Generational Tensions Pose a Challenge
to Credit Unions

As we know, credit unions are mutual organizations that operate on the principle of one-member-one-vote. However, members of credit unions age just like the rest of us. As the members age, credit unions gradually accumulate surpluses. These surpluses accumulate from the profits earned on loans to members who are typically younger than the savers. Since the members' savings accounts cannot be bought and sold like common stock, they do not have a "market value" that reflects the value of the accumulating surplus.

This situation creates an inter-generational conflict within the credit union. On the one hand, the young members are most likely to be borrowers and favor low interest rates on their loans. The old generation provides the bulk of the savings of the credit union and favors a good return on their savings, even if it means higher interest rates on loans. Moreover, they observe the growing surplus and believe that most of it belongs to them. Because the credit union is a mutual organization, that is not true. But, if the credit union became a joint-stock company, with most of the stock purchased by the "depositors," the old generation would own a major share of the stock of the company and might reap handsome profits. Instead of one member, one vote, control would be vested with the stockholders.

In his well-written article in the most recent issue of the Journal of Financial Services Research, Kevin Davis expresses concern that this outcome may be "socially suboptimal." He argues that conversion to a joint-stock form of organization would violate what he calls an "intergenerational contract" between junior and senior members. "Older members, with little time remaining to enjoy a flow of future net benefits from their dealings with the credit union, are more likely to perceive a net private benefit from conversion, and vote for conversion."

Davis' major concern is that regulatory agencies will raise capital requirements for credit unions. This may trigger structural changes that would ultimately diminish competition and threaten the benefits that the credit union alternative has brought to financial services markets (e.g., price competition on both loans and deposits). One option for a credit union to increase its capital base would be to make savings more attractive by raising interest rates on loans to members. Alternatively, the credit union could convert to a joint-stock company. A joint-stock company could increase its capital base by issuing more stock, thereby avoiding an increase in interest rates. Given those alternatives, younger members (borrowers) who might otherwise have voted against conversion to a joint-stock company would favor it.

Davis fears that this outcome would reduce the credit unions' competitive advantage in relation to other lenders. Under the current cooperative structure of credit unions, the surplus can only be returned to members through either higher interest rates on deposits or lower interest rates on loans. Both have an important disciplining effect on pricing in local markets, effectively constraining the pricing decisions of banks and other institutions. He recognizes that the advantages of the cooperative form have diminished over the past decade, and that those that remain may not be sufficient to justify a vote by members of a credit union to retain the cooperative form of organization rather than a joint-stock company. In addition he fears that credit unions are threatened by technological changes, increased competition, deregulation and reduced preferential tax treatment.