NCUA’s modernization efforts should reduce both financial and political risks to the credit union system.
This spring marks the beginning of a new era in the National Credit Union Administration’s approach to call reporting, compliance examinations and regulatory capital for federally insured credit unions. These changes should help strengthen the American credit union system.
Significant changes are taking effect with the March 2022 Call Report and credit unions’ examinations will start being conducted using the Modern Examination & Risk Identification Tool, or “MERIT.” In addition, NCUA’s Risk-Based Capital Rule and Complex Credit Union Leverage Ratio are now effective, making natural-person, federally insured credit unions with more than $500 million in assets subject to Basel Framework risk-based capital rules for the first time, similar to how banks are regulated.
These NCUA supervisory modernization efforts should reduce both financial and political risks to the credit union system.
New, Modernized Call Report Asks for More Granular Information
Qualitative improvements to credit union prudential (safety and soundness) regulation should result from providing NCUA with more granular information about individual credit unions’ financial positions in the new call report. The modernized call report should also help reduce reporting burdens on credit unions to at least some degree. According to NCUA guidance, the new call report should reduce the number of fillable lines for credit unions with assets of $500 million or less by 18%. For larger credit unions, the modernized call report should reduce the number of fillable lines by 16% for credit unions that elect the CCULR, and by 8% for credit unions that follow the RBC rule. This is because there are 176 lines related to calculating the RBC ratio.
MERIT Examination Tool Updates Technology
NCUA examinations conducted in 2022 will also be conducted using MERIT, which replaces the antiquated Automated Integrated Regulatory Examination System, or AIRES. Having a supervisory tool named “MERIT” seems far more auspicious for regulated credit unions than one named after a war god who, according to The Iliad, is “the most hateful . . . of all the gods who hold Olympus.” MERIT and its related tools should help reduce compliance and reporting burdens through the use of more modern technology.
Risk-Based Capital Rule Aligns U.S. Credit Union Compliance With the World
The phase-in of NCUA’s RBC rule is also a positive development for the American credit union system. The absence of a risk-based capital framework had been one of the system’s biggest political vulnerabilities as it was inconsistent with international financial regulatory standards under the Basel Committee on Banking Supervision’s “Basel Framework” (formerly known as “Basel III”) for depository institutions of internationally significant asset sizes, such as $153 billion Navy Federal Credit Union, not to be subject to Basel-style risk-based capital rules. The political implication of American natural-person credit unions lacking a risk-based capital rulebook—even though credit unions in other wealthy economies, like Australia and Canada, were subject to Basel risk-based capital standards—was that it looked to outsiders like American credit unions were not sufficiently regulated.
This implication was false, of course, because American credit unions are arguably the most stringently regulated depository institutions in the world. It was difficult to prove that contention, however, because apples-to-apples comparisons between institutions are challenging unless all of them follow international standards, even though American credit unions simply do not have the sorts of risks that were present on the balance sheets of American banks or large credit unions in Australia or Canada. This is because American credit unions are subject to much more stringent portfolio shaping rules under the Federal Credit Union Act and NCUA regulations that remove risks by prohibiting outright or severely limiting risky investments or lending practices.
Yet the political optics of not having risk-based capital for federally insured credit unions—even when one was not necessary—remained poor because the Basel Framework is the international standard, and it was previously difficult to make apples-to-apples comparisons between credit unions and banks. Now the U.S. credit union system can respond more effectively to such policy concerns because NCUA will have just such a Basel-based RBC rule in place and can provide data allowing better comparisons with other institutions.
NCUA has also sensibly implemented the CCULR as an alternative to the RBC rule. The CCULR trades the simplicity of an increased net worth ratio requirement in exchange for reduced granularity and is also consistent with the Basel Framework and the rules for American community banks.
NCUA’s RBC rule combined with its portfolio-shaping rules limiting federally insured credit unions’ investments will demonstrate conclusively just how safe and sound American credit unions really are. It is also unlikely to significantly increase the capital requirements at complex natural-person credit unions that follow orthodox business models. Credit unions following riskier business models, however, may face increased capital requirements in-line with their higher risks, although having a risk-based capital requirement related to a business activity does not prohibit a credit union from undertaking that activity so long as it has enough capital. This more granularized approach to the capital requirement for individual credit unions will be more equitable to the credit union system because it helps avoid the “lemon socialism” scenario where losses related to individual institutions are socialized by the system via the Share Insurance Fund or similar mechanisms.
This spring has big changes in store for credit unions as we commence a new era. Hopefully the modernization of the NCUA call report and the implementation of the MERIT system will help reduce reporting burdens on most, if not all, institutions. The RBC and CCULR rules will also help protect the credit union system financially and politically because they finally bring the American credit union system’s regulatory capital rules in line with the international Basel Framework standards and the standards applicable to American banks derived from the Basel Framework. Combined, these NCUA supervisory innovations should help demonstrate to policymakers and the public just how strong the American credit union system really is.
Michael S. Edwards is an attorney-at-law with extensive experience representing credit unions, community banks and credit union organizations in the United States and around the world on a wide range of regulatory, compliance and other legal matters. Now with his own law firm based in the Washington, D.C., area, Edwards previously served as SVP/advocacy and general counsel of the World Council of Credit Unions and was senior assistant general counsel in the regulatory advocacy section of the Credit Union National Association.