## 1polea2019007 - EXECUTIVE SUMMARY

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### EXECUTIVE SUMMARY: key findings
- The note reviews the cooperative bank and credit union sectors, focusing on: (i) the situation of the two sectors that are both in states of transition; (ii) the regulatory and supervisory arrangements; and (iii) the safety net and resolution regime within the context of the crisis management framework.
- The analysis is based on information received in the first semester of 2018 at the time of the visit of the authors; some subsequent improvements were noted but did not substantially modify the main conclusions and recommendations.
- Combined, cooperative banks and credit unions represent less than 8 percent of deposit takers and serve about 18 percent of the population.
- The FSAP is broadly supportive of the policy direction for cooperatives, while it questions whether the credit union sector should remain standalone.

### Cooperative banks: sector structure and transition risks
- Supervisory arrangement:
  - Evolving to a “supplementary” supervision model under EU legislation (Article 113 (7) Capital Requirement Regulation (CRR)).
  - Since 2015 authorities promoted that cooperative banks be part of an Institutional Protection Scheme (IPS) that includes an affiliating commercial bank.
  - Currently, there are two IPS networks; a proposal for a third network using “Integrated Affiliation” appears unlikely as the PFSA decided not to license the affiliating bank.
  - Two cooperative banks have independent status in line with Article 1 of the CRR (e.g., capital over EUR 5 million, other prudential requirements).
  - IPSs perform internal control functions that complement supervision by the Polish Financial Supervision Authority (PFSA) (see Art 22i of the Act on the Functioning of Cooperative Banks, their Association and Associating Banks from year 2000), but are in transition and reliance on the PFSA remains necessary.
  - IPSs can direct liquidity or solvency support to cooperative banks before resorting to official institutions; PFSA informally cooperates with IPSs to avoid turmoil.
  - Each of the two IPSs has been successfully tested in the assisted merger of a troubled cooperative bank with a strong one.

- Elevated risks for the cooperative bank sector:
  - (i) about 40–45 cooperative banks that were seeking to establish their own affiliating bank and network will now need to affiliate back within an existing network; note: this number had decreased to 42 entities by August 2018, and more than 30 cooperative banks had applied to be accepted into an existing IPS.
  - (ii) approximately 12 cooperative banks still appear as likely to remain outside a cooperative bank network/IPS as they are viewed as either too large, and/or too weak to join an existing IPS.
  - (iii) for the existing 2 networks, their affiliating banks have legacy issues of weak asset quality and capital and in the past required member cooperative bank support.

- Key reform directions for IPSs and affiliating banks:
  - Strengthen supplementary internal control models and align internal control activities with PFSA requirements.
  - Revisit scope of affiliating bank activities; consider focusing activities to support their owners/members and limit credit activity.
  - Promote greater integration of networks, including operational consolidation among network cooperative banks.
  - Harmonize liquidity and solvency support arrangements across schemes in relative size, capacity, and accessibility.

- Sector performance notes:
  - Most cooperative banks are well capitalized and profitable, but some individual banks’ situations are declining and may require resolution activities (including purchase and assumption transactions) to limit spillovers.
  - Cooperative banks expanded above inflation; housing finance grew by 17 percent between June 2016 and June 2017, while enterprise lending remained flat.
  - Enterprise loan portfolio NPL ratio: 15 percent.
  - Housing loans NPL ratio: 2 percent.
  - Larger cooperative banks represent around 65 percent of the cooperative bank sector assets but only 40 percent of its members.
  - At end-2017, there were 162 cooperative banks with a capital base above 5 million, though only 2 operate independently.

- Performance by size (as of end 2017) — preserve exact figures:
  - < EUR 1 million: Number of entities 4; Average Regulatory Capital ratio (in percent) -1; Average Return on Assets (in percent) -2.95; Average NPL ratio (in percent) 15.14; Average of Loan Growth (in percent) -0.21
  - EUR 1–5 million: Number of entities 387; Average Regulatory Capital ratio (in percent) 22; Average Return on Assets (in percent) 0.59; Average NPL ratio (in percent) 4.51; Average of Loan Growth (in percent) 5.71
  - EUR 5–10 million: Number of entities 114; Average Regulatory Capital ratio (in percent) 18; Average Return on Assets (in percent) 0.59; Average NPL ratio (in percent) 6.24; Average of Loan Growth (in percent) 4.61
  - > EUR 10 million: Number of entities 48; Average Regulatory Capital ratio (in percent) 16; Average Return on Assets (in percent) 0.68; Average NPL ratio (in percent) 9.91; Average of Loan Growth (in percent) 3.08
  - Total: 553 entities; Average Regulatory Capital ratio (in percent) 17; Average Return on Assets (in percent) 0.57; Average NPL ratio (in percent) 5.41; Average of Loan Growth (in percent) 5.21

### Affiliating banks: condition, risks, and network performance
- Findings:
  - Cooperative banks when grouped by affiliating bank networks are in better condition than affiliating banks individually.
  - One affiliating bank sustained losses requiring member cooperative banks (who are also shareholders) to provide capital support.
  - Business models of the two affiliating banks are transitioning towards lower risk-return activities; both exhibit weakness compared to most commercial banks and require continued close monitoring.
  - If confronted with a severe event, there would be spillover to the network of cooperative banks; individual recovery plans are underdeveloped.
  - One affiliating bank is subject to a group rehabilitation plan with the PFSA; IPS solvency fund support in the form of a subordinated liability was essential for that case.
  - Lingering distress from past weak lending practices: corporate loan portfolios of affiliating banks caused significant losses; at end-2017, NPLs were more than 10 percent of loans for the two affiliating banks.

- Performance of Cooperative Banks by Current Network Affiliation (as of end-2017):
  - Cooperative Banking Group (SGB) Network: Number of Entities 199; Average Regulatory Capital Ratio (in percent) 20.07; Return on Assets (in percent) 0.58; NPLs to Loans (in percent) 4.44; Asset Growth (in percent) 8.03
  - Bank of Polish Cooperatives (BPS) Network: Number of Entities 352; Average Regulatory Capital Ratio (in percent) 21.10; Return on Assets (in percent) 0.57; NPLs to Loans (in percent) 5.93; Asset Growth (in percent) 8.21
  - Independent Cooperative Banks: Number of Entities 2; Average Regulatory Capital Ratio (in percent) 15.90; Return on Assets (in percent) 0.52; NPLs to Loans (in percent) 11.47; Asset Growth (in percent) 6.82
  - Total 553 cooperative banks: Average Regulatory Capital Ratio (in percent) 20.70; Return on Assets (in percent) 0.57; NPLs to Loans (in percent) 5.41; Asset Growth (in percent) 8.14

- Stand-alone affiliating bank soundness indicators (as of end-2017):
  - SGB: Total assets (PLN billion) 19.47; Percent of Banking System 1.30; Capital Adequacy Ratio (in percent) 14.62; NPL Ratio (in percent) 15.51; NPL Coverage Ratio (in percent) 38.05; Return on Equity (gross in percent) 0.97; Return on Assets (gross in percent) 0.05; Cost/Income Ratio (in percent) 60,32
  - BPS: Total assets (PLN billion) 23.69; Percent of Banking System 1.60; Capital Adequacy Ratio (in percent) 10.83; NPL Ratio (in percent) 12.10; NPL Coverage Ratio (in percent) 43.80; Return on Equity (gross in percent) 2.06; Return on Assets (gross in percent) 0.07; Cost/Income Ratio (in percent) 70.77

