In today’s conservative regulatory environment, the relatively high number of issued documents of resolution revealed in a recent survey of credit unions may not seem so alarming. However, if credit unions do not adequately manage their relationship with regulators, this hands-on approach could hinder their ability to provide the services their membership has come to expect.
Credit unions, or any financial institution for that matter, manage risk to produce yield. These profits are reflected in competitive services for their membership. The need to find the balance between risk and reward is one of the core fundamentals of finance. If a credit union were to cede its ability to manage to a potentially risk-averse examiner, the quality of their membership services could be jeopardized.
As reported in the Feb. 25 issue of Credit Union Times, a survey conducted by the CUNA revealed that 43%t of 1,500 respondents had received one or more DORs to correct unacceptable risk situations during their last exams. CUNA Deputy General Counsel Mary Dunn said the survey shows that “there are too many DORs out there.”
The high number of DORs is troubling, but maybe even more alarming is how it points to the growing influence of regulators in the administration of a credit union’s policies. The danger lies not so much in any particular examiners’ approach but in the potential for overly simplistic ratios and prescriptive actions to become systemic and evolve into indirect, or even direct, management of the industry.
Some credit union managers have come to me for help because they felt that their examiner did not care if the credit union lost money over the next couple of years while waiting out today’s low-rate environment and were only concerned about not taking on any additional risk. I suspect that members of those credit unions would care if they were to lose money. And, to be fair, I think the examiners care as well–earnings are an integral component of the CAMEL rating system.
Keeping a balance sheet very short may be thought of as being conservative if rates are expected to rise. However, this is not risk management, it is taking a risk position that rates will rise. The problem here is that no one knows how long this rate environment may last. The 10-year Treasury in Japan has been below 2% for 15 years and counting. Losing money for 15 years would surely impact any credit union’s capital, which is another component of the CAMEL rating system, and threaten the safety and soundness of the credit union.
Examiners should be promoting strong risk management processes rather than dictating a specific risk position. Balance sheets should be managed in way that addresses the risk of rates rising, falling or staying the same. I am a firm believer that good risk management is good business, and by definition there needs to be risk for there to be a business to manage. In short, examiners should examine and managers should be left to manage.
My regulatory background is with the Office of the Comptroller of the Currency, and the distinction between examining an institution and managing an institution was clearly drawn for us. In a speech last year, then Acting Comptroller John Walsh stressed one of the key principles of supervision, examiner judgment does not replace that of management.
Walsh explained that the examiner’s objective is to ensure that management is effectively carrying out its fiduciary responsibilities, operating in a safe and sound manner, complying with regulations, and appropriately managing risks. He said that within these parameters it is up to the institution, and not the examiner, to decide what products to offer, what prices to charge and what loans to make.
We must recognize that the NCUA is in a tough spot. It is being asked to rein in credit unions that may be taking on dangerous levels of unmanaged risk, while not overstepping its role as regulator. In light of the near collapse of the industry due to poor risk management in corporate credit unions, and the large number of less sophisticated institutions that often need more direction, it is an unenviable position.
I am sure the NCUA is taking all the necessary steps to ensure that its examiners are doing the most to protect the industry. Chairman Debbie Matz announced at the CUNA Government Affairs Conference that there is a “new NCUA,” stating that the NCUA is not here to hold credit unions back but to guide the industry forward. In order to grow and move forward, credit unions must be allowed to manage risk.
The NCUA’s recent interest rate risk regulation does an excellent job of requiring risk management that is commensurate with the risk. It acknowledges that some IRR exposure is a normal part of financial intermediation, and the NCUA states that it recognizes that there are differences between credit unions. The regulation emphasizes the importance of robust measures of IRR while also discrediting simplistic ones. So if a particular examiner is attempting to prescribe a simplistic approach or ratio, such as the long-term assets ratio, my best suggestion is to refer to the NCUA’s regulation.
With all that being said, what can credit unions do to protect the interests of their membership in this kind of market and regulatory environment? Well, the answer is equally simple and complicated. Plainly stated, it behooves an institution to have a proactive regulatory risk management approach and sound policies that ensure risk is effectively identified, measured, monitored and controlled. This should alleviate any individual examiner’s temptation to cross the line to managing an institution.
If a credit union wants to be reactive in its regulatory risk management and wait for their examiner to tell them what to do, I caution that they may get more than they bargained for.
E. Prescott Ford is managing director, office of regulatory affairs at First Empire Securities.
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