MADISON, Wis. -
Dr. William E. Jackson III, the author of the report, suggested the capital level of the CU industry stood at 11.6% at the end of 2006, more than four percentage points higher than the legislatively mandated level of “Well Capitalized,” and exactly four percentage points higher than it was in 1990. He further concluded the credit union industry in 2006 was less risky than it was in 1990, and that overall CUs are “overcapitalized by an amount in the 30% to 40% range.” Translated into dollars, CUs are overcapitalized between $8.8 billion and $11.7 billion. In this CUJ Q&A, Jackson, who is a professor of finance at the University of Alabama, and a Filene Research Fellow, provides additional insights on the research.
CUJ: What brought about this study?
Jackson: Over the last several years, I have developed a strong research interest in the public policy issues surrounding credit unions. This interest lead to my first Filene Research Institute publication in 2004 entitled, “The Future of Credit Unions: Public Policy Issues.” As part of that study, I was introduced to issues related to the regulation of credit union capital levels and the fact that the current aggregate level of capital in the credit union industry was much higher than that required by regulations. Also, I was fascinated by the tremendous increase in credit union aggregate capital levels over the last 20 to 25 years. Given my interests in this area, I was encouraged and inspired by my colleagues at Filene to investigate this phenomenon.
CUJ: Were you surprised by any of your findings in the course of the research?
Jackson: There were two characteristics about the trend in credit union net worth ratios that I found especially interesting. The first characteristic was the speed of the increase in the aggregate net worth ratio for the credit union industry. The second characteristic was the relative stability of the capital ratio at this new high level.
This second trend is more difficult to explain. However, I believe I understand the first trend. For example, between the end of 1991 and the end of 1997, the aggregate capital ratio for the credit union industry increased by nearly 50%. Why did capital levels (and ratios) increase so rapidly during this period? It is likely the result of strict regulators, conservative management, and a growing economy that combined to produce a “perfect storm” for increasing capital levels.
The second characteristic about credit union capital ratios remaining at relatively high levels may be the result of several factors. But, the main factor is probably credit union management.
CUJ: A high capital ratio is an entrenched tradition at many conservative CUs and regulators. Do you anticipate this will ever change?
Jackson: I definitely believe it will change. I believe that most credit unions are committed to providing the best possible services and products to their membership. And, this commitment to the best possible services is why it will change. A credit union that holds more capital than is necessary deprives its membership of the benefits that could have been provided by a more efficient management of its capital reserves. Holding excessive amounts of capital costs the membership of the credit union in terms of better rates on loans and shares and lower fees on services, and better overall service.
Credit union regulators and management are moving toward capital policies that emphasize the efficient use of resources. Such policies are bound to challenge the existing high levels of capitalization in the credit union industry. These policies will also bring us face-to-face with the questions of what is the optimal amount of capital for the industry, and for individual credit unions.
CUJ: How do you feel that excess capital could be better deployed?
Jackson: Credit unions have a long history of providing significant benefits to their memberships and society in general. For example, many large credit unions have formal foundations that champion causes such as broader access to higher education, low-income housing assistance, and financial literacy improvement. Doing “good” in their communities is nothing new to most credit unions.
I would advise credit unions to continue to do good things for their memberships and society. For example, credit unions could return part of this overcapitalization directly to their memberships by lowering rates on loans and fees on products and increasing rates on shares and deposits. And, credit unions could use part of this overcapitalization to provide more contributions to societal programs. In addition, I think credit unions would be well served to use part of their abundant capital reserves to support programs that will help the industry, and individual credit unions, efficiently manage capital levels.
Overcapitalization in the credit union industry provides great challenges but also great opportunities. In the process of addressing the issue of capital we may just improve our overall understanding of how to regulate and manage credit unions in general.
CUJ: What has been the feedback, positive and negative, since the research has been released?
Jackson: The feedback so far has been overwhelmingly positive and supportive. Of course, the study is still very new, and so that could change very quickly. As long as the study causes a serious conversation to take place about credit union capital levels, I believe it will have served its purpose.
