Since the Great Recession, the financial institution industry has been flooded with regulatory changes. From the Dodd-Frank Wall Street Reform and Consumer Protection Act to the expected change in the allowance for loan losses to a current expected credit loss model, the purpose of regulatory reform is to provide stability and confidence in the industry. To that end, the National Credit Union Administration (NCUA) recently approved a final risk-based capital (RBC) rule.
The NCUA proposed sweeping changes to the capital rules in 2014 in an effort to replace the current risk-based net worth ratio with a metric that more adequately addresses the amount of capital compared to credit union balance sheet risks. The NCUA expects credit unions will be able to better absorb losses through sufficient capital without causing systemic losses to the National Credit Union Share Insurance Fund (NCUSIF). The RBC rule will apply to complex credit unions—those with more than $100 million in assets. This exempts 78 percent of federally insured credit unions from the risk-based capital requirements.
The final rule also will incorporate minimum ratios for credit unions to be considered adequately capitalized (8 percent) or well-capitalized (10 percent). The 2014 proposed RBC rule included an individual minimum capital requirement. This was removed in the final RBC rule, though the final rule offers the NCUA remedies to address credit unions with capital-level deficiencies.
Calculating the RBC Ratio
The RBC ratio will be determined by dividing the RBC by the credit union’s total risk-weighted assets. RBC includes tangible and/or liquid balance sheet items that would be available to cover losses incurred by the credit union, including undivided earnings, appropriation for noncomforming investments, equity acquired in a merger, net income and secondary capital accounting in net worth with the addition of the allowance for loan losses. Deducted from RBC will be the credit union’s NCUSIF capitalization deposit and any intangible assets, including goodwill.
The denominator of the ratio will represent the credit union’s total risk-weighted assets, including certain off-balance sheet assets, and will be reduced by the same items that reduce the numerator. There are 10 categories of risk weights, comparable to the FDIC’s Basel III risk weights implemented by the banking system in 2015. The risk weighting of the balance sheet will require higher levels of capital for credit unions with concentrations in real estate loans, commercial loans or noncurrent loans. A significant change from the 2014 proposed RBC rules is the elimination of interest rate risk from the calculation of risk-based assets.
The rule’s implementation date is January 1, 2019. While most credit unions affected by this rule will be considered well-capitalized, the extended implementation date will allow credit unions to implement capital strategies to reduce risk on the balance sheet and/or maintain the current risk. Credit unions also should consider how proposed changes in business operations or potential mergers or acquisitions will impact the credit union’s RBC ratio. Extensive changes will be required to the 5300 Call Report; these are expected to be complete in early 2018. The changes will affect not only regulatory capital schedules but also loan, investment and other schedules. Complex credit unions also will be required to implement a capital policy addressing the credit union’s strategy for assessing capital adequacy and maintaining appropriate capital levels.
For more information on how the final RBC rules could affect your credit union, contact your BKD advisor.