May 17 2010

Withstanding a Financial Firestorm: Credit Unions vs. Banks

This report contributes to the regulatory debate by comparing the financial stability of banks and credit unions from 1986 to mid-2009, a period that covers several business cycles and ends during some of the most pronounced effects of the Great Recession. Starting from the observation that unemployment coincides closely with loan delinquencies and charge-offs, the researchers aim to describe how the same economic shocks treat the loan portfolios of credit unions and banks.

The researchers found quantifiable correlation between unemployment and bank lending: With every one percentage point rise in unemployment, bank lending growth declined 1.15 percentage points. Conversely, credit union lending does not correlate in a statistically significant way with the unemployment cycle. In other words, credit union lending seems to continue apace, even during downturns.

So what? Well, the researchers highlight several important implications from this quantitative comparison between banks and credit unions:

  • Credit unions are less sensitive to the business cycle than banks. Both certainly suffer when unemployment rises, but the trajectory and magnitude of delinquencies and charge-offs at banks— especially during the latest downturn—are much more pronounced.
  • Because credit unions appear to be about 75% as sensitive to macroeconomic shocks as banks, regulators should consider imposing lower capital requirements to account for the lower risk.
  • More open charters do not seem to have made credit unions more risky. Despite gradual moves away from closed charters following the passage of the Membership Access Act, credit unions in general seem to have retained conservative portfolio strategies.
David Smith
David Smith
Associate Professor of Economics
Pepperdine University
Stephen A Woodbury
Stephen A Woodbury
Senior Economist
Michigan State University
Report Number 214

Executive Summary

Keeping up with the Joneses is a familiar North American feel-ing. When a new car appears next door, you want it. When your daughter's playmate enrolls in private school, you want in. Rightly or wrongly, the sideways glances and scorekeeping come with the culture. And the feelings are not much different in financial services. For the sake of broad comparison, let's call credit unions the Carters and banks the Joneses.The Great Recession has been excruciating for the Carters and the Joneses alike. 

The Carters have lost hard-earned savings, have suffered painful pay cuts, and have been forced to stop eating out. But while the Carters didn't make as much as the Joneses in their heyday, they have also lost much less in the downturn. In general terms, the Carters saved up before they bought, while the Joneses acquired their cars with credit and their investments on margin. Today the Carters may have to postpone that new car purchase, but the Joneses are los-ing their homes.