This Thursday (June 20) the NCUA Board has only one topic on the agenda: the Risk Based Capital Rule (RBNW). Rodney Hood will be the 4th Chairman to address the issue.
He and fellow board member McWatters will have the chance to set a whole new direction for regulatory policy if they choose to do the obvious and cancel outright this deeply flawed rule-making effort.
Not only would such an action align with the administration’s policy priorities, it would also end a regulatory approach that is problematic. All other financial regulators have moved away from the belief that future risk can be both predicted and modeled so accurately so as to require specific and relative levels of capital more than sufficient for any future crisis.
The Proposal’s Flawed Foundation
In the post 2008/2009 financial crisis, FDIC and bank regulators reduced reliance on risk-based approaches in favor of a simple leverage capital ratio. Tomas Hoenig, the former Vice Chairman of the FDIC, championed this clearly understood and easily calculated capital ratio. At the same time, he repeatedly documented the flawed premises and historical errors of modeling future risk relativities among myriad categories of bank assets.
However, NCUA under Chairman Matz introduced this flawed approach that was so lacking in factual foundation that the initial draft had to be withdrawn; but then it was reintroduced a second time.
This revised proposal drew significant dissent from new board member McWatters who was in the minority 2:1 board vote to approve the regulation.
“Based upon my thirty plus years of experience as an attorney who has worked in many intricate issues of statutory and regulatory interpretation, I am of the view that NCUA does not possess the legal authority under the NCUA to adopt a two-tier RBNW regulatory standard.
NCUA staff did not undertake a formal estimate of the recurring compliance costs of the proposed regulations… Regrettably this additional burden falls on a financial services sector that is not too-big-to-fail and was in manner responsible for the recent financial crisis.”
- Why The Risk-Based Formula Fails As A Measure Of Financial Soundness
- Risk-Based Capital And The Human Factor
- RBC Rule Would Double Credit Union Capital Requirements
Kicking the Can Down the Road
The objections and complications of the rule were so great that NCUA delayed the final implementation until 2019 to allow time for the agency to expand its call report and internal software to be able to monitor the new rule.
When there were two board members only, Metzger and McWatters, they agreed to postpone implementation another year, til 2020. Congress has even proposed a law to delay this proposal further, a traditional political tactic when a flawed policy cannot be ended outright.
In the meantime, credit unions reported continually rising levels of capital, ending at over 11% collective net worth as of March 31. This is 400 basis points over the well-capitalized regulatory requirement of 7%.
Taking a Cue from Bob Dylan
In 1966 the folk singer Bob Dylan faced a circumstance which he memorialized in the song 4th Time Around. It starts with these words:
When she said, “Don’t waste your words, they’re just lies.” I cried she was deaf.
This is the 4th NCUA Board to consider imposing a detailed capital model when the credit union system was the only one to navigate the last crisis relatively intact under no risk-based rule. The RBNW rule is not only flawed but potentially dangerous to the future of credit unions. It rates certain categories of assets as risk free versus other assets.
This approach could induce credit unions to make decisions that could end up pushing all credit unions into the same risk profiles. As FDIC Vice Chairman Hoenig pointed out, the lowest rated risk categories before the Great Recession were sovereign debt and real estate collateralized securities. Both asset classes were at the center of the declines in asset values in the 2008-2009 crisis.
As the woman in Dylan’s song pleads, “Don’t get cute.” The circumstances and history of this wrong-headed regulatory effort suggest that it is time for the board not to get cute once again. Rather it should reject this approach to determining credit union capital adequacy. Or will the Board be deaf to the lessons provided by the last sixty years of this misguided effort?