Presentation to Credit Union Workshop St. Vincent and the Grenadines By Shelton Nicholls Resident Adviser on Financial Stability, CARTAC

1. Credit Unions in the Caribbean Financial System (Stylized FACTS) 2. Framework for Developing Financial Soundness Indicators 1.CAMELS and PEARLS Framework 2.CAMELS/PEARLS COMPARISON 3. Financial Soundness Indicators: 1.Core /Enhanced (Deposit-Takers) 2.Pearls Ratios 3.CAMELS/PEARLS COMPARISON 4. Reporting Regime for Credit Union Financial Indicators 5. Application of PEARLS to a Caribbean Credit Union 6. Database Development for Credit Unions: Often Neglected Area! 7. Imperatives for Enhanced Regulation of Credit Union Sector.

 Domestic On-shore Financial Sector is quite large relative to the size of the regional economy. ◦ Total financial assets amount to around 131% of regional GDP (IMF estimate, WP/13/175)(p.7)  Banking System Assets (95% of regional GDP)  Non-Banking System Assets (36% of regional GDP)  Insurance Companies (20% of regional GDP)  Security Firms (9% of regional GDP)  Credit Unions (7% of regional GDP)

 Share of Indigenous institutions in the Caribbean on-shore financial sector in decline.  Foreign Banks dominate landscape of Caribbean Financial Sector ◦ 60% of regional banking assets held by Canadian- based banks.

 Credit Union Sector has grown in several Caribbean countries: Financial Assets to GDP  Dominica (39% of national GDP)  Belize (21% of national GDP)  Barbados (17% of national GDP)  Grenada, St. Vincent and St. Lucia range between 13% and 19% of GDP of these respective countries.

Financial Institution Commodity – Based Producers Service- Based Producers ECCU Area Total Caribbean Banks Credit Unions Insurance Companies Offshore Banks -143na143 Total

Credit Unions

 CAMELS FRAMEWORK ◦ Revolves around the following six groups of indicators that focus on the health of financial institutions.  Capital Adequacy  Asset Quality  Management Soundness  Earnings and Profitability  Liquidity  Sensitivity to Market Risks C A M E L S

Capital Adequacy Determines how well financial institutions manage shocks to their balance sheets by focusing on capital position of institution to support loan portfolio growth and potential deterioration in assets. Asset Quality Judges overall quality of assets by looking at exposure of assets in institutions portfolio to various risks. M’gmt Soundness Judges overall soundness and effectiveness of management of the institutions by looking at governance, human resources, processes, controls and audit.

Earnings & Profitability Judges the Institution’s ability to generate to absorb losses by building an adequate capital base, finance expansion and pay dividends to its share holders. Liquidity Judges ability of Institution to meet its present and anticipated cash flow needs including funding loan demand, share withdrawals and liabilities and expenses. Sensitivity to Mkt Risks Judges the sensitivity of loans and deposits to sudden changes in interest and exchange rates.

 PEARLS FRAMEWORK ◦ Adopted by WOCCU in 1994; ◦ Revolves around the following six groups of indicators that focus on the health of financial institutions. Proposes a system of 44 financial ratios that deal with:  Protection  Effective Financial Structure  Asset Quality  Rates of Return  Liquidity  Signs of Growth P E A R L S

Protection Assesses extent to which credit unions can provide a safe environment to protect their members’ money. Effective Financial Structure Gauges financial structure of credit unions by assessing sources and uses of funds. Financial structure is effective when assets, financed by savings deposits, generate sufficient income to pay market rates on savings, cover operating costs and maintain capital adequacy. Asset Quality Assesses overall quality of assets and identifies impact of non- earning assets on credit union income.

Rates of Return & Costs Monitors the return on all types of assets (uses of funds) as well as the costs of each liability. Looks at how yields and costs affect the growth of the credit union. Liquidity Judges ability of Institution to meet its present and anticipated cash flow needs including funding loan demand, share withdrawals and liabilities and expenses Signs of Growth Judges the growth of various areas in credit unions with a view to assessing member-client satisfaction as well as to help management maintain an effective financial structure.

