CREDIT UNIONS

UNITED STATES DEPARTMENT OF THE TREASURY

December 1997
DEPARTMENT OF THE TREASURY

WASHINGTON, D.C.

SECRETARY OF THE TREASURY December 1, 1997

The Honorable Alfonse M. D’Amato

Chairman

Committee on Banking, Housing,

 and Urban Affairs

U.S. Senate

Washington, D.C. 20510-6075

Dear Mr. Chairman:

I am pleased to transmit the Department of the Treasury’s report on credit unions.

As required by section 2606 of the Economic Growth and Regulatory Paperwork Reduction Act

of 1996, this report evaluates: (1) the potential for, and the potential effects of, having some

entity other than the National Credit Union Administration (NCUA) administer the National

Credit Union Share Insurance Fund; (2) whether the 1 percent deposit that federally insured credit

unions have made into the Share Insurance Fund should continue to be treated as an asset on

credit unions’ books or whether credit unions should, instead, expense that deposit; (3) the 10

largest corporate credit unions, including their investment practices and their financial stability,

financial operations, and financial controls; (4) the NCUA’s regulations; and (5) the NCUA’s

supervision of corporate credit unions.

In preparing this report, we consulted with the NCUA and its Board, the Office of the

Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance

Corporation, and the Federal Reserve Board. We also met with all the major credit union, bank,

and thrift trade associations, and with numerous credit union representatives. We published a

request for comments in the Federal Register and received 181 responses. We visited eight credit

unions and two corporate credit unions. In evaluating the 10 largest corporate credit unions, we

assembled an interagency team of federal banking examiners to assist us, as required by the

mandate.

Credit unions intermediate only a small portion of the savings and credit in our financial system,

but they serve some 70 million Americans. As a group, they appear to be in strong financial

condition. Similarly, the Share Insurance Fund, which insures deposits at credit unions, is at its

statutory maximum reserve level and has had few losses in recent years. Although we found

credit unions and the Share Insurance Fund in good condition, we also identified several

important aspects of the NCUA’s safety and soundness regulations, the NCUA’s administration

of the Share Insurance Fund, and the statutes under which the NCUA operates that need

strengthening.
2

In 1994, several corporate credit unions with investment portfolios heavily concentrated in

collateralized mortgage obligations experienced financial difficulties. The NCUA closed one

corporate credit union (Capital Corporate) and its member credit unions recorded $60 million in

aggregate losses. These developments, coupled with a $225 million investment by U.S. Central

Corporate Credit Union in a Spanish bank that failed in 1993, raised questions about the financial

strength of the corporate system and the NCUA’s oversight of that system. We found that both

corporate credit unions and the NCUA have made significant improvements since 1994. 

However, we also found a need for further strengthening of the corporate credit union system and

the NCUA’s oversight of it.

An emerging trend among credit unions involves the consolidation of credit unions into fewer but

larger institutions, some of which have become quite complex. Our report describes some of the

safety and soundness issues raised by this trend. However, the current dispute regarding credit

unions’ fields of membership is beyond the scope of our report. We continue to monitor the

issues involved and await a ruling by the Supreme Court.

If you would like to discuss the findings and recommendations in this report, please contact

Assistant Secretary Richard Carnell.

Sincerely,

Robert E. Rubin

Enclosure

[Identical letter sent to the Honorable Paul S. Sarbanes]
DEPARTMENT OF THE TREASURY

WASHINGTON, D.C.

SECRETARY OF THE TREASURY December 1, 1997

The Honorable James A. Leach

Chairman

Committee on Banking and Financial Services

U.S. House of Representatives

Washington, D.C. 20515-6050

Dear Mr. Chairman:

I am pleased to transmit the Department of the Treasury’s report on credit unions.

As required by section 2606 of the Economic Growth and Regulatory Paperwork Reduction Act

of 1996, this report evaluates: (1) the potential for, and the potential effects of, having some

entity other than the National Credit Union Administration (NCUA) administer the National

Credit Union Share Insurance Fund; (2) whether the 1 percent deposit that federally insured credit

unions have made into the Share Insurance Fund should continue to be treated as an asset on

credit unions’ books or whether credit unions should, instead, expense that deposit; (3) the 10

largest corporate credit unions, including their investment practices and their financial stability,

financial operations, and financial controls; (4) the NCUA’s regulations; and (5) the NCUA’s

supervision of corporate credit unions.

In preparing this report, we consulted with the NCUA and its Board, the Office of the

Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance

Corporation, and the Federal Reserve Board. We also met with all the major credit union, bank,

and thrift trade associations, and with numerous credit union representatives. We published a

request for comments in the Federal Register and received 181 responses. We visited eight credit

unions and two corporate credit unions. In evaluating the 10 largest corporate credit unions, we

assembled an interagency team of federal banking examiners to assist us, as required by the

mandate.

Credit unions intermediate only a small portion of the savings and credit in our financial system,

but they serve some 70 million Americans. As a group, they appear to be in strong financial

condition. Similarly, the Share Insurance Fund, which insures deposits at credit unions, is at its

statutory maximum reserve level and has had few losses in recent years. Although we found

credit unions and the Share Insurance Fund in good condition, we also identified several

important aspects of the NCUA’s safety and soundness regulations, the NCUA’s administration

of the Share Insurance Fund, and the statutes under which the NCUA operates that need

strengthening.

In 1994, several corporate credit unions with investment portfolios heavily concentrated in
2

collateralized mortgage obligations experienced financial difficulties. The NCUA closed one

corporate credit union (Capital Corporate) and its member credit unions recorded $60 million in

aggregate losses. These developments, coupled with a $225 million investment by U.S. Central

Corporate Credit Union in a Spanish bank that failed in 1993, raised questions about the financial

strength of the corporate system and the NCUA’s oversight of that system. We found that both

corporate credit unions and the NCUA have made significant improvements since 1994. 

However, we also found a need for further strengthening of the corporate credit union system and

the NCUA’s oversight of it.

An emerging trend among credit unions involves the consolidation of credit unions into fewer but

larger institutions, some of which have become quite complex. Our report describes some of the

safety and soundness issues raised by this trend. However, the current dispute regarding credit

unions’ fields of membership is beyond the scope of our report. We continue to monitor the

issues involved and await a ruling by the Supreme Court.

If you would like to discuss the findings and recommendations in this report, please contact

Assistant Secretary Richard Carnell.

Sincerely,

Robert E. Rubin

Enclosure

[Identical letter sent to the Honorable Henry B. Gonzalez]
TABLE OF CONTENTS

LIST OF TABLES ......................................................... vi

LIST OF FIGURES ........................................................ viii

LIST OF ABBREVIATIONS AND DEFINITIONS ................................ ix

ACKNOWLEDGMENTS .................................................... xi

NOTE ON TERMINOLOGY ................................................ xiii

SUMMARY ............................................................... 1

I. CREDIT UNIONS .................................................... 15

A. CREDIT UNIONS: AN HISTORICAL OVERVIEW .......................... 15

B. CREDIT UNIONS AS DEPOSITORY INSTITUTIONS ......................... 17

C. CREDIT UNIONS RELATIVE TO OTHER DEPOSITORY INSTITUTIONS ........... 19

1. Credit Union Assets ....................................... 24

2. Credit Union Net Worth .................................... 26

D. STUDY REQUIREMENTS, METHODOLOGY, AND DESIGN ................... 27

1. Requirements ............................................ 27

2. Methodology ............................................ 28

3. Overview ............................................... 29

II. THE SHARE INSURANCE FUND ....................................... 31

A. THE NCUA’S OVERSIGHT OF THE SHARE INSURANCE FUND ............... 31

1. Examining and Supervising Credit Unions ....................... 32

2. Resolving Troubled Credit Unions ............................ 34

a. Special Assistance ................................... 36
ii

b. Closing Failed Credit Unions ........................... 37

c. Analysis and Recommendations ......................... 39

3. Managing the Share Insurance Fund ........................... 42

a. Asset Management and Liquidation ...................... 44

b. Monitoring the Adequacy of Reserves .................... 44

c. Modeling Risk to the Share Insurance Fund ................ 47

B. THE ADMINISTRATION OF THE SHARE INSURANCE FUND .................. 50

1. The Potential for Conflicts of Mission .......................... 50

2. Analysis and Recommendations ............................... 52

C. THE ONE PERCENT DEPOSIT SYSTEM ................................. 53

1. Background ............................................. 53

2. Current Debate ........................................... 55

3. Analysis and Recommendations ............................... 58

D. SUMMARY .................................................... 59

III. THE NCUA’S SAFETY AND SOUNDNESS REGULATIONS ................. 63

A. COMPARISON OF DEPOSITORY INSTITUTION SAFETY AND SOUNDNESS

REGULATIONS .................................................. 63

B. SAFETY AND SOUNDNESS REGULATIONS .............................. 64

C. CREDIT UNION NET WORTH REQUIREMENTS ........................... 66

1. Moral Hazard ............................................ 66

2. Credit Union Net Worth .................................... 67

3. Credit Unions Are Not Subject to Net Worth Requirements ......... 68
iii

a. Reserves .......................................... 68

b. Examiner Guidance .................................. 69

c. Capital-Based Monitoring ............................. 70

4. Recommended Credit Union Net Worth Requirements ............. 70

D. PROMPT CORRECTIVE ACTION ...................................... 73

1. Prompt Corrective Action for FDIC-Insured Depository Institutions ... 74

2. Current NCUA Policies ..................................... 75

3. Prompt Corrective Action for Credit Unions ..................... 76

E. ANNUAL OUTSIDE INDEPENDENT AUDITS ............................. 80

F. TOWARD THE FUTURE ............................................ 81

G. SUMMARY .................................................... 82

IV. CORPORATE CREDIT UNIONS ........................................ 85

A. INTRODUCTION AND BACKGROUND .................................. 85

1. A Credit Union for Credit Unions ............................. 85

2. U.S. Central Credit Union ................................... 88

3. Investing Member Deposits .................................. 90

4. Corporate Credit Unions’ Consolidated Balance Sheet ............. 91

a. Assets ............................................ 91

(1) Investments ............................ 92

(2) Loans to Members ....................... 93

b. Liabilities .......................................... 93

c. Capital ............................................ 94
iv

5. Recent History ........................................... 96

6. Study Mandate and Methodology ............................. 98

B. THE 10 LARGEST CORPORATE CREDIT UNIONS ......................... 99

1. General Findings and Observations ........................... 100

a. Corporate Credit Unions are Thinly Capitalized and Operate

with Narrow Margins ............................... 100

b. An Interdependence Risk Exists Among Corporate Credit

Unions and U.S. Central ............................. 104

c. Competition ...................................... 104

2. Investment Practices ...................................... 105

3. Financial Stability, Financial Operations, and Financial Controls ..... 107

C. THE NCUA’S CORPORATE CREDIT UNION REGULATIONS ................ 109

D. THE NCUA’S OVERALL SUPERVISION OF CORPORATE CREDIT UNIONS ...... 112

E. SUMMARY ................................................... 115

V. CREDIT UNION LIQUIDITY AND THE CENTRAL LIQUIDITY FACILITY .... 117

A. CREDIT UNION LIQUIDITY ........................................ 117

B. EMERGENCY LIQUIDITY ......................................... 118

1. The Central Liquidity Facility ............................... 119

a. Capitalization ..................................... 120

b. Member Loans .................................... 123

2. The Federal Reserve Discount Window ........................ 123

3. Conclusions ............................................ 124
v

4. Recommendations ........................................ 124

APPENDIX A: RECOMMENDATIONS .................................. 127

APPENDIX B: COMPARISON OF OCC, OTS, AND NCUA SAFETY AND

SOUNDNESS RULES .................................... 131
vi

LIST OF TABLES

Table I.1: Federal Credit Unions by Type of Membership ......................... 19

Table I.2: Number of Credit Unions and Total Assets by Size Category .............. 20

Table I.3: Credit Unions Compared to Banks, Thrifts, and Community Banks and

Thrifts ....................................................... 21

Table I.4: Federal Credit Union Products and Services by Asset Size ................ 23

Table I.5: Credit Unions’ Consolidated Assets by Asset Size ...................... 25

Table II.1: Distribution of CAMEL Ratings .................................... 33

Table II.2: Troubled Credit Unions: Number and Assets, 1990-1996 ................. 34

Table II.3: The Share Insurance Fund’s Balance Sheet ............................ 43

Table II.4: Reported Versus Actual Reserve Ratio of the Share Insurance Fund: 

1990-1996 .................................................... 46

Table II.5: Status of the Share Insurance Fund at Year-End 1996 ................... 48

Table II.6: Results of Stress Tests for the Share Insurance Fund .................... 49

Table III.1: Ratio of Total Reserves to Total Assets for Credit Unions, Commercial

Banks, and Thrifts: 1991-1996 ..................................... 67

Table III.2: Ratio of Total Reserves to Total Assets for Credit Unions by Asset Size: 

1991-1996 .................................................... 68

Table III.3: Credit Union Net Worth .......................................... 73

Table IV.1: Asset Distribution of Corporate Credit Unions ......................... 87

Table IV.2: U.S. Central Credit Union Asset Composition ......................... 88

Table IV.3: U.S. Central Credit Union Investments ............................... 89

Table IV.4: Credit Union Investments in Corporate Credit Unions ................... 90
vii

Table IV.5: Corporate Credit Unions’ Investments in U.S. Central ................... 91

Table IV.6: Corporate Credit Unions’ Consolidated Assets ......................... 92

Table IV.7: Corporate Credit Unions’ Consolidated Investments ..................... 93

Table IV.8: Corporate Credit Unions’ Consolidated Deposit Accounts ................ 94

Table IV.9: Corporate Credit Unions’ Consolidated Capital ........................ 95

Table IV.10: The 11 Largest Corporate Credit Unions by Asset Size ................... 99

Table IV.11: Corporate Credit Union Earnings .................................. 101

Table IV.12: Corporate Credit Union Capital Ratios .............................. 102

Table IV.13: Corporate Credit Union Core Capital as a Percent of Total Assets: 1994-

1996 ........................................................ 103

Table IV.14: Investments of the 10 Largest Corporate Credit Unions ................. 106

Table IV.15: Aggregate CAMEL Ratings for the 11 Largest Corporate Credit Unions .... 108

Table V.1: Central Liquidity Facility Balance Sheet ............................. 122
viii

LIST OF FIGURES

Figure I.1: Number of Credit Unions and Total Assets by Size Class ................. 20

Figure I.2: Total Members and Credit Unions .................................. 24

Figure II.1: Organization of the NCUA ........................................ 31

Figure II.2: The Resolution Decision-Making Process ............................. 36

Figure II.3: Number of Failures By Closure Method: Selected Years, 1981-1996 ........ 39

Figure III.1: Proposed Net Worth Ratios for Credit Union Prompt Corrective Action ...... 78

Figure IV.1: The Structure of the Credit Union System ............................ 86

Figure V.1: CLF Loans Outstanding: 1980-1996 ............................... 119

Figure V.2: The Redeposit Program ......................................... 121
ix

LIST OF ABBREVIATIONS AND DEFINITIONS

Bank Board Federal Home Loan Bank Board

CAMEL Capital adequacy, asset quality, management, earnings, and

asset/liability management; for banks and thrifts, the L component

stands for liquidity

CAMELS Capital adequacy, asset quality, management, earnings, liquidity,

and sensitivity to market risk; part of the revised Uniform Financial

Institution Rating System 

Cap Corp Capital Corporate Credit Union, Lanham, Maryland

C.F.R. Code of Federal Regulations

CLF Central Liquidity Facility

CUNA Credit Union National Association

FDIC Federal Deposit Insurance Corporation

Federal agency security Primarily debt and mortgage-backed securities issued or guaranteed

by such GSEs as the Federal National Mortgage Association

(Fannie Mae), the Federal Home Loan Mortgage Corporation

(Freddie Mac), and the Federal Home Loan Bank System; the

federal government does not guarantee GSE securities; also

includes federally guaranteed securities issued by the Government

National Mortgage Association (Ginnie Mae) 

Fed. Reg. Federal Register

FSLIC Federal Savings and Loan Insurance Corporation

GAO General Accounting Office

GSE Government-sponsored enterprise

NAFCU National Association of Federal Credit Unions

NASCUS National Association of State Credit Union Supervisors

NCUA National Credit Union Administration

NEV Net economic value

OCC Office of the Comptroller of the Currency

OTS Office of Thrift Supervision

Share Insurance Fund National Credit Union Share Insurance Fund

U.S.C. United States Code

xi

ACKNOWLEDGMENTS

Richard S. Carnell, Assistant Secretary of the Treasury for Financial Institutions, directed

this study. Edward J. DeMarco managed the study team, which consisted of W. Scott Frame,

Margaret D. Nilson, Brian S. Tishuk, and Margaret Woolley. Other Treasury officials making

significant contributions to the study included Victoria P. Rostow, Joan Affleck-Smith,

David Icikson, and Patricia A. Milon.

The study mandate directed the Treasury to analyze the 10 largest corporate credit unions

“in cooperation with appropriate employees of other Federal agencies with expertise in the

examination of federally insured financial institutions.” With assistance from the Office of the

Comptroller of the Currency, we assembled an inter-agency team of examiners to work with us in

this aspect of the study. The examiner team consisted of Anthony DiLorenzo (OCC), who was

the team leader, Todd Bethany (Federal Reserve), Stan Crisp (OCC), Michael Finn (OTS), Roy

Henson (FDIC), and Michael Sullivan (OCC). The Treasury acknowledges and deeply

appreciates the examiners’ outstanding professionalism and effort.

xiii

NOTE ON TERMINOLOGY

Over the years, credit unions and their regulators have developed a rich stock of

specialized terminology. Some of this terminology involves different words for things that also

exist, at least in some analogous form, at other depository institutions. In credit union parlance,

deposits are “shares,” savings accounts are “share accounts,” checks are “share drafts,”

certificates of deposit are “share certificates,” capital or net worth is “reserves,” and deposit

insurance is “share insurance.” This terminology in part reflects credit unions’ status as memberowned cooperatives in which deposits are legally equity capital.

Some credit union terminology refers to entities or distinctions that do not exist among

depository institutions generally. Thus, for example, one can refer to regular credit unions -- the

sort that individuals can join -- as “natural person credit unions” to distinguish them from

“corporate credit unions,” which are wholesale financial institutions that serve natural person

credit unions’ needs for transaction, investment, and liquidity services.

We have sought to make this study readily accessible to a wide range of people -- both

those who are familiar with credit unions and those who are not. To this end, when we have

faced a choice between using specialized credit union terminology and a plain-language, generic

equivalent applicable to depository institutions generally, we have typically opted for the plainlanguage equivalent. Thus, for example, we refer to deposits, deposit insurance, checking and

savings accounts, and net worth. We refer to natural person credit unions simply as “credit

unions.”

SUMMARY

Credit unions are depository institutions. Like banks and thrift institutions, they accept

deposits and make loans. At this basic financial level, credit unions resemble banks and thrifts: by

intermediating funds from savers to borrowers, credit unions take on credit risk (the risk that

borrowers will not repay loans) and interest rate risk (the risk that changes in interest rates will

alter the value of assets relative to liabilities). Managing these risks represents a key aspect of

credit unions’ financial operations.

The National Credit Union Administration (NCUA) -- credit unions’ federal safety and

soundness regulator -- supervises such risk-taking much as the federal banking agencies supervise

the safety and soundness of banks and thrifts. The NCUA administers a deposit insurance fund --

the National Credit Union Share Insurance Fund -- that insures deposits at credit unions, just as

the Federal Deposit Insurance Corporation (FDIC) insures deposits at banks and thrifts.

However, credit unions have several characteristics that, taken together, distinguish them

from banks and thrifts. First, credit unions are member-owned, member-directed depository

institutions. Credit unions do not issue capital stock. Instead, they derive their net worth from

their accumulated retained earnings.

Second, credit unions rely on unpaid, volunteer boards of directors elected by, and drawn

from, each credit union’s membership.

Third, credit unions do not operate for profit.

Fourth, credit unions have a public purpose. Congress intended credit unions “to make

more available to people of small means credit for provident purposes.” Of course, other

depository institutions also operate under statutes that delineate public purposes, so any

distinction here is one of degree.

Fifth, credit unions have certain limitations on their membership, limitations generally

based on some affinity among members. The Federal Credit Union Act limits federal credit union

membership to “groups having a common bond of occupation or association, or to groups within

a well-defined neighborhood, community, or rural district.” Most state credit union statutes also

impose some sort of common bond requirement. Thus, unlike other depository institutions, a

federal credit union cannot serve just anyone from the general public. Current disputes about the

terms of the federal common bond requirement are beyond the scope of this study.

At the end of 1996, 11,392 federally insured credit unions provided depository services to

some 70 million Americans. Collectively, credit unions’ $327 billion in assets pale compared to

commercial banks’ $4.6 trillion in assets.

Of the 11,392 credit unions, over 7,000 have less than $10 million in assets. These small

credit unions offer a simple array of deposit accounts and a limited set of loan products, such as
2

automobile loans and unsecured personal loans. At the same time, a small, but growing number

of credit unions are large, complex financial institutions. They offer a wide array of deposit and

loan products, generally comparable to the consumer product offerings of mid-size and large

commercial banks.

Moreover, all credit unions, large and small, operate in an ever more complex financial

system. The NCUA can and should continue modernizing and improving its safety and soundness

oversight of, and standards for, all credit unions.

The National Credit Union Share Insurance Fund

We examined the NCUA’s oversight of the National Credit Union Share Insurance Fund,

the advantages and disadvantages of having some entity other than the NCUA administer the

Share Insurance Fund, and the strengths and weaknesses of the Fund’s financial structure.

Condition of the Share Insurance Fund

The Share Insurance Fund is well capitalized, has had few losses in recent years, and

appears capable of handling various types of stress. We found that the NCUA generally seeks to

assist troubled credit unions by providing, for example, cash or noncash assistance through the

Share Insurance Fund. We found no particular problems in how the NCUA administers the Share

Insurance Fund, although we concluded that the broad discretion available to the NCUA should

be channeled to ensure timely and consistent treatment of troubled credit unions.

The Share Insurance Fund’s reserve ratio -- its ratio of total reserves to total insured

deposits -- is the standard measure of the Fund’s health. The reserve ratio has been at or near its

statutory ceiling of 1.3 percent every year since 1985. We do, however, have two concerns about

the reserve ratio.

The reserve ratio does not reflect the actual composition of the Share Insurance Fund’s

assets. When credit unions come under stress (e.g., during an economic recession), illiquid assets

acquired from failed or troubled institutions will tend to increase at the expense of liquid assets --

leaving the Fund less able to provide cash assistance to other ailing credit unions. We recommend

that Congress require the Share Insurance Fund to maintain an available assets ratio of 1.0 percent

of insured deposits. Should the available assets ratio fall below this level, the NCUA would not

be permitted to pay dividends even if the Fund’s reserve ratio were to exceed 1.3 percent.

We are also concerned that the NCUA’s method of measuring the Share Insurance Fund’s

reserve ratio generally overstates the reserves actually available. The NCUA calculates the

reserve ratio each month by dividing the Fund’s reserve balance for that month by the previous

year-end total of insured deposits. Thus each year-end reserve ratio is calculated using a

denominator that may be up to 12 months old, which tends to inflate the ratio. For example, at

year-end 1996 the Share Insurance Fund had $3.4 billion in reserves and insured $275.5 billion in
3

deposits, which implied a reserve ratio of 1.24 percent. However, the NCUA calculated the

Fund’s year-end 1996 reserve ratio as 1.3 percent by dividing the year-end 1996 total Fund

reserves by the year-end 1995 total insured deposits.

Because the NCUA must, by law, distribute dividends to member credit unions whenever

the Share Insurance Fund’s reserve ratio exceeds 1.3 percent, the NCUA’s procedure has led it to

pay dividends when the Fund’s reserve ratio, measured contemporaneously, was actually less than

1.3 percent. Paying dividends under such circumstances dissipates the Fund’s reserves without

good reason. We accordingly recommend that the NCUA correct this non-contemporaneous

measurement of the reserve ratio.

The NCUA’s Administration of the Share Insurance Fund

Congress directed us to evaluate the potential costs and benefits of having some entity

other than the NCUA administer the Share Insurance Fund. Neither the statutory language

requiring this study nor its legislative history indicates what entity or entities Congress had in

mind as possible candidates to administer the Fund. Nor do they indicate the policy objective of

such a change. We identified two possible conflicts of mission in having the NCUA operate the 

Share Insurance Fund. The first involves the NCUA’s role in chartering federal credit unions and

in administering the Fund. The second involves the NCUA’s role in supervising credit unions and

administering the Fund. These two possible conflicts, although distinguishable, significantly

overlap (e.g., a chartering entity also supervises the institutions it charters). They raise many of

the same issues and invite many of the same arguments.

Based on our review, we found no compelling case for moving the Share Insurance Fund

out of the NCUA. In our view, any potential for conflicts of mission is best handled by applying a

system of prompt corrective action to credit unions. The tension between the incentives of the

charterer and the goals of the regulator may be balanced by prompt corrective action rules that

require the regulator to take certain corrective actions when a depository institution’s condition

deteriorates. For credit unions, charterer, examiner, and insurer are the same entity and, in a

sense, make the decision together. The NCUA, with no statutory prompt corrective action

requirements like those for the FDIC, has broad discretion about whether, when, and how to take

corrective action. We believe that prompt corrective action rules for credit unions would impose

an important and highly constructive discipline on both the NCUA’s supervisory and insurance

functions. That discipline should, to a significant degree, offset any incentive to permit the

promotion of credit unions to interfere with the NCUA’s responsibilities for the Fund.

The Share Insurance Fund’s Financing Structure

Each insured credit union maintains on deposit in the Share Insurance Fund an amount

equal to 1 percent of the credit union’s insured deposits. The Fund’s reserves consist of this 1

percent deposit plus any additional amounts accumulated through interest earnings and insurance

premiums. Although the NCUA has no formal policy about when to assess premiums, it
4

considers charging a premium if the reserve ratio falls below 1.25 percent. The NCUA has

assessed a premium only once since 1984. If the reserve ratio exceeds 1.3 percent, the NCUA

must pay the excess as a dividend on credit unions’ 1 percent deposit.

The Share Insurance Fund counts the 1 percent deposit as its reserves. At the same time,

credit unions count the 1 percent deposit as an asset on their own books, which makes their

reported net worth higher than it would be than if they had expensed the deposit. This treatment

of the same dollars as reserves of the Fund and as an asset of credit unions results in double

counting if one views the Fund and credit unions’ net worth as the total buffer available to absorb

credit union losses. If the Share Insurance Fund has losses large enough to dip into the 1 percent

deposit, credit unions must then expense that portion of the cost and replenish the deposit. 

Incurring these expenses during a time of stress could further debilitate already weak credit

unions.

Proponents of the 1 percent system, including virtually all credit union managers, argue

that this funding structure appropriately treats the deposit as an asset because it is refundable

(under certain conditions) and it may earn dividends. They also note that the structure provides a

mechanism for promptly correcting any deficiencies in the Share Insurance Fund’s reserves, and in

effect gives the Fund a claim on the entire net worth of all credit unions.

Critics of the 1 percent system, including many bankers, argue that the accounting

treatment of the 1 percent deposit overstates the resources available to offset losses to the Share

Insurance Fund. During times of economic stress, they argue, credit unions are likely to have

reduced income or even have losses, and credit union failures are likely to increase. If the Fund’s

reserve ratio falls below 1.25 percent, the NCUA may begin assessing premiums. If losses are

large enough to impair the 1 percent deposit, then credit unions must write off and replenish the

amount that was impaired. The critics point out that credit unions would thus have to pay

premiums and write off and replenish the impaired deposit at a time when earnings are depressed

and net worth may already be declining. By expensing the 1 percent deposit now, credit unions

would not have to expense it during a time of economic stress. They would, however, still have

to pay premiums to rebuild the Fund’s reserves.

The overriding federal interest in the Share Insurance Fund’s financial structure lies in

protecting taxpayers from potential losses, while creating a healthy set of incentives for insured

credit unions. Thus, whatever the accounting issues and their resolution, the ultimate policy

concern must be the Share Insurance Fund’s fiscal soundness.

The financing structure of the Share Insurance Fund fits the cooperative character of

credit unions. Because credit unions must expense any losses to the Share Insurance Fund, they

have an incentive to monitor each other and the Share Insurance Fund. This financing structure

makes transparent the financial support that healthier credit unions give to the members of failing

credit unions. Credit unions understand this aspect of the Share Insurance Fund and embrace it as

a reflection of their cooperative character.
5

It would be feasible for credit unions to expense the 1 percent deposit now, when they are

healthy and have strong earnings. However, expensing the deposit would add nothing to the

Share Insurance Fund’s reserves, and better ways of protecting the Fund are available. 

Accordingly, we do not recommend changing the accounting treatment of the 1 percent deposit.

Instead, we recommend a strengthened reserving requirement. Under current law, credit

unions set aside a small percentage of their gross earnings as reserves until their net worth reaches

6 percent. We recommend increasing the 6 percent threshold to 7 percent. Thus we would not

require credit unions to write off part of their net worth but instead to add to it (if they did not

already meet the 7 percent target). This additional net worth cushion would more than offset the

double counting of the 1 percent deposit. And this approach should ultimately strengthen both

individual credit unions and the Share Insurance Fund.

In addition, the NCUA should have some flexibility to let the Share Insurance Fund

accumulate additional investment earnings in good times that would increase its resiliency during

economic downturns. The Federal Credit Union Act currently imposes a rigid 1.3 percent ceiling

on the Fund’s reserve ratio. We recommend that Congress give the NCUA discretion to let

investment earnings increase the Fund’s reserve ratio to 1.5 percent.

Current law also permits the NCUA to assess insurance premiums only at a fixed rate of

1/12 of 1 percent of insured deposits. Here again, we believe that the NCUA should have more

flexibility to ensure adequate, timely financing of the Share Insurance Fund. Specifically, we

recommend that Congress give the NCUA flexibility to set premiums higher or lower than 1/12 of

1 percent, as needed. Similarly, it may be appropriate to consider authorizing the NCUA to

assess risk-based premiums and perhaps to make risk-based adjustments in dividends from the

Share Insurance Fund. Although this study does not recommend such changes, we see value in a

broader debate over their possible advantages and disadvantages.

The NCUA’s Safety and Soundness Regulations

The NCUA establishes and enforces safety and soundness regulations as charterer and

supervisor of federal credit unions and deposit insurer of both federal and state credit unions. In

view of the extensive statutory and administrative modernization of bank and thrift regulation

over the past decade, we used the federal banking agencies’ safety and soundness regulations as a

starting point for our review of the NCUA’s safety and soundness regulations. When we

identified differences between the two sets of regulations, we evaluated them in light of credit

unions’ distinctive character and their size and complexity relative to banks and thrifts. We

identified four key differences between the NCUA’s regulations and those of the federal banking

agencies that we believe warrant action by Congress or the NCUA.
6

Rulemaking

In formulating fundamental safety and soundness policies, the NCUA has often relied on

such informal means as examiner manuals, policy statements, or bylaws. To some degree, this

informal approach reflects the historical prevalence of small credit unions with relatively simple

operations. Such informality has its benefits for the NCUA and for credit unions, but it may also

have significant potential drawbacks. For example, reliance on unwritten or informal rules

reduces or eliminates the opportunity for public comment. And a lack of clear public rules

increases the risk of the NCUA treating or being perceived as treating similarly-situated credit

unions differently without good reason. We recommend that the NCUA make important safety

and soundness rules readily accessible to all interested parties. And, if it intends its rules to have

the force of law and apply to credit unions generally, it should promulgate them as regulations and

codify them in the Code of Federal Regulations. As part of this rulemaking process, the NCUA

should publish proposed rules in the Federal Register and solicit comments from interested

parties.

Net Worth Requirements

Credit unions are not subject to net worth requirements. Regulators of other federally

insured depository institutions establish minimum net worth (capital) requirements to help ensure

that such institutions have a sufficient buffer to absorb unforseen losses without in turn imposing

losses on depositors or the deposit insurance fund. Requiring depository institutions to have

adequate net worth also helps counteract the moral hazard of deposit insurance (i.e., the tendency

of deposit insurance to permit or encourage insured depository institutions to take excessive risks

-- risks that they would not take in a free market). Net worth is like the deductible on an

insurance policy: the higher the deductible, the greater the incentive to avoid loss. Adequate net

worth gives a depository institution’s owners incentives compatible with the interests of the

insurance fund because the fund absorbs losses only after the institution has exhausted its net

worth and thus eliminated the economic value of the owners’ investment.

A credit union’s net worth represents the sum of the various reserve accounts on its

balance sheet. These accumulated reserves form the buffer that protects the credit union and the

Share Insurance Fund from possible losses. Yet the NCUA’s regulations do not impose any net

worth requirement on credit unions in the sense of requiring credit unions to have at least a given

ratio of net worth to assets in order to be in good standing. We recommend the following

changes that together should provide adequate, effective net worth requirements.

Most importantly, a credit union should have to meet a net worth requirement -- a

requirement that the credit union maintain a specified ratio of net worth to total assets. We

recommend that Congress require a credit union that has existed for a given number of years or

has attained a certain asset size (whichever occurs first) to have at least a 6 percent ratio of net

worth to total assets. (As described next, we would make such a requirement part of a system of

prompt corrective action designed to ensure that credit unions correct any net worth deficiency
7

expeditiously.) Other credit unions should be required to build reserves in a manner that ensures

that they will meet the 6 percent net worth target by the time they have existed for the specified

number of years or reached the specified asset size.

Additionally, the existing statutory reserving requirement (i.e., the requirement that a

federal credit union set aside as reserves a certain percentage of its gross income) should have a

higher target reserve ratio. Specifically, we recommend that Congress raise the current reserving

target from 6 percent of “risk assets” to 7 percent of total assets. A 1 percentage point increase in

the reserving target would approximate credit unions’ 1 percent deposit in the Share Insurance

Fund. Furthermore, credit unions should deduct from their reserves, some portion of any member

capital accounts at a corporate credit union and all paid-in capital issued by a corporate credit

union.

Congress should also authorize the NCUA to develop an appropriate risk-based net worth

requirement for larger, more complex credit unions. This risk-based requirement would

supplement the simple 6 percent net worth to total assets requirement and permit the NCUA to

take account of risks -- such as off-balance sheet risks or interest rate risk (from, for example, a

large mortgage portfolio) -- that may be appreciable only for a small subset of credit unions. 

Most credit unions are well capitalized. At the end of 1996, 93 percent of all federally insured

credit unions had at least 7 percent net worth total assets.

Prompt Corrective Action

Congress enacted a system of prompt corrective action for banks and thrifts in 1991. 

Prompt corrective action is a capital-based approach to safety and soundness supervision aiming

to resolve net worth deficiencies before they grow into large problems. The goal of a prompt

corrective action structure is to minimize -- and, if possible, avoid -- losses to the deposit

insurance fund. Prompt corrective action lays clear markers for when regulatory action must

occur and identifies a range of acceptable actions for a given degree of net worth deficiency.

The NCUA has some informal policies analogous to prompt corrective action. However,

it has no regulations or even formal guidelines for taking corrective action regarding a troubled

credit union.

We recommend that Congress adopt a system of prompt corrective action for federally

insured credit unions. This system would be a streamlined version of that currently applicable to

FDIC-insured institutions and would be specifically tailored to credit unions as not-for-profit,

member-owned cooperatives. It would thus, for example, omit the various provisions keyed to

the existence of capital stock since credit unions have no capital stock.

A prompt corrective action system for credit unions, like the system already in effect for

other federally insured depository institutions, might have five net worth categories. A credit

union with a ratio of net worth to total assets meeting the revised reserving target of 7 percent
8

would be “well capitalized.” In keeping with our recommendation to generally require credit

unions to maintain 6 percent net worth, credit unions with at least 6 percent net worth would be

“adequately capitalized,” and credit unions with less than 6 percent net worth would be

“undercapitalized.” A credit union with less than 4 percent net worth would be “significantly

undercapitalized.” A credit union with less than 2 percent net worth (or such higher level, not

exceeding 3 percent, as the NCUA may prescribe by regulation) would be “critically

undercapitalized.”

We would not apply these prompt corrective action provisions to credit unions that have

existed for less than a given number of years (the same as the phase-in period for meeting the

6 percent net worth requirement) or reached a given asset size. New credit unions should,

however, be subject to prompt corrective action if they are not making sufficient progress towards

meeting the 6 percent requirement.