### Transition of the cooperative bank sector (affiliations and scale)
- Transition snapshot (as of April 2018, in millions of PLN):
  - BPS: Number of Cooperative Banks 303; Aggregate Assets 67,864; Average Assets per Cooperative 224; Average NPL Ratio (in percent) 5.8; Total Number of Depositors 3,506,895
  - SGB: Number of Cooperative Banks 199; Aggregate Assets 46,997; Average Assets per Cooperative 236; Average NPL Ratio (in percent) 4.4; Total Number of Depositors 2,422,666
  - Proposed affiliating bank: Number of Cooperative Banks 47; Aggregate Assets 8,735; Average Assets per Cooperative 186; Average NPL Ratio (in percent) 6.2; Total Number of Depositors 446,545
  - Independent: Number of Cooperative Banks 2; Aggregate Assets 4,725; Average Assets per Cooperative 2,363; Average NPL Ratio (in percent) 11.5; Total Number of Depositors 241,968
  - Applying to be independent: Number of Cooperative Banks 2; Aggregate Assets 1,991; Average Assets per Cooperative 995; Average NPL Ratio (in percent) 14.1; Total Number of Depositors 176,154
  - Grand Total: Number of Cooperative Banks 553; Aggregate Assets 130,310; Average Assets per Cooperative 236; Average NPL Ratio (in percent) 5.4; Total Number of Depositors 6,794,228

- Transition risks and contingency needs:
  - Some cooperative banks that have not committed to an IPS network are large and/or weak and may not be able to rejoin; they may not meet eligibility requirements because they are either too large or too weak relative to the limited size of resolution/liquidity funds available in existing IPS networks.
  - Possible contingency actions:
    - Some cooperative banks could achieve independent status (requires PFSA approval).
    - Some cooperative banks may restructure including consolidation with an existing cooperative or commercial bank.
    - Resolution using the special resolution regime (SRR), for example, the purchase and assumption.

### Supervision: PFSA, resources, and onsite inspections
- Institutional roles:
  - PFSA supervises cooperative banks; deposits are insured by the BGF; liquidity support can be drawn from the National Bank of Poland (NBP).
  - PFSA responsible for supervising recovery planning, early supervisory intervention, and determining failing/likely-to-fail/insolvent status.
  - BGF is the deposit insurance and resolution authority for cooperative banks, affiliating banks, and credit unions.
  - NBP provides emergency liquidity assistance; PFSA, BGF, NBP, and MoF are members of the Financial Stability Committee responsible for macroprudential policy.

- Findings on supervisory capacity:
  - PFSA’s supervisory approach is risk based, with most resources prioritized to larger commercial banks.
  - Migration of banking supervision from NBP in 2008, widening of perimeter in 2012, and strained funding have weakened PFSA’s ability to deliver supervision promptly and sufficiently.
  - On-site inspections for cooperative banks lack depth; inspection frequency averages between six and eight years.
  - For affiliating banks (BPS and SGB), inspection presence is annually but with limited scope; PFSA staffing shortages have resulted in longer inspection cycles on average and lower loan review samples than appropriate.
  - Basel Core Principles assessment identified deficiencies at PFSA including inability to set a budget, shortage of financial resources, and high workload on current staff.
  - The PFSA’s resource constraints limit its ability to assess credit risk governance, detect loan forbearance, insider abuse, and related-party lending.

- Recommendations to strengthen supervision:
  - Address PFSA resource constraints to improve adequacy and frequency of on-site inspections and depth of supervisory work.
  - Improve PFSA oversight of IPS internal control activities and align IPS functions with supervisory and stability objectives.
  - Require both affiliating banks to report using IFRS to ensure comparability and proper determination of risks and financial health (currently BPS uses IFRS; SGB and all cooperative banks use local accounting standards).
  - Ensure obligatory audits of annual financial statements by external auditors and consider supplemental audits when adequacy is in question.

### IPSs, moral hazard, and internal controls
- Findings:
  - IPSs provide internal control functions; PFSA closely monitors quality of IPS internal control activities and questions IPS reports.
  - IPS system may contribute to moral hazard if insufficient regard is paid to risks incurred by member cooperative banks.
  - Shortcomings include insufficient coverage of refinancing and restructuring of loans and treatment of related-party exposures.

- Recommendations:
  - Strengthen IPS staff capacity, standards, review of control systems, information systems, and actual loan samples.
  - IPSs should have clear rules of operation to reduce implicit moral hazard, particularly around support arrangements.
  - Refocus affiliating bank activities and business model toward lower credit risk and services to member cooperative banks for fees; limit credit activities to loans in participation subject to strict underwriting mandates.

### Financial safety nets and resolution framework
- Safety-net arrangements vary by three membership types:
  - (i) Part of an affiliating bank network with a dedicated IPS.
  - (ii) Part of an affiliating bank network under the Integrated Affiliation model.
  - (iii) Independent cooperative bank able to meet standalone capital and supervisory requirements.

- IPS model details:
  - Member cooperative banks must contribute to both a solvency fund and a liquidity fund to support a member bank in stress.
  - Liquidity fund derives from dedicated deposits placed by member cooperative banks in the affiliating bank; amount agreed by contract based on members' insured deposits.
  - Deposit insurance premium paid by member cooperative banks to the BGF is 50 percent of what would normally be paid by commercial banks, independent cooperative banks, or cooperative banks that do not participate in an IPS.
  - BGF remains the backstop for failures that result in insured deposit payout and/or resolution transactions if the IPS declines or is unable to provide support.
  - The two existing IPSs have different contribution requirements to their respective solvency and liquidity funds, providing different degrees of safety.

- Experience and risks:
  - Two IPSs were tested with resolution of two failing cooperative banks; IPSs facilitated mergers of failing banks with healthier cooperative banks but required general assembly decisions and exposed additional risks.
  - No legal mandate requires IPS participation; decisions have been driven by reputational considerations, which may increase moral hazard.

- Integrated Affiliation model:
  - Law foresees possibility of Integrated Affiliation allowing affiliation without an IPS; requires support funds for liquidity and solvency pursuant to a contractually binding Affiliation Agreement and PFSA approval and licensing.
  - FSAP supports robust approval procedures for Integrated Affiliation including credible timelines for building support funds and high prudential standards for eligible cooperative banks.
  - FSAP supports that there be no reduction in premiums paid to the BGF for deposit insurance in the absence of an IPS.

### Box 1 summary: IPS resolution experience and contagion risks
- IPS resolution structures observed:
  - Case 1:
    - IPS assisted the acquiring bank’s purchase of NPLs at book value through a loss sharing arrangement that reversed provisions to maintain capital levels through the acquisition process.
    - Transaction supported with liquidity arranged by the IPS.
    - NPLs transferred at book value after provisions were reversed, permitted because of guarantees provided by the solvency fund.
    - The successor will realize value for the NPLs over time, with the solvency fund making up any valuation shortfall in the NPLs.
    - Shareholders of the failing cooperative bank kept their participation in the shareholding of the merged bank.
    - There are no bail-in tools at the level of the IPS; resolution costs will be absorbed by the solvency fund provided by member cooperative banks.
  - Case 2:
    - IPS facilitated a purchase and assumption (P&A): the purchase of assets and assumption of liabilities of the failing bank by a healthy successor bank.
    - NPLs acquired at book value by an asset management vehicle supported by the solvency fund.
    - The asset vehicle is owned by the IPS and holds the loss exposure from the transaction.
    - NPLs entrusted for recovery to a private asset management company; while a contract is set, the incentive to proceed efficiently to maximize recovery is not clear.
    - Recommendation: IPS should review operational procedure to minimize the cost of the IPS intervention in the shortest term.