MAIN AREASCAMELSPEARLS REGULATORY/SUPERVISORY FRAMEWORK SUPERVISORY TOOL INDUSTRY BENCHMARKING TOOL INFORMATION USED MIX OF QUANTITATIVE AND QUALITATIVE INFORMATION LARGELY QUANTITATIVE INDICATORS NATURE OF SUPERVISORY EXAMINATION REQUIRES ON- SITE AND OFF-SITE EXAMINATION ON-SITE EXAMINATION NOT REQUIRED

CAMEL-BASED AND PEARLS-BASED

 Conceptual Framework and Classification for Financial Soundness Indicators developed by IMF around 2001 with input from international bodies.  Financial Soundness Indicators Compilation Guide published in  New Compilation Guide with a focus on non- banks being prepared.

Institutional Sector Financial Corporations Deposit-takers Commercial banks Investment banks Mortgage Banks Development Banks Savings and Loans Assoc. Building Societies Credit Union/Co-operatives Micro-Finance Institutions Other Financial Corporations Engaged in Financial Intermediation (but Non-Deposit Takers) Insurance Corporations Pension Funds Investment Funds Securities Dealers

CAMEL FRAMEWORK KEY INDICATORS Capital Adequacy Regulatory capital to risk -weighted assets Regulatory tier 1 capital to risk -weighted assets Asset quality Non-performing loans to total gross loans Non-performing loans net of provision to capital Sectoral distribution of loans to total loans Earnings and Profitability Return on Assets Return on Equity Net interest margin to gross income Non-interest expenses to gross income Liquidity Liquid assets to total assets Liquid assets to short-term liabilities Sensitivity to market risk Net open position in foreign exchange to capital 19

KEY INDICATORS Deposit-Takers Capital to assets Large Exposures to capital Geographical distributions of loans to total loans Gross asset position in financial derivatives to capital Gross liability position in financial derivatives to capital Trading income to total income Personnel expenses to noninterest expenses Spread between reference lending and deposit rates Spread between highest and lowest interbank rate Customer deposits to total loans Foreign currency-denominated loans to total loans Foreign currency-denominated liabilities to total liabilities Net open position in equities to capital

KEY INDICATORS Other Financial CorporationsAssets to total financial system assets Assets to GDP Nonfinancial CorporationsTotal debt to equity Return on equity Earnings to interest and principal expenses Corporate net foreign exchange exposure to equity Number of applications for protection from creditors HouseholdsHousehold debt to GDP Household debt service and principal payments to income Market LiquidityAverage bid-ask spread in the securities market Average daily turnover ratio in the securities market Real Estate MarketsReal estate prices Residential real estate loans to total loans Commercial real estate loans to total loans

 Although not mentioned in FSI Compilation Guide (2006), PEARLS has emerged as a prudential standard for credit unions operating worldwide. ◦ Provides standardised financial ratios for individual credit unions. ◦ While meeting specific needs of credit unions, complements existing financial soundness indicators based on other frameworks (CAMEL).

 P1. Loan Losses Allowances / Delinquent Loans >12 Months. ◦ Purpose: To measure the adequacy of the provisions for loan losses when compared to all delinquent loans over 12 months. ◦ Items Required: A-Allowance for Loan Loss (Balance Sheet); B- Percentage of Allowance Required to cover delinquent Loans > 12 months and C – Loan Balances of all delinquent loans > 12 months. ◦ Formula : (A)/(B*C).

 P6. Solvency Ratio. ◦ Purpose: To measure the degree of protection that credit union has for members’ deposits and share savings in the event of liquidation. ◦ Items Required: A- Total Assets; B- Allowance for Risk Assets; C – Balance of Delinquent Loans >12 mnths; D- Balance of Delinquent Loans <12 mnths; E – Total Liabilities; F – Problem Assets (losses to liquidate); G –Total Deposit Savings; H – Total Shares  Formula: – [(A+B)-(C+.035(D)+E+F-G]/(G+H)

E - Effective Financial StructureGoals (Excellence) E1. Net Loans / Total Assets70-80% E2. Liquid Investments / Total Assets≤ 16% E3. Financial Investments / Total Assets≤ 2% E4. Non-financial Investments / Total Assets0% E5. Savings Deposits / Total Assets70-80% E6. External Credit / Total Assets0-5% E7. Member Share Capital / Total Assets≤ 20% E8. Institutional Capital / Total Assets≥ 10% E9. Net Institutional Capital / Total Assets≥ 10%

 E1. Net Loans / Total Assets ◦ Purpose: To measure the percentage of total assets that are invested in the loan portfolio, or to ascertain what percentage of assets the members have borrowed. ◦ Items Required: A – Total Gross Loan Portfolio Outstanding); B- Total Loan Loss Allowances; C – Total Assets. ◦ Formula : (A - B)/(C).

