The Federal Credit Union Act in 1934 required the application of cooperative design to the regulatory process. Section 101 of the Federal Credit Union Act defines a credit union as a “cooperative association.”
While the term “cooperative association” is undefined in the Act, the seven cooperative principles predate the 1934 passage by several generations. They are a vital source for implementing this Congressional intent for our unique financial system. The following long term goals embody this cooperative foundation and provide criteria to evaluate regulatory effectiveness:
SUSTAIN an autonomous and independent cooperative system
ENSURE continuous member participation in all levels of governance
PRACTICE cooperative principles
PROVIDE access to complete and timely information on system performance
PROMOTE credit unions’ innovative role in building communities
ENABLE credit to be available for members in all economic circumstances
MANAGE collective system resources in the member-owners’ interest
In passing the Membership Access Act in 1998 Congress re-affirmed the cooperative model even while mandating that credit unions be subject to the Prompt Corrective Action (PCA) capital standards that applied to banks and thrifts. Congress directed that NCUA’s implementation take into account the unique characteristics of credit unions as follows:
§ 216. Prompt corrective action
(B) Cooperative character of credit unions
The Board shall design a system that takes into account that credit unions are not-for-profit cooperatives that:
(i) do not issue capital stock;
(ii) must rely on retained earnings to build net worth; and
(iii) have boards of directors that consist primarily of volunteers.
Creating A 21st -Century Design For Cooperative Regulation And Oversight Functions
To promote the continuous evolution of the credit union charter and its multifaceted contributions to the country’s economic progress, a new cooperative regulatory structure is needed.
System oversight has three primary regulatory roles:
Managing a mutual insurance and re-capitalization fund for all insured credit unions;
Providing a cooperative liquidity facility to coordinate system resources and to deploy them as needed to sustain credit unions as a reliable source for credit, whatever the economic conditions;
Chartering, supervising and examining federal credit unions
The three functions require different governance models because the underlying purposes are different.
1. Cooperative Principles And Mutual Insurance
Unlike the FDIC, the NCUSIF is financed on cooperative principles. Each member-owner deposits and maintains 1% of its shares as a capital base. This structure provides a permanent capital base which increases as shares grow. Premiums are used only as a last resort.
Cooperative insurance reflects the unique member-owner structure of credit unions. There are no private interests in conflict with the public’s interest as is the case when the FDIC must determine whether to liquidate a bank. In a cooperative system, everyone’s interest is served when problem institutions are resolved so as to continue serving member-owners.
The use of temporary capital from the collective mutual pool has been a role since the first days of the NCUSIF. Initially this was in the form of 208 guarantees. Temporary capital infusions have also been used as far back as 1980.
To ensure the cooperative funds in the NCUSIF are used for system benefit and to disentangle their deployment from the examiner’s role, the administration of the NCUSIF should be separated from the sole oversight of the NCUA Board.
While NCUA would be the fund’s regulator, daily operations would be separated and overseen by a new board. The board would include an NCUA board member, a state regulator, and representatives from the credit union member-owners. They would be charged with using the funds to stabilize problem credit unions in the least-cost, most effective manner.
The reformed NCUSIF would rely on state and federal examination reports as well as quarterly call reports to monitor individual performance. These would be provided under contract as needed from NCUA or the state. Once a credit union was coded a CAMEL 3, the responsibility for oversight would become joint with the chartering authority. If a credit union were rated a code 4 or 5, the NCUSIF would have primary responsibility for recovery or resolution.
In cases where the credit union was unable to continue operations resulting in merger or P&A, the full supervisory and examination files would be open for post-mortems on what went wrong.
The NCUSIF board would publish monthly financial statements and be accountable to its member-owners for performance. The Fund would pay dividends in years of minimal losses. Effectiveness would be measured by annual expense for problem resolution.
2. Rebuilding An Independent Cooperative System For Liquidity
During the period 1978-2008 credit unions created a multi-tiered cooperative solution to the prospect of a systemic liquidity crisis. The system was repeatedly successful in several economic downturns, for Y2K, and after the 9|11 attacks. Even in the Great Recession, corporates provided $54 billion in advised lines of credits so that no credit union had to deny members for liquidity reasons.