- Interdependence and liquidity risk statistics:
  - Cooperative banks in the IPS are required to deposit 20 percent of non-financial clients’ deposits in the affiliating bank.
  - By end-2017, affiliating banks’ total interbank deposits equalled 29 percent of total non-financial client deposits in cooperative banks.
  - Interbank deposits financed as much as 71 percent of the affiliating banks’ assets.
  - The deposits establish the liquidity fund and are not covered by the BGF, generating a risk of liquidity shortage in the safety net of cooperative banks members of a failing affiliating bank.

### Credit unions: performance and strategic choices
- Background and structure:
  - Emerged post-1990; initially employee focused, expanded membership over time to include geographical-based credit unions.
  - Operate under the Cooperative Credit and Savings Unions Act from 2009, amended in 2012 and consolidated in 2017.
  - Can collect funds exclusively from members, extend loans to them, perform financial settlements and distribute insurance contracts.
  - Not allowed to undertake non-credit risk activities (e.g., cash handling or money transfer services); framework lags banks in electronic means.
  - NACSU: mandatory affiliation; objectives include stability oversight and an industry-financed stabilization fund.

- Sector consolidation trends:
  - End 2012: 55 credit unions with assets of PLN 17 billion served 2.6 million members.
  - By September 2017: 35 credit unions with assets of PLN 10 billion providing services to 1.7 million members.
  - As of September 2017, the 3 largest credit unions comprised about 80 percent of the sector’s assets and 65 percent of its membership.
  - The largest credit union manages around 55 percent of the sector’s assets and is twice the size of the largest cooperative bank.

- Financial performance — solvency and profitability:
  - At end-June 2017:
    - Only 26 credit unions with 15 percent of the system’s assets complied with the Capital Adequacy Requirements (CAR) of 5 percent.
    - Only 23 credit unions had positive income.
    - The CAR for the industry is only 2.95 percent.
  - Following PFSA action: 28 out of 37 credit unions mandated to prepare rehabilitation plans; 5 individual plans later accepted; 3 credit unions placed into receivership.
  - Only one of the five largest credit unions complies with the 5 percent CAR and only two report positive net income through end-June 2017.
  - PFSA reports that at June 2018, the sector average capital adequacy increased to 4.4 percent, though it remains below the regulatory requirement.

- Regulatory Capital Ratio of the 35 Credit Unions Operating in September 2017 (Table 4):
  - Dec-14: Regulatory Capital Ratio 4.50; Return on Assets 0.50
  - Dec-15: Regulatory Capital Ratio 5.60; Return on Assets -0.01
  - Dec-16: Regulatory Capital Ratio 3.20; Return on Assets 0.04
  - Sep-17: Regulatory Capital Ratio 3.00; Return on Assets 0.01

- Asset quality — Evolution of the NPL Ratio for Credit Unions (Table 5):
  - All Credit Unions: Dec-14 26.6; Dec-15 19.9; Dec-16 19.9; Sep-17 16.3
  - Small Credit Unions* (assets less than PLN 20 million): Dec-14 18.5; Dec-15 22.8; Dec-16 26.2; Sep-17 28.5
  - Medium and Large Credit Unions: Dec-14 26.7; Dec-15 19.9; Dec-16 19.8; Sep-17 16.2

- Contributing factors to weak performance:
  - Individuals owning shares of credit unions less attractive; member shares not always recognized as capital.
  - Volume of share capital decreased; retained earnings generally only source of capital.
  - Poor loan quality, recovery practices, historical mergers of weak credit unions without sufficient restructuring.
  - Prevalent loan “evergreening” through roll-over of NPLs.
  - Collateral difficult to execute due to legal procedures.
  - Small credit unions showing higher deterioration; medium and large slight improvement.

### Credit unions: supervision, safety nets, and resolution
- Supervision:
  - PFSA assumed supervision in 2012; on-site examinations performed since 2013; by end-2016 PFSA completed examination of all credit unions.
  - PFSA revealed significant deficiencies in valuation and loan portfolio performance compared to NACSU valuations, requiring increased loan loss provisions and equity adjustments; discrepancies have been reduced over time.
  - Capital regime recommendation: align with sector risk profile and better conform to a harmonized 8 percent international standard; current 5 percent minimum capital ratio has eroded sector stability.
  - There is no minimum amount of capital required for credit unions (contrast: cooperative banks must comply with EU minimum equivalent of EUR 1 million if part of an affiliating bank network or EUR 5 million if standalone).
  - Auditors of credit unions do not need to meet PFSA accrediting requirements; recommendation to change this.
  - PFSA and NACSU roles may overlap; recommendation: limit NACSU supervisory functions to internal control auditing to help PFSA and avoid duplications, particularly in reporting.

- Financial safety nets and resolution framework:
  - Credit Union Act of 2009 (amended 2012 and 2017) and Bank Guarantee Fund Act of 2016 together with two EU Directives provide deposit insurance and resolution framework.
  - Since 2013, BGF covers credit union deposits and is the resolution authority for failing credit unions.
  - BGF tools include insured deposit transfers and purchase and assumption transactions following a least cost criterion.
  - BGF manages two Deposit Guarantee Funds (DGFs) for failing credit unions; NACSU manages a stabilization fund intended to be 2 percent of the sector’s assets, based on ex-ante contributions and NACSU net profits.
  - DGF for credit unions can be buttressed by the DGF for banks; cross subsidy occurred because the DGF for credit unions proved insufficient.
  - If NACSU refuses to provide support, this usually results in failure.
  - BGF can act without consent of credit union shareholders.
  - Early intervention usually requires financial assistance of BGF, available only by application of the failing institution.
  - Restructuring of credit unions is possible after individual notification approved by EU; there is no State Aid Scheme allowing BGF assistance in self-restructuring processes of CUs.
  - Assistance available upon application and should align with credit union’s recovery plan; can be subordinated loan or guarantee.
  - Financial assistance should not exceed costs of fulfilling BGF statutory or contractual mandate regarding deposit guarantee.
  - No indication of availability of liquidity support to the acquiring entity after the process, if needed.

- Resolution practice evolution:
  - Since PFSA supervision, several credit unions exited via orderly liquidation or assisted mergers.
  - Liquidation: court supervised process with BGF payout of insured deposits and BGF taking over depositors’ claim.
  - Assisted mergers: BGF (and in some cases NFSCU) provide financial incentives to acquiring bank or credit union, conditioned on PFSA favorable opinion and least cost criteria.
  - Over time, time required for resolution decreased and greater use of less costly resolution techniques (shift from liquidation to P&A).

