The National Credit Union Administration is an independent federal agency that charters, regulates and supervises federal credit unions. With the backing and credit of the U.S. Government, it manages and ensures proper operation of the National Credit Union Share Insurance Fund (NCUSIF) by insuring the deposits of almost 93 million account holders in all credit unions and the majority of state-chartered credit unions. (The National Credit Union Administration, 2008).
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National Credit Union Administration was established as an independent federal agent in 1970. Its sole mandate was to charter and supervise all federal credit unions. During the 1970s, financial institutions and credit unions experienced many changes in the products they offered hence resulting to expansion of their services. Legislation enabled credit unions to offer better services, such as share certificates and mortgage lending to their members. By offering a wide range of services, credit unions tremendously grew in the 1970s as membership doubled and assets increased. During the 1980s, high interest rates and unemployment brought about supervisory changes and insurance losses. This facilitated the government to approve a plan to recapitalize the fund. This decade was also characterized by increased flexibility in merger and membership criteria as well as service expansion. As from 1990s onwards, credit unions have experienced huge growth both in assets and membership. The failure of union credits remains low.
NCUA is a government owned institution having a three-member board. The President appoints these board members, who are later approved by the Senate. The members must be from different political parties, and each member serves for a period of six years. The institution protects credit unions and their members through effective regulations. NCUA is entrusted by the US government to supervise and issue regulations on management and services rendered by federally chartered credit unions as well as state and federally chartered corporate. NCUA has administration and regulatory authority over the state and federally chartered corporate as they offer services to federally insured credit unions. In addition, NCUA has the responsibility to ensure state-chartered credit unions do not pose a risk to the insurance fund. In its supervision, NCUA conducts on-site examinations and field monitoring of credit union report data and other financial information that are necessary for evaluation. Such financial documents must be submitted on a regular basis.
Over the past few years, NCUA has reviewed most of its policies to be on track with the changes occurring in financial markets. Like in 2008, NCUA changed its examination schedule for credit unions from a risk-based scheduling program that required only two examinations every three years to a one year cycle. For financial corporate, NCUA conducts annual examinations and reviews their call report data and operational trends (Lavrushin, 2008). For complex corporate that requires regular evaluation, on-site NCUA examiners and financial market specialists may be assigned to them on a full-time basis. In supervision and regulation of state chartered credit unions, the National Credit Union Administration relies on state supervisory regulations and the provisions of the Federal Credit Union Act (1934) that constitute the primary federal regulatory framework. State-chartered credit unions are supervised by supervisory agencies, which issue regulations on membership and scope of services (Didar Erdinc, 2008).
NCUA categorizes corporate supervision into 3 categories (type 1, 2 and 3). This is based on the complexity of operations, investment authorities, asset size, and influence by the financial market. A corporate with Type 3 supervision usually has billions of dollars in assets, exercises huge investment authorities, maintains innovative operations, and has an important effect on the credit union system and in the market place. NCUA allocates a full-time on-site examiner to various financial institutions including the credit unions. As part of its examinations, NCUA determine a credit union’s degree of exposure to various risks. After the determination has been done it assigns risk-weighted ratings based on CAMEL rating system. The ratings reflect a credit union’s condition in five basic components i.e. management, asset quality, capital adequacy, liquidity and earnings. Each of these components is rated on a scale of 1 – 5. The component with a rating of 1 is considered the best and 5 the worst. A single average rating, also ranging from 1-5 is then developed from the five component ratings. Credit unions with mean ratings of 1 or 2 are considered to be in a safe condition, while credit unions with mean ratings of 3, 4, or 5 reflect different levels of safety and financial constraints. In doing corporate assessment, a similar rating system referred to as the Corporate Risk Information System is used (Lavrushin, 2008).
NCUA has the authority to take enforcement action against credit unions and financial institutions to correct any deficiency established during an assessment or as a result of off-site monitoring. NCUA can either issue a letter of understanding, which is an accord between the credit union or corporate and NCUA on certain ways the credit union will take to correct deficiencies. They can also issue warning letters, which comprise of an NCUA directive to a corporate or a credit union to make certain adjustments to correct the established deficiencies. Furthermore, NCUA can sometimes issue a cease-and-desist order, requiring the management of a credit union or corporate to take action to correct deficiencies. NCUA examiners can also issue documents of resolution, which records NCUA’s directions that a credit union or corporate should take in order to correct a deficiency or issue within a specified period. In case of a corporate or a credit union that is insolvent or has severe deficiencies, NCUA can take the following actions: it can place the financial institution into conservatorship i.e. NCUA takes over the credit unions or corporate operations. After assuming control of the institution’s operation, NCUA assess and determines whether the corporate or the credit union is in a position to continue operating as a viable body. If a credit union or corporate is no longer viable, NCUA may merge it, conduct a purchase, or in some cases liquidate its assets. When NCUA assists in merger, a stronger credit union or corporate assumes the assets and liabilities of the failed credit union. NCUA provides financial incentives and an asset guarantee (The National Credit Union Administration Magazine, 2008).
