Will The Role of Supervisory Guidance Really Change?

An overly zealous examiner is probably pretty high on the list of concerns that can keep credit union executives up at night. But if an interagency statement issued last year has any bearing, the discretionary range of an examination may become clearer – for examiners and credit unions.

In September, the NCUA was joined by the Board of Governors of the Federal Reserve System, FDIC and the Office of the Comptroller of the Currency in clarifying the role of supervisory guidance.

In the Interagency Statement Clarifying the Role of Supervisory Guidance, they said “supervisory guidance does not have the force and effect of law,” and stated their intent to limit the use of numerical thresholds in published guidance. The statement also called for the elimination of guidance-based “violations.”

Anecdotally speaking, for years credit unions have complained about increasingly prescriptive exams that were not just citing existing regulation, but also supervisory guidance. This is not all that surprising because the NCUA actually trains examiners to support Examiner Findings and Document of Resolution items with references to Letters to Credit Unions, the NCUA Examiners Guide and Supervisory Guidance, when appropriate citations to statute or regulation are not there.

Only time will tell if there will be a discernible shift in how examiners are interpreting the new guidance and whether they refrain from incorporating existing guidance into the review process.  In the meantime, it makes sense for credit unions to be aware of some of the more prominent examples where examiners have been intertwining guidance and regulation in their enforcement actions.

One of the more noticeable instances of guidance infiltration in the exam process is the interest rate risk review procedures outlined in Letter 16-CU-08. Published in 2016 and implemented at the beginning of 2017, the guidance introduced the Net Economic Value (NEV) Supervisory Test and tolerance thresholds for acceptable levels of interest rate risk.

The NEV Supervisory Test is not in NCUA Rules and Regulations, the Federal Credit Union Act or the Federal Credit Union bylaws, yet examiners have been prone to use the test’s results to “require” credit unions to adjust their risk positions.

The NCUA has not publicly indicated whether it plans to rescind or revise Letter 16-CU-08, but if last year’s interagency statement is to be adhered to, it probably should. This letter is the textbook example of guidance issued by a financial regulator that includes numerical thresholds that end up being used by examiners to support administrative action (e.g. reduce interest rate risk). The letter goes as far as to state, “If the test should result in an extreme risk level, this will typically require your credit union management to implement a de-risking strategy.”

Another common situation of guidance being enforced as if it were law or regulation is the suggested aggregate limit for Credit Union Owned Life Insurance found in the Interagency Statement on the Purchase and Risk Management of Life Insurance, released in 2004.

That statement warns institutions against owning life insurance with an aggregate cash surrender value (CSV) in excess of 25% of capital. It notes that agencies have previously “identified this capital concentration threshold as the level that institutions should consider when establishing internal limits for their BOLI holdings.”

Notwithstanding that the NCUA is not listed as an issuing agency for this statement, NCUA examiners continue to enforce the aforementioned 25% aggregate limit. This is yet another textbook example of numerical thresholds that are found only in guidance, and certainly not law or regulation, being enforced by field examiners. It is perfectly acceptable if the NCUA wishes to use this threshold to determine if an expanded examination scope is necessary; however, it certainly should not be the basis for requiring a credit union to reduce a position.

Assessing a credit union’s net worth percentage is another scenario where examiners have shown a tendency to look past existing regulations. Citing interest rate risk and credit risk levels that exceed peer institutions, examiners are prompting credit unions to either reduce their risk position(s) and/or increase capital. The only problem with that is the net worth percentage thresholds recommended are arbitrary and, in fact, exceed statutory requirements.

In essence, examiners are applying their own risk-based capital requirements based solely on their own opinion of how much capital is sufficient for a given level of risk. Examiners should not be enforcing conceived requirements for the level of net worth; instead, they should only enforce the statutory capital and risk-based capital limits included in the Federal Credit Union Act and NCUA regulations.

These are just a couple of illustrations where examiners have been citing supervisory guidance in their enforcement actions. While guidance certainly plays a key role in helping examiners and credit unions be more aware of what is expected, it is imperative that examiners keep within the framework of existing laws and regulations. Anything less causes uncertainty and contributes to an inefficient system.

Christopher Dahlgren is Director of the Office of Regulatory Affairs for Balance Sheet Management Services, a Stifel Company, and a former Principal Examiner for the NCUA. He can be reached at cdahlgren@bsmservices.com.