CUNA Comment Letter

Comments to Treasury on its Request for Comments on Restructuring the Financial Services Industry.

November 21, 2007

The Honorable Henry M. Paulson, Jr.
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Dear Secretary Paulson:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on the Treasury Department’s Notice and Request for Comments in connection with its review of the framework for the regulation and insurance of financial institutions. By way of background, CUNA is the largest credit union trade association in this country, representing approximately 90 percent of our nation's 8,500 state and federal credit unions, which serve nearly 87 million members.

In the context of the department’s review, we feel it is important to address several related matters of continuing significance for the credit union system. Credit unions are unlike any other financial institutions for several key reasons1. As Congress provided in the findings accompanying the Credit Union Membership Access Act of 1998:

(1) The American credit union movement began as a cooperative effort to serve the productive and provident credit needs of individuals of modest means.
(2) Credit unions continue to fulfill this public purpose....
(3) Credit unions, unlike many other participants in the financial services market, are exempt form Federal and most State taxes because they are member-owned, democratically cooperated, not-for profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means…..

1 Credit union products and services may closely resemble those of other banking institutions, but the differences between credit unions and other institutions, including in the areas of corporate ownership and control, are undeniable.

In addition to these factors, federal credit unions are the only financial institutions that operate under a federal usury ceiling, currently at 18% (depending on market conditions, the ceiling is set by NCUA at 15%-21%).

As these facts and congressional findings demonstrate, credit unions are distinctive and exceptional financial organizations. As a result and in order to preserve those differences -- which Congress has determined benefit the public -- the regulatory framework for supervising credit unions must reflect and facilitate those distinctions.

An Independent Regulator for Credit Unions Is Good Public Policy

The Treasury Department‘s request for comments follows the release of the report required of the Government Accountability Office under the Financial Services Regulatory Relief Act of 2006, which also examined federal financial institution oversight. Both the GAO study and the Treasury review raise the issue of regulatory consolidation, which we believe would have dire consequences for credit unions.

Integration of the federal banking regulators may be an effective way to increase efficiencies and cut costs. Such action may also enable capital markets to work more efficiently in the allocation of funds, providing expanded savings to meet private and public needs. However, unless credit unions were forced to become for-profit institutions, little efficiency would be accomplished by including credit unions under a combined bank regulatory schema.

NCUA acts as both regulator and insurer of credit unions and may serve as a lender to credit unions through the Central Liquidity Facility. Through this coordination of supervision and insurance under the administration of an independent agency, NCUA has effectively served the best interests of credit unions and their members as well as the public for the last 37 years.

There are several positive arguments that support the existing separate regulatory structure for credit unions: First, a separate system for banks and credit unions provides charter choices for institutions while imposing some checks and balances on arbitrary government authority. Second, we think that a separate credit union regulator promotes consumer interests and protection. Credit unions have generally not been part of the subprime debacle, as reported by NCUA Board Chairman JoAnn Johnson in her testimony to the House Financial Services Committee last month regarding the mortgage reform legislation, HR. 3915. We think there are several reasons for this, including the fact that as not-for-profit institutions, credit unions are motivated by the desire to serve their members -- not take advantage of them. We also think that while the independent regulation of credit unions may on the one hand encourage certain innovations, on the other hand it creates a regulatory environment that discourages involvement with uncertain products, including through affiliated organizations.

In addition, as Members of Congress, consumer groups, and periodic surveys of the financial services sector repeatedly note, credit unions offer more favorable e rates and fewer fees than banking institutions. They also provide practical, ongoing financial education to their members, which often helps consumers avoid financial pitfalls such as inappropriate loan offerings from other institutions.

There are a number of reasons why credit unions would be disadvantaged if financial institution regulation were consolidated. CUNA is concerned that the orientation of such an amalgamated agency would in all likelihood favor stronger and more affluent institutions – large commercial banks. The deposit insurance program would give the agency substantial control over all of the institutions, but especially over the relatively smaller credit unions. In time, CUNA fears this would erode the individuality of credit unions as a unique service-orientated movement.

