As Prepared for Delivery on December 15, 2022
I would like to thank Chairman Harper for bringing today’s rule before the Board. I have said it before, and I will say it again, that this may be the most well-functioning NCUA Board in quite some time. I think it starts at the top with the Chairman and the fact that we all like each other and get along, and we realize that when we do have policy differences, it is not personal. But just as important, if not more so, for a well-harmonized Board is the relationship among the Board’s Chiefs of Staff.
Since the Board cannot talk to each other directly about policy outside of Board meetings, negotiations must be shuffled amongst our Chiefs of Staff. I would like to personally thank my Chief of Staff, Lenwood Brooks, Catherine Galicia, Chairman Harper’s Chief of Staff, and Sarah Bang, Vice Chairman Hauptman’s Chief of Staff.
I would also like to thank our talented NCUA staff. The initial work for this rule began early this year with a legal memo drafted by Rachael Ackmann, John Brolin, Kevin Tuininga, Ian Marenna, and Frank Kressman in the Office of General Counsel. This was one of the most robust memos I have ever seen in my career, both in the public and private sectors. The Office of Examination & Insurance also played a pivotal role in developing this rule. Thank you, Naghi Khaled, Laura Smith, Simon Hermann, Jessica Yam, Viki Nahrwold, Amanda Parkhill, and Kelly Lay in E&I, for your excellent work.
Today’s proposed rule began under this premise: Fintech companies are originating significant numbers of consumer loans. Credit unions want to effectively reach borrowers digitally by utilizing fintech. Are there ways the NCUA could provide additional clarity? The answer is yes, there are. Today’s proposed rule is the NCUA’s response.
Let me ask a question before moving forward:
How large is the loan participation market for credit unions and how has it grown over the last several years?
Thank you. And to my fellow Board members, I would support making any additional changes to the call report that would modernize it even further to address the changes that fintech is rapidly making to the industry. I think this also is imperative for us to have this data as a safety and soundness regulator. We may be surprised to learn how quickly the industry is evolving with more data.
Because the industry is rapidly evolving, credit unions need to be exploring how to best integrate fintech tools and partnerships into their business models. In 2022, this is no longer a luxury. It is a strategic imperative if we want the credit union industry to remain viable in the years ahead. To take that a step further, I personally believe if fintech does not fit into the credit union business model, it is a long-term safety and soundness issue for the industry.
Fintech is particularly important when it comes to attracting a new generation of credit union members who are younger, more mobile, and more online. Moreover, I believe fintech can be tremendously beneficial in terms of financial inclusion to help us to extend financial services more broadly to underserved communities. So, it’s vitally important that we get this right, and that’s why it is so important for the public to send comments for today’s proposed rule.
Credit unions are currently losing market share to fintech companies. For example, according to TransUnion, fintech loans comprise 41 percent of all unsecured personal loan balances, up from 5 percent of outstanding balances in 2013. During that same period, the credit union market share for unsecured personal loan balances declined from 31 percent in 2013 to 21 percent in 2021. I understand that fintech lending is beginning to interest research economists at the Fed, in academia, and elsewhere.
Preliminary research suggests that fintech lenders are beginning to make significant inroads in mortgage and small business lending – at the expense of traditional financial institutions. These loans are mostly to previously underserved borrowers – lower conventional credit scores for consumer loans and zip codes with higher bankruptcy and unemployment rates for small business loans. Part of this is traceable to creative use of alternative data in underwriting. Additionally, a recent paper by the Philadelphia Fed suggests that it may also be due to regulatory burden. I would also note that fintech market share grew even more during the pandemic, which I assume is because of changing consumer behavior.
Our current regulations have prescriptive limits for credit unions being able to compete in this market, and if changes are not made to the regulations, credit unions may never be able to regain their presence in the new normal of lending. Today’s proposed rule, if enacted as a final rule, would clarify that credit unions that acquired loans through an indirect lending relationship, such as from fintechs, could qualify as the originating lender and be eligible to participate the loan to other institutions in an elegant way.
This is important because one of the biggest and growing sources of loans in the financial marketplace is fintech-originated loans. Younger and more tech-savvy borrowers and potential members are looking to technology companies to provide their financial needs and credit unions are getting left behind. Even when a credit union can develop a relationship with a fintech lending provider, they are severely limited in their ability to cultivate this relationship under the current regulations. The current loan purchasing regulations, which we are proposing to change, only allow a federal credit union to purchase the loans of its members from any source up to five-percent of the purchasing federal credit union’s unimpaired capital and surplus. There are several exceptions to this five-percent cap, but they are cumbersome to understand and impose a high regulatory burden. Additionally, it is my understanding that if allowed by state law, state-chartered credit unions can acquire non-member loans from eligible organizations. NCUA rules do not speak to state-chartered and federally insured credit unions loan purchases, so it would only be addressed in state law.
