How Much Capital is Enough?

Debate rages within the industry as to how much net worth credit unions should keep on their books.


Credit unions are constantly grappling with how much capital they should keep on their books to mitigate unforeseen circumstances. According to the NCUA, a seven percent net worth to asset ratio is considered "well capitalized" and six percent is considered "adequately capitalized."(1) A closer look, however, reveals that almost 96% of credit unions are in excess of the seven percent threshold and two-thirds are above ten percent. Such high levels of net worth beg the question, does a high capital balance benefit credit union members and the institutions themselves?

Argument For a High Net Worth Ratio

The primary rationale for a high net worth ratio is to protect the credit union against financial losses caused by unforeseen risks. These can include event risks (e.g. natural disasters), operating risks (e.g. fraud), market risks (e.g. unexpected interest rate changes), and credit risks. Hurricane Katrina is an extreme example of event risk, but it illustrates the point that an adequate amount of net worth should be retained to protect against unexpected occurrences.

There are other reasons to justify a high net worth ratio. Certain credit unions that engage in specific "risky" lending practices may want to maintain a higher net worth ratio. For example, business loans are considered more risky than much of the loan portfolio. The average business loan has grown to almost $146,000 and has higher loan loss rates than other consumer loans, which credit unions must closely monitor.

Argument Against a High Net Worth Ratio

Many executives advocate that credit unions should maintain a lower net worth ratio.
Examples of how credit unions could use the excess capital include:

  • Offering better loan rates to their members.
  • Providing higher dividend rates on members' share accounts.
  • Investing in technology that enhances the member experience.
  • Issuing a one-time bonus dividend before a merger.

Credit unions that have a high net worth ratio also report a lower return on equity (ROE) ratio. As of June 2005, credit unions with a net worth ratio above 10 percent had a ROE of 7.85 percent versus a ROE of 8.83 percent for credit unions with a net worth ratio below 10 percent. According to John Dolan-Heitlinger, CEO of Keys Federal Credit Union ($170 million in assets, Key West, Florida) in an article he wrote in February on (view this article), "in a competitive economy, capital flows to businesses that can earn satisfactory returns on equity and away from businesses that cannot maintain an adequate return." Credit unions could be setting themselves up for slower growth rates as they become less competitive in relation to other financial institutions.

Regardless of asset size, credit unions are maintaining net worth ratios well in excess of the NCUA's regulation. (see chart above). Assuming the definition of "well capitalized" is sufficient, the argument against a high net worth ratio holds that the credit union should find a more productive use of the funds or give it back to the members.

(1) NCUA Rules & Regulations §702.106.




Sept. 26, 2005


  • Carrying a high "Undivided Earnings" at a credit union is a key question that all Credit Union members should be asking. Have we forgotten why credit union's were started? I continue to attend training in the credit union world that the instructor is talking about making a "Profit". When asked about the instructors background you seldom hear that they belong to or have worked in a credit union environment. Have we forgotten about the "Not for Profit" phrase we used to rally around? It is easier to access of funds in the Undivided Earnings account, you do not need permission from the state or federal regulators, just the Board of Directors to move funds. While the Regular Reserves you must get permission to withdraw funds under the regulations from state and federal regulators. If only the Regular Reserves were used to determine Net Worth, most credit unions remain above 10.0% requirement. Most are in the 20% levels. This account should be used for major losses. Thus, I agree that the Undivided earnings should be capable of supporting the expenses and dividends at a credit union over a period of time ( I look for 5 years when I look at the amounts. ). Anything over this amount should be returned to the members in dividends or lower interest rates. But, I also feel the interest rates offered at all the credit union today are reasonable and just for the risk to the members. Then we have to ask, why state and federal regulators look only at the Net Income on a statement for credit unions with a 19-20% Net Worth Ratio see it going negative and blow a gasket. Should these people be better trained on what the purpose of a credit union is and look more at the full operations?
  • My guess is that a number if industry specific variables are at work here. Capital ratios are increasing because of slow asset growth and regulatory influence. (CAMEL ratings on earnings require a 1.00 ROA.) Credit union management and boards are typically more risk averse in planning and decision making than bank competitors. Is slow asset growth a result of risk averse behavior? Is risk averse behavior driven inherently by the non-profit (less incentive driven) nature of the industry? For many credit unions, the answer is YES. Simply put, lower asset growth rates combined with all earnings retained to capital will continue to cause the ratio to grow. It is up to management to deploy the excess capital strategically relative to future expected growth rates. If that doesn't happen eventually, then the board should direct management to come up with a plan to do so.
  • Another argument against such a high net worth ratios is that it makes a credit union a juicy target for conversion to a mutual savings bank and later a stock-issuing company. Those law firms that prey on such CUs aren't attracted to 6% capital, but 10% or 11% can mean a windfall for them and for greedy board members.
  • Thanks for the "thumbnail" approach to the issue. As a credit union board member, I need to know as much as I can, and as quickly as I can.
  • Enough capital is that which can withstand a severe adverse impact and still let the cu operate without governmental supervisory oversight while it rebuilds it's capital base. In the Carter era we saw an inflation caused rate increase of 13 basis points in a mere 13 months, and much of the financial industry was in dire straits, capital wise. Those of us who experienced that era don't want us or our cu's to go through it ever again!