The NCUA removed interest rate risk provisions from its risk-based capital rule after credit unions overwhelmingly voiced their opposition. However, if the Switzerland-based Basel Committee on Banking Supervision includes all institutions in its interest rate risk guidelines, credit unions will likely see a new interest rate rule from the NCUA that could require them to increase capital to offset the risk.
"Since the RBC proposal is based on Basel III, [the NCUA is] probably looking very carefully at this proposal," WOCCU Vice President and General Counsel Michael Edwards said. "It will for sure be implemented for big banks, probably community banks, too."
Edwards said after years of WOCCU advocacy for small institutions, the Basel Committee is starting to more seriously consider exemptions when appropriate. In the interest rate consultative document released in June, the committee said the proposal would be mandatory for large, internationally active banks. However, regulators would have national discretion to apply their interest rate risk framework to non-internationally active institutions.
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That changes the conversation, Edwards said. He added that WOCCU's position is that current regulations that require an interest rate risk policy is probably enough.
Should that language survive in Basel's final guidance, which is expected next spring, it would provide leverage for credit union trade associations.
"When the NCUA proposes to do something about this, CUNA and other credit union system people can point to this Basel paper and say, Basel said you don't have to do this," Edwards said. "That's huge – it moves the goal posts closer to reducing regulatory burden."
NCUA Public Affairs Specialist John Fairbanks said the agency is continuing to evaluate how best to regulate and supervise interest rate risk going forward.
"No decisions have been reached at this time," Fairbanks said. "The agency is evaluating the Basel proposal as part of our analysis of how best to address interest rate risk for federally insured credit unions."
However, there's no guarantee Basel will exempt small institutions, he added. The committee also said in guidance for the resolution of weak banks that rules should be applied equally to all institutions. The committee was referring to regulators in Europe who, rather than take corrective action against struggling institutions, promoted them.
Basel proposed three different approaches to interest rate risk management, Edwards said, which the committee called pillars in its document.
Pillar 1 would mandate a global minimum capital standard. It would require new capital reserves to account for interest rate risk, abandoning the current principles-based approach and replacing it with what Edwards called a complicated equation. Pillar 2, which WOCCU supported in its comment letter, would require very little change in current IRR management standards, only slightly changing what principles are reviewed and retaining regulator supervisory discretion. Pillar 2 would require institutions to establish a reserve based on IRR analysis, but would not require an addition to the main capital requirement.
"We support the committee's proposed stand-alone, enhanced Pillar 2 approach because it would allow supervisors sufficient discretion to prevent unintended consequences and unjustified regulatory burdens on credit unions that would be likely to result from a one-size-fits-all approach to interest rate risk regulation that is designed primarily for large internationally active banks," Edwards wrote in WOCCU's comment letter.
Pillar 3 would require a hybrid approach, Edwards said, retaining some principles but also adding an equation that would be applied to net worth ratio requirements.
Pillars 1 and 3 would not only raise net worth requirements – Edwards said the equations could not be modified by national regulators or applied differently to large and small institutions.
"I'm not sure how that would work," he said. "They proposed some adjustment based on national economic conditions, but that couldn't be done by the national government. I'm not sure who would do that – folks in Switzerland, I guess."
Most concerning, Edwards said, was that Pillars 1 and 3 would change prompt corrective action rules and make interest rate risk a PCA issue. That would result in a much higher cost for affected institutions and have considerable practical implications, he added.
The Mortgage Bankers Association also supported the Pillar 2 approach in its comment letter.
"(The) MBA believes that prudential U.S. bank regulators have a robust Pillar 2 framework that includes a detailed quarterly call report, the ratings of banks based upon the CAMELS system, a robust on-site supervisory examination process and a program for prompt corrective action. U.S. bank regulators, likewise require banks of a certain size to conduct periodic stress tests. Further, banks of all sizes in the United States generally have software that facilitates conducting rate shocks," MBA President/CEO David Stevens wrote in the letter. He added that other approaches floated by Basel appear to be an attempt to fix something that is not broken.
Edwards called the proposal a government policy designed to solve a problem created by another government policy, referring to the Federal Reserve's policy of maintaining a low-rate environment.
"Rates are far lower than they have ever been historically," he said. "That has affected the ability of financial institutions to get any yield at all, so they had to get into longer term financial instruments. A simple end result would be for the other government policy to take this into consideration and raise rates slowly. You can't view these things in isolation, one thing caused another."
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