The proposed changes before the Board today would narrow the application of the five precent limitation, and instead provides for the credit unions to establish policies to govern their due diligence and risk management practices regarding these purchases, including establishing their own risk limits based on the size and complexity of its portfolio. I am a believer in a principles-based approach to regulation. Focusing on the credit decision, and who is making it, is a deciding factor under the proposed rule. Credit unions will need to justify how they are making the credit decision, which is implied in today’s proposed rule. I like the idea that the onus is on the credit decision and linking it to the origination process.
Similarly, this rule would remove the requirement for certain credit unions to request NCUA approval to purchase certain non-member loans from other federally insured credit unions. Currently only credit unions rated a CAMELS 1 or 2 and classified as well-capitalized may engage in this activity without prior NCUA approval. These credit unions would now be able to purchase these types of eligible obligations after establishing sound policies, but without having to send in a written request for approval.
Some have expressed concern that eliminating the limits in the regulation and the requirement to be a well-run credit union causes safety and soundness concerns. This is particularly important in this regulation since a credit union can materially change its balance sheet structure in a very short period of time. I believe we need to eliminate barriers so credit unions can compete, but can you talk about how this risk will be mitigated in the proposed rule?
I have heard it said time and time again that it is difficult for small credit unions to concentrate on good lending decisions and not get caught in legal technicalities with the loan participations and purchases regulations. The current system is not very clear, as I have previously outlined today. This was first flagged years ago during the Regulatory Reform Task Force. Additionally, I have heard larger credit unions may be limited in their ability to participate in loans originated by non-traditional financial institutions due to the ambiguity in NCUA’s current regulations. This proposed rule attempts to solve these issues.
I do have several questions at this point:
While we have a clear definition in this proposed rule for loan participation, we say in this rule an eligible obligation is essentially anything else that is not a loan participation. Can you discuss why it was drafted like this?
Thank you. I do worry that this definition may cause some confusion in our examinations, so I would urge that if this rule becomes final as is, additional guidance may benefit our examiners and provide greater clarity and consistency in the industry.
The originating lender language in today’s proposed rule is important because it closes a blind spot in the regulations. Can you please elaborate?
I noticed that a legal agreement needs to be reviewed by counsel according to this rule. Has the NCUA ever considered a template of an approved agreement? Uniformed legal agreements could really benefit our smaller credit unions and our MDIs.
Thank you. I am delighted the Board is considering this action because I believe this proposed rule will reduce confusion about circumstances when a federal credit union can still be the originating lender when working with fintechs in indirect lending arrangements, which allows the federal credit union to participate loans out, as opposed to circumstances when the federal credit union is simply buying loans, when participations are not permitted. If this rule becomes final in its current form, it will no longer require federal credit unions to search for a legal opinion that supplements current regulations to decipher what is permissible in this area. I hope this rule provides more clarity and will be transformative to keep this industry vibrant by utilizing fintech.
Today’s proposed rule asks numerous questions that would allow the NCUA to hopefully get a better read on industry practice when it comes to indirect lending relationships at present, such as how quickly loans are generally assumed by a federal credit union after the original contract date and how federal credit unions communicate their underwriting standards in a way that would still show that they are making the final underwriting decision. I would also like to hear from both buying and selling credit unions in how they use loan participations to mitigate concentration risk to limit acute stress on their assets through balance sheet management.
I’m focused on these reforms before us today because I’m convinced they’re essential to ensure that the credit union industry remains strong now and in the future. Because while credit unions have been performing well, we can’t stay blind to the competitive pressures credit unions are facing. We must acknowledge the threats that credit unions face from a changing marketplace, the structural restrictions the credit union industry has placed upon itself, and a regulatory solution, like today’s proposed rule, that enables credit unions to more effectively compete in the increasingly challenging and rapidly changing financial marketplace with the appropriate safety and soundness guardrails. If we do nothing to respond to the changing marketplace, history will not be kind to this Board or this agency, so I view today’s action as a positive first step.
So, again, I’m urging credit unions and the NCUA to be proactive on fintech. You may recall the quote from the famed financier J.P. Morgan, who said that “The first step towards getting somewhere is to decide that you are not going to stay where you are.” For credit unions and the NCUA, that means we need to be pursuing these opportunities, although I need to be clear I am speaking about fintech generally and not any particular product or service.
If there’s anything further that we can be doing on the regulatory side to help credit unions take advantage of the most promising fintech innovations that are available to meet the needs of credit union members while ensuring the safety and soundness of the credit union system, please let us know. My door is always open.
I have nothing further.