Imposing the Risk-Based Capital Ratio Alongside the Leverage Ratio to Credit Unions: Go or No-Go?

Abstract

The credit union (CU) amendments to the Prompt Corrective Action (PCA) include bank-like risk-based capital rule (RBC) imposed alongside the leverage ratio (LR). This new RBC implemented since 2022 targets credit unions (CUs) with assets above $500 million. The reform draws heavy criticisms on the basis that it is inappropriate for the CU mutualist model that differs from the profit-oriented bank businesses. Using semiannual panel data from National Credit Union Administration (NCUA) Call reports from 1994 to 2015, we ask which one, the RBC or LR, or both, works well to enhance CUs’ solvency and to predict their failures. We find that the regulatory accounting measures for asset risk used in the RBC computations are compatible with the CU financial performance and risk measures. Both capital metrics (RBC and LR) exhibit power in predicting CU solvency and stability proxied by the Z-score. Only the LR matters in the determination of CU failure and the RBC predicts well the failure of lowly capitalized CUs. We underscore the imposition of the RBC alongside the LR only to large CUs. Larger CUs have less capital than do small CUs, and more importantly, these large CUs are effectively constrained by the RBC rather than by the LR.

Keywords: Credit unions, risk-based capital ratio, leverage ratio, Z-score, asset quality and risk, financial performance, failure

JEL Classification: G23