Proposed amendments to the Credit Unions Act 1979

A Consultation Document by H M Treasury November 1998

Deregulation and Contracting Out Act 1994 Proposed Amendments to the Credit Unions Act 1979 Regulatory reform

Foreword by Patricia Hewitt MP

Introduction

Costs to credit unions

Proposed Amendments to the 1979 Act

Annex 1. Deregulation Proposals and Orders - Parliamentary consideration

Annex 2. Proposals for the Regulation of Credit Unions by the Financial Services Authority

Foreword by Patricia Hewitt MP, Economic Secretary to the Treasury

Credit unions are often the unsung heroes of the mutual sector. The Social Exclusion Unit Report on the most disadvantaged areas published in September highlighted the problem of financial exclusion. For too many people financial services means cheque-cashing shops, and loan sharks. We have one of the most competitive and sophisticated financial services sectors in the world - but some people are still missing out. Without fanfare, credit unions have been doing invaluable work encouraging people to save money by providing savings facilities, low cost credit, and financial education to the less well off, giving them the chance to build up a good credit record. There can be no doubt that credit unions are vital in poorer communities but, at the same time, can be a competitive provider of basic services for the better off.

That is why the Government supports fully their ethos of self help and thrift and is determined to encourage the sector. A Credit Union Taskforce, under the Chairmanship of Fred Goodwin, is looking at ways banks and building societies can help credit unions expand their business and so assist more people on low incomes who have difficulty gaining access to financial services. But more can be done.

In some other countries, notably Australia, the United States and Ireland, credit unions reach millions of people and there has been modest but encouraging growth in the number of credit unions in recent years here. I want to see that growth continue, and have been considering how that can be achieved whilst maintaining credit unions' focus on the financially excluded.

This document contains some proposals suggested by the sector to remove some of the legislative constraints, and asks for views on how the movement should be regulated in the future. There are important questions to be answered about the future development of the sector. On regulation, the Government will be looking to the Financial Services Authority to come forward with a fee structure that meets credit unions' needs.

The credit union sector is a diverse one, so I hope that as many credit unions as possible - large and small, community, associational and employee based - will respond so that we can take account of their very different perspectives and needs before reaching final decisions.

PATRICIA HEWITT MP

1. Introduction

1. Credit unions are mutual savings and loan organisations, registered and regulated by the Registry of Friendly Societies under the Industrial and Provident Societies Acts 1965 to 1968 and the Credit Unions Act 1979. Members save by subscribing for non-transferable shares deposited with the credit union. Members may take out loans, at a maximum rate of interest of 1% per month and, for the majority, up to 5,000 in excess of their shareholding.

2. The objects of credit unions, as defined by the 1979 Act, are:

the promotion of thrift among the members by the accumulation of savings;
the creation of sources of credit for the benefit of the members at a fair and reasonable rate of interest;
the use and control of the members' savings for their mutual benefit; and
the training and education of the members in the wise use of money and in the management of their financial affairs.

3. The main benefits to members are that they can save and take out loans at reasonable rates of interest.

4. Membership is restricted to those who meet the qualification ("the common bond"), for a particular credit union. The common bond may be one of four main types: residence in a locality; being a member of, or association with, an organisation; working for a common employer or in a locality; and following a particular occupation. Most credit unions are largely run by unpaid volunteers, they provide basic savings and loan service to low income groups, who may well have no dealings with the commercial banking sector.

5. Each share in a credit union is fixed by statute at Â£1.00. The maximum saving permitted is Â£5,000 or 1Â½% of the total shareholding of a credit union, whichever is the greater. A credit union may accept deposits only as subscription for its shares. It may pay a dividend on shares, not exceeding 8%, after all expenses and taxes have been accounted for. The normal range of dividend payments is between 3 and 5%.

6. In most credit unions loans may be made to members up to a maximum of Â£5,000 in excess of their share capital. So a member with the maximum of Â£5,000 shares may borrow up to Â£10,000. But, under a Deregulation Order passed in 1996, the Registrar may permit a credit union to grant individual loans up to a maximum of 1Â½ of its aggregate shareholdings with some constraints to limit its exposure to large loans if it has adequate management and systems. Loans are repayable over two years if unsecured, and over five if secured. Most loans are under Â£1000. Interest charged on loans may not exceed 1% per month on the reducing balance (12.68% APR maximum). Credit unions may borrow short term from other credit unions and from authorised banks, and may hold their surplus on deposit subject to restrictions (broadly they are restricted to current and deposit accounts and banks).