Today the CLF is moribund and the corporates have a much limited operating capability.
The first step for rebuilding a cooperative liquidity safety net is to reform the CLF. The CLF as the ultimate liquidity backstop should retain its borrowing authority with the U.S. Treasury. While recourse to Treasury may rarely be used, the knowledge that it is available is a fundamental component of a fail safe system.
Cooperatively designed changes would include:
A new CLF board under separate governance from the NCUA regulator. Board composition would be similar to the FHLB but also include a federal and a state regulator and the President or chief operating officer of the NCUSIF. The new board would be responsible for all operations and policy.
Capital funding for the CLF would come from credit unions and/or corporates. Credit union and corporate agent membership would be voluntary and require a capital contribution that could be withdrawn upon notice.
The scope of CLF operations would be changed from the current definitions of liquidity to also include facilitating credit union access and loan sales to the secondary market on a continuing basis. However, unlike the GSEs and FHLBs, the CLF would portfolio no loans. Any credit union loan meeting CLF underwriting criteria would be eligible for sale. The CLF would be able to set underwriting standards and provide credit enhancement in the form of guarantees or other underwriting such as repurchase commitments.
The CLF would be able to provide liquidity to credit union insurers and to CUSOs having a majority of credit union owners that themselves are CLF members.
All operations would be fully transparent and accountable to the credit union owners. While NCUA would be the regulator, it would not have operational responsibility.
3. NCUA's Role As A Cooperative Regulator
NCUA's role would encompass these four areas:
CHARTERING: The chartering process should be simple, quick, and focused on helping organizers get started. Although charter demand may now be low, many organizations in the credit union system are willing to provide resources to startups. Regulatory approval should be based on these system commitments. Examiners should be recognized for their new chartering efforts.
SUPERVISION: The primary supervising activity is the collection and publishing of call report information. Call report data is the primary source for self-analysis and improvement by credit unions. The format can be enhanced for helping credit unions learn from the performance of their peers.
Timely, clear, and easily accessible data is critical for informed member participation, for democratic governance, for understanding the performance and value of individual credit unions, and for the system‘s contribution to the nation’s economy.
REGULATION: The issuance of rules governing credit union operations arises from different perspectives. Some are mandated by law, some are prudential in character, and some are driven by situational assessments.
Rules should provide broad authority for activity, with the responsibility for safe and sound performance placed on the management and boards. Rules should enable credit unions to create solutions and not mandate one size fits all requirements.
Today, NCUA’s rule making evades check-and-balance and is wholly controlled by NCUA. Credit unions should be able to petition to have rules changed or eliminated.
EXAMINATIONS: This is the most resource-intensive activity of a regulator today. Historically 85-90% of credit unions are rated a CAMEL 1 or 2. Only a small minority are CAMEL 4 or 5. Because credit unions pay for their examinations, the goal should be a positive return from this interaction, not just identifying performance problems. The exam report should enable self-improvement.
For credit unions to gain a return on their exam investment, regulators should document their advice and analysis and point to directions for enhancing performance. Credit unions should share their exam results in summary format with members and their peers. Regulators should summarize and monthly publish their major examination findings, including CAMEL ratings with percentage changes, critical trend concerns, and common recommendations.
Examination commentary should also provide an assessment of the credit union’s implementation of cooperative principles and how these contribute to member value. A process for recognizing credit unions that deliver significant member benefit as well as cooperative business innovation should be another public outcome from examinations.
The interdependence of state and federal exam activity is a vital aspect of credit union system success. State examiners are often closer to local circumstances and are able to act more quickly, and are supportive of state chartering innovations. Federal examination resources should be supportive of the state’s prerogatives and insights.
A New Governance Structure
The credit union cooperative advantage is not painting by the numbers. You cannot take the seven cooperative principles and follow a script. They must be translated into meaningful benefits for consumers.
Standardization, consolidation, and the urge for scale can all limit the capabilities of cooperatives to serve diverse communities. One-size-fits-all strategies and tactics, whether pushed by regulators or credit union pundits, dilute the power of cooperative designs. The proposals in this article would go a long way in applying cooperative principles to a new regulatory design.