 E5. Saving Deposits/ Total Assets ◦ Purpose: To measure the percentage of total assets financed by savings deposits. ◦ Items Required: A – Total Saving Deposits; B – Total Assets. ◦ Formula : (A )/(B).

 E9. Net Institutional Capital */ Total Assets ◦ Purpose: To measure the real level of institutional capital, after adjusting the allowances for risk assets to meet the standards of P1&P2, and covering any other potential losses. ◦ Items Required: Items Required: A- Total Assets; B- Allowance for Risk Assets; C– Balance of Delinquent Loans >12 mnths; D- Balance of Delinquent Loans <12 mnths; E- Problem Assets (losses to liquidate); F – Total Assets; ◦ Formula : [(A+B ) – (C (D) +E)]/(F). * Institutional Capital comprise all legal and non-distributable reserves, non- withdrawable members’ share capital; capital donations and non-distributable reserves (from surplus).

A - Asset Quality Goals (Excellence) A1. Total Loan Delinquency / Gross Loan Portfolio≤ 5% A2. Non-earning Assets / Total Assets≤ 5% A3. Net Zero Cost Funds / Non-earning Assets≥ 200%

 A1. Total Loan Delinquency / Gross Loan Portfolio ◦ Purpose: To measure the total percentage of delinquency in the loan portfolio, using the criterion of outstanding delinquent loan balances instead of accumulated delinquent loan payments. ◦ Items Required: Items Required: A- Total Loan Delinquent Balances; B – Total Gross Loan Portfolio; ◦ Formula : (A)/(B).

 A2. Non-Earning Assets* / Total Assets ◦ Purpose: To measure the percentage of the total assets that are not producing income. ◦ Items Required: Items Required: A- Total Non-Earning Assets; B – Total Assets; ◦ Formula : (A)/(B). * Examples of Non-Earning assets include Cash on hand and floats, non - interest bearing current accounts, accounts receivable, fixed assets and prepaid expenses, assets in liquidation.

R - Rates of Return and Costs Goals (Excellence) R1. Net Loan Income / Average Net Loan Portfolio Entrepreneurial Rate R2. Liquid Inv. Income / Avg. Liquid InvestmentsMarket Rates R3. Fin. Investment Income / Avg. Fin. InvestmentsMarket Rates R4. Non-fin. Inv. Income / Avg. Non-fin. Investments≥ R1 R5. Fin. Costs: Savings Deposits / Avg. Savings Deposits Market Rates > Inflation R6. Fin. Costs: External Credit / Avg. External CreditMarket Rates

R - Rates of Return and Costs Goals (Excellence) R7. Fin. Costs: Member Shares / Avg. Member SharesMarket Rates, > R5 R8. Gross Margin / Average AssetsˆE9=10% R9. Operating Expenses / Average Assets≤ 5% R10. Provisions for Risk Assets / Average Assets ˆP1=100%, ˆP2=35% R11. Other Income or Expense / Average AssetsMinimized R12. Net Income / Average Assets (ROA) ˆE9=10%

 R9. Operating Expenses / Average Assets ◦ Purpose: To measure the cost associated with the management of all the Credit Union assets. This metric is an indicator of the degree of operational efficiency or inefficiency. ◦ Items Required: A- Total Operating Expenses (exclusive of Provisions for loan losses); B- Total Assets of Current year-end; C-Total Assets as of Last year-end. ◦ Formula : (A)/[(B+C)/2].

 R12. Net Income / Average Assets (ROA) ◦ Purpose: To measure the adequacy of earnings and also, the capacity to build Institutional Capital. ◦ Items Required: A- Net Income (After dividends); B- Total Assets of current year-end; C-Total Assets as of last year-end. ◦ Formula : (A)/[(B+C)/2].

