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Why credit unions should consider stress testing

September 26, 2014
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Within the financial industry, the word “regulation” often receives a mixed reaction. Viewed as a necessity by many, it draws opposition from others. Last week, the biggest names in banking addressed their balance sheets, and announced the results of their mid-year stress testing practice. The “big guys” like Citigroup, Bank of America, Wells Fargo and others are required under the Dodd-Frank financial laws to release their findings publicly, as a step to prepare for the Fed’s annual check-up in the spring.

What’s been mostly out of the mainstream news cycle, though, is the effects of regulation following the financial crisis on the community banks– specifically, credit unions. Earlier this month, as Congress came back in session, the political news site TheHill.com covered the issue of pending policies on CUs, with an op-ed titled, “Congress: ‘Measure twice, cut once’ on proposed risk-based capital rule.” The piece was written by B. Dan Berger, the president and CEO of the National Association of Federal Credit Unions (NAFCU).

The regulation currently on the table for Congress is a proposed rule from the National Credit Union Administration (NCUA) on risk-based capital. As proposed in January, the rule (read a summary here) would require federally insured credit unions with more than $50 million in assets to maintain a risk-based capital ratio of 10.5 percent or above, and pass both net worth ratio and risk-based capital ratio requirements, in order for the institution to be classified as well capitalized. This could mean significant increases in capital for many credit unions.

Berger argues that further regulation on credit unions would prove detrimental. He cites that since the implementation of Dodd-Frank, “more than 800 Main Street credit unions have shut their doors.” Following numerous discussion sessions this summer on the rule, the NCUA has indicated that significant changes will need to be made to pass the proposal, and perhaps even a second comment period for credit unions to voice their concerns on the rule.

So what’s next? Regardless of this particular rule’s implementation or not, those in credit union management should see stress testing in their crystal balls. For those institutions that are not already proactively managing their risk with a method of stress testing, examiners likely have encouraged them to start. While credit unions don’t necessarily have the same challenges as the nation’s largest banks, there are a few benefits of conducting stress testing that are universal, including:

    An institution can better understand where the loan portfolio may be overexposed in terms of concentration, either in type of real estate, geography or other factors,

    Better identify which types of loans within a certain concentration have more potential for troubles and

    Identify and target potentially problematic loans for additional scrutiny, such as more frequent rent-roll reviews or owner-income updates.

    Implementing an efficient and effective stress testing process now not only benefits the credit union in the short-term – by identifying pockets of their portfolios that are especially vulnerable to swift changes in the economy – but may satisfy potential regulatory requirement headaches in the future.

    For a comprehensive look at stress testing as a practice and a risk management tool, download this complimentary whitepaper, “Stress Testing: The Who, What, When & Why.”

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Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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