7. There are over 600 registered credit unions, with new registrations averaging around 50 a year. Total assets now exceed Â£100 million and are growing at about Â£20 million a year. Loans amounted to Â£92 million in 1996. Membership is around 200,000 concentrated in the North of England and Scotland, although there is increasing growth in the South and West of England, and in Wales.

8. The Government supports fully the credit unions' ethos of self help and wishes to encourage the movement's growth, and so strengthen its capacity to provide financial services to the poor. The proposals in this consultation document, taking into account representations listed below, are designed to further that aim.

9. The proposals have taken into account suggestions by the credit union movement in "Common ground: National goals for improving the laws governing credit unions" issued on 15 December 1997 in a joint submission by the Association of British Credit Unions Limited (ABCUL), the Association of Independent Credit Unions (AICU), the National Association of Credit Union Workers (NACUW), the National Federation of Credit Unions Limited (NFCU) and the Scottish League of Credit Unions (SLCU).

10. This document seeks views on proposed amendments to the Credit Unions Act 1979 ("the 1979 Act") through an Order made under section 1 of the Deregulation and Contracting Out Act 1994 ("the 1994 Act") and an Order made under section 11 of the 1979 Act.

11. The two Orders are subject to different procedures. The Section 11 Order is made by the Chief Registrar with the consent of the Treasury and is subject to negative resolution. There is a special Parliamentary procedure for the Deregulation Order, which is set out in more detail in Annex 1. The intention is for both Orders to be made, and to come into force, together - hence this simultaneous consultation.

12. Responses to this consultation document may be disclosed, unless the information relates to a particular person or business. You should identify any such information and tell us whether the person involved consents to it being made public in an anonymous form.

13. In a separate consultation (set out in Annex 2) views are sought on the integration of credit unions within the authorisation and supervisory framework to be operated by the Financial Services Authority ("the FSA"). The duties and powers of the FSA will be set out in the Financial Services and Markets Bill, on which there is separate consultation.

14. Comments should be sent by 12 February 1999 at the latest to:

Jeremy Jones

Room 37/G

Â H M Treasury Parliament Street

LONDON

SW1P 3AG

2. Costs to credit unions

15. The possible costs applicable to credit unions wishing to make use of the proposed changes are set out at the end of each proposed amendment to the 1979 Act. The current (1998) fees are cited as a reference. Where the adoption of an additional power requires a certificate under section 11C of the 1979 Act, it will be necessary to make only a single application to cover all adopted powers listed. Where a credit union already has a certificate issued under section 11C, it will not be required to apply for a new one, but must inform the Registry that it proposes to adopt further powers.

16. The proposed amendments are intended to relieve credit unions from administrative burdens and it would help if respondents could indicate the cost savings that might arise in each case. Equally, if respondents do not think there will be savings they should explain why. If any additional cost burdens are envisaged, an estimate should be given.

3. Proposed amendments to the 1979 Act

A: To allow credit unions to borrow money from external sources, other than authorised banks and other credit unions

Current Position: Under section 8 of the Credit Unions Act 1979, credit unions can accept deposits only in the form of share accounts. They may borrow only from an authorised bank or, temporarily, from another credit union under section 10 of the Act.

They also receive grants.

Burden: In their early years it can be difficult for credit unions to acquire enough funds to make loans. Apart from members' savings, they are largely reliant on grants, usually from local authorities. Community-based credit unions can admit to membership only individuals, not local groups or institutions. For example, a local church or mother-and-toddler group cannot deposit funds with a credit union. Views are sought on how such groups might be identified as bona fide lenders to credit unions. One possibility is that community groups that fall within the common bond criteria of a particular credit union may be permitted to lend to it.

Deregulation amendment: Amend section 10 to allow credit unions to borrow from authorised institutions (building societies, insurance companies, friendly societies), Local Authorities, and organisations that fall within the common bond, in addition to their existing powers to borrow from banks and other credit unions.

Safeguards: The existing safeguard - that credit unions' borrowings may not exceed 50% of total paid up share capital - will be maintained, to ensure that they are not over-committed to external sources of finance; and no one loan (other than from a bank, building society or other credit union) may exceed 10% of the credit union's share capital.

