Three questions to jumpstart a useful RBC debate

To paraphrase the immortal words of Buffalo Springfield, when it comes to NCUA’s Risk Based Capital Proposal, nobody’s right if everybody’s wrong.

In proposing a more sophisticated Risk-Based-Capital framework for credit unions with at least $50 million in assets, NCUA has put forward a flimsy proposal, short on explanations or a compelling rationale beyond arguing that all the cool agencies are already implementing risk based capital proposals and some credit unions went bankrupt during the Great Recession.

Not to be outdone, the industry has responded by saying it likes the idea of risk based capital regulation, just not NCUA’s version of it.  This sounds great, except the industry hasn’t stepped forward with an alternative plan of its own.  In short, whether you are a regulator who believes that RBC is the best way to protect the Share Insurance Fund, or a credit union executive who feels that this might be the dumbest idea since New Coke, it is time for a more coherent dialog before the industry ends up with a regulation of little value.

Let’s start the dialogue by asking some basic questions:

1. Does the industry really need Risk Based Capital reform? Debbie Matz responded to this question in a recent video by explaining that 102 credit unions failed during the Great Recession costing three quarters of a billion dollars.  I hope that the NCUA is doing this for more reasons than the fact that a relatively small group of credit unions went bankrupt during a severe recession.  This is, after all, precisely why there is an insurance fund in the first place.  Over the last five years, credit unions demonstrated that if policy makers have to choose between Risk Based Capital and sound underwriting practices to best promote safety and soundness, they would choose the latter.

2. What does the industry want from Risk Based Capital reform? When credit unions say they like Risk Based Capital in theory, but not as proposed by NCUA, they actually mean that any well-conceived capital framework would free up more money for their credit union.  In fact, there are credit unions that will make out better under NCUA’s plan than they do now.  This is hardly surprising since credit unions have complained for years that the existing PCA system distorts the value of a credit union’s assets by basically treating almost all investments and loans the same.  The problem is that for years credit unions have also deluded  themselves into believing that a properly constructed capital framework is a win-win proposition.  Of course there are credit unions that are going to benefit, but if you believe in Risk Based Capital, then you have to be willing to acknowledge that there are going to be losers, as well.  I have a sneaking suspicion that this is the real reason why the trades have not come forward with a comprehensive proposal of their own.

3. Why is the agency so obsessed with concentration risk? NCUA says it got the idea for this proposal from reviewing Basel III, but the odd thing is if you reviewed the Basel III banking regulations, you would find no corresponding concern.  The reason for this is simple.  When an agency  begins to make categorical assumptions about the type of investments and loans a financial institution should be making in the future it is actually engaged before the fact in micromanaging decisions that should be left to CEO’s and directors.  For instance, is a concentration of 30 year mortgages really more dangerous than an investment in Detroit Municipal Bonds?

Fortunately, there still is time for what has been a half hazard process to result in a meaningful dialog. For this to occur, all sides have to agree that not everyone is going to win under a true Risk Based Capital scheme.

First, let’s raise the $50 million RBC thresh hold to at least $1 billion. The vast majority of credit unions don’t need Risk Based Capital.  In addition, since it is the largest credit unions that have the most to gain and lose from a more sophisticated capital framework, as well as the resources to properly manage it, they could work with the NCUA to devise an RBC plan more in line with what is being proposed for banks.  In addition, if the true goal is to better guard against systemic risk, then the system should be designed for those relative handful of credit unions that truly represent a systemic risk for our industry.

Second, NCUA has to stop proposing to punish credit unions for investing in the credit union industry. Take a look at the proposed risk weighting’s and you will see that among the most dangerous assets in which a credit union can invest are Corporate Credit Unions and CUSO’s. This is simply no time to be inhibiting the growth of third party vendors.  As Comptroller of the Currency Curry pointed out, small financial institutions are inevitably growing more and not less dependent on third party vendors.  As for corporate capital, NCUA is retroactively telling credit unions they were foolish to recapitalize the corporate system.

Third, NCUA should define what exactly its goals are for a more sophisticated capital system.  If its goal is to do everything it can to avoid any losses then you end up with the micromanaging nuggets sprinkled in this proposal.  You can’t have a risk free banking system.  If NCUA’s goal is to avoid “systemic risk,” then it should come up with a definition of what that means and demonstrate how its proposal addresses those concerns.

Forth, as an industry, credit unions should put up or shut up.  Let’s devise a model risk based plan the same way model codes are used to lobby legislatures.  Doing so would make credit unions articulate not simply about what they are against but what they favor.

Fifth, the industry should unite behind a legislative push to allow credit unions to take in secondary capital.  Whereas banks can respond to demands for bigger capital cushions by getting more capital in the form of stock credit unions have no similar option.  Without capital reform the biggest legacy of RBC reform won’t be safer credit unions, just smaller ones that can’t grow to meet the demands of their membership.