Such a system of prompt corrective action would reinforce the commitment of credit

unions and the NCUA to resolve net worth deficiencies promptly, before they worsen. Its clarity

and predictability should promote fair, consistent treatment of similarly situated institutions. It

should also ultimately reduce the number and cost of credit union failures. In so doing, it should

conserve the resources of the Share Insurance Fund, make it even more resilient, and make more

money available for lending to credit union members. And it would respect and complement the

cooperative character of credit unions.

Audit Requirements

Although the NCUA requires each federal credit union to undergo an annual audit

satisfying criteria prescribed by the NCUA, the NCUA does not generally require even large

credit unions to obtain outside independent audits. Instead, a credit union’s supervisory

committee, which consists of volunteer members of the credit union appointed by the credit

union’s board of directors, has responsibility for conducting the audit itself or retaining an

independent, licensed certified public accountant to do so. The NCUA requires an independent

audit only if the supervisory committee has not conducted an annual audit, the supervisory

committee’s audit failed to meet the NCUA’s requirements, or the credit union has had serious

and persistent recordkeeping deficiencies.

With the rise of large, financially complex credit unions, the audit becomes increasingly

more difficult for unpaid volunteers to carry out personally. The NCUA has noted the

inadequacies of supervisory committee audits in general. Accordingly, we recommend that the

NCUA require each large federally insured credit union to obtain an annual audit from an

independent public accountant. The audit should be at least comparable to those required for

banks and thrifts.
9

Corporate Credit Unions

Corporate credit unions are cooperatively owned by their member credit unions. They

serve their members primarily by lending or otherwise investing excess funds deposited by

member credit unions. At the end of 1996, corporate credit unions held 7 percent of all regular

credit unions’ assets. Corporate credit unions also provide services comparable to the

correspondent services that large commercial banks have traditionally provided to smaller banks. 

U.S. Central Credit Union is a corporate credit union serving 38 of the 40 other corporate credit

unions.

General Observations

Corporate credit unions invest in high-quality assets, and thus have limited exposure to

credit risk. To maintain a liquid balance sheet, they keep their investments mostly short-term. At

the same time, corporate credit unions tend to be thinly capitalized (that is, have relatively little

net worth) and they operate with very narrow margins (that is, have only a small spread between

their interest earnings and interest expenses). These narrow margins hinder corporate credit

unions from increasing their capital quickly through retained earnings.

This combination of thin capitalization and narrow margins leaves little room for error and

heightens the importance of proper internal controls and strong management. Corporate credit

unions’ asset size may also fluctuate greatly as member deposits rise and fall, and as member loan

demand changes. This potential volatility, combined with the difficulty of building capital quickly

through retained earnings, reinforces the need for sufficient capital.

In recent years the NCUA has encouraged corporate credit unions to increase their net

worth, and corporate credit unions have done so. We believe that this trend is critically important

and that further increases in net worth are essential. We anticipate that the NCUA’s new

corporate credit union regulation will encourage corporate credit unions to continue to build their

net worth. In particular, we believe that the new regulation correctly bases permissible investment

risk on core capital (retained earnings), and emphasizes the importance of corporate credit unions

coming to rely on core capital rather than other forms of capital.

The three-tier cooperative structure of the credit union system -- regular credit unions,

corporate credit unions, and U.S. Central -- creates an interdependence risk among and within the

various levels. Specifically, a credit union’s deposits at its corporate credit union, and its

membership capital account, are assets on its books. At the same time, the credit union’s

corporate credit union carries these funds as (largely uninsured) deposits and secondary capital,

respectively, on its balance sheet. The same relationship holds between corporate credit unions

and U.S. Central. Thus, if U.S. Central were to fail, its member corporate credit unions could

face losses on their deposits -- reducing their own net worth. Similarly, if a corporate credit union

were to fail, its member credit unions could face losses on their deposits -- reducing their own net

worth.
10

This interdependence raises at least two issues. First, each level of the credit union system

must have sufficient net worth relative to the risks undertaken so as not to pose a risk of losses

cascading to the level below it. Second, if a system-wide demand for liquidity arises, corporate

credit unions have only limited ability to bring in liquidity from outside the system. Corporate

credit unions would largely have to rely on liquidating their investments to meet their members’

liquidity needs, but members’ deposit withdrawals would tend to deplete those investments.

Corporate credit unions face increasing competitive pressure from each other (due largely

but not entirely to their overlapping fields of membership) and from other market participants. 

The investment, liquidity, and transaction services that corporate credit unions offer to their

members are by no means unique; viable market alternatives exist, although small credit unions

may have access to a far more limited range of alternatives than large credit unions.

This competitive environment poses important safety and soundness issues for both the

near-term and the long-term. Some consolidation among corporate credit unions has begun and

we anticipate more in the future. It is unclear what the corporate system will look like in 5 to 10

years, but it is quite likely to look much different than today. How corporate credit unions, and

their members, respond to competition among themselves and from other market participants --

whether through rapid growth, developing new activities, increased risk-taking, consolidation,

shifting business strategy, or standing still -- will determine the sort of safety and soundness issues

that will arise. The NCUA will clearly need to monitor these developments closely.

Financial Condition of the Largest Corporate Credit Unions

Having analyzed the investment portfolios of the 10 largest corporate credit unions and

U.S. Central, we concluded that those portfolios generally have limited credit risk exposure, but

that concentration risk is an issue and that some institutions’ portfolios are vulnerable to changes

in interest rates. In particular, we observed a concentration in certain classes of asset-backed

securities.

We have several concerns about this concentration of corporate credit union investments

in particular classes of assets. First, corporate credit unions’ generally small net worth ratios

leave little room for error. Second, although the NCUA limits the amount that a corporate credit

union can invest in obligations of a single issuer, it does not limit the amount that a corporate

credit union can invest in a class of assets. Third, the risks of concentrating investments in a

single asset class are exacerbated by the interdependence risk among corporate credit unions and

by the relative homogeneity of the different corporate credit unions’ balance sheets.

We therefore recommend that the NCUA develop policy guidance or regulations

governing asset concentration risks. The NCUA also needs to consider the implications of such

concentration risk across all corporate credit unions. That is, although an examiner may conclude

that any one corporate credit union’s concentration in a particular asset class is within some
11

acceptable level of tolerance, the NCUA should also consider the corporate system’s overall

exposure to that particular asset class.

We reviewed the NCUA’s examinations of U.S. Central and the 10 largest corporate

credit unions. We found continued problems involving internal controls and management quality

at some corporate credit unions -- although improvements have been made. We also found that,

during the most recent examination cycle, the NCUA had various degrees of concern about 6 of

the 11 institutions.

NCUA’s Corporate Credit Union Regulations

Earlier this year, the NCUA completed a sweeping overhaul of its corporate credit union

safety and soundness regulation. The new regulation strengthens minimum capital requirements,

clarifies the responsibilities of a corporate credit union’s management and board of directors,

explicitly limits exposure to interest rate risk, implements strict credit review procedures, and

requires corporate credit unions to formulate contingent liquidity plans.

These changes have significantly improved the regulation of corporate credit unions. With

corporate credit unions operating in a highly dynamic market, the NCUA will, over time, need to

reexamine various elements of the new regulation. In fact, when the NCUA published that

regulation, it committed itself to issuing a report within 18 months on the issues involved.

NCUA’s Supervision of Corporate Credit Unions

We evaluated the Office of Corporate Credit Union’s approach to supervising corporate

credit unions, including its staffing, its policies and procedures, its examiner guidance, and its

safety and soundness standards. The Office is relatively new -- the NCUA created it in 1994 --

yet it represents a significant improvement over the NCUA’s previous, less rigorous approach to

supervising corporate credit unions. Based on our evaluation, we identified several areas for

continued development.

First, we found that the Office of Corporate Credit Unions is understaffed. The resources

currently devoted to supervising corporate credit unions fall short of reflecting the proportionate

risk these institutions pose to both credit unions and the Share Insurance Fund.

Second, the NCUA’s practices for regulating corporate credit unions diverge in some

respects from the best-practice approaches developed cooperatively by other federal regulatory

agencies. In particular, the bank and thrift regulators have been developing risk assessment

techniques that focus examiner attention on high risk areas and overall portfolio risk. Our review

of NCUA corporate examination reports found a more audit-oriented focus, rather than one

keyed to the critical risk areas in a particular credit union. We also found that examination

reports contained excessive detail about small deficiencies, which detracted from the major

findings and prescriptions for corrective action. More generally, the NCUA could benefit from
12

more regular interaction with the federal banking agencies to learn about, and participate in

developing best practices for approaching emerging financial market risks.

Third, the NCUA has not adequately developed written guidance for examiners and

corporate credit unions. Moreover, the NCUA does not currently have sufficient capacity to

review industry trends, assess potential systemic risks, and assess corporate credit unions as a

group.

Fourth, the rating system used for corporate credit unions does not reflect the current

risks and risk-taking in such institutions. In particular, the NCUA has not adopted the federal

banking agencies’ revised rating system, which includes a component rating for an institution’s

sensitivity to market risk.

Fifth, the NCUA’s examination reports and work papers for the 11 corporate credit

unions we reviewed did not always sufficiently support examiner ratings. We also have concerns

about the Office of Corporate Credit Unions’ policy of basing the overall rating on the lowest of

the five component ratings.

In view of these findings, we recommend that the NCUA: commit greater resources to

the Office of Corporate Credit Unions; interact more with the four federal banking agencies and

make greater use of risk-based approaches to supervision; improve its written examiner guidance;

add to its ratings of corporate credit unions a component rating for sensitivity of market risk; and

provide better analysis and documentation in connection with its examinations.

Credit Union Liquidity and the Central Liquidity Facility

Liquidity refers to the relative ease with which one can convert assets into cash. One of

the key functions of corporate credit unions is to provide liquidity to member credit unions.

Corporate credit unions are currently well positioned to do so because their portfolios consist of

investments of high credit quality with relatively short maturities. However, they are not

equipped to deal with systemic liquidity demands by regular credit unions. For this purpose,

Congress created the Central Liquidity Facility (CLF) in 1978, when credit unions had no access

to emergency liquidity from a governmental lender of last resort. In 1980, however, Congress

expanded access to the Federal Reserve’s discount window to all depository institutions, including

credit unions, offering accounts that are subject to reserve requirements. 

The CLF is a mixed-ownership government corporation within the NCUA. CLF

membership is voluntary and available to all credit unions. Most credit unions join the CLF

through their corporate credit union, which acts as an agent for its members. Unlike credit

unions, however, corporate credit unions do not actually pay cash for CLF shares. Through a

complex series of accounting transactions involving corporate credit unions, U.S. Central, and the

CLF, entries are recorded to show stock purchases, although no funds actually change hands. 

These transactions artificially inflate the parties’ balance sheets.
13

The CLF creates a concentration of credit risk for itself by holding all of its investments at

U.S. Central. If U.S. Central were ever to become impaired, the CLF’s elaborate redeposit-based

capital structure could collapse and its share accounts could suffer losses; the combined effect

could largely eliminate the CLF’s net worth.

The CLF has authority to lend to member credit unions and the Share Insurance Fund but

actual CLF lending has been modest. The CLF currently has statutory authority to borrow

$17 billion. Moreover, the Justice Department’s Office of Legal Counsel has stated that full faith

and credit of the United States backs such borrowing. Although the CLF may borrow from any

source, it has long had a credit arrangement in place with the Federal Financing Bank, which is

part of the Treasury. Various appropriations acts have limited to $600 million the amount that the

CLF can lend directly to credit unions, yet they have not limited the CLF’s ability to borrow the

full $17 billion at any one time and lend it to the Share Insurance Fund. In a systemic crisis, the

federal government could incur significant losses if such funds were advanced to shore up

troubled credit unions or a troubled insurance fund.

We recommend that Congress discontinue the CLF. Credit unions, particularly larger

ones, should apply to their Federal Reserve Bank for discount window access. Smaller credit

unions should at least have firm lines of credit for emergency liquidity from their corporate credit

unions or other depository institutions. In addition, we recommend that corporate credit unions

and the NCUA each evaluate credit unions’ potential liquidity needs and the options available for

credit unions and corporate credit unions to meet those needs. A recent NCUA regulation directs

corporate credit unions to do this.

15

 NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions (Alexandria, VA: NCUA, 1997), 7. 1

Because some people belong to more than 1 credit union, the 70 million figure reflects some double counting.

 Credit Union National Association, Response to the Treasury’s Data Request, Nov. 6 (Washington, DC: 2

CUNA, 1997).

CHAPTER I

CREDIT UNIONS

Credit unions are member-owned depository institutions that serve individuals belonging

to a defined field of membership. The nation’s 11,392 federally insured credit unions provide

basic retail financial services to some 70 million Americans. Most credit unions are relatively 1

small institutions that rely, to a significant degree, on member-volunteers to help run them. Many

small credit unions offer a relatively simple set of products, such as deposit accounts and

consumer loans. Although they are numerous, small institutions hold a relatively small proportion

of total credit union assets. Conversely, the largest 1,300 credit unions (11 percent of all credit

unions) hold approximately 75 percent of total credit union assets. These large credit unions

commonly offer a wide range of financial services, including mortgages, small business loans, and

credit cards. Although most credit unions have federal deposit insurance, 462 credit unions do

not. This study deals with only federally insured credit unions. 2

Federal credit unions have traditionally had “fields of membership” defined by “common

bonds” of association, occupation, or geographic location. Associational credit unions may

include members of a religious congregation, a fraternal organization, or a civic group. 

Occupational credit unions may include individuals sharing a common employer or workplace. 

Community credit unions may include anyone who lives, works, or worships in a single

neighborhood, city, county, or metropolitan area.

In this introductory chapter, we will first briefly sketch the history of credit unions and

their federal regulator, the National Credit Union Administration (NCUA). Second, we will

compare credit unions with other depository institutions. Third, we will discuss the current

condition of credit unions. Finally, we will summarize the statutory requirements for this study,

describe our methodology, and outline the structure of the study.

A. CREDIT UNIONS: AN HISTORICAL OVERVIEW

Modern-day credit unions trace their origins to credit organizations formed in Central

Europe during the mid-1800s. In 1850, German craftsmen and farmers in need of credit services

formed the first credit association by pooling their savings and offering loans to each other. 

Credit associations spread to North America in the late 1800s. In 1909, members of St. Mary’s

Parish in Manchester, New Hampshire, organized the first credit union in the United States,
16

 J. Carroll Moody and Gilbert C. Fite, The Credit Union Movement: Origins and Development, 1850-1980, 2d 3

ed. (Dubuque, IA: Credit Union National Association, 1984), 1-5, 23-27.

 Ibid., 123. 4

 NCUA, 1994 Annual Report (Alexandria, VA: NCUA, 1995), 2. 5

 Like the Federal Deposit Insurance Corporation, which manages insurance funds for both banks and thrifts, the 6

Share Insurance Fund insures credit union deposit accounts to $100,000.

 NCUA, 1996 Annual Report (Alexandria, VA: NCUA, 1997), 17. 7

 Pub. L. No. 91-468, § 10(1), 84 Stat. 994, 1017 (1970). 8

 S. Rep. 1128, 91st Cong., 2d Sess. 9 (1970). 9

known as the St. Mary’s Cooperative Credit Association. Shortly thereafter, Massachusetts

became the first state to create a credit union charter.3

Credit unions proliferated during the early decades of this century. By 1934, the United

States had approximately 2,500 credit unions, with 38 states and the District of Columbia offering

credit union charters. In 1934, the Federal Credit Union Act created a federal credit union 4

charter and established the Bureau of Federal Credit Unions as the regulator. The bureau began

as part of the Farm Credit Administration and then moved to the Federal Deposit Insurance

Corporation (1942), the Federal Security Agency (1948), and the Department of Health,

Education, and Welfare (1953).5

In 1970, Congress created the NCUA and the National Credit Union Share Insurance

Fund (Share Insurance Fund). The NCUA, an independent federal agency, is governed by the

three-member NCUA Board, with members appointed by the President and confirmed by the

Senate for six-year terms. In appointing the Board members, the President designates the

Chairman. The NCUA also administers the Share Insurance Fund.6

Like banks and thrift institutions, credit unions have a dual chartering and supervisory

system. The NCUA supervises federal credit unions, while states supervise the credit unions they

charter. But the NCUA, as manager of the Share Insurance Fund, also has some supervisory

authority over all federally insured state credit unions. The NCUA currently supervises and

insures 7,152 federal credit unions and insures 4,240 state-chartered credit unions.7

In 1970, Congress directed the NCUA to certify eligible institutions as low-income credit

unions. As credit unions serving predominantly low-income persons could not meet their 8

members’ credit needs using only deposits from other members, Congress permitted low-income

credit unions, or community development credit unions (CDCUs), to accept deposits from

nonmembers. CDCUs may have occupational or geographic fields of membership. CDCUs 9

distinguish themselves from traditional credit unions by serving those who may have a difficult

time obtaining credit, such as people who receive public assistance or reside in public housing. As
17

 NCUA, 1996 Annual Report (Alexandria, VA: NCUA, 1997), 15. 10

 In 1996, CDCUs obtained the exclusive authority (among credit unions) to issue secondary capital with a 11

maturity of at least five years. This secondary capital generally comes from philanthropic sources interested in

strengthening CDCUs’ capital base so that they can accept more deposits and make more loans.

 The federal banking agencies are the Office of the Comptroller of the Currency, the Office of Thrift Supervision, 12

the Federal Reserve Board, and the Federal Deposit Insurance Corporation.

 Credit unions are structured as a cooperative. As a business form, the modern cooperative dates from the mid- 13

1800s. Democratic participation in management by the cooperatives’ members is a fundamental characteristic of

cooperatives. Bankline, Encyclopedia of Banking and Finance, 10th ed. (Chicago: Bankline, 1994), 254.

 As of year-end 1996, uninsured deposits represented only 4 percent of all deposits at federally insured credit 14

unions. Sheshunoff Information Services, Inc., BankSearch (Austin, TX: Sheshunoff, 1997).

of year-end 1996, 346 CDCUs served over 800,000 people. CDCUs’ assets total over $2 billion,

with the average CDCU having under $7 million in assets.10, 11

B. CREDIT UNIONS AS DEPOSITORY INSTITUTIONS

Credit unions are depository institutions. Like banks and thrifts, they accept deposits and

make loans. At this basic financial level, credit unions very much resemble banks and thrift

institutions: by intermediating funds from savers to borrowers, credit unions take on credit risk

(the risk that borrowers will not repay loans) and interest rate risk (the risk that changes in

interest rates will alter the value of assets relative to liabilities). Managing these risks represents a

key aspect of credit unions’ financial operations. Supervising such risk-taking represents a key

aspect of credit unions’ federal oversight and makes the NCUA’s responsibilities much like those

of the federal banking agencies.12

However, credit unions have several characteristics that, taken together, distinguish them

from banks and thrifts. As part of our research, we asked credit unions, credit union trade

associations, and the NCUA to describe what makes a credit union different from a bank or thrift. 

The answers given pointed to five basic credit union characteristics. Although other financial

institutions may also have one or more of these characteristics, it is the combination of them that

defines credit unions as a distinct class of depository institutions.

First, credit unions are member-owned, member-directed depository institutions. Each 13

member has one vote in selecting board members and making certain other decisions. This voting

structure (one member, one vote) differs from that of mutual savings associations and mutual

savings banks in that a mutual institution, although also member-owned, allocates voting rights

according to the size of a member’s deposit (roughly equivalent to one vote per $100).

Like mutual savings institutions, credit unions do not issue capital stock. Credit union

members’ deposits are generally considered part of capital. But federal insurance protects

virtually all of these deposits, and the deposits themselves do not represent the kind of capital

available for absorbing losses and thereby protecting the Share Insurance Fund. Credit unions 14
18

 Although mutual savings banks and mutual savings associations also do not issue stock, such institutions have 15

the option of converting to stock form without fundamentally altering their basic character. Credit unions cannot

become stock institutions and still remain credit unions.

 Pub. L. No. 73-467, 48 Stat. 1216, 1216 (1934) (long title). 16

 12 U.S.C. § 1752(1). 17

 World Council of Credit Unions Membership Council, International Credit Union Operating Principles 18

(Madison, WI: World Council of Credit Unions, 1984), leaflet.

 12 U.S.C. § 1759. 19

derive that kind of capital (i.e., net worth) from their accumulated retained earnings. Most credit

unions start their existence with no net worth, and then build it up over time. The absence of

capital stock -- and the concomitant reliance on retained earnings -- reinforces the member-owned

character of credit unions. It also means that credit unions, unlike most other depositories, do not

have the option of increasing their net worth in times of stress by issuing stock.15

Second, credit unions rely on unpaid, volunteer boards of directors elected by, and drawn

from, each institution’s membership. The board sets policy for the credit union and hires the

senior management team. In small credit unions, member-volunteers may staff the institution. 

The board appoints member-volunteers to a supervisory committee, which has responsibility for

auditing the credit union, reviewing its performance, and making recommendations to the board

on these and other policy matters.

Third, credit unions do not operate for profit. They return any earnings to their members,

typically as reduced fees or reduced interest rates on loans or as “dividends on shares” (which in

substance resemble interest paid on deposits), or reinvest those earnings in the credit union as

retained earnings.

Fourth, credit unions have a public purpose. According to the Federal Credit Union Act,

Congress intended credit unions “to make more available to people of small means credit for

provident purposes.” The Act declares that credit unions are established for “promoting thrift 16

among [their] members and creating a source of credit for provident or productive purposes.”17

Of course, other depository institutions also operate under statutes that delineate public purposes,

so any distinction here is one of degree.

Fifth, credit unions have certain limitations on their membership, generally based on some

affinity among members. According to the International Credit Union Operating Principles of the

World Council of Credit Unions, “[m]embership in a credit union is voluntary and open to all

within the accepted common bond of association that can make use of its services and are willing

to accept the corresponding responsibilities.” The Federal Credit Union Act embodies this 18

principle by limiting federal credit union membership to “groups having a common bond of

occupation or association, or to groups within a well-defined neighborhood, community, or rural

district.” Most state credit union statutes also impose some sort of common bond 19
19

 According to the National Association of State Credit Union Supervisors, of the 47 states with credit union acts, 20

all but 7 have some statutory reference to a common bond. However, common bond requirements vary widely

among the states. National Association of State Credit Union Supervisors, Letter to the Treasury, Apr. 15

(Birmingham, AL: NASCUS, 1997), 1.

 Federal Deposit Insurance Corporation, FDIC Quarterly Banking Profile, 4th qtr. (Washington, DC: FDIC, 21

1996), 5.

requirement. Thus, unlike other depository institutions, a federal credit union cannot serve just 20

anyone from the general public. Table I.1 displays the number of federal credit unions and their

total assets in each type of membership category.

Table I.1: Federal Credit Unions by Type of Membership*

(Dollar figures in billions; data as of December 31, 1996)

Occupational CUs Assocational CUs Community CUs Other CUs**

Number Total Assets Number Total Assets Number Total Assets Number Total Assets

5,283 $179 743 $3 469 $11 573 $19

Source: NCUA, Response to the Treasury’s Data Request, Oct. 28.

*Data on state-chartered credit unions were not available.

**Most credit unions in this category have multiple groups with more than one type of membership.

C. CREDIT UNIONS RELATIVE TO OTHER DEPOSITORY INSTITUTIONS

 As of year-end 1996, the Share Insurance Fund insured 11,392 credit unions, which

together controlled $327 billion in assets. Thus each credit union averages $29 million in total

assets. Moreover, some 65 percent of credit unions had less than $10 million in total assets. In

contrast, commercial banks average $480 million in total assets. However, these aggregate 21

figures fail to capture two important facts about credit unions’ size relative to other depositories.

First, as with other depositories, a significant concentration of credit union assets exists in

the largest institutions. Table I.2 and Figure I.1 present the number of credit unions by asset size

category and the percentage of total assets in each category. The 11 percent of credit unions with

over $50 million in assets (1,284 institutions) hold 74 percent of credit unions’ aggragate assets.
< 2m 2m-10m 10m-50m > 50m

0

1,000

2,000

3,000

4,000

5,000

3,352

3,942

2,814

1,284

Asset Size (in dollars)

< 2m 2m-10m 10m-50m > 50m

0

50

100

150

200

250

300

3

20

64

240

Asset Size (in dollars)

Number of Credit Unions Total Assets (in billions of dollars)

20

Table I.2: Number of Credit Unions and Total Assets by Size Category

(Dollar figures in billions; data as of December 31, 1996)

Asset Size Category # of Institutions Total Assets % of Credit Union Assets

< $2 million 3,352 $3 1%

$2-10 million 3,942 $20 6%

$10-50 million 2,814 $64 19%

> $50 million 1,284 $240 74%

Total 11,392 $327 100%

Source: NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions.

Figure I.1: Number of Credit Unions and Total Assets by Size Class

(Data as of December 31, 1996)

Source: NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions.

Second, although both banks and thrifts collectively dwarf credit unions in asset size,

credit unions may well (according to comments we received from banks) be significant

competitors for individual community banks and thrifts in local markets. As Table I.3 indicates,
21

credit unions are comparable in number and aggregate assets to banks and thrifts that have less

than $100 million in assets (community banks and thrifts). Indeed, the $324 billion in assets held

by community banks and thrifts at the end of 1996 is almost identical to credit unions’

$327 billion in assets.

Table I.3: Credit Unions Compared to Banks, Thrifts, and Community Banks and Thrifts

(Data as of December 31, 1996)

Number of Total Assets Average Assets

Institutions (in billions) (in millions)

Commercial Banks 9,528 $4,578 $481

Thrifts 1,924 $1,028 $534

Community Banks and Thrifts 7,049 $324 $46 *

Credit Unions 11,392 $327 $29

Sources: Federal Deposit Insurance Corporation, FDIC Quarterly Banking Profile, 4th qtr.; and NCUA, 1996 Yearend

Statistics for Federally Insured Credit Unions.

Defined as all federally insured banks and thrifts with less than $100 million in assets. *

Large credit unions offer a range of products and services comparable to that of banks and

thrifts. The Credit Union National Association (CUNA), the largest credit union trade

association, describes how credit unions’ products and services differ according to asset size:

$1 million to $2 million: Credit unions with less than $2 million in assets comprise about

30 percent of all credit unions. They primarily offer their members shares [deposit accounts]

and loans. Just over a third of credit unions with $1 million to $2 million in assets receive

ACH [automated clearing house] payments. The average membership for these credit

unions is 690, the average savings per member is $1,810 and the average size of a loan

outstanding is $3,914.

$5 million to $10 million: Credit unions that have reached this asset size have larger

memberships that require and can support more extensive services. They probably offer

share draft [checking] accounts, IRAs [individual retirement accounts] and larger consumer

loans. Half of them offer credit cards and almost half offer ATM [automated teller machine]

access. More than four fifths of these credit unions receive ACH payments. The average

membership for these credit unions is 2,280, the average savings per member is $2,709 and

the average size of a loan outstanding is $4,611.
22

 CUNA, Credit Union Report 1996 Year-end ([Madison, WI]: CUNA, 1997), 3. 22

 NCUA, Board Action Bulletin, Jul. 23 (Alexandria, VA: NCUA, 1997), <http://www.ncua.gov/news/ 23

board_reports/board_reports.html>.

 CUNA, Credit Union Executive’s 1997 Risk-Based Lending Survey Report (Madison, WI: CUNA, 1997), vi. 24

Risk-based pricing is controversial among credit unions. Some argue that such a pricing policy conflicts with

credit union philosophy by treating members unequally. Others argue that risk-based pricing increases a credit

union’s total volume of lending, thereby helping all members, by making the credit union a more competitive

source of credit for low-risk members while remaining the best source of credit for high risk members.

$50 million to $100 million: These credit unions are large full-service financial institutions. 

They receive ACH payments and two-thirds of them own at least one ATM. Over

80 percent have more than one office. The average membership for these credit unions is

16,001, the average savings per member is $3,839 and the average size of a loan outstanding

is $5,379.22

Table I.4 presents data from CUNA’s annual survey, which reflect this size-based differentiation.

For example, only 10 percent of small credit unions offer first mortgage loans, while 97 percent of

the largest institutions offer such loans. Moreover, few small credit unions offer telephone

banking or ATM cards, but nearly all institutions with assets over $200 million offer these

services.

As credit unions continue to grow in size and complexity, the range of their product

offerings will almost certainly continue to expand. For example, the NCUA Board recently

approved a pilot program that would permit up to 500 credit unions to offer IRAs with returns

tied to the stock market. In addition, whether to use risk-based pricing (i.e., charging members 23

different rates based on their creditworthiness) is an emerging issue for credit unions. A recent

report by CUNA showed that 13 percent of credit unions use such pricing and that another

17 percent are considering doing so within the next three years. The report also indicates that the

larger the credit union, the more likely it is to practice or consider adopting risk-based pricing.24
23

Table I.4: Federal Credit Union Products and Services by Asset Size

(Percent of credit unions; data as of December 31, 1996)

Asset Size (in millions)

$1-2m $5-10m $50-100m Over $200m All Credit Unions

Loans:

 Unsecured 99% 100% 100% 100% 99%

 First Mortgage 10% 35% 85% 97% 38%

 Guaranteed Student 6% 17% 40% 52% 18%

 Used Auto 96% 99% 100% 100% 95%

 New Auto 96% 99% 100% 100% 95%

 Auto Leasing 2% 8% 32% 38% 10%

 Plane/Boat/RV 71% 86% 96% 96% 78%

 Credit Cards 5% 50% 93% 98% 43%

Member Services:

 Stock/Bond Brokerage* 2% 4% 33% 55% 9%

 Mutual Funds* 1% 2% 32% 57% 8%

 Safe Deposit Boxes 1% 3% 50% 65% 12%

 Audio Response 2% 22% 89% 97% 30%

 PC-Based Banking 1% 1% 22% 47% 6%

 ATM Cards 3% 47% 93% 99% 42%

Deposit Accounts/Services:

 CDs 38% 74% 96% 97% 63%

 IRAs 22% 66% 94% 98% 54%

 Business Checking 8% 38% 51% 45% 29%

 Personal Checking 16% 71% 96% 98% 55%

Source: CUNA, Credit Union Services Profile 1996.

*Institutions may not provide these services themselves, but may offer them if another entity actually provides the services.

In recent years, consolidation has accelerated among credit unions, as among other

depository institutions. The number of credit unions has declined 21 percent since 1987, as

shown in Figure I.2, even as the number of credit union members has grown 38 percent.

Significant asset growth has accompanied consolidation, with credit unions’ assets expanding
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

20

40

60

80

100

120

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

50

53 55 56 59 62 64 65 67 69

14,335 13,878 13,373 12,860 12,960 12,653 12,317 11,991

11,687 11,392

year

Members (in millions) Credit Unions

Members Credit Unions

24

 Over the same period, assets of FDIC-insured institutions grew 23 percent (to $6 trillion). Federal Deposit 25

Insurance Corporation, Statistics on Banking: 1996 (Washington, DC: FDIC, 1997), B-25; and FDIC, Statistics

on Banking: Historical, 1934-1994 (Washington, DC: FDIC, 1995), A-48, B-42.

 Sheshunoff Information Services, Inc., BankSearch (Austin, TX: Sheshunoff, 1997). 26

 NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions (Alexandria, VA: NCUA, 1997), 1. 27

 Federal agency securities consist chiefly of debt and mortgage-backed securities issued or guaranteed by such 28

GSEs as the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the

Federal Home Loan Bank System. The federal government does not guarantee GSE securities. This category also

includes securities that are federally guaranteed such as those of the Government National Mortgage Association.

50 percent between 1991 and 1996. The largest credit unions accounted for most of this 25

growth. Credit unions with over $250 million in assets recorded growth over 64 percent, whereas

institutions with less than $2 million in assets grew only 18 percent between 1991 and 1996.26

Figure I.2: Total Members and Credit Unions

(Data as of December 31, 1996)

Source: NCUA, 1996 Annual Report.

1. Credit Union Assets

As of year-end 1996, loans comprised 65 percent of total credit union assets. The vast

majority of these loans were automobile loans, first mortgage loans, and unsecured consumer

loans. Investments -- primarily U.S. Treasury and federal agency securities (primarily securities 27

issued by government-sponsored enterprises (GSEs)) and deposits in corporate credit unions 28
25

 NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions (Alexandria, VA: NCUA, 1997), 1. 29

and commercial banks -- accounted for 30 percent of credit unions’ total assets. Table I.5 29

shows credit unions’ consolidated assets by asset size.

Table I.5: Credit Unions’ Consolidated Assets by Asset Size

(Percent of total assets; data as of December 31, 1996)

Asset Size (in millions)

<$2m $2-10m $10-50m >$50m

Cash 5% 3% 2% 2%

Total Loans Outstanding: 65% 65% 65% 65%

Unsecured Credit Card 1% 2% 5% 6%

All Other Unsecured 18% 13% 9% 7%

Vehicle 36% 36% 30% 24%

1st Mortgage Real Estate 1% 4% 9% 15%

Other Real Estate 1% 4% 8% 8%

All Other Loans 8% 6% 5% 4%

Allowance for Loan Losses (2%) (1%) (1%) (1%)

Total Investments: 31% 31% 30% 31%

U.S. Government Obligations 1% 1% 2% 5%

Federal Agency Securities 0% 2% 6% 15%

Mutual Fund & Common Trust 1% 1% 0% 1%

Corporate Credit Unions 16% 13% 10% 5%

Commercial Banks, S&Ls 11% 13% 10% 4%

Credit Unions 1% 1% 0% 0%

NCUSIF Capitalization Deposit 1% 1% 1% 1%

All Other Investments 0% 0% 0% 1%

Allowance for Investment Losses N/A N/A N/A N/A

All Other Assets 1% 2% 3% 3%

Source: NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions.
26

 Sheshunoff Information Services, Inc., BankSearch (Austin, TX: Sheshunoff, 1997). 30

 This investment concentration in securities issued by GSEs underscores the critical need to keep GSEs safe and 31

sound. See, e.g., U.S. Department of the Treasury, Government Sponsorship of the Federal National Mortgage

Association and the Federal Home Loan Mortgage Corporation (Washington, DC: Treasury, 1996); Treasury,

Report of the Secretary of the Treasury on Government-Sponsored Enterprises (Washington, DC: Treasury,

1991); and Treasury, Report of the Secretary of the Treasury on Government-Sponsored Enterprises

(Washington, DC: Treasury, 1990).

 Sheshunoff Information Services, Inc., BankSearch (Austin, TX: Sheshunoff, 1997). 32

 Ibid. 33

Although loans comprise 65 percent of total assets, the prevalence of loan types varies

over time and by institution size. Both small and large credit unions concentrate primarily on

automobile and unsecured lending; however, larger institutions also devote a substantial portion

of their portfolios to mortgage lending as well. For example, as of year-end 1996, automobile

loans averaged 57 percent of the loan portfolio at credit unions with less than $10 million in

assets, but 34 percent at credit unions with more than $250 million in assets. Mortgage loans, on

the other hand, averaged only 5 percent of the loan portfolio at credit unions with less than

$10 million in assets, but 28 percent at credit unions with more than $250 million in assets. 

Between 1991 and 1996, automobile lending increased from 27 percent to 34 percent of average

credit union assets, mortgage lending held steady, and unsecured lending declined.30

Investments can provide credit unions with a prudent degree of liquidity (e.g., to meet

deposit withdrawals and future loan demand) and a profitable way to employ unloaned funds. As

credit union lending activity has increased in recent years, investments have declined as a

percentage of total assets at institutions of all sizes. Nevertheless, investments remain an

important component of credit unions’ aggregate balance sheet. Between 1991 and 1996, federal

agency securities (primarily GSE securities) supplanted deposits in corporate credit unions as

credit unions’ largest single type of investment. As a proportion of total credit union 31

investments, federal agency securities increased from 20 percent to 38 percent during that

period.32

Corporate credit unions provide wholesale financial services, such as investment services,

to credit unions. By collecting and investing surplus funds from hundreds of different credit

unions, a corporate credit union provides investment expertise, diversification of risk, and

economies of scale in buying and selling securities. Credit union investments in corporate credit

unions declined between 1991 and 1996. However, corporate credit unions remain a vital

resource for credit unions with less than $10 million in total assets. These small credit unions

make approximately 45 percent of their investments through corporate credit unions.33

2. Credit Union Net Worth

Credit unions, like banks and thrift institutions, have increased their net worth over the

past five years. These gains generally reflect the nation’s sustained macroeconomic expansion and
27

 Ibid. By contrast, commercial banks average 8 percent capital to total assets, although among small banks and 34

thrifts the ratio typically exceeds 10 percent. Ibid.

