When the NCUA Board last considered amendments to our risk-based capital rule my colleague and I did not see exactly eye-to-eye on this issue. I supported the final rule the Board issued in October 2015, and my colleague did not. I am pleased to report that after extensive work by his staff, my staff, and the agency’s staff, we have reached a non-partisan consensus that still achieves our mutual goal of protecting the credit union system.
Our analysis and understanding of risk-based capital has evolved over the intervening three years, and today we are on exactly the same page. I want to thank my colleague, and his Chief-of-Staff, Sarah Vega, for their willingness to find common ground.
We are proposing a one-year delay of the effective date of the risk-based capital rule, and a modification in the definition of a “complex” credit union. Under the proposed rule, the threshold for complex will increase from $100 million in assets (in chart above) to $500 million in assets (see chart the following page). As a result of this change, only 531 credit unions will be defined as complex. That is less than 10 percent of the more than 5,500 credit unions in the U.S. The remaining 90 percent of all credit unions will be defined as not complex, and will thus be exempt from the risk-based capital rule.
In making this change, however, we will still protect taxpayers and the Share Insurance Fund because the relatively small number of complex credit unions collectively hold more than three-quarters of the system’s assets. In essence, we balanced the need to protect the safety and soundness of the system with our desire to provide regulatory relief to smaller, non-complex credit unions. This is an elegant solution to a complex problem.
It is as important to understand how we got to where we are today as it is to understand what we are proposing.
There is a consensus that all insured depository institutions need a meaningful and effective risk-based capital requirement. A simple leverage ratio does not provide sufficient protection for taxpayers or the Share Insurance Fund — especially for large, complex credit unions.
I can’t tell you how often I have heard from credit unions that the NCUA needs to avoid “one size fits all” regulation. Yet, that is exactly what a leverage ratio is. It says, no matter how big or how small a credit union is, or how complex or how simple its portfolio is, there should be one simple leverage test for everyone.
Credit unions are right; one size does not fit all. That’s why all modern depository insurance capital systems impose a risk-based capital requirement on top of a leverage ratio.
The NCUA was first required to create a risk-based capital system in 1998 when the Congress passed the Credit Union Membership Access Act. Section 301 of that law created a new Section 216 of the Federal Credit Union Act spelling out the requirements for a “risk-based net worth requirement” for complex credit unions and “prompt corrective action” for credit unions failing to meet minimum leverage and risk-based net worth requirements. Congress mandated that the prompt corrective action requirements for credit unions be both “consistent with” and “comparable to” the requirements for insured banks under Section 38 of the Federal Deposit Insurance Act.
The NCUA Board issued its first rule in this area in 2000, and made minor modifications in 2003, 2008, 2011, and 2013. Unfortunately, the rule was confusing and ineffective. It did not capture any of the risks corporate or natural-person credit unions experienced during the Great Recession, and it has only captured more recent risks and losses after it was too late for the credit unions involved to take corrective action. By the time the rule caught up to these credit unions, they were already in danger of insolvency. In addition, the rule was poorly understood. Almost no one could explain what it was or why it was the way it was. It was totally opaque, not transparent.
Regulatory understanding of risk-based capital evolved dramatically over the last two decades. In September and October of 2013, the federal banking regulators, the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, issued new and improved risk-based capital rules to capture risks in the financial system better and to protect both depositors and taxpayers. Insured banks are now operating successfully under significantly enhanced risk-based capital rules.
It should also be noted that no banks are exempted from their risk-based capital rule, no matter how small they are, while the NCUA’s rule exempts all credit unions under $100 million in assets — 72 percent of all credit unions. If this proposed rule is adopted, the exemption will grow to $500 million in assets and will include more than 90 percent of all credit unions.
The NCUA waited until after the other federal financial regulators had issued their new rules before issuing its first major revision in January 2014. The NCUA bent over backwards to adhere to both the letter and the spirit of the Administrative Procedure Act and to maximize input from stakeholders. It extended the original comment period to create one of, if not the longest, comment periods in agency history. It waded through several thousand comments. It then issued a second proposed rule in January 2015 with another extensive comment period. And then it digested and analyzed several thousand more comments before issuing its final rule in October 2015.
