The current U.S. bank risk-based capital regulations implement the 1988 Basel Accord on risk-based capital. The Basel Accord established the widespread use of capital ratios that bank and thrift regulators could use as a starting point for assessing the financial condition—that is, safety and soundness—of internationally active banks and thrifts. In the United States, U.S. bank regulators applied the Basel Accord to all banks, rather than just internationally active ones. In 1991, GAO recommended a tripwire approach—incorporating capital and safety and soundness standards, or levels at which supervisory actions would be triggered—based on our findings that regulatory discretion and a common philosophy of trying to resolve the problems of troubled institutions informally and cooperatively resulted in enforcement actions that were neither timely nor forceful enough to prevent or minimize losses to the deposit insurance fund. Moreover, acting in response to the large number of bank and thrift failures in the late 1980s and early 1990s, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which included a capital-based regulatory structure known as PCA. Specifically, FDICIA categorizes depository institutions into five classifications on the basis of their capital levels and imposes increasingly more severe restrictions and supervisory actions as an institution’s capital level deteriorates. CUMAA required NCUA to adopt a system of PCA comparable with that of FDICIA for use on federally insured credit unions, which NCUA initially implemented in 2000. CUMAA defined the net worth ratio for PCA purposes as net worth to total assets. Under CUMAA, net worth is defined as the retained earnings balance of the credit union at quarter end, as determined under generally accepted accounting principles (GAAP). NCUA regulations provide four alternative methods that credit unions can use to calculate total assets for use in the net worth ratio: (1) average of quarter-end balances of the current and three preceding calendar quarters, (2) average of month-end balances over the three calendar months of the calendar quarter, (3) average daily balance over the calendar quarter, or (4) quarter-end balance of the calendar quarter as reported on the credit union’s call report. NCUA regulations state that for each quarter, a credit union must elect a measure of total assets from these four alternatives to apply for all PCA purposes, except for the risk-based net worth requirement. CUMAA prescribes three principal components of the PCA system for credit unions: (1) a comprehensive framework of actions, including actions prescribed by statute and discretionary actions to be developed by NCUA, for credit unions that are less than well-capitalized; (2) an alternative system of PCA to be developed for credit unions that NCUA defines as “new”; and (3) a risk-based net worth requirement to apply to credit unions that NCUA defines as “complex.” Table 1 summarizes the PCA capital requirements for regular and complex credit unions. CUMAA imposes up to four mandatory supervisory actions—an earnings transfer, submission of an acceptable net worth restoration plan, a restriction on asset growth, and a restriction on member business lending—depending on a credit union’s capital classification, as determined by net worth ratios. Credit unions that are not well-capitalized are required to take an earnings transfer. Credit unions that are undercapitalized, significantly undercapitalized, or critically undercapitalized are subject to all four actions. In addition, CUMAA requires NCUA to appoint a conservator or liquidation agent within 90 days of a credit union becoming critically undercapitalized unless the NCUA Board of Directors determines that other action would better achieve PCA’s purpose. Pursuant to CUMAA, NCUA also developed discretionary supervisory actions, such as the dismissal of officers or directors of an undercapitalized credit union, to complement the prescribed actions under the PCA program. While CUMAA required NCUA to implement a system of capital-based tripwires, capital-based safeguards of insurance funds are inherently limited because capital does not typically show a decline until an institution has experienced substantial deterioration in other components of its operations and finances. Deterioration in an institution’s internal controls, asset quality, and earnings can occur years before capital is adversely affected. Financial regulators recognize that, though essential, a capital requirement is only one of a larger set of prudential tools used to protect customers and ensure the stability of financial markets they regulate. For depository institutions, the key or critical tool that financial regulators use to ensure the adequacy of an institution’s capital levels and its safety and soundness is the on-site examination process. The credit union industry’s recent interest in using alternative forms of capital appears to be associated primarily with three concerns about PCA for credit unions. First, several credit union officials argued that secondary capital or other alternatives were needed, given