 Ibid. 35

 Pub. L. No. 104-208, § 2606, 110 Stat. 3009-394, 3009-473 (1996) (codified at 12 U.S.C. § 1752a note). 36

Id. § 2606(b)(1)(C), 110 Stat. 3009-394, 3009-474. 37

interest rate stability, as well as individual credit unions’ decisions to strengthen their capital base. 

Credit unions as a group held capital (in the form of retained earnings) equal to 11 percent of total

assets as of year-end 1996. Among credit unions, the ratio of capital to total assets varies 34

inversely with credit unions’ total assets -- averaging 15 percent for credit unions with less than

$2 million in total assets, but about 10 percent for credit unions with more than $250 million in

total assets. Banks and thrifts exhibit a similar inverse relationship between capital ratios and

institution size.35

D. STUDY REQUIREMENTS, METHODOLOGY, AND DESIGN

1. Requirements

The Treasury conducted this study pursuant to section 2606 of the Economic Growth and

Regulatory Paperwork Reduction Act of 1996, which President Clinton signed into law on

September 30, 1996. That section required the Treasury to evaluate: 36

! the feasibility of having some entity other than the NCUA administer the Share Insurance

Fund, and the implications of such a change;

! whether the 1 percent deposit that federally insured credit unions have made into the

Share Insurance Fund should continue to be treated as an asset on credit unions’ books or

whether credit unions should, instead, expense that deposit;

! the NCUA’s regulations;

! the condition of the 10 largest corporate credit unions -- including their investment

practices, financial stability, financial operations, and financial controls; and

! the NCUA’s supervision of corporate credit unions.

The statute required us to conduct the study in consultation with the NCUA, the Office of the

Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC). It

also specifically required us to evaluate the 10 largest corporate credit unions “in cooperation

with appropriate employees of other federal agencies with expertise in the examination of

federally insured financial institutions.”37
28

 60 Fed. Reg. 1,358 (1997). 38

2. Methodology

To better understand the issues raised by this mandate, we reviewed past research on

credit unions and met with a broad range of credit union representatives and regulators. We also

solicited the opinions of a wide range of interested parties on the various study topics. In

particular, we actively sought the views of credit unions on the study topics and on how they

viewed credit unions’ role in the financial marketplace.

To ensure the broadest public comment from interested parties, we published a notice in

the Federal Register describing our approach to the study and inviting comment on 15 specific

questions and on the study topics generally. We received 181 written responses to our notice. 38

We met with about 50 credit union chief executive officers (CEOs), individually and in

small groups. We participated in a conference call with the CEOs of 11 state-chartered credit

unions. We met with the CEOs of eight corporate credit unions. In connection with our study,

we also visited eight credit unions and two corporate credit unions.

We had several meetings each with CUNA, the National Association of Federal Credit

Unions (NAFCU), and the National Association of State Credit Union Supervisors (NASCUS).

We met with the Executive Director of the National Federation of Community Development

Credit Unions. Early in our study, representatives of the Association of Corporate Credit Unions

made a half-day long presentation to us and to the interagency team of banking examiners

(described below) on the operations of corporate credit unions.

We met with representatives of the American Bankers Association, the Independent

Bankers Association of America, and America’s Community Bankers.

We also met with representatives of the Consumer Federation of America and the U.S.

Public Interest Research Group.

We held numerous meetings with NCUA officials to learn about the NCUA’s supervision

of credit unions and corporate credit unions as well as the NCUA’s operation of the Share

Insurance Fund. We also attended numerous NCUA board meetings and reviewed many NCUA

documents, manuals, directives, policy statements, and the like. We also shared a draft of this

study with the NCUA and gave the NCUA an opportunity to comment on it.

We consulted with officials from the OCC, the Federal Reserve, the Office of Thrift

Supervision (OTS), and the FDIC.

With assistance from the OCC, we assembled an inter-agency team of federal banking

examiners to assist in our review of the financial condition of the 10 largest corporate credit 
29

unions. The six-member team included examiners from the OCC, FDIC, OTS, and Federal

Reserve. This team conducted off-site reviews of the 10 largest corporate credit unions as well as

on-site reviews of the two largest corporate credit unions, and met with NCUA officials on

several occasions to discuss those institutions.

We received full cooperation from all the credit unions, corporate credit unions, trade

associations and other parties that we contacted during the course of our study. We also received

information that we requested from the NCUA and, with one exception, had access to appropriate

NCUA officials. After encouraging us to meet with the Director of the Office of Community

Development Credit Unions, the NCUA canceled our scheduled meeting with her, asserting that

the mission of that office lay outside the scope of our study.

3. Overview

We divided the study mandate into three subject-areas -- the Share Insurance Fund, the

NCUA’s regulations, and corporate credit unions -- and we devote one chapter to each of these 

topics. Chapter II analyzes issues relating to the Share Insurance Fund. Chapter III examines the

NCUA’s regulations. Chapter IV discusses corporate credit unions. Chapter V analyzes credit

union liquidity issues that emerged during our review of corporate credit unions. We offer

recommendations within each of these chapters.

NCUA Board and Chairman

Inspector General Board Staff Executive Director

Central Offices

Corporate Credit Unions Examination and Insurance

Investment Services

Chief Financial Officer

General Counsel

Congressional Affairs

Training and Development

Administration Technology and 

Information Services

Human Resources

Regional Offices

Concord, CA

Atlanta, GA

Chicago, IL

Albany, NY

Austin, TX

Alexandria, VA

Office of Community

Development Credit Unions

31

CHAPTER II

THE SHARE INSURANCE FUND

The Share Insurance Fund insures deposits at all federally chartered credit unions and

those state-chartered credit unions that obtain federal insurance. This chapter will discuss three

issues related to the Fund: (1) the NCUA’s oversight of the Fund; (2) whether some entity other

than the NCUA should oversee the Fund and the implications of such a change; and (3) the

1 percent deposit system, under which federally insured credit unions maintain on deposit at the

Fund an amount equal to 1 percent of their own insured deposits.

A. THE NCUA’S OVERSIGHT OF THE SHARE INSURANCE FUND

The NCUA’s Office of Examination and Insurance carries out the agency’s oversight of

the Share Insurance Fund. The Office of Examination and Insurance has headquarters in the

NCUA’s central office, but delegates routine supervision to six regional offices (see Figure II.1).

Figure II.1: Organization of the NCUA

Source: NCUA, <http://www.ncua.gov/org/orgchart.html>.
32

 In the context of this study, “resolving” a troubled credit union means giving it special assistance, helping it to 39

merge with a healthy credit union, or liquidating it.

 NCUA, Federal Credit Union Handbook (Alexandria, VA: NCUA, 1996), 3. 40

 Each region and the respective state authority develop mutually satisfactory procedures for on-site contacts to 41

accommodate each state’s procedures. NCUA, Examiner's Guide (Alexandria, VA: NCUA, 1996), 21.1.

 Credit unions with assets over $50 million file quarterly; the rest file semi-annually. 12 C.F.R. § 741.6(a). 42

 State examiners assign CAMEL ratings to state institutions, just as NCUA examiners assign CAMEL ratings to 43

federal institutions.

The NCUA’s responsibilities for overseeing the Share Insurance Fund fall into three areas,

to which we will now turn:

! developing policies for examining and supervising credit unions;

! formulating policies for resolving troubled credit unions; and 39

! managing the Share Insurance Fund, including monitoring the adequacy of its reserves,

modeling its risks, and selling the assets it acquires from failed credit unions.

1. Examining and Supervising Credit Unions

The NCUA carries out its examination and supervisory responsibilities through on-site

visits by its 504 regional examiners and through off-site monitoring. In the case of a federally

chartered credit union, the main on-site contact is an annual examination: (1) to evaluate the

institution’s financial soundness; (2) to determine whether the institution is complying with

applicable laws and regulations; and (3) working with the institution’s management, to develop

plans to correct any problems. In the case of a state-chartered credit union insured by the Share 40

Insurance Fund, a federal examiner makes an on-site contact only if, after reviewing the state

authority’s examination report, the examiner has safety and soundness concerns about the

institution. The NCUA also makes on-site quality control contacts at a random sample of state 41

institutions and may participate in examinations led by the state examiner.

Off-site monitoring consists mainly of reviewing the financial reports of condition and

income (known as call reports) that federally insured credit unions submit to the NCUA semiannually or quarterly, depending on the institution’s size. These call reports resemble those filed 42

quarterly by banks and thrifts. Examiners review the reports filed by the credit unions in their

district, looking for such adverse trends as declining net income or declining net worth. Staff in

the Office of Examination and Insurance also monitor call report data to identify institutions with

existing or emerging problems and to gauge the performance of credit unions as a group.

Examiners use information from on-site contacts and call reports to rate credit unions’

condition using the CAMEL rating system. The NCUA’s CAMEL rating system provides an 43
33

 61 Fed. Reg. 67,021 (1996). The L component in bank and thrift CAMEL ratings stands for Liquidity. 44

assessment of a credit union’s financial condition in the areas of: Capital adequacy, Asset quality,

Management, Earnings, and Asset/Liability Management. The NCUA’s system differs from that

used by the bank and thrift regulators mainly in that the NCUA has not incorporated the “S”

component (denoting Sensitivity to market risk) that the Federal Financial Institutions

Examination Council adopted on December 19, 1996. NCUA officials told us that they believe 44

the “S” component is unnecessary because the Asset/Liability component includes an assessment

of interest-rate risk sensitivity and exposure.

Examiners rate each CAMEL component on a 1 to 5 scale and then assign a composite

rating (also on a 1 to 5 scale) reflecting the credit union’s overall condition. A CAMEL rating of

1 indicates the strongest performance and least degree of supervisory concern, while a CAMEL

rating of 5 indicates the weakest performance and highest degree of supervisory concern. Table

II.1 shows the number and assets of institutions in each CAMEL rating at year-end 1996.

Table II.1: Distribution of CAMEL Ratings

(Dollars figures in millions; data as of December 31, 1996)

CAMEL rating Total Federal Credit Unions State Credit Unions

Number Assets Number Assets Number Assets

CAMEL rating 1 2,040 $138,899 1,287 $94,520 753 $44,379

CAMEL rating 2 6,578 $165,095 4,004 $97,895 2,574 $67,200

CAMEL rating 3 2,515 $21,207 1,691 $13,390 824 $7,817

CAMEL rating 4 273 $1,822 180 $1,053 93 $769

CAMEL rating 5 15 $41 8 $4 7 $37

Total 11,421 $327,064 7,170 $206,862 4,251 $120,202

Source: NCUA, Response to the Treasury’s Data Request, Jun. 27.

At the end of 1996, a quarter of all credit unions had CAMEL ratings of 3, 4, or 5 --

indicating some degree of supervisory concern. These credit unions, however, hold only about

7.1 percent of all credit union assets. Troubled credit unions, which the NCUA defines as those

rated CAMEL 4 or 5, represent an even smaller portion of credit union assets -- less than
34

 The NCUA’s regulatory definition of a troubled credit union also includes any institution receiving special 45

assistance. 12 C.F.R. § 701.14(b)(3)(ii).

1 percent. As Table II.2 illustrates, the number of troubled credit unions has steadily declined 45

over the past 6 years, from 665 institutions (5 percent of all credit unions) in 1990 to 288

institutions (3 percent) in 1996. The proportion of total credit union assets in troubled credit

unions has declined even more over this period, from 5 percent to under 1 percent.

Table II.2: Troubled Credit Unions: Number and Assets, 1990-1996

(Dollar figures in millions)

Year Troubled Credit Unions Assets in Troubled Credit Unions

Number Percent of Total Amount Percent of Total

1990 665 5% $10,301 5%

1991 654 5% $9,814 4%

1992 583 5% $3,263 1%

1993 418 3% $4,340 2%

1994 308 3% $2,523 1%

1995 273 2% $2,282 1%

1996 288 3% $1,863 1%

Source: NCUA, Response to the Treasury’s Data Request, Jun. 27.

2. Resolving Troubled Credit Unions

When examiners identify problems in a credit union or downgrade its CAMEL rating

below a 2, they help the institution develop a plan for corrective action. NCUA officials told us

that the majority of troubled credit unions overcome or work out their problems on their own, or

successfully merge with another credit union at no cost to the Share Insurance Fund. If the credit

union’s problems persist, the NCUA can use an array of formal actions to help improve the

institution’s condition. Such actions can include issuing a cease-and-desist order or an order to

remove a management official.

If a credit union is unable to improve its condition and problems persist, the NCUA can

resolve the institution by: (1) providing special assistance (e.g., cash or loans) to help it return to

financial health; (2) merging it with a healthy credit union; or (3) liquidating it. The NCUA’s
35

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 46

tab 6. These factors resemble the criteria in the NCUA’s Risk Management Processing Guidelines that a credit

union must satisfy and that an examiner must document for the institution to be eligible for special assistance. 

NCUA, Risk Management Processing Guidelines (Alexandria, VA: NCUA, 1997), 1.4. The criteria also appear

in various forms in informal examiner guidance. NCUA, Examiner’s Guide (Alexandria, VA: NCUA, 1996),

chaps. 20 and 29.

 Depending on the requested amount, the decision to provide assistance may be made by the regional director (up 47

to $200,000), the Office of Examination and Insurance (up to $2 million), or the NCUA Board (over $4 million).

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 48

tab 6.

policies direct an examiner to recommend one of these resolution methods based on the

examiner’s judgment of the credit union’s viability, potential costs to the Share Insurance Fund,

and the potential effect of each method on the institution’s members. NCUA officials told us that

examiners consider the following factors in determining an institution’s viability:46

! whether the institution has corrected the root causes of its problems;

! the competence of management officials, including their progress in resolving existing

problems or their record of resolving past problems;

! the adequacy of the institution’s written policies and business plan;

! the condition of the institution’s books and records, including whether management has

fully and fairly disclosed the institution’s condition; and

! the viability of the institution’s field of membership.

The NCUA told us that if the examiner, having weighed these factors, concludes that the

credit union is viable, the examiner will recommend providing special assistance from the Share

Insurance Fund to keep the institution open while it works out its problems. If the examiner 47

concludes that the credit union is not viable, the examiner will recommend arranging a merger

with a sound credit union. If the NCUA fails to find an appropriate merger partner, it will

liquidate the institution. Figure II.2 depicts the typical decision-making process. A more 48

detailed description of the three resolution methods follows.
Examiner Discovers Problem at Credit Union

Supervisory Efforts to Resolve Problems

Consider Special Assistance

Normal Supervision

Seek Merger Partner

Liquidate Seek Merger Partner

Liquidate

Normal Supervision Problem Persists Problem Corrected

Assistance Impractical

or Inappropriate

Merger Partner 

Cannot be Found

Problem Persists Problem Corrected

Provide Special Assistance

Merger Partner Cannot be Found

36

 12 U.S.C. § 1788. 49

 NCUA, Response to the Treasury’s Data Request, Jun. 27 (Alexandria, VA: NCUA, 1997), tab 6. 50

 The name “guarantee account” reflects the Share Insurance Fund’s implicit decision to cover the credit union’s 51

negative net worth if the credit union fails before amortizing the assistance.

 12 U.S.C. § 1787(a)(1)(A); and NCUA, Examiner’s Guide (Alexandria, VA: NCUA, 1996), 27.3. 52

Figure II.2: The Resolution Decision-Making Process

a. Special Assistance

The Federal Credit Union Act authorizes the NCUA to provide troubled credit unions

cash and noncash assistance from the Share Insurance Fund. Cash assistance includes capital 49

notes, loans, deposits, or asset purchases. The cash infusion can be used, for example, to hire

new management or to acquire income-producing assets to offset accumulated losses. The

NCUA also uses cash assistance to facilitate mergers, purchase and assumption transactions, or

liquidations. The amount of outstanding cash assistance has steadily declined from a peak of

$101 million in 1992 to just one capital note for $265,000 in 1996.50

Noncash assistance, also called a guarantee account, involves the NCUA permitting a

troubled credit union to create an account on its books equal to the institution’s negative net

worth. Without the noncash assistance the credit union would be insolvent, and the Federal 51

Credit Union Act would require the NCUA to close the institution. Noncash assistance can be 52
37

 NCUA, Response to the Treasury’s Data Request, Jun. 27 (Alexandria, VA: NCUA, 1997), tab 6. 53

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 54

tab 7.

 In a liquidation, the NCUA distributes recoveries on the failed institution’s assets in the following order: (1) the 55

administrative costs of the liquidation; (2) claims for wages and salaries; (3) unpaid federal and state taxes; (4)

debts owed to the U.S., including the NCUA in its corporate capacity (not as deposit insurer); (5) general

creditors; and (6) uninsured depositors and the Share Insurance Fund (as successor to the claims of insured

depositors). 12 C.F.R § 709.5(b). Credit union deposits are technically equity -- whereas bank deposits are

liabilities of the bank. Accordingly, in a liquidation, the Fund is paid only after all creditors. The FDIC, by

contrast, benefits from a depositor preference statute that puts it ahead of other creditors in a liquidation.

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 56

tab 3. The reported charge rates reflect the NCUA’s actual experience over the period January 1, 1994 to October

31, 1996. Over that period there were 16 assisted mergers, 21 purchase and assumptions, and 10 liquidations.

viewed as capital forbearance in that it allows a credit union to operate while otherwise insolvent. 

At year-end 1996, 11 credit unions had some $1.2 million in outstanding guarantee accounts. 

Noncash assistance is more common than cash assistance. Over the past 10 years, for example,

the NCUA granted noncash assistance to 224 institutions but gave cash assistance to only 30.53

Before providing assistance, NCUA policy requires examiners to justify that the institution

has reasonable prospects for recovery. The examiner must also demonstrate that keeping the

institution open is the best available course of action for its members and the Share Insurance

Fund. If a less costly alternative to assistance is available, the examiner must justify the decision

to pursue the more costly approach. The institution must agree to a detailed plan for solving the

credit union’s financial problems and returning to profitability and solvency. If the credit union

fails to return to solvency within 12 to 24 months, the NCUA’s policy is to close it.

b. Closing Failed Credit Unions

Once the examiner concludes that a troubled credit union is not viable, the NCUA’s policy

is to close it in one of three ways: merger, purchase and assumption transaction, or liquidation.54

In a merger, the continuing credit union absorbs the failed credit union’s assets, liabilities,

deposits, and field of membership. In a purchase and assumption transaction, the NCUA

technically liquidates the troubled institution and the continuing credit union purchases assets and

assumes liabilities and deposits. The Share Insurance Fund becomes responsible for assets not

purchased and liabilities not assumed -- including any nondeposit or other uninsured liabilities. A

purchase and assumption transaction may or may not involve transferring the failed credit union’s

entire field of membership. If the NCUA cannot arrange a merger (usually because the institution

is too small, has severe asset quality problems, or does not have a readily transferable membership

base), the NCUA will liquidate the credit union.55

The average cost to the Share Insurance Fund per dollar of assets (i.e., the charge rate) is

lower for mergers (about 4 percent of assets) than for purchase and assumption transactions

(about 18 percent of assets) or liquidations (about 69 percent of assets). The cost to the Fund 56
38

 The discussion here focuses on mergers involving assistance from the Share Insurance Fund. Mergers between 57

healthy credit unions involve no financial assistance from the Fund.

 Interpretive Ruling and Policy Statement 96-1, Federal Credit Union Field of Membership and Chartering 58

Policy, 61 Fed. Reg. 11,721 (1996) (incorporated by reference at 12 C.F.R. § 701.1; and relying upon the

statutory membership requirements of 12 U.S.C. § 1759).

of closing a troubled credit union comes from providing assistance and from losses on asset sales. 

These costs depend more on the characteristics of the failed credit union than on the closure

method. For example, mergers have the lowest charge rate because the failed credit unions that

cost the Fund the least (i.e., those with the most attractive franchise values, the least severe

problems, and the fewest troubled assets) are more likely to attract merger bids. A failing credit 57

union with an attractive franchise, but a large portfolio of troubled assets, is more likely to attract

purchase and assumption bids because the continuing institution may not want to deal with some

or all of the problem assets. Thus purchase and assumption transactions have a slightly higher

charge rate than mergers because the NCUA is responsible for selling the assets not assumed by

the continuing credit union. These assets, likely to be of poor quality, have often contributed to

the credit union’s failure.

Credit unions with the least desirable characteristics (e.g., severe asset quality problems)

are more likely to end up in liquidation. The NCUA usually incurs significant costs to make good

on its guarantee of insured deposits and dispose of the institution’s assets. Credit unions needing

quick resolution are also more likely to end up in liquidation, as the NCUA may lack sufficient

time to market the institution and find a viable acquirer. Cases involving significant uncertainty

about the severity of the credit union’s problems (e.g., fraud-induced failures) almost always

result in liquidation because of potential merger partners’ reluctance to take on the uncertainty.

Figure II.3 shows that the NCUA must often liquidate failed institutions because it cannot

find viable merger partners. In 1981, for example, the NCUA liquidated over twice as many

credit unions as it merged. A 1982 change in the NCUA’s field of membership policies facilitated

finding acceptable merger partners. However, even as the number of credit union failures has 58

declined, the NCUA has in some years liquidated more institutions than it has merged.
39

 12 U.S.C. § 1823(c)(4)(A). The FDIC can depart from this strict rule of least-cost resolution only in 59

extraordinary cases of systemic risk, and then only pursuant to a rigorous set of procedural safeguards. Id.

§ 1823(c)(4)(G).

Figure II.3: Number of Failures By Closure Method: Selected Years, 1981-1996

Sources: NCUA, 1996 Annual Report, Share Insurance Fund Annual Reports 1984-1992, and the NCUA.

*Involuntary liquidations for 1981 include purchase and assumption transactions for which separate data are unavailable.

c. Analysis and Recommendations

When resolving a failed or failing bank or thrift, the FDIC must select the resolution

method that is “least costly to the deposit insurance fund of all possible methods” of meeting the

FDIC’s deposit insurance obligation. In deciding whether to provide special assistance to keep a 59

troubled credit union open, seek a merger partner, or liquidate the institution, the NCUA’s

Examiner’s Guide encourages examiners to weigh the institution’s viability against such other
40

 NCUA, Examiner’s Guide (Alexandria, VA: NCUA, 1996), 30.4. 60

 World Council of Credit Unions Membership Council, International Credit Union Operating Principles 61

(Madison, WI: World Council of Credit Unions, 1984), leaflet.

 Dianne Molvig, “What Pushes CEOs’ Worry Buttons,” Credit Union Management (Jul. 1995): 11-18. 62

 Competition among credit unions has sparked disagreement within the NCUA Board in recent months. Credit 63

unions applying for community charters often propose a field of membership that overlaps with that of an existing

credit union. The NCUA Board has been split over whether to seek to protect the existing credit union by

excluding persons in its field of membership from the community credit union’s field of membership.

factors as continued credit union services and the cost to the Share Insurance Fund. Neither the 60

law nor policy, however, requires the NCUA to make the cost to the Fund determinative in this

decision. For example, as depicted in Figure II.2, the NCUA will always first consider giving a

troubled credit union special assistance. If the NCUA decides against special assistance, or if

special assistance fails to turn the credit union around, the NCUA will seek a merger partner. The

NCUA will liquidate the credit union only after failing to find a merger partner that will minimize

loss to the Fund and allow service to continue to the institution’s members.

Should the NCUA select a resolution option that is not the least costly to the Share

Insurance Fund, other insured credit unions will bear the additional cost. Credit unions have

historically viewed such assistance as a form of “mutual aid.” The World Council of Credit

Union’s International Credit Union Operating Principles describe mutual aid as follows: “credit

unions within their capability actively cooperate with other credit unions . . . in order to best serve

the interests of their members and their communities.”61

Yet this tradition may be challenged as more credit unions begin to compete directly with

each other for members. For example, a credit union trade journal recently reported that credit

union executives are increasingly concerned about credit unions expanding into markets already

served by other credit unions. Credit unions serving the same market may be less supportive of 62

helping each other and more likely to object to the NCUA assisting a competitor.63

Apart from the nascent competition among credit unions, the growing size and complexity

of some credit unions raise questions about the NCUA’s approach to resolving troubled

institutions. In some ways, large, complex credit unions may reduce risk to the Share Insurance

Fund. For example, compared to smaller, less complex credit unions, such institutions may have

more experienced management, a more diverse asset portfolio, and better technology. Larger

credit unions are also more likely to have a larger, more diverse membership base, which may help

cushion the institution against the troubles of a single employer or a single group of members.

Yet large, complex credit unions may also pose new or increased risks to the Share

Insurance Fund. Such a credit union may:

! Present greater risk of “moral hazard” -- here the risk that deposit insurance permits an

institution to act in a way that increases the risk of loss to the deposit insurance fund.
41

 NCUA, Response to the Treasury’s Data Request, Sept. 30 (Alexandria, VA: NCUA, 1997). 64

 Sheshunoff Information Services, Inc., BankSearch (Austin, TX: Sheshunoff, 1997). 65

-- For example, if a large, complex credit union gets into serious financial straits, the

institution’s professional management may be more likely to make excessively

risky loans or investments in an effort to turn the institution around. If successful,

such risk-taking may preserve the credit union and the managers’ jobs. If

unsuccessful, such risk-taking is likely to increase the ultimate loss to the Share

Insurance Fund. We believe that smaller, less complex credit unions generally

have both less incentive and less opportunity to engage in such excessive risktaking. Insofar as their operations are simpler, small credit unions are easier for

members and regulators to oversee. Insofar as members share a greater affinity

with one another, and identify more closely with the credit union, they are less

likely to tolerate a strategy based on excessive risk-taking.

! Be harder for a board of directors consisting of unpaid member-volunteers to oversee. 

Such member-volunteers may or may not have the expertise needed to oversee and set

policy for a complex financial institution.

! Be more difficult for the NCUA to resolve (should they fail) because there are likely to be

fewer viable acquirers.

-- The NCUA’s resolution strategy centers on finding a suitable merger partner for a

failing institution. The NCUA may, however, be unable to find an interested credit

union with sufficient management expertise and infrastructure to absorb a large

failed credit union’s membership, much less its assets. If the NCUA must liquidate

the institution, or sell it off piecemeal, the Share Insurance Fund may face greatly

increased costs because the NCUA would receive little, if any, premium for selling

the membership base and because it would probably incur larger transaction costs.

-- To date, the largest -- and costliest -- federally insured credit union to fail had

$180 million in assets. According to the NCUA, this institution’s demise resulted

from a diverse set of problems, including speculative real estate loans, illegal loans

to non-members, unsafe and unsound business loan policies, excessive operating

costs and high cost of funds, the collapse of the New England real estate market,

and poor management. Although the NCUA ultimately resolved this credit union 64

through a purchase and assumption transaction, the Share Insurance Fund’s losses

totaled about 50 percent of the credit union’s assets -- an enormous charge rate for

a credit union of this size.

-- At year-end 1996, only 223 of the 11,392 federally insured credit unions had assets

above $250 million, yet these credit unions held 39 percent of all federally insured

credit union assets. If one of these larger credit unions were to fail, especially 65
42

 See pp. 73-79. 66

one of the 23 with assets above $1 billion, it is unclear how the NCUA would

resolve the institution or how high the cost might be. Although a large bank

failure can impose high costs on the FDIC, banks are (or can be readily converted

into) stock institutions, therefore the potential pool of acquirers is less constrained

than it is for credit unions as member-owned cooperatives.

On balance, it is difficult if not impossible to say whether large, complex credit unions

pose relatively greater or lesser risk of loss to the Share Insurance Fund than smaller, less

complex, less diversified credit unions. Of course, the actual dollar losses associated with the

failure of a large, complex credit union probably would be much greater than those associated

with a small credit union. We believe that the trends outlined here raise significant concerns about

how well the NCUA’s resolution practices may work should a large, complex credit union

become seriously troubled.

We know from past experience that when regulators practice forbearance toward large

troubled institutions (i.e., fail to take needed action to correct problems), they exacerbate the

insurance fund’s losses. For the Share Insurance Fund to avoid such problems, we believe that

the NCUA’s process for dealing with troubled institutions should be more rigorously formulated,

especially for large credit unions. To that end, we recommend in Chapter III that Congress adopt

a system of prompt corrective action to deal with troubled credit unions. This structure would 66

be a streamlined version of that already applicable to banks and thrifts, and would be

appropriately tailored to credit unions’ unique characteristics. Such a system would lead to more

rigorous guidelines for dealing with troubled credit unions, especially large ones.

3. Managing the Share Insurance Fund

Beyond the supervision and resolution responsibilities already described, the NCUA’s

management of the Share Insurance Fund involves (at least) three additional responsibilities:

! managing the assets of failed credit unions; 

! monitoring the adequacy of reserves; and

! modeling and anticipating potential risks to the Share Insurance Fund.

Table II.3 shows the condition of the Share Insurance Fund at the end of 1996.
43

 NCUA, Examiner’s Guide (Alexandria, VA: NCUA, 1996), 5.1-5.4. 67

Table II.3: The Share Insurance Fund’s Balance Sheet

(Dollar figures in millions, totals may not add due to rounding; data as of December 31, 1996)

Assets

Investments $2,924.5

Cash and equivalents $500.2

Assets acquired in assistance to insured credit unions $21.8

Other Assets $77.3

Total Assets $3,524.0

Liabilities and Fund Balance

 Liabilities

Estimated losses from supervised credit unions $89.7

Estimated losses from asset and merger guarantees $0.2

Other Liabilities $22.0

Total Liabilities $111.8

 Fund Balance

Insured credit unions’ accumulated contributions (1% deposit) $2,637.7

Insurance fund balance $774.4

Total Fund Balance $3,412.2

 Commitments and Contingencies --

 Total Liabilities and Fund Balance $3,524.0

Source: NCUA, 1996 Annual Report.

The Share Insurance Fund’s earnings (mainly on its investment portfolio) reached a record

$187 million in 1996. Indeed, the Fund’s earnings for the past two years have been sufficient to

keep it at its normal operating ratio, pay its operating expenses, cover the costs of credit union

failures, and pay a cash dividend to all federally insured credit unions. Moreover, the NCUA has

made no provisions for losses since 1994 because the Fund’s balance has been sufficient to cover

any anticipated losses. In fact, the NCUA’s auditors concluded that the Fund was over-reserved

and the agency accordingly adopted new reserving procedures in January 1997.67
44

 The NCUA occasionally provides cash assistance to troubled credit unions through asset purchases. 68

 NCUA, Response to the Treasury’s Data Request, Sept. 30 (Alexandria, VA: NCUA, 1997). 69

 12 U.S.C. § 1782(h). 70

 12 U.S.C. § 1783(d)(1), (f). 71

 GAO, Credit Unions: Reforms for Ensuring Future Soundness (Washington, DC: GAO, 1991), 176-77. 72

 Ibid., 345. This change would have required Congressional action because of the statutory 1.3 percent limit on 73

the Share Insurance Fund’s reserve ratio, which makes no distinction between available assets and other assets. 

12 U.S.C. § 1782(c)(3), (h)(2). The NCUA includes this ratio as one of its annual performance measures included

a. Asset Management and Liquidation

The NCUA manages assets acquired from failed or troubled credit unions through its

Asset Management and Assistance Center (AMAC), which is located in Austin, Texas. At the 68

end of September 1997, AMAC managed a total of $42 million of such assets, the majority of

which were consumer loans ($26 million). The remaining $8 million was real estate loans ($5

million) and real estate ($3 million). The relatively small amount of assets under management 69

reflects the small number of credit union failures in recent years.

b. Monitoring the Adequacy of Reserves

The Share Insurance Fund’s reserve ratio -- its ratio of total reserves to total insured

deposits -- is the standard measure of the Fund’s health. For the past two years, the Fund has

been at its statutory ceiling of 1.3 percent. However, we identified two concerns about this 70

measure. First, the ratio does not indicate whether the Fund’s assets are actually available to

cover losses at failing credit unions, thereby potentially overstating the Fund’s strength. Second,

the NCUA’s procedures for calculating this ratio do not measure reserves and insured shares at

the same point in time, thereby overstating the Fund’s actual reserve ratio.

The reserve ratio does not reflect the actual composition of the Share Insurance Fund’s

assets. When credit unions are under stress (e.g., during an economic recession), illiquid assets

acquired from failed or troubled institutions will tend to increase at the expense of liquid assets --

leaving the Fund less able to provide cash assistance to other ailing credit unions. Beyond its own

assets, the Fund has only limited access to working capital -- cash available to the Fund to finance

assets recovered from failed credit unions until such assets may be liquidated. The Fund’s

working capital sources, beyond its own assets, are a $100 million line of credit at the Treasury

and advances from the Central Liquidity Facility. We are concerned that these sources could 71

prove inadequate if significant credit union failures created a liquidity crunch for the Fund.

In 1991, the GAO recognized this problem and proposed that the NCUA establish a

minimum “available assets” ratio for the Share Insurance Fund. The Fund would have to achieve

this ratio before distributing dividends to insured credit unions. The NCUA concurred in this 72

recommendation. We believe that the GAO’s recommendation is even more appropriate now, 73
45

in the strategic plan required by the Government Performance and Results Act, which the NCUA submitted to

Congress on September 30, 1997. Pub. L. No. 103-62, § 3, 107 Stat. 285, 286 (1993).

 12 U.S.C. § 1825(c)(5). 74

 In collecting its insurance premiums from FDIC-insured depository institutions, the FDIC uses the latest 75

quarterly data available on assessable deposits.

 NCUA, 1996 Annual Report (Alexandria, VA: NCUA, 1997), 60-61. 76

 Ibid. 77

with credit unions growing rapidly. Thus we recommend that Congress require the Share

Insurance Fund to maintain an available assets (i.e., liquid assets) ratio of 1.0 percent. Should the

available assets ratio fall below this level, the NCUA would not be permitted to pay dividends,

even if the Fund’s reserve ratio exceeded 1.3 percent. By ensuring that the Fund’s reserves are

not concentrated in holding illiquid assets obtained from failed credit unions, the Fund would have

the liquidity needed to handle additional credit union demands for assistance.

As an alternative, or a complement, to an available assets ratio, the Share Insurance Fund

could receive expanded access to working capital from the Treasury: that is, Congress could

increase the Fund’s current $100 million line of credit. The FDIC, for example, may borrow from

the Federal Financing Bank up to 90 percent of the value of its non-cash assets plus its reserves

and any remaining line of credit with the Treasury. Although a similar arrangement could be 74

established for credit unions, it would be less in keeping with credit unions’ traditional approach

of dealing with such matters from their own resources, rather than relying upon government

sources of funding.

We are also concerned that the NCUA’s method of measuring the Share Insurance Fund’s

reserve ratio generally overstates the reserves actually available. The NCUA calculates the

reserve ratio each month by dividing the Fund’s reserve balance for that month by the previous

year-end total of insured deposits. Thus each year-end reserve ratio is calculated using a

denominator that may be up to 12 months old -- which tends to inflate the ratio. For example, 75

as Table II.4 shows, at year-end 1996 the Fund had $3.4 billion in reserves and insured

$275.5 billion in deposits, implying a reserve ratio of 1.24 percent. However, the NCUA 76

calculated the Fund’s year-end 1996 reserve ratio as 1.3 percent by dividing the year-end 1996

total Fund reserves by the year-end 1995 total insured deposits.77
46

 12 U.S.C. § 1782(c)(3), (h)(2). 78

Table II.4: Reported Versus Actual Reserve Ratio of the Share Insurance Fund: 1990-1996

(Dollar figures in billions)

Year Fund Balance Number of Federally Total Insured Reported Actual

Insured Credit Unions Deposits Reserve Ratio Reserve Ratio

1990 12,860 $180.0 $2.1 1.25 1.14

1991 12,960 $199.8 $2.3 1.23 1.13

1992 12,653 $229.5 $2.6 1.26 1.11

1993 12,317 $240.3 $2.8 1.26 1.17

1994 11,991 $247.7 $3.1 1.27 1.23

1995 11,687 $261.4 $3.3 1.30 1.24

1996 11,392 $275.5 $3.4 1.30 1.24

Source: NCUA, 1996 Annual Report.

