How To Stop Conversions, & Enhance The Charter
Just a few years ago, Congress passed the sweeping Bank Modernization Act. Improved powers for credit unions were not part of the bill. But now, with some credit unions seeking to become banks, along with regulatory relief needed for small credit unions, it appears time to enact sweeping advancements in the credit union charter.
Credit unions' rules, too, seemingly need a similar spectacular updating-to make the future more promising. We know the restrictions that need to be lifted. They are the ones most often recited by the credit unions moving to bank charters. They are the demands small credit unions say cause them to fall behind and eventually cause mergers. It means implementing the CUNA Renaissance Commission recommendations. It ends the things that prevent narrow institutional specialization, and formation of not-for-profit cooperative financial holding company structures with operating subsidiaries.
Broader powers would define a brighter set of options and opportunities for all credit unions, as well as access to additional sources of capital. A Credit Union Modernization Act sounds good. It might be necessary and may need to occur soon. Getting it to happen could take the combined choreography of our collective industry, our regulators and the Congress.Will the regulatory agencies and the Congress go along? Of course they will. Here's why. If regulators went to Regulator School (and some do), they would learn the ultimate goal of regulation and supervision is to promote systemic stability. Additionally, good public policy needs to promote the development of both the banking and credit union sectors, as those institutions are the gears of our economic engine and the organizations through which monetary policy is applied.
The mid-term exam at Regulator School would ask our rule-makers, "Why is a progressive charter and broad mix of permissible activities good for credit unions?" The good student-of-the-system regulators, the ones who have actually been reading recent academic literature, would cite studies and write essays on why fewer restrictions are better; because expanded powers, they would say:
* Permits the exploitation of economies of scale and scope, assists in managing different types of risk for consumers, distributes financial services for all groups, and builds reputational capital within communities.
* Increases the franchise value of institutions and thereby enhances their incentive to behave prudently.
* Leads to diversified income streams, creating more stable organizations.
* Limits the ability of the government to use financial institutions as artificial instruments of social change to redistribute wealth, and thereby promotes true institutional performance and stability.
* Improves competition (which benefits consumers) because for-profit banks would not be granted an exclusive franchise in tomorrow's marketplace.
And on and on. The student-regulators' essay could run on forever. In other words, broadening credit unions' powers and authorities is good! Unfortunately, there's no mandatory Regulator School. Additionally, appointed regulators, Treasury officials, as well as hired system executives, lobbyists and CEOs who campaign to serve on committees, don't read many books on banking theory. If they did, we would all know of the literature suggesting there are highly positive benefits from permitting broader charter powers. Much academic study exists on the subject.
Let's pretend the alarming trend of credit unions converting to bank charter represented a Rome-is-burning event, and Nero the Regulator wanted to cover his Italian back-side with academic data before going to the Senate. Our new-age Nero could say, for instance, Berger and Udell (1996), DeLong (1991) and Ramirez (1995, 2002) find that expanded powers are associated with lower costs, more capital and less stringent cash-flow constraints. Vander Vennet (1999) finds that unrestricted financial institutions have higher levels of operational efficiency than those with more restricted powers. In terms of diversification, Eisenbeis and Wall (1984) and Kwan and Laderman (1999) argue that because profits from providing different financial services are not highly correlated, there are diversification benefits from allowing broader powers. Furthermore, Ang and Richardson (1994), Kroszner and Rajan (1994), Puri (1996), and Ramirez (1995) find that those with broad authorities do not systematically abuse their powers. Gande, Puri and Saunders (1999), moreover, find that broad powers boost competition.
Guess what our Nero could continue saying to the Senate: regulatory restrictions may be bad. Let's end the policy of undue restrictions for some, and put an end to the need for credit union-to-bank charter conversions. Again from the literature, Barth, Caprio and Levine (2001) find that greater regulatory restrictions are associated with a higher probability of a system suffering a major crisis, and lower sector efficiency. They found no positive effects from restricting banking-sector activities. More recently, Barth, Caprio, and Levine (2003) find that restricting financial products and services is negatively associated with institutional performance and stability, as compared to when financial institutions can diversify into other financial activities.
It is absolutely feasible and possible for us to fix the problems that cause conversions to banks, and to do a lot more at the same time. The academic literature is on our side; it's time to fix the miscellaneous charter shortcomings. But NCUA is shy about using its Interpretative Ruling authority and has pushed the industry into doing its regulatory relief housekeeping before Congress. Unfortunately, at present, we only have an "Improvement" bill moving on Capitol Hill, not a real Modernization Act. It does not provide for secondary capital and capital reform, nor does it lift the needless restrictions on business lending. Those are the relief needs being cited by converting credit unions.
CURIA A Good Start, But...
The Credit Union Regulatory Improvements Act (CURIA) is the focus for Hill visits during the CUNA GAC. The CURIA bill is getting co-sponsors and a hearing is planned. Testifying industry professionals and regulators need to remember their reading: broadening credit unions' powers is good, continued restrictions is bad. There is literature and logic and case studies and real-life examples to back it up.
If two steps are necessary, they are get CURIA passed, and then come back and finish fixing the real problems that cause conversions to banks. At a minimum, CU powers should be sufficiently expansive so that credit unions can keep pace with the evolving array of financial services so that bank and non-bank competitors are not granted an exclusive franchise in tomorrow's marketplace.
Going to Congress is easy. Strangely, working together to fix charter limitations seems more difficult-even if the wave of conversions is a crisis in our system. More modern powers adds flexibility, as well as contemporary relevance to our cooperative financial system. Charter flexibility and capital alternatives are needed as a show of respect for credit union executives and boards that truly believe they need to keep up with the banking sector (which is different than becoming a bank). The lesson being learned is that as credit unions are becoming increasingly dissimilar in asset size and structure, our most important strength might be our ability to stay together in these changing times. It also may prove to be a challenge that's bigger than getting incremental additions of powers. Too bad. Working together has been the system's sustainable competitive advantage and the most distinguishing characteristic of the credit union movement. It's disappointing that it feels like getting the credit union system to work together is going to be harder than getting a bill passed on Capitol Hill. Agreement is necessary. Expanded powers will only define the opportunities within the CU system, not the future of credit unions, the character of our leadership, or the quality of consumer relations. Everything, absolutely everything in contemporary financial services, can be done on a people-first, not-for-profit basis. Charter limitations, therefore, do not make sense. Agreed?
For more than 100 years, the CU system has been the embodiment of the concept that by working together we can do far more than by working alone. Together, we can effectively work together for warranted regulatory relief and charter improvements. Conversions to banks, difficulties of small credit unions, and growth limitations that prevent credit unions from serving a far greater percentage of American consumers, are all indicators that sweeping change must be enacted-as soon as possible.
John Annaloro is president of the Washington Credit Union League.