Thursday, March 27, 2014

Risk-Based Capital: Commenting On Your Future - Part 9: DISSING THE FED !

Better watch your step!
Well, had enough of this "stuff" yet?  One has to wonder how the NCUA could get so much so wrong in this proposed risk-based capital (RBC) rule.  

One thing you can say about  NCUA's "robust" capital market specialists is they are "magnificent"!  In the sense that when they get it wrong, the capital markets folks generally get it magnificently wrong! Their work on the Corporates was an expensive example of the quality and depth of their expertise. 

Here's another classic example….

All they had to do was
 "Get On The Bus"!
One might have expected that the folks at NCUA would have issued an RBC rule reeking of "near perfection"!  Why?  Because after over a decade of international debate, negotiation, and political "push and shove"; the international banking community had agreed, for the most part, on the overall structure of RBC for banks; and, the U.S. banking regulators had negotiated RBC with the banks to "tailor" the international guidelines to the realities of the American financial marketplace. U.S. banking regulators published and implemented those RBC ("Basel III") standards for banks way back in early 2013.

But even with a well fought out RBC model
High risk !!!
At least, so says NCUA !
staring them dead in the eye, NCUA couldn't get even the easiest, most basic, most fundamental risk rating category right - determining a capital risk weight for CU funds on deposit with The Federal Reserve System (The FED!)

Under bank RBC standards, the risk weight for the FED is  (even a 3-year old could guess this one!)  0% !!! 

FED up
According to the NCUA's RBC standards, credit unions must use a 20% risk weight for FED deposits !!! (Explain that to a 3-year old!?)

    IF NOT

Don't wait for "never"


Anonymous said...

This is an absolute absurdity. If I am understanding this correctly risk based weights are intended to reflect the real value of an asset factored for the relative likelihood that asset will fail to be realized as a future asset. So your risk based capital would need to be greater for your assets with a riskier characteristics. It makes sense that a loan portfolio should have a risk based weight because it is irresponsible to assume that 100% of that portfolio will be realized in the future, and a credit union that has a bad loan portfolio is a risk to the credit union movement as a whole. The risk weights offset (in a perfect world), at a macro level, the risk of the entire credit union’s loan portfolio, so that incorrect optimistic expectations of the future don’t cripple the movement. It can also be used to see which credit union’s have riskier portfolios and need more attention to prevent said crippling. So the goal of assigning risk based capital requirements is not to punish, or allow certain actions, but to prepare for turns for the worst, so that a bad situation doesn’t compound into a failed institution.
Using this assumption and the NCUA’s 20% criteria, assets held in the federal reserve have a 20% chance of not being there at all, will definitely depreciate 20%, or will do a combination of both resulting in a 20% markdown in the value of the asset. If the NCUA has credible, empirical evidence that this is in fact the case, then forget the credit union movement; America’s financial system is in grave jeopardy. The potential harm to credit unions would be a drop in the bucket compared to the effects of a Federal Reserve system that can’t pay its deposit base. If this is the case then the NCUA should focus its efforts on convincing the people in charge to fix the system that is resulting in a 20% risk, rather than worrying about offsetting it with capital in the portfolio. More likely however this is just a way for the NCUA to classify more credit unions as risky and therefore implement more controls and enforce higher capital reserves.
While all other parts of the proposal you have talked about so far have dealt with situations that DO HAVE risk and they are just being more conservative than the for-profit banks. If they believe that a more conservative approach is required than our counterparts then that opinion could be validated with fact and evidence. Our for-profit friends have been grossly wrong about things before so challenging their assumptions is not inherently wrong. However, As you have illustrated in previous posts it seems unnecessary, overbearing and not based in empirical evidence, but at least there is risk in those areas and they are just off on the degree. In this instance they are assigning risk to something with an all but 0 risk factor, and when that risk does result the effect would likely not be offset but larger capital reserves.
This is a major problem with their premise and is far more troubling than just having a more conservative mindset (even if its for self interested reasons) on an issue. The claim that deposits in the Federal Reserve pose a significant risk is absurd and can’t be justified. Any entity that can make such a significant error in evaluating the simple dynamics around them simply can’t be trusted to do so in the future. The fact that this entity is at the head of a movement like that of the credit union’s is disconcerting to say the least.

That all being said, if I have any assumptions about the situation wrong please feel free to correct me. I would love to be wrong about all of this.

Anonymous said...

Don't be so dramatic. NCUA only put the 20% RW in so they could take it out in the final rule and make it look like our opinions matter to them. I predict CUNA will call getting the 20% down to zero and a few other changes like that a big "win".

Anonymous said...

Let's hope CUNA CEO BC can get this 20% risk kicked out of the final rule so he can at least say he accomplished something after 4 years at the CUNA throne. His taking credit for maintaining our historic tax exempt status is hysterical!

Jim Blaine said...

Sure don't feel like the first commenter is in error with the analysis.

Think it wise of the commenter to point out that NCUA has presented no empirical evidence (told by a "source who wished to remain anonymous" that it was little more than "little boys playing with tinker toys" around a big table on Duke St. - I hope that isn't true!) concerning their analysis.

Many of us with some experience are very sure that NCUA is extremely weak in this area… do I need to mention the Corporate fiasco again to anybody… no didn't think so! Or note the recent self-confession that they don't have the internal expertise to manage derivatives nor the "stress tests" on larger CUs?

Given the lack of analytical abilities at the NCUA, would have to go with the banks weightings… far less likely to be totally wrong as occurred with NCUA and the Corporates...