Note: Because of rounding, the “actual reserve ratio” reported here may not be the same as that calculated from the data

reported in this table.

Because the NCUA must, by law, distribute dividends to member credit unions whenever

the Share Insurance Fund’s reserve ratio exceeds 1.3 percent, the NCUA’s procedure has led it 78

to pay dividends when the Fund’s reserve ratio, measured contemporaneously, was actually less

than 1.3 percent. Paying dividends under such circumstances dissipates the Fund’s reserves

without good reason. Accordingly, we recommend that the NCUA correct this noncontemporaneous measurement of the reserve ratio.

Such a correction should have two related components. First, we recommend that the

NCUA use the most current data available on insured deposits. Credit unions report their insured

deposits to the NCUA quarterly (for credit unions with more than $50 million in assets) or semiannually (for credit unions with less than $50 million in assets). Thus, to calculate the Share

Insurance Fund’s year-end reserve ratio, the NCUA should use the September data reported by

large credit unions and the June data reported by small credit unions. Similarly, we recommend

that the NCUA not declare dividends on credit unions’ 1 percent deposit until the close of the

year in order to ensure that the actual reserve ratio exceeds the target ratio. Technical changes in

the Federal Credit Union Act regarding the timing of dividends may facilitate more

contemporaneous measurement of the reserve ratio than possible under current law.
47

Second, the Federal Credit Union Act currently requires credit unions to adjust their

1 percent deposit annually. We recommend that Congress direct the NCUA to require these

adjustments up to four times per year, and to measure deposits using a four-quarter average to

account for seasonal fluctuations in deposits. Credit unions would thus generally have to adjust

their 1 percent deposit each time they submit call report data to the NCUA on insured deposits. 

(Credit unions currently make this adjustment each January 31.) Thus large credit unions would

adjust their deposit quarterly and small credit unions would adjust their deposit semi-annually.

These two changes would increase the timeliness and accuracy of both components of the

Share Insurance Fund’s reserve ratio.

c. Modeling Risk to the Share Insurance Fund

Officials in the Office of Examination and Insurance told us that they estimate potential

risks to the Share Insurance Fund using a variety of microeconomic and macroeconomic analyses. 

On a macroeconomic level, the office analyzes overall trends and reports them quarterly to the

NCUA Board and to credit unions. The office continually monitors the number of credit unions

rated CAMEL 4 or 5 as well as the amount of insured deposits in those institutions. This

macroeconomic analysis also includes general monitoring of such potential system-wide problems

as increasing levels of consumer debt, bankruptcies, and delinquencies.

On a microeconomic level, the Office of Examination and Insurance produces risk

management reports to identify and track various risk factors within individual credit unions (e.g.,

troubled assets over 2 percent of total assets). At the end of every month, examiners notify the

Office of Examination and Insurance of any potential losses to the Share Insurance Fund identified

during this risk review process so that it can set aside the necessary reserves.

We asked NCUA officials if they undertook any stress testing to see how the Share

Insurance Fund would withstand various possible catastrophic loss scenarios. They said that they

did not do such testing. To test the strength and resiliency of the Fund, we identified several

possible scenarios that could generate large insurance fund losses. We then ran some simple

simulations to see how well the Fund could withstand the losses generated under the various

stress scenarios.

Table II.5 provides data on the Fund for 1996, the baseline for our stress tests.
48

 Using credit union failure data from January 1, 1994, to October 31, 1996, we calculated the weighted average 79

charge rate to the Share Insurance Fund to be 19 percent. We rounded this to 20 percent, which we used as our

charge rate in the stress tests reported here.

Table II.5: Status of the Share Insurance Fund at Year-End 1996

(Dollar figures in billions)

Amount of Insured Deposits $275.5

Total Equity $3.4

Reported Reserve Ratio 1.30%

Actual Reserve Ratio 1.24%

Source: NCUA, 1996 Annual Report.

Note: We calculated the actual reserve ratio using 1996 year-end deposits and 1996 year-end reserves.

For our stress tests, we estimated the potential effect on the Share Insurance Fund of:

! the failure of the largest credit union;

! the failure of three of the ten largest credit unions (assuming each was the average size of

the ten largest);

! the failure of all credit unions with CAMEL ratings of 4 or 5; and

! a repetition of the worst loss period in the Share Insurance Fund’s history (1981-1983).

These stress tests are hypothetical -- they do not represent a judgment that the outcomes in

question are likely. Rather, the tests seek to gauge the Share Insurance Fund’s ability to

withstand various negative effects. For the first three stress tests, we assumed a 20 percent

charge rate to calculate total losses to the Fund. The final test used the actual cumulative loss 79

rate over the three-year period. Table II.6 presents the results of the stress tests.
49

 Dollar losses per $1,000 of insured deposits were 0.99 for 1981, 1.48 for 1982, and 0.88 for 1983. NAFCU, 80

National Credit Union Share Insurance: 25 Years Safe and Strong (Washington, DC: NAFCU, 1995), 9.

 Our calculations adjusted the 1981-1983 losses for inflation. 81

Table II.6: Results of Stress Tests for the Share Insurance Fund

(Dollar figures in billions)

Size of Loss Amount of Insured New Reserve Ratio @

Deposits 20% Charge Rate

Largest credit union $6.5 0.79%

Average of 10 largest credit unions (x3) $6.8 0.77%

CAMEL 4 and 5 Credit Unions $1.9 1.12%

Loss Rate from 1981-1983 N/A 0.97%

Sources: Sheshunoff, BankSearch, and NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions.

Note: The reserve ratio for each test uses estimated year-end deposits and year-end reserves. The last row applies the

Fund’s cumulative losses for 1981 to 1983 as a percent of average insured deposits to total year-end 1996 insured deposits.

In general, the Share Insurance Fund fared well under the stress tests. Credit unions’

insured deposits are not so concentrated in the largest credit unions that the failure of one or more

large institutions would greatly impair the Share Insurance Fund. Still, the failure of the largest

credit union, or three of the largest credit unions, could require credit unions to write off about 20

percent of their deposits at the Share Insurance Fund. And insofar as consolidation of credit

unions continues to lead to fewer but larger credit unions, the potential effects of such failures

may become more severe in the future.

Because we are in the sixth year of an economic expansion, the number and assets of

credit unions with CAMEL ratings of 4 or 5 are currently small, and thus the failure of all such

institutions would have little effect on the Share Insurance Fund. However, should the economy

take a downturn, experience suggests that the number and total assets of such low-rated

institutions would significantly increase. The recessions of the early 1980s produced the three

largest annual loss rates for the Fund. To test how a repeat of those high loss years might affect 80

the Fund today, we analyzed the cumulative losses of 1981 through 1983 as a percentage of

insured shares. We calculated that such a repetition of losses would still only reduce the Fund’s 81

reserve ratio to 0.97 percent.
50

 GAO, Credit Unions: Reforms for Ensuring Future Soundness (Washington, DC: GAO, 1991), 187-198; and 82

U.S. Department of the Treasury, Modernizing the Financial System: Recommendations for Safer, More

Competitive Banks (Washington, DC: Treasury, 1991), 63-64, XIII-6-XIII-8.

 Richard Posner, “Theories of Economic Regulation,” The Bell Journal of Economics 5 (1974): 335-58; and 83

George Stigler, “The Theory of Economic Regulation,” The Bell Journal of Economics 2 (1971): 3-21.

B. THE ADMINISTRATION OF THE SHARE INSURANCE FUND

Congress directed us to evaluate the potential costs and benefits of having some entity

other than the NCUA administer the Share Insurance Fund.

Neither the statutory language requiring this study nor its legislative history indicates what

entity or entities Congress had in mind as possible candidates to administer the Share Insurance

Fund. Nor do they indicate the policy objective of such a change. Accordingly, we cast our net

widely and reviewed past discussions of this issue by the Treasury, the GAO, and various trade

groups. We considered the structural problems that some analysts have linked to the failure of 82

the Federal Savings and Loan Insurance Corporation (FSLIC), the old thrift deposit insurance

fund administered by the Federal Home Loan Bank Board (Bank Board). We also examined the

structure of the FDIC.

1. The Potential for Conflicts of Mission

We began our analysis of the NCUA’s role in administering the Share Insurance Fund by

asking whether that role, as currently structured, could create conflicts of mission: i.e., significant

unresolved tensions between the agency’s role or duties in administering the Fund and the

agency’s other roles and duties.

From our review of past research, our discussions with interested parties, and the

comment letters we received, we identified two possible conflicts of mission. The first involves

the NCUA’s role in chartering federal credit unions and in administering the Share Insurance

Fund. The second involves the NCUA’s role in supervising credit unions and administering the

Share Insurance Fund. These two possible conflicts, although distinguishable, significantly

overlap (e.g., a chartering entity also supervises the institutions it charters). They raise many of

the same issues and invite many of the same arguments. In the interest of simplicity, we will

generally refer to supervising (rather than chartering), but we believe that the same considerations

hold true of chartering -- both in the charterer’s capacity as a supervisor and otherwise.

A potential conflict of mission between deposit insurance and supervision could

conceivably arise in several ways.

First, economists have long observed that regulators (however able and upright) have

some tendency to identify (however unconsciously) with the entities that they regulate. In an 83

agency responsible for both supervision and deposit insurance, such a tendency might leave the

agency reluctant to take stringent action against an institution, even if such action would protect
51

 Edward J. Kane, The Savings and Loan Insurance Mess: How Did It Happen? (Washington, DC: The Urban 84

Institute, 1989), 103.

 GAO, Credit Unions: Reforms for Ensuring Future Soundness (Washington, DC: GAO, 1991), 190. 85

the insurance fund. It may, for example, prefer to nurse the institution back to health even at the

cost of increased risk to the insurance fund. Moreover, just as legislators create depository

institution charters to advance a public purpose, regulators see their role as including the general

advancement of that public purpose.

Second, supervisors of federally insured depository institutions (whether banks, thrifts, or

credit unions) have some short-term incentives to practice forbearance toward troubled

institutions (i.e., fail to take needed action to resolve institutions’ problems). Forbearance has

short-term, easily identifiable benefits -- and long-term, less obvious costs. Stringency runs the

risk of immediate criticism and perhaps even blame for causing the problem regulators seek to

resolve. Forbearance, on the other hand, is inconspicuous and defers unpleasant consequences, 84

and is therefore less likely to draw criticism. Thus forbearance, although against the interests of

the deposit insurance fund, may well serve the supervisor’s self-interest.

Third, a deposit insurer that is also a supervisor has incentives to resolve failed or failing

institutions in ways that conceal the agency’s supervisory mistakes. If observers would perceive

an institution’s failure as reflecting poorly on the supervisor, the insurer/supervisor can use the

deposit insurance fund to resolve the institution in a way that does not draw attention to its

failure, even though such a course of action might increase the cost to the insurance fund.

Fourth, a supervisor that administers an insolvent insurance fund has incentives not to

force the resolution of deeply insolvent institutions -- lest it render the fund’s insolvency more

conspicuous and risk precipitating its collapse.

Critics of the NCUA’s dual responsibilities often use the old Bank Board as a case study. 

Before its abolition in 1989, the Bank Board had responsibility for chartering federal thrift

institutions, supervising federally insured thrift institutions, and administering FSLIC, whose

insolvency ultimately cost the nation’s taxpayers some $130 billion. For example, there is

widespread belief that the Bank Board’s control of FSLIC rendered FSLIC less effective as an

insurer. The GAO emphasized the Bank Board’s statutory mandate to promote housing finance

and the thrift charter. Some scholars have stressed the perverse incentives created by FSLIC’s 85

own deep insolvency, the Bank Board’s coziness with the thrift industry, and the agency’s reliance

on examiners employed by the industry-owned Federal Home Loan Banks. In fact, so much went

so wrong in so many different ways that the Bank Board’s problems, far from resolving debates

about agency structure, provide grist for competing sides of those debates.

Although many policy issues divide the American Bankers Association (ABA) from

CUNA and NAFCU, all three trade associations share a disinclination to have the FDIC

administer the Share Insurance Fund. The ABA told us that banks would probably oppose
52

 GAO, Credit Unions: Reforms for Ensuring Future Soundness (Washington, DC: GAO, 1991), 194. 86

 NASCUS, Letter Responding to the Treasury’s Request for Comments, Feb. 28 (Washington, DC: NASCUS, 87

1997), 6.

 The NCUA estimates the portion of its expenses that are insurance-related, and then charges that portion to the 88

Share Insurance Fund through an accounting procedure called the “overhead transfer.” The current overhead

transfer rate (i.e., that portion of the NCUA’s operating expenses allocated to insurance-related activities) is

50 percent. The NCUA told us that establishing the overhead transfer rate is highly subjective because the agency

expends most of its resources on tasks that carry out both its insurance and non-insurance responsibilities. The

NCUA pointed out that the GAO, the NCUA’s independent auditors, and a bi-partisan credit union committee

have reviewed the NCUA’s method for determining the overhead transfer rate and all found it fair. NCUA,

Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), tab 11.

requiring the FDIC to manage the Fund. Credit unions would also oppose having the FDIC as

insurer because they believe such an arrangement would create additional and duplicative

oversight costs, and that the FDIC may be more inclined to treat credit unions like banks.

The GAO’s 1991 report recommended, among other things, placing the NCUA’s

regulatory and insurance responsibilities in two separate offices, with each director reporting

individually to the Board. The National Association of State Credit Union Supervisors 86

(NASCUS), in its letter to us, also recommended having a separate office within the NCUA

administer the Share Insurance Fund. NASCUS views the NCUA’s use of the same staff to 87

examine and supervise federally chartered credit unions -- and to determine their continued

insurability -- as heightening the potential for conflict.

2. Analysis and Recommendations

We found no compelling case for removing the Share Insurance Fund from the NCUA’s

oversight and transferring it to another federal agency such as the FDIC. The NCUA maintains

some level of separation between its insurance activities and its other responsibilities by separating

the operating costs of the Fund from its non-insurance expenses. Moreover, separating the Fund 88

from the NCUA would provide no assurance of improved supervision or strengthened fund

health. We are also concerned that without the Fund, the NCUA might be too small to be viable

or efficient. An insurer with limited supervisory authority would have more limited control over

the risks taken by credit unions. Under the current structure, the NCUA can use supervision to

control risks taken by credit unions -- providing an additional measure of protection for the Fund. 

We also believe that separating the Fund from the NCUA could: (1) reduce the regulator’s

incentives to concern itself with insurance costs, should an institution fail; (2) create possible

confusion over the roles and responsibilities of the insurer and of the regulator; and (3) place the

insurer in the situation of safeguarding the insurance fund without having control over the risks

taken by the insured entities.

Moving responsibility for managing the Share Insurance Fund out of the NCUA would

reduce the potential for conflicts between supervising credit unions and protecting the insurance

fund. Such a move would, however, be a large undertaking involving moving staff and functions
53

 See pp. 73-79. 89

out of the NCUA and into another entity (e.g., the FDIC). Keeping these responsibilities within

the NCUA but separating them into two offices could reduce potential conflicts between the

insurance and supervisory functions -- with much less disruption than removing the Fund from the

NCUA. Each office director would report separately to the NCUA Board, and the staff

responsible for managing the Fund would be separate from supervisory examiners, which could

serve as an important check on supervisory examiners’ use of the insurance fund to manage

troubled credit unions out of their problems.

Keeping examination and insurance in the same office may make examiners feel more

responsible for ensuring that the credit unions they examine do not cause losses to the Share

Insurance Fund. Separating examination and insurance into two offices, on the other hand, could

reduce the amount of communication on supervisory and failure resolution issues. Moreover, the

paucity of credit union failures in recent years makes it difficult to justify establishing a separate

office for insurance -- much less a separate agency. We believe that if the NCUA Board finds

conflicts or weaknesses in the current organizational structure, it can reorganize the agency’s

examination and insurance functions as appropriate.

In the case of the NCUA and the Share Insurance Fund, we believe any potential for

conflicts of mission is best handled by applying a system of prompt corrective action to credit

unions. For banks and thrifts, the regulator, which may also be the charterer, decides when to

close an institution. The tension between the incentives of the charterer and the goals of the

regulator are balanced by prompt corrective action rules that require the regulator to take certain

corrective actions when a depository institution’s condition deteriorates. For credit unions,

charterer, examiner, and insurer are the same entity and, in a sense, make the decision together. 

The NCUA, with no comparable statutory prompt corrective action requirements, has more

discretion about whether, when, and how to take corrective action. To be sure, prompt

corrective action rules are a recent development responding to costly delays in dealing with

troubled banks and thrifts. We believe, however, that prompt corrective action rules for credit

unions would introduce an important and highly constructive discipline on the NCUA’s

supervisory and insurance functions that should largely offset any incentive to permit the

promotion of credit unions to interfere with the NCUA’s responsibilities for the Fund. We set

forth our prompt corrective action proposal in the next chapter.89

C. THE ONE PERCENT DEPOSIT SYSTEM

1. Background

When established in 1970, the Share Insurance Fund had a funding structure similar to that

of the FDIC (the Permanent Insurance Fund, now the Bank Insurance Fund) and FSLIC. Insured

credit unions paid premiums to the Share Insurance Fund, which used the proceeds to protect

depositors at failed credit unions, pay the Fund’s operating expenses, and build reserves.
54

 Congress originally set the “normal operating level” at 1 percent. Pub. L. No. 91-468, § 1(3), 84 Stat. 994, 999 90

(1970). But in 1984, it raised the level to 1.3 percent. Pub. L. No. 98-369, § 2809, 98 Stat. 494, 1205 (1984).

 12 U.S.C. § 1782(c). 91

 A reserve ratio of 1.3 percent means that the Share Insurance Fund reserves has a 1.3 percent ratio of reserves 92

to total insured deposits. Of the 1.3 percent, 1.0 percentage point comes from the 1 percent deposit and 0.3

percentage point reflects the Fund’s accumulated insurance premiums and interest earnings.

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 93

tab 10.

 12 U.S.C. § 1782(c)(3), (h)(2). 94

This system appeared to work reasonably well during the 1970s. The Share Insurance

Fund faced only minimal insurance losses. In many years, the Fund could cover both its losses

and its operating expenses from the interest earned on its reserves. Premiums paid by credit

unions enabled the Fund to continue to build its reserves. By 1979, the Fund had a reserve ratio

of 0.32 percent.

But during the economic recession of the early 1980s, credit union failures mounted, the

Share Insurance Fund’s losses increased sharply, and the Fund’s reserve ratio -- far from rising

steadily toward the statutory target of 1 percent -- steadily declined. Even a steep increase in 90

premium rates failed to reverse that decline. Faced with the prospect that the Fund would remain

weak for the foreseeable future and could become insolvent, the NCUA and credit union trade

associations devised a new system for capitalizing the Fund. Congress enacted that system in

1984 and, with only minor changes, it remains in effect.

The system aims not only to ensure the Share Insurance Fund’s solvency but to keep the

Fund’s reserve ratio at or near 1.3 percent. Each insured credit union maintains on deposit in the

Fund an amount equal to 1 percent of the credit union’s insured deposits. The Fund’s reserves 91

consist of this 1 percent deposit plus any additional amounts accumulated through interest

earnings and insurance premiums. The reserves are invested in Treasury securities, and the 92

interest on those securities becomes part of the reserves. In addition, the NCUA has discretion to

impose an annual premium of 1/12 of 1 percent of insured deposits. Although the NCUA has no

formal policy about when to assess premiums, its officials told us that it has an informal policy of

keeping the Fund’s normal operating range for the reserve ratio between 1.25 percent and

1.30 percent. The NCUA Board would seriously consider assessing a premium if the reserve ratio

were to fall below 1.25 percent. If the Fund’s reserve ratio exceeds 1.3 percent, the NCUA 93

must pay the excess as a dividend on credit unions’ 1 percent deposit.94
55

 If a credit union chooses to withdraw from the Share Insurance Fund or voluntarily liquidate, it can withdraw its 95

1 percent deposit. If the NCUA must involuntarily liquidate a credit union, it uses that credit union’s deposit -- as

it would any other asset -- to satisfy claims against the institution.

In an assisted merger, the NCUA transfers the troubled credit union’s 1 percent deposit to the continuing credit

union along with the insured deposits of the merging institution. In a purchase and assumption transaction, the

NCUA transfers all of the troubled credit union’s insured deposits to the acquiring institution along with the 1

percent deposit. If in a purchase and assumption transaction the NCUA transfers only part of the credit union’s

deposits, it likewise transfers a pro rata portion of the 1 percent deposit. The remainder of the deposit may be

transferred to any other credit union participating in the purchase and assumption transaction, or may be

liquidated, depending on the structure of the purchase and assumption agreement. NCUA, Responses to

Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), tab 1.

 12 U.S.C. § 1782(c)(1)(B)(iv). 96

The 1 percent deposit constitutes an asset on credit unions’ books. When covering 95

losses and expenses, the Share Insurance Fund first uses reserves other than the 1 percent deposit

(namely, the amount by which the reserve ratio exceeds 1 percent). But if the reserve ratio ever

falls below 1 percent, credit unions must write off a proportionate amount of their 1 percent

deposit and treat that amount as an expense on their income statements. Having thus recognized 96

any impairment of the deposit, credit unions must restore the deposit to 1 percent by January 31

of the following calendar year. The following example illustrates the process of impairment and

restoration. If the Fund’s reserve ratio fell to 0.75 percent (i.e., if the 1 percent deposit were

25 percent impaired), each credit union would have to write off, and expense, 25 percent of its

1 percent deposit. Then, by January of the following year, each credit union would have to

increase its deposit so that it once again equaled 1 percent of the credit union’s insured deposits.

The Share Insurance Fund’s reserve ratio has not fallen below 1 percent since January

1985, when the new funding structure took effect. During every succeeding year but one,

investment earnings on the Fund’s reserves have sufficed to cover losses and expenses. The

NCUA imposed a premium only in 1991. And the Fund paid dividends on the 1 percent deposit

for 1995 and 1996 (at a rate of approximately 4 percent).

2. Current Debate

The Share Insurance Fund counts the 1 percent deposit as its reserves. At the same time,

credit unions count the 1 percent deposit as an asset on their own books, making their reported

net worth (i.e., total reserves) higher than it would be than if they had expensed the deposit. This

treatment of the same dollars as reserves of the Fund and as an asset of credit unions results in

double counting if one views the Fund and institutions’ net worth as the total buffer available to

absorb credit union losses. If the Fund has losses large enough to dip into the 1 percent deposit,

credit unions must then expense that portion of the cost and replenish the deposit. Incurring these

expenses during a time of stress could further debilitate already weak institutions.

Proponents of the 1 percent deposit system, including virtually all credit union managers,

argue that this funding structure appropriately treats the deposit as an asset because it is
56

 AICPA, Letter to U.S. Representative Marcy Kaptur, Apr. 3 (Washington, DC: AICPA, 1989), 1-2. 97

 In a deposit insurance system financed by premiums, a long-established, slow-growing credit union will have 98

contributed far more to the insurance fund over the years than a new, rapidly growing credit union. Moreover, the

new credit union’s rapid growth helps dilute the Fund, thereby increasing the premiums required of every other

member institution, including the older institution. By contrast, under the 1 percent deposit system, credit unions

must maintain a deposit equal to 1 percent of their insured deposits. The old, slow-growing credit union must

increase its deposit only if its insured deposits increase. The new, fast-growing credit union must increase its

deposit in direct proportion to the growth of its insured deposits.

 For example, in its letter to the Treasury, NAFCU described the 1 percent deposit system as a “cooperative 99

insurance system for a cooperative industry.” NAFCU, Letter Responding to the Treasury’s Request for

Comments, Feb. 28 (Washington, DC: NAFCU, 1997), 5.

refundable (under certain conditions) to a credit union should the institution elect to liquidate,

become privately insured, or convert to another charter (e.g., become a mutual savings

institution), and because it earns dividends when the Share Insurance Fund’s reserve ratio exceeds

1.3 percent. Furthermore, the American Institute of Certified Public Accountants (AICPA) has

certified that the accounting treatment of the deposit conforms with generally accepted

accounting principles. Critics, however, charge that the 1 percent deposit lacks the 97

characteristics of a true asset because credit unions do not make the deposit voluntarily and

cannot draw upon it as a normal asset to cover losses.

Proponents argue that the 1 percent deposit system is superior to a traditional premiumbased system because it:

! provides a mechanism for promptly correcting any deficiencies in the Share Insurance

Fund’s reserves;

! in effect, gives the Share Insurance Fund a claim on the entire net worth of all insured

credit unions -- and thus helps ensure that the Fund can meet its obligations to insured

depositors without becoming a burden on taxpayers;

! gives credit unions strong incentives to keep the Share Insurance Fund healthy and

support prompt, efficient resolution of problems at other credit unions; and

! promotes fairness among credit unions with different growth rates by more closely linking

credit unions’ contribution to the Share Insurance Fund with their deposit size.98

Credit unions and their trade associations strongly support the 1 percent deposit system,

including both the legitimacy of its accounting treatment and its effectiveness as a device for

capitalizing the Share Insurance Fund. They assert that the 1 percent deposit system reflects the

cooperative character of credit unions and, by fostering a sense of ownership, encourages credit

unions to protect the Fund by monitoring their own behavior as well as the behavior of other

insured credit unions. The NCUA also lauds the 1 percent deposit system for enabling the Fund 99

to grow proportionally with credit unions without having to charge a premium.
57

 GAO, Credit Unions: Reforms for Ensuring Future Soundness (Washington, DC: GAO, 1991), 174; and 100

U.S. Department of the Treasury, Modernizing the Financial System: Recommendations for Safer, More

Competitive Banks (Washington, DC: Treasury, 1991), 64.

 12 U.S.C. § 1782(c)(2). 101

 ABA, Letter Responding to the Treasury’s Request for Comments, Feb. 28 (Washington, DC: ABA, 1997), 102

2, 6. 

 12 U.S.C. § 1817(b)(3). 103

On the other hand, many bankers’ comment letters argued that the accounting treatment

of the 1 percent deposit overstates the resources available to offset losses to the Share Insurance

Fund. During times of economic stress, credit unions are likely to have reduced income or even

have losses, and credit union failures are likely to increase. If the Fund’s reserve ratio falls below

1.25 percent, the NCUA may begin assessing premiums. If losses are large enough to impair the

1 percent deposit, then credit unions must write off and replenish the amount that was impaired. 

Critics of the 1 percent deposit point out that credit unions would thus have to pay premiums and

write off and replenish the impaired deposit at a time when earnings are depressed and net worth

may already be declining. By expensing the 1 percent deposit now, credit unions would not have

to expense it during a time of economic stress. They would, however, still have to pay premiums

to rebuild the Fund’s reserves.

Because of the risks associated with this type of scenario, bankers recommend that the

deposit be expensed over a given number of years and that credit unions begin paying regular,

explicit premiums. In 1991 the GAO and the Bush Administration both recommended that the

1 percent deposit be expensed. However, the NCUA contends that simultaneously paying 100

premiums and expensing and replenishing the 1 percent deposit would not likely lead to additional

credit union failures.

Although the NCUA has authority to assess insurance premiums, those premiums must, by

law, be priced at a flat rate of 1/12 of 1 percent of deposits. Bankers argue that premiums 101

should be risk-based to discourage risky behavior and more accurately reflect individual credit

union’s risk.102

FDIC officials told us that, in their view, the 1 percent deposit system creates the same

incentives for credit unions as the FDIC funding structure does for banks and thrifts. The officials

view the difference in funding structures as essentially a matter of timing. Credit unions write

down the 1 percent deposit only if the Share Insurance Fund’s reserve ratio falls below 1 percent. 

But if that happens, credit unions recognize the impairment immediately and then replenish the 1

percent deposit by the following January. By contrast, FDIC-insured institutions prepay for

losses to the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF)

through premiums that they expense when paid. But FDIC-insured institutions have up to 15

years in which to bring a depleted insurance fund’s reserve ratio up to the statutorily required 1.25

percent. On balance, FDIC officials concluded that the 1 percent deposit system fosters neither 103

stronger nor weaker incentives to safeguard the insurance fund than does the FDIC system.
58

 See pp. 66-73. 104

3. Analysis and Recommendations

The overriding federal interest in the Share Insurance Fund’s financial structure lies in

protecting taxpayers from potential losses, while creating a healthy set of incentives for insured

credit unions. Thus, whatever the accounting issues and their resolution, the ultimate policy

concern must be the Share Insurance Fund’s fiscal soundness.

Although the Share Insurance Fund’s financial structure differs from that of BIF and

SAIF, that does not necessarily make one approach better than the other. We believe that both

approaches are reasonable and work well for their respective insurance funds. The financing

structure of the Share Insurance Fund fits the cooperative character of credit unions. Because

credit unions must expense any losses to the Share Insurance Fund, they have an incentive to

monitor each other and the Fund. This financing structure makes transparent the financial support

that healthier credit unions give to the members of failing credit unions. Credit unions understand

this aspect of the Fund and embrace it as a reflection of their cooperative character.

The current structure gives each credit union a financial incentive to ensure that it and

others remain solvent and do not require Share Insurance Fund assistance. Because their

1 percent deposit is at risk when other credit unions fail, and because the Share Insurance Fund

may have to levy additional assessments on surviving credit unions, credit union managers have an

incentive to alert federal regulators to unsound or illegal practices at other credit unions. 

Although credit unions cannot directly prevent excessive risk-taking by other credit unions, they

can report undesirable practices by other credit unions to regulators, who can take remedial

actions. Similar incentives should, however, exist in the FDIC funds.

The 1 percent deposit does present a double-counting problem. And it would be feasible

for credit unions to expense the deposit now, when they are healthy and have strong earnings. 

However, expensing the deposit would add nothing to the Share Insurance Fund’s reserves, and --

as we will explain -- better ways of protecting the Fund are available. Accordingly, we do not

recommend changing the accounting treatment of the 1 percent deposit.

Instead, we recommend a strengthened reserving requirement. Under current law, credit

unions set aside a small percentage of their gross earnings as reserves until their net worth reaches

6 percent of total assets. We recommend increasing the 6 percent threshold to 7 percent and

basing the measure on the ratio of total net worth to total assets. Thus we would require credit

unions not to write off part of their net worth but to add to it (if they did not already meet the

7 percent target). This additional net worth cushion would more than offset the double counting

of the 1 percent deposit. This approach should ultimately strengthen both individual credit unions

and the Share Insurance Fund. We discuss net worth requirements in detail in the next chapter.104
59

In addition, four changes directly relating to the Share Insurance Fund would better enable

the Fund to deal with potential future losses. First, establishing an available assets ratio (as

recommended above) would help to ensure that the Share Insurance Fund has adequate liquidity

to cover credit union losses. Second, correcting the NCUA’s measurement of its reserve ratio

and requiring credit unions to adjust their 1 percent deposit each time they submit call report data

(also recommended above) would ensure that the Share Insurance Fund’s reported reserve ratio

accurately reflects what reserves the Fund actually possesses at any given time.

Third, the NCUA should have some additional flexibility to let the Share Insurance Fund

accumulate additional investment earnings in good times that would increase its resiliency during

economic downturns. The Federal Credit Union Act currently imposes a rigid 1.3 percent ceiling

on the Fund’s reserve ratio. We recommend that Congress give the NCUA the discretion to let

investment earnings increase the Fund’s reserve ratio to 1.5 percent. This flexibility would

likewise better enable the NCUA to protect the Fund -- as well as protect credit unions’ 1 percent

deposit -- from possible future losses. The NCUA would, of course, have discretion to distribute

as dividends any reserves above 1.3 percent (and any interest they had earned).

Fourth, current law permits the NCUA to assess insurance premiums only at a fixed rate

of 1/12 of 1 percent of insured deposits. Here again, we recommend that Congress give the

NCUA more flexibility to ensure adequate, timely financing of the Share Insurance Fund. 

Specifically, the NCUA should have authority to charge premiums higher or lower than 1/12 of

1 percent.

Similarly, it may be appropriate to consider authorizing the NCUA to assess risk-based

premiums or make risk-based adjustments in dividends from the Share Insurance Fund. Although

this study does not recommend such changes, we see value in a broader debate over their possible

advantages and disadvantages.

D. SUMMARY

In analyzing issues relating to the Share Insurance Fund, we examined the NCUA’s

oversight of the Fund, the advantages and disadvantages of having some entity other than the

NCUA administer the Fund, and the strengths and weaknesses of the 1 percent deposit system.

In carrying out the Congressional requirement that we evaluate how the NCUA has

exercised its responsibility for the Share Insurance Fund, we focused on three key areas: 

(1) developing standards and procedures for examination and supervision; (2) formulating

policies and procedures to resolve troubled credit unions; and (3) managing the Share Insurance

Fund. We found no weaknesses in the NCUA’s examination and supervision process. In the

resolution area, however, we are concerned that neither the law nor policy requires the NCUA to

make cost to the Fund determinative in deciding how to resolve a troubled institution. We believe

that the NCUA needs a more rigorously formulated resolution decision-making process to deal

adequately with the new and increased risks posed by the growing size and complexity of some
60

credit unions. To this end, we recommend that Congress establish a prompt corrective action

system tailored to credit unions’ unique characteristics.

As for the NCUA’s management of the Share Insurance Fund, we found that the Fund is

in good condition, but that the techniques used to monitor the adequacy of its reserves need

improvement. We performed stress tests to assess the Fund’s strength and resiliency. The results

showed the Fund to be strong and resilient. However, because the current reserve ratio includes

in its numerator both liquid and illiquid assets, we believe that the NCUA should maintain an

available assets ratio of 1 percent and that maintaining that ratio should take precedence over

distributing dividends to insured credit unions. In addition, we found that the NCUA calculates

the Share Insurance Fund reserve ratio using non-contemporaneous figures, which inflates the

reported ratio. We recommend that the NCUA correct this measurement problem by using the

most current data on insured deposits it possesses as well as by requiring credit unions to adjust

their 1 percent deposit each time they submit data to the NCUA on their insured deposits.

In considering whether some entity other than the NCUA should administer the Share

Insurance Fund, we acknowledged that possible conflicts of mission exist between the NCUA’s

role in administering the Fund and its role as a charterer and supervisor. We concluded, however,

that on balance it is unclear if the benefits of having an entity other than the NCUA manage the

Fund would outweigh the substantial costs involved in making such a change. Moreover, we

believe that prompt corrective action rules for credit unions would introduce a constructive

discipline on the NCUA’s supervisory and insurance functions, which should largely offset any

incentives to permit the promotion of credit unions to interfere with the NCUA’s responsibilities

for the Fund.

Congress also directed the Treasury to examine the Share Insurance Fund’s 1 percent

deposit system. All insured credit unions currently maintain in the Share Insurance Fund a deposit

equal to 1 percent of their assets. Although the Fund carries these deposits on its balance sheet as

reserves, credit unions simultaneously carry them as assets, thereby increasing credit unions’

reported net worth. The double counting implicit in this structure may exacerbate credit union

failures during stressful periods if the 1 percent deposit becomes impaired. Many have suggested

abolishing the system and requiring credit unions to pay insurance premiums just as banks and

thrifts do in order to eliminate the double-counting problem. We found, however, that the 1

percent deposit system -- although different from the financing of the FDIC -- is effective. Credit

unions’ ownership of the Share Insurance Fund reflects their cooperative character while giving

them a financial incentive to monitor and seek to curtail unsound or illegal practices at other

credit unions.

Although we recommend maintaining the funding structure of the Share Insurance Fund,

we do recommend other ways to strengthen the Fund and credit unions as a whole. As already

noted, we recommend establishing prompt corrective action rules as well as requiring the NCUA

to maintain an available assets ratio for the Fund and to correct its methodology for measuring the

Fund’s reserve ratio. We recommend loosening the current statutory ceiling of 1.3 percent on the
61

 See p. 71. 105

Share Insurance Fund’s reserve ratio to give the NCUA some flexibility to build up the Fund. We

also recommend granting the NCUA the authority to assess premiums, when it deems necessary,

at a rate higher or lower than the current statutory requirement of 1/12 of 1 percent of insured

deposits. Furthermore, as risk levels among credit unions become more varied, the idea of riskbased premiums warrants consideration. Finally, imposing net worth requirements and tightening

reserving requirements (as we recommend in the next chapter) would be preferable to expensing

the 1 percent deposit. Rather than forcing credit unions to write off the 1 percent deposit 105

(thereby lowering their net worth), these steps involve credit unions carrying additional net worth

to support the 1 percent deposit.

