FROM THE OFFICE OF PUBLIC AFFAIRS

1. Why did the Treasury undertake this study? What is the scope of the study?

In a statute enacted on September 30, 1996, Congress required the Treasury to conduct a study of credit unions.

The statute specifically required the Treasury to evaluate the following:

(1)the potential for, and the potential effects of, having some entity other than the National Credit Union Administration (NCUA) administer the National Credit Union Share Insurance Fund;

(2)whether the 1 percent deposit that federally insured credit unions have made into the Share Insurance Fund should continue to be treated as an asset on credit unions' books or whether credit unions should, instead, expense that deposit;

(3)the condition of the 10 largest corporate credit unions, including their investment practices and their financial stability, financial operations, and financial controls;

(4)the NCUA's regulations; and

(5)the NCUA's supervision of corporate credit unions.

2. Does the study take a position on the common bond issue currently before the Supreme Court or on taxation of credit unions?

No. Both of those topics are outside the scope of the study.

3. What is the National Credit Union Share Insurance Fund?

The Share Insurance Fund is the federal deposit insurance fund for credit unions. It is operated by the National Credit Union Administration, the federal regulator of credit unions.

4. Is the Share Insurance Fund in good condition?

Yes. The Share Insurance Fund is well capitalized, has had few losses in recent years, and appears capable of handling various types of stress. The Treasury found no particular problems in how the NCUA manages the Fund.

5. Does the Treasury recommend separating the Fund from the NCUA?

Based on its review, the Treasury found no compelling case for moving the Share Insurance Fund out of the NCUA. Some potential for conflict may exist between the NCUA's mission as a charterer or regulator of credit unions and the NCUA's responsibilities for the Share Insurance Fund. However, in the Treasury's view, any such potential conflict is best handled by applying a system of prompt corrective action to credit unions. Such a system would impose an important and highly constructive discipline on the NCUA's supervisory and insurance functions. This discipline should, to a significant degree, offset any potential for conflicts of mission.

6. What is the 1 percent deposit in the Share Insurance Fund?

Under current law, each federally insured credit union must maintain on deposit in the Share Insurance Fund an amount equal to 1 percent of the credit union's insured deposits. Thus, for example, if the credit union has $50 million in insured deposits, it must keep $500,000 on deposit in the Fund. The credit union's deposit in the Fund counts as an asset on the credit union's books. It also counts as reserves of the Fund -- that is, the money is available to protect depositors at failed credit unions. Because this accounting treatment involves some double-counting of the same money, some have called for credit unions to write off the 1 percent deposit, so that it would no longer count as an asset on their books.

7. Does the Treasury recommend changing credit unions' 1 percent deposit in the Share Insurance Fund?

No. The Treasury concluded that writing off the 1 percent deposit would add nothing to the Share Insurance Fund's reserves, and that better ways of protecting the Fund are available. The Treasury recommends strengthening the requirement for credit unions to build net worth.

Under current law, credit unions set aside a small percentage of their gross earnings as reserves until their net worth reaches 6 percent of risk assets. The Treasury recommends raising this target so that credit unions would build net worth until they had 7 percent net worth to total assets. This approach should strengthen both individual credit unions and the Share Insurance Fund.

The overwhelming majority of credit unions already meet the 7 percent target. Of the 11,392 federally insured credit unions operating at the end of 1996, 10,592 (93 percent) had at least 7 percent net worth to total assets, and those credit unions held 93 percent of all credit union assets. And of the 800 credit unions that did not have at least 7 percent net worth, 400 (with 5 percent of total credit union assets) had at least 6 percent net worth to total assets. Under the Treasury's approach, the small number of credit unions that do not already meet the 7 percent target would need to add to their net worth by setting aside part of their annual gross earnings.

The Treasury believes that the 7 percent target, coupled with other reforms proposed in the report, would be far more constructive and effective than compelling credit unions to write off their 1 percent deposit.

8. What key changes does the Treasury recommend in the NCUA's regulation of regular credit unions?

Treasury recommends four key changes in the NCUA's regulation of regular credit unions (as distinguished from corporate credit unions).

First, in formulating fundamental safety and soundness policies for credit unions, the NCUA has often relied on unwritten or informal rules. This approach reduces or eliminates the opportunity for public comment, and may make it more difficult for credit unions or others to know what the rules really are. The Treasury recommends that the NCUA make important safety and soundness rules readily accessible to all interested parties. As a part of the process of formulating those rules, the NCUA should publish proposed rules in the Federal Register and solicit comments from interested persons.

Second, credit unions -- like all other federally insured depository institutions -- should have to meet net worth requirements. As discussed more fully in the response to Question 9, the Treasury recommends that Congress require credit unions to maintain at least a 6 percent ratio of net worth to total assets.