### Policy recommendations and restructuring options
- Cooperative banks (agents and timelines):
  - Strengthen supplementary internal control and safety net arrangements for cooperative banks to address elevated risk (PFSA, MoF, ABs, IPS) — I (immediate: within one year)
  - Develop a strategy to promote further integration/consolidation of the cooperative bank sector (PFSA, NBP, MoF, Affiliating Bank Networks, National Associations) — NT (near term: 1–3 years)
  - Focus scope of affiliating bank activity to provision of services to members (Regulator (MoF /PFSA)) — NT
  - Enhance member participation (Regulator (MoF /PFSA); National Association) — MT (medium term: 3–5 years)

- Credit unions (agents and timelines):
  - Develop and implement restructuring strategy focused on (i) resolving non-viable credit unions through exit; (ii) evaluating consolidation measures; and (iii) strengthen recovery of NPLs (PFSA, MoF, NASCU) — NT
  - Strengthen credit risk management capacity of viable entities (PFSA, NACSU) — MT
  - Policymakers to weigh practicality of retaining a separate credit union sector and consider transitioning viable credit unions into cooperative-commercial bank system (MoF, PFSA, NACSU, NBP, BGF) — NT
  - Further evaluate capital requirements for credit unions to ensure appropriate consideration of risk and a level playing field—including evolving capital requirement to a harmonized 8 percent minimum (MoF, PFSA) — MT

- Supervision and safety nets (selected items):
  - Strengthen PFSA supervisory capacity (MoF, PFSA) — I
  - Align IPS internal control and affiliating bank capital (PFSA) — NT
  - Revise reporting and supervision methodologies (PFSA) — MT
  - Require recovery plans for networks and significant cooperative banks/credit unions (PFSA, BGF, MoF) — I
  - Remedy legal impediments to resolution tools for affiliating banks, cooperative banks, and IPS networks (MoF, BGF) — I

- Credit union sector structural options:
  - Segment credit unions into three groups:
    - (i) solvent and viable;
    - (ii) could be viable with restructuring; and
    - (iii) not viable and requiring resolution.
  - Promote market solutions: merge viable credit unions with other viable credit unions or banks (including eligible cooperative banks).
  - For non-viable credit unions: resolution through purchase and assumption (P&A) to transfer deposits and performing loans to a successor credit union or bank.
  - Operational pathway: PFSA → segmentation (Healthy CUs / Undercapitalized but viable CUs / Non viable CUs) → restructure and capital recovery for viable; resolution and P&A for non-viable; possible consolidation with cooperative banks.

### Financial system context and sector roles
- Historical and structural notes:
  - Cooperative banks have been part of the banking system for over 150 years; credit unions emerged around 1990.
  - In 2018, the nearly 600 cooperative banks and credit unions serve about 7.5 million people, equivalent to about 18 percent of the population.
  - Cooperative banks are important lenders to agriculture and small- and medium-sized enterprises (SME); credit unions mainly provide consumer finance, important for pensioners.
  - Combined, cooperative banks and credit unions are not viewed as systemic.

- Market shares (June 2018):
  - Cooperative banks 7.1%; Credit unions 0.5%; Foreign owned 42.6%; Branches of foreign credit institutions 2.5%; Domestic privately-owned 6.7%; Domestic state-controlled 40.5% (Source: PFSA).

*Source: REPUBLIC OF POLAND — EXECUTIVE SUMMARY (technical note prepared using information received in the first semester of 2018).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 4

### 1polea2019007 - EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY: key findings
- The note reviews the cooperative bank and credit union sectors, focusing on: (i) the situation of the two sectors that are both in states of transition; (ii) the regulatory and supervisory arrangements; and (iii) the safety net and resolution regime within the context of the crisis management framework.
- The analysis is based on information received in the first semester of 2018 at the time of the visit of the authors; some subsequent improvements were noted but did not substantially modify the main conclusions and recommendations.
- Combined, cooperative banks and credit unions represent less than 8 percent of deposit takers and serve about 18 percent of the population.
- The FSAP is broadly supportive of the policy direction for cooperatives, while it questions whether the credit union sector should remain standalone.

### Cooperative banks: sector structure and transition risks
- Supervisory arrangement is evolving to a “supplementary” supervision model under EU legislation (Article 113 (7) Capital Requirement Regulation (CRR)).
- Since 2015 authorities promoted that cooperative banks be part of an Institutional Protection Scheme (IPS) that includes an affiliating commercial bank.
- Currently, there are two IPS networks; a proposal for a third network using “Integrated Affiliation” appears unlikely as the PFSA decided not to license the affiliating bank.
- Two cooperative banks have independent status in line with Article 1 of the CRR (e.g., capital over EUR 5 million, other prudential requirements).
- IPSs perform internal control functions that complement supervision by the Polish Financial Supervision Authority (PFSA) (see Art 22i of the Act on the Functioning of Cooperative Banks, their Association and Associating Banks from year 2000), but are in transition and reliance on the PFSA remains necessary.
- IPSs can direct liquidity or solvency support to cooperative banks before resorting to official institutions; PFSA informally cooperates with IPSs to avoid turmoil.
- Each of the two IPSs has been successfully tested in the assisted merger of a troubled cooperative bank with a strong one.

- Elevated risks for the cooperative bank sector stem from:
  - (i) about 40–45 cooperative banks that were seeking to establish their own affiliating bank and network will now need to affiliate back within an existing network; note: this number had decreased to 42 entities by August 2018, and more than 30 cooperative banks had applied to be accepted into an existing IPS.
  - (ii) approximately 12 cooperative banks still appear as likely to remain outside a cooperative bank network/IPS as they are viewed as either too large, and/or too weak to join an existing IPS.
  - (iii) for the existing 2 networks, their affiliating banks have legacy issues of weak asset quality and capital and in the past required member cooperative bank support.

- Key reform directions for IPSs and affiliating banks:
  - Strengthen supplementary internal control models and align internal control activities with PFSA requirements.
  - Revisit scope of affiliating bank activities; consider focusing activities to support their owners/members and limit credit activity.
  - Promote greater integration of networks, including operational consolidation among network cooperative banks.
  - Harmonize liquidity and solvency support arrangements across schemes in relative size, capacity, and accessibility.

- Sector performance notes:
  - Most cooperative banks are well capitalized and profitable, but some individual banks’ situations are declining and may require resolution activities (including purchase and assumption transactions) to limit spillovers.
  - Cooperative banks expanded above inflation; housing finance grew by 17 percent between June 2016 and June 2017, while enterprise lending remained flat.
  - Enterprise loan portfolio NPL ratio: 15 percent.
  - Housing loans NPL ratio: 2 percent.
  - Larger cooperative banks represent around 65 percent of the cooperative bank sector assets but only 40 percent of its members.
  - At end-2017, there were 162 cooperative banks with a capital base above 5 million, though only 2 operate independently.

