BANKTHINK

Increasing Business Lending Cap Will Make Credit Unions TBTF

If you thought "Too Big to Fail" and massive taxpayer-funded bailouts for big banks make for good policy, then you’re going to love what the credit unions have in store.

The top two credit union trade groups are currently lobbying Congress to allow credit unions to make even more of the same kind of risky loans that nearly sunk the financial sector just a few years ago.

One of the major features of the original credit union model, first recognized by Congress in 1934, was the closely knit relationship between its members. In fact, the purpose of the very first credit union in the U.S. was to provide limited banking services to a small and closely bonded group of French-speaking immigrants who might otherwise have been unable to bank elsewhere. By requiring credit unions to serve only groups with pre-existing associations or relationships, Congress effectively tapped the members of the credit union to monitor each other. It is no accident that most credit unions are "generally managed by volunteer boards of directors."

The logic behind the common bond requirement was both simple and elegant: If the credit union's members associated with each other on a regular basis, they would be less likely to default on their obligations knowing that their friends, neighbors and co-workers would end up paying the price. The same logic can be seen from the lender's side of the table as well. The numbers and data from a credit history can be invaluable, but so too is personal knowledge, forged through a common bond, of how a potential borrower conducts himself.

However, credit unions today are strikingly different than those originally chartered by Congress. Thanks to a 1998 law that effectively gutted the long-standing common bond requirement, many modern-day credit unions look more like a big Wall Street bank than they do a friendly organization of individuals who share the same profession or employer.

That 1998 law did, however, maintain capped member business loans made by credit unions at 12.25% of a credit union's assets. The two biggest credit union lobbying groups are now pushing Congress to more than double that limit. 

According to credit union lobbyists, increasing the cap on risky business loans will increase lending activity, create over 140,000 jobs and primarily benefit small credit unions – without risk. Unfortunately, their numbers don't add up at all.

A study that I recently completed takes an in-depth look at the U.S. credit union industry and how increased MBL activity might impact it. I analyzed the individual balance sheets of over 7,000 credit unions to better understand lending activities throughout the industry.

First, over 70% of credit unions make no MBLs: These institutions have decided they do not want to be in the business of commercial lending. Remarkably, proponents of raising the MBL cap contend that 98% of those credit unions will begin making MBLs if the cap is lifted.

Second, only 3% of all credit unions would benefit from the increased MBL cap, and they are not "small" credit unions by any stretch of the imagination. The 85 credit unions that currently find themselves bumping up against the current cap have, on average, assets of nearly half a billion dollars each. By way of comparison, the average credit union has about $140 million in assets.

Finally, an analysis of recent credit union failures shows that credit unions with high MBL-to-asset ratios comprise a disproportionate share of failures since 2008. Although 1.5% of all credit unions were above the existing 12.25% cap – current law contains a number of loopholes that allow credit unions to skirt the existing cap – they were responsible for 11% of all failures.

One credit union, Telesis Community in California, maintained an MBL-to-asset ratio that approached 50% – four times higher than the legal limit. At the end of 2010, a year in which its CEO took home $2.1 million, financial reports submitted by the credit union to its federal regulator showed Telesis to be "undercapitalized." Over $30 million worth of business loans, which comprised more than half of the credit union's assets, were delinquent. And $7.5 million in bad loans that year – two-thirds of which were MBLs – were written off as completely uncollectible. Ironically, its CEO had previously testified before Congress that "there is no safety and soundness reason" to cap business loans at 12.25% of total credit union assets. Federal regulators finally shut down Telesis in June.

Unfortunately for the credit union lobbyists who claim that an increased MBL cap will increase jobs and help small banks without increasing the risks of failure, the data just don't agree. Increasing the cap won't significantly increase employment and won't help small, community-based institutions since there is no reason why a higher cap would spur them to begin making MBLs.

At the same time, the increased cap will almost certainly lead large institutions, hungry for short-term profits, to take greater risks that they are ill-equipped to handle.

We have had enough bank failures and bailouts. Rather than give permission to a few big credit unions to pursue even more of the same kinds of risky loans that caused the 2008 financial crisis, we should encourage them to focus on what they do best: making personal, non-commercial loans to their members.

Ike Brannon, a former senior adviser at the U.S. Treasury and the Senate Finance Committee, is director of economic policy at the American Action Forum.

Comments (4)
The size of these large CUs pale in comparison to a good portion of U.S. banks. The credit union designation is tax beneficial and offers depositors/shareholders a unique way of banking. If they don't want to be constrained by CU requirements then we should allow CU to banks conversions to take place. Then they will have to pay FDIC insurance premiums, be held to new capital standards, auditing and the like. There's no need to up loan limits and change the risk profile for the entire industry.
Posted by @Patrick_J_Sims | Tuesday, November 27 2012 at 1:32PM ET
Contrary to the author's assertions, credit unions have been making business loans for most of the industry's history, and there was no cap on credit union business lending before 1998, when the banking lobby succeeded in getting one established. (Credit unions also do pay for deposit insurance, have capital standards, and are audited and examined.) As to the argument that the failure of a handful of credit unions due to soured business loans is a reason to restrict them, would the same rationale apply to banks, which experienced many more commercial lending-induced failures?
Posted by david529 | Tuesday, November 27 2012 at 5:00PM ET
It is completely incomprehensible that at a time when we are just days away from going over the fiscal cliff that there would be any discussion whatsoever about allowing tax-exempt credit unions to take business away from tax-paying community banks. The recent conversion of Thrivent Financial Bank to a credit union in order to avoid $1.6 million each year in taxes is a travesty. It's a zero sum game folks! There is no free lunch.
Posted by terryj | Thursday, November 29 2012 at 2:51PM ET
In line with one of the bankers' arguments for why credit unions don't need an expansion on the MBL cap, credit unions haven't charged eagerly toward their 12.25% cap over the past 14 years since it was implemented. Credit unions are easing into business lending, with the NCUA reporting just a 1.5% increase in the third quarter. And, counter to bankers' arguments, credit unions aren't particularly known for a Polar Bear Club attitude when it comes to taking risks, so they aren't diving into Arctic waters with both feet. And the TBTF argument isn't even worth rebutting since the entire industry is smaller than a each of a handful of banks. Yes Telesis (and Texans) let business loans get out of hand but another 1700 credit unions are just fine. In fact a recent report demonstrated that credit unions offering member business lending are healthier in key financial categories than non-MBL credit unions. --Sarah Snell Cooke, http://www.cutimes.com/2012/11/29/stop-honking-and-cook-bankers-christmas-goose-edit?ref=hp
Posted by scooke | Friday, November 30 2012 at 8:18AM ET
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