As member-owned and typically community-based financial intermediaries, credit unions and other cooperative financial institutions can be more responsive to local economic needs, especially during a crisis. But there are emerging threats to their business model.
What is the role of financial cooperatives like credit unions in mobilising savings and extending credit during periods of crisis? This article outlines the importance of financial cooperatives to low-income individuals, who are often excluded by mainstream financial institutions, and their potential role in the pandemic.
As locally based organisations with a membership-based governance structure, credit unions are more responsive than other financial institutions to local economic needs. As the Covid-19 crisis has unfolded, UK credit unions have proved to be a lifeline for many, responding to members’ needs in a variety of constructive ways: facilitation of transactions for vulnerable members unable to conduct their business online; provision of emergency business loans; establishment of Covid-19 information hubs for members; and provision of low-cost loans to enable members to consolidate and repay existing debts.
But high cost to income levels, low return on assets and a deterioration in loan book quality may result in capitalisation problems for some UK credit unions, leading to consolidation within the sector.
What’s more, the pandemic has accelerated consumer demand for online financial solutions: since many UK credit unions do not have the necessary scale to facilitate the provision of financial services accessed and delivered through digital channels, their role may come under threat from alternative ‘fintech’ (financial technology) providers.
Cooperative banks and credit unions
Cooperative financial institutions are member-owned intermediaries. Two of the more dominant forms are cooperative banks and credit unions.
Cooperative banks are for-profit organisations although they do not seek to maximise profits but rather generate profits in order to bolster capital and fund long-term growth. They provide financial services to both members and non-members (customers). They have a particularly strong presence in Europe with 2,816 independent cooperative banks serving 210 million clients of which 84 million are members (European Association of Cooperative Banks, EACB, 2019). In the UK, there is only one major cooperative bank.
Credit unions are not-for-profit entities providing their services only to members within a defined ‘common bond’. The common bond is based on a pre-existing social connection such as belonging to a particular community, industry or association. Common bonds are effectively the social glue that bind credit union members together, and remove many of the problems of ‘asymmetric information’ inherent in financial service transactions.
Credit unions seek to bring about human and social development. A vision of social justice extends both to individual members and to the larger community in which they work and reside. Credit unions have a role to play in combating financial exclusion, liberating individuals from the grip of moneylenders and encouraging a savings habit (McKillop et al, 2006).
In the UK at the end of the second quarter of 2020, there were 418 credit unions (173 in England, 87 in Scotland, 16 in Wales and 142 in Northern Ireland) with approximately two million adult members. They had total assets of £3.81 billion (49% of which was held by credit unions in Northern Ireland).
The credit unions provided £1.597 billion in loans to members. The average member loan was highest in Northern Ireland, at £3,767, and lowest in Wales, at £1,460 (Bank of England, 2020). Total income in the year to 30 September 2019 amounted to £210.9 million, of which 84% came from interest paid by members on their loans (Bank of England, 2019).
What does evidence from economic research tell us?
Financial cooperatives have a membership that is concentrated at a local or regional level. Financial cooperatives cater to the financial needs of their members and more generally to the community within which they are based.
Through their role in mobilising savings and extending credit, financial cooperatives play an important role in the smoothing of lending and liquidity to households and small firms, including during periods of crisis.
Financial cooperatives have a role to play in combating financial exclusion, liberating individuals from the grip of moneylenders and encouraging a habit of saving. UK credit unions have received significant support from government in support of this mission.
Members view financial cooperatives as a safe haven for savings in periods of crisis. But savings inflows may cause pressure on regulatory capital requirements.
There has been industry consolidation driven by both mergers and failures.
Fintech and the digitalisation of products and services are increasingly shaping the business model of financial cooperatives. Fintech is both a threat to and an opportunity for financial cooperatives.
How reliable is the evidence?
The evidence is from peer-reviewed journals and investigative research undertaken by organisations such as the Filene Research Institute and the World Council of Credit Unions. The Bank of England provides data on credit unions for the four countries of the UK but at an aggregate level.
A majority of cooperatives have a membership that is concentrated at a local or regional level and cater to the financial needs of individual members, community groups and small firms (Lang et al, 2016). A membership-based governance structure makes financial cooperatives highly responsive to local economic needs (Goglio and Alexopoulos, 2013).
The social impact of credit unions in their locality can be thought of in terms of exclusive and non-exclusive benefits (MacPherson, 1999). Exclusive benefits are those that accrue exclusively to members, such as loans, savings and other financial services. But the operating principle of social responsibility that credit unions have ensures that their sphere of influence extends beyond members. Non-exclusive benefits include practical support and donations to schools, community groups and local enterprise initiatives within the credit union’s common bond (Power et al, 2012).
Financial cooperatives respond to financial crises differently than commercial banks (Aghabarari et al, 2020). Lending by financial cooperatives decreased less during the global financial crisis of 2008/09 and the subsequent euro area sovereign debt crisis than that of commercial banks (Meriläinen, 2016; Migliorelli, 2018). During these periods, financial cooperatives also required less collateral and offered longer loan maturities compared with other kinds of banks (Aghabarari et al, 2020).
An objective of credit unions is to encourage financial inclusion through the provision of small loans, low balance share accounts and financial advice to low-income individuals that are excluded by mainstream financial institutions (McKillop and Wilson, 2008). In the UK, this coincides with the government’s financial inclusion priorities: increased access to basic banking services; free money advice; and access to affordable credit.