Liquidity Goals (Excellence) 1. Liquid Assets - ST Payables / Total Deposits15-20% 2. Liquidity Reserves / Total Savings Deposits10% 3. Non-Earning Liquid Assets / Total Assets< 1%

 L1. [Liquid Assets – Short-term Payables ]/ Total Deposits ◦ Purpose: To measure the adequacy of the liquid cash reserves to satisfy deposit withdrawal requests, after paying all immediate obligations <30 days. ◦ Items Required: A- Total Earning Liquid Investments; B-Total Non-Earning Liquid Assets; C-Total Short-term Payables <30 days; D- Total Savings Deposits; ◦ Formula : (A + B -C)/(D).

Signs of Growth (Annualized Rates)Goals (Excellence) 1. Net LoansˆE1=70-80% 2. Liquid InvestmentsˆE2 ≤ 16% 3. Financial InvestmentsˆE3 ≤ 2% 4. Non-financial InvestmentsˆE4=0% 5. Savings DepositsˆE5=70-80% 6. External CreditˆE6=0-5% 7. Member Shares ˆE7 ≤ 20% 8. Institutional Capital ˆE8 ≥ 10% 9. Net Institutional Capital ˆE9 ≥ 10% 10. Membership≥ 15% 11. Total Assets> Inflation + 10%

 S11. Growth in Total Assets ◦ Purpose: To measure the year-to-date growth of Total Assets. ◦ Items Required: A- Total Current Assets; B-Total Assets as of the Last year-end; ◦ ◦ Formula : [(A/B)-1]*100.

PEARLS RATIOACRO NYM COMMON GROUND ACRO NYM CAMELS RATIOS P1. Loan loss allowances/ Delinq Loans> 12. P6. Net Val. Assts/Total Shares & Deposits (Solvency) Capital/Risk-Weighted Assets E1. Net Loans / Total Assets. E.9. Net Institutional Capital / Total Assets Non-Perf. Loans/Total Gross Loans A1. Total Loan Delinquency / Gross Loan Portfolio. A2. Non-Earning Assets/Total Assets. Return on Assets. Return on Equity. Operating Expenses/Total Assets Net Income/ Average Total Assets (ROA) Rating (1 -5) Liquid Assets – Short- term Payables/Total Deposits Liquid assets to total assets Growth in Total Assets ?? Net open position in foreign exchange to capital E P A R L S C A M E L S

PEARLS

 CARTAC has developed a useful reporting regime that can help Credit Unions Regulators collect information from the sector.  The reporting forms have been deployed and adapted in various CARTAC member States, including OECS, Jamaica and Suriname.

Form NumberMain Contents CU1Assets and Liabilities CU1 – Supp A CU1 – Supp B CU1 – Supp C CU1 – Supp D CU1 – Supp E CU1 – Supp F CU1 – Supp G Deposits Borrowing Loans Investments Receivables and Payables Interest Rates Deposit &Loans by Interest Rate &Size. CU2Economic Activity CU3Income Statement CU 4Credit Quality CU 5AGeneral and Specific Reserves CU 5BReconciliation of Allowance for Loan Losses and Change in Equity CU SUMMARYKEY PEARLS RATIO

 SWITCH TO PROVIDE A VIEW OF THE REPORTING FORMS IN EXCEL (OECS EXAMPLE)

COK SODALITY CO-OPERATIVE CREDIT UNION LIMITED

COK Credit Union ASSETS (J$’000s) EARNING ASSETS 6,369, ,327,710.0 Loans to Members 4,600, ,125,625.0 Credit Card Advances 25, ,775.0 Loan Loss Allowance (-) 110, ,114.0 Liquid Assets 876, ,081,200.0 Financial Investments 976, ,208,224.0 NON-EARNING ASSETS 748, ,989.0 Liquid Assets 112, ,744.0 Property Plant and Equipment 231, ,272.0 Other Non-Earning Assets 404, ,973.0 TOTAL ASSETS

COK Credit Union LIABILITIES (J$’000s) Interest-Bearing Liabilities 6,594, ,556,733.0 Savings Deposits 4,062, ,045,737.0 Voluntary Shares 2,185, ,167,227.0 Deferred Shares 300,000.0 External Credits 47, ,769.0 Non-Interest Bearing Liabilities 185, ,065.0 Payables and Accruals 177, ,895.0 Other Non-interest Liabilities 8, ,170.0 Total Liabilities 6,779, ,772,798.0

