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Credit Union Capital Requirements Stifle Access to Credit

Credit unions provide essential retail financial services in the form of depository accounts and consumer loan products and services. Perhaps at no point since the Great Depression has the role of credit unions been of greater importance to consumers than the present financial crisis. 

Historically, credit unions provided a countercyclical balance when the economy weakens by offering a ready source of lending to members and as a safe harbor for deposits. However, the current statutory framework for credit union capital introduces a set of unintended consequences that constrain lending and deposit-taking activities while increasing customer costs at the very time that services are needed most.

Under current law, retail credit unions cannot raise capital. Unlike all other federally insured depository institutions that have access to some form of supplemental capital (including low-income credit unions), retail credit unions can only improve their net worth through retained earnings. 

Like all other federally insured depository institutions, credit unions are subject to Prompt Corrective Action rules, a set of capital-based supervisory standards.  The combination of PCA rules and a restrictive statutory definition of net worth, however, create unique challenges for retail credit unions during stress periods and make it more difficult for them to address capital deficiencies should they arise.

In the years following enactment of PCA, credit unions largely enjoyed a favorable economic environment resulting in sustained strong performance. But as the recent financial crisis unfolded, credit unions faced unique challenges.

As markets became volatile and a general uneasiness fell over the investing public regarding the relative safety of instruments traditionally viewed as low-risk, credit unions were viewed as a safe haven. But at the very time consumers were looking to move their money into credit unions to shelter them during a crisis, the influx of deposits was causing a reduction in the net worth ratios of many credit unions.    

As the crisis grew, banks tightened underwriting terms. The result is the credit crunch that has yet to abate. 

Recent evidence from the crisis indicates that several well-capitalized credit unions slowed deposit gathering in apparent response to eroding net worth ratios.  An unintended consequence of PCA for credit unions is that without a mechanism other than retained earnings to raise capital, credit unions are forced to take drastic measures to ensure their capital ratios remain at well-capitalized levels. This is called the "PCA Trap."  

The alternatives faced by credit unions caught in this PCA Trap have the effect of penalizing consumers and sidelining credit unions from helping to do their part to stimulate an economic recovery. 

For example, credit unions may be forced to lower the rates they pay on deposits to limit inflows. Or they may be forced to raise fees on customer services, lending and products offered to members, as well as reduce noninterest operating expenses and member services in order to improve their retained earnings position. This is a problem that must be fixed.

Congress should revisit the issue of credit union capital and explore supplemental forms of capital specifically tailored to credit unions as not-for-profit financial cooperatives. 

The Capital Access for Small Businesses and Jobs Act (H.R. 3993) introduced this year in the House offers one such solution. 

The bill would strengthen the capital and improve the safety and soundness of credit unions by allowing the National Credit Union Administration to authorize qualified credit unions to accept additional forms of capital to supplement their retained earnings.  The legislation would impose two important limitations on this new authority.

First, the bill excludes from consideration any form of supplemental capital that would alter the cooperative nature of credit unions (e.g., by providing voting rights). Second, the measure expressly confines supplemental capital to only those credit unions that the NCUA determines to be sufficiently capitalized and well-managed. Weak CUs won't get a handout, which would promote undesirable behavior, but strong ones will be spared having to throttle back on lending or deposit-gathering.

The NCUA would determine the specific forms of capital that could be offered through a future rulemaking (subordinated debt is one possibility). But in simplest terms, supplemental capital is a tool that could help well-managed credit unions, large and small, meet their members' demand for access to affordable credit. This would benefit consumers, small businesses and the economic recovery by keeping private credit flowing at a time that we need it most.

Clifford Rossi, PhD, is an Executive-in-Residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.    


(16) Comments



Comments (16)
Restraints on raising supplemental capital are designed to ensure credit unions use their generous tax subsidy to serve their mission of helping people of modest means with a common bond. Providing credit unions with the power to bring in investor capital will make them like any other for-profit corporation that issues debt and stock---except that they will keep their tax-free status. It also would create conflicts between credit unions' mutual owners and investors.

Raising supplemental capital would allow credit unions to expand like any for-profit entity and stray from their mission. If credit unions want to be able to raise supplemental capital, they should have to pay taxes like other for-profit companies.
Posted by Camden_Fine | Monday, September 10 2012 at 3:19PM ET
Mr. Wilcox - the idea that credit unions do not comply with consumer compliance laws is bogus. Look at the alphabet list of regulations that the CFPB has over banks and credit unions for consumers and credit unions are there to the same extent. Not to mention that federal credit unions have an interest rate cap that does not apply to banks. And additional limitations on benefits received by directors that do not apply to banks.

IF credit unions accept taxation, then it will be for complete banking authorities and powers. Not the limited powers that you'all saddled S&Ls with when they became taxable in the 1950s. Full taxation for full banking powers. Including all consumers being able to be served in such mutually-owned banks (which is not possible today under federal law).
Posted by no political hacks preferred | Monday, September 10 2012 at 2:01PM ET
Mr.Rossi, given that you are viewing this from academia, rather than the real world and guessing that you belong to a non-tax paying credit union, I guess I can see, although don't understand your viewpoint.