UK credit unions have therefore received significant government support (legislative, regulatory and financial) to help them to serve existing members better, to attract new members and to meet the demand for modern banking products from those on low incomes (Lee and Brierley, 2017; Lee and Carlisle, 2019). But the provision of support from government (particularly financial subsidies) leaves the sector vulnerable to the withdrawal of that support (Dobcheva, 2015).
Savings with financial cooperatives increase in times of economic uncertainty. Evidence from the United States suggests that in the aftermath of the Great Recession, consumers turned to credit unions in record numbers because of their not-for-profit, member-focused business model (Credit Union Times, 2019).
But the low interest rate environment that has prevailed since the Great Recession has squeezed profits from interest-generating activities (Rauterkus et al, 2018). Furthermore, savings inflows have led to capitalisation issues for some credit unions, encouraging an increase in merger activity (Altavilla et al, 2017).
Evidence also suggests that during a crisis and its aftermath, failures increase (Dopico and Wilcox, 2020). Smaller credit unions, those with a high proportion of assets in liquid form, those with low loan-to-assets ratios and those excessively capitalised are at greater risk of failure (Goddard et al, 2014).
Membership growth, in conjunction with consolidation through mergers, has been a feature of the credit union sector in the UK. Between 2013 and 2020, the number of credit unions declined by 21.1% – from 530 to 418 – while adult membership increased by 12.4% – from 1.7 million to 1.91 million (Bank of England, 2020).
Digitalisation of products and services and online provision has increasingly shaped the business model of all financial institutions including financial cooperatives. But many smaller financial cooperatives have a weak online presence with, for example, informational as opposed to transactional websites (McKillop and Quinn, 2015).
Recently, fintech solutions to processing customer and application data has enabled some community-based financial institutions to restore profitability to some forms of consumer and small business lending after several decades of thinning and/or negative operating margins. (Eckblad et al, 2017; Kim and McKillop, 2019).
Less positively (for financial cooperatives), fintech companies have now succeeded in scaling a relationship banking technology, which may erode the relationship and soft informational capture advantage of small-scale, localised financial cooperatives (Jaksic and Marinc, 2018).
What else do we need to know?
The global financial crisis of 2008/09 was a failure of credit practices, which led to a significant period of austerity as governments repaired bank balance sheets. This time it is a health crisis. Economies (at least in the short run) are on hold with massive levels of funding support by governments of firms and employees.
During the initial phase of the Covid-19 crisis, new lending by UK credit unions appears to have marginally declined, exacerbated by loan repayments supported by income subsidies: loans to members fell from £1.697 billion in the first quarter of 2020 to £1.597 billion in the second quarter. But as in other crises, savings inflows continue: total shares rose from £3.029 billion in the first quarter of 2020 to £3.188 billion in the second quarter.
Historically, the sector has been subject to high cost to income levels and a low return on assets. Thankfully, these have not deteriorated further: the average cost to income ratio (average returns on assets) went from 83.4% (0.25%) in the first quarter of 2020 to 75.2% (0.36%) in the second quarter. Nevertheless, warning signs are on the horizon in the form of a deterioration in loan book quality: loan arrears were £95.612 million in the first quarter of 2020 and £115.25 million in the second quarter.
Ultimately, loan book difficulties will result in capitalisation problems for some credit unions. If this occurs, there will be further consolidation within the sector. What we do not know are the likely extent of the consolidation nor the eventual mix of mergers and failures, although experience would suggest that the number of mergers will far exceed failures.
In addition, the pandemic has accelerated consumer demand for online financial solutions and unfortunately many UK credit unions do not have the necessary scale to facilitate the provision of financial services accessed and delivered through digital channels. This could be achieved if credit unions acted collectively and invested in support organisations (Credit Union Service Organisations) tasked with developing standardised digitally based product and service offering for their members. Such change is required if UK credit unions are to expand further their role as a vehicle for financial inclusion.
Where can I find out more?
- Credit unions and the coronavirus: notes on the impacts and implications of the COVID-19 Crisis, Part 3: A Filene Research Institute report by Taylor Nelms and Stephen Rea provides preliminary analysis of the pandemic’s effects on workers and consumers, and the implications for credit unions.
- COVID-19 updates: The World Council of Credit Unions (WOCCU) has created a resource for the latest Covid-19 news, information and recommendations specifically relevant to credit unions across the globe.
- Supervision: credit unions: Bank of England information pertaining to the supervision of UK credit unions by the Prudential Regulatory Authority is available here, including ‘waivers and modification of rules’ due to Covid-19.
- COVID-19 cooperative banks’ actions: The European Association of Cooperative Banks (EACB) provides daily updates of initiatives taken by European cooperative banks to help society face the coronavirus crisis.
- Cooperative financial institutions: a review of the literature: Donal McKillop, Declan French, Barry Quinn, Anna Sobiech and John Wilson review research on financial cooperatives over the last 50 years. They conclude with a summary of what we know (and do not know) about financial cooperatives and provide suggestions as to where future research should concentrate.
Who are experts on this question?
- Paul Jones, Nick Money and Ralph Swoboda, Centre for Community Finance Europe
- Research on the impact of COVID-19 on British Credit Unions
- Research on the Impact of COVID-19 on Irish Credit Unions
- Bill Lee, Management School, University of Sheffield
- Research on information disclosure on the websites of British credit unions
- Research on product innovation by British credit unions
- Donal McKillop and Declan French, Queen’s University Belfast