One More Time: Why Risk Based Capital is a Bad Idea

In the June 2020 NCUA board meeting, Chairman Hood’s latest RBC proposal was withdrawn from the agenda at the last moment. It did not receive the light of day, so we do not know what was in it. Even so, outgoing board member McWatters indicated his opposition to any change in a June 29 credit union press release stating; “this was not the right time for a material diminution in the RBNW capital requirement for credit unions. . .”

Even though all three banking regulators ended RBNW as a valid approach for community banks in September 2019 and McWatters earlier opposed the rule as “illegal” it appears this destructive concept has somehow come back to life.

With that prospect in mind, I think it is useful to remember some of the reasons why the concept Is so flawed. The article excerpt below urged credit unions to comment on the second RBC proposal by NCUA in 2015. It looks as if the battle may have to be fought again.

Training Fleas and RBC
Escape the circus and live beyond the limits of the imaginary lid. (March 2015

This YouTube video demonstrates how to train fleas. This column urges credit unions not to behave the same way when it comes to NCUA’s redrawn risk-based capital proposal.

The sequence of events the video illustrates are as follows:

  • The fleas are placed in a glass jar.
  • A lid is placed on the jar and left undisturbed for three days.
  • When the lid is removed, the fleas will never jump out of the jar; their behavior has been set for the rest of their lives.
  • Moreover when the fleas reproduce their offspring will follow their example.

Policy Lessons For Risk-Based Capital

The NCUA’s RBC #2 proposal lists more than 70 categories for which credit unions would be required to calculate capital according to their legally mandated rule’s risk weighting.

These weightings — like the lid on the jar — become the primary screen for filtering decisions such as what assets a credit union should hold, how loans should be priced, and the composition of the balance sheet.

This one-size-fits-all formula will reduce the diversity of credit union activity and in so doing, change the focus from serving members needs first, to meeting examiner expectations.

Two Comment Letters Address This Outcome

Chuck Bruen, CEO of First Entertainment Credit Union ($1.1B, Hollywood, CA) wrote this in his Feb. 13 comment letter:

“The NCUA’s risk-based capital rule is overly complex and inappropriate for credit unions and their business model. … NCUA’s risk-weights also experimentally incent and dis-incent credit union lending and investment behaviors in unprecedented and untested ways.”

This steering of balance sheet decisions was also a concern in a comment posted by Randy Karnes, CEO of CU*Answers:

“I believe the revised RBC rule penalizes credit unions for specific activities such as real estate lending, member business lending, and credit unions chartered to assist the un-bankable, by placing a capital tax on the resulting assets from low income or credit lending to the poor.

“We believe the end result will be thousands of homogenous balance sheets in 2025 that the NCUA can easily understand from a supervisory perspective. However, this current risk posture of the NCUA cannot but fail to lead credit unions to shy away from diversity or the cooperative reason for the charter and field of membership.

“This rule would ultimately force credit unions into potential areas of investment and lending in which the credit union lacks experience, or create industry-wide concentrations that could be impacted by similar economic variables. In and of itself, this rule creates more risk than it proposes to control.”

FDIC Vice Chairman Analyzes RBC And Finds It Flawed

These concerns are not theoretical. The banking industry’s reliance upon the RBC formula already shows how it creates results that do not enhance safety and soundness. The outcome can even undermine the critical economic value contributed by financial intermediaries.

FDIC vice chairman Thomas Hoenig noted this in a speech to the International Association of Deposit Insurers in April 2013:

“If the Basel risk-weight schemes are incorrect — which they often have been — this too could inhibit loan growth, as it encourages investments in other more favorably, but incorrectly, weighted assets.

“Basel systematically encourages investments in sectors pre-assigned lower weights — for example, mortgages, sovereign debt, and derivatives — and discourages loans to assets assigned higher weights: commercial and industrial loans.

“We may have inadvertently created a system that discourages the very loan growth we seek, and instead turned our financial system into one that rewards itself more than it supports economic activity.”

RBC Comments Needed More Than Ever

The second comment period is even more critical than the response to RBC #1. The debate now is not about risk weights, ratios, phase-in periods, etc., but whether this new rule is good public policy for cooperatives.

The impact of the rule will be to create behaviors contrary to credit unions’ purpose and their role in the market place. It will decrease diversity and increase asset concentrations.

Credit union leaders must not become fleas in a jar. Comments on RBC#2 are more critical than ever — or this new rule could become a lid on the future of your credit union and the credit union movement.

Source: Training Fleas And RBC | Credit Unions

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