Blurring the Lines
Newkirk, Kristine, Independent Banker
EDITOR'S NOTE: When asked to name their competition, community banks often place credit unions high on the list. This is the first in a series designed to help community banks better understand the challenges posed by credit unions.
The idea behind credit unions was a sound one. Intended as a relief tool of the Great Depression, lawmakers established the credit union charter to "make available to people of small means credit for provident purposes through a national system of cooperative credit." In exchange for restrictions on membership, Congress endowed federal credit unions with a number of competitive advantages over other depository institutions that include tax-exempt status and a waiver from Community Reinvestment Act coverage.
So what went wrong? An industry that was chartered to serve those of limited means is now serving persons with incomes greater than patrons of commercial banks. An industry founded on a cooperative, nonaggressive premise is now predatorially pursuing customers of commercial banks, as well as encroaching on the territory of other credit unions. Institutions intended to serve a specific, well-defined group of individuals are assuming a national, and in some cases international, presence.
Where are the institutions that Congress envisioned in passing the Federal Credit Union Act of 1934? What has prompted their predatorial actions of late and the blurring of the lines between the credit union industry and the banking industry? What cause is there for the privileged status that credit unions continue to enjoy? The banking industry has a competitive obligation to raise these questions and others, and to remain abreast of the rapidly evolving credit union industry.
Raising the awareness and understanding of credit union issues is important to maintaining and furthering community banks' market share.
Growth Gone Unchecked
The rapid and ongoing relaxation of regulations governing credit unions has fostered tremendous growth in the industry, an aggressiveness that to date has gone unchecked by Congress. In the past, lawmakers have been unwilling to review the actions of the regulator for federally insured credit unions, the National Credit Union Administration. And the very subject of credit unions has been Congressional taboo. As a result, the NCUA continues to operate unfettered, and the credit union industry continues to experience tremendous growth.
It is evident from the rapid rate of equity generation during 1993 that credit unions have embraced an aggressive growth agenda. This growth is made possible only due to the benefits of tax-exemption and the ever-loosening common-bond restrictions.
The Revenue Act of 1916 exempted cooperative banks and mutual savings associations from federal taxation due to their structure as cooperative, nonprofit banks. Shortly thereafter, the Attorney General extended the exemption to credit unions because they were "substantially identical" to cooperative banks.
In 1951, cooperative banks and mutual savings associations lost their tax-exempt status. As stated in the accompanying Senate Report, cooperative banks and mutual savings associations were actively competing with banks and other taxable institutions for public savings. Retaining the tax exemption would have been discriminatory, while taxing mutual savings banks would place them on a parity with their competitors. Credit unions however, retained their tax-exempt status, though no explanation was given in the Senate Report for the continuing exception.
Credit unions' tax-exempt status translates into a higher rate of return than that earned by banks. Tax payments made by banks in 1993 resulted in a 47-basis-point charge to earnings, thereby contributing to a net income for credit unions which exceeded that of banks by 23 basis points.
The windfall from foregone tax payments permits credit unions to grow at a faster rate than banks as they return what they would pay out in taxes to capitalization and dividends. …