Primary Risks
Each of the seven risk areas can affect a credit union’s earnings. These risks are:
Credit Risk
Credit risk is the risk of default on expected repayments of loans or investments. A credit union experiencing rising loan losses will need to fund the ALLL account to cover anticipated losses. The resulting charge to the PLLL account will reduce earnings.
Interest Rate Risk
IRR is the risk that changes in market rates will adversely affect a credit union’s capital and earnings. A credit union’s earnings may be negatively affected if its cost of funds rises faster than loan and investment yields.
Liquidity Risk
Liquidity risk is the current and prospective risk to earnings or capital that arises from a credit union’s inability to meet obligations when they come due, without incurring material costs or unacceptable losses. For example, a credit union may need to borrow money or sell assets, such as investments, to meet liquidity needs. Both of these options have related costs and can strain earnings through losses on the sale of assets and lower future earnings.
Compliance Risk
Compliance risk is the current and prospective risk to earnings or capital arising from violations of, or nonconformance with, laws, rules, regulations, prescribed practices, internal policies and procedures, or ethical standards. Compliance risk can expose a credit union to fines, legal and litigation fees, civil money penalties, payment of damages, and the voiding of contracts, all of which may reduce earnings.
Transaction Risk
Transaction risk is the risk of fraud or operational problems in transaction processing that results in accounting write-offs or an inability to deliver services, remain competitive, and manage information. These outcomes and related corrective efforts can reduce a credit union’s earnings.
Strategic Risk
Strategic risk is the current and prospective risk to earnings or capital arising from adverse business decisions, improper implementation of strategic plans, or lack of responsiveness to industry changes. For example, if management fails to plan for sufficient resources to implement business plans or fails to offer competitive products and services, it may result in weak or negative earnings.
Reputation Risk
Reputation risk is the current and prospective risk to earnings or capital arising from negative public opinion or perception. A loss of member confidence and withdrawal of member shares may have an impact on a credit union’s earnings. For example, following an incident impacting public perception, a credit union may have to spend unbudgeted funds on a marketing campaign to counteract a perceived negative image.
Last updated on October 1, 2020