Federal credit unions have not always had an independent regulator and have been overseen by several agencies successively. One such regulator was the Federal Deposit Insurance Corporation, which supervised federal credit unions from 1942 to 1948. The relationship between FDIC and credit unions was short-lived and acrimonious because the agency was preoccupied with regulating banks and did not have an interest in the credit union movement or the federal credit union charter. The CUNA president at the time, Mr. R.A. West, remarked that credit unions were “an orphan” at the FDIC. – a fate we fear would be repeated should the regulation of credit unions be folded into bank oversight.

There are a number of incidents from that time period that indicate the FDIC was not concerned with credit unions, such as in 1946, when the FDIC submitted an audit report to Congress declaring, “The supervision and examination of Federal Credit Unions was an extraneous function of the Corporation.”

In 1947, the CUNA Board of Directors wrote President Harry Truman asking that the regulation of federal credit unions be transferred from FDIC to an agency that “would be looked upon with more favor in the development of Federal Credit Unions.” In 1948, Congress created a new, solely credit union- oriented regulatory agency, the Bureau of Federal Credit Unions (NCUA’s predecessor), and removed credit unions from FDIC’s regulatory jurisdiction.

In more recent types, the immediate past Chairman of the FDIC, Don Powell, called for the taxation of credit unions, directly contradicting the position of President Bush which supports credit unions’ tax exempt status.

It is clear that consolidation of the regulation of credit unions with banks would not benefit credit unions or their members and any reorganization efforts should exclude NCUA, leaving it as an independent agency, regardless of other changes recommended to streamline the financial regulatory system.

The NCUSIF Should Remain Independent

Since 1970, the National Credit Union Administration has provided federal share insurance for credit unions. The NCUSIF avoided the failure experienced by the Federal Savings and Loan Insurance Corporation (FSLIC) in 1989, and the insolvency of the Bank Insurance Fund (BIF) in 1991-1992 (see attached table), due to the unique structure of credit unions and the insurance fund.

Credit unions would not support the transfer of NCUA’s insurance functions to a general deposit insurance agency. We believe deposit/share insurance administration and credit union supervision substantially overlap and should not be separated. Share insurance gives rise to the moral hazard of excessive risk taking, requiring NCUA to have supervisory authority so as to protect the NCUSIF.

We also believe it would be inappropriate to include the NCUSIF in any plan to consolidate the banking regulators due to the significant organizational and incentive differences between credit unions and other depository institutions. The major difference between credit unions and banks is credit unions’ cooperative structure, which makes it less feasible for their officials to pursue and benefit from either corrupt lending or excessive risk taking strategies. Moreover, the cooperative form limits any effort to expand rapidly the credit unions deposit/asset base in an attempt to increase risk taking.

Further, the credit union federal insurance system differs from the FDIC insurance model in three important ways, making combination problematic. First, since 1985, credit unions have funded what amounts to a deposit insurance premium ‘prepayment’ system. Insured credit unions are required to hold one percent of their shares on deposit with the NCUSIF. Income from this “Capitalization Deposit’ is assigned to meet NCUSIF’s operating expenses and to cover the costs of closing insolvent credit unions. To supplement this income, NCUA may levy additional assessments as it deems necessary. Establishing this fund of prepaid premiums aligns the incentives of credit unions to restrain NCUSIF loss exposure.

Second, the NCUSIF-insured credit unions coinsure one another. All credit unions insured by NCUSIF are jointly responsible for curing any shortage the fund might develop. This responsibility turns movement net worth into a supplementary off-balance sheet fund of insurance reserves on which NCUSIF can draw as needed. Besides greatly expanding the effective size of the NCUSIF fund, it strengthens incentives for credit unions to cross-monitor one another.

Third, the insurance deposit is permanent capital that cannot be removed. So even in the event of a large number of credit union failures that exhausted the capitalization deposit, NCUA would be required to levy a supplemental assessment on the remaining credit unions. This limits backup taxpayer guarantees of NCUSIF coverage to truly catastrophic situations.

In general, banks take on greater risks than credit unions in both their investment and loan portfolios. The credit union movement may be concerned that consolidation of the two insurance funds may be an attempt to prop up the DIF in a time of massive collateralized debt write-offs experienced by many banks today.

For the aforementioned reasons, CUNA would strongly oppose folding NCUA into a super-regulatory agency or the removal of NCUA’s insurance function. Such consolidation would only reduce credit unions involvement in the U.S. financial system, to the detriment of consumers, without providing any substantial economic or governmental efficiency.

