NCUA Chairman Todd M. Harper’s Remarks at the 2023 REACH Conference

As Prepared for Delivery on October 24, 2023

Good afternoon, everyone. And, thank you, Diana, for the kind introduction. Thanks as well to the California and Nevada credit union leagues for inviting me to join your conference.

2023 Q2 Performance Data

To get us started, I’m eager to report on the industry’s most recent performance metrics. Last month the NCUA released the credit union system’s performance data for the second quarter of 2023. These aggregate statistics provide important insights into the current state of the credit union system. Overall, the metrics indicate that credit unions remain generally well positioned at this time.

For example, the industry’s aggregate net worth ratio grew to 10.63 percent, which represents an increase of 21 basis points over last year, and a recovery of 61 basis points from the pandemic’s low. And, at the end of the second quarter, we recorded a 12.6 percent year-over-year increase in the number of credit union loans. While that figure lags slightly behind what we observed during the previous four quarters, it indicates a continuing trend of healthy loan growth.

Warning Signs

But, that good news is only part of the story. Economists are forecasting an economic slowdown as the lagged effects of elevated interest rates take hold. Moreover, the downgrade in the Moody’s credit ratings for several regional banks earlier this year signals ongoing stress on the financial system’s funding and economic capital.

During the last few quarters, the NCUA has also seen growing stress within the system because of a rise in interest rate and liquidity risk. In fact, this financial stress is reflected in the increasing number of composite CAMELS code 3, 4, and 5 credit unions. Assets in composite CAMELS code 3 institutions increased sizably in the last quarter, especially among those complex credit unions with more than $500 million in assets. And, such increases may well continue in future quarters. We have also seen more credit unions fall into the composite CAMELS code 4 and 5 ratings during the second quarter.

The increase in the level of reserves in the Share Insurance Fund — more than $6 million since the last quarter — is tied directly to the number of troubled credit unions. Further, we are seeing growing signs of credit risk emerging, especially in the commercial real estate market and among families with increasingly stressed household budgets, which have spent down pandemic-related savings and struggle with higher prices for goods and services. Although inflation has moderated over the last year, many households are increasingly showing signs of significant financial strain, as seen in rising delinquency rates for various credit union loan types, including automobile loans and credit cards.

The recent rise in home equity lines of credit balances could also indicate financial stress in some households stretching to make ends meet. Any inflationary “surprises” in the coming months, such as food and supply chain disruptions from the wars in Ukraine and the Middle East, could put further pressure on household finances.

To compound those concerns, we are seeing an increase in net charge-off ratios at credit unions and declining annualized returns on average assets. Plus, the high levels of interest rate risk we are seeing can     increase a credit union’s liquidity risks, contribute to asset quality deterioration and capital erosion, and place pressure on earnings.

In fact, several credit unions, including those with more than $1 billion in assets, are already experiencing an impact on their performance. Other timely issues, including the reinstatement of federal student loan repayments and rising costs for property and casualty insurance, will also have an impact on already strained household finances, and it seems more likely than not that credit union delinquency and charge-offs will continue to rise in future quarters.

Second Quarter Takeaways

So, what should we make of this good news-bad news picture of the second quarter data and current economic realities and expectations? For me, the biggest takeaway is that we are seeing a tale of two types of credit union members emerging, both of which represent risks that credit unions must manage.

The first type are the savers who have shifted deposits to share certificates to take advantage of better rates. The growth in timed share deposits has jumped by 69 percent over the last four quarters. Unless carefully managed, this dramatic switch away from low-paying savings and share checking accounts can expose credit unions to greater interest rate and liquidity risks. And, the second type of members are those with growing financial stress, many of whom are on the wrong side of the higher delinquency rates in credit cards and automobile loans. With this rising household financial strain, credit unions must carefully manage their credit risks going forward and consider early intervention to prevent a delinquency from becoming a charge-off. Credit unions must also remain prudent and proactive in managing interest rate risk and the related risks to capital, asset quality, earnings, and liquidity.

