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Applying Risk-Based Capital Ratios to Credit Unions

In this study, Professor Harold Sollenberger and Kurt Schneckenburger examine risk-based capital – a capital measure that links risk and capital adequacy – and its application to credit unions.

Executive Summary

Not all participants in the credit union environment automatically pursue the same mixture of capital and risk. The authors point out that in a credit union, members typically want high dividend rates and low loan rates which lead to smaller equity positions. They also note that the National Credit Union Association (NCUA) encourages high equity in its surrogate creditor role — looking for safety and soundness. Thus, the problem credit union managers and boards of directors face is finding a proper mix of risk and return. The "just right" point or range of points can be very difficult for a credit union to find. 

What is this research about?

Using credit union data provided by NCUA’s 5300 report and making certain assumptions, this research transforms the traditional data into the needed formats for calculating credit union risk-based capital ratios. The researchers discuss how capital adequacy fits with risk and return, past capital adequacy measures, and issues involved in implementing a system of risk-based capital. They then construct a risk-based capital measure, apply it to a group of credit unions, and assess the results.

What are the credit union implications?

A problem with capital adequacy measures is the temptation by regulators and others to continually argue that "more is better." How much capital is enough? The trade-offs must be weights. The problem of having too little capital are fairly obvious. However, too much capital can also lead to serious problems: non-competitiveness; false assurances of safety; and discrimination against sound, efficient, and effective managers.