Derivative Investment

Derivatives are complicated financial instruments. Credit unions therefore need a full and complete understanding of whether this is the right tool for them to use.

by. Michael Fryzel, NCUA Board Member

Last October, I penned a column in which I discussed the use of derivatives. The column, available in the October 2012 issue of The NCUA Report, discusses how credit unions could use derivatives to protect themselves from the interest rate risk that is inherent in the current economic environment, while at the same time working to achieve acceptable investment returns.

Derivatives are complicated financial instruments. Credit unions therefore need a full and complete understanding of whether this is the right tool for them to use. Along with that understanding, comes the need to have a level of specialized expertise to assess the inner workings of derivatives.

Before I even attempted to write about and advocate for derivatives as a product for some of our credit unions, I sought multiple briefings and asked many experts numerous questions. I found that derivatives are the kind of subject where you quickly learn that the more questions you ask, the more questions you have.

Even though I would have liked to have acted on allowing derivatives as an approved investment option for credit unions some time ago, their complicated and intricate nature required a longer than anticipated timeframe for consideration.

The good news is that the NCUA Board will soon move forward with a proposed rule that would allow credit unions to use derivatives. If used properly, derivatives can hedge against interest rate risk. With that in mind, a regulation to allow the use of this instrument must be carefully crafted and be presented to the industry for their comments and suggestions before a final decision is made.

Safety and soundness is of course a major consideration for the Board when deciding to approve an investment option such as derivatives. Therefore, the goal is that the proposed regulation will have the proper controls, sufficient due diligence, effective monitoring and a common-sense approach.

The role of NCUA is to maintain an environment within the industry that continues to ensure that the citizens of this country continue to have faith and confidence in their credit unions. In addition, we must view the regulator’s role as one that provides credit unions an environment in which to evolve, grow and be of even greater service to their members.

In my opinion, if NCUA’s proposed rulemaking is approached carefully and the rule is drafted reasonably, we can create that delicate balance between maintaining safety and soundness and providing another effective risk-management tool for credit unions that qualify to engage in this type of strategy.

This would be a step in the right direction. I look forward to hearing your comments and suggestions.

Michael Fryzel

Michael Fryzel

Michael Fryzel is the former Chairman of the National Credit Union Administration and is now a financial services consultant and government affairs attorney in Chicago. He can be reached at ... Details