For our part, the NCUA will continue to monitor credit union performance through the examination process, offsite monitoring, and tailored supervision. And, when appropriate, we will take action to protect credit union members and their deposits. In addition, the NCUA is coordinating with other federal financial institutions regulators to ensure the overall resiliency and stability of our nation’s financial services system.

Credit union executives, supervisors, and boards of directors, therefore, must remain diligent in managing the potential risks on their balance sheets and monitoring economic conditions, household finances, and the interest rate environment.

Decline of Overdraft Programs

The issue of household finances brings up an important topic that has generated recent headlines: overdraft and non-sufficient funds fees. Banks have worked in recent years to restructure their overdraft and NSF fee programs. The time has come for credit unions to do the same, if they want to remain competitive and live up to the statutory mission of credit unions of meeting the credit and savings needs of members, especially those of modest means.

Research also shows that overdraft and NSF fees fall disproportionately on underserved communities. Problematic overdraft programs include those that charge fees that aren’t reasonable and proportional, rely on systems that authorize positive and settle negative, or impose multiple representment or non-sufficient funds fees. Multiple representment fees can be especially onerous as consumers foot the bill for both themselves and merchants, while financial institutions get paid multiple times. As we are in Las Vegas, I can compare the financial institution’s position to that of the house, because the house always wins no matter how small the take is. It is a clear case of winners and losers.

But, in this industry’s scenario, the winners are entrusted with the financial well-being of the losing players — the consumers — who are struggling to break even. This dynamic is shown in recent data from the state of California. One recent analysis of that data from an independent think tank found that 114 state-chartered credit unions in California took in approximately $252 million in overdraft and NSF fees in 2022. Of those credit unions, eight derived their entire positive net earnings from overdraft and NSF fees. And, 30 institutions earned at least half of their positive net earnings from the same fees. This overreliance on overdraft and NSF fees adversely impacts both parties.

Financial institutions that rely on fee income from overdrafts and NSF fees have concentration risk issues, which raises potential safety-and-soundness concerns and is not sustainable in the long term. And, on the other side of the transaction, consumers who can least afford it are paying an oversized portion of those fees. The Federal Reserve Bank of New York reports that most depositors rarely or never overdraw, while 9 percent overdraw 10 or more times per year. According to the Consumer Financial Protection Bureau, nearly half of financially vulnerable households paid overdraft fees last year, compared with just 4 percent of financially healthy households. These vulnerable households have difficulty paying bills on time, saving for emergencies, and managing debt, and are more likely to be Black and Latino.

Because of these issues, many banks and credit unions are evaluating how to restructure their overdraft programs or even drop overdraft fees entirely. And, some have already made that leap. In a report issued two weeks ago, the CFPB stated roughly two out of three banks with over $10 billion in assets have eliminated NSF fees, saving consumers nearly $2 billion annually. And, three out of four banks that earned the most in overdraft and NSF fee revenue in 2021 have now eliminated NSF fees.

Now, contrast those numbers with the CFPB’s findings for credit unions. Among credit unions with over $10 billion in assets, 16 of 20 continue to charge NSF fees, including four of the five largest. So, as it stands, credit unions — especially the largest ones — are behind the curve. And, how can it be that banks, on this metric, are more consumer friendly than credit unions? That fact should give everyone in the credit union industry pause.

Now, I recognize that not all credit unions are ready to make the jump to reduce or eliminate overdraft and NSF fees overnight. These decisions require adjustments to revenue expectations, especially as overdraft fees comprise a sizable proportion of non-interest income at some credit unions. If your credit union plans to maintain an overdraft program, I encourage you to consider features like linking to savings accounts; offering affordable lines of credit or short-term, small-dollar loans; and helping members build their savings. However, as more financial institutions dramatically decrease overdraft fees or drop them altogether, consumers will begin to expect their institution to follow suit.

So, it is time for credit unions to rethink their overdraft programs if the industry wants to remain competitive and achieve its statutory mission and purpose. The good news is that credit unions and banks that have already made the switch have not had to cut services to members or pare back operations. Instead, many have created new income streams. You, too, can diversify your revenue streams in creative ways.

