scale and complexity of relevant banks’ activities.
- Where appropriate, supervisors should determine that banks have in place a scenario analysis program that is proportionate to their size, business model and complexity to assess the resilience of their business models and strategies to a range of plausible climate-related outcomes.
- Banks should manage climate-related financial risks in a manner that is proportionate to the nature, scale and complexity of their activities and the overall level of risk that each bank is willing to accept.
This strong embrace of proportionality should provide clear direction to credit union supervisors and regulators to engage in the important and necessary process of tailoring these principles for credit unions in a manner that does not impose an unreasonable regulatory burden on credit unions, while allowing the regulated entity to address climate-related risks.
A copy of the principles can be viewed here.
Why this matters to your credit union: While the principles represent a potentially significant regulatory burden, the embrace of proportionality in the standard directs national-level regulators to properly tailor these standards for the size, risk and complexity of the credit union.
ENCU Touts Benefits of Credit Unions in EU Report on Social Taxonomy
The European Network of Credit Unions (ENCU) urged the Platform on Sustainable Finance of the European Commission to consider credit unions and the credit union not-for-profit cooperative model to be classified as their own social taxonomy based on the social benefits that credit unions provide to society.
The Platform on Sustainable Finance issued its Final Report on Social Taxonomy wherein it is focused on aligning the structure of a suggested social taxonomy more closely to the existing environmental taxonomy.
In the letter, ENCU suggests that credit unions should be designated as their own social taxonomy because their cooperative structure lends itself to different behavior than investor-owned financial institutions and that difference in behavior produces substantial benefits to the world’s millions of credit union members, non-members and the economy.
Access to affordable, reliable and self-sustainable financial services improves lives on many different levels and credit unions work to expand services to people of all income levels. This makes credit unions uniquely positioned to drive how the financial services industry can better foster financial inclusion. The credit union model places the interests of their members top of mind, prioritizing personable, altruistic service. The “people helping people” philosophy is at the core of their “DNA” which operates to the social benefit of all. Financial inclusion and the nexus with sustainable communities is embodied by the credit union cooperative model.
The letter also notes the work of Donore Credit Union in Ireland, wherein it has documented the social benefits of the credit union to society. Their study documents that for every EUR 1 equivalent invested into Donore Credit Union, EUR 10 of social value was created in the region. This is an astounding number that could only be accomplished by the unique cooperative model afforded by a credit union.
A copy of the ENCU comment letter can be viewed here.
Why this matters to your credit union: Regulatory developments in sustainable finance represent potential regulatory burdens for credit unions. However, there are many opportunities for credit unions to obtain recognition for its cooperative model that benefits their local communities.
Basel Discusses AI and Machine Learning
The Basel Committee on Banking Supervision (Committee) issued a newsletter discussing its internal discussions regarding artificial intelligence and machine learning. The newsletter made the following observations:
- Banks are increasingly exploring opportunities for using artificial intelligence (AI), including machine learning (ML).
- Banks' use of AI/ML presents significant opportunities but can also heighten certain risks and challenges.
- The Committee intends to continue exploring banks' use of AI/ML, especially in the areas of explainability, governance, and resilience and financial stability.
The paper notes that banks are increasingly exploring opportunities for using AI/ML. AI/ML technology is expected to increase banks' operational efficiency and also facilitate improvements in risk management. While significant opportunities are emerging from the increasing use of AI/ML in many areas of banking, there are also risks and challenges associated with these techniques.
It notes that given the challenges associated with AI/ML, both supervisors and banks are assessing existing risk management and governance practices to determine whether roles and responsibilities for identifying and managing risks remain sufficient. As with other complex operations and technologies, it is important that banks have appropriately skilled staff, which can include model developers, model validators, model users and independent auditors.
The Committee is working to develop further insights on this topic, with a focus on the following areas:
- The extent and degree to which the outcomes of models can be understood and explained.
- AI/ML model governance structures, including responsibilities and accountability for AI/ML-driven decisions.
- The potential implications of broader usage of AI/ML models for the resilience of individual banks and more broadly, for financial stability.
A copy of the newsletter can be viewed here.
Why this matters to your credit union: The use of artificial intelligence in lending poses numerous challenges for a credit union and for regulators. Understanding the regulatory approaches will help a credit union make informed decisions when exploring or adopting this emerging technology.
Andrew T. Price, Esq.