Costs: None.

B: To permit credit unions to offer interest bearing (share) accounts

Current position: Section 8(1) prohibits the acceptance of deposits other than by subscription for its shares. Section 14 details how a credit union may apply its surplus at year end, capping the payment of a dividend at 8%.

Burden: The current position restricts credit unions' ability to offer a predetermined return on members' savings, and thereby attract further funding.

Deregulation amendment: Amend section 8(1) to specify that shares may be held in either interest bearing or dividend accounts. Amend section 14 to permit the payment of interest, which may not exceed three-quarters of the current maximum rate set in section 14(4) - currently 8% - which applies to dividend share accounts.

Safeguards: Offering interest bearing accounts will be restricted to those credit unions with a certificate under section 11C, under which the registrar needs to be satisfied that there are appropriate policy manuals documenting the systems, and committees in place to manage the functions - in particular loans and internal audit/supervisory committees.

A credit union is currently limited to offering dividend accounts. This gives it the flexibility to raise or lower the dividend depending on the financial circumstances in any given year; ultimately, it need not provide a dividend at all. Offering interest bearing accounts would limit a credit union's ability to do this. But the rules governing shares set out in section 7 will apply, and a credit union must have reserves of 10% before it is permitted to operate such accounts. In order to limit the commitment of the credit union to make payments it cannot afford, in addition to the restriction on the interest rate, no individual member should be permitted to hold more than 50% of his or her savings in an interest bearing account.

Costs: A section 11C certificate (which generally requires a letter of comfort from an auditor) and associated rule change - Â£525.

C: Allow credit unions to provide additional basic services and charge fees (e.g. bill payments)

Current Position: Under section 1(2) a credit union must have only the objects set out in section 1(3), (described in paragraph 2 of the Introduction).

Burden: These constraints limit credit unions' ability to charge members for providing services other than loans, and hence the provision of such services. For example, although some credit unions pay bills on members' behalf by making out a cheque drawn on their accounts, others are deterred by not being able to pass on the costs. As a mutual, the cost effectively has to be shared by those members who do not take advantage of such services.

Deregulation amendment: Derogate from section 1(2)(a) to allow credit unions to add, as an object, the provision of chargeable ancillary services: money transmission, issuing and administering means of payment, and bill payments.

Safeguards: Only credit unions with a section 11C certificate would be able to do so, and only by changing their rules by means of a special resolution (subject to approval by the Registrar).

Costs: Â£525 for a section 11C certificate and rule change.

D: Abolish the limit on the maximum amount that can be held in youth accounts (currently Â£750) and lower the minimum age for joining a credit union, (without conferring voting rights).

Current Position: Section 9 restricts deposits by juveniles to Â£750. Under section 20 of the Industrial and Provident Societies 1965 (IPSA 65) they cannot be full members until they reach 18 or, if the credit union's rules provide, 16.

Burden: The current maximum of Â£750 - last updated in 1989 - is limiting. The provisions for membership are restrictive and are a disincentive to younger members.

Deregulation amendment: The limit on deposits can be abolished by a separate Order under section 9(4), bringing it into line with the adult limit of Â£5,000 in most cases. Removal of the age restriction on membership can be achieved by repealing section 20 IPSA 65 as it applies to credit unions and replacing it with a provision similar to paragraph 5(3) of Schedule 2 to the Building Societies Act 1986, which permits a minor, regardless of age, to be admitted as a member (providing the rules do not otherwise prohibit membership at that age), except that a member under 18 may not vote, hold office, or nominate anyone else to office. The new definition of membership for minors could be introduced as an amendment to section 9 CU Act 1979. Section 11(1) of the Act should be amended to permit loans to be made to members, without reference to age.

Safeguards: junior members will have the same safeguards as those applied to full members. Deposits taken from those too young to be full members (as defined in the credit union's rules) would continue to be protected by the provisions of section 9 CU Act 1979. Under this section these funds must be accounted for separately, and are held on trust for the depositor.

Costs: May involve a change to a credit union's rules at a cost of Â£225.

E: Make the common bond requirements more flexible.

Current Position: Section 1(2)(b) requires a credit union's membership to be "restricted to persons all of whom fulfil a specific qualification and is appropriate to a credit union ..... in consequence a common bond exists between the members...". Section 1(4) (a-e) lists qualifications deemed to be appropriate. The 1996 deregulation order added a further paragraph, (f), in which the qualification rests on a combination of criteria: a member may either reside, or work, in a particular locality.

