Stagnation by Overcapitalization

NCUA’s risk-based capital proposal would inhibit CU growth.

August 1, 2014

Stagnation by overcapitalization would be a long-term effect of NCUA’s risk-based capital proposal if credit unions were required to hold more capital than other federally insured financial institutions with similar risk profiles.

A higher required capital-to-asset ratio would cause credit union asset growth to stagnate and decline over the long term for any given rate of return on assets. This decline in credit union asset growth (which comes from accepting deposits and making loans) would lead to reduced member services and lower national economic growth.

We hope NCUA will quantify these costs and then weigh them against the uncertain benefit of minor reductions in the relative cost of credit union failures.

We can estimate the effect of the proposal on long-term credit union asset growth by using the rule that, in the long run, a credit union’s sustainable asset growth rate is equal to its average long-term return-on-equity (ROE) ratio.

You can calculate the ROE ratio by dividing the return-on-assets (ROA) ratio by the capital-to-assets ratio. So in the long-run, a credit union’s sustainable asset growth rate equals ROA/capital ratio.

This equation calculates the necessary asset growth rate to maintain a given capital-to-asset ratio and an assumed ROA ratio. Simple math shows that a higher capital ratio in the denominator of this ratio will reduce the sustainable asset growth rate.

Using a few simple assumptions, we can demonstrate the slower balance sheet growth credit unions could experience in the long run under NCUA’s risk-based capital proposal.

FutureAssetGrowthWe assume that without this proposal, credit unions would want to return to precrisis, 10-year average capital ratios of 11% and ROA of almost 1%. At that earnings rate, to maintain the average 11% capital ratio, credit union assets could increase by 9.1% each year.

If we now assume that credit unions respond to the risk-based capital proposal by increasing, on average, their desired capital ratios by 0.35% to 11.35%, and then we assume the ROA ratios decrease to 0.90% (due to increased risk aversion and balance sheet repositioning induced by the proposal), then asset growth would have to slow to 8%. That’s 1.1 percentage points lower than without the proposal.

This slowdown in asset growth would result in a significantly smaller credit union movement during the next 20 to 30 years. The table shows the dramatic difference in the future size of the credit union system that would result from these different growth rates (“Future CU asset growth”).

Indeed, the difference between the two cases after 20 years, $1.2 trillion, is larger than the size of the credit union movement today. After 30 years, the movement would be one-third smaller than it would be without the proposal.

This stagnation by overcapitalization would also mean banks would gain market share, putting credit unions at a serious competitive disadvantage in an industry where economies of scale are a major determinant of success. Smaller credit unions would be put at an even greater disadvantage.

Based on our analysis, the conclusion is unavoidable that this proposal would condemn the credit union movement in the long-run to an inconsequential role in the financial services marketplace—to the detriment of our economy, communities, small businesses, and consumers.

STEVE RICK is CUNA Mutual Group’s chief economist. Contact him at 800-356-2644, ext. 6655454, or at