Over the recent past, NCUA has experienced various challenges as a result of financial crisis. The financial crisis experienced in 2008 exposed problems to credit unions sectors causing a severe liquidity crisis. The downturn lowered the value and market for private-labels and depositors lost confidence in the banking system because of the institutions’ heavy investment in private securities. The decline in value of these investments resulted in financial institutions borrowing substantial amounts of short-term funds from other financial institutions other than the credit union in order to meet their liquidity needs. However, these options were cut short when lenders lost confidence in individual institutions and some lines of credit were suspended. Among the financial institutions that were affected were the United States Central’s short-term and long-term credit ratings. Also, in 2009 the Federal Reserve Bank of Kansas City was also affected by the financial crisis (Van, January 01, 2010). The management of failed credit unions exposed their financial institutions to increased operational, credit, liquidity, and concentration risks. These are the risks that have led to the failure of credit unions.
Operational risk may be defined as the risk of loss resulting from inadequate or failed internal controls. Management’s failure to control operational risk contributes the highest percentage to the failure of an institution. It can also create a channel for fraud due to inadequate system controls. Credit risk refers to the likelihood that a borrower will default or will not repayy a loan. Management’s failure to control for credit risk contributes to 58-85% of credit union failures. For instance, in 2009 Clearstar Financial Credit Union management originated and funded a number of loans that were poorly underwritten i.e. they were made to borrowers who had poor credit histories(National Credit Union Administration Annual Report, 1999). Management then merged these mistakes through delinquent loans and poor collection practices, contributing to the credit union’s failure. Liquidity risk refers to the risk that the credit union may not be in a position to cover member withdrawals because of illiquid assets. Credit unions should always ensure they have enough liquid assets as per the demands of the customers. A significant amount of the assets should be easily convertible to cash to cater for high demands in case of calamities. Some unions have been kicked out of business due to lack of liquid assets. For example, Ensign Federal Credit Union management relied on a $13 million deposit in order to fund credit union operations. However, during the financial crisis in 2009, the deposit was withdrawn and the credit union had no other funding sources in order to meet its members’ demands as well as operational expenses hence contributing to the credit union’s failure(Ellene Kebede & Curtis Jolly, 2010).
Concentration risk occurs, when a financial institution overexposes itself to certain markets or industries. While some levels of concentration may not be avoidable, the management should always put in place appropriate control, policies, and systems to examine the associated risks. NCUA has remained effective in supervising and regulating the operations of credit unions and corporate since its formation in 1970. During times of crisis, NCUA takes a variety of ways to resolve the failed institutions and maintain financial payment processing services for credit unions. In April 2009, NCUA passed a temporary waiver to allow institutions not meeting their minimum capital limits to continue providing services to credit unions (Van, 2007). The waiver allowed credit unions to use their capital levels on their December 2008 call reports in order to continue providing the core operational services to credit unions. Furthermore, it gave the Office of Corporate Credit Unions authority mandate to restrict or modify the use of capital waiver for various institutions based on safety and soundness. If it was not for the waiver, financial institutions that failed to meet the minimum requirements would have had to curtail operations, including payment system services and lending activities. As a result, the credit union system would have faced significant interruptions in its business operations leading to loss of confidence in other sectors of the financial system (Chee, 2011).
There are multiple financial indicators that can help to highlight differences in asset quality and liquidity between those unions that have already failed and the ones in operation well before failure. Such indicators may be useful to detect early distress in the credit union system. To compare the performance of financial institutions, CAMEL rating is able to demonstrate liquidity, earnings, management and asset quality. Return on assets is another indicator that can be used to measure a credit union’s financial performance based on the net income that a union makes as a percentage of its total assets. Liquidity refers to the sum of cash on hand or assets that can be readily converted to cash. A credit union has a high liquidity, if it is able to make payment on a short-time basis as per request of the customers. A credit union is likely to move out of business, if it has fewer liquid assets as compared to its peer group. NCUA has taken various steps to stabilize and reform the corporate sector though most of them are yet to be implemented. Those that have been implemented relate to improving the corporate governance, corporate structure, examination processes and guidance on concentration risk. Once all recommendations put forward by the auditors and examination agencies are adhered to, then NCUA will have fully improved in service delivery to credit unions and corporate.
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