- Table 2 (performance by size, as of end 2017) — preserve exact figures:
  - < EUR 1 million: Number of entities 4; Average Regulatory Capital ratio (in percent) -1; Average Return on Assets (in percent) -2.95; Average NPL ratio (in percent) 15.14; Average of Loan Growth (in percent) -0.21
  - EUR 1–5 million: Number of entities 387; Average Regulatory Capital ratio (in percent) 22; Average Return on Assets (in percent) 0.59; Average NPL ratio (in percent) 4.51; Average of Loan Growth (in percent) 5.71
  - EUR 5–10 million: Number of entities 114; Average Regulatory Capital ratio (in percent) 18; Average Return on Assets (in percent) 0.59; Average NPL ratio (in percent) 6.24; Average of Loan Growth (in percent) 4.61
  - > EUR 10 million: Number of entities 48; Average Regulatory Capital ratio (in percent) 16; Average Return on Assets (in percent) 0.68; Average NPL ratio (in percent) 9.91; Average of Loan Growth (in percent) 3.08
  - Total: 553 entities; Average Regulatory Capital ratio (in percent) 17; Average Return on Assets (in percent) 0.57; Average NPL ratio (in percent) 5.41; Average of Loan Growth (in percent) 5.21

### Credit unions: performance and strategic choices
- Since coming under PFSA supervision, some improvement occurred due to resolution of nonviable credit unions and better performance of remaining entities, but overall performance and financial information quality remain unsatisfactory.
- Capital adequacy at end-January 2018 remains below the regulatory minimum of 5 percent, reflecting the troubled situation of larger credit unions.
  - Note: following restructuring actions after the April/May 2018 IMF visit, PFSA reports that at mid-2018, average credit union capitalization increased to 4.4 percent; for a group of 25 mostly smaller credit unions at mid-2018, all have a capital adequacy ratio above the 5 percent requirement.
- Sources of low capital: losses from poor loan underwriting and a series of past mergers allowed without addressing viability issues.
- The sector requires restructuring to consolidate viable entities and resolve non-viable entities through exit.
  - Restructuring strategy options:
    - (i) merger of weak but solvent credit unions with other viable credit unions or with banks (including eligible cooperative banks);
    - (ii) resolution and exit through application of the purchase and assumption (P&A) tool to transfer franchise value (depositor base and performing loans) to a successor entity.
  - Strategy should emphasize recovery of overdue loan portfolios due to faulty loan management and collection practices.
- Policymakers need to decide whether to retain a standalone credit union sector; alternatives:
  - Reform and recapitalization including changes to the Credit Union Act 2009.
  - Phase out credit unions.
  - Medium-term path: consolidation and transformation into one or more cooperative banks or consolidation with a commercial bank.
- Credit unions constitute less than 1 percent of deposit taker assets; most of the sector by assets is deeply troubled, and the legal framework has deficiencies.

### Supervision, safety nets, and resolution
- Supervisory arrangements and recommendations:
  - Strengthen PFSA supervisory capacity by increasing (at least during a transition period) available resources to oversee cooperative banks and credit unions.
  - Strengthen IPS internal control and audit practices to align with PFSA requirements; each affiliating bank should meet higher capital requirements.
  - Revise reporting requirements and supervision methodologies for cooperative banks and credit unions to ensure proportionality as feasible under EU regulations.
  - Evaluate criteria for auditors and establish a short list of qualified auditors if feasible.
  - Further enhance IPS monitoring and align methodologies with PFSA.
  - Shorten supervisory inspection cycle for cooperative banks until IPS capacity is established.
  - Identify additional cooperative bank capital instruments compatible with EU CRR.
  - Unify accounting standards among sectors and institutions.
  - Finalize evaluation of credit unions.
  - Eliminate apparent duplication of supervisory functions and credit union reporting to NACSU and PFSA.

- Safety nets and resolution recommendations:
  - Ensure all protection schemes complementing the Bank Guarantee Fund (BGF) (e.g., IPS, NACSU) can provide the same level of support in terms of liquidity and solvency funds, and harmonize these funds as to relative size, capacity, and accessibility.
  - Require recovery plans for networks (including the possible need to address multiple distressed cooperative banks simultaneously); and for “significant” credit unions and cooperative banks undergoing rehabilitation.
  - Remedy legal and other impediments to use resolution tools in context of affiliating banks, cooperative banks, and their IPS networks.
  - Use of purchase and assumption (P& A / Purchase and Assumption) transactions as a resolution modality to limit spillovers.

### Main recommendations (agents and timelines)
- Time Frame legend: C = continuous; I (immediate) = within one year; NT (near term) = 1–3 years; MT (medium term) = 3–5 years.
- Cooperative banks:
  - Strengthen supplementary internal control and safety net arrangements for cooperative banks to address elevated risk (PFSA, MoF, ABs, IPS) — I
  - Develop a strategy to promote further integration/consolidation of the cooperative bank sector (PFSA, NBP, MoF, Affiliating Bank Networks, National Associations) — NT
  - Focus scope of affiliating bank activity to provision of services to members (Regulator (MoF /PFSA)) — NT
  - Enhance member participation (Regulator (MoF /PFSA); National Association) — MT
- Credit unions:
  - Develop and implement restructuring strategy focused on (i) resolving non-viable credit unions through exit; (ii) evaluating consolidation measures; and (iii) strengthen recovery of NPLs (PFSA, MoF, NASCU) — NT
  - Strengthen credit risk management capacity of viable entities (PFSA, NACSU) — MT
  - Policymakers to weigh practicality of retaining a separate credit union sector and consider transitioning viable credit unions into cooperative-commercial bank system (MoF, PFSA, NACSU, NBP, BGF) — NT
  - Further evaluate capital requirements for credit unions to ensure appropriate consideration of risk and a level playing field—including evolving capital requirement to a harmonized 8 percent minimum (MoF, PFSA) — MT
- Supervision and safety nets (selected items):
  - Strengthen PFSA supervisory capacity (MoF, PFSA) — I
  - Align IPS internal control and affiliating bank capital (PFSA) — NT
  - Revise reporting and supervision methodologies (PFSA) — MT
  - Require recovery plans for networks and significant cooperative banks/credit unions (PFSA, BGF, MoF) — I
  - Remedy legal impediments to resolution tools for affiliating banks, cooperative banks, and IPS networks (MoF, BGF) — I

### Financial system context and sector roles
- Historical and structural notes:
  - Cooperative banks have been part of the banking system for over 150 years; credit unions emerged around 1990.
  - In 2018, the nearly 600 cooperative banks and credit unions serve about 7.5 million people, equivalent to about 18 percent of the population.
  - Cooperative banks are important lenders to agriculture and small- and medium-sized enterprises (SME); credit unions mainly provide consumer finance, important for pensioners.
  - Combined, cooperative banks and credit unions are not viewed as systemic.
- Market shares (June 2018): Cooperative banks 7.1%; Credit unions 0.5%; Foreign owned 42.6%; Branches of foreign credit institutions 2.5%; Domestic privately-owned 6.7%; Domestic state-controlled 40.5%. (Source: PFSA)

*Source: REPUBLIC OF POLAND — EXECUTIVE SUMMARY (technical note prepared using information received in the first semester of 2018).*

### 8.      The vast majority of cooperative banks meet the regulatory capital requirements but

### 8–D. Cooperative banks: capital, consolidation, affiliating banks, supervision, and safety nets

### Capital generation and constraints
- Findings:
  - Earnings retention is the most important source of capital generation for cooperative banks.
  - Most cooperative banks chose not to pay dividends while shareholders face higher risks than depositors.
  - Volume of cooperative bank share capital decreased from PLN 736 million in 2013 to PLN 513 million as of September 2017.
  - Number of share-holding members declined from 1.04 million to 970 thousand.
  - Member shares in cooperative banks cannot be counted as regulatory capital except for cooperative banks that adjust their statutes to limit withdrawal of shares so they can be used to cover losses, if needed.
- Policy recommendations / measures:
  - Improve attractiveness of share ownership by achieving greater efficiency and improving services to reverse decline in member share-holdings.
  - Authorize other common equity tier 1 capital instruments for cooperative banks (CRR Article 29 introduces the possibility of alternative capital instruments that qualify as common equity tier 1 for mutual, cooperative banks, and other similar institutions). Such instruments could include qualifying debt convertible into capital and could be used for pre-emptive recapitalization or to facilitate mergers of weak though still solvent cooperative banks.

