Study Suggests Community Banks Offer Capital Model For CUs

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A new study suggests that if credit unions were granted certain regulatory flexibility, they could employ a number of strategies already in use by banks to meet their capital requirements.

The study, released by the Filene Research Institute and entitled, "Capital Instruments for Credit Unions: Precedents, Issuance and Implementation," seeks to evaluate the mechanisms by which credit unions could issue subordinated debt, and draws on the successful experience of community banks in meeting their capital needs, particularly the use of trust preferred securities (TPS) and pooling mechanisms.

'Thorough Treatment of Options'

The new report, authored by economist James A. Wilcox of the Haas School of Business at the University of California, Berkeley, "provides a thorough treatment of options by which credit unions could issue subordinated debt in ways that would minimize both interest and issuance cost," according to Filene.

The author evaluates these instruments in the context of the market of potential purchasers, and covers the ways in which these issues could be made attractive to a variety of purchasers through credit enhancements and other features. The report further delves into how these issues can be made suitable for capital, yet offer appropriate flexibility through the maturity used and the appropriate use of call options and call premiums.

"The research concludes that use of subordinated debt is feasible for many credit unions," Filene said. "This strengthens the case for regulatory reform made in an earlier Filene report, Subordinated Debt for Credit Unions. In that study, Professor Wilcox argued that requirements imposed on credit unions are more onerous and less flexible than those imposed on banks."

Direct Market Discipline

According to the author, subordinated debt would, for regulators, impose an element of direct market discipline upon the industry.

"The higher interest costs associated with debt of riskier credit unions would reduce the temptation of excessive risk taking," the author suggested. "At the same time, the higher yields imposed by financial markets would send a forward- looking signal to regulators if credit unions' riskiness rose, thereby introducing an element of indirect market discipline. Early signals could give regulators more time to seek corrective action."

"This important research addresses an issue affecting the basic ability of credit unions to compete in the financial services marketplace," says Bob Hoel, Executive Director, Filene Research Institute. "Professor Wilcox has impeccable credentials in the field of capital accumulation and banking regulation."

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