Tax Exempt Status of Credit Unions Is Essential

Credit unions were quite concerned earlier this year when the department issued a report, “Treasury Conference on Business Taxation and Global Competitiveness” in July that listed, among 14 items, the exemption of credit union income as one of “Major Preferences Under the Current Corporate Income Tax” that was Part of Table 2.1: “Special Provisions Reduce the Corporate Tax Base By Up to 20%,” given the relatively small amount of revenue that repealing the exemption would garner for the U.S. Treasury. We were also concerned about the letter also this summer from then Acting IRS Commissioner Kevin Brown to the Senate Finance Committee as part of the IRS’ report on “Key Current Compliance Issues.” That letter stated that “a blurring of the line between the tax-exempt and commercial sector” as the number two ‘compliance” issue. Included in this discussion was the wrongful portrayal of credit unions as “hard to distinguish from for-profit banks” – thus raising doubt regarding the justification for credit unions’ exemption from federal income taxes. As we did at the time, we question why the credit unions’ tax exemption was even brought up in either of these contexts, given the Administration’s commitment to supporting credit unions on this issue. Despite repeated opportunities to remove credit union’s tax exemption, Congress has not sought to do so or to revise the findings of the Credit Union Membership Access Act, which reinforce why the tax exemption for credit unions continues to be justified.

Dual Chartering Benefits Institutions and the Public

The request for comments raises questions regarding dual chartering. CUNA is committed to a viable dual chartering system and opposes any unnecessary restrictions on institutions moving from state to federal regulation or vice versa. Several states permit private insurance for credit unions, and we support credit union’s ability to determine for themselves whether federal or private insurance is in the best interests of their members, as long as members approve such a decision following full and fair disclosure of the ramifications..

PCA Reform is Critical for Credit Unions

Earlier this month, a final rule implementing the Advance[d?]s Approaches of the Basel II Accord was approved and the regulators are developing a proposal that would provide a standardized approach as an option for institutions that are not under the Advanced Approaches.

In light of these developments, it is appropriate for Congress to consider prompt corrective action reform for credit unions. Credit unions are the only group of financial intuitions that have statutory net worth requirements as opposed to capital requirements that are set by the regulator.

The NCUA Board has developed a proposal that has been included in the 2007 Credit Union Regulation Improvements Act, H.R. 1537, to replace the current net worth requirements with standards that are designed to more fully reflect credit unions’ material risks.

Such a change would be sound public policy as it would promote safety and soundness, provide for more effective net worth management and improve asset risk evaluation by replacing the current, less precise net worth requirements with a structure that more closely monitors risk.

We feel that we have been very close to agreement on this issue in the past with Treasury officials, and we urge the department to support this significant regulatory goal for credit unions.

Regulatory Relief for All Financial Institutions In Certain Area is Overdue

One of the most important things this Administration could do for all financial institutions, which would promote regulatory improvement and marketplace efficiencies, would be to advocate lasting regulatory relief that starts with the Bank Secrecy Act. This summer, CUNA established a Bank Secrecy Act Task Force, chaired by Eugene Foley, President and CEO of Harvard Employees Credit Union. The Task Force has met several times this fall and is convening in Washington, DC next month to meet with regulators and congressional officials to discuss BSA concerns and recommendations. We look forward to sharing our report with appropriate officials at the U.S. Treasury Department, FinCEN, NCUA and others.

Proper Role of Financial Regulators

The request for comments raises several questions such as what should be the key objectives of financial intuition regulators. We think the objectives are generally three-fold. Certainly safety and soundness is a critical consideration. However, safety and soundless cannot come at the price of unreasonable limitations on innovations, and there must be a balance of sufficient caution and risk mitigation with adequate latitude for institutions to experiment and respond to the needs of consumers. A third objective should be to safeguard reasonable consumer interests. However, unless specifically tasked by Congress to address consumer protection, this is an area that some regulators have generally avoided. The current regulatory framework can be improved if the need for safety and soundness is combined with flexibility to innovate and if regulators will routinely assess how their rules and actions impact consumers.

In closing, we would welcome the opportunity to discuss our comments further and thank you for the opportunity to express our views.


Mary Mitchell Dunn
Senior Vice President
and Deputy General Counsel