Ito: Aim for earlier – not later – adoption of ‘S’ in CAMEL
June 14, 2016 -- Pointing out that 16 states have already adopted an “S” for “sensitivity to market risk” in their state CAMEL ratings – and at least five more are considering doing the same – NASCUS President and CEO Lucy Ito urged the NCUA Board to adopt the same rating for federally insured credit unions “earlier rather than later.”
In a letter to Board Chairman Rick Metsger and Member J. Mark McWatters, Ito noted that the agency is considering adopting the rating for federally-insured credit unions by year-end 2018.
“NASCUS and State supervisory agencies encourage NCUA to consider earlier adoption of ‘CAMELS,’” Ito wrote. “We again note that the separation of the “S” component does not require a credit union to develop additional management system enhancements where market risk is already appropriately identified, measured, monitored and managed as part of the ‘L’ component.”
The NCUA Board is scheduled to hear a “board briefing” at its open meeting Thursday on the subject of adding an “S” for “sensitivity to market risk” to the agency’s own CAMEL rating system for federally insured credit unions.
The NASCUS leader wrote that in states that have adopted CAMELS, regulators and credit unions report positive outcomes with nearly no additional regulatory burden. She stated that, in practice, state supervisors have continued to use the same examination procedures for assessing liquidity and interest rate risks. However, she wrote, by rating the “L” and “S” components separately—rather than in a combined component—state regulators have been able to provide better information to credit unions to clearly delineate analysis between liquidity risk and interest rate risks.
“From a credit union perspective, an ‘S’ rating is no longer masked by a stronger ‘L’ rating nor is an ‘L’ rating ‘dinged’ by a weaker ‘S’ rating; conversely, an ‘L’ rating is no longer masked by a weaker ‘S’ rating nor is an ‘S’ rating ‘dinged’ by a weaker ‘L’ rating,” she wrote.
Noting that earlier rather than later adoption of “S” is prudent, Ito wrote that state examiners (“and NCUA examiners, to be sure”) have observed that the extended low-yield environment continues to encourage greater risk-taking by financial institutions. “Across the nation, historically low net interest margins have led some credit unions and their bank peers to ‘reach for yield’ by increasing their holdings of longer-duration assets or by engaging in other forms of increased risk-taking to maintain earnings,” she wrote.
Ito added that the anticipated rising rate environment may adversely affect earnings, net worth, net economic value as well as the market value of liabilities. “With investment income, loan income, and share dividends all being interest-sensitive, credit union earnings may be affected,” she stated. “In short, it behooves credit unions and their regulators to monitor ‘sensitivity to market risk’ separately from liquidity risk before rates start to rise—not after the fact,” Ito wrote.