NCUA Chairman Todd M. Harper at the NCUA’s Headquarters in Alexandria, Virginia.
As Prepared for Delivery on May 20, 2021
Thank you, Tom, Rick, and Justin, for your diligent efforts in bringing this final rule on derivatives before the NCUA Board today.
As the credit union industry grows and becomes more complex, the NCUA’s regulations must keep pace with that new reality. This final derivatives rule is a good example of the agency working to innovate and scale its regulations.
Since the adoption of the agency’s first derivatives rule in 2014, the NCUA and credit unions have learned what is necessary for maintaining a responsible derivatives program in the credit union system. And, this experience has allowed the agency to develop a revised rule that moves to a more principles-based approach.
Although the near-term economic outlook has improved a great deal in the last few months, credit unions likely face a prolonged period of very low interest rates. Short-term interest rates are expected to remain low for the foreseeable future. Longer-term interest rates have increased recently and are expected to edge higher. They will generally remain lower than pre-pandemic levels, suppressing already compressed net interest margins.
In the years ahead, a credit union’s ability to manage interest-rate risk will play a crucial role in its financial performance. As such, this rule is a timely and appropriate measure that ensures complex federal credit unions can manage a variety of interest-rate scenarios. It also provides a way for smaller credit unions, which demonstrate proficiency and obtain regulatory approval, to use simple derivatives to hedge their loan portfolios.
Increasingly, the credit union system has turned to mortgage lending, and the industry now has half of its assets in long-term real estate loans. A vast majority of those loans are at fixed rates. The savings-and-loan crisis taught us what happens when an industry lends long at fixed rates and borrows short. Problems can happen when a depository institution moves from a low interest-rate environment, like we are experiencing now, into a higher-rate environment.
In that regard, this final rule is forward-looking. More federal credit unions will gain access to the tools they need to manage interest-rate risk. So, this rule will help position credit unions for future success, provided they do so prudently.
While the final rule gives federal credit unions greater flexibility to manage interest-rate risk, we must also adopt appropriate guardrails to protect the system. Among these essential guardrails is regular credit union board training on derivatives. As I noted when this rule was first proposed, even “plain vanilla” derivatives are sophisticated financial instruments that require close monitoring.
Credit union board directors are the first line of defense for the Share Insurance Fund. If a credit union chooses to authorize the use derivative hedges, these stewards need to have a firm understanding of derivatives transactions, reinforced, from time to time, through regular training and briefings in order to conduct effective oversight.
Additionally, the final rule ensures that credit unions using derivatives must maintain strong internal controls, including the separation of duties to ensure effective governance. For example, under the final rule, duties for asset-liability management, financial reporting, derivatives execution and oversight, and collateral, counterparty, and margining management will be handled by different professionals within the credit union. This separation of duties is necessary to ensure the safe-and-sound operations of a derivatives program and to mitigate potential opportunities for insider fraud and abuse.
In conclusion, this forward-looking final rule will modernize the agency’s derivatives regulations and provide all complex federal credit unions with an important tool to optimize their earnings and preserve vital capital. It will also give federal credit unions the flexibility needed to manage interest-rate risk and strategically position themselves in the post-COVID economic recovery and beyond.
Thank you again, Tom, Rick, and Justin, for your good work. I now recognize Vice Chairman Hauptman for his remarks.