This study illustrates that subordinated debt can simultaneously benefit public policy and credit unions. Credit union regulators could benefit from both the direct and indirect effects afforded by subordinated debt. Because subordinated debt is at risk of loss, its yields will reflect the risks of not receiving full payment of interest and principal. The direct effects of higher yields occasioned by higher risks would reduce temptations for credit unions to take unwarranted risks. Regulators would also benefit by receiving signals in the form of market yields on subordinated debt about the riskiness and performance of credit unions.
In addition, in order to issue subordinated debt, credit unions would likely face market pressures for greater transparency and disclosure, which would improve the abilities of markets, regulators, and credit unions themselves to evaluate the safety and soundness of credit unions. To protect their investments, debt holders would emerge as an additional constituency that favored safety and soundness and opposed supervisory forbearance.
What is the research about?
The study shows how subordinated debt could increase the total cushion for the share insurance fund against credit union insolvencies. The study also shows how current regulatory authority permits subordinated debt to be incorporated in credit unions’ current (risk-based) capital requirements. Finally, the study outlines how credit unions might pool their individual issues of subordinated debt in order to reduce issuance and interest costs to economically practical levels.
What are the credit union implications?
Under current public policies, faced with opportunities for growth, net worth requirements effectively force some credit unions to turn away deposits by depressing the interest rates that may be paid. Allowing credit unions to use subordinated debt to meet their net worth requirements along the lines currently allowed for banks would grant them much needed flexibility. Having the option to use subordinated debt to meet net worth requirements would also provide an avenue for more rapidly re-capitalizing troubled credit unions than is now the case.