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The CFPB Starts Flexing Its Muscles
The CFPB is coming online and has begun proposing rules and examining financial institutions. While questions still abound on the bureau’s stance and operations, credit unions should consider the potential impact of new regulations. For example, most credit unions weathered overdraft protection regulations fairly well by getting members to opt-in. However, the CFPB is currently examining the policies and practices of the nine largest banks to see if additional regulation is necessary (Office of Information and Regulatory Affairs and Consumer Financial Protection Bureau). Depending on the findings, income from overdrafts could be under threat.
Mortgage statements are another example. The CFPB has stated that it would like to increase transparency in the mortgage servicing industry. To do this, it is proposing regulations for monthly mortgage statements that would include alerts for delinquent borrowings with information for housing counselors and options to avoid foreclosures. For adjustable rate mortgages, institutions would have to send warnings of interest rate adjustments and list alternatives consumers can pursue to avoid the adjustment (CFPB Seeks to Enhance Consumer Protections by Targeting the Mortgage Servicing Sector, National Mortgage Professional Magazine, April 2012). Such changes can increase expenses as a result of changing the statements as well as the possibility of additional paper and postage from warnings depending on how the regulation is worded.
While the CFPB has said it will consider credit unions’ unique needs, the cost of compliance could likely increase as a result of new regulations.
Policy Limits And The Proposed Regulation For IRR
The following is an excerpt from our response to NCUA’s proposed regulation on IRR. While the excerpt focuses on a potential issue with the proposed regulation, it also highlights a concern we have with the way certain policy limits are written that don’t look at the actual risk of an institution.
Appropriate Policy Limits
Another concern is the evaluation of appropriate policy limits to ensure “compliance” with the regulation. The proposed regulation states:
- Set risk limits for IRR exposures based on selected measures (e.g. limits for changes [emphasis ours] in repricing or duration gaps, income simulation, asset valuation, or net economic value); (Federal Register, Page 16575).
While NCUA has stated in the proposed regulation that these are examples of the types of limits to set and how to set them, the concern is that these examples will become the rule.
Our question is: Why the focus on percent change versus focusing on the actual risk?
If a line in the sand is never drawn, then as long as a credit union continues to be within the percent change they identified, it would be acceptable for their risk profile to continue to deteriorate. Also, these types of limits don’t address if the credit union has an adequate net worth ratio.
Consider the following example if the guidance NCUA provides to examiners regarding this proposed regulation is similar to that in the below excerpt from the IRR Questionnaire (click on image to see Table A):
If a credit union has a 1.00% ROA, to maintain a “moderate” level of risk to earnings, the ROA can’t fall below 0.25% (maximum 75% decline) in a 300bp change. Whereas, a credit union with a 0.40% ROA can have their earnings drop to 0.10%. What if, at the time of the next simulation, the credit union with a 1.00% ROA is at 1.25%? Then their ROA can’t fall below 0.31%. If the credit union that was earning 0.40% now earns 0.30%, then their earnings can’t fall below 0.08%.
In essence, using the percent change methodology, if an institution’s earnings increase in the future, the bar is raised. Conversely, if earnings drop in the future, the bar is lowered. Is this really a good measure of safety and soundness?
Additionally, a percent decline approach applied to earnings would never allow a credit union with positive earnings to make the business decision to allow for negative earnings. There are several cases where external forces or strategic plans make negative earnings in the short term a reality in order to balance the long-term viability of the organization.
Using these guidelines would put any credit union with negative earnings out of policy. Does that mean that every credit union losing money would automatically be “out of compliance”? Note that, in 2010, approximately 40% of all credit unions had negative earnings after factoring additional NCUSIF expense. The potential ramification of this path could be detrimental to the industry.
To see our full response, please click here.
