Credit Union Portfolio Management: An Application of Goal Interval Programming

By Sharma, Hari P.; Ghosh, Debasis et al. | Academy of Banking Studies Journal, Annual 2007 | Go to article overview

Credit Union Portfolio Management: An Application of Goal Interval Programming


Sharma, Hari P., Ghosh, Debasis, Sharma, Dinesh K., Academy of Banking Studies Journal


ABSTRACT

The uncertainty of cash flows, cost of funds and return on investments in ever changing financial markets require financial institutions to develop mathematical models for managing portfolios effectively and efficiently. In this paper, we propose a goal interval programming (GIP) technique for credit union portfolio management. In this technique, penalty functions are introduced in a goal programming (GP) formulation. We present how a system of penalties acts in a GIP to obtain efficient portfolios for credit union problems that have multiple goals and constraints. A comparison of GIP with penalty function and lexicographic goal programming (LGP) has been used to test the results for the same data. We observed from our results that the GIP provides better results in terms of portfolio allocation with maximum returns compared to traditional LGP model.

INTRODUCTION

Credit unions are chartered by their respective states or by the federal government in the United States under provisions of the Credit Union Act of 1934. In 1970, the Bureau of Federal Credit Unions became an independent federal agency with the establishment of the National Credit Union Administration (NCUA). The same year, credit unions, without the use of federal tax dollars established the National Credit Union Share Insurance Fund (NCUSIF) to protect credit union deposits against loss. According to the published data by USA Federal Credit Union, currently, there are more than 85 million credit union members in the United States, with deposits worth over $520 billion (National Credit Union Administration, 2006). Credit unions are financial institutions that specialize in consumer credit and residential mortgages. The primary function of credit unions is similar to other financial institutions and involves generating funds from their members by selling shares and savings deposits to its members and then lending the funds to members in the form of personal or consumer loans (Taylor, 1971).

Financial institutions are fundamentally different from other corporations. When a corporation goes bankrupt, shareholders, debtors and creditors suffer financial losses. The overall impact of the failure; however, is limited to stakeholders directly. In contrast, the failure of a financial institution can be potentially much more harmful. Financial institutions play a special role of intermediation e.g. payment flows across customers and maintain markets for financial instruments. This role can also make failure of financial institution much more disruptive for the economy than the failure of other entities. Credit unions are generally local and relatively small institutions whose failure is unlikely to destabilize financial markets. However, their failure can affect the growth and sustainability of such institutions as they are usually composed of persons from the same occupational group or the same local community. Credit unions have a comparatively weak governance structure compared to shareholder-owned financial institutions in the sense that no private individuals has the financial incentive to intervene strongly to discipline the management when the credit union's policies or performance go astray (Rasmusen, 1988). The Unions are operated as member-owned, tax-exempt, not-for-profit financial cooperatives and are democratically governed by a volunteer member-elected board of directors (Walker and Chandler, 1976 and 1977). The tax exemption status of credit unions, which is regulated at the federal level by the NCUSIF arises neither from the credit unions' limited fields of membership nor from the type of services they offer. Moreover, in 1951 and 1999, Congress reaffirmed credit union tax exemption status because credit unions operate "without capital stock" and are "organized and operated for mutual purposes without profit." The single exemption of state chartered credit unions is the 5% state corporate income tax. Federally chartered credit unions are exempt from both the State Sales and Corporate Income taxes (Tax Equalization Act, 1951 and Credit Union Access Act, 1999). …

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