Time Now For Deliberate Path To...
It’s no secret that credit unions are the only financial institutions that cannot raise capital outside of retained earnings. However, some may argue that there is no need for credit unions to raise additional forms of capital because credit unions are well capitalized and there is no crisis calling for alternatives.
Often, it takes critical circumstances to push for and achieve change. In the case of capital reform, there is no reason why we shouldn’t act with deliberation so credit unions could benefit from the advantages of capital reform and access to alternative capital.
Consider the current economic environment which has been weakened and challenged by consequences of the subprime lending market. While the majority of credit unions have not been directly involved in subprime lending, this situation demonstrates the need for building a capital infrastructure to help weather unexpected and unfavorable economic conditions.
Value of Risk-Based Capital
NASCUS and state regulators believe that implementing risk-based capital and allowing access to alternative capital are important to ensure the continued longevity of credit unions. NASCUS has advocated for capital reform for years, urging legislators and the credit union community to consider risk-based capital and alternative capital options.
Several past NASCUS Chairman, including Jerrie Lattimore (NC) and Linda Jekel (WA), have testified before Congress about the importance of capital reform for credit unions. In 2003, Lattimore stated, “As a regulator, it makes no business sense to deny credit unions the use of other forms of capital that improve their safety and soundness. We should take every financially feasible step to strengthen the capital base of this nation’s credit union system.”
Similarly, Jekel told the Senate Banking, Housing and Urban Affairs Committee in 2006 that “credit unions need capital reform in three distinct areas. First, the definition of net worth in the Federal Credit Union Act should be changed to include more than just retained earnings; second, credit unions need access to risk-based capital; and third, credit unions should have access to alternative capital. From a state regulatory perspective, capital reform that addresses these three issues makes logical sense for the safety and soundness of credit unions and the members they serve.”
The three-part wish list described by Jekel continues to be one of NASCUS’ main focuses. State regulators and state-chartered credit unions have communicated to NASCUS that capital reform is a priority, and we are continuing to advocate for these changes.
Restrictions On Growth
The capital structure for credit unions potentially restricts credit union membership, services and growth. The current PCA regulations, Part 702 of the NCUA Rules and Regulations, require that a federally insured credit union have seven percent or more in net worth to be well capitalized.
If the net worth of a credit union drops below the 7% threshold, the credit union must meet prescribed risk-based net worth requirements.
The requirement can add regulatory burden and potential restrictions on credit union membership growth. A credit union’s goal is to provide quality member service.
Successful member service potentially leads to asset growth; rapid asset growth can result in diminished capital ratios and the end result is a challenge to PCA. PCA restrictions affect growth and may curtail member service.
The NASCUS Capital Modernization Subcommittee, a group comprised of state regulators and state-chartered credit union executives focused exclusively on capital reform, recently encouraged the Filene Research Institute to synthesize existing research on capital, namely alternative capital, to add clarity to the reasoning and discussion regarding capital reform. The report authored by Robert F. Hoel, PhD titled Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform was published in November 2007.
The Public Interest
The report highlights the fact that legislation and regulation regarding capital for U.S. credit unions have not been updated to allow credit unions access to modern capital options. “The unusual limitations on U.S. credit unions capital formation powers raise questions about why these financial institutions are so restricted, and whether credit union members and the general public would be better served if U.S. credit unions had access to more capital formation options.” (Hoel, Robert. 2007. Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform. Madison, WI: Filene Research Institute, pg 2.)
The report goes on to address whether it is in the public interest to allow alternative capital and if so, how it would be organized and can credit unions use alternative capital in a way that doesn’t dilute their cooperative ownership, values and governance structure.
Filene concluded that it is in the public interest to permit credit unions greater access to alternative capital sources and that several mechanisms are both feasible and appropriate and would maintain credit union’s unique governance structure.
“Steps should be taken promptly to repeal or reform statutes and regulations that prohibit credit unions from obtaining alternative capital. No compelling reasons to delay were uncovered during the course of this research,” stated the recent Filene study.
NASCUS agrees with Filene and believes that a risk-based capital regime complimented by alternative capital is a much needed regulatory improvement to enhance the safety and soundness of credit unions and to enable credit unions to continue to expand service to members.
The Debate Over Structure
Debate continues in the credit union system about how to structure risk-based capital and whether alternative capital is necessary and appropriate for credit unions. True, not all alternatives to raise capital are appropriate for all credit unions.
However, NASCUS believes that for those credit unions that determine alternative capital is right for them, the option to raise additional forms of capital should be available to them.
Further, it should be counted as regulatory capital for net worth purposes. Access to additional forms of capital would be diligently regulated and credit unions would need the expertise to manage it appropriately.
NASCUS leadership will continue to advocate for capital reform. We will continue to discuss its importance and work to build consensus. I encourage you to review Filene’s recent report and NASCUS’ white paper “Alternative Capital for Credit Unions, Why Not?” The NASCUS white paper is available at www.nascus.org and it illustrates the feasibility of several debt and equity models for alternative capital.
By working collaboratively, we can determine the most feasible and beneficial capital reform plan while maintaining the safety and soundness of the credit union system. NASCUS welcomes your involvement and input on capital reform for credit unions.
Mary Martha Fortney is president of the National Association of State Credit Union Supervisors and can be reached at marymartha