63

 Pub. L. No. 104-208, § 2606, 110 Stat. 3009-394, 3009-473 (1996) (codified at 12 U.S.C. § 1752a note). 106

CHAPTER III

THE NCUA’S SAFETY AND SOUNDNESS REGULATIONS

Fostering the safe and sound operation of banks, thrifts, and credit unions constitutes the

most important goal of depository institution regulation. How well regulation achieves this goal

affects the economy, consumers, taxpayers, and the financial services system. The NCUA

charters and supervises federal credit unions and provides federal deposit insurance to both

federal and state credit unions. Integral to these responsibilities is the NCUA’s establishment and

enforcement of safety and soundness regulations.

Congress directed the Treasury to “conduct a study and evaluation of . . . the regulations

of . . . the [National Credit Union] Administration.” The NCUA’s regulations occupy over 250 106

pages of the Code of Federal Regulations. Congress did not identify which of these regulations it

considered most important. Given the central importance of safety and soundness regulations to

the NCUA’s regulatory mission and the relevance of those regulations to the other study topics

(including the Share Insurance Fund), we analyzed those regulations. We consider the NCUA’s

regulations regarding corporate credit unions in the following chapter. This chapter focuses on

the NCUA’s safety and soundness regulations for all other credit unions.

In view of the statutory and administrative modernization of bank and thrift regulation

over the past decade, we used the federal banking agencies’ safety and soundness regulations as a

starting point for our review of the NCUA’s safety and soundness regulations. When we

identified differences between the two sets of regulations, we evaluated them in light of credit

unions’ distinctive character and their size and complexity relative to banks and thrifts.

A. COMPARISON OF DEPOSITORY INSTITUTION SAFETY AND SOUNDNESS REGULATIONS

As part of our process of comparing the safety and soundness regulations governing credit

unions with those governing banks and thrifts, we asked the NCUA, OCC, and OTS to provide us

with a list of the most important safety and soundness rules -- both statutory and regulatory --

applicable to the institutions they regulate. We also asked CUNA and NAFCU each to provide us

with a list of the most important safety and soundness rules applicable to federally insured credit

unions. From these lists, we selected the provisions that we judged to be most important. 

Appendix B presents a side-by-side comparison of the safety and soundness regulations of the

NCUA, OCC, and OTS -- the three federal agencies that charter depository institutions.

We identified four key differences between the NCUA’s regulations and those of the

federal banking agencies that we believe warrant action by Congress or the NCUA:
64

 Banks generally have considerable experience in commercial lending; for them it represents a major line of 107

business. By contrast, most credit unions offer business loans more as a courtesy to members with their own

businesses than as a product line important in itself. It is reasonable that stricter standards apply to the institutions

with more limited experience in dealing with the risks of commercial lending.

 Such regulations, known in administrative law as “legislative rules,” affect the rights and duties of both the 108

agency and the regulated entities.

! In formulating fundamental safety and soundness policies that do or should rise to the

level of rules, the NCUA has often relied on such informal means as examiner manuals,

policy statements, or model bylaws, which provide no opportunity for public comment and

may not clearly indicate the operative norms to those who must comply with them.

! Credit unions must set aside reserves, but are not required to maintain a minimum level of

net worth.

! Credit unions are not subject to a system of prompt corrective action.

! The NCUA does not generally require even large credit unions to obtain outside

independent audits.

This chapter will discuss each of these points in turn. We note at the outset, however, that the

NCUA’s safety and soundness regulations are in some respects more demanding than those of the

federal banking agencies (e.g., the NCUA has stricter real estate appraisal requirements and more

stringent business lending limitations).107

B. SAFETY AND SOUNDNESS REGULATIONS

By “regulations” we mean rules formally promulgated by a federal agency and having the

force of law. A federal agency must generally publish a proposed regulation in the Federal 108

Register and give interested persons an opportunity to comment. After considering the comments

received, the agency may issue a final regulation. The Code of Federal Regulations codifies all

current federal regulations. The NCUA’s regulations, like those of the other federal agencies that

regulate depository institutions, appear in title 12 of the Code of Federal Regulations.

The NCUA follows a more informal approach to safety and soundness regulation than the

federal banking agencies, relying more on guidance and less on formal rules. To some degree,

this informal approach reflects the historical prevalence of small credit unions with relatively

simple operations. Such informality has its benefits for the NCUA and for credit unions, but it

may also have significant potential drawbacks, such as the following:

! Documents not easily accessible to the public contain important credit union safety and

soundness rules.
65

 12 U.S.C. § 1757(5)(A)(x); 12 C.F.R. § 701.21(c)(5). 109

 NCUA, Comments on Treasury’s Comparison of OCC, OTS, and NCUA Safety and Soundness Rules,

110

Apr. 11 (Alexandria, VA: NCUA, 1997), 4.

 12 U.S.C. §§ 84 (national banks); 1464(u) (federal savings associations). The following example illustrates 111

how much greater the limit on loans to one borrower is for credit unions than for other depository institutions. 

Assume that a federal credit union and a national bank each have $100 million in assets and $8 million in net

worth (8 percent). The national bank’s lending limit is 15 percent of $8 million -- or $1.2 million. By contrast, a

federal credit union’s statutory lending limit is keyed to the sum of its deposits and its net worth, a sum roughly

equaling the credit union’s total assets. Thus the credit union’s lending limit is 10 percent of approximately $100

million -- or $10 million. The credit union therefore has a lending limit over 8 times larger than that of the bank.

 62 Fed. Reg. 11,778 (1997). 112

Madias v. Dearborn Fed. Credit Union, 929 F. Supp. 1059, 1063 (E.D. Mich. 1996). 113

See, e.g., American Mining Congress v. Mine Safety and Health Admin., 995 F.2d 1106 (D.C. Cir. 1993) 114

(citing factors to be considered in determining whether a rule is intended to have the force of law).

! An important lesson of the thrift debacle is that unstructured, informal oversight can result

in undue leniency by depository institution regulators in times of stress.

! Establishing rules in an informal manner reduces or eliminates the opportunity for public

comment.

! The absence of clear, public rules increases the risk of the NCUA treating or being

perceived as treating similarly situated credit unions differently without good reason.

Limits on loans to one borrower illustrate the informality of the NCUA’s approach -- and

a significant weakness in the agency’s regulations. The Federal Credit Union Act limits a credit

union’s loans to one borrower to 10 percent of its “unimpaired capital and surplus.” The 109

NCUA has construed “capital” as including deposits. Thus the statutory limit on loans to one 110

borrower is 10 percent of deposits plus 10 percent of net worth. This exceeds the limit on other

depository institutions, which is generally 15 percent of capital. The NCUA told us it views the 111

statutory lending limit as an outer bound and that it determines the appropriate limit case by case,

when an institution adopts bylaws. But bylaws are not regulations and thus do not have the force

of law. The NCUA recently published proposed changes in its model bylaws in the Federal

Register and solicited public comments on them -- but only after a court ruled that it owed no 112

deference to the model bylaws because the NCUA had not promulgated them as a regulation.113

We recommend that the NCUA make important safety and soundness rules, like the limit

on loans to one borrower, readily accessible to all interested parties. If the NCUA intends rules to

have the force of law, and apply to credit unions generally, it should promulgate them as

regulations and codify them in the Code of Federal Regulations, preferably after publishing a 114

proposal in the Federal Register and soliciting comments from interested parties. Such a
66

NLRB v. Wyman-Gordon Co., 394 U.S. 759, 777-78 (1969) (Douglas, J., dissenting). 115

 5 U.S.C. § 552(a)(1)(D). 116

NLRB, 394 U.S. at 779 (Douglas, J., dissenting) (noting the statutory requirement that all rules intended to be 117

generally applicable and legally binding must be formally promulgated).

 Deposit insurance impairs the discipline that depositors would otherwise exert over depository institutions’ 118

risk-taking. It permits a depository institution to take increased risks without suffering a corresponding increase in

its cost of funds.

procedure “gives notice to an entire segment of society . . . [and] agencies discover that they . . .

learn from the suggestions of outsiders and often benefit from that advice.”115

The law does not require an agency to publish policy statements and guidance if they are

not intended to be legally binding, although they must be published in the Federal Register if 116

they are of general applicability. The NCUA should decide whether to solicit comments, keeping

in mind how the comment process can “force important issues into full public display and in that

sense make . . . for more responsible administrative action.”117

In recent years the NCUA has issued formal interpretive ruling and policy statements

(IRPS) establishing regulatory and safety and soundness standards. The NCUA has published

some of these statements for public comment and thus can give them the force of law. Although

comporting with the requirements for rulemaking, these statements are still less readily accessible

than rules codified in the Code of Federal Regulations.

C. CREDIT UNION NET WORTH REQUIREMENTS

1. Moral Hazard

Regulators of FDIC-insured depositories establish minimum net worth requirements to

help ensure that such institutions have a sufficient buffer to absorb unforeseen losses without in

turn imposing losses on depositors or the deposit insurance fund. Requiring institutions to have

adequate net worth also helps counteract the moral hazard of deposit insurance (i.e., the tendency

of deposit insurance to permit or encourage insured depository institutions to take excessive

risks -- risks that they would not take in a free market). Net worth is like the deductible on an 118

insurance policy: the higher the deductible, the greater the incentive to avoid loss. Adequate net

worth gives a depository institution’s owners incentives compatible with the interests of the

insurance fund because the fund absorbs losses only after the institution has exhausted its net

worth and thus eliminated the economic value of the owners’ investment.

The thrift debacle of the 1980s stands as ample warning of the possible consequences of

inadequate or unenforced capital requirements. Regulators permitted thrift institutions to

continue operating with little or no capital. Some of these institutions’ owners and managers --

having little left to lose -- took excessive risks that increased the losses of the insurance fund.
67

2. Credit Union Net Worth

A credit union’s net worth represents the sum of the various reserve accounts on its

balance sheet. These reserve accounts -- some required by statute or regulation and some

established at the institution’s discretion -- reflect the cumulative net retained earnings of the

credit union since its inception. These accumulated net reserves form the buffer that protects the

institution and the Share Insurance Fund from possible losses. During the 1990s, credit unions

have increased their net worth, as shown in Table III.1. On average, credit union net worth

stands at 11 percent of total assets, a 3 percentage point increase over the past five years.

Table III.1: Ratio of Total Reserves to Total Assets for Credit Unions, Commercial Banks, and

Thrifts: 1991-1996

1991 1992 1993 1994 1995 1996

Credit Unions 8% 8% 9% 10% 10% 11%

Commercial Banks 7% 8% 8% 8% 8% 8%

Thrifts 7% 7% 8% 8% 8% 8%

Source: Sheshunoff Information Services, Inc., BankSearch.

The strength of credit union net worth is consistent across all asset categories, as shown in

Table III.2. Smaller institutions have a higher ratio of net worth to assets than larger ones, but all

categories boast strong total reserves.
68

 12 U.S.C. § 1762. Risk assets consist of all assets (including outstanding loans), except for specific types of 119

assets that the NCUA has determined present less risk to credit unions. These exceptions include: (1) cash; (2)

loans, and other assets insured by the federal government having remaining maturities of five years or less; (3)

loans fully insured or guaranteed by the federal or state government with maturities of three years or less; and (4)

shares on deposits in state-insured depository institutions or in a corporate credit union with remaining maturities

of five years or fewer. 12 C.F.R. § 700.1(h)(i).

Table III.2: Ratio of Total Reserves to Total Assets for Credit Unions by Asset Size: 1991-1996

Asset Size Category 1991 1992 1993 1994 1995 1996

<$2 Million 11% 11% 12% 13% 14% 15%

$2-10 Million 9% 9% 10% 11% 12% 13%

$10-50 Million 8% 8% 9% 10% 11% 11%

$50-250 Million 7% 8% 9% 9% 10% 11%

>$250 Million 8% 8% 9% 9% 10% 10%

All Credit Unions 8% 8% 9% 10% 10% 11%

Source: Sheshunoff Information Services, Inc., BankSearch.

3. Credit Unions Are Not Subject to Net Worth Requirements

The NCUA’s regulations do not impose any net worth requirement on credit unions -- in

the sense of requiring credit unions to have at least a given ratio of net worth to assets in order to

be in good standing. When we asked the NCUA to describe credit union net worth requirements,

it pointed to three things: the statutory reserving requirement (discussed next); an NCUA Letter

to Credit Unions setting forth criteria that examiners employ to evaluate the adequacy of credit

unions’ net worth; and the NCUA’s use of capital ratios to identify risky institutions.

a. Reserves

The agency’s regulations implement the statutory requirement that a federal credit union

transfer a certain percentage of its annual gross income into a reserve account, known as “regular

reserves,” until that account reaches a specified level. Specifically:

! A credit union in operation for more than four years and having at least $500,000 in assets

must annually transfer 10 percent of its gross income to its regular reserve account until its 

regular reserves reach 4 percent of outstanding loans and “risk assets,” then 5 percent of 119

gross income until its regular reserves reach 6 percent of outstanding loans and risk assets.
69

 12 U.S.C. § 1762. The NCUA permits credit unions to add their allowances for loan losses and for investment 120

losses to their regular reserve for purposes of determining the required transfer. 12 C.F.R. § 702.2. By contrast,

bank and thrift capital regulators permit loan loss allowances to count only to a very limited extent toward meeting

capital requirements. Such allowances may count, as part of Tier 2 capital, toward part of the risk-based capital

requirement; it cannot count at all toward the leverage ratio. We note that regular reserves constitute only part of a

credit union’s net worth; the remainder consists of other reserve accounts, such as undivided earnings.

 As credit unions’ loan portfolios tend to grow during good economic times and shrink during bad economic 121

times, the implied net worth-to-asset ratio rises as the economy expands and falls as the economy contracts (other

things being equal). The 3.9 percent implied ratio is for credit unions as a group; an individual credit union may

have a higher or lower implied ratio, depending on the particular characteristics of its assets.

 NCUA, Responses to Questions about the Share Insurance Fund, Nov. 22 (Alexandria, VA: NCUA, 1996), 122

tab 5. 

 For a description of the CAMEL rating system, see pp. 32-33. 123

! A credit union in operation for less than four years or with less than $500,000 in assets

must annually transfer 10 percent of its gross income to its regular reserve account until

those reserves reach 7.5 percent of outstanding loans and risk assets, then 5 percent of

gross income until reserves reach 10 percent of outstanding loans and risk assets.120

This is, however, merely a reserving requirement -- not a net worth requirement. It simply sets

forth the circumstances under which a credit union must add to its reserves a specified percentage

of its current earnings. It neither requires the credit union to keep its net worth above a particular

ratio nor even requires that the credit union ever reach that level.

One can legitimately view the reserving requirement as implying a net worth target (for

most credit unions, 6 percent of risk assets). Risk assets include most loans and most investments

with a maturity exceeding five years. As a practical matter, for most credit unions, risk assets

roughly correspond to total loans, and, at year-end 1996, loans amounted to some 65 percent of

total credit union assets. Thus the implied net worth target amounts to about 3.9 percent of total

assets (65 percent of 6 percent). But the only legal consequence of failing to meet the target is 121

that a credit union must set aside as reserves a small percentage of its current gross income.

b. Examiner Guidance

The NCUA’s Letter to Credit Unions, number 161, dated December 1994 (as summarized

by the NCUA), “explains . . . what the examiners review when evaluating capital adequacy,”

“provides the formulas of the ratios used in determining the component rating for capital,” and

has “[g]uidelines for assigning component ratings according to asset size.” The letter describes 122

in general terms the net worth ratios associated with various ratings for the capital component of

the CAMEL rating system. It says that a credit union must have capital “well in excess of 123

NCUA regulatory requirements” to receive the highest rating for capital adequacy, and that an

institution will receive the lowest capital rating if it is “critically undercapitalized.” However,

neither the letter nor the NCUA’s regulations defines the “NCUA’s regulatory requirements” or

what it means for a credit union to be “critically undercapitalized.”
70

 The capital-to-assets ratio consists of the sum of the allowance for loan and investment losses, regular reserves, 124

investment valuation reserves, other reserves, accumulated unrealized gains or losses on “available for sale”

investments, undivided earnings, and net income divided by total assets.

 The net capital-to-total assets ratio consists of the sum of all of the capital components identified in the capital- 125

to-total assets ratio, minus the sum of problem loans, other identified losses, and the difference between the book

and market value of investments, divided by total assets.

 NCUA, Responses to the Treasury’s Questions about the Share Insurance Fund, Nov. 22 (Washington, DC: 126

NCUA, 1997), tab 5.

 Ibid. 127

 Ibid. 128

 See pp. 55-57. 129

The letter does describe the capital-to-assets ratio and the net capital-to-assets ratio 124 125

that the NCUA associates with each possible rating for the capital component. These ratios vary

by credit union size, with small credit unions needing higher net worth ratios than large credit

unions to obtain a given capital rating. For example, to receive the highest capital rating of 1: a

credit union with less than $2 million in assets should have a capital-to-assets ratio of more than

11 percent; a credit union with $2-10 million in assets should have more than 9 percent; and a

credit union with more than $10 million in assets should have more than 8 percent. The net

capital requirements are somewhat lower, and the relationship between size groups, and between

the two capital ratios, are not consistent across the possible CAMEL ratings.

c. Capital-Based Monitoring

The NCUA also pointed to its use of capital ratios in identifying risky credit unions. The

NCUA’s Division of Risk Management produces a risk evaluation report that, among other

things, identifies all credit unions with a “net equity ratio of less than 3 percent.” The NCUA 126

uses this report to identify adverse trends. The six NCUA regional offices also run similar 127

reports “with their own criteria for capital levels” (emphasis added).128

Despite the considerable weight the NCUA places on credit unions’ net worth, its

regulations include no net worth requirements or even a statement of the primary measures of

capital adequacy. Moreover, even the NCUA’s informal net worth-related policies do not amount

to net worth requirements.

4. Recommended Credit Union Net Worth Requirements

In considering the role of regulatory net worth requirements as a buffer to protect the

Share Insurance Fund, one should also consider the double-counting issues associated with credit

unions’ 1 percent deposit in the Fund and with credit unions’ ownership of capital shares in 129
71

 See pp. 94-96. 130

 “Risk assets,” as currently defined by the NCUA, excludes most securities with maturities under five years, and 131

thus does not require a credit union to build net worth against such securities. Yet maturity alone is a poor

measure of credit risk, interest rate risk, prepayment risk, or other relevant risks. On balance, we regard the fiveyear rule as an inadequate test of a security’s riskiness. We also found risk assets to be unnecessarily cumbersome.

corporate credit unions. Effective net worth requirements for credit unions, set at an adequate 130

level, should allay concerns about such double counting.

We recommend four changes that together should provide adequate, effective net worth

requirements.

First and most importantly, Congress should require credit unions to meet net worth

requirements (i.e., a specified ratio of net worth to assets). We recommend that Congress require

a credit union that has existed for a given number of years or reached a given asset size to have at

least a 6 percent ratio of net worth to total assets. As described in Section D, we would make

such a requirement part of a system of prompt corrective action designed to ensure that credit

unions correct any net worth deficiency expeditiously.

Credit unions that have not existed the specified number of years or reached the specified

asset size should be required to build reserves on a schedule aimed at ensuring that they will meet

the 6 percent net worth target by the end of the phase-in period. The NCUA should promulgate

appropriate regulations to achieve this goal. Also, the phase-in period could be automatically

ended once the credit union reaches a certain asset size as specified in regulation.

Second, the reserving requirement (i.e., the requirement that a credit union set aside as

reserves a certain percentage of its gross income) should have a higher target reserve ratio. 

Specifically, we recommend that Congress raise the current reserving target from 6 percent of

“risk assets” to 7 percent of total assets. A one percentage point increase in the reserving 131

target would approximate credit unions’ 1 percent deposit in the Share Insurance Fund.

Third, we recommend that Congress require credit unions to deduct from their reserves

some portion of any member capital accounts at a corporate credit union and all paid-in capital

issued by a corporate credit union. We propose deducting member capital accounts and paid-in

capital from reserves, rather than increasing the reserve target, because not all credit unions have

such assets. Consequently, a deduction requirement would affect only those credit unions holding

member capital accounts or paid-in capital.

Fourth, we recommend that Congress require the NCUA to develop an appropriate riskbased net worth requirement for larger, more complex credit unions. This risk-based requirement

would supplement the simple 6 percent net worth requirement and permit the NCUA to take

account of risks -- such as off-balance sheet risks or interest rate risk (from, for example, a large

mortgage portfolio) -- that may exist only for a small subset of credit unions.
72

 Credit unions differ from mutual savings associations and mutual savings banks, which can convert to stock 132

form if they must raise significant equity.

 A credit union that retains a dollar of earnings adds the entire dollar to its net worth. A bank or thrift that 133

retains a dollar of earnings must first pay income tax on that dollar. Thus it can add only the after-tax portion of

that dollar to its net worth.

Our recommendations respect credit unions’ cooperative character and would leave credit

unions and the Share Insurance Fund stronger and more resilient than they are now. We

recognize that the net worth requirements outlined here may require a credit union to hold

somewhat more net worth than would be required of a similarly situated bank or thrift. Even if

that were the case, we believe that a higher level would be justified. Chapter II describes how a

credit union’s 1 percent deposit in the Fund commits an appreciable part of the institution’s net

worth to the Fund’s reserves, and Chapter IV describes how an institution’s member capital

account (or paid-in capital) at its corporate credit union in effect transfers that part of the credit

union’s net worth to the corporate credit union. Thus the credit union records as assets both the

1 percent deposit and member capital accounts. Yet these assets effectively assign part of the

credit union’s net worth to the net worth of the Fund and to the net worth of its corporate credit

union, respectively.

Additionally, credit unions cannot increase their net worth quickly. They cannot raise

capital by issuing stock, and they are not subject to the market discipline brought to bear by 132

stockholders and by potential owners who think they could operate the institution more

efficiently. Although credit unions can take steps to reduce expenses and increase revenues,

accumulating retained earnings takes time -- and may be particularly difficult during times of

stress, when earnings tend to decline.

It should be noted that credit unions’ exemption from federal income tax gives them an

advantage over banks and thrifts in generating net worth internally. Also, unlike banks and 133

thrifts, most credit unions would not be subject to risk-based capital requirements. We also note

that the NCUA’s guidance to examiners generally calls for credit unions to have higher net worth

levels than we are proposing here as regulatory minimums.

As shown in Table III.3, credit unions’ balance sheets indicate that credit unions

themselves recognize the wisdom of maintaining a net worth exceeding 7 percent of total assets.
73

Table III.3: Credit Union Net Worth

(Dollar figures in millions, totals may not add due to rounding, data as of December 31, 1996)

Institutions Assets

Net Worth Number % of Total Cumulative % Amount % of Total Cumulative %

Under 3% 86 1% 1% $246 1% 1%

3-6% 314 3% 4% $5,603 2% 2%

6-7% 400 4% 7% $16,004 5% 7%

7-8% 669 6% 13% $31,681 10% 17%

8-9% 961 8% 21% $43,505 13% 30%

9-10% 1,121 10% 31% $46,644 14% 44%

Over 10% 7,841 69% 100% $183,199 56% 100%

Total 11,392 100% $326,883 100%

Source: Sheshunoff Information Services, Inc., BankSearch.

Of the 11,392 credit unions operating at year-end 1996, 10,591 (93 percent) had more than 7

percent net worth, and those institutions held 93 percent of total credit union assets. More

specifically, 7,840 credit unions (69 percent of all credit unions) had more than 10 percent net

worth, another 2,082 (18 percent) had 8-10 percent net worth, and an additional 669 (6 percent)

had 7-8 percent net worth. Of the 800 credit unions that did not have at least 7 percent net

worth, 400 (with 5 percent of total credit union assets) had at least 6 percent. Only 400 credit

unions (4 percent) had less than 6 percent net worth, and those institutions held only 2 percent of

total credit union assets. Thus the vast majority of credit unions would already satisfy both the

net worth requirement and the reserving targets we propose.

Insofar as these reforms would require a small minority of credit unions to increase their

net worth, we note that achieving such an increase now -- in a stable, prosperous economic

environment -- would be much easier than doing so under more difficult economic circumstances. 

In any event, increased net worth would help ensure that those credit unions have the financial

strength to meet their members’ needs even during difficult economic times.

D. PROMPT CORRECTIVE ACTION

Prompt corrective action is a capital-based approach to safety and soundness supervision

aiming to resolve net worth deficiencies at federally insured depository institutions before they

grow into large problems. The goal is to minimize -- and, if possible, avoid -- losses to the

deposit insurance fund.
74

 As net worth falls, an institution’s incentives to avoid losses falls with it. A decapitalized institution has strong 134

incentives to take risks: if it succeeds, it reaps the benefit; if it fails, the insurance fund bears the loss. By taking

big risks, the institution better exploits the value of its insurance. For further explanation, see p. 66.

 Federal Deposit Insurance Corporation Improvement Act, Pub. L. No. 102-242, § 131, 105 Stat. 2236, 2253- 135

66 (1991) (codified at 12 U.S.C. § 1831o).

Id. § 1831o(b)(1). 136

Id. § 1831o(d). 137

Id. § 1831o(e). 138

Id. § 1831o(f). Other such actions include: further restricting the institution’s transactions with affiliates; 139

further restricting the institution’s asset growth, or requiring the institution to shrink; requiring the institution to

Prompt corrective action helps counteract the perverse incentives created by deposit

insurance. The “moral hazard” of deposit insurance occurs as a depository institution depletes its

net worth. Regulators, too, may face perverse incentives that prompt corrective action serves 134

to offset. Taking timely, forceful action to deal with emerging problems depository institutions

may bring criticism on a regulator, while forbearance may delay unpleasant outcomes until the

regulator leaves office, or may permit economic conditions to change in a way favorable to the

troubled entity. Prompt corrective action lays clear markers for when regulatory action must

occur and identifies a range of acceptable actions for a given degree of net worth deficiency. 

Prompt corrective action better aligns the incentives of depository institutions’ owners, managers,

and regulators with the interests of the deposit insurance fund.

1. Prompt Corrective Action for FDIC-Insured Depository Institutions

Congress enacted a system of prompt corrective action for FDIC-insured depository

institutions in 1991. This system classifies depository institutions into five categories, 135

according to their capital: well capitalized; adequately capitalized; undercapitalized; significantly

undercapitalized; and critically undercapitalized. An institution falling below minimum capital 136

standards faces progressively more stringent regulatory restrictions and requirements.

A well capitalized institution is eligible for various benefits (e.g., broader powers and less

restrictive regulation) accorded by Congress and the regulators under other laws. 

In general, no institution can make any capital distribution (e.g., dividend payment or

stock redemption) that would render it undercapitalized, nor can an undercapitalized institution

make any capital distribution.137

If an institution becomes undercapitalized, it must submit an acceptable plan for restoring

its capital, comply with limits on its asset growth, and obtain prior regulatory approval for

acquisitions, branching, and new lines of business. Regulators may also take one or more of an 138

array of discretionary actions, such as restricting overly risky activities or requiring the institution

to hold a new election for its board of directors.139
75

oust a director or senior executive officer, or employ new senior executive officers acceptable to regulators;

prohibiting the institution from accepting deposits from correspondent institutions; requiring a parent bank holding

company to obtain the Federal Reserve’s approval before making a capital distribution; or requiring divestiture of

the institution or any affiliate; or requiring other actions that would better carry out the purpose of avoiding or

minimizing loss to the insurance fund. A significantly undercapitalized institution also cannot pay a senior

executive officer any bonus without prior regulatory approval.

Id. § 1831o(h). 140

Id. § 1831o(g). Regulators cannot, however, use this authority to move any institution into the critically 141

undercapitalized category.

If an institution is significantly undercapitalized, regulators must normally: (1) require the

institution either to sell enough stock or subordinated debt to recapitalize, or to undergo a merger

or acquisition; (2) restrict the institution’s transactions with affiliated depository institutions; and

(3) prohibit the institution from paying more than the prevailing regional rates of interest on

deposits. Each of these safeguards is mandatory unless regulators determine that the safeguard

would not help avoid or minimize loss to the insurance fund. Regulators may also take any of the

discretionary actions applicable for undercapitalized institutions.

A critically undercapitalized institution faces stringent activity restrictions aimed at

minimizing the potential for loss to the insurance fund, a prohibition against making payments on

its subordinated debt, and the appointment of a conservator or receiver. Within 90 days of the

institution becoming critically undercapitalized, regulators must either appoint a conservator or

receiver for the institution, or take such alternative action as they determine would better achieve

the purpose of avoiding or minimizing loss to the insurance fund, after documenting why the

action would better achieve that purpose.140

Because capital is a lagging indicator of problems, regulators have discretion to reclassify

a depository institution into the next lower capital category if: (1) the institution is in an unsafe or

unsound condition; or (2) when most recently examined, the institution received an unsatisfactory

rating for any of the four noncapital elements of the CAMEL rating (asset quality, management,

earnings, or asset/liability management) and has not corrected the deficiency.141

Since the prompt corrective action statute took effect in December 1992, capital

deficiencies among FDIC-insured institutions have become rare. Problem cases, failures, and the

FDIC’s insurance losses have fallen to insignificant levels. These favorable developments largely

reflect the strength of the national economy. But we believe that the prompt corrective action

system has also had a beneficial effect by preserving capital that institutions have accumulated

during the economic recovery.

2. Current NCUA Policies

The NCUA pays close attention to credit unions’ net worth and has some informal policies

analogous to prompt corrective action. If an institution’s regular reserves fall below 6 percent of

total assets, the NCUA will monitor the interest rate that the credit union pays on deposits. 
76

 NCUA, Responses to Questions, Jun. 4 (Alexandria, VA: NCUA, 1997), 4.b. 142

 Omitted provisions would include the rule that regulators must require a significantly undercapitalized 143

institution either to sell enough stock or subordinated debt to recapitalize or undergo a merger or acquisition. Also

omitted would be regulators’ discretionary authority to prohibit a significantly undercapitalized institution from

accepting deposits from correspondent institutions, require any parent bank holding company to obtain the Federal

Reserve’s approval before making a capital distribution, or require divestiture of the institution or any affiliate.

Decreasing net worth will lower the capital component of the credit union’s CAMEL rating, and

the examiner may recommend various actions to strengthen the institution’s net worth. 

Furthermore, the NCUA must approve any changes in a troubled credit union’s senior executives.

Most of these possible actions derive from informal rules allowing the NCUA considerable

leeway to act or not, and that (unlike prompt corrective action) provide no rigorous structure for

decision making that promotes accountability. For example, when we asked the NCUA whether

falling net worth levels triggered any particular response from the NCUA, the agency replied:

The reserve levels that correspond to CAMEL categories are benchmarks, not established by

regulation or statute. Examiners are instructed to use the numbers as benchmarks only. 

However, if a credit union’s reserves are trending downward, the examiner may address the

situation with credit union officials and develop plans for corrective action. Additionally, if

a credit union’s problems are severe enough to deplete its reserves to the point where the

credit union was insolvent or “in danger of closing” and if NCUA has exhausted all other

supervisory solutions, NCUA may grant 208 assistance to continue operations, in lieu of

liquidation or merger.142

The relevant statutes, regulations, and policies fall short of providing a system of prompt

corrective action for credit unions. The NCUA has no regulations or even formal guidelines for

taking corrective action regarding a troubled credit union, and once a credit union depletes its net

worth, the NCUA’s response may be to provide assistance from the Share Insurance Fund rather

than to close the institution. Although this approach may sometimes turn around a troubled

institution, it also has risks. In particular, regulatory forbearance may delay the actual recognition

and correction of serious deficiencies. When this occurs in a general downturn with many

institutions getting into difficulty, what might otherwise have produced small losses to the

insurance fund could produce much larger losses. The breakdown in regulatory discipline and

management discipline becomes difficult to correct. Unstructured regulatory discretion may also

promote unfairly disparate treatment of similarly situated credit unions.

3. Prompt Corrective Action for Credit Unions

We recommend that Congress establish a system of prompt corrective action for federally

insured credit unions. This system would be a streamlined version of that currently applicable to

FDIC-insured institutions and would be specifically tailored to credit unions as not-for-profit,

member-owned cooperatives. It would thus, for example, omit the various provisions keyed to

the existence of capital stock since credit unions have no capital stock.143
77

We note that the NCUA’s authority to administer a prompt corrective action system for

credit unions would be in addition to the NCUA’s other authorities. In particular, it would not

preclude the NCUA from dealing with emerging problems before those problems deplete a credit

union’s net worth.

A prompt corrective action system for credit unions, like the system already in effect for

other federally insured depository institutions, might have five net worth categories. A credit

union with a ratio of net worth to total assets meeting the revised reserving target of 7 percent

would be “well capitalized.” In keeping with our recommendation to generally require credit

unions to maintain 6 percent net worth, credit unions with at least 6 percent net worth would be

“adequately capitalized,” and credit unions with less than 6 percent net worth would be

“undercapitalized.” A credit union with less than 4 percent net worth would be “significantly

undercapitalized.” A credit union with less than 2 percent net worth (or such higher level, not

exceeding 3 percent, as the NCUA may prescribe by regulation) would be “critically

undercapitalized.” Figure III.1 depicts these categories.
78

Figure III.1: Proposed Net Worth Ratios for Credit Union Prompt Corrective Action

Net Worth to

Assets >12%

11%

Well

Capitalized

10%

Adequately

Capitalized

9%

At Least 6%

8%

Required 7% >7%

Minimum

Level 6%

5%

< 6%

Under-capitalized 4%

3%

< 4%

Significantly

Under-capitalized 2%

1%

<2%

Critically 

Under-capitalized

Insolvency

The rules applicable to credit unions with net worth deficiencies might be along the

following lines:

An undercapitalized credit union would have to submit an acceptable net worth restoration

plan to the NCUA, specifying the steps it would take to become adequately capitalized. The

credit union could not increase its average total assets unless it had an approved plan, the asset

growth comported with the plan, and the credit union’s net worth ratio increased at a rate

sufficient to enable the institution to become adequately capitalized within a reasonable time. An

undercapitalized credit union would also need NCUA approval to establish new offices or

commence new lines of business.

If a credit union were significantly undercapitalized, the NCUA would have to take at least

one action from an array such as the following: limiting the interest (dividend) rate paid on

deposits; restricting overly risky activities; further restricting the institution’s asset growth, or
79

 The NCUA would make such a determination under section 206(b)(1) of the Federal Credit Union Act, after 144

notice and a hearing. 12 U.S.C. § 1786(b)(1).

requiring the institution to shrink; requiring the institution to hold a new election for its board of

directors, oust a director or senior executive officer, or employ new senior executive officers

acceptable to the NCUA; or requiring the institution to take other action that the NCUA

determines would better carry out the purpose of avoiding or minimizing loss to the Share

Insurance Fund than the specific actions listed here. In addition, a significantly undercapitalized

credit union could not pay any senior executive officer a bonus without the NCUA’s approval.

The NCUA would be required to prescribe regulations governing the activities of a

critically undercapitalized credit union -- with the goal of stabilizing the institution to minimize the

potential for additional losses to the Share Insurance Fund. The applicable restrictions and

requirements might vary according to the size and complexity of the credit union.

The NCUA would have discretion to liquidate a critically undercapitalized credit union. 

However, if a credit union remained critically undercapitalized for longer than a specified period

(such as 180 or 270 days), the NCUA would have to either liquidate the institution, or take such

alternative action as it determined would better achieve the purpose of avoiding or minimizing

loss to the Share Insurance Fund, after documenting why the action would better achieve that

purpose.

The NCUA could reclassify a credit union into the next lower capital category if: (1) the

NCUA formally determined that a credit union were in an unsafe and unsound condition; or 144

(2) when most recently examined, the credit union received an unsatisfactory rating for any of the

noncapital elements of the CAMEL rating and had not corrected the deficiency.

We would not apply these statutory prompt corrective action provisions to credit unions

that had not existed for the minimum number of years or reached the minimum asset size,

whichever comes first. Such credit unions should, however, be subject to prompt corrective

action if they are not making sufficient progress towards meeting the 6 percent requirement. 

Congress should direct the NCUA to implement by regulation a system of prompt corrective

action appropriate for credit unions that had not existed for the specified number of years or

reached the specified asset size.

