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This edition was written by Elijah Asdourian, Georgia Nabors, Lorae Stojanovic, and Louise Sheiner.
Rising interest rates decrease the value of long-term assets on balance sheets, creating unrealized losses. Using financial data from the first quarter of 2023, Grant Rosenberger and Peter Zimmerman of the Cleveland Federal Reserve find that accounting for all unrealized losses would have lowered the net worth of the credit union industry by 40%. As a result, the industry’s status would have dropped from “well-capitalized” to “adequately-capitalized” according to supervisory standards set by the National Credit Union Administration. A large portion of these unrealized losses came from fixed-rate real estate loans, and losses were most extreme for large credit unions. However, credit unions were less affected by unrealized losses than commercial banks, and a majority of credit union deposits are insured, reducing the likelihood of a run. The authors conclude that credit unions were less susceptible to risk from unrecognized losses than commercial banks.
Previous literature has pinned the 2007 subprime mortgage crisis on the Community Reinvestment Act (CRA) of 1995, which encouraged banks to lend more to low-income households in their local areas. Using Census and mortgage data, Kenneth Brevoort of the Federal Reserve Board finds that the 2007 subprime mortgage crisis was not due to the CRA. He shows that loans for low-income households increased after 1998, but not mainly in lenders’ local areas, as the CRA tried to incentivize. Instead, Brevoort argues that this increase in low-income loans post-1998 was due to a collapse of the subprime loan market, in which many large nonbanks went bankrupt and traditional banks took over the bulk of the market for subprime loans to low-income families, thus increasing the volume of bank-originated subprime loans.
“One of the greatest threats to smaller banks' business models comes not from any one regulatory reform initiative or changed expectations in supervision but rather from the cumulative impact. The tendency of policymakers can be to add new regulations, guidance, and supervisory expectations, becoming more and more prescriptive and creating an ever-larger body of material that a banker must digest and apply over time. At some point, however, this overwhelming body of material (more than 5,000 pages just last year) is simply undigestible by the individual or small staff at a community bank primarily responsible for making sure the bank meets all relevant expectations..." says Michelle Bowman, member of the Federal Reserve Board of Governors.
"...I think we need to focus on effective prioritization of risks, particularly for the smaller and community banks. While we should not ignore new and evolving risks, we know that certain core risks are always important in the sound management of a bank—for example, credit risk, liquidity risk, interest rate risk, succession planning, and information technology. Particularly in the wake of some supervisory gaps in the lead-up to the failure of Silicon Valley Bank, one response by bank examiners could be to simply flag as many issues as possible. However, we must be very careful not to assess the effectiveness of the supervisory process by the quantity of findings documented in examination reports. Quantity alone does not tell us that we have identified the right issues or taken appropriate steps to ensure these issues are addressed in a timely way.”
The Brookings Institution, 1775 Massachusetts Ave NW, Washington,DC, 20036
