The Most Cataclysmic NCUA Proposal Ever

Last Thursday the NCUA board asked for comment on a new capital rule that would:

• Raise the well capitalized threshold from 7% to 10%, a 43% increase, in less than six months;
• Establish three separate, different capital rules and provide NCUA the power to override a credit union’s choice;
• Require credit unions that choose the new 10% option to hold $24 billion more in required regulatory net worth than under the Risk Based version passed in 2015;
• Set 60 days only for comment with implementation of the Board’s decision by Jan. 1, 2022

If approved, the result would significantly undermine credit unions’ ability to serve their members and the system’s financial soundness.

Three Capital Standards

NCUA’s proposal introduces a whole new capital standard alongside RBC. The RBC rule from 2015 has yet to be implemented. There is no actual credit union experience with either RBC or this second higher minimum capital standard called CCULR, or Complex Credit Union Leverage Ratio.

The accelerated, short time frame for this far-reaching change is unnecessary and unwise. In the 8 years since NCUA proposed RBC, banking regulators evaluated their experience and dropped it as a requirement. Now NCUA retains RBC and adds another banking creation without any analysis or data for either option.

The most cogent reaction to this proposal was by Board Member Hood who opened his questions by saying: “Mr. Chairman, after serious study and consideration, my preference would be to table the risk-based capital rule indefinitely—or even repeal it—and fine-tune the risk-based net worth rule as needed.”

The Most Restrictive Rule Since Deregulation

This race to alter credit unions’ proven capital framework will severely lesson the system’s strength and resilience. Both options constrain the most important decisions a CEO and board make about their business model: how much and where to invest in member value versus how much to keep in reserves.

RBC is a regulatory tax on every asset transaction made by a credit union. To avoid this regulatory capital tax credit unions can use CCULR, the new “simpler” option. This would increases a credit union’s restricted earnings by 43% versus the current 7% capital requirement.

The most important operational judgments for members are no longer a credit union’s to determine. Rather, NCUA defines a single definition of balance sheet risks, weighs them, and then sets the minimum capital using an untried formula.

All credit union’s transactions are treated identically for the same asset risk whether located New York, Peoria, or Charleston. This one size fits all denies the objective reality that every credit union’s operating environment is different.

NCUA then reserves the authority to change a credit union’s decision or to modify its weightings, definitions and the required capital minimum at any time. Just as it does in the current proposal!

Existing Capital Approach Has Stabilized Credit Unions for 110 years—Risk Based Net Worth Approved by GAO

The proposition that credit union’s minimum capital standards have not been sufficient is false. NCUA provided not a single example, data or historical event to suggest otherwise.

In 1998 the well-capitalized threshold was raised from 6% to 7% as a political compromise to the suggestion that credit unions expense their 1% underwriting in the NCUSIF. There was no accounting or factual basis for this change.

In 2004, GAO reviewed NCUA’s implementation of this new PCA risk based net worth concept and concluded:

We are aware that NCUA is constructing a more detailed risk-based capital proposal . . .and that any proposal should be based on the premise that risk-based capital be used to augment, but not replace, the current net worth requirement for credit unions. The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

Credit unions start with no reserve capital. The cooperative approach of reserving from earnings has been sufficient to sustain the industry through both macro events and decades of financial innovation including:

• Introducing share drafts, mortgage lending, member business loans, credit/debit cards;
• Building out distribution capabilities including branches, call centers, Internet Retail services and shared ATM and branch networks;
• Investing in CUSO’s to bring scale and collaborative solutions for member value;
• Incorporating the latest financial tools including ALM risk modeling, derivatives and hedges, and off balance sheet servicing to manage risk;
• Building capital to navigate deregulation and open competition, the FSLIC crisis and ultimate industry shutdown, two FDIC insolvencies, numerous recessions, the Great Recession 2008-2009, and the recent COVID economic shutdown and recovery,

Credit unions have demonstrated the ability to establish appropriate capital levels to meet every risk itemized in the RBC rule plus dozens of other events and changes that no model could incorporate.

Board and management have managed their individual capital levels to correspond to their business plans and the local economy in which they compete. Now NCUA wants to override that proven practice with a rule that treats each asset’s risk the same wherever and however the credit union operates.

Tomorrow’s blog will document the proposal’s unprecedented financial and regulatory burdens.