A system of prompt corrective action would reinforce the commitment of credit unions

and the NCUA to resolve net worth deficiencies promptly, before they become more serious. Its

clarity and predictability should promote fair, consistent treatment of similarly situated

institutions. It should also ultimately reduce the number and cost of credit union failures. In so

doing, it should conserve the resources of the Share Insurance Fund, make it even more resilient,

and make more money available for lending to credit union members. And it would respect and

complement the cooperative character of credit unions.
80

 12 C.F.R. § 701.12(c). The NCUA revised these regulations in 1996. 61 Fed. Reg. 41,312 (1996). However, 145

the final rule differed markedly from the 1993 proposal to require credit unions with over $50 million in assets to

obtain annual independent audits of their financial statements. 51 Fed. Reg. 17,808, 17,809 (1993).

 12 U.S.C. § 1761(b). 146

 12 C.F.R. § 701.12(c)(5). 147

 12 C.F.R. § 701.13(a), (implementing 12 U.S.C. § 1782(a)(6)(A)). 148

 The NCUA requires that supervisory committee audits be performed by “persons having adequate technical 149

training and proficiency as an auditor commensurate with the level of sophistication and complexity of the credit

union under audit,” but does not require that even the most complex credit union hire a professional accountant. 

12 C.F.R. § 701.12(c)(2)(i).

 The “NCUA continues to have concerns with the scope of the supervisory committee audit . . . because: Many 150

supervisory committee audits have been inadequate; Examiners have been placed in the position of brokering

disputes between external auditors and supervisory committees relative to audit inadequacy; The standards

supervisory committee[s] have been held to are not definitive . . . [and] greater uniformity in audit scope is

needed . . . . ” 61 Fed. Reg. 41,312, 41,313 (1996).

E. ANNUAL OUTSIDE INDEPENDENT AUDITS

The NCUA requires each federal credit union to undergo an annual audit satisfying criteria

prescribed by the NCUA. The credit union’s supervisory committee, which consists of 145

volunteer members of the credit union appointed by the credit union’s board of directors, has 146

responsibility for conducting the audit itself or retaining an independent, licensed certified public

accountant to do so. The supervisory committee must, in any event, ensure that the credit 147

union’s financial statements accurately and fairly represent the institution’s financial condition,

and that the credit union’s management practices and procedures sufficiently protect members’

assets. The NCUA requires an independent audit only if: (1) the supervisory committee has not

conducted an annual audit; (2) the supervisory committee’s audit failed to meet the NCUA’s

requirements; or (3) the credit union has had serious and persistent recordkeeping deficiencies.148

With the rise of large, financially complex credit unions, the audit becomes increasingly

more difficult for unpaid volunteers to carry out personally. The NCUA has noted the 149

inadequacies of supervisory committee audits in general. Accordingly, we recommend that the 150

NCUA require each large federally insured credit union to obtain an annual audit from an

independent certified public accountant. The audit should be at least comparable to those

required by the FDIC under section 36 of the Federal Deposit Insurance Act. The credit union

would engage an independent public accountant to audit and report on its annual financial

statements in accordance with generally accepted auditing standards. The audit’s scope should be

sufficient to permit the accountants to determine and report whether the financial statements are

presented fairly and in accordance with generally accepted accounting principles. Moreover,

during the audit, the accountant should be required to attest to the adequacy of the credit union’s

internal controls for financial reporting. Internal controls play an important role in safeguarding

assets, protecting against fraud, and ensuring reliable data.
81

 12 C.F.R. § 363.1(a) (implementing 12 U.S.C. § 1831m). 151

 Table I.4 shows the extensive product offerings of the nation’s large credit unions, and Chapter I also describes 152

the rapid growth taking place at these credit unions. See p. 23.

The FDIC requires banks and savings associations with at least $500 million in assets to

obtain such audits. We believe the $500 million asset threshold to be reasonable for credit 151

unions as well. As of the end of 1996, 74 credit unions (with $77 billion in aggregate assets)

exceeded that threshold. The independent audit requirement should not impose any hardships on

these institutions; according to the NCUA, all credit unions of that size voluntarily obtained audits

by certified public accountants in 1996. Numerous smaller credit unions also obtained outside

independent audits. The NCUA should also have discretion to require independent audits of

smaller credit unions.

F. TOWARD THE FUTURE

Financial markets and financial products continue to change rapidly, presenting consumers

with an increasingly broad array of financial services. Credit unions are also continuing to grow,

evolve, and expand their product offerings. These trends pose three significant challenges for the

NCUA as a safety and soundness regulator.

First, although most credit unions remain relatively small institutions with simple product

offerings, a growing number are large and have extensive, complex product offerings. These 152

credit unions commonly compete head-on with other depository institutions. This increasing size

and complexity raises several related issues:

! As credit unions increase in size and complexity -- competing directly with banks and

thrifts and taking on similar financial risks -- policymakers need to ensure that comparable

safeguards apply to credit unions’ risk-taking. Insofar as credit unions truly differ from

other federally insured depository institutions (e.g., in their cooperative ownership and

capital structure), safety and soundness regulation should reflect those differences. But

insofar as activities and risks are similar without safeguards being comparable, more

stringent safeguards are appropriate.

! Experience indicates some correlation between federally insured depository institutions

rapidly expanding their asset size and product offerings, and subsequent problems. Some

institutions grew too rapidly to understand or properly manage the risks they were

undertaking. Such problems played a significant role in the thrift debacle. The NCUA

should be mindful of how to limit any increased risk to the Share Insurance Fund posed by

rapid growth in credit unions’ asset size or product offerings.

! Another, more general factor in the thrift debacle involved the failure to update and

strengthen regulatory safeguards in light of changes in markets and in the activities

permissible for federally insured depository institutions. For decades, federal regulation
82

 Pub. L. No. 73-43, § 5(c), 48 Stat. 128, 132 (1933). 153

narrowly constrained thrift institutions’ business activities (e.g., the original Home

Owners’ Loan Act limited a federal savings association to making first mortgage loans on

real property located within 50 miles of its main office). Such constraints may have 153

diminished the impetus for more formal safeguards. Yet as Congress and thrift regulators

liberalized the thrift charter, they failed to provide an adequate alternative set of

safeguards to limit risk to the deposit insurance fund.

Second, changes in a credit union’s charter type -- specifically, in whether the credit union

has an associational, occupational, or community field of membership -- may affect its risk profile. 

NCUA officials commented to us that, for example, a credit union with a community charter

would tend to have a relatively higher risk profile than a similar-sized credit union with an

occupational charter. The occupational charter tends to foster a greater sense of affinity among

members (and encourages them to identify more closely with the credit union). It also directly

connects employment and credit union membership. Both of these factors may tend to make an

occupationally based credit union less risky than an institution in which members’ affinity rests

only on geography and in which members may or may not be employed. (On the other hand, a

credit union with a community charter may have greater diversity of credit risk if its members do

not have the same employer.) The recent trend has been for credit unions to convert from

occupational charters to community charters. If this trend continues, the NCUA and other

policymakers will need to carefully consider its implications for credit union safety and soundness,

and bolster such safeguards to the extent appropriate.

Third, credit unions, like other depository institutions, can choose between state and

federal charters. Not all of the NCUA’s safety and soundness rules apply to state-chartered,

federally insured credit unions. For example, the recent changes in the NCUA’s investment

regulation (part 703) apply only to federal credit unions. As part of its responsibilities to manage

and protect the Share Insurance Fund, the NCUA should ensure that the safety and soundness

safeguards applicable to state-chartered credit unions are equivalent to those applicable to federal

credit unions. If a state regulates an activity or type of risk inadequately, the NCUA should

ensure that the Share Insurance Fund remains adequately protected.

G. SUMMARY

Credit unions have generally been regulated more informally than banks and thrifts,

primarily because they have typically been engaged in less risky activities and are smaller in size. 

The difference between safety and soundness regulation of credit unions and that of other

federally insured depository institutions increased after the bank and thrift failures of the 1980s

and early 1990s, when bank and thrift regulations underwent significant updating and

transformation.
83

The continuing informality of credit union regulation raises some concerns as a growing

number of credit unions evolve into larger and more complex financial institutions. The NCUA’s

approach to safety and soundness regulation is still basically geared to the small local credit union

with limited products and limited risk. Safety and soundness regulation must keep pace with

expanding credit union operations.

Our comparison of credit union safety and soundness rules with those applicable to banks

and thrifts highlighted four areas in which the NCUA’s safety and soundness regulations need

improvement:

! The NCUA should codify its key safety and soundness rules, after publishing them for

public comment.

! Congress should enact, and the NCUA should implement, net worth requirements for

credit unions.

! Congress should enact, and the NCUA should implement, a system of prompt corrective

action for dealing with credit unions that have low net worth deficiencies.

! The NCUA should require large credit unions to obtain annual independent audits.

We view these as the most important -- but not necessarily the only -- changes needed. 

The NCUA should undertake its own review of its safety and soundness regulations to identify

and implement other improvements as appropriate. In particular, we encourage the NCUA to

continue to develop regulations like the recent changes in part 703 that are flexible enough to deal

with the differences in operational risks and risks to the Share Insurance Fund posed by $2 million

credit unions and $200 million credit unions. We also encourage the NCUA to be watchful of

emerging trends among credit unions, including their:

! increasing size and complexity;

! movement from occupational to community charters; and

! separate regulation of state-chartered credit unions.

85

 Ownership in corporate credit unions is represented by the deposit (share) accounts of their member credit 154

unions, with each member having equal voting rights.

 This prohibition became effective on January 1, 1996. 59 Fed. Reg. 59,357, 59,360 (1994) (codified at 12 155

C.F.R. § 704.12).

 Dividing the $23 billion in corporate credit unions by all 11,392 credit unions yields an average investment in 156

corporate credit unions of roughly $2 million per credit union.

CHAPTER IV

CORPORATE CREDIT UNIONS

Corporate credit unions serve their member credit unions’ needs for transaction,

investment, and liquidity services. In recent years, some observers have questioned corporate

credit unions’ safety and soundness and the NCUA’s oversight of these institutions. Since

corporate credit unions hold a considerable portion of credit unions’ unloaned deposits, their

safety and soundness is critically important to credit unions and the Share Insurance Fund.

We begin this chapter by describing the various functions of corporate credit unions,

noting why their operations raise public policy issues, and explaining how we conducted this

portion of our study. We then evaluate: (1) the financial condition of the 10 largest corporate

credit unions; (2) the NCUA’s safety and soundness regulation of corporate credit unions; and

(3) the NCUA’s supervision of corporate credit unions.

A. INTRODUCTION AND BACKGROUND

1. A Credit Union for Credit Unions

Corporate credit unions are financial institutions that are cooperatively owned by their

member credit unions. Corporate credit unions serve their members primarily by investing and 154

lending excess funds (unloaned deposits) that member credit unions place with them. Additional

services provided by corporate credit unions include automated settlement, securities safekeeping,

data processing, accounting, and paper-based and electronic payment services. These services are

roughly comparable to the correspondent services that large commercial banks have traditionally

provided to smaller banks.

The first corporate credit union commenced operations in 1968. Most corporate credit

unions grew out of the various state credit union leagues. Director interlocks between corporate

credit unions and these state-level trade associations were prohibited by the NCUA in 1994.155

As of year-end 1996, credit unions had $23 billion -- representing 7 percent of their total

assets -- invested in corporate credit unions. The majority of these deposits in corporate credit

unions exceed the $100,000 limit on federal deposit insurance and are thus uninsured. It is this 156
U.S. Central

Corporate Credit Unions

Deposit Excess Funds

Liquidity Loans

Transactions Services

Liquidity Loans

Transactions Services

Members

Loans

Deposits

Capital Markets

Asset-Backed Securities

Treasury Securities

Fed Agency Securities

U.S. Banks

Investments

Investments

Investments

Deposit Excess Funds

Credit Unions

Other

86

 Two corporate credit unions are not members of U.S. Central. The League of IBM Credit Unions (LICU), 157

Endicott, NY, which provides limited services to a narrow membership group. LICU has total assets of $5 million

and a core capital-to-assets ratio of 22 percent. The other is the Central Credit Union Fund, Inc., Auburn, MA. 

This corporate credit union has total assets of $14 million and a core capital-to-assets ratio of 4 percent.

concentration of credit union assets that creates a public policy interest in the financial condition

of corporate credit unions.

At year-end 1996, there were 41 corporate credit unions in operation. Of these, U.S.

Central Credit Union serves as a “corporate’s corporate” -- providing investment and liquidity

services to 38 of the other 40 corporate credit unions. The remainder of this chapter considers

only these 38 institutions and U.S. Central.157

Thus the nation’s credit union system consists of three distinct tiers: the top tier at the

national level (U.S. Central); the middle tier at the state or regional level (corporate credit

unions); and the bottom tier at the local level (credit unions). Figure IV.1 depicts this structure.

Figure IV.1: The Structure of the Credit Union System

At the end of 1996, corporate credit unions had over $13 billion in deposits at U.S.

Central, representing 57 percent of credit union deposits in corporate credit unions. This results
87

 These calculations omit U.S. Central to avoid double counting many assets. 158

 12 C.F.R. § 704.1(a); 12 C.F.R. § 703.5(e). 159

 A credit union service organization (CUSO) is a corporation or limited partnership that provides services 160

primarily to credit unions or members of affiliated credit unions.

 Five other state-chartered corporate credit unions have multi-state fields of membership. 161

in a significant investment concentration for credit unions and corporate credit unions. Because

of the deposit linkages between the three tiers, the financial health of U.S. Central is of

considerable importance in maintaining the safety and soundness of the nation’s credit unions.

The 38 corporate credit unions considered here control some $30 billion in total assets. 

Table IV.1 presents data on the size of these institutions. The largest corporate credit union 158

(Western Corporate (WesCorp) with $9.7 billion in total assets) dwarfs the smallest (South

Dakota Corporate Credit Union with $54 million in total assets). Although the average corporate

credit union has $790 million in total assets, the median has only $366 million.

Table IV.1: Asset Distribution of Corporate Credit Unions

(Dollar figures in millions; data as of December 31, 1996)

Total Assets $30,013

Largest $9,672

Smallest $54

Mean $790

Median $366

Source: NCUA, 5310 Call Report.

Corporate credit unions have a dual (state and federal) chartering system. Of the 41

corporate credit unions, 15 have federal charters and 26 (including U.S. Central) have state

charters. The NCUA’s rules apply to all federally chartered corporate credit unions and all statechartered corporate credit unions that accept deposits from federally insured credit unions.159

Corporate credit unions have designated fields of membership, typically consisting of the

credit unions and credit union service organizations located in a particular state or group of

states. Fourteen state-chartered corporate credit unions have national fields of membership. 160 161

Some federally chartered corporate credit unions have also received approval to expand their
88

 For example, Southwest Corporate Credit Union has the widest field of membership among federally chartered 162

institutions. Its charter allows it to serve credit unions in 23 states plus Puerto Rico and the U.S. Virgin Islands.

 This figure also includes privately issued mortgage-backed securities. 163

fields of membership. As a result, most corporate credit unions have overlapping fields of

membership.162

2. U.S. Central Credit Union

U.S. Central, located in Overland Park, Kansas, is a state-chartered credit union that

provides wholesale financial services to corporate credit unions. It has historically functioned as a

central depository for corporate credit unions and a conduit between those institutions and the

capital markets. Table IV.2 summarizes U.S. Central’s year-end 1996 balance sheet by asset type. 

Not surprisingly, investments constitute the vast majority of U.S. Central’s assets (96 percent).

Table IV.2: U.S. Central Credit Union Asset Composition

(Dollar figures in millions; data as of December 31, 1996)

Assets Total Amount Percent of Assets

Net Investments $17,165 96%

Net Loans $685 4%

Net Fixed Assets $3 0%

Other Assets $72 0%

Total Assets $17,925 100%

Source: NCUA, 5310 Call Report.

U.S. Central keeps most of its assets in short-term investments of high credit quality to

offset the overnight nature of its liabilities (50 percent of its deposits are overnight). Table IV.3

shows that 67 percent of U.S. Central’s investment portfolio is in asset-backed securities. Of 163

these, 53 percent are backed by credit card receivables, 21 percent by home mortgages, and 16

percent by automobile loans. Some 97 percent of these asset-backed securities have AAA ratings.
89

 Fitch Research, Special Report: U.S. Central Credit Union, Jun. 5 (New York: Fitch Investors Service, L.P., 164

1995), 4. 

Table IV.3: U.S. Central Credit Union Investments

(Dollar figures in millions; data as of December 31, 1996)

Investments Total % of Investments

U.S. Government Obligations $473 3%

Federal Agency Securities $84 0%

Central Liquidity Facility Stock $678 4%

U.S. Banks $278 2%

Repurchase Agreements $2,788 16%

Government / Agency Mortgage Related Issues $1,096 6%

Privately Issued Mortgage / Asset-Backed Securities $11,506 67%

Corporate Debt $255 1%

Credit Union Service Organizations $4 0%

Total Investments $17,162 100%

Source: NCUA, 5310 Call Report.

U.S. Central’s concentration in asset-backed securities represents a marked change in its

investment strategy -- as it has moved away from very-short-term federal funds and repurchase

agreements. For example, the proportion of U.S. Central’s investment portfolio in repurchase

agreements fell from 35 percent at year-end 1994 to 16 percent at year-end 1996. Likewise, U.S.

bank deposits fell from 23 percent of the portfolio to 2 percent.

U.S. Central’s asset-backed portfolio currently has a weighted average life of two years. 

In order to hedge some of the additional risk associated with mismatched assets and liabilities,

U.S. Central often enters into interest rate swap agreements to match the cash flows from its

asset-backed securities. To eliminate basis risk, it then matches these swaps with specific assets

based on the same index. Although these hedges mitigate interest rate risk, they do not 164

eliminate the risk that market spreads could change (e.g., the price of a class of asset-backed

securities could fall relative to other securities).
90

3. Investing Member Deposits

Most credit unions are small relative to other depository institutions; for example, 64

percent of all credit unions have less than $10 million in total assets. These small credit unions

rely relatively more heavily on their corporate credit unions than do larger credit unions. Table

IV.4 presents the average investment in corporate credit unions for various size classes of credit

unions. For example, on average, credit unions with less than $2 million in total assets place

52 percent of their unloaned funds with corporate credit unions, while those with $2-10 million in

assets place 44 percent of such funds with corporate credit unions. By contrast, credit unions

above $50 million in total assets make more than 80 percent of their investments themselves. 

Nevertheless, their $13 billion investment in corporate credit unions dwarfs small credit unions’

$448 million. These data indicate that, although large credit unions make a significant portion of

their investments independently of corporate credit unions, their corporate credit union deposits

are nevertheless sizable in dollar terms. As such, deposits from large credit unions represent

corporate credit unions’ dominant funding source.

Table IV.4: Credit Union Investments in Corporate Credit Unions

(Dollar figures in millions; data as of December 31, 1996)

Asset Category Number of Total Total CCU CCU Inv. CCU Inv.

Institutions Assets Invest. Invest. (% Invest.) (% Assets)

< $2 million 3,352 $2,855 $860 $448 52% 16%

$2-10 million 3,942 $19,806 $6,029 $2,634 44% 13%

$10-50 million 2,814 $63,809 $18,618 $6,483 35% 10%

> $50 million 1,284 $240,413 $72,767 $13,188 18% 5%

All Credit Unions 11,392 $326,883 $98,274 $22,753 23% 7%

Source: NCUA, 1996 Yearend Statistics for Federally Insured Credit Unions.

Corporate credit unions vary greatly not only in their asset size but also in the scope of

their activities. Corporate credit unions historically acted as conduits of investment funds

between credit unions and U.S. Central. In recent years, however, many corporate credit unions

have begun investing directly in eligible fixed-income securities in order to earn higher yields. 

Most corporate credit unions still tend to place their overnight investments with U.S. Central. 

Table IV.5 compares the 10 largest corporate credit unions’ investments at U.S. Central with

those of the 28 other corporate credit unions. The 10 largest institutions have some 40 percent of

their investments at U.S. Central, while the other 28 institutions have some 76 percent.
91

 This consolidated schedule aggregates the individual balance sheets of the 38 corporate credit unions. To avoid 165

double counting, the analysis does not include U.S. Central.

Table IV.5: Corporate Credit Unions’ Investments in U.S. Central

(Dollar figures in millions; data as of December 31, 1996)

Total U.S. Central U.S.C. Investments

Investments Investments (% of Investments)

10 Largest CCUs $19,381 $7,786 40%

28 Smallest CCUs $7,586 $5,725 76%

Total $26,967 $13,511 50%

Source: NCUA, 5310 Call Report.

4. Corporate Credit Unions’ Consolidated Balance Sheet

Corporate credit unions’ balance sheets consist of high-quality, short-term investments

funded by members’ short-term deposits. Corporate credit union capital is segmented into

primary and secondary accounts.

a. Assets

The composition of corporate credit unions’ consolidated assets suggests that their

investment function is currently more important than their role as liquidity provider (as proxied by

loans to members). Indeed, Table IV.6 shows that investments constitute nearly 90 percent of

corporate credit union assets.165
92

 Federal agency securities consist primarily of securities issued and guaranteed by GSEs. This category also 166

includes federally guaranteed securities such as those of Ginnie Mae. Private securities consist of corporate debt

and asset-backed securities. The new corporate credit union call report (5310) will have a specific line item for

asset-backed securities. Currently, corporate credit unions itemize their “other investments” in schedule B of the

5310. However, there is significant variation in the level of reporting detail on these schedules.

Table IV.6: Corporate Credit Unions’ Consolidated Assets

(Dollar figures in millions; data as of December 31, 1996)

Assets Total % of Total Assets

Net Investments $26,967 90%

Net Loans to Members $368 1%

Cash $176 1%

Other Assets $2,502 8%

Total Assets $30,013 100%

Source: NCUA, 5310 Call Report.

(1) Investments

In general, corporate credit unions’ investment portfolios are of very high credit quality. 

At year-end 1996, deposits at U.S. Central (50 percent), asset-backed securities and corporate

debt (26 percent), and federal agency securities (20 percent) comprised 96 percent of all

corporate credit union investments (see Table IV.7).166
93

Table IV.7: Corporate Credit Unions’ Consolidated Investments

(Dollar figures in millions; data as of December 31, 1996)

Investment Total % of Total Investments

U.S. Govt. Obligations $85 0%

Federal Agency Securities $5,355 20%

U.S. Central $13,511 50%

CMOs / REMICs $688 3%

Commercial Banks $278 1%

Credit Unions / CUSOs $26 0%

NCUSIF Deposit $9 0%

Other Investments $7,032 26%

Investment Loss Provision ($18)

Total Investments $26,966 100%

Source: NCUA, 5310 Call Report.

(2) Loans to Members

Corporate credit unions are currently well positioned to meet their members’ normal

liquidity needs as corporate credit unions’ balance sheets consist of high-quality investments with

relatively short maturities. Some of the larger corporate credit unions have also taken steps to

ensure contingency funding by establishing commercial paper programs or obtaining lines of

credit. In addition, corporate credit unions (including U.S. Central) are currently developing a

credit union loan securitization program that will serve to provide credit unions with an additional

liquidity option. Although these initiatives should help increase credit union liquidity, we have

concerns about the extent to which the credit union system would have sufficient access to

liquidity during periods of financial stress. Chapter V examines credit union liquidity --

particularly credit unions’ access to emergency liquidity.

b. Liabilities

Corporate credit union liabilities include general liabilities and deposit (share) accounts. 

Credit union deposits in corporate credit unions total $25 billion, or 86 percent of total corporate

credit union liabilities. The remainder of corporate credit union liabilities consist of notes payable
94

 12 C.F.R. § 704.2. 167

 The data on secondary capital include membership capital share deposits and membership capital accounts. 168

and uncollected deposits. As Table IV.8 indicates, overnight deposits constitute 57 percent of

total credit union deposits, while time deposits constitute an additional 36 percent.

Table IV.8: Corporate Credit Unions’ Consolidated Deposit Accounts

(Dollar figures in millions; data as of December 31, 1996)

Account Total % of Total Deposits

Shares/Daily Transactions Accts. $14,369 57%

Time Certificates $8,975 36%

Membership Shares* $1,673 7%

Repurchase Certificates $5 0%

Total Deposits $25,022 100%

Source: NCUA, 5310 Call Report.

* Membership shares may include membership capital accounts, which constitute secondary capital.

c. Capital

Like other credit unions, corporate credit unions accumulate capital -- net worth -- by

retaining earnings in various reserve accounts. These reserves and undivided earnings constitute

core capital for regulatory purposes. Core capital can also include paid-in capital. The NCUA

describes paid-in capital as funds obtained from credit union and non credit union sources, having

no maturity, and being callable only at the option of the corporate credit union and only if the

corporate credit union meets its minimum level of required capital after the funds are called. To 167

date, only WesCorp has issued paid-in capital.

Corporate credit unions may also raise secondary capital -- in the form of “membership

capital” -- from their members. Membership capital involves an uninsured deposit that, if the

corporate credit union were to fail, would be subordinated to both the Share Insurance Fund and

member deposits. Membership capital can be withdrawn only on one to three years notice. Table

IV.9 provides the weighted-average capitalization of corporate credit unions (excluding U.S.

Central). As of year-end 1996, core capital equaled 3.3 percent of corporate credit union assets,

while secondary capital equaled 5.4 percent.168
95

 GAO, Credit Unions: Reforms for Ensuring Future Safety (Washington, DC: GAO, 1991), 144-51 and 164- 169

65; and Harold Black, Albert DePrince, William Ford, James Kudlinski, and Robert Schweitzer, Corporate

Credit Union Network Investments: Risks and Risk Management (Alexandria, VA: NCUA, 1994), 45-54. 

 62 Fed. Reg. 33,989, 34,003 (1997) (to be codified at 12 C.F.R. § 703.100(c)); effective on January 1, 1998). 170

Table IV.9: Corporate Credit Unions’ Consolidated Capital

(Dollar figures in millions; data as of December 31, 1996)

Capital Total Percent of Assets

Core Capital $979 3.3%

Secondary Capital $1,612 5.4%

Total Capital $2,591 8.7%

Source: NCUA, 5310 Call Report.

Corporate credit unions’ total assets -- and thus their regulatory capital ratios -- vary

seasonally and cyclically. For example, many credit unions experience significant deposit

outflows around the holiday season and, in turn, draw down their corporate credit union

accounts. In addition, both U.S. Central and WesCorp participate in the Treasury Tax and Loan

program, which has its own seasonality. Because corporate credit unions have difficulty in

quickly adding reserves, large inflows (outflows) of deposits may decrease (increase) their core

capital-to-assets ratio.

Recent studies of corporate credit unions by the GAO (1991) and Black, et al. (1994)

emphasized the need for higher capital ratios. Managers of corporate credit unions had long 169

questioned the need for having more than 2 percent capital, citing their cooperative structure and

the high credit quality of their investment portfolios. However, in addition to credit risk,

corporate credit unions face market (interest rate) risk, liquidity risk, and operational risk.

The adequacy of corporate credit unions’ capital is particularly important because of the

interdependence of the credit union system’s three tiers. Membership capital accounts, which

constitute secondary capital for corporate credit unions, are essentially a device for up-streaming

net worth from credit unions to corporate credit unions. Effective January 1998, an NCUA rule

will limit the sum of a credit union’s investment in membership capital accounts and paid-in

capital to 1 percent of its total assets. If a corporate credit union were to fail, credit unions 170

holding membership capital accounts could have to write off some (or all) of the value of these

accounts. Credit unions would then take a charge against their net worth for the amount written 
96

 GAO, Credit Unions: The Failure of Capital Corporate Federal Credit Union, statement of Charles A. 171

Bowsher, Comptroller General, Feb. 28 (Washington, DC: GAO, 1995), 2-6.

 This recommendation sought NCUA supervisory authority over state-chartered corporate credit unions. In 172

1991, the NCUA prohibited federal credit unions from purchasing shares or deposits from corporate credit unions

that either did not comply in significant respects with the NCUA’s corporate credit union regulation, part 704, or

were not examined by the NCUA. 56 Fed. Reg. 56,000, 56,003 (1991). This prohibition became effective on

off. If losses exceeded a corporate credit union’s reserves, any paid-in capital, and membership

capital accounts, the uninsured portion of each member’s deposits would then be at risk.

5. Recent History

Two recent incidents -- U.S. Central’s investment in a failed foreign bank, Banco Espanol

de Credito (Banesto), and the failure of a large corporate credit union, Capital Corporate Credit

Union (Cap Corp) of Lanham, Maryland -- led to increased scrutiny of both corporate credit

unions and the NCUA. In the first instance, U.S. Central recouped all of its $255 million

investment in Banesto, a bank seized by the Spanish government in 1993. Following that incident,

an immediate, voluntary moratorium ensued on all foreign investments until the NCUA could

comprehensively review corporate credit union investments.

The failure of Cap Corp in January 1995 raised specific concerns about the interest rate

risk that corporate credit unions were taking, particularly with their investments in collateralized

mortgage obligations. Congress held hearings in early 1995 to examine these issues. The GAO

testified that Cap Corp’s failure resulted from “inadequate board oversight of an inappropriate

investment strategy.” The GAO also criticized the NCUA’s supervision of Cap Corp. The GAO

outlined five factors that precipitated the failure of Cap Corp:

! Cap Corp lacked an effective risk management system and effective board oversight.

! Cap Corp’s accounting did not reflect declining market values.

! The NCUA’s examination and supervision of Cap Corp were inadequate.

! The NCUA’s call report data were too limited and inaccurate.

! The NCUA’s capital standards were inadequate and not targeted to corporate credit union

risks.171

Two other studies also focused attention on corporate credit unions and the NCUA. The

GAO’s (1991) study presented the following recommendations -- each of which the NCUA

subsequently implemented:

! Permit a federally insured credit union (or corporate credit union) to invest in other credit

unions only if those institutions are federally insured.172
97

December 1, 1992. 57 Fed. Reg. 22,626, 22,626 (1992). Effective January 1, 1998: (1) corporate credit unions

must adhere to the requirements of part 704, which will require them to submit to NCUA examinations in order to

accept deposits or shares from federally insured credit unions; and (2) federal credit unions may not purchase the

shares or deposits of corporate credit unions identified by the NCUA as not complying with part 704. 62 Fed.

Reg. 12,929, 12,938 (1997) (to be codified within the corporate credit union regulation at 12 C.F.R. § 704.1(a));

62 Fed. Reg. 33,989, 34,003 (1997) (to be codified within the regulation on investment and deposit activities of

federal credit unions at 12 C.F.R. § 703.100(c)).

 12 C.F.R. pt. 704. 173

! Increase corporate credit unions’ capital ratios and set maximum limits (based on total

assets) on loans to or investments in a single entity by corporate credit unions.

! Obtain more complete information about corporate credit unions for use in assigning

CAMEL ratings.

Commissioned by the NCUA, Black, et al.’s (1994) study, Corporate Credit Union

Network Investments: Risks and Risk Management, included the following recommendations,

which the NCUA also subsequently implemented: 

! The NCUA should establish stronger capital standards, including primary and risk-based

requirements. Risk-based requirements should take account of credit risk, interest rate

risk, and derivative activities.

! Corporate credit unions, instead of simply reviewing published reports by rating agencies

or the financial press, should develop internal credit quality systems to monitor all assets

subject to credit risk.

! The NCUA should revise its limit on a corporate credit union’s maximum allowable

exposure to one borrower by making the limit a percentage of core capital rather than a

percentage of assets.

! The NCUA should improve its oversight of corporate credit unions’ interest rate risk

management practices.

! Corporate credit union management should understand the investments in their portfolios. 

! The NCUA needs to retain corporate credit union examiners that specialize in derivatives.

Part 704 of the NCUA’s regulations, together with the relevant provisions of the Federal

Credit Union Act, constitute the primary rules governing corporate credit unions. The NCUA 173

first issued part 704 in 1982. In 1995, the NCUA proposed a comprehensive revision of part 704

in response to concerns arising from the failure of Cap Corp, the findings and recommendations in

the GAO’s 1991 and 1994 reports, and the Black, et al. (1994) study of corporate credit unions’

risk management practices. In 1996, the NCUA revised that proposal and re-issued it for public
98

 Pub. L. 104-208, § 2606, 110 Stat. 3009-394, 3009-473 (1996) (codified at 12 U.S.C. § 1752a note). 174

comment. The NCUA issued a final regulation in March 1997 after evaluating the 289 comments

received and making relatively minor revisions. The new regulation, described in detail in Section

C, becomes effective January 1, 1998.

6. Study Mandate and Methodology

Congress directed us to study and evaluate: the 10 largest corporate credit unions in the

United States including their “investment practices” and their “financial stability, financial

operations, and financial controls”; and the NCUA’s supervision of corporate credit unions.174

Congress directed us, in evaluating the 10 largest corporate credit unions, to work with

“appropriate employees of other Federal agencies with expertise in the examination of federally

insured financial institutions.” Working with the OCC, we assembled an interagency team of six

bank and thrift examiners. The interagency team consisted of three examiners from the OCC

(New York, Chicago, and San Francisco offices), and one each from the Federal Reserve System

(Federal Reserve Bank of Atlanta), the FDIC (Dallas office), and the OTS (New York office). 

The examiners spent three months working nearly full-time on this project.

The interagency team did not itself conduct a formal, on-site examination of the corporate

credit unions. Instead, the team observed and evaluated the results of the NCUA’s examinations

of these institutions, and discussed the approach to and findings of such examinations with

appropriate NCUA staff.

At the beginning of its work, the interagency team attended a half-day presentation on

corporate credit unions’ activities and operations made to the Treasury by the Association of

Corporate Credit Unions. In evaluating the 10 largest corporate credit unions, the interagency

team reviewed and assessed NCUA documentation, including examiner work papers,

correspondence, and reports of examination. The team also interviewed various NCUA officials. 

At the end of one month, the team completed its initial review of the NCUA documents. The

team then spent two weeks conducting on-site visits to U.S. Central in Overland Park, Kansas,

and WesCorp in San Dimas, California. During these visits, the team met with each of the two

corporate credit unions’ senior management team, reviewed credit union documents, and

observed certain operational and risk assessment activities to better gauge management

performance and overall operations.

The interagency team also evaluated the NCUA’s supervision of corporate credit unions. 

The team reviewed the organization of the Office of Corporate Credit Unions and the examiner

guidance used. The team also reviewed the NCUA’s part 704 regulation.
99

Throughout its existence, the interagency team worked closely with Treasury staff. The

team concluded its work by reporting its findings to the Treasury. The findings and

recommendations in this study, although reflecting the significant contributions made by the

interagency team, are those of the Treasury.

We have organized the remainder of this chapter as follows: Section B describes the

financial condition of the 10 largest corporate credit unions and U.S. Central. Section C reviews

the NCUA’s corporate credit union regulations. Section D assesses the NCUA’s supervision of

those institutions. Section E summarizes our findings and recommendations.

B. THE 10 LARGEST CORPORATE CREDIT UNIONS

This section describes the overall financial condition of the 10 largest corporate credit

unions. Specifically, we report on our general findings and observations, followed by our

evaluation of the investment practices, and financial stability, financial operations, and financial

controls of the 10 largest corporate credit unions. The statutory study mandate did not clearly

indicate whether U.S. Central constituted a corporate credit union for purposes of determining the

10 largest corporate credit unions. Accordingly, we decided to evaluate both U.S. Central and

the 10 largest corporate credit unions serving regular credit unions. Table IV.10 ranks the 11

largest corporate credit unions by asset size.

Table IV.10: The 11 Largest Corporate Credit Unions by Asset Size

(Dollar figures in millions; data as of December 31, 1996)

Corporate Credit Union Location Total Assets

U.S. Central Overland Park, KS $17,925

WesCorp San Dimas, CA $9,672

Southwest Dallas, TX $2,660

CenCorp Detroit, MI $1,508

Empire State Albany, NY $1,367

Mid-States Naperville, IL $1,364

Mid-Atlantic Harrisburg, PA $1,304

Southeast Tallahassee, FL $1,201

Corporate One Columbus, OH $829

Indicorp Indianapolis, IN $794

Constitution State Wallingford, CT $656

Source: NCUA, 5310 Call Report.
100

1. General Findings and Observations

Corporate credit unions give small credit unions a safe place to invest their unloaned

deposits. Small credit unions turn to corporate credit unions because they often do not have the

size or investment expertise necessary to invest on their own. This arrangement, while a strength

of the credit union system, demonstrates the importance of safe and sound operations at corporate

credit unions.

Based on our review of the 10 largest corporate credit unions and U.S. Central, we have

three general findings. First, corporate credit unions are thinly capitalized and operate with

narrow margins. Second, an interdependence risk exists among corporate credit unions and U.S.