### Consolidation, mergers, and scale
- Findings:
  - There is limited appetite for mergers between cooperative banks, unless prompted by the supervisor/IPS.
  - Lack of scale affects performance and stability; cost structures for cooperative banks generally remain too high (particularly compared to commercial banks).
  - Recent mergers were prompted by healthier cooperative banks absorbing troubled ones, sometimes with financial support from the IPS.
- Policy recommendations / incentives:
  - Authorities and industry need to identify incentives toward consolidation to achieve greater economies of scale.
  - Consolidation will be necessary to reach higher efficiency beyond what affiliating bank networks can deliver through internal control and back-office functions.

### Affiliating banks: condition and risks
- Findings:
  - Cooperative banks when grouped by affiliating bank networks are in better condition than affiliating banks individually.
  - One affiliating bank sustained losses requiring member cooperative banks (who are also shareholders) to provide capital support.
  - Business models of the two affiliating banks are transitioning towards lower risk-return activities; both exhibit weakness compared to most commercial banks and require continued close monitoring.
  - If confronted with a severe event, there would be spillover to the network of cooperative banks; individual recovery plans are underdeveloped.
  - One affiliating bank is subject to a group rehabilitation plan with the PFSA; IPS solvency fund support in the form of a subordinated liability was essential for that case.
  - Lingering distress from past weak lending practices: corporate loan portfolios of affiliating banks caused significant losses; at end-2017, NPLs were more than 10 percent of loans for the two affiliating banks.

- Key statistics (Performance of Cooperative Banks by Current Network Affiliation, as of end-2017):
  - Cooperative Banking Group (SGB) Network: Number of Entities 199; Average Regulatory Capital Ratio (in percent) 20.07; Return on Assets (in percent) 0.58; NPLs to Loans (in percent) 4.44; Asset Growth (in percent) 8.03.
  - Bank of Polish Cooperatives (BPS) Network: Number of Entities 352; Average Regulatory Capital Ratio (in percent) 21.10; Return on Assets (in percent) 0.57; NPLs to Loans (in percent) 5.93; Asset Growth (in percent) 8.21.
  - Independent Cooperative Banks: Number of Entities 2; Average Regulatory Capital Ratio (in percent) 15.90; Return on Assets (in percent) 0.52; NPLs to Loans (in percent) 11.47; Asset Growth (in percent) 6.82.
  - Total 553 cooperative banks: Average Regulatory Capital Ratio (in percent) 20.70; Return on Assets (in percent) 0.57; NPLs to Loans (in percent) 5.41; Asset Growth (in percent) 8.14.

- Stand-alone affiliating bank soundness indicators (as of end-2017):
  - SGB: Total assets (PLN billion) 19.47; Percent of Banking System 1.30; Capital Adequacy Ratio (in percent) 14.62; NPL Ratio (in percent) 15.51; NPL Coverage Ratio (in percent) 38.05; Return on Equity (gross in percent) 0.97; Return on Assets (gross in percent) 0.05; Cost/Income Ratio (in percent) 60,32.
  - BPS: Total assets (PLN billion) 23.69; Percent of Banking System 1.60; Capital Adequacy Ratio (in percent) 10.83; NPL Ratio (in percent) 12.10; NPL Coverage Ratio (in percent) 43.80; Return on Equity (gross in percent) 2.06; Return on Assets (gross in percent) 0.07; Cost/Income Ratio (in percent) 70.77.

### Transition of the cooperative bank sector (affiliations and scale)
- Findings (as of April 2018, in millions of PLN):
  - BPS: Number of Cooperative Banks 303; Aggregate Assets 67,864; Average Assets per Cooperative 224; Average NPL Ratio (in percent) 5.8; Total Number of Depositors 3,506,895.
  - SGB: Number of Cooperative Banks 199; Aggregate Assets 46,997; Average Assets per Cooperative 236; Average NPL Ratio (in percent) 4.4; Total Number of Depositors 2,422,666.
  - Proposed affiliating bank: Number of Cooperative Banks 47; Aggregate Assets 8,735; Average Assets per Cooperative 186; Average NPL Ratio (in percent) 6.2; Total Number of Depositors 446,545.
  - Independent: Number of Cooperative Banks 2; Aggregate Assets 4,725; Average Assets per Cooperative 2,363; Average NPL Ratio (in percent) 11.5; Total Number of Depositors 241,968.
  - Applying to be independent: Number of Cooperative Banks 2; Aggregate Assets 1,991; Average Assets per Cooperative 995; Average NPL Ratio (in percent) 14.1; Total Number of Depositors 176,154.
  - Grand Total: Number of Cooperative Banks 553; Aggregate Assets 130,310; Average Assets per Cooperative 236; Average NPL Ratio (in percent) 5.4; Total Number of Depositors 6,794,228.

- Transition risks and contingency needs:
  - Some cooperative banks that have not committed to an IPS network are large and/or weak and may not be able to rejoin; they may not meet eligibility requirements because they are either too large or too weak relative to the limited size of resolution/liquidity funds available in existing IPS networks.
  - Despite comparatively high NPL ratios, the two existing independent cooperative banks and the two entities applying to operate independently meet all requirements concerning capital, including obligatory capital buffers, liquidity, quality of assets and organizational arrangements.
  - Contingency arrangements needed for dozen cooperative banks slated to remain outside an IPS. Possible actions:
    - Some cooperative banks could achieve independent status (requires PFSA approval).
    - Some cooperative banks may restructure including consolidation with an existing cooperative or commercial bank.
    - There could be a resolution using the special resolution regime (SRR), for example, the purchase and assumption.

### Supervision: PFSA, resources, and onsite inspections
- Institutional roles:
  - PFSA supervises cooperative banks; deposits are insured by the BGF; liquidity support can be drawn from the National Bank of Poland (NBP).
  - PFSA responsible for supervising recovery planning, early supervisory intervention, and determining failing/likely-to-fail/insolvent status.
  - BGF is the deposit insurance and resolution authority for cooperative banks, affiliating banks, and credit unions.
  - NBP provides emergency liquidity assistance; PFSA, BGF, NBP, and MoF are members of the Financial Stability Committee responsible for macroprudential policy.
- Findings on supervisory capacity:
  - PFSA’s supervisory approach is risk based, with most resources prioritized to larger commercial banks.
  - Migration of banking supervision from NBP in 2008, widening of perimeter in 2012, and strained funding have weakened PFSA’s ability to deliver supervision promptly and sufficiently.
  - On-site inspections for cooperative banks lack depth; inspection frequency averages between six and eight years.
  - For affiliating banks (BPS and SGB), inspection presence is annually but with limited scope; PFSA staffing shortages have resulted in longer inspection cycles on average and lower loan review samples than appropriate.
  - Basel Core Principles assessment identified deficiencies at PFSA including inability to set a budget, shortage of financial resources, and high workload on current staff.
  - The PFSA’s resource constraints limit its ability to assess credit risk governance, detect loan forbearance, insider abuse, and related-party lending.

