‘Interest Rate Risk at U.S. Credit Unions’: Insights & Opportunities

A new interest-rate study on the credit union industry published last week by the Federal Reserve Bank of Cleveland reveals some interesting findings and opportunities that credit union leaders can be aware of as they navigate 2024 and beyond.

In “Interest Rate Risk at U.S. Credit Unions,” the report shows that while rising interest rates pose a risk to credit unions, their unique characteristics make them more resilient than banks.

However, continued monitoring and research are necessary. Rising interest rates still pose a risk, potentially leading to losses similar to those experienced by Silicon Valley Bank in 2023:

• If forced to sell assets immediately after a significant interest rate rise, the credit union industry’s aggregate net worth could have fallen by 40 percent in first-quarter 2023.
• Larger credit unions faced the most severe potential losses.
• Deposit insurance protects most depositors, limiting the risk of a Silicon Valley Bank-style run on credit unions.
• Credit unions’ deposit rates are less sensitive to market interest rates, offering a buffer against rising rates.

Nonetheless, credit unions overall appear more resilient to interest rate risk than banks. The study emphasizes that unrealized losses are potential losses if assets were sold immediately — not actual losses. The authors acknowledge limitations in their analysis, calling for further research.

Financial Health, Hypotheticals, and Larger CUs
A deeper dive indicates:

• The hypothetical 40-percent decline in aggregate net worth represents a substantial drop in the industry’s overall financial health (a hypothetical scenario based on specific assumptions that might not reflect the actual impact in a real-world situation).
• These potential losses were not evenly distributed across the industry in the analysis. Larger credit unions were estimated to face more severe potential losses compared to smaller ones. This could be due to their typically larger investment portfolios containing assets that are more sensitive to interest rate fluctuations.

The report doesn’t specify the exact interest rate increase scenario used for its estimation. Understanding the assumed rate change would provide more context on the severity of the simulated stress test. The analysis focuses on the impact on net worth, which is the difference between an institution’s assets and liabilities. While a significant decline in net worth raises concerns, it’s not the sole indicator of financial stability.

Potential Future Opportunities for Credit Unions
Based on the report’s analysis and the broader financial landscape today, some potential future risks can be inferred. It gave further analysis on:

• Continued interest rate fluctuations — While the report focuses on a specific stress test scenario, the ongoing volatility in interest rates remains a concern for credit unions and banks. Their investment/asset portfolios may be sensitive to any further increases.
• Competition from banks — As banks adapt to the changing interest rate environment, they might offer more competitive products and services, potentially attracting customers away from credit unions. This could be particularly challenging for smaller credit unions with limited resources.
• Regulatory changes — Regulatory changes in response to the evolving financial landscape could impact credit unions’ operations and profitability. It’s crucial for credit unions to stay informed and adapt to new regulations effectively.
• Technological disruption — The financial industry is constantly evolving, and new technologies could disrupt traditional credit union operations. Embracing technological advancements and adapting business models will be crucial for credit unions to remain competitive in the future.
• Economic downturn — A potential economic downturn could lead to increased loan defaults and reduced loan demand, impacting credit unions’ income streams and potentially raising credit risk. Maintaining strong risk management practices will be essential in such scenarios.
• Cybersecurity threats — As cyber threats become more sophisticated, credit unions need to invest in robust cybersecurity measures to protect customer data and financial assets.

It’s important to note that these are just potential future risks, and the actual impact on the credit union industry will depend on various factors and how effectively they can adapt and mitigate these risks.