NCUA has come a long way with its revised Risk Based Capital rule. The agency took a very progressive step forward last year by deciding to issue a revised rule for additional comment. All signs coming from the agency prior were that it wasn't going to go down that path. I am glad it did, as we have a much better product, and have yet another opportunity to comment and improve on RBC. This two-proposal process was appropriate given the scope and impact of this rule.
NCUA's revised RBC — so-called RBC 2.0 — clearly demonstrates that the agency listened to the more than 2,000 stakeholders that made their voices heard with comment letters. The agency has proven it is certainly not deaf to the system and it carefully considers system input. It has adjusted many of the risk weightings, lowered the risk based capital requirement to be well-capitalized, increased the threshold from $50 million to $100 million for falling under the rule, implemented a 2019 effective date, and made many other substantive changes. There is room for more incremental change, but by and large the agency incorporated many of the system's recommendations and the rule is much more effective in its current form.
This was a good step forward, but more is needed. We often talk about regulatory "relief" but we first need a "reasonable" regulatory environment and it starts with how NCUA handles other issues related to RBC.
The agency has been highlighting the dangers of Interest Rate Risk going on four years now. It has warned of a spike in rates and has asked credit unions to shock their portfolios beyond the traditional 300 basis points. NCUA Chairman Debbie Matz has been vigilant on IRR in speeches and statements, and with good reason. We are in a protracted low-rate environment so it's logical and prudent for the regulator to highlight the potential risk, but NCUA shouldn't manage how CUs deal with IRR. In the original RBC proposal, IRR was woven throughout, much to the dismay of credit unions, given it didn't consider the full financial picture of a credit union. NCUA has appropriately stripped IRR out of RBC 2.0 and has specifically asked the system for recommendations on how to deal with IRR going forward.
Before we, as a system, give NCUA new recommendations on how to handle IRR, let's first look at what the agency currently has at its disposal from a supervisory standpoint.
NCUA already has a regulation on the books that requires CUs to have a vetted, board-approved IRR policy. That's a policy that examiners have free rein to review, comment on and use supervisory authority. NCUA has a number of supervisory action authorities in its toolbox to deal with "outliers" in IRR. NCUA has said time and again that IRR is not a widespread issue, but instead is focused among a small number of outliers. "Reasonable" regulation doesn't call for new regs to deal with a small group of outliers.
At this stage, IRR is a "supervisory" issue not a rule-making issue. Credit unions deal with IRR in so many different ways that any prescriptive rulemaking approach would not be effective. A high long-term asset ratio isn't enough to determine IRR. A credit union that has a longer-than-average investment portfolio does not automatically mean IRR is extraordinary. Different areas of the country have consistently higher long-term ratios just by the economics of their region. Credit unions utilize different strategies to mitigate IRR, and they've done it quite well historically. Any IRR reg that sets arbitrary thresholds and triggers actions like sales of assets is turning NCUA from "regulator" to "manager", a common complaint of the original RBC rule.
Given the extended low-rate environment, NCUA is right to focus exam resources on IRR, but this isn't the first protracted low-rate environment credit unions have lived through and the agency shouldn't overreact with a separate rule on IRR. If, after the NCUA finalizes RBC 2.0, it proposes a separate IRR rule, we must again rally the system from the ground up and generate even more than 2,000 comment letters and yet again engage our lawmakers about regulatory overreach. RBC 2.0 was a great step forward, but if a separate IRR regulation is lurking around the corner, it's one step forward and two steps backward for "reasonable" regulation.
While the agency has improved RBC and is on record in support of supplemental capital, it has not elevated the supplemental capital issue to the level it needs to be. For years supplemental capital has swirled around the system but many credit union executives have a difficult time describing how it would work in their credit unions. It's not an easy issue. Is there enough potential within a CU's member base to make supplemental capital viable? Is it economically feasible given the added yield it requires? NCUA is getting deeper into this with its new working group on supplemental capital that is focused primarily on low-income credit unions.
Although statute limits NCUA's ability to adopt supplemental capital across the board, it can arguably incorporate it into the RBC structure beyond low-income credit unions. From a technical standpoint, NCUA would be best served to issue a separate rule on supplemental capital that can be fully implemented into RBC. It is a complex issue and deserves vetting by the system in a proposed rule. Incorporating supplemental capital into an updated RBC framework would serve as a great testing ground for supplemental capital to be used in the core capital framework. If the system decides to aggressively pursue supplemental capital legislatively, having a track record to look back on within RBC would be a great story to tell.
NCUA surprised the system with how aggressive its initial RBC proposal was. It surprised the system yet again by making so many great strides to improve the rule. No more surprises, NCUA: do not issue a separate IRR reg. Instead, use your existing supervisory authority and start the rulemaking process to implement supplemental capital in the RBC structure. Those two items would get us further down the road toward "reasonable" regulation. With nearly 11% capital, an incredible track record during the recession, and the power of the cooperative model, the credit union system deserves a reasonable regulatory framework.
Paul Gentile is president/CEO of the Cooperative Credit Union Association. He can be reached at firstname.lastname@example.org.