Burden: As credit unions grow, they find that the common bond qualifications act as a restriction on who they can attract as members, particularly where workplace and community based ones wish to merge. The "living or working" common bond does not always address the problem. For example, a residential credit union may wish to join with one based on worship at a particular church in the area (this would be under an associational common bond - category (e)), whose congregants do not necessarily live in the common bond area). This applies to groups wanting to register as well as credit unions wishing to merge.

Deregulation amendment: To add to the list in Section 1(4) common bonds combining category (e) - the associational common bond - with the other four types: (a) following a particular occupation; (b) residing in a locality; (c) being employed in a particular locality; and (d) working for a particular employer.

Safeguards: The existing safeguard contained in section 1(5) would continue to operate, i.e. that "in ascertaining that a common bond exists . . . the appropriate registrar shall have regard to the nature of the qualification for admission to membership of the society". Experience in other countries (USA, Canada and the Irish Republic) does not suggest that widening the common bond weakens credit unions. The common bond is helpful in the early years; but as they grow, so the development of appropriate management and systems gains in importance.

Costs: For those wishing to adopt a new common bond a fee of Â£100 or Â£125 (depending on the procedure used).

F: Remove the current Â£5,000 maximum membership limit.

Current Position: Section 6(2) limits the number of members to Â£5,000. Under section 6(5) the registrar may grant an exemption, if it is in the public interest and does not jeopardise the common bond. Credit unions are usually granted an exemption if they can satisfy the registrar that they have the management and systems in place to cope with an increase in numbers, and that the common bond is not adversely affected. In practice the same standards are applied as for granting a certificate under section 11C.

Burden: Currently credit unions have to apply separately for a Section 11C certificate and exemption from the Â£5000 maximum limit.

Deregulation amendment: Repeal sub-sections (3), (4) and (6) of section 6, and amend subsection (5) so that obtaining a Section 11C certificate meets the requirement for exemption from the Â£5000 limit.

Safeguards: The requirement for approval under Section 11C effectively replicates the current position, and the Registry expects to satisfy itself during the normal course of supervision that there are adequate systems and controls in place. One constraint on the ultimate size of a credit union will be retained, as members must still meet the qualification set out in the common bond.

Costs: In practice, a credit union already has to meet the requirements of Section 11C before being granted an exemption from the Â£5000 maximum, and in almost all cases a credit union will have already obtained a Section 11C before applying for an exemption.

G: Allow credit unions more flexibility to dispose of re-possessed collateral.

Current Position: Section 12(4) requires a credit union to sell any interest in land that it acquires "...as soon as may be conveniently practicable". Failure to comply is a criminal offence under subsection (5).

Burden: The requirement could force a credit union to put property on the market at an inappropriate time, and to sell at a price detrimental to it and the defaulting member.

Deregulation amendment: Require credit unions to dispose of any land in which they acquire an interest within three months or in such other period as may be approved - for individual credit unions or case-by-case - by the registrar.

Safeguards: The position is clarified for credit unions, with some flexibility built in, but they are still prevented from being able to indulge in property speculation. This does not detract from section 12(1) by which a credit union may own land or property only for the sole use as its offices, except under subsection (3) where land is held as security for a loan.

Costs: None.

H: Extend repayment periods for loans.

Current Position: Credit unions with a Section 11C certificate may make unsecured loans for periods not exceeding four years; those without may make unsecured loans for two years. Secured lending may be made for periods of ten and five years respectively.

Burden: Many credit unions find there is insufficient flexibility in the present arrangements for members with debt problems to overcome their difficulties by making easier repayment arrangements. The current, mainly, short repayment periods may deter some borrowers altogether and may increase the risk that others fall into arrears in servicing their loans.

Proposal: To increase the re-payment period for:

secured lending to twelve years for credit unions holding Section 11C certificates, and seven years otherwise.
unsecured lending to five and three years respectively.

These changes can be made by an order under Section 11(7).

Costs: May require rule amendments costing between 200 and 450 depending on whether or not model rules are used.