Credit unions may well provide what you call essential financial services, but so too do thousands of tax paying community banks around the country. And while I agree that historically credit unions did provide some form of of counter cyclical balance to the economy, they were able to do this solely because they really were serving people of modest means who shared a common bond. A real common bond, such as a place of employment, not a common bond like a membership fee or state of residence. The fact of the matter is that credit unions today are operating so far outside their mandate that they are non longer able to provide this counter cyclical balance, and they have not been able to for some time.

The real issue is tax exempt credit unions becoming greedy and always wanting more while at the same time preserving all of the exemptions granted to them that we're designed to focus their efforts on a small offering of products to pele of modest means.

You can cite all of the regulatory burdens that credit unions face, but let me point it that credit unions play by an entirely separate set of rules, heavily slanted in their favor than those that FDIC insured financial institutions must comply with. For example, credit unions are not subject to the Community Reinvestment Act, and they are not subject to consumer compliance laws. Their primary regulator, the NCUA is nothing more than the fox in the hen house.

HR 3993, is bad policy. It doesn't address the problem, it only would serve to further a credit union industry that is taking on more risk than they understand or know how to manage all the while operating so far out of their mandate that they look like banks.

The overwhelming majority of credit unions today do not truly serve people of modest means or a true common bond. So let them convert their charter, like many have, and we will welcome them to the real world party where we pay taxes, comply with CRA and cons,er compliance and where capital makers abound for community banks.

Mr. Rossi, your argument could not be more flawed. If it looks like a bank and acts like a bank, call it a bank. Tax it like a bank. And, let it ay by the same rules as a bank.

Noah Wilcox
Mr. Wilcox is a fourth genration banker, bank owner and active advocate for free market community banking and the dual banking system in the United States.
Posted by grsb | Saturday, September 08 2012 at 9:00AM ET
Taxation is not the issue. The issue is providing access to credit to help stimulate the economic recovery. The article makes clear that H.R. 3993 limits the types of capital that would be made available to credit unions, consistent with their status as not-for-profit financial cooperatives. Credit unions can and do serve an important role for a segment of the market. Current law makes it difficult for some healthy, well-managed credit unions to fully assist in the recovery. As Dr. Rossi notes, Congress should act to fix the problem. H.R. 3993 offers a bi-partisan solution.
Posted by strand | Friday, September 07 2012 at 8:27PM ET
Re: Credit Unions and Taxation

For some 50+ years I was an investor in and served on the board of a couple of small, mid-west community banks. The first had survived the depression due to an infusion of capital from one local businessman. It had a handful of stockholders, all local farmers, businessmen etc. Dividends were non existent for at least the first 15 years I was on the board as we strove to gain capital and serve the community. There was no market for the stock other than putting two individuals together. Our main focus was on survival, growth without too much risk and hoping to someday pay our fellow patient stockholders a dividend. Laws changed and eventually we were acquired in a stock-for-stock exchange by a much larger regional bank. Those patient stockholders who hung onto the new stock did quite well for a number of years until it got hammered in the recent financial meltdown.

I also serve as a volunteer, first on the supervisory committee and now on the board, of a community credit union for nearly 30 years. 10 or 15 of those years overlap with my banking experience and you can imagine the good natured kidding I have received from both camps!

Thus in my opinion and based on my experiences I can say with certitude that the community banks cry for taxation of credit unions is totally specious and BS.

Banks do not exist to serve their depositors, rather they exist to reward their shareholders. Some small banks with limited numbers of shareholders can pass through the net-profit/loss to the individuals and avoid federal taxes. All banks take taxation minimization into their planning.

Credit unions, where each depositor is an owner with one vote, exist to serve the financial needs of it's member-owners, a far cry from banks attempting to maximize returns to shareholders. A simple look at the ratio of shareholders (a small number) to depositors at any bank will illustrate the difference. In credit unions the ratio is 100% as they are one and the same.

All capital in a credit union comes from those member-owners by management adjusting the spreads between dividend rates and loan rates. Capital in banks comes initially from shareholders then thereafter from the accumulated profits gained from the depositors and borrowers. Much the same process but with a different driving force. Banks can raise capital by issuance of stock, certain types of long-term loans, etc. Not so credit unions. Capital in credit unions comes solely from from retained earnings which all come from the member-owners transactions over time from inception onward. A huge difference in the ability to raise capital.

By the way the premiums banks pay for FDIC deposit insurance are paltry compared to what credit unions pay for NCUA insurance. Banks insurance premiums, as we have recently seen, are subsidized by our fellow taxpayers, credit union not so.

