I have just come back from a conference for board directors of credit unions and it’s time that I talked about this type of financial institution. Not because I want to make you a credit union member, although this would be great, but because, in some special ways, credit unions are the anti-paradigm of for-profit businesses and what we come to take for granted regarding human economic behavior.
First, a few things about credit unions. They operate as financial cooperatives that belong to their members. In contrast to earlier times, anyone can now join a credit union without the condition of a common bond among members. Like commercial banks, credit unions are regulated by the federal government or their state. Because credit unions are recognized as not-for-profit entities, they enjoy a tax-free status. Historically speaking, credit unions were a German invention imported in the US early in the twentieth century. The idea was to allow people of low economic means with limited access to the banking system to pool their savings together so that they could borrow from this common pool of funds. Today’s credit unions have grown in size and sophistication, rivaling banks in the range of retail banking products and services they offer, including financial technology.
One hundred fifteen million Americans – slightly more than one third of the US population – belong to 5,500 credit unions, which control $1.5 trillion worth of assets. Of course, for-profit banks far outweigh credit unions in value of assets; for example, JP Morgan-Chase alone controls $2.3 trillion of assets. But the membership size clearly shows that Americans are eager to embrace an economic institution with a social purpose. And this is true in blue and red states. Indeed, the US credit union movement is the strongest and biggest in the world.
Credit unions are a different business species in several important respects. First, their members are both owners and consumers of their credit union products and services. Profits remain within the organization or are distributed to members which implies that the members never lose value to somebody else. Whether they pay higher interest rates on loans or receive lower interest rates on deposits, in either case, the resultant surplus remains with the credit union and, thus, belongs to the members. This is entirely different from the case of for-profit businesses where shareholders can benefit at the expense of customers. Because of the dual status of members as owners-consumers, credit unions are very responsive to the needs of their members. In fact, on average, credit unions charge lower loan rates and pay higher deposit rates than banks.
Credit unions are governed by board of directors comprised of volunteers. Federal rules allow only one board member – usually the chair – to be paid a stipend. Board volunteers (as well supervisory committee* volunteers) are reimbursed for expenses to attend meetings and conferences. Some states allow stipends for board members but such payments are kept quite low. In general, direct and indirect compensation of board and supervisory committee volunteers is meager when compared to the compensation packages paid to members of corporate boards.
Now, one may infer that since credit union volunteers receive very low compensation, credit unions attract low-skill volunteers. Nothing would be farthest from the truth. Credit unions are governed just fine by these – let’s call them – lay people. Credit unions have fared much better than banks through various financial crises, including that of 2008. Board members come from all professions and backgrounds. By applying common sense and a high dose of diligence and loyalty to their fellow members, these volunteer directors provide competent and responsible custody of their credit union’s assets through booms and busts.
This experience begs two questions. First, why corporations lavish inordinately high compensation packages to their boards when the credit union governance model shows successful governance can be had at a much lower cost? Second, why do credit union volunteers offer their services for no or very low compensation when this type of service commands hefty rewards in the for-profit sector? One answer is that not every type of effort has to be monetized to attract takers. The reason behind this is the presence of a strong social altruistic instinct that we see through out the volunteer movement. So, when we are told that monetary reward is necessary to induce certain effort and the more of it the greater the effort is, this neglects to consider that not all things can be bought with money only. My hypothesis is that if corporate boards were open to all – as opposed to the members of “boys or girls” networks, we would see a lot of people stepping forward willing to do the job at much lower compensation.
There is an important reason why credit union boards remain competent. Board members (as well as supervisory committee members) attend one or two conferences a year. This way, they are updated about new laws and regulations, learn about developments in the financial sector, and how to be more effective directors or supervisory committee members. Most importantly volunteers learn from each other. Because credit unions are part of a movement under the motto “People helping People,” volunteers feel no competitive pressure to be secretive. That is, the cooperation spirit extends to exchanging ideas among volunteers for the purpose to make credit unions as a whole successful. This is unheard in the world of for-profit businesses.
The overall success of credit unions is also driven by another advantage in governance. Credit union boards are chaired by one of the volunteer directors, not the CEO, as is typical in the corporate world. That implies there is a clear distinction between those who set policy (the board) and the top executive who executes the policy. This way, the main stakeholders, i.e., the members/owners, are directly represented in the top echelons of governance and the chief executive has less opportunity or power to pursue self-dealing, as we frequently see in the corporate world.**
Of course, financial cooperatives cannot replace the for-profit banks. But by being part of the market, they enhance competition and help us better understand the pros and cons of different corporate governance models. This is a gain for all – credit union members and bank customers.
* Supervisory committees have the purpose to stave off fraud and lapses in operational rules within credit unions.
** Exhibit A here is the case of pharmaceutical firm Theranos. A twenty something founder and CEO of this start up was able to fool high-caliber board directors, including the former Secretary of State, Henry Kissinger!!! So much for lavishly-paid corporate boards.
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