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ARLINGTON, Va.-Banks and credit unions are close to an agreement on how a risk-based capital system for credit unions should be set up, according to American Bankers Association Senior Economist Keith Leggett. “There is a general agreement between [NAFCU President and CEO] Fred [Becker] and myself and the banking industry generally: yes, we think it’s wise that you have risk-based capital standards that are comparable to banks’ risk-based standards,” Leggett said in a debate with Becker last week at a meeting of the Metropolitan Area Credit Union Management Association. However, the conflict lies in NCUA’s proposed 5% leverage ratio, which he considers too low. “When you look at risk-based capital, risk-based standards are not comprehensive,” Leggett stated. It does not take into account risk other than credit risk, such as reputation, liquidity, operational or interest rate risk. Nor does the calculation account for credit unions’ equity investments in corporate credit unions or the non-profits’ inability to access the capital markets to raise capital. This is where the leverage ratio steps in. When pressed after the debate for what might be an appropriate leverage ratio, Leggett said he had not done a thorough analysis to arrive at an exact number but 5.6% or 5.7% could be about right. Becker shot back during the debate, “Credit union management of capital has been superb.” The average capital ratio is 11% despite the 7% minimum requirement, he pointed out. He argued that NCUA’s 5% leverage ratio does take other risks into account and the current system unfairly treats less risky credit unions in the same manner as those with more risk in their portfolios. Becker gave the example of a new, unsecured personal loan under the current system carrying the same risk weighting as a mortgage in its last year. “The current system of capital makes no sense. At least that’s what we’ve been told by members of Congress when we’ve raised the issue on Capitol Hill,” he said. Becker even noted observations of current ABA Executive Director for Financial Institutions Policy and Regulatory Affairs Wayne Abernathy while he was serving at the Treasury Department on how credit union capital calculations should be reviewed when Cedar Point Federal Credit Union explained to him that it had to turn away the purchase of a $100,000 share certificate because of Prompt Corrective Action concerns. Leggett argued, “It is not regulation that causes you to hold more capital. It’s your incentive structure that’s at work.” And capital can drain very quickly, he warned. He pointed to an unnamed New Jersey credit union that has fallen from an 8% capital ratio in September 2004 to 2.63% as of September 2005. Not being able to go to the capital markets shuts down options and adds risk. Additionally, Leggett indicated that the PCA system from the 1998 Credit Union Membership Access Act has not been thoroughly tested in practice and the proposed risk-based structure is based on a time period that may be “fleeting,” noting the healthy economic conditions of the last few years. The current PCA system has not been stress tested through one full credit cycle, according to Leggett. Becker countered that the point of a risk-based system for credit unions is to better position them for when they are put to the test. He also pointed out that the banks are looking to update the Gramm-Leach-Bliley Act, which came about after H.R. 1151. Congress did consider the unique nature of credit unions in drafting 1151, Leggett said. “It is universally agreed that institutions with greater risk should hold more capital,” he explained. “PCA is intended to curb aggressive growth. If a credit union gets in PCA trouble then it’s taking on too much risk.” He also noted that NCUA already has the authority to subject complex credit unions to risk-based standards under 1151. Becker cited a Filene Research Institute study that found credit unions do not require as much capital as banks because they have less charge-offs, fewer delinquencies, and are 66% as sensitive to macroeconomic shocks as their for-profit counterparts. He also said that having a risk-based system would provide regulators a more accurate picture of the risk each credit union is taking on and the risk to the insurance fund, which is particularly important because credit unions cannot access the capital markets. When fielding a question from the audience on why banks have an interest in credit unions’ safety and soundness, Leggett responded that during the S&L crisis of the 1980s, the banking industry could have been more proactive to prevent some of the problems. Now, he emphasized, “We are checks on each other.” Becker replied, “We remember, although we didn’t cost the taxpayers $123 billion. We didn’t cost the taxpayers a dime.” “We are not that far away from each other,” Leggett said. “One of the things I stated when NCUA came out with this proposal is it’s a good first step.Risk models and the capital standards that arise from them are only as good as their assumptions.” “What’s at stake here is the enhanced safety and soundness of credit unions,” according to Becker. Leggett cautioned, “Saying this is a cure-all is selling people a false bill of goods.” The entire issue for the banking industry boils down to competition, Becker said. If credit unions had a risk-based capital system as proposed by NCUA, many would be required to carry less capital and would use the new-found funds to invest in technology or branches “or they might even grow. Isn’t that the real problem here?” [email protected]

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