In my experience I believe that credit unions can be strengthened in their mission of serving their member-owners financial needs if they can have access to additional sources of capital.
Posted by EvH | Friday, September 07 2012 at 5:05PM ET
Credit Unions have been engaging in high volumes of commercial lending and banking for decades without paying any federal income taxes whatsoever, giving them an unfair competitive advantage and adding to the national deficit by a calculated $30 billion over the last decade. This ridicuous and unfounded subsidy has helped them steal the best community bank commercial customers and commercial lenders, and to protect and further their unfair advantages with huge lobbying and marketing budgets. Why should a credit union that provides commercial banking services and makes tens of millions of dollars in profit pay no tax? Ridiculous. One of their lobbying defenses has always been that they can't access the capital markets, which really isn't a valid excuse for tax evasion. I say, let credit unions access the capital markets, and let them pay their fair share of taxes!
Posted by SHorton | Friday, September 07 2012 at 4:12PM ET
Query whether there's any actual capital
anywhere in the financial sector?

But CUs represent, what?; 2%.

So it's a tempest in a teapot, but the
comments show what a slippery political
football it is.
Posted by bob-dc | Friday, September 07 2012 at 3:35PM ET
If Credit Unions wouldn't be trying to change into something they were not created to do, then they wouldn't be having all these issues. They want to become commercial banks, but retain tax exempt status, etc. If they want to be a bank, let them apply for a bank charter, and join the banks on equal territory.
Posted by cwilson622 | Friday, September 07 2012 at 3:02PM ET
If it walks like a duck and quacks like a duck - it's a duck!!! If the CUs want to participate in capitalism let them become banks and be regulated like a bank and pay their fair share in taxes like a bank. Their free ride should come to an end. If they want to be responsible members of our society they should contribute to it as well and stop being tax exempt banks.
Posted by petwal | Friday, September 07 2012 at 3:01PM ET
Equal footing with banks, same rules. You can't have it both ways. Be taxed and have access to capital. How sorry can anyone be to think they can play by different rules and yet have access to capital. One charter- same rules. No one feels sorry for credit unions. Did you know they pay tax in Canada.
Posted by Bank doctor | Friday, September 07 2012 at 2:14PM ET
They can become a bank, pay their fair share of this county's obligations and raise all the capital investors will entrust to them.
Posted by bobjon | Friday, September 07 2012 at 2:06PM ET
Mr. Rossi characterizes the problems facing credit unions very well. In effect, credit unions are between a rock and a hard place. They are one of the few financial institutions whose assets and liabilities both are predominantly consumer oriented and yet the capital conundrum facing credit unions is severe. The tax advantage in effect has become a substitute for lack of effective access to the capital markets.

The commenters on taxation make a good point and maybe what the answer is focuses on defining tax exemptions. Credit unions, mutual savings banks and perhaps even mutual insurance firms with a very narrow business line that fall below a maximum asset test (say $200 million or so) and commit to remain mutual could be considered tax exempt. Any institution, regardless of mutuality, that exceeds the maximum asset test would be taxed but allowed to convert and raise capital as necessary.

From the NUCA's standpoint, the option would allow for stock credit unions. As someone who has been around the credit union industry for some time, I recognize this is a culture change for credit unions. But it makes sense to preserve an important focus for local consumer lending and it ensures that well-run, well-managed credit unions will have access to growth. It also underscores the credit union's business of promoting financial knowledge and financial strength.
Posted by helmudt | Friday, September 07 2012 at 2:01PM ET
What the credit unions need to do without losing there status is to have Permanent shares. These share are used to capitalize the credit unions and the members can't use them to borrow against or cash them in .
Posted by pman | Friday, September 07 2012 at 1:55PM ET
If credit unions want to be on equal footing with other federally insured depository institutions, revoke their non-profit status and have them apply for a bank charter. Credit Unions have morphed into something that they were never meant to be. By extending their loans (and membership) beyond a core group, they have exposed themselves to more risk and thus losses/lack of earnings. Now they want to increase their lending ability for commercial credits. When will their requests for more and more meet with reality?

You'll get no sympathy from any knowledgeable person in the financial industry regarding the "drastic" steps credit unions may have to take to address their capital predicaments. Credit unions pay above market rates on deposits and charge below market rates on loans, all because they enjoy non-profit status. Why should they now be able to compete for capital, just because they can't earn their way out of poor management decisions, even without paying taxes.

Their non-profit status alone is a competitive advantage that most other financial entities will never have access to. And the steps outlined by Mr. Rossi are those things financial institutions are confronted with today while still managing to pay taxes on their earnings. Sorry, credit unions shouldn't be exempt from those tough and very real decisions.

It seems to me that Credit Unions want their cake and eat too. Time for a reality check and to to ask the tough question, "is the credit union model no longer viable in the 21st Century?"
Posted by jdrakepbtx | Friday, September 07 2012 at 1:45PM ET
Let them raise all the capital they are able to so long as they pay income taxes like the rest of community banks
Posted by harry wahlquist | Friday, September 07 2012 at 1:44PM ET
Let them raise all the capital they are able to so long as they pay income taxes like the rest of community banks
Posted by harry wahlquist | Friday, September 07 2012 at 1:44PM ET
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