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Annex 1

Deregulation Proposals and Orders - Parliamentary Consideration

This note is sent to you at the request of the Deregulation Committee of the House of Commons

Introduction

1. You are being consulted by the Government about a proposal which may lead to an order under the Deregulation and Contracting Out Act 1994. If it does, then, when the Government has completed its consultations, the Minister concerned may lay proposals before both Houses of Parliament, in the form of a draft of the order he or she proposes to make.

2. This note is to tell you about the Parliamentary stage of the process, and the opportunities available to you.

Deregulation Proposals

3. When the Minister lays proposals before Parliament, he or she must also lay a report setting out:

the burden proposed to be reduced;
whether there is "necessary protection" and how it is to be retained;
what cost savings are expected;
what other benefits there will be from the removal of the burden;
details of the consultation process;
any representations received as a result of that consultation; and
the changes made as a result.

4. On the day the Minister lays the proposals and report, the period for Parliamentary consideration begins. It lasts for 60 days, excluding Parliamentary recesses. If you want a copy of the proposals and the Minister's report, you should contact the Government Department concerned.

The Deregulation Committee

5. Both Houses of Parliament have made special arrangements to scrutinise deregulation proposals and orders. In the House of Commons, an all-party Select committee of 18 members has been set up.

6. The Committee must consider in each case whether proposals:

a. appear to make an inappropriate use of delegated legislation;
b. remove or reduce a burden or the authorisation or requirement of a burden;
c. continue any necessary protection;
d. have been the subject of, and take appropriate account of, adequate consultation;
e. impose a charge on the public revenues or contain provisions requirements to be made to the Exchequer or any government department or to any local or public authority in consideration of any licence or consent or of any services to be rendered, or prescribe the amount of any such charge or payment;
f. purport to have retrospective effect;
g. give rise to doubts whether they are intra vires;
h. require elucidation or appear to be defectively drafted;
i. appear to be incompatible with any obligations resulting from membership of the European Union
j. and it may take oral or written evidence to help it decide these matters.

7. It must then report:

whether the Minister should proceed to lay a draft order in the same terms as the proposal, or
whether amendment is necessary, or
whether the order-making power should not be used (for example, because of the significance or sensitivity of the proposal).

8. If you want a copy of the Committee's Report, you may obtain it through HMSO. If you have difficulty doing so, contact the Committee staff.

9. After 60 days for Parliamentary consideration, the Minister may lay a draft order before both Houses, this time for the approval of Parliament.

10. In the House of Commons, the Deregulation Committee will examine the draft order to see how far its views have been taken into account. It must then report, within 15 sitting days, whether the draft order should be approved or not, and it is then for the House of Commons itself to take a final decision. Approval by the House of Lords is also required.

How to make your views known

11. Your first and main opportunity is in the Government's consultation process. If, when the Minister lays proposals before Parliament, you feel that your concerns have not been adequately reflected, you are welcome to put your views before the Deregulation Committee.

12. In the first instance, this should be in writing. The Committee will normally decide on the basis of written submissions whether to take oral evidence.

13. Your submission should be as concise as possible, and should focus on one or more of the criteria listed in paragraph 6 above.

14. Because of the time limit, your submission should reach the Committee staff as soon as possible. It helps if you let them know in advance that you intend to make a submission.

15. Your submission may be sent by post or delivered by hand to:

The Clerk of the Deregulation Committee House of Commons 7 Millbank London SW1P 3JA

It may also be faxed to 0171 219 2509; if you are faxing, please send a hard copy as well. Alternatively, you may send your submission on disc (Wordperfect 5.1).

If you need further information or guidance, write to the Clerk of the Committee at the address or fax number above, or telephone the Committee staff on 0171 219 2837 or 2833.

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Annex 2

CONSULTATION PAPER ON PROPOSALS FOR THE REGULATION OF CREDIT UNIONS BY THE FINANCIAL SERVICES AUTHORITY

1. Introduction

1. This paper seeks the views of consultees on the regulatory framework that should apply to credit unions, when responsibility for their registration and supervision is transferred from the Registry of Friendly Societies to the Financial Services Authority (FSA). The FSA will generally derive its regulatory powers from the Financial Services and Markets Bill, on which there is separate consultation (copies can be obtained by phoning 0191 215 0110.