concerns that credit unions might trigger PCA restrictions because of rapid inflows of deposits due to investors’ “flight to safety”; however, we have not found widespread evidence to support these concerns. To assist credit unions that fall marginally below “adequately capitalized” primarily because asset growth has outstripped income growth, NCUA proposed the use of an abbreviated net worth restoration (NWRP) plan. According to an NCUA official, the proposed rule was not pursued further because it was considered too complicated, would only benefit a very small number of credit unions, and did not appear to provide material relief. Second, other credit union officials contended that PCA acts as a restraint on credit union growth. Our analysis of credit union and bank data indicates that credit unions have been growing faster than banks in the 3 years credit union PCA has been in effect. Finally, several credit union officials are concerned that the PCA tripwires for credit unions are too high, given the conservative risk profile of most credit unions. It should be noted that, according to Treasury, Congress established the capital level 2 percentage points higher because 1 percent of a credit union’s capital is deposited in NCUSIF and another 1 percent of the typical credit union’s capital is invested in a corporate credit union. As investors sought high-quality (that is, safe) investments due to weak performance by the stock and other investment markets in the early 2000s, credit unions experienced significant growth in member share deposits. Several credit union industry officials expressed concern that this inflow of new shares into credit unions might dilute net worth ratios, thus triggering net worth restoration plans and other supervisory actions under PCA. To assist credit unions that fall marginally below “adequately capitalized” primarily because asset growth outstrips income growth, NCUA introduced the concept of an abbreviated NWRP in June 2002. While no specific proposal was introduced, the NCUA board invited public comment on the concept of what was then referred to as “safe harbor” approval of a NWRP—that is, notice of certain criteria established by regulation that, when met, will ensure approval. In November 2002, NCUA put forth a proposed rule and request for public comment on allowing the use of abbreviated NWRP—which NCUA referred to as a first-tier NWRP—by qualifying federally insured credit unions whose net worth ratio declined marginally below the adequately capitalized threshold (6 percent) because growth in assets outpaced growth in net worth. Under the proposal, a credit union would have been eligible to file an abbreviated NWRP if it satisfied three criteria: historical net worth, performance, and growth. There were three principal differences between the content requirement of a standard NWRP and the abbreviated NWRP proposed by NCUA. First, the proposed abbreviated NWRP would require only 4 quarters of pro forma projections of total assets, shares and deposits, and return on average assets, while the standard NWRP required complete pro forma financial statements covering a minimum of 2 years. Second, the abbreviated NWRP would not require a credit union to specify what steps it would take to meet its schedule of quarterly net worth targets, which is required for a standard NWRP. Finally, a standard NWRP requires those steps to extend beyond the term of the plan to ensure that the credit union remains at least adequately capitalized for 4 consecutive quarters thereafter. In contrast, the proposed abbreviated NWRP did not address the credit union’s net worth after the end of the term of the plan. NCUA’s proposed rule also detailed the criteria for approval of the abbreviated NWRP and the circumstances in which a credit union that would otherwise be eligible to file an abbreviated NWRP would have been required to file a standard NWRP instead. According to an NCUA official, the proposed rule was not pursued further because it was considered too complicated, would benefit only a very small number of credit unions, and did not appear it would provide material relief since some form of NWRP (albeit somewhat abbreviated) was still required by statute. NCUA officials stated that the credit union industry supported the proposal for an abbreviated NWRP but the credit union industry was advocating a proposal that would be automatically approved if it met a fixed set of objective criteria. However, NCUA officials explained that CUMAA requires a case-by-case determination by NCUA that a plan “is based on realistic assumptions and is likely to succeed in restoring the net worth of the credit union.” Although NCUA’s proposal to assist certain credit unions that fall marginally below “adequately capitalized” was not pursued further, we found that despite a recent inflow of member share deposits, the credit union industry as a whole has been able to maintain net worth ratios well above the PCA threshold for well-capitalized credit unions. Moreover, current data suggest that the “flight to safety” may be over, as investors appear to be returning to the investment markets.