Are CUs Using Their Ultimate Competitive Advantage?
It’s safe to conclude that the cooperative model remains robust and viable today.
The recent financial crisis has shone a bright light on the differences between the banking sector and the credit union system.
As we look at the future of the credit union system, we should re-examine the cooperative principles upon which the system was founded to understand how these principles contrast with the basic tenets of banks structured as stock entities.
We must also ask whether these cooperative principles remain relevant and valid as the foundation of the credit union system today, and how well the system has embraced those principles.
The International Cooperative Alliance defines a cooperative entity in terms of the seven cooperative principles:
1. Voluntary, open membership;
2. Democratic member control;
3. Member economic participation;
4. Autonomy and independence;
5. Education, training, and information;
6. Cooperation among cooperatives; and
7. Concern for the community.
One can immediately identify key differences between stock banks and the credit union model by comparing the second, third, and fourth principles against the typical stock bank structure.
While the equity ownership interest in a stock bank is held by shareholders whose relative voting power depends upon the number of shares owned, a cooperative is owned and controlled by its members, each having one vote.
In fact, most large banks have significant institutional ownership, meaning the equity ownership is concentrated in the hands of a limited number of shareholders.
While the typical stock bank seeks to generate a profit for its shareholders—whose interests may not ultimately be aligned with interests of the bank’s customers—the cooperative entity returns any economic benefits to its members by reinvesting in the cooperative, paying member dividends, or offering enhanced services.
The autonomy and independence cooperatives enjoy can also be contrasted with the loss of control often associated with a stock bank taking on major shareholders.
One key difference to emphasize: For a credit union, the member is the customer and the owner. For a typical stock bank, the retail customer is not the owner.
So the differences, at least in principle, seem clear. But are the cooperative principles, which were originally developed in 1844 by the Rochdale Society of Equitable Pioneers in England, still relevant and viable today?
Does the cooperative model offer real advantages when compared with the stock bank model?
NEXT: Stock Bank Model
Let’s briefly examine two criticisms of the stock-ownership model as it has been applied in retail and investment banking. It encourages:
1. Short-term thinking. This criticism of the stock ownership model, particularly in regard to publicly traded corporations, surfaced about 40 years ago in the Harvard Business Review. It contends that the public equity ownership model pressures bank management and directors to achieve quarterly earnings targets to support the stock price.
2. Excessive risk-taking due to the need to achieve near-term objectives. Nassim Taleb, author of “The Black Swan,” has said that Wall Street has encouraged a series of “asymmetric incentives” whereby the employees of some large trading firms are motivated to take large, long-term (five years or longer) risks with the firm’s capital to achieve short-term (one-year) bonus targets.
Taleb and others have argued this critical mismatch in incentives was a key factor in causing the recent financial crisis.
CU business model faces many challenges
It’s dangerous to be complacent and to simply assume credit unions will thrive for decades to come. Real threats exist to the credit union business model in its current form, including:
Macroeconomic trends. The recent financial shocks to the global economic system were the most severe since the Great Depression. But what happens next? Will the severity of the shock result in permanently altered behavior by consumers, businesses, and governments?
Interest rates. As the savings rate declined and consumer debt increased from 1980 to 2007, interest rates declined. An entire generation of business leaders has never had to manage during a prolonged cycle of rising interest rates—but they soon might.
Government debt. The current U.S. debt level isn’t sustainable. Forthcoming corrective actions will further reinforce the concept that the “new normal” will be very different from the recent past.
Spreads. Credit union gross spread declined steadily from 1992 to 2007 by roughly 100 basis points relative to assets. Although credit unions’ return on assets has bounced back somewhat, the long-term trend remains in overall decline.
The cooperative model, as embraced by credit unions, seems to provide built-in protections against the potential weaknesses of the equity-ownership model.
During the recent financial crisis, the U.S. credit union system (despite corporate credit unions’ woes) was, by and large, a model of good practice, avoiding the excesses of subprime and Alt-A lending (nonprime loans often granted with limited documentation).
The credit union system was a stabilizing, rather than de-stabilizing, force in the economy. In part, this can be attributed to the democratic nature of the system, which has not been built upon asymmetric incentives.
The cooperative model also gives management and board members the ability to take a truly long-term perspective when determining what’s in the best interests of members and the institution.
Recent history suggests the cooperative model, as embodied by the credit union system, withstood the test of the financial crisis.
The credit union system did not cause or even contribute to what’s now called the Great Recession, but rather should be seen as an antidote to the practices that led to the worst financial crisis since the Great Depression.
It’s worth remembering that Congress passed the Federal Credit Union Act in response to the Great Depression.
It’s safe to conclude that the cooperative model, in essence, remains as robust and viable today as it was 80 years ago. However, it’s important to question whether the credit union system today fully embraces its cooperative principles in practice.
For example, democratic member control is a wonderful concept. But is it truly being practiced if a credit union attracts only a small portion of its members to an annual meeting?
Is it fully realized if a board of volunteer directors has minimal turnover and few directors under the age of 50?
As we consider a future vision for the credit union system, now is an ideal time to recognize that the cooperative principles are the ultimate competitive advantage differentiating credit unions from banks.
At the same time, we should be our own worst critics and identify how we can embrace those principles more fully in everyday practice.
JOHN LASS is senior vice president of Strategy & Business Development at CUNA Mutual Group.