In April 2014, the NCUA Board approved an initial capital planning and stress testing rule for the nation’s largest credit unions. I supported that rule, and I support this revised rule today because it builds on what we have learned over the past four years.
It is important to remember that when we adopted the initial capital planning and stress testing rule in 2014, we did so for very different reasons than the Federal Reserve did when it adopted similar rules for banks. Although our methods and principles were similar to the Federal Reserve’s, our goal was different. The Federal Reserve was principally concerned with systemic risk to our national economy. Our principal concern was to protect against systemic risk to the National Credit Union Share Insurance Fund, a very different risk.
While the FDIC has both capital planning and stress testing requirements for federally insured banks, there are differences between their rules and ours because there are significant differences between the capital regimes for banks and credit unions. The largest banks are orders of magnitude larger than the largest credit unions, and the on-balance sheet and off-balance sheet risks of banks and credit unions are very different.
It should also be noted that just as we are modifying our capital planning and stress testing regime today, the other federal financial institutions regulators have also modified their regimes over time, and, like the NCUA, are increasingly incorporating this work into their regular supervision.
I pointed out when we adopted the initial rule in 2014 that the covered credit unions should be proud of the fact that they had all weathered the largest financial crisis in the history of the credit union system. I also stated that our capital planning and stress-testing program was designed to set them up to survive the next crisis, which might be very different from the last crisis, and to reduce systemic risk to the Share Insurance Fund.
As someone who comes from the Pacific Northwest, I pointed out that this process is similar to how we, as a nation, prepare for earthquakes. They may not happen often, but when they do occur, the damage can be great and thus an ounce of prevention can be worth a proverbial pound of cure. Our building codes are based on the size and nature of a building, where it is located, and the risk it faces. The requirements for multi-family housing are typically more stringent than for single-family housing. Furthermore, the requirements for commercial and very large buildings are more stringent, and the requirements for buildings in precarious locations are even more stringent.
Our capital planning and stress-testing requirements are similarly nuanced and varied based on the size of credit unions and the potential risk they pose to the Share Insurance Fund.
I also said in 2014, and I reiterate today, that just as building codes to protect against earthquakes are mandatory and not just a set of best practices, so too we needed a rule that was mandatory, and not just guidance.
When some people complained in 2014 about the cost of implementing our capital planning and stress testing requirements, I pointed out the Share Insurance Fund insures members up to $250,000 and that the first-year cost of the program was equal to the insurance we were providing to just 20 of the more than 7.5 million members the covered credit unions had at that time. I also added that, “an insurance actuary would tell you that is pretty cheap insurance. It is a small price to pay, to protect against systemic risk to the Share Insurance Fund and the more than 100 million Americans who depend on it.”
When we adopted the initial rule in 2014, we set up a system under which the NCUA would establish both capital planning and stress testing requirements, and run the stress tests with technical support from outside experts, because at the time, we did not have the staffing and skills at the agency to run the stress tests in-house. We committed, however, to building up our capabilities in this area and to give covered credit unions the ability — after successfully passing three successive stress tests — to run their own tests under our guidance and subject to our specifications and validation. In 2014, I said it was appropriate to bring in additional outside expertise in the early years, but that it was, “imperative that we develop the talent that we need here in-house to run and supervise stress tests.”
This new, final rule implements that plan and builds upon the experience both we, and covered credit unions, have had under the initial rule. I want to thank the staff in our Office of National Examinations and Supervision for developing this proposal, and for diligently building their in-house capabilities and expertise over the last four years. This growth will continue under the two-year budget the Board unanimously adopted last November, and we will continue to phase-out our reliance on external expertise.
I also want to thank the Chairman and his staff for their leadership in this area and for working with me and my office on this, as on many other matters, in a cooperative way to find non-partisan solutions that prepare both our agency and the credit unions system to meet the challenges of tomorrow, as well as the challenges of today. I should note for the record, Mr. Chairman, that this meeting marks the end of two full years where you and I have been working side-by-side, able to resolve any and all differences through our staffs and the agency’s staff, to further the work of the agency. We’ve made great progress over those 24 months, and I dare say that if other federal agencies worked as cooperatively as we did, our nation would not be suffering from partisan gridlock and distrust.
In this final rule, we are providing some regulatory relief by phasing-in both the capital planning and stress testing requirements as credit unions grow in size. We are adjusting the thresholds to account for inflation, changes in the credit union system, and the growth of the Share Insurance Fund.
We are not, however, increasing the threshold for covered credit unions to $50 billion as some requested. Instead, we are adopting an incremental regulatory approach with three phased-in tiers for capital planning and stress testing.
The threshold for the smallest, Tier I covered credit unions will remain at $10 billion. This is the level at which credit unions move from being supervised by our regions to our Office of National Examinations and Supervision. Tier I credit unions will conduct capital planning and will begin preparing for stress testing, but will not be required to conduct stress tests. Capital plans will be reviewed through ONES’s normal supervision of the covered credit unions.
At $15 billion, Tier II credit unions will be required to incorporate NCUA’s stress testing scenarios into their capital plans and will begin conducting stress tests. The $15-billion threshold for Tier II credit unions is functionally similar to the three-year period under the old rule between when a covered credit union was subject to capital planning, and when it had to start stress testing.
It is worth noting that $15 billion is also the approximate size of the Share Insurance Fund. While the failure of a $15 billion credit union would be unlikely to wipe out the Share Insurance Fund if the losses were roughly one-third, it could cause the fund’s equity ratio to fall below 1.2 percent. This would require the agency to adopt a net-worth restoration plan to restore the Share Insurance Fund. If the failure caused the equity ratio to fall below 1 percent, it would impair the 1 percent deposit all insured credit unions have in the Share Insurance Fund, requiring them to write down those deposits on their own books.
At $20 billion, Tier III covered credit unions must meet a minimum stress-test ratio of 5 percent and must submit a plan to restore their capital to 5 percent if they fail to meet that requirement.
Under this rule, as under the existing rule, the NCUA retains the rights to move a credit union to a higher tier if facts and circumstances warrant it, and to conduct a stress test itself, rather than allowing a credit union to conduct it. In addition, the NCUA will continue to define capital planning requirements, the stress scenarios, and how stress tests must be conducted.
Even though the composition of the NCUA Board today is different from the Board that adopted the initial rule four years ago, we have fulfilled the commitment made in 2014 to review and update our capital planning and stress testing rules. We have done so in a non-partisan manner that emphasizes the paramount importance of protecting the safety and soundness of the system, while at the same time being cognizant of the burden we place on covered credit unions. Furthermore, we are, as my colleague has often suggested, regulating smarter, and as I have suggested, doing more of the work in-house. This will enable us to incorporate what we have learned into the development of better and virtual, real-time supervision and examination of all natural person credit unions — another goal that my colleague and I share.
I thank the ONES staff, our General Counsel’s office, and our Chairman and his staff for working cooperatively with me and my staff to develop an improved capital planning and stress testing rule that will enable us to build, as I said four years ago, “a stronger regulatory framework that is capable of addressing the challenges of the future as well as the challenges of the past.”