For starters, build your member base and create new loan products. You can also originate a greater number of safe, fair, and affordable mortgages and other loans using alternative ways to identify the creditworthiness of your members. Once you make those loans, service them. These are just a few ideas, and I am certain that if you apply the insights and innovation of your teams, you will find there are other ways to operate more fairly and equitably.

Artificial Intelligence

Another factor driving the elimination or reduction of overdraft and NSF fees is competition from financial technology providers. The showcase earlier today highlighted the promise of fintech in helping the credit union system compete in the future. And, on a related note, all of us have heard the stories about the potential of ChatGPT and other examples of generative artificial intelligence that are poised to play a significant role in fintech.

But, AI — including its use in fintech applications — offers both promise and peril. As a regulator, insurer, and supervisor, the NCUA’s goal is to maximize and deliver on the former while identifying and mitigating the risks of the latter. Some of the pitfalls in relying on artificial intelligence to make important, even life-changing, decisions have already come to light.

The CFPB issued guidance last month reminding creditors that they must provide specific reasons for an adverse action taken against an applicant under the Equal Credit Opportunity Act and the Fair Credit Reporting Act. The CFPB notes that many financial institutions “use complex algorithms involving AI and other predictive decision-making technologies in their underwriting models.” However, the agency warns the data harvested by AI may not accurately reflect the likelihood a consumer will repay a loan. If the credit union system is to live up to its foundational philosophy of “people helping people,” it must ensure the information used to evaluate an applicant’s creditworthiness captures the individual’s full credit profile.

And, that is not merely a courtesy to members who entrust their finances to credit unions, it is their right under the law. Earlier this year, the NCUA joined with other federal financial regulators to issue proposed rules for automated valuation models that incorporated fair lending principles. We anticipate finalizing that rule in the year ahead.

So, while AI can allow credit unions to smartly automate certain functions, like member communication and loan underwriting, it must be harnessed in a responsible way to ensure fairness, transparency, and consumer protection. The NCUA is keeping a close eye on developments in this field and measures adopted by our peer regulatory agencies, so the credit union system can continue to innovate while remaining faithful to its statutory mission.

Real-Time Payments

Now, that’s not to say that technology’s role in the financial services landscape is all bad news. Far from it. In fact, technology — when properly harnessed and consistent with consumer financial protection — can facilitate a better member experience and potentially advance financial inclusion.

One case in point is FedNow, the around-the-clock instant payment network recently launched by the Federal Reserve. FedNow joins other instant payment services like PayPal, Zelle, and Venmo to give consumers 24-hour access to their money and the ability to conduct transactions in real time. And, it is no exaggeration to say real-time payments are both the present and future of financial services and products. Indeed, they have recalibrated customer expectations for what depository institutions should offer to keep their business.

In addition, two important benefits of instant payments — convenience and cost savings — chip away at the barriers to financial inclusion. They have the potential to give consumers and businesses more control over their money and reduce the time and cost of receiving payments, which makes them more economically resilient.

Moreover, consumers who use instant payments vehicles could be at a lower risk of incurring penalties and fees on their bank accounts. That said, the availability and velocity of funds under an instant payment regime are cause for both excitement and potential worry. Faster settlement has inherent risks and can pose liquidity and risk management challenges for financial institutions. And, because instant payments are irrevocable, they present an increased opportunity for fraudsters to steal the hard-earned savings of victims with little to no recourse for recovery. That’s why credit unions and banks must prioritize instant payments security by applying sound anti-fraud and cybersecurity measures. Staying ahead of bad actors to realize the promise of these innovations without jeopardizing consumers’ financial well-being will require close collaboration among all stakeholders.

All the points I raised today — meeting the challenges of an evolving economic environment and changing risks to credit unions, rethinking overdraft and NSF fee programs, and understanding both promise and the peril of fintech to harness this technology safely and soundly and consistent with consumer financial protection laws — will require your credit union to apply creativity and ingenuity when shaping the prospects of your institution and members.

By working together, regulators and industry can ensure that as the industry grows and evolves, it remains true to its mission and its commitment to serve all members. That’s a future that’s good for consumers, good for credit unions, and good for the economy.

Thank you again for the kind invitation. With that, I will pass the floor back to our conference’s emcee, Andrew Davis.