Thursday, May 14, 2015

Supplemental Capital and Interdependency Risk

Low income credit unions can accept supplemental capital as part of their net worth and earlier this year National Credit Union Administration (NCUA) Chairman Matz stated that the agency would issue a proposed rule allowing complex credit unions to count supplemental capital as part of the numerator for their risk-based capital ratio.

However, since supplemental capital is available to absorb losses, NCUA has expressed concerns about the source of this supplemental capital. In other words, does this supplemental capital come from within the credit union industry or outside the credit union industry?

In its 2010 Supplemental Capital White Paper, NCUA wrote that "a supplemental capital structure which allows for investment between credit unions has the potential for increasing systemic risk within the credit union industry without actually producing new capital to buffer losses. The result is increased risk exposure to the NCUSIF without a corresponding increase in new capital."

Therefore, the NCUA needs to adopt measures to protect the credit union industry when credit unions invest in each other so as to minimize interdependency risk.

The simplest way to control for this risk would be to follow the standards set in NCUA's corporate credit union regulation regarding adjusted core capital. According to its corporate rule, if a corporate credit union contributes any capital to another corporate credit union, that corporate credit union must deduct an amount equal to this capital contribution when calculating its adjusted core capital.

But it is not clear whether NCUA has the authority to require such an adjustment via regulation for natural person credit unions.

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