WASHINGTON, D.C. (April 7, 2014) – Following more than two decades of chasing ever-more-complicated ways of measuring capital adequacy, economic and financial professionals are realizing that the risk-based capital method is not only ineffective, but likely does more harm than good. In a new Co-Ops for Change analysis, Chip Filson details why such an approach is inappropriate for credit unions. And, he says, disenchantment with the Basel standards is now widespread among leading financial industry voices.
“After nearly 25 years of risk-based efforts to set the right level of capital, there is a growing consensus among regulators, academics, and expert commentators that RBC, and similar Basel efforts, do not work as well as a simple leverage ratio,” Filson said.
Notably, Thomas Hoenig, Vice Chairman of the FDIC and former Kansas City Federal Reserve Bank President, wrote in The Financial Times that using tangible equity capital and total assets is a more conservative, more credible method of assessing capital adequacy.
“Each new Basel standard attempts to correct the errors and unintended consequences of earlier versions. But instead of resulting in better outcomes, each do-over has been more complicated and less effective than the last,” said Hoenig. “Unfortunately, the weightings are more arcane than ever, and therefore, even less useful.”
In its place, Hoenig suggests a tangible equity capital ratio and the use of a simplified risk-weighted measure. Filson agrees, stating that the RBC method did nothing to prevent the bank-centered financial crisis; yet credit unions, relying on simpler measures such as the leverage ratio, required no bailout assistance. Further, Filson says RBC is particularly wrong for credit unions.
“Credit unions start with no capital,” he said. “Through time, a credit union accumulates reserves from its earnings by setting aside a certain percentage of income as collective savings for potential losses or other contingencies. This 100-year-old financial design has underwritten a system that now has $1.1 trillion in assets.”
Filson, who is Chairman of Callahan & Associates as well as Founder of Co-Ops for Change, has released a series of papers, explaining why a single national formula for determining the right level of net worth for credit unions does not work. Not only has RBC neutered corporate credit unions’ ability to serve the industry, but it has not worked for banks and relies too deeply on subjective criteria.
The new report includes Professional Reviews of RBC by economic, business and financial authorities.
“It’s interesting that credit unions’ traditional credit union leverage formula for net worth is now the standard experts recommend for the banking industry,” Filson said.
The full series can be found here. Co-Ops for Change also will host an upcoming webinar on the issue, which will be open to the public.
About Co-Ops for Change
Co-Ops for Change is a grassroots movement to increase awareness both within the credit union community and among elected policymakers that our regulatory leadership should understand and support the seven cooperative principles. The regulatory process should consider credit unions’ cooperative character, as well as the shared economic value they create for people and communities. Credit union members, volunteers, professionals and industry supporters can learn more about the campaign at www.Coops4Change.org.