MADISON, Wis. (12/6/07)--Credit union board members and employees are likely to measure their credit union using two metrics: asset size and capital ratio. There is a range of thought on what constitutes a reasonable capital level. Most credit unions have a general preference for more capital in the service of safety and soundness.
The Filene Research Institute wanted to know whether the “more capital is better” preference has led to U.S. credit unions holding too much capital. The result is a newly released study by William E. Jackson III, professor of finance at the University of Alabama, and a Filene Research Fellow. In “Is the U.S. Credit Union Industry Overcapitalized? An Empirical Examination,” Jackson addresses two fundamental questions: Was the capitalization rate in 1990 reasonable given the risk profile of the credit union industry? And has the risk profile of the credit union industry increased to such an extent as to warrant an increase in capitalization to current levels? Jackson reports that the capital level of the U.S. credit union industry stood at 11.6% at the end of 2006, more than four percentage points higher than the legislatively mandated level of “well capitalized” and exactly four percentage points higher than U.S. credit union capital in 1990. Jackson concluded that the industry capitalization rate in 1990 was reasonable and perhaps too high; and that the credit union industry in 2006 was less risky than it was in 1990. These answers, coupled with an analysis of credit union regulatory capital regime and a comparison of credit union and bank capital requirements, lead Jackson to state that U.S. credit unions are “overcapitalized by an amount in the 30% to 40% range.” Translated into dollars, U.S. credit unions are overcapitalized between $8.8 billion and $11.7 billion. “The dramatic conclusions from this research may cause considerable debate in the industry,” said Filene Chief Research Officer George Hofheimer. “Credit unions need to balance their efforts to achieve safety and soundness with efforts to put their capital to best use. “To meet the challenges of the future, credit unions need to invest in new delivery channels, technology, innovative products, talent development, collaborative strategies, marketing, and many other capital-intensive activities. According to Jackson’s assessment, almost all credit unions are overcapitalized,” he continued. Hofheimer urges credit unions “to have an honest discussion about the most appropriate balance of safety and soundness versus reinvestment in the credit union. As credit unions move forward, an honest debate about the appropriate use of capital is warranted.” Copies of “Is the U.S. Credit Union Industry Overcapitalized? An Empirical Examination” and other Filene research reports are available free to Institute members; $125 to non-members. An electronic version is available. For more information, use the link.