COK Credit Union TOTAL LIABILITIES & EQUITY (J$’000s) TOTAL EQUITY 337, ,901.0 Permanent Shares 380, ,865.0 Non-Institutional Capital (609,086.0) (610,981.0) Institutional Capital 462,466.0 Investment Revaluation Reserve 5, ,877.0 Loan Loss Reserve - - Pension Reserve 97, ,674.0 TOTAL LIABILITIES AND EQUITY 7,117, ,101,699.0

COK Credit Union NET INTEREST INCOME (J$’000s) INTEREST INCOME794,507761,084 Loans to Members648, Investments and Deposits INTEREST EXPENSE-210, ,500 Members' Deposits (160,211.0) (196,241.0) External Credits (50,679.0) (14,259.0) NET INTEREST INCOME583,617550,584 Provisions for Loan Losses (51,363.0) (101,212.0) Loans to Members (40,667.0) (91,324.0) Interest Receivable 1, ,875.0 Other Assets (11,761.0) (19,763.0)

COK Credit Union Profit/Loss (J$’000s) NET INTEREST INCOME (write- offs and Loan Loss Provisions) 532, ,372.0 NON-INTEREST INCOME/(EXPENSES) 266, ,916.0 GROSS MARGIN 799, ,288.0 Operating Expenses 793, ,325.0 Surplus/Deficit 5,191.0 (126,037.0) Other Comprehensive Income/Loss (16,323.0) 7,509.0 Total Comprehensive Loss (11,132.0) (118,528.0)

DELINQUENT LOANS2013 (J$’000s) Period Overdue Num in Arrears Loans in Arrears Provision (ratio)Loan Loss Provision 1-2 Months 3, , Months , , Months , , Months , ,345 Between 1-12 Months 5, ,260 54,828 Over 12 Months , ,661 Total 6, , ,489

DELINQUENT LOANS2012 (J$’000s) Period Overdue Num in Arrears Loans in Arrears Provision (ratio)Loan Loss Provision 1-2 Months 2, , Months , , Months , , Months , ,335 Between 1-12 Months 4, ,893 60,161 Over 12 Months , ,174 Total 5, , ,335

COK Credit Union Benchmark PEARLS RATIO PROTECTION Provision for Loans Delinquent >12 months 100% % Provision for Loans Delinquent < 12 months 35%12.60%15.35% EFFECTIVE FINANCIAL STRUCTURE Net Loans/Average Total Assets 80% 63.08%56.40% Savings Deposits/Total Assets 80% 57.07%56.97%

COK Credit Union Benchmark ASSET QUALITY Total Delinquency/Gross Loan Portfolio Max 5% 10.63%10.84% Non-Earning Assets/Total AssetsMax 5%10.51%10.90% RATES OF RETURN Operating Expenses/Average Assets 5% 11.89%12.74% Net Income/Average Total Assets2%7.49%6.32% LIQUIDITY Liquid Assets – ST Payables/ DepositsMin 15%20.01%23.78% SIGNS OF GROWTH Growth in Total AssetsMin 10%

 SWITCH TO PROVIDE A VIEW OF THE COK FINANCIALS IN EXCEL (IF TIME PERMITS).

 What Conclusions would you draw about COK given the PEARLS Ratios?  Discussion?

 Building an Effective Database for Credit Union Requires: ◦ Setting up a functional reporting regime. ◦ Mapping and Developing Workflows necessary to support information gathering, analysis and dissemination. ◦ Choosing an effective, affordable, flexible and scalable database system. Good Examples include:  Sungard’s FAME/MARKET MAP (Data Warehouse)  map/analytic-platform  Vizor (Newly available system specifically for financial sector regulators).   (DEMO OF VIZOR)

 SWITCH TO PROVIDE A VIEW FAME and VIZOR (IF TIME PERMITS).

 Building an Effective Database for Credit Union Requires: ◦ Building a reliable IT Platform. ◦ Keeping current with IT innovations and database enhancements and that can impact the sector positively.

 Organize Reporting Regime & Database System;  Invest in and Upgrade IT Resources;  Push for Infusion of Expertise in Finance, Accounting, Economics, Law and IT in Credit Union Regulatory Bodies;  Intensify Regional and International Collaboration on Credit Union Regulatory Matters;

 Pay Attention to Financial Stability Developments Globally.  Leverage assistance, where necessary and appropriate from CARTAC and other bodies.

END OF PRESENTATION