Central. Third, corporate credit unions are facing increasing competitive pressures from each

other and from other market participants.

a. Corporate Credit Unions are Thinly Capitalized and Operate

with Narrow Margins

Corporate credit unions invest in high-quality assets and thus have limited exposure to

credit risk. Their investments are mostly short-term to maintain a liquid balance sheet. At the

same time, corporate credit unions tend to be thinly capitalized (that is, have a relatively small

ratio of net worth to assets) and operate with very narrow margins (that is, have only a small

spread between their interest earnings and interest expenses). These narrow margins hinder

corporate credit unions from increasing their capital quickly through retained earnings.

The combination of thin capitalization and narrow margins leaves little room for error and

heightens the importance of proper internal controls and strong management. Corporate credit

unions’ asset size may also fluctuate greatly as member deposits rise and fall, and as member loan

demand changes. This potential volatility, combined with the difficulty of building capital quickly

through retained earnings, reinforces the need for a sufficient capital base. Table IV.11 shows the

return on assets and net interest margin (NIM) for the 10 largest corporate credit unions and U.S.

Central during 1996.
101

 The NCUA bases its regulatory capital requirements for corporate credit unions on a percentage of average 175

daily net assets. 12 C.F.R. § 704.2. Our calculations are based on year-end data, because the call report data

(through year-end 1996) did not include average daily net assets.

Table IV.11: Corporate Credit Union Earnings

(In basis points; data as of December 31, 1996)

Corporate Credit Union Net Income to Total Assets NIM to Interest-Earning Assets

U.S. Central 16.07 24.05

WesCorp 24.24 41.74

Southwest 27.87 69.04

CenCorp 27.95 67.94

Empire State 50.48 74.51

Mid-States 37.82 58.21

Mid-Atlantic 30.48 70.07

Southeast 42.45 54.08

Corporate One 34.83 95.00

Indicorp 36.79 66.16

Constitution State 10.73 54.61

Source: NCUA, 5310 Call Report.

*NIM is calculated as follows: [(interest earnings - interest expenses) / interest-earning assets]*100. Interest-earning

assets equal the sum of total loans and total investments. Figures are then converted to basis points by multiplying by 100. 

A basis point is one hundredth of a percent.

Table IV.12 shows the core, secondary, and total capital ratios for the 10 largest

corporate credit unions and U.S. Central. Core capital consists of reserves and paid-in capital; 175

secondary capital consists of membership capital accounts. At the end of 1996, one corporate

credit union (Mid-Atlantic) had core capital of less than 3 percent. U.S. Central had core capital

of 1.4 percent. However, none of these corporate credit unions had core capital exceeding 4

percent of assets.
102

Table IV.12: Corporate Credit Union Capital Ratios

(In percentage points; data as of December 31, 1996)

Corporate Credit Union Core capital Secondary Capital Total Capital

(% Total Assets) (% Total Assets) (% Total Assets)

U.S. Central 1.4% 3.5% 4.9%

WesCorp 3.1% 2.2% 5.3%

Southwest 4.0% 6.8% 10.8%

CenCorp 3.3% 7.6% 10.9%

Empire State 3.8% 5.5% 9.3%

Mid-States 3.8% 6.0% 9.8%

Mid-Atlantic 2.7% 8.1% 10.8%

Southeast 3.8% 8.5% 12.3%

Corporate One 3.2% 9.7% 12.9%

Indicorp 3.5% 8.2% 11.7%

Constitution State 3.9% 3.7% 7.6%

Source: NCUA.

In recent years the NCUA has encouraged corporate credit unions to increase their net

worth. (In the next section, we will describe in detail the NCUA’s recent regulatory changes in

corporate credit unions’ net worth requirements.) Table IV.13 provides the core capital ratios for

the 10 corporate credit unions since 1994.
103

 The regulation requires a corporate credit union to limit the effect of changes in interest rates to its net 176

economic value. The required degree of interest rate risk testing is based on a corporate credit union’s level of

operating powers. Expanded operating powers, which permit corporate credit unions to assume more interest rate

risk, require increasing levels of core capital relative to total assets. 12 C.F.R. § 704.8.

Table IV.13: Corporate Credit Union Core Capital as a Percent of Total Assets: 1994-1996

Corporate Credit Union 1994 1995 1996

U.S. Central 1.3% 1.3% 1.4%

WesCorp 2.0% 2.3% 3.1%

Southwest 2.1% 3.1% 4.0%

CenCorp 2.8% 3.0% 3.3%

Empire State 2.7% 2.8% 3.8%

Mid-States 2.6% 3.4% 3.8%

Mid-Atlantic 3.4% 2.2% 2.7%

Southeast 3.2% 3.1% 3.8%

Corporate One 2.0% 2.9% 3.2%

Indicorp 1.8% 2.6% 3.5%

Constitution State 2.3% 3.5% 3.9%

Source: NCUA.

The ratios show that corporate credit unions have significantly enhanced their capital positions. 

In general, these corporate credit unions have accomplished this by increasing their overall levels

of core capital, while reducing their total assets. We believe that this trend is critically important

and that further increases in net worth are essential. We anticipate that the NCUA’s new

corporate credit union regulation will encourage corporate credit unions to continue to build their

net worth. In particular, we believe that the new regulation correctly bases permissible investment

risk on core capital and emphasizes the importance of corporate credit unions coming to rely on 176

core capital rather than secondary capital.
104

 See Figure IV.1 on p. 86. 177

b. An Interdependence Risk Exists Among Corporate Credit

Unions and U.S. Central

The three-tier cooperative structure of the credit union system creates an interdependence

risk among and within the various levels. Specifically, a credit union’s deposits at its corporate 177

credit union, and its membership capital account, are assets on its books. At the same time, the

credit union’s corporate credit union carries these funds as (largely uninsured) deposits and

secondary capital, respectively, on its balance sheet. The same relationship holds between

corporate credit unions and U.S. Central. Thus, if U.S. Central were to fail, its member corporate

credit unions could face losses on their deposits -- reducing their own net worth. Similarly, if a

corporate credit union were to fail, its member credit unions could face losses on their deposits

and thus a reduction in their net worth.

This interdependence raises at least two issues. First, each level must have sufficient net

worth relative to the risks undertaken so as not to pose a risk of losses cascading to the level

below it. Second, the current structure facilitates the movement of excess funds around the credit

union system to meet the liquidity needs in a particular geographic area or at a particular credit

union. However, if a system-wide demand for liquidity arises, corporate credit unions have only

limited ability to bring in liquidity from outside the credit union system. Corporate credit unions

would largely have to rely on liquidating their investments to meet their members’ liquidity needs,

but members’ deposit withdrawals would tend to deplete those investments. We explore in the

next chapter the issue of liquidity risk and the limits on corporate credit unions’ ability to deal

with a systemic demand for liquidity.

c. Competition

Corporate credit unions face increasing competitive pressure from each other (due largely

but not entirely to their overlapping fields of membership) and from other market participants. 

The investment, liquidity, and transaction services that corporate credit unions offer to their

members are by no means unique; viable market alternatives exist, although small credit unions

may have access to a far more limited range of alternatives than large credit unions.

In many ways, large credit unions form the backbone of the corporate credit union

structure. Large credit unions make the vast majority of the deposits at corporate credit unions

and they often provide the volume of transaction services necessary for a given corporate credit

union to provide those services economically to its smaller members. At the same time, most, if

not all, large credit unions could find alternatives to their corporate credit union. As shown in

Table IV.4, large credit unions deposit a much smaller portion of their unloaned funds in their

corporate credit union than do small credit unions. This is because many large credit unions have

the ability to make investments directly. Large credit unions may also undertake transaction 
105

services in-house rather than relying on their corporate credit union and, in any event, are large

enough to be attractive customers for other firms offering such services to depository institutions.

This competitive environment poses important safety and soundness issues for both the

near-term and the long-term. Some consolidation among corporate credit unions has begun and

we anticipate more in the future. It is unclear what the corporate system will look like in 5 to 10

years, but it is quite likely to look much different than today. How corporate credit unions and

their members respond to competition among themselves and from other market participants --

whether through rapid growth, developing new activities, increased risk-taking, consolidation,

shifting business strategy, or standing still -- will determine the sort of safety and soundness issues

that will arise. The NCUA will clearly need to monitor these developments closely.

2. Investment Practices

Having analyzed the investment portfolios of the 10 largest corporate credit unions and

U.S. Central, we concluded the following: (1) that those portfolios generally have little credit risk

exposure, but that concentration risk is an issue; and (2) that some institutions’ portfolios are

vulnerable to changes in interest rates.

As Table IV.14 indicates, corporate credit unions’ investments are almost entirely in U.S.

Central, federal agency securities (primarily GSE securities), or asset-backed securities (the

principal component of “other investments”). Likewise, as shown in Table IV.3, U.S. Central’s

investments are primarily in federal agency and asset-backed securities. These investments, most

of which carry the highest rating assigned by private rating agencies, have limited credit risk.
106

Table IV.14: Investments of the 10 Largest Corporate Credit Unions

(In percentage points; data as of December 31, 1996)

Corporate Credit Union Federal Agency Deposits in Other 

Securities U.S. Central Investments

WesCorp 43% 42% 10%

Southwest 22% 18% 53%

CenCorp 1% 22% 68%

Empire State 6% 58% 34%

Mid-States 0% 36% 58%

Mid-Atlantic 3% 63% 18%

Southeast 2% 88% 10%

Corporate One 11% 17% 67%

Indicorp 31% 33% 25%

Constitution State 13% 15% 40%

Source: NCUA, 5310 Call Report.

The NCUA’s recently revised corporate credit union regulation establishes concentration

limits on a corporate credit union’s investments in the obligations of a particular issuer (excluding

U.S. Central and the federal government and its agencies). However, the regulation does not limit

concentration by asset class. Thus for example, a corporate credit union could hold an unlimited

share of its investments in, credit card receivables, as long as it did not exceed the limit on

exposure to any single issuer. The risk with concentration in a single asset class is the possibility

that market events have a deleterious effect on all issuers of that class of securities. For example,

a significant increase in the general rate of credit card charge-offs could lower the market’s

perception of the credit worthiness of credit card receivables, and thus the value of all such

securities, regardless of issuer.

A few years ago, collateralized mortgage obligations issued by GSEs and Ginnie Mae

were the preferred investment for many corporate credit unions. Although posing limited credit

risk, these investments are particularly sensitive to changes in interest rates. Poor management of

this interest rate risk brought down Cap Corp and led to significant problems at several other

corporate credit unions. Many of the corporate credit unions we evaluated have been moving

away from investments in collateralized mortgage obligations and towards other types of assetbacked securities (such as credit card receivables and home equity loans). This shift in investment
107

 GAO, Credit Unions: Reforms for Ensuring Future Safety (Washington, DC: GAO, 1991); and Harold 178

Black, Albert DePrince, William Ford, James Kudlinski, and Robert Schweitzer, Corporate Credit Union

Network Investments: Risks and Risk Management (Alexandria, VA: NCUA, 1994). 

practices evidently reflects a desire to reduce the interest rate risk associated with collateralized

mortgage obligations, while maintaining a high yield relative to other highly-rated securities.

We have several concerns about this apparent concentration of corporate credit union

investments in particular classes of assets. First, corporate credit unions’ generally low net worth

ratios leave little room for error. Second, although the NCUA limits the amount that a corporate

credit union can invest in obligations of a single issuer it does not limit the amount that a

corporate credit union may invest in a single class of assets. Third, the risks of concentrating

investments in a single asset class are exacerbated by the interdependence risk among corporate

credit unions and by the relative homogeneity of different corporate credit unions’ balance sheets.

We therefore recommend that the NCUA develop policy guidance or regulations

governing asset concentration risks. The NCUA also needs to consider the implications of such

concentration risk across all corporate credit unions. That is, although an examiner may conclude

that any one corporate credit union’s concentration in a particular asset class is within some

acceptable level of tolerance, the NCUA should also consider the corporate system’s overall

exposure to that particular asset class. 

3. Financial Stability, Financial Operations, and Financial Controls

Previous reports on corporate credit unions, as well as the NCUA’s recent experience 178

with Cap Corp and other corporate credit unions, have indicated concerns about corporate credit

unions’ financial stability, operations, and controls. Based on our review of the NCUA’s

examinations of U.S. Central and the 10 largest corporate credit unions, we found continued

problems involving internal controls and management quality at some institutions -- although

improvements have been made. We also found that, during the most recent examination cycle,

the NCUA had various degrees of concern about 6 of the 11 corporate credit unions. Table

IV.15 aggregates the NCUA’s CAMEL ratings for the 11 corporate credit unions studied.
108

Table IV.15: Aggregate CAMEL Ratings for the 11 Largest Corporate Credit Unions

(Data as of December 31, 1996)

CAMEL 1 CAMEL 2 CAMEL 3 CAMEL 4 CAMEL 5

Capital 1 6 3 1 0

Asset Quality 4 4 3 0 0

Management 1 4 5 1 0

Earnings 2 6 3 0 0

Liquidity 2 8 1 0 0

Composite 1 4 5 1 0

Source: NCUA.

The NCUA identified internal control weaknesses in 4 of the 11 institutions. For example,

the NCUA cited 2 institutions for internal control problems relating to access and authority levels

for data processing and wire transfer systems. The NCUA described these weaknesses as readily

correctable by the institutions. Nevertheless, corporate credit unions’ thin capitalization and

margins reinforce the need for strong internal controls.

In 6 of the 11 institutions, the NCUA gave management a CAMEL rating of 3 or worse,

indicating some material concern about management (5 had a CAMEL rating of 3; 1 had a rating

of 4). According to the NCUA, a rating of 3 reflects performance that is lacking in some measure

of competence desirable to meet the responsibilities of the situation in which management is

found. Either it is characterized by modest talent when above average abilities are called for, or it

is distinctly below average for the type and size of the corporate credit union it operates.

Finally, the NCUA classified 5 of the 11 corporate credit unions as “institutions raising a

degree of concern,” while another raised even more serious concerns. Specifically, 5 had a

composite CAMEL rating of 3, and one had a composite CAMEL rating of 4. However, 2 of

these 6 institutions had ratings of 2 for each CAMEL component except management; the NCUA

has a policy of basing a corporate credit union’s composite CAMEL rating on the lowest

component rating.

In short, we found that the general condition of the largest corporate credit unions has

improved in recent years but that lingering difficulties from past investment problems, weak

management, or poor internal controls must be dealt with by individual institutions and monitored

by the NCUA.
109

 Other regulations relating to corporate credit unions include parts 701 (organization and operation of federal 179

credit unions), 703 (investment and deposit activities), 709 (involuntary liquidation of federal credit unions and

adjudication of creditors), 725 (Central Liquidity Facility), and 741 (requirements for insurance).

 62 Fed. Reg. 12,929, 12,940 (1997) (to be codified at 12 C.F.R. § 704.3(b)); Id. at 12,948 (to be codified at 180

12 C.F.R. pt. 704 app. B).

Id. at 12,930. 181

Id. at 12,940 (to be codified at 12 C.F.R. § 704.2). 182

C. THE NCUA’S CORPORATE CREDIT UNION REGULATIONS

We studied and evaluated the NCUA’s corporate credit union regulations -- particularly

part 704, which establishes capital requirements and other risk parameters for corporate credit

unions. This section refers to the regulation currently in effect as “Old 704” and the regulation

that becomes effective in 1998 as “New 704.” We reviewed both Old 704 and New 704, as well

as the regulations that part 704 incorporates by reference. We compared these regulations with 179

those of the other federal depository institution regulators to help assess the adequacy of the

NCUA’s guidance and oversight for corporate credit unions. We also reviewed prior studies of

corporate credit unions to determine the extent to which changes to the NCUA’s regulations

resolve past concerns.

New 704 contains numerous changes that should help make corporate credit unions safer

and sounder. In particular New 704: (1) strengthens minimum capital requirements; (2) clarifies

the responsibilities of a corporate credit union’s management and board of directors; (3) explicitly

limits exposure to interest rate risk; (4) implements strict credit review procedures; and

(5) requires corporate credit unions to formulate liquidity contingency plans.

New 704 specifically requires corporate credit unions to maintain total capital of at least

4-6 percent of total assets, depending on the complexity and risk sensitivity of the institution’s

investment portfolio. Old 704, by contrast, employs a risk-based standard keyed to credit risk. 180

That standard is inappropriate given that corporate credit unions generally have little credit risk

exposure. New 704 also emphasizes the need for corporate credit unions, over time, to rely more

on core capital than on secondary capital. In the preamble to New 704, the NCUA wrote: 

This final rule is designed to strengthen core capital so that the corporate credit union

network can better withstand financial stress without placing an inappropriate reliance upon

its membership resources. Corporate credit unions should gradually reduce their reliance on

secondary capital as core capital accumulates over time.181

The New 704 also permits corporate credit unions to build core capital by issuing paid-in

capital. For corporate credit unions, paid-in capital is subordinate to membership capital 182

accounts. Thus, in order to assume such risk, providers of such capital demand higher returns. 

The ability of non-credit union investors to have an ownership stake in corporate credit unions

could have implications for their operating objectives (i.e., they could become motivated to
110

Id. at 12,942 (to be codified at 12 C.F.R. § 704.4). 183

Id. at 12,948-49 (to be codified at 12 C.F.R. pt. 704 app. B). 184

Id. at 12,944 (to be codified at 12 C.F.R. § 704.8(d)(ii)). These calculations must include the value of forward 185

settlements, embedded options, and such off-balance sheet financial derivatives as futures, options, interest rate

swaps, and forward rate agreements, and must treat member capital accounts as liabilities. 

Id. at 12,944 (to be codified at 12 C.F.R. § 704.8(d)(i)). 186

Id. at 12,948-49 (to be codified at 12 C.F.R. pt. 704 app. B). 187

Id. at 12,943-44 (to be codified at 12 C.F.R. § 704.6(d) and (e)). 188

 Id. at 12,944 (to be codified at 12 C.F.R. § 704.7(c)). 189

maximize earnings). However, corporate credit union paid-in capital, as currently structured by

the NCUA, does not include voting rights. This structure limits the attractiveness of investment

in corporate credit unions from outside the credit union system.

New 704 also specifically articulates the respective duties of a corporate credit union’s

management and board of directors. For example, it requires the board to “understand the role 183

that financial instruments play in the corporate credit union’s business strategies” and to provide

adequate staffing as well as the technological and financial resources required to support the

institution’s investment activities.

In general, New 704 contains more stringent investment restrictions than Old 704,

although a corporate credit union can take on more credit and interest rate risk if it meets higher

capital, managerial, procedural, and systems requirements. For example, corporate credit 184

unions with at least 5 percent capital may, with NCUA approval, purchase long-term investments

rated no lower than AA- and asset-backed securities rated no lower than AA.

New 704 limits corporate credit unions’ interest rate risk exposure. First, corporate credit

unions must keep their net economic value (NEV) -- i.e., the fair value of their assets minus the

fair value of their liabilities -- above 1 percent of their total assets. Second, corporate credit 185

unions must periodically test the interest rate sensitivity of their portfolios to determine the change

in NEV resulting from changes in interest rates. Specifically, changes in NEV are based on

interest rate shock scenarios in which interest rates are increased and decreased 100 to 300 basis

points and resulting changes in a portfolio’s NEV are examined. New 704 allows for a 186

maximum simulated decline in NEV of 18-50 percent based on the institutions’ level of operating

authorities.187

Credit review procedures set forth in New 704 establish minimum credit ratings for certain

investments as well as specific reporting and documentation procedures. For example, the new 188

regulation limits a corporate credit union’s unsecured loans to one member to the greater of 50

percent of total capital or 75 percent of core capital and limits secured loans to one member to the

greater of 100 percent of total capital or 200 percent of core capital. The regulation also 189
111

Id. at 12,943-44 (to be codified at 12 C.F.R. § 704.6(e)). 190

Id. at 12,945 (to be codified at 12 C.F.R. § 704.9). 191

Id. at 12,929. 192

 The other federal depository institution regulators (through the Federal Financial Institutions Examination 193

Council), having decided to emphasize institution-wide risk management, are in the process of rescinding existing

securities testing requirements. 62 Fed. Reg. 51,862 (1997) (proposed Oct. 3, 1997).

requires the corporate credit union to compile a monthly “watch list” of existing or potential

credit problems -- so that it can justify any decision to hold a downgraded investment.190

New 704 limits lending and investment concentrations as a percentage of a corporate

credit union’s capital -- in contrast to Old 704's limitation of investments to a percentage of

assets. Specifically, New 704 limits investments in any mortgage-backed security, asset-backed

security, or trust to 200 percent of core capital, and limits repurchase and securities lending

agreements to 400 percent of core capital. New 704 does not apply concentration limits to

investments in U.S. Central.

The new regulation also requires a corporate credit union to follow strict liquidity policies

and procedures, which include having a liquidity contingency plan. Each corporate credit union

must evaluate its members’ potential liquidity needs under a variety of economic scenarios,

monitor its sources of liquidity, and demonstrate that its designation of investments as available

for sale or held to maturity are consistent with the corporate credit union’s liquidity needs.191

The changes just listed reflect significant improvements the NCUA has made in its

regulation of corporate credit unions. With corporate credit unions operating in a highly dynamic

market and, with financial theory and practice continuing to evolve, the NCUA will, over time,

need to reexamine various elements of the new regulation. In fact, when the NCUA published

New 704, it committed itself to issuing a report on issues involving the new regulation within 18

months. The NCUA may wish to monitor the following aspects of New 704. 192

First, with respect to NEV calculations, models offered by various vendors and outside

service providers may provide dissimilar results. Thus a corporate credit union may be inclined to

select a model that puts the institution’s portfolio in the most favorable light, rather than the

model that best reflects the risks in that portfolio.

Second, given the intensive risk management required for modeling and managing interest

rate risk in New 704, the requirement to test individual securities may be redundant. Although 193

pre-purchase interest rate sensitivity testing is crucial to understanding how the characteristics of

a particular security may influence a portfolio, post-purchase testing is unnecessary if prudent risk

management systems are in place.

Third, New 704 permits all corporate credit unions to invest in securities with embedded

options, such as collateralized mortgage obligations. However, the NCUA permits corporate
112

 Most corporate credit unions are currently unlikely to have the depth of knowledge and experience in 194

management that the NCUA requires for derivatives authority. Moreover, as of January 1998, the NCUA will

prohibit institutions with less than a 5 percent ratio of net worth to daily average net assets from using derivatives,

even when derivatives may help those institutions manage risk. 62 Fed. Reg. 12,929, 12,948 (1997) (to be

codified at 12 C.F.R. pt. 704 app. B).

credit unions to invest in interest rate risk reducing derivatives only if they meet rigorous

standards. Such restrictions limit corporate credit unions’ ability to hedge the risks associated 194

with these permissible investments.

In summary, New 704 represents a significant improvement in the NCUA’s corporate

credit union regulations. At the same time some of the regulation’s prohibitions seemingly reflect

concern about corporate credit unions’ ability to manage some of the risks they undertake. We

anticipate that as the NCUA and corporate credit unions gain experience with the new regulation

-- and as both the NCUA’s supervisory expertise and corporate credit unions’ management

expertise continue to develop -- the NCUA can and should make modifications to the new rules.

D. THE NCUA’S OVERALL SUPERVISION OF CORPORATE CREDIT UNIONS

Given the concentration of credit union assets in the corporate credit union system, the

safety and soundness of these institutions is critical to the financial soundness of many of their

credit union members. Accordingly, under the leadership of Chairman D’Amours, the NCUA has

worked systematically during the past four years to update and improve its supervision of

corporate credit unions.

Recognizing corporate credit unions’ distinct place in the credit union system, the NCUA

created the Office of Corporate Credit Unions in 1994. This key development has led to stronger,

and more focused, supervision of corporate credit unions. The Office of Corporate Credit Unions

has trained 22 examiners charged with annual on-site visitations of the 38 corporate credit unions

and U.S. Central. These examiners, on average, have 11 years of depository institution

examination experience -- including 8 years with the NCUA.

We evaluated the Office of Corporate Credit Unions’ approach to supervising corporate

credit unions, including its staffing, its policies and procedures, its examiner guidance, and its

safety and soundness standards. The Office is still relatively new, yet it represents a significant

improvement over the NCUA’s previous, less rigorous approach to supervising corporate credit

unions. Based on our evaluation, we identified several areas for continued development.

First, we found that the Office of Corporate Credit Unions is understaffed. The resources

currently devoted to supervising corporate credit unions fall short of reflecting the proportionate

risk these institutions pose to both credit unions and the Share Insurance Fund. In particular, the

amount of time devoted to an on-site examination at a particular corporate credit union may be

insufficient for the complex risk analysis that should be done in critical risk areas. We recognize,

however, that corporate credit union examiners do receive assistance from the NCUA’s Office of
113

 The Office of Investment Services aids both credit union and corporate credit union examiners. 195

Investment Services in the evaluation of interest rate risk present in the more complex investment

portfolios.195

Beyond having sufficient examiner resources for on-site examinations, the Office also

needs sufficient resources to evaluate market developments and emerging risks that affect all

corporate credit unions. In particular, the Office should develop the capacity to review industry

trends and assess potential systemic risks. Given the interdependence risk described earlier, the

Office must continually monitor the risk of the entire corporate credit union system, not just its

individual institutions.

Second, the NCUA’s regulatory practices for corporate credit unions diverge in some

respects from the best-practice approaches developed cooperatively by other federal regulatory

agencies. In particular:

! the bank and thrift regulators have been developing risk assessment techniques that focus

examiner attention on high risk areas and overall portfolio risk;

! our review of NCUA corporate examination reports found a more audit-oriented focus,

rather than a focus keyed to the critical risk areas in the particular credit union; and

! examination reports contained excessive detail on small deficiencies, which detracted from

the major findings and prescriptions for corrective action.

More generally, the NCUA could benefit from more regular interaction with the federal banking

agencies to learn about, and participate in, the development of best practice approaches to

managing risks associated with new financial services.

Third, the Office of Corporate Credit Unions has not adequately developed written

guidance for examiners and corporate credit unions. Since the Office is still fairly new and has

had to manage several serious situations, the delay in developing such guidance is understandable.

Fourth, the CAMEL rating system used for corporate credit unions does not reflect all of

the current risks and risk-taking in corporate credit unions. In particular, it does not include a

component rating for an institution’s sensitivity to market risk like that recently adopted by the

federal banking agencies. Since the basic business of most corporate credit unions is managing

investments, market sensitivity is a key aspect of their safety and soundness. Making market

sensitivity risk a separate component in the examiner rating would highlight its importance for

examiners, management, and boards of directors.

Fifth, the NCUA’s examination reports and work papers for the 11 corporate credit

unions we reviewed did not always sufficiently support CAMEL component ratings for these 
114

institutions. For the Director of the Office of Corporate Credit Unions and the Director of the

Office of Examination and Insurance to be fully informed of the condition of a given corporate

credit union, the examination report must be complete in both the analysis provided and the

rationale for examiner comments and CAMEL composite and component ratings. We found

instances where CAMEL component ratings appeared to be inconsistent with the written support

provided for the rating given; this created uncertainty as to whether written support or the rating

itself best represented the true condition. In other places, an examination report may have little or

no written analysis (that is, the factual basis) to support the examiner’s comments or the assigned

rating. We also have concerns about the Office of Corporate Credit Unions’ policy of basing the

CAMEL composite rating on the lowest of the five component ratings. NCUA officials

contended that the policy focused management attention on problem areas. We believe that the

NCUA should be able to focus management’s attention on such areas without using a rating

scheme that may overstate an overall negative assessment of a corporate credit union’s condition.

In view of these findings, we recommend that the NCUA:

! commit greater resources to the Office of Corporate Credit Unions; 

! interact more with the four federal banking agencies and make greater use of a risk-based

approach to depository institution supervision;

! improve its written corporate credit union examiner guidance; 

! add a component for sensitivity to market risk to its CAMEL rating system for corporate

credit unions; and

! provide better analysis and documentation in connection with its examinations, including

revising the composite CAMEL rating system for corporate credit unions to take account

of all of an institution’s component scores.

The NCUA responded to these findings and recommendations by noting that:

! it is developing risk-based examination procedures that will focus examiner attention on

key risk areas in the corporate credit union being examined;

! a new examination manual should become available in January 1998; and

! as part of the new examiner guidance, it expects to add some measure of market

sensitivity to the CAMEL rating.
115

E. SUMMARY

Corporate credit unions are cooperatively owned by their member credit unions. They

serve their members primarily by lending or otherwise investing excess funds (or unloaned

deposits) deposited by member credit unions. At the end of 1996, corporate credit unions held 7

percent of all regular credit unions’ assets. Corporate credit unions also provide services

comparable to the correspondent services that large commercial banks have traditionally provided

to smaller banks. U.S. Central Credit Union is a corporate credit union serving 38 of the 40 other

corporate credit unions.

Based on our review of the 10 largest corporate credit unions and U.S. Central, we have

three general findings. First, corporate credit unions are thinly capitalized and operate with

narrow margins. Second, an interdependence risk exists among corporate credit unions and U.S.

Central. Third, corporate credit unions are facing increasing competitive pressures from each

other and from other market participants. 

Corporate credit union assets are primarily high credit quality, short-term investments. 

Corporate credit unions have historically served as a deposit conduit for U.S. Central. However,

the larger corporate credit unions invest the majority of their funds directly rather than through

U.S. Central. At the end of 1996, corporate credit unions invested half of their $27 billion

investment portfolio with U.S. Central.

For corporate credit unions, total capital consists of core capital (reserves, undivided

earnings, and paid-in capital) and secondary capital (membership capital accounts). For the 10

largest corporate credit unions, core capital amounts to roughly 3.5 percent of assets. Although

corporate credit unions have been building their capital base in recent years, they should continue

to do so.

Corporate credit unions face increasing competitive pressure from each other and from

other market participants. This competitive environment poses important safety and soundness

concerns for both the near-term and long-term. Consolidation among corporate credit unions has

begun and this trend will likely continue. 

Having analyzed the investment portfolios of the 10 largest corporate credit unions and

U.S. Central, we concluded that, while those portfolios generally have little credit risk exposure,

concentration risk is an issue. First, corporate credit unions’ generally low net worth ratios leave

little room for error. Second, the NCUA limits the amount that a corporate credit union can

invest in the obligations of a single issuer but does not limit the amount that a corporate credit

union may invest in a single class of assets. Third, the risks of concentrating investments in a

single asset class are exacerbated by the interdependence risk among corporate credit unions and

by the relative homogeneity of the different corporate credit unions’ balance sheets. The NCUA

should develop policy guidance or regulations governing concentration risks.
116

The NCUA’s updated corporate credit union regulations represent a significant step

toward making corporate credit unions safer and sounder. Of particular note are: (1) minimum

capital requirements; (2) statements of board and management responsibilities; (3) explicit limits

on interest rate risk; (4) strict credit review procedures; and (5) a requirement for liquidity

contingency planning.

The NCUA has made great strides in improving its supervision of corporate credit unions

over the past four years. Nevertheless, our review concluded that: (1) the Office of Corporate

Credit Unions is understaffed; (2) some of the NCUA’s regulatory practices diverge from the

best-practices approach developed by the federal banking agencies; (3) written examiner guidance

is underdeveloped; (4) the rating system needs to be updated; and (5) documentation and support

of examiner ratings should be strengthened. We recommend that the NCUA take steps necessary

to improve its supervision in each of these five areas.
117

 Loan securitization is the process of pooling residential mortgages, automobile loans, or other loans and 196

issuing securities representing interests in the loan pool.

CHAPTER V

CREDIT UNION LIQUIDITY

AND THE CENTRAL LIQUIDITY FACILITY

Liquidity refers to the relative ease with which one can convert assets into cash. 

Depository institutions typically maintain an asset mix that enables them to readily meet normal

deposit withdrawals or increases in loan demand. To meet abnormal cash outflows, depository

institutions may also borrow funds from correspondent institutions, in the public money markets,

or -- under exigent circumstances -- from the Federal Reserve System.

Loans and investments constitute depository institutions’ primary financial assets. In the

case of investment securities, liquidity reflects the issuer’s credit quality as well as the security’s

terms and maturity. Although investment securities are generally more liquid than loans, loan

securitization has made certain types of loans much more liquid than before.196

Credit unions’ aggregate assets consist mainly of loans to members (65 percent of total

assets) and investments (30 percent of total assets). For liquidity, credit unions typically hold

assets such as cash and short-term Treasury and federal agency securities as well as short-term

deposits at corporate credit unions. Corporate credit unions also lend to credit unions needing

liquidity. The Central Liquidity Facility (CLF) exists as credit unions’ lender of last resort to meet

emergency liquidity needs or other liquidity needs corporate credit unions cannot meet.

A. CREDIT UNION LIQUIDITY

Depository institutions manage their liquidity needs in two basic ways. Asset-side

liquidity management involves holding sufficient liquid assets, such as cash or short-term Treasury

securities, to meet normal increases in deposit withdrawals or loan demand. Liability-side

liquidity management involves using credit arrangements with other financial institutions to meet

normal liquidity needs. In general, small depository institutions use asset-side liquidity

management, while larger institutions tend to rely more on liability-side management.

One of the key functions of corporate credit unions is to provide liquidity to member

credit unions. Corporate credit unions are currently well positioned to do so because their

portfolios consist primarily of investments of high credit quality with relatively short maturities,

which can be readily sold to meet unusually large demands for liquidity.

In recent years, as credit unions have responded to increased loan demand from their

members by holding relatively fewer assets at corporate credit unions, some corporate credit
118

 12 U.S.C. § 1795. By liquidity needs, Congress meant: (1) “short-term adjustment credit . . . to assist in 197

meeting temporary requirements for funds or to cushion more persistent outflows of funds pending an orderly

adjustment of credit union assets and liabilities”; (2) seasonal credit; and (3) “protracted adjustment credit . . . in

the event of unusual or emergency circumstances of a longer term nature resulting from national, regional, or local

difficulties.” Id. § 1795a(1). This definition resembles the discount window policies set forth in the Federal

Reserve’s Regulation A. 12 C.F.R. § 201.3(a)-(c). The CLF may also make loans to cooperative share insurers

and the Share Insurance Fund under terms and conditions established by the NCUA Board. Id. § 1795e(a).

 Pub. L. No. 96-221, § 103, 94 Stat. 133, 138 (codified at 12 U.S.C. § 461(7)). 198

unions have taken steps to strengthen their access to outside liquidity. First, they have obtained

lines of credit from U.S. Central or commercial banks. Second, some have begun issuing

commercial paper. Corporate credit unions have generally received very high debt ratings for

their commercial paper. However, such ratings rest less on corporate credit unions’ overall

financial strength than on the subordination to creditors (including holders of commercial paper)

of member credit unions’ deposits. Thus corporate credit unions’ reliance on commercial paper

or other borrowed money may increase risk for member credit unions.

Corporate credit unions are also helping credit unions manage liquidity in non-traditional

ways. For example, a task force organized by the Association of Corporate Credit Unions is

considering asset securitization, long-term lending, and corporate credit union loan participations. 

The Association’s “Auto Pilot Project” will soon enable a select number of credit unions to pool

automobile loans and issue asset-backed securities backed by these pools. The institutions can

use the proceeds from the loan securitization to make more loans or purchase liquid investments.

B. EMERGENCY LIQUIDITY

In rare circumstances, depository institutions may face sudden, large deposit withdrawals 

-- perhaps prompted by some sort of financial crisis or other crisis of confidence -- in which their

normal liquidity sources may prove inadequate. Otherwise solvent institutions may find

themselves unable to meet depositors’ claims. In such situations, the Federal Reserve acts as a

lender of last resort, providing fully collateralized liquidity loans to solvent but illiquid depository

institutions to stem panic and to provide sufficient liquidity to the financial system.

Historically, the Federal Reserve served as a governmental provider of liquidity for its

member banks, and the Federal Home Loan Banks served this function for savings institutions. 

For many years, however, credit unions had no access to a governmental provider of liquidity

when they could not obtain liquidity from their usual sources. Accordingly, in 1978, Congress

created the CLF to help meet the liquidity needs of credit unions. In 1980, however, Congress 197

expanded access to the Federal Reserve’s discount window to all depository institutions, including

credit unions, that offer accounts subject to reserve requirements.198
Years

Loans

1980 1985 1990 1995

0

50,000

100,000

150,000

200,000

250,000

300,000

119

Id. § 1795b. 199

1. The Central Liquidity Facility

The CLF is a mixed-ownership government corporation within the NCUA. The NCUA 199

administers the CLF through the Division of Risk Management in the Office of Examination and

Insurance. The NCUA’s Director of Risk Management serves as President of the CLF, and the

CLF has one additional full-time employee.