2. The Regulatory Framework of the Credit Unions Act 1979

(a) The Role of the Chief Registrar of Friendly Societies

2. Under the Credit Unions Act 1979 the Chief Registrar is responsible for:

deciding whether to register a new credit union;
requiring each credit union to produce an annual return including its accounts, which is placed on the public register;
requiring each credit union to satisfy the Registry that it has in place a valid insurance policy covering its members against the loss of their savings through fraud by their officers or employees;
issuing a certificate (under section 11C of the Act) to any credit union which wishes to offer the increased loans generally up to a maximum of 1 1/2% of total shareholdings permitted under the 1996 Deregulation Order, provided they can demonstrate that they have adequate management and systems in place.

3. Apart from the Registrar having to be satisfied of the existence of a common bond, that the rules conform to the Act, the registered office is in Great Britain and it has the required fidelity insurance, there are no other statutory criteria that a credit union has to satisfy before it is registered to do business.

4. The Registrar has limited statutory powers to intervene in the affairs of a credit union after its registration. Under sections 17 and 18 of the Act he has the power to require financial or other information and may appoint an inspector to investigate credit unions' affairs. If a credit union gets into financial difficulties or no longer meets the conditions for registration, the Registrar under Sections 19 and 20 of the Act ultimately has the power to:

suspend its operations;
suspend or cancel its registration;
petition for its winding up.

5. But the Registrar has no statutory powers of the kind available to other financial regulators to intervene in the affairs of a credit union (for example, to require it to remedy defects in its management of the business), or to discipline its officers or employees, where things have gone wrong.

6. Despite the absence of statutory powers, the Registrar has over recent years developed an informal system of supervision and guidance to credit unions. For example, before any credit union is registered, Registry officials have thorough discussions with the organisers of the project and the prospective "Committee of Management" (culminating in a pre-registration visit) to satisfy themselves that those involved have undertaken appropriate training and understand the responsibilities of managing a credit union. The Registrar has issued guidance to the sector both on the registration requirements and on management and systems issues. In 1996 the Registrar introduced a voluntary system of quarterly returns as a basis for monitoring the financial health of credit unions.

(b) Financial Resources

7. Under Section 14 of the Act, credit unions are required to transfer not less than 20% of their annual surplus to a general reserve until it reaches at least 10% of assets. The sector average currently stands at 8% of assets.

(c) Share Protection

Section 16 of the Act allows credit unions to set up a share protection scheme, subject to approval from a registrar, or make appropriate insurance arrangements. But no scheme is in existence.

3. The Financial Services Authority

(a) Objectives, functions and powers

9. The Financial Services and Markets Bill, published for consultation on 30 July, sets out the FSA's proposed objectives, functions and powers. Its proposed regulatory objectives are market confidence, public awareness, the protection of consumers and the reduction of financial crime. In achieving those objectives it will be required to exercise its powers in a way that is proportionate between the burden that is placed on the regulated and the benefit that is sought to achieve. Thus, although the same regulatory powers will be available in relation to all types of deposit takers, they will be applied in a way that is appropriate to particular institutions. The FSA will also be required to carry out and publish cost-benefit assessments of its regulatory proposals and, in discharging its general functions, to have regard to the desirability of facilitating innovation in connection with regulated activities.

10. The FSA will authorise financial institutions to carry on their business in accordance with statutory "fit and proper" criteria. It will have broad rule-making powers to establish regulatory standards for the authorised persons and individuals it will supervise. These powers are described in the consultative document and notes mentioned in paragraph 1.

(b) Authorisation

11. The FSA may authorise an individual or other body to carry out regulated activities. It will have powers to make rules setting conditions or standards that must be met for authorisation, which may be refused or withdrawn if standards are not met or maintained. Authorisation will be a pre-requisite to carrying on any regulated activity, subject to any appropriate transitional arrangements.

(c) Supervision

12. The FSA will have a wide range of powers to require information, and impose conditions on, and intervene in, the activities of regulated bodies and persons - for example when an organisation has failed to comply with FSA rules or other requirements or when remedial action is needed to protect the interests of its customers.

(d) Enforcement

13. Where a regulated body or person has failed to comply with a requirement, the FSA will be able to impose a fine as a disciplinary measure or use its powers of intervention to enforce compliance. This will provide the means to take appropriate and flexible action that focuses on a specific failing minimising the possibility of the enforcement action outweighing the effects of the wrongdoing.

