WOCCU Objects to Basel Rule
A new proposal regarding credit risk measurement, which was issued for comment by the Basel Committee on Banking Supervision in December, has the potential to put bank loans out of reach for smaller credit unions that are not subject to risk-based capital rules, according to the World Council of Credit Unions. The proposal could also cause credit unions without a formal RBC analysis to be rated at 10 times the current risk level when attempting to borrow from RBC-compliant banks, WOCCU said.
The Madison, Wis.-based international credit union trade organization strenuously objected to several components of the rule in its March 27 comment letter to the Basel Committee Secretary General William Coen. The proposal’s intent to strengthen financial institutions’ regulatory capital standards by requiring greater adherence to RBC rules would cause problems for smaller financial entities, including credit unions not subject to RBC, which then would be classified as a greater borrowing risk, according to World Council VP/General Counsel Michael Edwards.
The proposal’s most challenging aspect applies to interbank lending done by banks subject to Basel III and the rate-risk impact on borrower institutions. Banks would be required to apply a risk ratio based on the borrowers’ Basel III risk-based capital adequacy ratio of Common Equity Tier 1 capital, or retained earnings, relative to the borrowers’ risk-weighted assets, Edwards said. Under the rule, conditions would change dramatically for borrowing institutions that lack applicable RBC risk weightings.
“Borrowers that can provide these RBC figures get a risk-weight for interbank loans as low as 30% of [the loan’s] face value, which is considered very low risk,” Edwards explained. “But if the credit union or other counterparty cannot provide the Basel III bank with its risk-based capital adequacy ratio, the bank has to rate the riskiness of that interbank loan at 300% of face value, which is considered very high risk.”
Hardest hit would be smaller credit unions not required to meet RBC standards, Edwards said, which currently are all but about seven U.S. institutions with assets of $10 billion or more from among the country’s more than 6,000 credit unions. The remaining credit unions trying to borrow from RBC-compliant banks would face a 300% risk-weighting level, or twice that of the current 150% risk weighting for consumer loans 90 days or more past due.
“The NCUA RBC2 proposal is based on Basel III, so RBC would probably get the credit unions the data they need to give to the banks to get a decent rate,” Edwards said. “But the NCUA rule, if finalized as proposed, would not become effective until Jan. 1, 2019.”
Read more: The rule could cause problems for credit unions wanting to borrow from banks until the RBC proposal takes effect...
The Basel Committee rule could cause problems for credit unions wanting to borrow from banks until NCUA’s RBC proposal takes effect. Since RBC2 applies to all credit unions with $100 million or more in assets, institutions that fall below this asset level would continue to struggle in the face of the current Basel proposal, Edwards explained.
Edwards also heard from “a foreign government source” that the current Basel proposal is being driven by influence from the U.S Department of Treasury and various U.S. bank regulators in an attempt to standardize the way mortgage loans are treated internationally. Edwards declined to identify the source of the information.
“I received the information on a confidential basis, but this person is in a position to know,” Edwards said.
Specifically, the proposal addresses the use of debt service coverage ratios, also known as “back-end ratios” which refer to the ratio of the mortgage payments relative to all of the borrowers’ debt payments, to assign risk weights to mortgages held by Basel III-compliant institutions. Mortgage lenders in the U.S. and Canada primarily use this process, while other countries do not, Edwards said.
“Most regulators outside of the U.S. did not support the proposal because it is based on U.S. mortgage underwriting standards and mortgage lenders in other parts of the world, like Australia and Europe, do not use the same approach to mortgage underwriting and lack the data to implement this proposal,” Edwards explained. “But apparently the U.S. pushed the Basel Committee to issue this proposal anyway, and they did despite the opposition from other parts of the world.”
World Council specifically did not support the proposal’s debt service coverage in mortgage lending for the reasons mentioned above, noting that the proposed process makes the Basel recommendations too North America-centric.
The trade group also “strongly opposed” using the capital adequacy ratio of Common Equity Tier 1 capital that would lead to 300% risk weightings of non-Basel III-compliant institutions in its March 27 letter.
“The vast majority of credit union capital is in the form of CET1 retained earnings, and credit unions are typically better capitalized than Basel III-compliant banks and more conservatively run from a risk management standpoint because they focus on providing retail banking services at reasonable rates,” Edwards wrote in the letter. “We believe that the Basel III leverage ratio would be a more appropriate measure than the CET1/RWA ratio.”
In addition, World Council requested clarification of certain mortgage guarantees as outlined in the proposal. The group also requested a broader scope for small and medium enterprises making business loans and a tenfold increase in the loan amounts allowed, as well as suggesting more reasonable risk-weights to enable greater access to business loans.
Edwards said the current Basel Committee proposal provides an “interesting twist” to the current NCUA RBC proposal.
“If the Basel Committee finalizes this as proposed – which we are asking them not to do – there would be a big benefit for U.S. credit unions using RBC,” Edwards added. “If the credit unions wanted to borrow from a bank, they would get much better rates, since the banks would consider an RBC-complaint credit union to be much less risky.”
Unless the Basel Committee takes time to revise the rule, the final version would likely be released before the end of the year, Edwards said. It would then be up to national governments to adopt the rule onto law.