WASHINGTON-Credit unions should be wary of what they ask for when it comes to risk-based capital, according to a letter to NCUA from American Bankers Association Senior Economist Keith Leggett. Following up on the NCUA's Credit Union Capital Summit, Leggett warned credit unions that a risk-weighted system of capital might not be such a positive for credit unions. He advocated that any risk-based capital system for credit unions must include a meaningful leverage ratio and there should be "no substantive difference" between bank and credit union ratio standards. CUNA Chief Economist Bill Hampel agreed with these two precepts; "Actually, I found parts of this thing encouraging," he said. But the agreement seems to stop there. Hampel called Leggett's argument against risk-based capital for credit unions a "red herring" and "silliness." Regarding risk-based capital, Leggett told NCUA that banks are required to deduct investments "that are deemed to be at risk requiring some isolation from the credit union" from capital. In other words, he explained in an interview, investments in certain credit union service organizations. To this, Hampel replied that in theory this scenario is possible, but, in practice, he is not aware of any CUSOs that are participating in activities that are not permitted to federal credit unions. The banking economist's letter continued, "Therefore, it appears to us that if such standards were applied by NCUA to credit unions, investments in some credit union service organizations, corporate credit unions, and the NCUSIF should be deducted from credit union's net worth before calculating a net worth ratio.Because credit unions do not deduct at risk equity investments from their net worth requirements, while banks do, this accounts for the higher PCA leverage capital trigger for credit unions." Leggett's letter offered up $821 million Arrowhead Credit Union as an example. A change from the current capital system to the banks' would drop their net worth from $60.1 million to $33.4 million. Its leverage ratio would plummet from well-capitalized at 7.82% to 4.21%, or "barely adequately capitalized." Hampel pointed out that Leggett's analysis presumed that all the CUSOs Arrowhead is invested in are performing activities that are not permissible by the credit union. In reality, they all are so all of the investments could be counted in the capital. In addition, Hampel explained, a credit union's 1% investment in the NCUSIF "is one of the safest credit unions have, instead of the opposite" and should be treated as such by including it in credit union capital. NAFCU Chief Economist Tun Wai disagreed with Leggett's entire premise. He did say, "I believe there is broad agreement among financial institution regulators and trade groups including NAFCU and the ABA as indicated in its comment letter that the goal of any capital requirements or system is to protect the taxpayer and bolster safety and soundness. Adoption of a risk-based capital system for which the credit union community – and it would appear the ABA – are in agreement could accomplish these objectives." However, that is where the agreement ended. "At the same time," Wai continued, "we believe that bank capital and credit union capital have "very little substantive difference," unlike the ABA's stance. If the credit union risk-based system includes risks like liquidity, interest rate, concentration, reputation, and operation, then the capital system would be more comprehensive than banks. Thus, an equal leverage requirement would be unfair to credit unions. Second, it would be unfair to credit unions if the same risks are treated in that same fashion as banks. Credit unions have different risks than banks and treatment of these risks should account for these differences." It is all in the application, the credit union economists agreed, and it is the same in handling secondary capital. "Allowing credit unions to issue secondary capital would fundamentally change the governance structure of credit unions," Leggett argued in his letter. That is true, Hampel said, if banks' system of subordinated debt were carried over to credit unions, "but no one's talking about that." Concerning subordinated debt, corporations allow the lenders to take over if the business reaches a certain capital ratio and is heading for financial ruin. Credit unions may have to pay more on subordinated debt, Hampel said, but credit unions "would do it in such a way the debt holders wouldn't be able to do that." [email protected]