- Recommendations to strengthen supervision:
  - Address PFSA resource constraints to improve adequacy and frequency of on-site inspections and depth of supervisory work.
  - Improve PFSA oversight of IPS internal control activities and align IPS functions with supervisory and stability objectives.
  - Require both affiliating banks to report using IFRS to ensure comparability and proper determination of risks and financial health (currently BPS uses IFRS; SGB and all cooperative banks use local accounting standards).
  - Ensure obligatory audits of annual financial statements by external auditors and consider supplemental audits when adequacy is in question.

### IPSs, moral hazard, and internal controls
- Findings:
  - IPSs provide internal control functions; PFSA closely monitors quality of IPS internal control activities and questions IPS reports.
  - IPS system may contribute to moral hazard if insufficient regard is paid to risks incurred by member cooperative banks.
  - Shortcomings include insufficient coverage of refinancing and restructuring of loans and treatment of related-party exposures.
- Recommendations:
  - Strengthen IPS staff capacity, standards, review of control systems, information systems, and actual loan samples.
  - IPSs should have clear rules of operation to reduce implicit moral hazard, particularly around support arrangements.
  - Refocus affiliating bank activities and business model toward lower credit risk and services to member cooperative banks for fees; limit credit activities to loans in participation subject to strict underwriting mandates.

### Financial safety nets and resolution framework
- Safety-net arrangements vary by three membership types:
  - (i) Part of an affiliating bank network with a dedicated IPS.
  - (ii) Part of an affiliating bank network under the Integrated Affiliation model.
  - (iii) Independent cooperative bank able to meet standalone capital and supervisory requirements.
- IPS model details:
  - Member cooperative banks must contribute to both a solvency fund and a liquidity fund to support a member bank in stress.
  - Liquidity fund derives from dedicated deposits placed by member cooperative banks in the affiliating bank; amount agreed by contract based on members' insured deposits.
  - Deposit insurance premium paid by member cooperative banks to the BGF is 50 percent of what would normally be paid by commercial banks, independent cooperative banks, or cooperative banks that do not participate in an IPS.
  - BGF remains the backstop for failures that result in insured deposit payout and/or resolution transactions if the IPS declines or is unable to provide support.
  - The two existing IPSs have different contribution requirements to their respective solvency and liquidity funds, providing different degrees of safety.
- Experience and risks:
  - Two IPSs were tested with resolution of two failing cooperative banks; IPSs facilitated mergers of failing banks with healthier cooperative banks but required general assembly decisions and exposed additional risks.
  - No legal mandate requires IPS participation; decisions have been driven by reputational considerations, which may increase moral hazard.
- Integrated Affiliation model:
  - Law foresees possibility of Integrated Affiliation allowing affiliation without an IPS; requires support funds for liquidity and solvency pursuant to a contractually binding Affiliation Agreement and PFSA approval and licensing.
  - FSAP supports robust approval procedures for Integrated Affiliation including credible timelines for building support funds and high prudential standards for eligible cooperative banks.
  - FSAP supports that there be no reduction in premiums paid to the BGF for deposit insurance in the absence of an IPS.

*Source: IMF staff report chapter on the cooperative bank sector in the Republic of Poland.*

### Box 1. Poland: Resolution Experience Under the IPS Model

### Box 1. Poland: Resolution Experience Under the IPS Model

### IPS resolution experience and structure
- Both IPS schemes have each resolved failing member cooperative banks in coordination with the PFSA and other official authorities.
- Two differing IPS resolution structures described:
  - Case 1:
    - IPS assisted the acquiring bank’s purchase of NPLs at book value through a loss sharing arrangement that reversed provisions to maintain capital levels through the acquisition process.
    - Transaction supported with liquidity arranged by the IPS.
    - NPLs transferred at book value after provisions were reversed, permitted because of guarantees provided by the solvency fund.
    - The successor will realize value for the NPLs over time, with the solvency fund making up any valuation shortfall in the NPLs.
    - Shareholders of the failing cooperative bank kept their participation in the shareholding of the merged bank.
    - There are no bail-in tools at the level of the IPS; resolution costs will be absorbed by the solvency fund provided by member cooperative banks.
  - Case 2:
    - IPS facilitated a purchase and assumption (P&A): the purchase of assets and assumption of liabilities of the failing bank by a healthy successor bank.
    - NPLs acquired at book value by an asset management vehicle supported by the solvency fund.
    - The asset vehicle is owned by the IPS and holds the loss exposure from the transaction.
    - NPLs entrusted for recovery to a private asset management company; while a contract is set, the incentive to proceed efficiently to maximize recovery is not clear.
    - Recommendation: IPS should review operational procedure to minimize the cost of the IPS intervention in the shortest term.
- Decision and governance risks:
  - IPS participation in recovery depends on a decision of its general assembly.
  - Resolution approaches to date have been ad hoc without clear processes.
  - Evident incentives of higher moral hazard, as the costs of rescue have been borne by IPS.

### Cooperative banks: interrelationships and contagion risks
- PFSA and BGF address the IPS networks collectively and do not require standalone individual bank recovery plans for the member cooperative banks; this collective treatment includes two affiliating banks that are classified as domestic systemically important banks (D-SIBs).
- Given the affiliating banks’ designation as D-SIBs there should be individual recovery plans.
- Interdependence and liquidity risk statistics:
  - Cooperative banks in the IPS are required to deposit 20 percent of non-financial clients’ deposits in the affiliating bank.
  - By end-2017, affiliating banks’ total interbank deposits equalled 29 percent of total non-financial client deposits in cooperative banks.
  - Interbank deposits financed as much as 71 percent of the affiliating banks’ assets.
  - The deposits establish the liquidity fund and are not covered by the BGF, generating a risk of liquidity shortage in the safety net of cooperative banks members of a failing affiliating bank.

### Credit unions — A. Background
- Emerged post-1990; initially employee focused, expanded membership over time to include geographical-based credit unions.
- Early support from World Council of Credit Unions (WOCCU) for harmonized norms and establishment of National Association of Credit Unions (NACSU).
- Legal framework:
  - Operate under the Cooperative Credit and Savings Unions Act from 2009, amended in 2012 and consolidated in 2017.
  - Can collect funds exclusively from members, extend loans to them, perform financial settlements and distribute insurance contracts.
  - Not allowed to undertake non-credit risk activities (e.g., cash handling or money transfer services); framework lags banks in electronic means.
- Sector consolidation:
  - End 2012: 55 credit unions with assets of PLN 17 billion served 2.6 million members.
  - By September 2017: 35 credit unions with assets of PLN 10 billion providing services to 1.7 million members.
  - NACSU: mandatory affiliation; objectives include stability oversight and an industry-financed stabilization fund.
  - As of September 2017, the 3 largest credit unions comprised about 80 percent of the sector’s assets and 65 percent of its membership.
  - The largest credit union manages around 55 percent of the sector’s assets and is twice the size of the largest cooperative bank.

