Many well-documented and thoughtful comments have been filed responding to NCUA’s proposed risk-based capital rule. Among the major objections are:
Multiple shortcomings and inconsistencies in the asset risk weightings
Failure to document any need for the rule
Competitive disadvantage imposed versus bank RBC requirements
Reduction in member value from higher capital levels
Overreach of examiner authority to interpret circumstances and override the rule
One-size-fits all formula for risk and capital adequacy
Banking regulators walking away from RBC in favor of a simple leverage ratio
The destructive impact of NCUA’s RBC on the corporate system’s ability to serve members
The flawed rule making process with no ANPR, no consultation with state regulators, and slow posting of comments during the comment period
The concept of RBC is appealing at an institutional level because decisions and reserves are based on specific experiences of asset performance. However, what works locally does not scale up to a single national formula.
The Fundamental Failure Of The RBC Concept
No team in any sport would try to win a contest by solely playing defense. To compete, you must have both offense and defense. In a debate, for example, this means presenting an argument as well as deconstructing the opposition’s position.
But a one-sided approach to financial soundness is just what RBC mandates. It requires credit unions to reserve based on a formula for risk but incorporates no factors for return.
Every cooperative succeeds by realizing, and sometimes seizing, opportunity. Credit unions were started as a solution for average consumers that were not well served by existing choices. The member-owner model was a historical breakthrough that overcame the inherent conflict in banking between the interests of management or shareholders for return and the value offered the customer.
A formula that attempts to measure only risk means examiners and credit unions will be unable to react responsively to individual circumstances. Every credit union analyzes risk every day when it prices loans or investments by balancing yield with duration. Using a single formula to evaluate these decisions distorts fundamental business practice.
Risk for an individual credit union is more nuanced than a simple formula imposing relative risk weightings on individual asset classes can ever capture. As any board or manager will state, such an approach does not correspond to reality. It does not reflect pricing in response to opportunities, and it distorts the financial experiences and judgments credit union leaders have accumulated in making these decisions for their individual institutions.
Risk is not a bad thing. Risk is a factor whenever a credit union makes a loan, a CUSO investment, or a fixed-asset purchase. The driver in the decision is the opportunity to help a member or improve the credit union’s capabilities, not what a rule requires in capital.
The risk-based capital rule is a mistake. Everyone should consider the fundamentals of cooperative purpose, which is to respond to the needs of people. Credit unions respond to situations out of the financial mainstream and serve those excluded or preyed upon by other firms.
Risk Based Capital Is A Tool, Not A Rule
If there is any benefit in a one-sided evaluation of a cooperative’s financial soundness, then NCUA should validate that effort by using the risk-based analysis as a modeling tool in examination reviews. Imposing a one-size-fits-all formula that does not takes into account the opportunities and accumulated knowledge of a credit union's leaders undermines why cooperatives were founded. If risk analysis were as simple as a single formula, then there would be no need for cooperatives — just have a single financial charter license, one common set of rules, and be done.
But credit unions were started because the existing financial frameworks and ways of doing business did not meet the needs of member-owners or of their communities. For more than 100 years, credit unions have used a reserving process that requires them to set aside a certain percentage of income as a cushion for difficult times or circumstances. This approach has worked and served well the members, the regulators, and the American economy. That is because reserving today is a holistic judgment that balances opportunity and member need with the uncertainties inherent in any circumstance.
Playing defense only and building up higher reserves using a single model serves no one well and in the end does not win any games. More importantly, if the formula is wrong in total or in respect to any asset category, it could push credit unions over a cliff. Reserving is best done by the boards and managers who are directly accountable for this judgment.