According to new National Credit Union Administration rules, before 2019, many credit unions will need to significantly increase their capital to adequate levels.
Capital represents the difference in value between a credit union’s assets (loans and fixed assets), and its liabilities (member deposits and debt owed). Capital fills this gap, providing a buffer against losses and allowing room for growth.
Credit unions that are adequately capitalized are able to withstand economic downturns, unfavourable yield curves, and higher loan costs. Adequate capital can also provide a competitive advantage, as well capitalized credit unions are better positioned to offer competitive rates, superior dividends, and able to introduce valuable services driving growth and member satisfaction.
The amount of capital needed by a credit union varies with the degree of risk inherent in its assets and the economic environment. The riskier the underlying assets or the less stable the economy, then the greater need for capital.
Capital is the last line of defense against insolvency. More importantly, adequate capital protects members’ deposits. As such, regulatory capital requirements are one of the fundamental elements of financial supervision.
Failure to maintain adequate capital can lead to intervention by regulatory agencies or loss over control of the credit union by the board.
THE REGULATION OF CAPITAL
While the Basel Committee on Banking Supervision of the Bank for International Settlements develops capital requirements for banks; in the US it is the National Credit Union Administration (NCUA) who has responsibility for setting credit union capital requirements.
It’s important to know, the NCUA has made recent changes to its Capital Rules. This latest set of rules is know as Risk Based Capital 2 or RBC2.
RBC sets forth how NCUA, through its supervisory authority, can address a credit union that does not hold capital that is commensurate with its risk and importantly establishes a risk-based capital ratio of 10 percent to be considered well-capitalized credit and 8 percent to be considered adequately-capitalized.
RBC2 also revised the existing asset risk weights to mirror recent changes made by other banking regulators under the Basel System; including those for member business loans, CUSOs, corporate credit unions, real estate loans, and long- term investments.
It raised the threshold of what’s considered a “complex credit union”, and thus covered under RBC2, from $50 million to those with greater than $100 million in assets.
Important for credit union mergers, it clarifies that “excluded goodwill” and “excluded other intangible assets” applies to mergers completed on or before 60 days after publication of the final rule in the Federal Register. It also extended the expiration of this definition to January 1, 2029.
Finally, the changes provide for an extended implementation period until January 1, 2019.
WHAT RBC2 MEANS FOR YOUR CREDIT UNIONS
In short, before 2019, many credit unions will need to significantly increase their capital to adequate levels.
Most of these credit unions will likely face the choice of raising capital via retained earnings and/or reducing their asset base (i.e. loans). Additionally, some will raise capital by increasing membership share investments, restricting the redemption of existing shares, or issuing non-membership share capital.
Of these choices, most will likely chose to build their retained earnings.
Retained earnings represent income earned that has not been paid out to members in the form of dividends. It is an inexpensive form of capital, as it does not require the payment of dividends or carry the contingency of having to redeem membership shares on demand.
Retained earnings can be grown in two ways: improving profitability or reducing cash dividends to members. While reducing cash dividends may not be popular with members, if a credit union’s profitability can’t be improved, reducing dividends may be necessary to prevent capital reserves from dropping below regulatory or policy minimums.
STRATEGIC RESOURCE MANAGEMENT (SRM) CAN HELP
Strategic Resource Management (SRM) specializing in increasing retained earnings and driving profitability. We use our considerable experience and industry benchmarks to deliver strategies that increase your retained earnings. We do this, not just by delivering strategies that increase interest and non-interest income, but more importantly, we deliver strategies that drive the penetration, activation, and utilization (PAU) of your credit union’s products. We also identify savings in your vendor costs.
Give SRM a call to see how we can help you tackle your capital challenges.
Senior Vice President