Richard Anderson, Vice President of the Federal Reserve Bank of St . Louis, and Yang Liu, a Senior Research Associate also with the Federal Reserve, examine how competition between credit unions and banks has evolved since the 1998 Credit Union Membership Access Act relaxed membership regulations for credit unions.
Arch Enemies Lock Horns
Banks and credit unions are aggressive competitors. And as it is with any industry where firms compete, each side points fingers saying that the other has an unfair advantage. At its core, the issue for bankers is whether a federal tax exemption tilts the competitive balance toward credit unions and away from banks, particularly community institutions. Banking industry supporters have long asserted that credit unions possess an advantage because they are exempt from federal income tax. State-chartered credit unions became exempt in 1917, federal credit unions in 1935. Although the exemption reduces credit unions’ cost of capital by approximately 40% relative to a fully taxed environment, several thousand small and medium-size banks are organized for tax purposes as Subchapter S corporations and are similarly exempt from federal income taxes.
Congress has been clear regarding the social purpose of the credit union exemption: “Credit unions are exempt from federal taxes because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means.” The words “modest means,” not defined by Congress, often have been interpreted as synonymous with lower- and middle-income wage earners.
The banking industry argues that they serve larger numbers of low- and middle-income households than credit unions. Credit unions counter that the banking industry serves more low-income customers because it is larger. And why should credit unions turn away eligible higher-income persons who wish to be members?
Credit Unions vs. The Banking Industry
Credit unions compete primarily with each other and with community banks (those banks with assets of $10 billion or less). At the end of September 2012, although the nationwide numbers of credit unions and all commercial banks were approximately equal — 7,030 for credit unions and 6,170 for all banks — credit unions in the aggregate held $1 trillion in assets and banks held $13 trillion.
Most credit unions and banks are small. At the end of last September, 97% of credit unions and 91.5% of banks held less than $1 billion in assets. Further, about 50% of the credit union industry’s assets but only 10% of the banking industry’s assets were held by small institutions (those with less than $1 billion in assets).
During the past 15 years, the banking and credit union industries have experienced remarkably similar trends. For example, the number of banks has decreased 30%, while total assets have increased 140%. The number of credit unions has decreased 36%, while total assets have increased 160%.
The Credit Union Industry Today Looks Nothing Like It Did 50 Years Ago
By the end of September 2012, there were approximately 2,710 state chartered credit unions and 4,320 credit unions chartered by the federal government. Credit unions had 96 million members, representing more than half of American families, and provided 16.7% of the country’s outstanding consumer credit. Credit unions have become a significant force in the home-mortgage and small-business lending markets, too.
When it comes to delivering retail financial services to common American households, credit unions and community banks continue to grow more similar. A 2006 study of 14 million credit union members concluded that the distribution of their incomes closely resembled the income distribution of the nation as a whole. Because most credit unions offer a full range of financial products and services, some have suggested that larger credit unions are effectively the equivalent to banks, but with one exception: banks can issue equity to raise capital, while credit unions cannot.
The researchers cite studies confirming that (1) rates on deposits at banks and credit unions move together, (2) credit union lending to small businesses partly displaces bank lending, and (3) credit union lending has been steadier through business cycles, including the recent financial crisis, than bank lending.
A series of studies have concluded that during 1989-2001, the presence of one or more credit unions in a county tended to reduce the number of banks and competition among the existing banks.
Community Charter Stretches Definition of ‘Common Bond’
Membership in a credit union is governed by its “field of membership” (FOM). Each FOM is composed of one or more groups of persons who share a “common bond.” Prior to 1982, federal regulations permitted only single-group FOMs for federally chartered credit unions. In 1982, federal regulators first allowed FOMs that included more than a single occupational or associational group. Then in 1983, they permitted FOMs for individual credit unions that included both occupational and associational groups. On August 7, 1998, then President Clinton signed the Credit Union Membership Access Act, which amended federal law to explicitly permit multi-group FOMs.
Since January 1999, multiple-group federal credit unions have added 151,000 groups that contained 29 million persons at the time they were approved. Of the 151,000 groups, 89% contained 200 or fewer people, while 806 groups contained at least 3,000 people.
The largest groups were large indeed. In 2005, Georgia United FCU added the 367,000 employees of the Catholic archdiocese of Atlanta. In 2006, South Florida Educational FCU added the 370,000 students attending Miami-Dade public schools. In 2007, the Pentagon FCU added the 300,000 persons in the Military Officers Association of America. In 2012, Logix FCU added 325,000 members of the California Teachers Association.
The Backdoor Loophole
Because some multiple-group associational credit unions include in their FOM certain professional, social and civic associations that accept anyone as a member, the number of their potential members is limited only by the U.S. population. The Pentagon Federal Credit Union, for example, includes several associations that offer membership to anyone for a nominal fee.
At New Jersey’s Affinity Federal Credit Union, for a one-time $25 fee, any resident of New York, New Jersey or Pennsylvania can join the New Jersey Coalition for Financial Education and become a member of the credit union.
Utah’s HeritageWest Credit Union offers membership to all people who contribute $10 or more to the “We Promise Foundation” of its parent, Chartway FCU.
Thrivent Financial for Lutherans, a mutual organization. As of this writing, Thrivent Financial for Lutherans’ web page offers for $19.95 an “associate membership” to anyone who “provides support for strengthening the membership efforts of Thrivent Financial for Lutherans.” The membership requires no purchase of products or services, but the web page notes that the $19.95 annual membership fee “may be waived when you purchase a product from a Thrivent Financial affiliate or subsidiary, such as a Thrivent mutual fund product or Thrivent Federal Credit Union product.”
In addition, some federal credit unions operate in multiple states. Noteworthy are the $6.9 billion Security Service Federal Credit Union, San Antonio, Texas, with 70 locations in three states, and the aforementioned Chartway, with 64 offices in 10 states. These credit unions, with complex FOMs, were created when federal regulators used broad emergency authority to enable the purchase and assumption of an insolvent credit union by a solvent one. Under this authority, the acquirer and acquired credit unions may be in different states, and the acquirer may retain the FOMs of the acquired in addition to its own.
Three federal credit unions bought assets from banks during 2012. One of the more closely watched was the purchase by GFA Federal Credit Union (a community charter) in Gardner, Mass., of Monadnock Community Bank in Peterborough, N.H., a shareholder-owned savings bank. At the outset, some analysts believed that it would be difficult for a credit union with a federal community charter to purchase a bank 25 miles away. That difficulty seems to have been resolved… but perhaps at the expense of credit unions further resembling banks.
Researchers Can’t Spot Anything Afoul, So The Game Goes On
Have the combined effects of the exemption from federal income taxes plus the multi-group expansion possibilities permitted by community charters tilted the competitive balance away from banks and toward credit unions? The evidence does not yield any sharp conclusions.
Despite the often-heated rhetoric of the two competing forces, both credit unions and banks have enjoyed similar growth trends since 1998. Furthermore, the relative proportions of assets held by federally chartered single, multiple and community bond credit unions have changed little. The only seemingly safe prediction is that, in the future, credit unions and community banks will continue to grow more similar.