Credit unions need government help to compete with commercial banks

The New Economics Foundation (NEF) has called on the British government to reduce legal restrictions on credit unions, even if this appears to be at the expense of...

The New Economics Foundation (NEF) has called on the British government to reduce legal restrictions on credit unions, even if this appears to be at the expense of commercial banks.

Its report, Credit Unions: International Evidence, said the financial co-operatives offer more inclusive banking than commercial banks, and performed much better during the financial crisis. But, it added, they need regulation which allows them to compete with commercial banks and collaborate in networks to create economies of scale.

According to World Council of Credit Union figures from 2011, the UK has one of the lowest rates of credit union membership among high income countries, at just 2%. In Ireland, 72% of the economically active population are members of a credit union. In Canada, the US and Australia the figures are 46%, 45% and 31% respectively.

Report co-author Lydia Prieg of NEF explained: “As well as differences in history, geography and regulation, one of the most important factors is whether or not small local credit unions have been able to achieve economies of scale. This goes a large way toward explaining why community finance has yet to really take off the ground in the UK.

“As the trend for mainstream banks merging and taking over one another took off over the past century, banks that wanted to stay local started to struggle to compete. This is because small institutions can’t individually achieve the economies of scale enjoyed by larger institutions, for example by spreading the costs of IT systems, advertising and marketing, and regulatory compliance departments over a larger number of customers, or being able to access better terms for lending and borrowing in financial markets.”

Almost all continental European and North American local banks, including co-operatives, public banks and credit unions, are now part of very large networks co-ordinated by a central institution. Central institutions have existed in Canada since 1938 and in the US since the 1970s. Australian credit unions started pooling liquidity in 1964, and have been sharing ATMs and joint-access to the payment systems and inter-bank lending markets since 1991.

Credit unions can only provide services to their members, who share a ‘common bond’, such as a shared location, employer, occupation, or religion. Tony Greenham, head of finance and business at NEF, said: “Governments typically place more restrictions on credit unions than on banks. This may be to help safeguard members’ savings from risky investment activities, to maintain their focus on lending to low-income households, or a reflection of their non-profit status. However, there’s a balance to be struck between promoting the safety and simplicity of credit unions, and undermining their financial viability and impact by over-regulating them.”

Factors determining credit unions’ success include the length of time since they were established, and since suitable regulatory structures were introduced, their ability to offer a broad range of loan products, including mortgages and business loans, and economies of scale. They were also limited by their ability to compete directly with commercial banks for more profitable customers.

Mr Greenham said: “There’s evidence to suggest that, in common with co-operative banks, the ownership structure of credit unions encourages long-term and prudent management, and a greater focus on the needs of customers. They deliver greater financial inclusion by maintaining branches in areas under-served by commercial banks, by out-performing on small and medium enterprise (SME) lending, and by successfully lending to low-income households and those with impaired credit records.

“Naturally, commercial banks resist the idea of allowing credit unions to grow beyond the niche of ‘poor-man’s bank’ and to directly compete with them. The evidence of the benefits of greater banking diversity in general, however, and of a financially viable credit union sector in particular, suggests that policymakers should be resolute in introducing policies to grow the sector, even if this appears to some degree to be at the expense of incumbent commercial banks.”

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