<p>WASHINGTON – A recent study from the Filene Research Institute, Differences in Bank and Credit Union Capital Needs, found credit unions have significantly lower capital needs than do banks. The study also found that credit unions, in general, fare better in economically bad times than banks. "I agree with the study that, broadly speaking, credit unions have a lower risk profile than do banks," said Keith Leggett, Senior Economist for the ABA. "With the caveat that they used historical data and it's very hard – particularly now – to make predictions based on historical data." The study researchers, David Smith of Pepperdine University and Michigan State's Stephen A. Woodbury, looked at unemployment levels in every state and the District of Columbia during the years 1986 – 2000 and levels of charge-offs and loan delinquencies at both credit unions and banks during the same period. Based on this data, Smith and Woodbury concluded bank loan delinquencies are more than twice as sensitive to the business cycle as those of credit unions and credit union losses are less than two thirds as sensitive to the business cycle than those of banks. A one point increase in the unemployment rate is correlated with a 23.7% increase in bank delinquencies and only a 10% increase in credit union delinquencies, the study found. Likewise a one point increase in the unemployment rate is correlated with a 30.8% increase in charge-offs at banks over a one year period while credit unions experienced only a 19% increase in charge-offs over a one year period. "A mild recession (2% increase in the unemployment rate for one year) would lead to a $11.8 billion increase in bank charge-offs and a $441 million increase in credit union charge-offs," the study reported. Jim Blaine, CEO of State Employees' Credit Union in Raleigh, North Carolina, hopes that the study will help start a more serious conversation among credit unions and regulators, both state and federal, about credit union capital needs and credit union capital levels. "People's eyes really tend to glaze over when we talk about capital," Blaine said, " but we really need to start a conversation about the topic." Blaine believes most credit unions are overcapitalized which means, in Blaine's view, they have accumulated too much of their members money – money for which, in any other financial institution or business, they would be held accountable. " Capital is a cost of doing business," Blaine said. "Few people understand that, but it's true. In the rest of the world if you have too much capital you are either bought out or fired. In the credit union world, you are praised." The mix of different federal and state regulations governing credit union capital is one reason credit unions are confused about it, Blaine said. Low-income and corporate credit unions have been granted permission to raise capital through a variety of different strategies, but the majority of credit unions can only raise capital through retaining earnings, a method Blaine criticizes as too slow and that, most crucially for him, forces credit unions to retain more of their members' money than they need. "My basic concern in this is that the current capital structure means that we hold on to too much of our members' money," Blaine said. "Money they need for car notes, sending their kids through school, savings. They need that money more than we do." Blaine is widely known for his efforts to give the majority of credit unions alternative strategies to raise capital than retaining earnings. In July of 2000 Jerrie Lattimore, North Carolina's credit union supervisor, agreed with Blaine that a $1 million equity investment from Self Help Credit Union was, in fact, capital. NCUA has not agreed, and Blaine hopes the Filene study will continue to raise the issue's profile and help lower the capital requirements for credit unions. Public Policy Implications Indeed, the study points directly toward lowering credit unions' capital requirements and comes to the very edge of actually recommending such a course. "Banks and credit unions differ significantly in their sensitivity to business cycles," the study pointed out. "These differences can provide legislators and regulators with an appropriate rationale to rethink the basis for capital requirements, and judge each type of financial institution on the basis of its capital needs. For credit unions, the research opens avenues to achieve reasonable capital levels without creating new infrastructure or capital programs," the report added. NASCUS Vice President Jonathan Lindley said the study could provide more impetus for credit unions to start lobbying to reduce their capital requirements, but expected that their need for alternative capital strategies would continue to climb. "The battle to reduce credit union capital requirements is a long-term struggle," Lindley said. "Credit unions are going to need capital alternatives much sooner than that." The study cites differences in credit union and bank governance as one reason for the risk differential. Bank boards of directors are motivated to increase returns to the shareholders who elect them and this translates into bank management motivation to take greater degrees of risk. Credit union boards of directors, the study contrasts, are elected on a one-member-one-vote basis and this changes the leadership's motivations. "Their primary incentive is to satisfy members which creates multiple objectives, instead of a single goal to generate profits," the study said. "Credit unions have no separate group of stockholders and no ability to use stock options to motivate management to take potentially profitable risks," the study said. But Leggett maintained that changing economic circumstances, credit union charters and credit union activities could combine to change credit union risk profiles. He pointed out that credit unions have traditionally based their fields of membership in employee groups that have helped insure a close bond between the employer, credit union members and credit unions. Community charters are becoming more popular, he said, and under a community charter a credit union may have less assurance that its members will all be employed. "Credit unions have also begun to diversify their portfolios to a greater extent," Leggett said. "Taking on more real estate and business loans. Those by definition will expose them more directly to economic risks," he said.</p>