### Credit unions — B. Financial performance (key statistics)
- Solvency and profitability:
  - At end-June 2017:
    - Only 26 credit unions with 15 percent of the system’s assets complied with the Capital Adequacy Requirements (CAR) of 5 percent.
    - Only 23 credit unions had positive income.
    - The CAR for the industry is only 2.95 percent.
  - Following PFSA action: 28 out of 37 credit unions mandated to prepare rehabilitation plans; 5 individual plans later accepted; 3 credit unions placed into receivership.
  - Only one of the five largest credit unions complies with the 5 percent CAR and only two report positive net income through end-June 2017.
  - PFSA reports that at June 2018, the sector average capital adequacy increased to 4.4 percent, though it remains below the regulatory requirement.
- Table 4 (Regulatory Capital Ratio of the 35 Credit Unions Operating in September 2017):
  - Dec-14: Regulatory Capital Ratio 4.50; Return on Assets 0.50
  - Dec-15: Regulatory Capital Ratio 5.60; Return on Assets -0.01
  - Dec-16: Regulatory Capital Ratio 3.20; Return on Assets 0.04
  - Sep-17: Regulatory Capital Ratio 3.00; Return on Assets 0.01
- Asset quality:
  - Table 5 (Evolution of the NPL Ratio for Credit Unions):
    - All Credit Unions: Dec-14 26.6; Dec-15 19.9; Dec-16 19.9; Sep-17 16.3
    - Small Credit Unions* (assets less than PLN 20 million): Dec-14 18.5; Dec-15 22.8; Dec-16 26.2; Sep-17 28.5
    - Medium and Large Credit Unions: Dec-14 26.7; Dec-15 19.9; Dec-16 19.8; Sep-17 16.2
- Contributing factors to weak performance:
  - Individuals owning shares of credit unions less attractive; member shares not always recognized as capital.
  - Volume of share capital decreased; retained earnings generally only source of capital.
  - Poor loan quality, recovery practices, historical mergers of weak credit unions without sufficient restructuring.
  - Prevalent loan “evergreening” through roll-over of NPLs.
  - Collateral difficult to execute due to legal procedures.
  - Small credit unions showing higher deterioration; medium and large slight improvement.

### Credit unions — C. Supervision
- PFSA assumed supervision in 2012; on-site examinations performed since 2013; by end-2016 PFSA completed examination of all credit unions.
- PFSA revealed significant deficiencies in valuation and loan portfolio performance compared to NACSU valuations, requiring increased loan loss provisions and equity adjustments; discrepancies have been reduced over time.
- Capital regime recommendation:
  - Capital regime should be aligned with sector risk profile and better conform to a harmonized 8 percent international standard.
  - Current 5 percent minimum capital ratio has eroded sector stability; higher minimum should be required.
  - There is no minimum amount of capital required for credit unions (contrast: cooperative banks must comply with EU minimum equivalent of EUR 1 million if part of an affiliating bank network or EUR 5 million if standalone).
- Audit and reporting issues:
  - Past accounting standards and unreliable audits diminished transparency.
  - Auditors of credit unions do not need to meet PFSA accrediting requirements; this should change.
  - PFSA and NACSU roles may overlap; information requirements diverge, creating additional compliance work for credit unions.
  - Recommendation: limit NACSU supervisory functions to internal control auditing to help PFSA and avoid duplications, particularly in reporting.

### Credit unions — D. Financial safety nets and resolution framework
- Legal and institutional framework:
  - Credit Union Act of 2009 (amended 2012 and 2017) and Bank Guarantee Fund Act of 2016 together with two EU Directives provide deposit insurance and resolution framework.
  - Since 2013, BGF covers credit union deposits and is the resolution authority for failing credit unions.
  - BGF tools include insured deposit transfers and purchase and assumption transactions following a least cost criterion; range of tools similar to other deposit insurance funds.
- Funds and cross-subsidies:
  - BGF manages two Deposit Guarantee Funds (DGFs) for failing credit unions; NACSU manages a stabilization fund intended to be 2 percent of the sector’s assets, based on ex-ante contributions and NACSU net profits.
  - DGF for credit unions can be buttressed by the DGF for banks; cross subsidy occurred because the DGF for credit unions proved insufficient.
  - If NACSU refuses to provide support, this usually results in failure.
  - BGF can act without consent of credit union shareholders.
- Financial assistance and constraints:
  - Early intervention of credit unions usually requires financial assistance of BGF, available only by application of the failing institution.
  - Restructuring of credit unions is possible after individual notification approved by EU; there is no State Aid Scheme allowing BGF assistance in self-restructuring processes of CUs.
  - Assistance available upon application and should align with credit union’s recovery plan; can be subordinated loan or guarantee.
  - Financial assistance should not exceed costs of fulfilling BGF statutory or contractual mandate regarding deposit guarantee.
  - No indication of availability of liquidity support to the acquiring entity after the process, if needed.
- Resolution practice evolution:
  - Since PFSA supervision, several credit unions exited via orderly liquidation or assisted mergers.
  - Liquidation: court supervised process with BGF payout of insured deposits and BGF taking over depositors’ claim.
  - Assisted mergers: BGF (and in some cases NFSCU) provide financial incentives to acquiring bank or credit union, conditioned on PFSA favorable opinion and least cost criteria.
  - Over time, time required for resolution decreased and greater use of less costly resolution techniques (shift from liquidation to P&A).

### Policy recommendations and restructuring options
- Improve NPL recovery practices to strengthen solvency and resolvability; historical evidence shows acquirers recovered substantially more value.
- Assess options to facilitate mobilization and signing of share capital more attractive for credit unions and their members to mobilize additional equity.
- Facilitate exit of non-viable entities and strengthen consolidation of viable entities.
- Increase incentives for ex-ante resolution mergers while entities remain viable to realize economies of scale; current mergers/takeovers mainly occur mid-resolution with BGF support.
- Strengthen PFSA capacity for early detection to reduce high cost of deposit payouts and prompt resolution processes; greater coordination of supervisory authorities recommended.
- Consider more fundamental sector reform:
  - Either reform and recapitalize weak credit unions and amend the Credit Union Act 2009, or consider a phase out of the entity type.
  - Note: credit unions constitute less than 1 percent of deposit takers and much of the sector is deeply troubled.
  - Policymakers to decide whether a standalone credit union sector remains appropriate and, if not, define a strategy to transition viable credit unions to become or consolidate with cooperative banks.

### Box 2: Contours of a consolidation strategy for the credit union sector (summary)
- Segment credit unions into three groups:
  - (i) solvent and viable;
  - (ii) could be viable with restructuring; and
  - (iii) not viable and requiring resolution.
- Strategy:
  - Promote market solutions: merge viable credit unions with other viable credit unions or banks (including eligible cooperative banks).
  - For non-viable credit unions: resolution through purchase and assumption (P&A) to transfer deposits and performing loans to a successor credit union or bank.
- Operational pathway illustrated by staff: PFSA → segmentation (Healthy CUs / Undercapitalized but viable CUs / Non viable CUs) → restructure and capital recovery for viable; resolution and P&A for non-viable; possible consolidation with cooperative banks.

*Source: Staff summary of Box 1, Poland: Resolution Experience Under the IPS Model.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1polea2019007.pdf_