Magazine article Regional Economist

Banks and Credit Unions: Competition Not Going Away

Magazine article Regional Economist

Banks and Credit Unions: Competition Not Going Away

Article excerpt

The U.S. financial system includes depository institutions small and large, some chartered by states and others by the federal government, some operated for profit and others not for profit, some operated by volunteers and others by the world's foremost financial professionals.

Credit unions and commercial banks are important parts of this system-and aggres sive competitors. Both types of institutions are chartered by the federal and state gov- ernments, often with the intent of fostering competition between the institutions. At the same time, a web of regulations seeks to maintain competitive balance between the institutions. In this essay, we examine aspects of these regulations and the com- petition between credit unions and banks since the 1998 Credit Union Membership Access Act (CUMAA) relaxed membership regulations for credit unions.

At the end of September 2012, approxi- mately 2,710 credit unions were chartered by 47 states and Puerto Rico, and approxi- mately 4,320 credit unions were chartered by the federal government. Each is a not- for-profit cooperative, democratically gov- erned (with each member having one vote) and operated by a volunteer board of direc- tors elected by the credit union's members. Credit unions had 96 million members, representing more than half of American families, and provided 16.7 percent of out- standing consumer credit.1 Credit unions have become important in home-mortgage and small-business lending, too.2

In the provision of financial services to households, credit unions and community banks continue to grow more similar, a trend that began with advances in technol- ogy during the mid-1970s and accelerated during the 1980s.3 Because most credit unions offer a full range of financial prod- ucts and services (either directly or through third parties), a number of news articles have suggested that households consider larger credit unions as full-service alterna- tives to banks.4 Academic studies have confirmed 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.5 Further, 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.

In any industry where firms compete, each asks if others have an unfair advantage. Bank- ing 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 percent 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.6

Congress has been clear regarding the social purpose of the credit union exemp- tion: "Credit unions are exempt from fed- eral taxes because they are member-owned, democratically-operated, not-for-profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means."7

The words "modest means," not defined by Congress, often have been interpreted as synonymous with lower- and middle-income wage earners. Banking industry support- ers argue that banks serve larger numbers of low- and middle-income households and that the exemption is a taxpayer subsidy that encourages credit union expansion. Credit union advocates argue (1) that the banking industry serves more low-income custom- ers because it is larger, (2) that credit unions should not turn away eligible higher-income persons who wish to be members, and (3) that banks can issue equity to raise capital, while credit unions cannot. …

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