Third, the Treasury recommends that Congress adopt a system of prompt corrective action for federally insured credit unions. This system would be a streamlined version of the system currently applicable to all FDIC-insured institutions, and would be specifically tailored to credit unions as not-for-profit, member-owned cooperatives.

Fourth, the Treasury recommends that the NCUA require each federally insured credit union with more than $500 million in assets to obtain an annual audit from an independent public accountant.

9. Why does the Treasury recommend net worth requirements for credit unions?

All other federally insured depository institutions must already meet net worth (capital) requirements. That is, these institutions must maintain a minimum ratio of net worth to assets. Net worth requirements help ensure that federally insured depository institutions have a sufficient buffer to absorb unforseen losses without in turn imposing losses on depositors or the deposit insurance fund.

Credit unions, by contrast, are not currently subject to net worth requirements (in the sense described above).

Yet credit unions' balance sheets indicate that credit unions themselves have recognized the wisdom of maintaining a net worth exceeding 6 percent of total assets. Of the 11,392 credit unions operating at the end of 1996, 10,992 (96 percent) had more than 6 percent net worth, and those institutions held 98 percent of total credit union assets. More specifically, 7,841 credit unions (69 percent of all credit unions) had more than 10 percent net worth, another 2,082 (18 percent) had 8-10 percent net worth, another 669 (6 percent) had 7-8 percent net worth, and an additional 400 (4 percent) had 6-7 percent net worth. Only 400 credit unions (4 percent) had less than 6 percent net worth, and those institutions held only 2 percent of total credit union assets.

Separately, as described in the response to Question 7, the Treasury recommends increasing credit unions' reserving target to 7 percent of total assets.

10. What would a system of prompt corrective action accomplish?

A prompt corrective action system would reinforce the commitment of credit unions and the NCUA to correct net worth deficiencies promptly, before they grow into large problems. The system's clarity and predictability should promote fair, consistent treatment of similarly situated institutions. Over time, it should also help minimize the number and cost of credit union failures, and -- in so doing -- conserve the resources of the Share Insurance Fund, make the Fund even more resilient, and make more money available for lending to credit union members.

11. What are corporate credit unions?

Corporate credit unions exist to provide services to regular credit unions. In particular, they invest funds deposited by their member credit unions. Corporate credit unions also provide services comparable to the correspondent services that large commercial banks have traditionally provided to smaller banks. U.S. Central Credit Union is a corporate credit union that serves most other corporate credit unions.

12. What did the Treasury conclude about the condition of corporate credit unions? What recommendations does the Treasury make regarding corporate credit unions and the NCUA's oversight of those institutions?

The Treasury reviewed the 10 largest corporate credit unions and U.S. Central. Based on this review, the Treasury made a series of findings.

First, corporate credit unions invest in high-quality assets. They also keep their investments mostly short-term, which helps limit their exposure to changes in interest rates. Second, corporate credit unions are thinly capitalized and operate with narrow profit margins. This heightens the importance of proper internal controls, strong management, and adequate capital. Third, corporate credit unions have increased their capital in recent years (at the urging of the NCUA). The NCUA's new corporate credit union regulation will encourage them to continue to do so, and it is essential that this trend continue. Fourth, the three-tier cooperative structure of the credit union system (with regular credit unions owning corporate credit unions, and corporate credit unions owning U.S. Central) involves significant interdependence among and within each of the three tiers. Fifth, corporate credit unions and the NCUA need to be careful about the extent to which corporate credit unions concentrate their investments in particular classes of assets. Sixth, corporate credit unions are facing increasing competitive pressures from each other and from other market participants. Seventh, over the past several years, the NCUA has made significant strides in improving its supervision of corporate credit unions, and its new corporate credit union regulation will encourage corporate credit unions to continue to make themselves even safer and sounder.

The Treasury recommends that the NCUA: (1) provide additional resources to its Office of Corporate Credit Unions; (2) make greater use of risk-based approaches to supervision; (3) improve its written guidance for examiners and corporate credit unions; (4) update its system for rating the strength of corporate credit unions; and (5) provide better analysis and documentation in connection with examinations.

13. What is the Central Liquidity Facility?

Congress created the Central Liquidity Facility (CLF) in 1978, when credit unions had no access to the Federal Reserve discount window. It intended the CLF to help credit unions that had good assets but faced abnormal cash outflows, just as the Federal Reserve discount window helps banks under similar circumstances.

14.Why does the Treasury recommend discontinuing the Central Liquidity Facility?

In practice, the CLF has been of marginal significance during the past decade -- doing only a modest amount of lending. Moreover, in 1980, Congress made credit unions eligible to borrow from the Federal Reserve discount window if they offer checking accounts. Against this background, the Treasury concluded that the CLF has outlived its usefulness.

In place of the CLF, the Treasury recommends that larger credit unions arrange for access to the discount window of their regional Federal Reserve bank; and that smaller credit unions at least have firm lines of outside credit (e.g., from their corporate credit union).