Although managed by the NCUA, the CLF is actually owned by its member credit unions. 

Membership in the CLF is voluntary and available to both federally and state-chartered credit

unions. A credit union can join the CLF directly or through a corporate credit union acting as its

agent. Although corporate credit unions may be agent members (i.e., conduits for their member

credit unions’ membership in the CLF) -- they may not join the CLF themselves. As nonmembers, corporate credit unions cannot borrow from the CLF for their own account.

Figure V.1 illustrates the dollar volume of year-end CLF loans outstanding between 1980-

1996.

Figure V.1: CLF Loans Outstanding: 1980-1996

(Dollar figures in thousands)

Source: NCUA, Response to the Treasury’s Data Request, Mar. 21.
120

 These subscriptions are adjusted at the end of each calender year based on the changes in credit unions’ paid-in 200

and unimpaired capital and surplus. 

 12 U.S.C. § 1795d(d). 201

 12 C.F.R. § 725.5(c), (d). 202

To date, use of the CLF has been modest. The CLF had over $200 million in loans

outstanding at year-end 1984 and 1985, but none at year-end 1995 and 1996. Although the CLF

has been dormant in recent years, credit union loan-to-share ratios are currently rising -- possibly

signaling a need for future liquidity.

a. Capitalization

Like corporate credit unions and credit unions themselves, the CLF is structured as a

cooperative. To obtain access to liquidity from the CLF, a credit union must be a member of the

CLF. To become a CLF member, a credit union must subscribe to CLF capital stock in an

amount equal to 0.5 percent of its paid-in and unimpaired capital and surplus. One half of the 200

stock subscription (or 0.25 percent of the unimpaired capital and surplus) must be paid directly to

the CLF in exchange for CLF shares. The other half is not actually purchased at the time a 201

credit union joins the CLF. Instead, the credit union agrees to invest in “specific liquid assets”

that it could use to purchase the additional stock should the CLF call for such a purchase. Such 202

a call has never been made.

Only about 30 percent of all credit unions joined the CLF during its first four years of

operation. To encourage membership growth, the NCUA began to permit credit unions to join

the CLF through their corporate credit unions. Although corporate credit unions could not (and

cannot) join the CLF, the NCUA allowed corporate credit unions to become agent members,

subscribing to CLF stock on behalf of their member credit unions. As agent members, corporate

credit unions acquire CLF stock on the same terms as credit unions -- with half of the subscription

paid and the other half callable. To calculate the required purchase, a corporate credit union

aggregates the paid-in and unimpaired capital and surplus of its members.

Unlike credit unions, however, corporate credit unions do not actually pay cash to the

CLF for CLF shares. Through a complex series of accounting transactions involving corporate

credit unions, U.S. Central, and the CLF, accounting entries are recorded to show stock

purchases, although no funds actually change hands. Figure V.2 illustrates these entries in two

steps using simple T-accounts (i.e., recording assets on the left side, and liabilities and equity on

the right). First, to become an agent member, a corporate credit union subscribes to CLF stock

by taking out a “loan” from U.S. Central and then redepositing the “loan” proceeds at U.S.

Central. The loan rate exactly equals the CLF’s dividend rate, thereby creating offsetting interest

expenses and income. Second, U.S. Central purchases the CLF stock on behalf of its corporate

credit union members using the “loan” proceeds. The CLF then redeposits the “loan” proceeds

back into U.S. Central. In reality, these transactions are merely bookkeeping entries that

artificially inflate the parties’ balance sheets.
Step 1

Step 2

Investment

(Deposit

 in USC)

Corporate Credit Unions

Loan

Loan Payable

(to USC)

Loan Receivable

(from CCU)

Investment

Deposit

(Investment 

from CCU)

U.S. Central

Investment

(Deposit

 in USC)

Loan Payable

(to USC)

Loan Receivable

(from CCU)

Deposit

(Investment 

from CCU)

Stock 

Purchase

Stock 

(from CLF)

Stock 

(Sold to USC)

Central Liquidity Facility

Investment

(Deposit

 in USC)

Deposit

(Investment 

from CLF)

Investment

$678m

$678m

$678m

$678m

U.S. Central

Central Liquidity Facility

Corporate Credit Unions

Note: All of these transactions are merely accounting entries; no cash payments are actually made.

121

Figure V.2: The Redeposit Program

Today, most credit unions opt to join the CLF through their corporate credit unions

because this method relieves the credit union from having to purchase and hold CLF stock

directly. As shown in Table V.1, at year-end 1996, the CLF had $706 million in capital consisting

of deposits made by credit unions and corporate credit unions (on behalf of member credit

unions). Specifically, credit unions had deposited $28 million directly and $678 million indirectly

through corporate credit unions. The $678 million corporate credit union deposit is actually

handled by U.S. Central acting as the “agent group representative” for corporate credit unions.
122

 12 U.S.C. § 1795f(a)(4)(A). 203

 The Justice Department’s Office of Legal Counsel issued an opinion to that effect on May 24, 1982. 6 Op. 204

O.L.C. 262, 263 (1982).

 A separate provision authorizes the Secretary of the Treasury to lend up to $500 million to the CLF in the event 205

that the NCUA Board certifies to the Secretary that the CLF does not have sufficient funds to meet the liquidity

needs of credit unions. 12 U.S.C. § 1795e(b).

See, e.g., Pub. L. No. 105-65, 111 Stat. 1344, 1379 (1997); Pub. L. No. 104-204, 110 Stat. 2874, 2918 206

(1996).

Table V.1: Central Liquidity Facility Balance Sheet

(Dollars figures in millions; totals may not add due to rounding; data as of December 31, 1996)

Assets Liabilities and Members’ Equity

U.S. Central - Redeposits $678 Liabilities $17

U.S. Central - Share Accounts $47 Capital Stock - Regular $28

Accrued Interest Receivable $9 Capital Stock - Agent Members $678

Retained Earnings $12

Total Assets $734 Total Liabilities and Members’ Equity $734

Source: NCUA, Response to the Treasury’s Data Request, Mar. 21.

In addition to the capital stock and surplus invested by credit unions, the CLF has

authority to borrow up to 12 times its subscribed capital stock (i.e., the required plus on-call

subscriptions). As of year-end 1996, that borrowing authority amounted to some $17 billion. 203

The Justice Department’s Office of Legal Counsel has said that the full faith and credit of the

United States backs such borrowing. Although the CLF may borrow from any source, it has 204

long had a credit arrangement in place (for the full 12 times subscribed capital) with the Federal

Financing Bank, which is part of the U.S. Treasury. Although various appropriations acts have 205

limited to $600 million the amount that the CLF can lend directly to credit unions, they have not

limited the CLF’s ability to borrow the full $17 billion at any one time. Thus nothing precludes 206

the CLF from borrowing the entire $17 billion and lending it to the Share Insurance Fund. 

Congress could circumscribe the CLF’s borrowing authority in future appropriations acts;

however, given the breadth of the authorization, such language would have to be very specific.
123

 12 C.F.R. § 201.3. The Federal Reserve Board also has authority to authorize a Federal Reserve bank to offer 207

emergency credit to non-depository institutions. 12 U.S.C. § 347b(b)(3).

b. Member Loans

The CLF acts as a signal for the Share Insurance Fund. If a corporate credit union seeks a

line of credit from the CLF for a particular credit union, then the corporate credit union has

probably concluded, in light of its own lending standards, that it would be better off not bearing

the credit risk involved. The corporate credit union might reach such a conclusion because of the

size of the line needed, the creditworthiness of the institution, or the quality of its collateral. 

Given the close relationship between the CLF and the Share Insurance Fund, such an inquiry

should signal a potential problem to the Fund. The CLF and the Fund can then work together to

help liquidity-constrained, financially troubled credit unions.

As an alternative to CLF loans, the NCUA may extend credit to a credit union by using

the Share Insurance Fund to guarantee a loan from a corporate credit union to a member credit

union. Such guaranteed loans are a form of special assistance. The NCUA believes that lines of

credit guaranteed by the Share Insurance Fund are an efficient means of providing liquidity to a

troubled credit union, are less expensive for the credit union involved, and reduce risk to the

Share Insurance Fund. In particular, NCUA officials told us that guaranteed lines of credit may

be more efficient than direct CLF lending when timing is critical. For example, advances from the

Federal Financing Bank typically take up to three days, whereas a loan guaranteed by the Fund

may be approved and issued within a few hours. 

As for reducing risk to the Share Insurance Fund, some questions remain because loan

guarantees place all credit risk squarely on the Fund. Specifically, the CLF should be extending

credit to illiquid, but solvent, credit unions. In such cases, loan guarantees may ultimately reduce

risk to the Fund by avoiding the failure of basically healthy but temporarily illiquid institutions.

However, in the case of illiquid and otherwise weak or insolvent credit unions, loan guarantees

may increase risk to the Fund. Specifically, the CLF could allow the NCUA to keep weak or

insolvent credit unions open beyond the point that would minimize losses to the Fund.

2. The Federal Reserve Discount Window

Because of the constraints on the CLF, the Federal Reserve System’s discount window is

a logical alternative governmental source of liquidity. Like the CLF, the discount window offers

adjustment credit, seasonal credit, and extended credit. The Federal Reserve generally makes 207

funds available through the discount window only in cases where funds are not reasonably

available from usual sources, such as correspondent institutions or the money markets.
124

 12 C.F.R. § 201.2(c)(1). Since most credit unions with fewer than $2 million in assets do not offer transaction 208

accounts, they may not be eligible for discount window advances. Still, the vast majority of credit unions with

more than $5 million in assets do offer transaction accounts and hence are eligible for discount window advances. 

See Table I.4 on p. 23.

 Corporate credit unions, on the other hand, generally may not borrow from discount window because they are 209

classified as “banker’s banks.” 12 U.S.C. § 461(b)(9). Corporate credit unions could waive their banker’s bank

exemption from maintaining reserves at the Federal Reserve. In that case, a corporate credit union would be

eligible to borrow from the discount window.

To be eligible to borrow from the discount window, a depository institution must offer

reservable transaction accounts (e.g., checking accounts) or nonpersonal time deposits. Most 208

credit unions, although eligible for discount window access on the same terms as other depository

institutions, have chosen not to take the steps necessary to be able to borrow. According to the 209

Federal Reserve Board, as of year-end 1996, only 333 credit unions had filed discount window

agreements and of these only 20 had pre-pledged collateral.

In short, almost all but the smallest credit unions have full access to the Federal Reserve as

a governmental source of liquidity. They face no barrier to relying on the Federal Reserve rather

than the CLF, although the NCUA and the Federal Reserve may need to improve coordination.

3. Conclusions

When Congress established the CLF in 1978, credit unions had no access to emergency

liquidity from a governmental liquidity provider. However, the Monetary Control Act of 1980

accorded credit unions access to the Federal Reserve’s discount window. The Federal Reserve is

the preeminent lender of last resort.

The CLF’s current borrowing authority raises serious policy and budget concerns. It has 

legal authority to advance several billion dollars to the Share Insurance Fund without regard to its

ability to repay. In a systemic crisis, taxpayers could be put at risk if such funds were advanced to

shore-up troubled credit unions or a troubled insurance fund. 

We are also concerned that the CLF creates a concentration of credit risk for itself by

holding all of its investments at U.S. Central. If U.S. Central were ever to become impaired, the

CLF’s elaborate redeposit-based capital structure could collapse and its share accounts could

suffer losses; the combined effect could largely eliminate the CLF’s net worth. If the CLF

continues to operate, credit unions should capitalize it directly and the concentration of credit risk

should be eliminated, perhaps by depositing CLF funds at the Treasury as the Share Insurance

Fund does.

4. Recommendations

The CLF provides minimal public benefits (i.e., acting as a signal to the Share Insurance

Fund). The CLF’s explicit public costs, like its benefits, are small: it had a 1997 operating budget
125

 62 Fed. Reg. 12,929, 12,945 (1997) (to be codified at 12 C.F.R. pt. 704 app. B). 210

of only $167,000. However, the CLF imposes several implicit public costs by being able to

increase taxpayer risk through its full faith and credit borrowing authority. Of course, these costs

are difficult to quantify and would be realized only if U.S. Central or the Fund were to suffer

significant losses.

We recommend that Congress discontinue the CLF. Credit unions, particularly larger

ones, should apply to their Federal Reserve Bank for discount window access. Smaller credit

unions should at least have firm lines of credit for emergency liquidity from their corporate credit

unions or other depository institutions. In addition, we recommend that corporate credit unions

and the NCUA each evaluate credit unions’ potential liquidity needs and the options available for

credit unions and corporate credit unions to meet those needs. In New 704, the NCUA directs

each corporate credit union to “develop a contingency funding plan that addresses alternative

funding strategies in successively deteriorating liquidity scenarios.”210

127

APPENDIX A

RECOMMENDATIONS

Chapters II through V contain recommendations to Congress, the NCUA, and credit

unions. This appendix lists those recommendations and provides references to the pages where

they appear in the report.

Chapter II: The Share Insurance Fund

We recommend that:

! Congress require the Share Insurance Fund to maintain an available assets ratio of 1.0

percent, and specify that the NCUA could not pay dividends from the Fund if the available

assets ratio fell 1.0 percent, regardless of the Fund’s overall reserve ratio (page 45).

! The NCUA, when calculating the Share Insurance Fund’s reserve ratio, use the most

current data available on insured deposits (pages 46).

! The NCUA not declare dividends on credit unions’ 1 percent deposit until the close of the

year in order to ensure the actual reserve ratio exceeds the target ratio (page 46).

! Congress direct the NCUA to require credit unions to adjust their 1 percent deposit in

conjunction with submitting their call reports, and direct the NCUA to measure deposits

using a four-quarter average to account for seasonal fluctuations (pages 47).

! Congress give the NCUA discretion to let investment earnings raise the Share Insurance

Fund’s reserve ratio up to 1.5 percent (page 59).

! Congress give the NCUA flexibility to set the premium rate for the Share Insurance Fund

as it deems appropriate, rather than requiring the NCUA to set the premium only at 1/12

of 1 percent (page 59).

We also suggest that Congress, the NCUA, credit unions, and other interested persons

consider whether Congress should authorize the NCUA to charge risk-based insurance premiums

(particularly in view of the growth of larger, more complex credit unions) or make risk-based

adjustments in dividends paid by the Share Insurance Fund (page 59).
128

Chapter III: The NCUA’s Safety and Soundness Regulations

We recommend that:

! The NCUA make important safety and soundness rules, such as the limit on loans to one

borrower, readily accessible to all interested parties. If the NCUA intends rules to have

the force of law and apply to credit unions generally, it should promulgate them as

regulations and codify them in the Code of Federal Regulations, preferably after

publishing a notice in the Federal Register and giving interested parties an opportunity to

comment (page 65-66).

! Congress require credit unions that have existed for a given number of years or reached a

given asset size to maintain a 6 percent ratio of net worth to total assets, and require the

NCUA to prescribe a regulation requiring other credit unions to build net worth so as to

meet the 6 percent level by the time they have existed for that number of years or reached

that asset size (page 71).

! Congress raise the current reserving target from 6 percent of risk assets to 7 percent of

total assets (page 71).

! Congress require credit unions to deduct from their reserves some portion of any member

capital accounts at a corporate credit union and all paid-in capital issued by a corporate

credit union (page 71).

! Congress require the NCUA to develop an appropriate risk-based net worth requirement

for larger, more complex credit unions (page 71).

! Congress adopt a system of prompt corrective action for credit unions. This system

would be a streamlined version of that currently applicable to FDIC-insured institutions,

and would be specifically tailored to credit unions as not-for-profit, member-owned

cooperatives (pages 76).

! Congress set at 6 percent the threshold at which a credit union can be considered

adequately capitalized within a prompt corrective action system for credit unions

(page 77).

! The NCUA require each large credit union to obtain an annual audit from an independent

certified public accountant (page 80).
129

Chapter IV: Corporate Credit Unions

We recommend that the NCUA:

! Develop policy guidance or regulations governing the risks associated with concentrations

of corporate credit unions’ portfolios in particular classes of assets. In so doing, the

NCUA should consider both the exposure of individual corporate credit unions, and the

overall exposure of corporate credit union system to any particular asset class (page 107).

! Commit greater resources to the Office of Corporate Credit Unions (page 114).

! Interact more with the four federal banking agencies (page 114).

! Make greater use of risk-based approaches to depository institution supervision

(page 114).

! Have the Office of Corporate Credit Unions develop adequate written guidance for

examiners and corporate credit unions (page 114).

! Include in its ratings of corporate credit unions a component rating for sensitivity to

market risk (page 114).

! Revise its composite CAMEL rating system for corporate credit unions to take account of

all of an institution’s component scores (page 114).

Chapter V: Credit Union Liquidity and the Central Liquidity Facility

We recommend that:

! Congress discontinue the Central Liquidity Facility (page 125).

! Large credit unions apply to their local Federal Reserve bank for access to liquidity

through the discount window, and smaller credit unions should have firm lines of credit for

emergency from their corporate credit union or other depository institution (page 125).

! Corporate credit unions and the NCUA each evaluate credit unions’ potential liquidity

needs and the options available for meeting those needs (page 125).

 Regular reserves consist of required transfers of gross income. 12 U.S.C. § 1762. 211

131

APPENDIX B

COMPARISON OF OCC, OTS, AND NCUA SAFETY AND SOUNDNESS RULES

Regulation/Legislation OCC OTS NCUA

Definition of capital A national bank’s total capital consists of core Same as the OCC, but with some minor Credit union capital consists of revocable

capital (Tier 1) and supplementary capital variations (e.g., in the case of mutual savings reserves and statutory reserves. Revocable

(Tier 2). associations, Tier I capital also includes certain reserves consist of undivided earnings and

Tier 1 capital includes common stock and deposits). 12 C.F.R. pt. 567. consist of regular reserves and the allowance

noncumulative perpetual preferred stock. for loan losses. 12 C.F.R. §§ 702.1,

Tier 2 includes cumulative perpetual preferred

stock, the allowance for loan and lease losses, (Statutes limit certain credit union powers to a

and hybrid instruments that combine debt and stated proportion of unimpaired capital and

equity features. 12 C.F.R. pt. 3. surplus or of total paid-in and unimpaired

nonwithdrawable accounts and pledged other reserve accounts. Statutory reserves

211

702.2(c)(1).

capital and surplus. See, e.g., 12 U.S.C.

§ 1757(7)(I) (1% limit on investments in credit

union service organizations), (13) (5% limit on

purchases of certain notes of liquidating credit

unions). These bases are broader than the

definition of capital because the NCUA has

construed unimpaired capital to include all

deposits (shares) in a solvent credit union.)
132

Regulation/Legislation OCC OTS NCUA

 Risk assets consist of all assets (including outstanding loans), except for specific types of assets that the NCUA has determined present less risk to credit 212

unions. These exceptions include: (1) cash; (2) loans, and other assets insured by the federal government having remaining maturities of five years or less; (3)

loans fully insured or guaranteed by the federal or state government with maturities of three years or less; and (4) shares on deposits in state-insured depository

institutions or in a corporate credit union with remaining maturities of five years or fewer. 12 C.F.R. § 700.1(h)(i).

Capital requirements National banks must meet three capital Savings associations must generally meet the Credit unions are not subject to capital

requirements: (1) a minimum leverage ratio, same basic capital requirements as national requirements in the sense of having to maintain

generally requiring 4% Tier 1 capital to total banks. 12 U.S.C. § 1464(t)(1)(C), (2) (C); 12 a specified ratio of net worth to assets in order

assets; (2) a total risk-based capital ratio of 8 C.F.R. pt. 567. to be in good standing.

percent capital to risk-weighted assets; and (3)

a Tier 1 risk-based capital ratio, requiring 4% A credit union that does not have a specified

Tier 1 capital to risk-weighted assets. 12 ratio of regular reserves to risk assets must 

C.F.R. pt. 3. add to its regular reserves a certain percentage

The risk-based system assigns each class of § 702.2(a).

assets a risk weight of 0%, 20%, 50%, or

100%. The 0% category includes assets such A credit union in operation for more than four

as cash and insured deposits. The 50% years and having at least $500,000 in assets

category includes some types of mortgage must set aside 10% of gross income until its

loans, construction loans, and multi-family reserves reach 4% of outstanding loans and

mortgage loans. risk assets, then 5% of gross income until its

Tier 2 capital may count toward meeting the risk assets.

8% risk-based capital requirement, but only to

the extent that the bank also has Tier 1 capital A credit union in operation for less than four

(i.e., Tier 1 capital must constitute at least years or with less than $500,000 in assets must

50% of the capital that counts toward meeting set aside 10% of gross income until its reserves 

the 8% requirement). reach 7.5% of outstanding loans and risk

212

of its annual gross income. 12 C.F.R.

reserves reach 6% of outstanding loans and

assets, then 5% of gross income until its

reserves reach 10% of outstanding loans and

risk assets. 12 U.S.C. § 1762.
Regulation/Legislation OCC OTS NCUA

 61 Fed. Reg. 33,166, 33,170 (1996) (Joint Agency Policy Statement: Interest Rate Risk). 213

133

Risk-based premiums Congress has required the FDIC to proportion Same as the OCC. None.

deposit insurance premiums to the risk that a

depository institution poses to the deposit The NCUA may assess premiums only at a

insurance fund. 12 U.S.C. § 1817(b)(1). The uniform rate of 1/12 of 1%. 12 U.S.C.

FDIC has established a premium system that § 202(c)(2).

bases an institution’s premiums on its capital

ratios and on a supervisory judgment of its

overall financial condition. 12 C.F.R. § 327.9.

Interest rate risk In evaluating a national bank’s capital The OTS has developed a supervisory model Unless a credit union invests only in insured

adequacy, the OCC also assesses the bank’s that it uses to assess a savings association’s CDs and shares and deposits in a corporate

exposure to declines in economic value interest rate risk exposure. The model credit union, the NCUA’s rules require the

resulting from interest rate changes. Unlike measures the decline in net portfolio value that credit union to provide extensive data relating

the OTS, the OCC has not prescribed its own would result from a 200 basis point increase or to its sensitivity to changes in interest rates. If

supervisory model for calculating an decrease in market interest rates. 12 C.F.R. the credit union has more risky investments

institution’s sensitivity to interest rate § 567.7. (such as amortizing securities or securities with

changes. Instead, the OCC directs a national maturities greater than three years) that exceed

bank to: (1) ensure that its board of directors Savings associations with less than $300 the credit union’s net worth, then the credit

and senior management understand the nature million in assets and risk-based capital ratio union must model an immediate and sustained

and level of interest rate risk it is taking and exceeding 12% (most thrift institutions) need parallel shift in market interest rates of plus

how that risk fits with the bank’s overall not satisfy the model, although most still and minus 300 basis points. 62 Fed. Reg. 33,

business strategies; and (2) develop a voluntarily provide the requisite information 989, 34,003 (1997) (to be codified at 12

comprehensive risk management process that and obtain the agency’s analysis in an effort to C.F.R. § 703.90).

(among other things) identifies and measures better understand and manage their interest rate

interest rate risk, with the formality and risk.

complexity of this process tailored to the

bank’s needs.213
134

Regulation/Legislation OCC OTS NCUA

Real estate lending National banks must adopt and maintain Similar to the OCC. 12 C.F.R. §§ 560.100 - Credit unions may extend credit to members,

standards written policies establishing appropriate limits 560.101. including business members, to finance the

and standards for all credit secured by real acquisition or construction of income

estate or for the purpose of financing producing property. In such cases, the

construction. These provisions assist institution’s board of directors must adopt

institutions in developing and maintaining a specific business loan policies and review them

real estate lending policy appropriate to the at least annually. In addition, NCUA

size of the institution and the nature and scope regulations impose restrictions on these loans

of its operations. 12 U.S.C. § 1828(c) (e.g., the borrower must have a 35% equity

(requiring every federal banking agency to interest in the property). 12 C.F.R.

adopt uniform regulations prescribing real § 701.21(h).

estate lending standards); 12 C.F.R. § 34.61-

34.62. Credit unions may make residential real estate

loans to members for one-to-four-family

dwellings for a maturity of up to 40 years, if

the residence is or will be the member’s

principal residence and the loan will be secured

by a perfected first lien. 12 U.S.C.

§ 1757(5)(A); 12 C.F.R. § 701.21(g)(1).
Regulation/Legislation OCC OTS NCUA

135

Lending limits Lending limits protect the safety and Generally the same as the OCC. 12 U.S.C. There is a general 12-year maturity limit for all

soundness of national banks by preventing § 1464(u); 12 C.F.R. § 560.93. loans, except that members may obtain a

excessive lending to one person or related mortgage on their principal residence for up to

persons. A national bank’s total outstanding In addition, a savings association may make 40 years and a second mortgage on their

credit to one borrower generally may not loans to one borrower of up to $500,000 even principal residence for up to 15 years.

exceed 15% of the bank’s capital. An if its general lending limit is less than that

additional 10% is permissible if fully secured amount. A credit union’s lending to any one member is

by readily marketable collateral: i.e., financial limited to 10% of unimpaired capital and

instruments and bullion salable under ordinary surplus. The NCUA has construed a credit

market conditions with reasonable promptness union’s deposits (shares) as equity for

at a fair market value determined by purposes of this limit, making the limit much

quotations based upon actual transactions on greater than that applicable to national banks

an auction or similarly available daily bid and and federal savings associations. 12 U.S.C.

ask price market. 12 U.S.C. § 84(a); 12 § 1757(5)(A)(x); 12 C.F.R. § 701.21(a)-(g).

C.F.R. pt. 32.

The aggregate amount of business loans

outstanding to any one member may not exceed

15% of regular reserves and undivided earnings

or $75,000, whichever is higher. 12 C.F.R.

§ 701.21. Business loans (i.e., construction

and development loans) to any one member

may not exceed 15% of the institution’s regular

reserves and undivided earnings, and may not,

in the aggregate, exceed 25% of regular

reserves and undivided earnings. Loans to

non-natural person members must be limited to

the amount of the member’s shares, except for

not-for-profit members. Moreover, loans to

other credit unions may not exceed 25% of an

institution’s paid-in and unimpaired capital and

surplus. 12 U.S.C. § 1757(5)(C).
136

Regulation/Legislation OCC OTS NCUA

Transactions with Specific limits apply to a national bank’s Same as the OCC. 12 U.S.C. § 1468(a). These limits do not apply to federal credit

affiliates transactions with affiliated companies (e.g., unions.

loans, guarantees, and other extensions of In addition, a savings association may not

credit to those companies, and purchases of make any extension of credit to any affiliate A credit union may invest up to 1% of its total

assets from those companies). The bank’s engaged in activities not permissible for a bank paid-in and unimpaired capital and surplus in --

total transactions with any one affiliate cannot holding company. 12 U.S.C. § 1468(a)(1)(A). and lend another 1% of its total paid-in and

exceed 10 percent of the bank’s capital. The unimpaired capital and surplus to -- credit

bank’s total transactions with all of its union service organizations. The NCUA has

affiliates cannot exceed 20 percent of the construed unimpaired capital to include 

bank’s capital. High-quality collateral must deposits. 12 U.S.C. § 1757(5)(D), (7)(I).

fully secure all transactions between the bank

and its affiliates. 12 U.S.C. § 371c. Any A specific conflict of interest provision

transactions between the bank and its affiliates prohibits persons who serve as a credit union

must also be conducted at arm’s length. 12 official or in senior management, or any of

U.S.C. § 371c-1. their immediate family members, from

receiving any compensation from a credit union

service organization. All transactions with the

organization must be conducted at arm’s

length. 12 C.F.R. § 701.27.
Regulation/Legislation OCC OTS NCUA

137

General audit National banks, like other FDIC-insured Same as the OCC. A credit union’s board of directors must

requirements institutions, must complete annual reports on appoint a supervisory committee. The

their financial condition and management, and supervisory committee must conduct, or hire

must have annual independent audits to competent parties to conduct, an annual audit. 

determine whether their financial statements 12 U.S.C. § 1761b(5). The supervisory

are presented fairly. 12 U.S.C. § 1831m(a), committee must also verify that the

(d). institution’s financial statements accurately and

fairly represent the institution’s financial

condition and that management practices and

procedures sufficiently protect member assets. 

12 U.S.C. § 1761d; 12 C.F.R. § 701.12. A

credit union’s financial statements must

provide full and fair disclosure of all assets,

liabilities, and member equity. 12 C.F.R. § 702.3.
138

Regulation/Legislation OCC OTS NCUA

Independent audit A large national bank, like any large FDIC- Same as the OCC, except that the OTS also A credit union, regardless of its size, is

requirements insured institution, must establish an requires any savings association with an generally not required to obtain an

independent audit committee and obtain an unsatisfactory CAMEL rating (3, 4, or 5) to independent, outside audit. 12 C.F.R. §

annual independent audit of its financial obtain an independent audit. 12 C.F.R. 701.12(c)(5)(i)(D). A credit union may satisfy

statements. 12 U.S.C. § 1831m(d), (g)(1). § 562.4(b)(1). the supervisory committee audit requirement

This requirement does not apply to institutions by hiring a licensed, certified public

with less than $500 million in assets. 12 accountant; with a compensated independent

C.F.R. § 363.1(a). accountant that need be neither licensed nor

certified; or with an “agreed upon procedures

engagement” performed by a licensed, certified,

independent accountant. 12 U.S.C. §

1782(a)(6); 12 C.F.R. § 701.12(c)(5)(i)(A)-(C). 

A credit union must have an outside,

independent audit by a certified public

accountant only if: (1) the supervisory

committee has not conducted an annual audit;

(2) the supervisory committee's audit did not

meet the NCUA’s requirements ; or (3) the

institution has experienced persistent and

severe record keeping deficiencies. 12 U.S.C.

§ 1782(a)(6); 12 C.F.R. § 701.13.
Regulation/Legislation OCC OTS NCUA

NCUA, Examiner’s Guide (Alexandria, VA: NCUA, 1996). 214

139

Examination frequency National banks, like other FDIC-insured Same as the OCC. No statutory annual examination requirement

institutions, must generally be examined at applies, but since 1985 the NCUA has had a

least once each year. However, an 18-month policy of examining federal credit unions

examination cycle is permissible for certain annually, and allowing exceptions only with the

healthy, well-capitalized institutions with less approval of the agency’s Executive Director. 

then $250 million in assets. 12 U.S.C. Federally insured state-chartered credit unions

§ 1820(d). are examined by their chartering state at least

once every 18 months. If these institutions are

troubled, however, they may be examined every

120 days either by the NCUA alone or jointly

by the NCUA and the state.214

Liquidity requirements National banks must be members of the Savings associations must also maintain Credit unions must also maintain reserve

Federal Reserve System and maintain reserve reserve balances and (upon making proper balances and (upon making proper

balances at their local Federal Reserve bank. arrangements) can obtain emergency liquidity arrangements) can obtain emergency liquidity

12 U.S.C. § 222; 12 C.F.R. § 204.1. National from the Federal Reserve discount window. from the Federal Reserve discount window.

banks can obtain emergency liquidity from the

Federal Reserve discount window. Also, all savings association must generally Credit unions can become members of the

maintain specified proportions of their assets in Central Liquidity Facility and seek liquidity

liquid assets and short-term liquid assets. 12 from it. 12 U.S.C. §§ 1795-1795K; 12 C.F.R.

U.S.C. § 1465; 12 C.F.R. § 566.2. pt. 725.
140

Regulation/Legislation OCC OTS NCUA

 Institution-affiliated parties include directors, officers, employees, and agents of the institution; anyone who has or is required to file a change-in-control 215

notice; shareholder, joint venture partner, or consultant who participates in the conduct of the institution’s activities; and any independent contractor who

knowingly or recklessly participates in any violation of statute or regulation, any breach of fiduciary duty, or any unsafe or unsound practice which has or may

harm the institution in a significant fashion. 12 U.S.C. § 1813(u). 

Prompt corrective action National banks, like other FDIC-insured Same as the OCC. 12 C.F.R. pt. 565. No system of prompt corrective action applies

depository institutions, are subject to prompt- to credit unions, although the NCUA has some

corrective action: a set of statutory provisions informal policies that are analogous to some

aimed at resolving capital deficiencies before aspects of prompt corrective action. The

they grow into large problems. The system statutory requirement to replenish regular

classifies depository institutions into five reserves in effect constrains dividends by credit

categories, according to their capital. An unions with net worth deficiencies. 12 U.S.C.

institution falling below minimum capital § 1762; 12 C.F.R. § 702.3(c)(iii).

standards faces progressively more stringent

regulatory restrictions and requirements. 12

U.S.C. § 1831o; 12 C.F.R. pt. 6.

Enforcement Notice of Charges Same as the OCC. Same as the OCC. 12 U.S.C. § 1786(e)(1).

If a national bank or an institution-affiliated

party has engaged or will engage in an 215

unsafe or unsound practice or violate a statute,

regulation, written agreement, or the like, then

the OCC may issue a notice of charges stating

the alleged violation and setting a time for a

hearing to determine if the agency should issue

a cease-and-desist order. The hearing must

occur 30 to 60 days after the notice is issued. 

12 U.S.C. § 1818(b)(1).
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141

Temporary Cease-and-Desist Order Same as the OCC. Same as the OCC. 12 U.S.C. § 1786(e)(3)-(4), 

If the OCC determines that the activity

covered in a notice of charges may weaken the

bank or compromise its depositors before the

proceedings described above can be

completed, it can issue a temporary cease-anddesist order, which becomes effective

immediately and remains effective until the

issue has been resolved. 12 U.S.C.

§ 1818(c)(1). The OCC may also limit an

institution’s activities or functions or require

the institution to take affirmative action if

necessary (e.g., restitution, growth restrictions,

disposition of loans or assets, hiring qualified

officers or employees). 12 U.S.C.

§1818(b)(6)-(7).

(f)(1).

Permanent Cease-and-Desist Order Same as the OCC. Same as the OCC. 12 U.S.C. § 1786(e)(1)-(2).

After a hearing on a notice of charges, the

OCC may issue a permanent cease-and-desist

order against the bank. The order becomes

effective 30 days after issuance (except that a

consensual order becomes effective

immediately). 12 U.S.C. § 1818(b)(1)-(2).
142

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Removal and Prohibition Authority Same as the OCC. Same as the OCC. 12 U.S.C. § 1786(g)(1),

If the OCC determines that an institutionaffiliated party has, directly or indirectly,

engaged in prohibited practices, the OCC may

permanently remove the party from office or

prohibit the party from any further

participation in the affairs of any insured

depository institution. Prohibited practices

include violations of statutes, regulations,

cease-and-desist orders, and written conditions

or agreements; unsafe or unsound practices;

and breaches of fiduciary duty. Such actions

must also: (1) harm or threaten to harm the

institution, prejudice or potentially prejudice

depositors, or result in financial gain to the

party; and (2) involve dishonesty or

demonstrate willful or continuing disregard for

the institution’s safety and soundness. 12

U.S.C. § 1818(e)(1). As with a notice of

charges, a notice of intent to remove or

prohibit must describe the charge and set a

hearing date that must occur 30 to 60 days

after issuance. If appropriate, the OCC may

suspend the party before the hearing until the

matter is resolved. 12 U.S.C. § 1818(e)(3)-(4).

(3), (4).
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143

Civil Money Penalties Same as the OCC. Same as the OCC. 12 U.S.C. § 1786(1), 

For violations of statute or regulation,

permanent or temporary orders, or written

conditions or agreements, the OCC may

require an institution, or a person affiliated

with the institution, to pay a civil money

penalty of up to $5,000 for each day the

violation continues. The agency may impose a

penalty of up to $25,000 a day for such

violations, or for recklessly engaging in an

unsafe or unsound practice, or breaches of a

fiduciary duty, if those acts: (1) are part of a

pattern of misconduct; (2) are likely to cause

the institution a significant loss; or (3) result

in financial gain to the person committing the

act. If the acts described above are committed

knowingly, the daily fine may be up to $1

million for individuals or the lesser of $1

million or 1% of assets for institutions. 12

U.S.C. § 1818(i)(1), (2)(A)-(D).

(2)(A)-(D), (H).