That rule had an effective date of January 1, 2019, thus giving all credit unions affected by the rule more than three years to either raise capital or adjust their portfolios to reduce their risk. To the best of my knowledge, that is the longest delay in an effective date in the agency’s history. In total, five years transpired between when the rule was first proposed, and its effective date — and that does not include the extensive time the NCUA’s staff spent preparing the first rule before it was proposed.
I am perplexed as to why some people feel credit unions need another two-year delay in the effective date. The NCUA’s data clearly shows that complex credit unions are ready for the new rule. Since the existing rule was adopted in 2015, the cumulative net worth of credit unions with more than $100 million in assets has grown by more than 25 percent, and that doesn’t include the distributions we just made from the Share Insurance Fund that will further increase those credit unions’ net worth. Today, on average, complex credit unions have more than 18 percent risk-based capital. That is 80 percent more than the 10 percent required under the rule to be considered well-capitalized. That’s not just a cushion, that’s a full-size airbag. And that is using the existing definition of complex at $100 million.
In order to be considered undercapitalized under the risk-based capital rule, a complex credit union must have less than 8 percent risk-based capital. That is more than 1,000 basis points below the actual average risk-based capital level of complex credit unions. A credit union that has a risk-based capital level that low isn’t just an outlier, it is an extreme outlier with a capital cushion that isn’t just one standard deviation outside the norm, it is multiple standard deviations outside the norm. The members of such a credit union should be asking their board and management why they could not meet a standard that virtually all other credit unions are meeting.
I have been committed to working cooperatively with the Chairman and his staff to find a solution that resolves this issue once and for all. This proposed rule meets that objective. It is a substantive solution, not just another delay. It will give the agency time to finalize its systems, and give the handful of complex credit unions who do not have adequate risk-based capital time to raise capital or adjust their balance sheets to achieve compliance and protect their members. That is plenty of time for everyone, especially since work in this area began in early 2014, more than four and a half years ago, and because these proposed changes to the final rule will affect only about a third as many credit unions as the original rule did — 531 instead of 1,557.
We invite thoughtful comment on the two specific changes made in this proposed rule — changing the effective date by one year and raising the threshold for complex from $100 million in assets to $500 million. We will consider all comments fully. I expect anyone who desires further delay to explain why credit unions need significantly longer than banks to prepare for risk-based capital and why continued delay in a rule that has been in development for five years meets our statutory obligation to adopt a system that is “consistent with” and “comparable to” the system with banks. I am not prepared to support delay as a subterfuge for defeat.
Why is the implementation of a risk-based capital system for credit unions important? Because twice in the last ten years we have seen how a very small number of credit unions — in both cases, less than a half a dozen — have taken on excessive risk that resulted or will result in hundreds of millions and, even, billions of dollars of losses to the Share Insurance Fund — losses that the remaining 5,000 plus credit unions and their members had to pay for.
As of June 30, 2018, the Share Insurance Fund has more than $850 million in specific reserves to protect against losses, which under GAAP accounting rules are considered both “probable” and “estimable.” While we cannot discuss specific institutions, this represents probable and estimable losses at only a handful of institutions. The Share Insurance Fund also holds another $100 million in general reserves to protect against losses that do not currently meet the GAAP standard for specific reserves. Together these reserves total nearly a billion dollars.
The risks that resulted in this build-up of reserves are precisely the kind of risks that an effective risk-based capital system is designed to protect against. Risk-based capital is designed to protect the many — especially innocent credit union members — against bad decisions made by just a few. It is disheartening that some who profess to advocate for credit union members have dragged their feet on reforms that would have actually helped them. When these self-appointed guardians ask why their Share Insurance Fund distributions were not greater, they should look in the mirror.
I am proud of the fact that over the last decade, even before I joined this Board, the NCUA Board acted in a non-partisan manner to address the most serious challenges the agency and the credit union system had faced in decades — probably since the passage of the Federal Credit Union Act in 1934. This proposed rule continues that tradition of non-partisan problem-solving. Most importantly, it will better position the Share Insurance Fund and the system for the next set of challenges.