(e) Fee-raising powers

14. The FSA will have the power to charge fees to recover the costs of carrying out its duties, and regulated bodies will be required to meet the full costs associated with their regulation. The effect of this is that the FSA will be able to carry out only the statutory functions for which it can recover the full cost through its fees. Associated with supervision by the FSA will be a requirement to join an appropriate compensation scheme. There will also be a single Ombudsman scheme for all regulated bodies.

4. Issues for Discussion

(a) Future regime for regulation and supervision of credit unions by the FSA

15. There are two options for consideration:

transfer to the FSA the existing functions of the Chief Registrar (described in paragraphs 2-4); or
bring credit unions within the scope of the FSA's full regulatory and supervisory powers (described in paragraphs 9-14). This would involve repealing some of the provisions of the 1979 Act, leaving the FSA free to lay down new, or amended, requirements under its rule-making powers.

16. Under (i), the FSA's role would, in practice, have to be less than the current Registry one, as they would be able to carry out only the limited statutory functions and transactions prescribed in the 1979 Act: registration; collecting, scrutinising and publishing annual returns; checking insurance against fraud; suspension of business and, ultimately, closure. Some of the informal supervision (described in paragraph 6) would lapse, because the FSA would have no power to raise fees to cover it. And, unlike option (ii), credit unions would not come under a statutory compensation or ombudsman scheme.

17. This would mean a reduced compliance burden on people setting up and then running a credit union compared to option (ii). In particular, the process of registration would be quicker and simpler. The only requirement would be to demonstrate a valid common bond and the existence of a valid fidelity insurance policy.

18. On the other hand, the absence of pre-registration checks and subsequent supervisory visits would increase the risk of closures and the possibility of losses from members' funds. The removal of the Registry's informal preregistration checks and subsequent supervisory visits carries the risk that new credit unions would be registered in significant numbers without any independent enquiry being made as to whether the prospective management were suitable. If things subsequently went wrong and members' funds were put at risk, the only powers available to the FSA would be to use Sections 19 and 20 of the Act to stop a credit union doing business or alternatively to close it down. There is thus a risk that these powers would be used more frequently than their current average of 3 or 4 a year. As now, there would be no formal compensation arrangements available (unless the movement establishes its own). In the past, losses have been relatively low - the biggest was about Â£7,000, amounting to 20% of members' savings. Most losses have been covered by a combination of the credit union sector, credit union development agencies, and local authorities.

19.Option (ii) would:

put the authorisation, regulation and supervision of credit unions on a clear and legally secure footing;
allow the regulatory regime to be adapted - through changes to the FSA's rule books - if this becomes necessary as credit unions develop;
allow the FSA to intervene, if a credit union got into difficulties, eg by imposing conditions on its authorisation - rather than having to chose between closing it down or doing nothing; and
credit unions would come under the statutory compensation and ombudsman schemes (explained in sections (c) and (d) below).

20. This would provide members with broadly the same kind of protection enjoyed by depositors in banks and members of building societies. This should mean that fewer credit unions get into financial difficulties and so strengthen the confidence of members and the general public. If this option is chosen, the Government would also be willing to consider allowing credit unions to offer their share accounts as cash-ISA deposits.

21. Although it would be for the FSA to set the rules, it is not expected that the intensity of, and approach to, supervision would - at least initially - differ greatly from the Registry's current practice.

(b) Costs and fees

At the moment, we cannot be certain about what the eventual cost of regulating credit unions will be, nor how much more expensive (ii) will be than (i). The present Registry regime costs Â£560,000 a year to operate, of which only Â£45,000 is recovered through charges. In very broad terms, (ii) ought to start out at around Â£560,000, though it is likely to be somewhat higher because of the more expensive premises and staffing costs of the FSA (which would also apply under (i)). The additional powers of intervention (which the Registry does not now possess) would also need to be managed.

23. (i) would clearly require fewer resources than now for registering new credit unions, as the FSA would not provide the Registry's pre-regulation vetting and advice. Nor would it have the option of graduated intervention when credit unions get into difficulties, so would not have the costs of operating it. But the actual amount would depend on how, precisely, the FSA decided to operate the regime. The current best estimate is that (i) would probably cost around Â£350,000 to Â£450,000 a year.

24. The FSA will be required by law to recover all its costs from the financial institutions it regulates, but to regulate in ways which make the restrictions on authorised bodies proportionate to the benefits. It has assured the Government that it would seek to supervise credit unions in a way which took account of the needs of small voluntary organisations.

