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What new capital reform may mean for credit unions

A woman is sitting at a legal desk.

In an Oct. 8 letter, National Credit Union Administration Board Chairman Debbie Matz assured Congress the agency's proposed risk-based capital rule would level the playing field between credit unions and big banks, while still taking into consideration the cooperative character of credit unions. The Oct. 15 finalization of the rule has stakeholders eager to see how the new regulation will take effect in January 2019.

The risk-based capital rule has been on the table since early this year, and aims to ensure each bank or credit union has enough capital to sustain operation costs, prevent insolvency, and protect investors. To be considered well-capitalized, credit unions will have to have a minimum RBC ratio of 10.5 percent, as well as 7 percent in net worth.The rule was passed in spite of congressional sponsors of The Risk-Based Capital Study Act, HR 2769, urging the NCUA to re-evaluate its proposal, the Credit Union Times reports.

In its final proposal, the rule recalculated many risk weights to better align with banks' capital requirements, removed interest-rate risk from the configuring of risk-based capital ratio and extended the implementation date. But not every credit union will experience the changes. The risk-based capital requirements would only apply to credit unions with assets over $100 million. Most credit unions would be exempt from the rules, possibly affecting their ability to compete in the changing market. About 22 percent of credit unions in the U.S. would qualify, according to

The disadvantage for small credit unions
Credit unions have traditionally grown by either reinvesting capital or merging with another financial institution to acquire it. But without additional capital, many credit unions will be left to lean on their own cash flow. The Credit Union Times reported that 132 mergers were approved through July of this year - the average asset size being $32.4 million. These larger institutions, however, may soon become more selective in their partnerships.

"Most credit unions would be exempt from the rule."

Banks and larger credit unions won't  exactly rush to the aid of their smaller counterparts if the return on their investment is questionable. David Giesen, a managing director at the Chicago-based Navigant Capital Advisors, suggested membership expansion and upward projection of franchise value are serious concerns that need to be settled before an acquisition or merger can take place, in a statement to Credit Union Times.

"Most mid-sized credit unions probably have one small merger in them before they get tight on capital, particularly when you consider the new Basel III risk-based capital standards that have been rolled out for comment by the NCUA," said Giesen.

Greg Smith, CEO at the $4.7 billion Pennsylvania State Employees credit union in Harrisburg fears the regulations will drive credit unions to strive for numbers, as opposed to implementing their best practices.

"Measuring a credit union's total risk cannot be distilled down to a range of ratios," Smith told CUToday. "To the extent that it is written that way in the final regulation, you'll have credit unions working to that ratio, regardless of the real risk in their balance sheet."

Long-term effects
Though the rule seeks to act as a safety net, the disparities between banks' operations and those of smaller institutions may make it more difficult for credit unions to access supplemental funds.

Industry veterans are standing by the idea that restricting the growth of an institution because of potential risks cannot be a lasting solution. Former NCUA Chairman Dennis Dollar agrees that smaller institutions deserve their own lane. Dollar told Credit Union Times how competing in a broader market doesn't warrant mutually exclusive rules and that instead, to remain a viable business, credit unions will need rules that take into account the unique nature of their institutions.

Comparing credit unions only to similarly functioning institutions, namely when they are in competition with larger banks whose net worths are equal or less, could put smaller, community-run institutions at a disadvantage.

"I think, over time, banks and some other competitors will have a significant advantage over credit unions from a regulatory point of view if the definition of a small institution - and the resultant considerations for regulatory exemptions - is not treated similarly and with parity," said Dollar.