25. The eventual cost to credit unions (whether based on (i) or (ii)) will depend on the structure of the FSA's fees and charges - which will be the subject of consultation later this year. In structuring their fees, the FSA will take account both of the capacity of small voluntary institutions to pay; and the fact that the relative intensity of supervision - under either option - will be less than that applied to banks and building societies. The FSA intend to hold discussions with other regulated financial institutions with a view to finding an acceptable solution to the problems credit unions will face over the cost of FSA supervision. Separately, and more widely, the credit unions taskforce, headed by Fred Goodwin, is looking at ways in which banks and building societies can help credit union development.

26. One other difference between the two options will be the reserve requirements. Under the 1979 Act credit unions must set aside 20% of profits per year (though those wishing to take advantage of the greater freedoms available from a Section 11C certificate need to achieve reserves of more than 10% of assets). If the FSA is given order making powers over credit unions, it would have the flexibility to set rules and reserve requirements for each one individually. It is difficult to say what the implications for the sector as a whole, or individual credit unions, would be - as this would be a matter for the FSA's supervisory judgement (subject to the need to regulate in a way proportionate to the benefits).

27. The choice is between a light regime, with low costs and few barriers to entry, with no statutory compensation or ombudsman schemes, and with the current restrictions on powers (subject to any changes made by the proposed deregulation order); and a somewhat more expensive regime but offering members better levels of protection, tailored to the needs of credit unions and removing the statutory restriction on their ability to offer cash ISAs.

Consultees are asked to comment on whether:

credit unions should enjoy a more rudimentary regime; or
be brought fully within the scope of the FSA's supervisory powers.

(c) Share Protection Scheme

29. If credit unions are brought within the FSA system of regulation (option (ii)), then this will also bring them within the FSA's statutory compensation scheme, which would provide members with the same kind of protection for their savings (if their credit union becomes insolvent) as bank depositors and building society members. But, as with the choice that has to be made about the appropriate level of supervision, contributions to a protection scheme would impose further additional costs on the sector.

30. The FSA have already published a consultation document (Consultation Paper No 5: Consumer Compensation) explaining how the single compensation scheme might be structured and financed. In brief, it is envisaged that there would be three sub-schemes covering deposit takers, investment business and insurance. If credit unions were included, they would be covered by the sub-scheme for deposit takers, along with banks and building societies.

31. There would then be some second order issues:

whether the compensation arrangements - and their funding - for credit unions, banks and building societies, should be kept separate, or whether there should be an element of integration for all three; and whether credit unions would have to contribute to an initial pool of funds, or whether they would have to pay only if insolvency occurred.

32. If it were decided to bring credit unions fully within the FSA system of regulation, the Authority would consult again about the terms under which they should be brought within the single scheme.

33. Bank depositors and building society members are currently protected at a rate of 90% up to a maximum of Â£20,000 - so the most one individual can receive is Â£18,000. But it would be possible to set different limits for credit unions given the lower average balances in the sector, and the maximum shareholding for many credit unions of Â£5,000.

34. If a statutory protection scheme is set up for credit unions, this would require periodic contributions from the sector to compensate members who lose savings if their credit unions fails. As stated above, in the past these costs have been relatively small, though if a large credit union were to fail, the costs could be higher.

35. The Government would like to have the views of consultees on:

If option (ii) is chosen, what level of protection should be provided?

(d) Complaints: The Single Ombudsman Scheme

36. Option (ii) would also bring credit unions within the FSA's Single Ombudsman Scheme for customers' complaints. Until now, credit unions have not belonged to an Ombudsman Scheme. So - as with supervision and with compensation schemes - there would be a cost to credit unions being required to have the same standards as other deposit takers. But there is no reason in principle why the FSA and the scheme could not devise its fee structure so that credit unions' contributions could be based on the number of complaints generated.

5. Summary

37. So the choice in all three areas - supervision, compensation and complaints - is the same. Should members of credit unions enjoy broadly similar standards of regulation and protection that currently apply to bank depositors and building society members; or should credit unions remain subject to a lesser degree of statutory supervision and protection, with no compulsory compensation or complaints arrangements?

38. The following summarises the questions set out in this paper.

should credit unions enjoy a more rudimentary regime; or
should they be brought fully within the scope of the FSA's supervisory powers?
if the latter, what level of compensation should be provided?

39. The address for replies is set out in the Introductory section to this document.