POSITIONING SASKATCHEWAN’S CREDIT UNIONS
FOR GROWTH
by Michael Grant
Director of Research, Industry and Business Strategy, The Conference Board of Canada
Cooperative banking institutions, such as credit unions, were
created in response to the weaknesses of traditional banks.
Banking typically develops in large urban areas – in Canada’s
case, Montréal and Toronto. Initially, banks may be reluctant to
lend outside of urban centres because they deem lending to be
risky, either because they do not understand the economies or
because those economies are tied to the fortunes of cyclical
resource industry.
Saskatchewan developed its credit union system in relationship to these traditional weaknesses. The importance of credit
unions is seen in their relative market share and operational footprint. In Saskatchewan, credit unions have about a 30 per cent
market share in commercial lending compared to only an eight
per cent market share nationally. Moreover, credit unions maintain physical branches in over 300 Saskatchewan communities,
about 60 more than those served by commercial bank branches.
THE CREDIT UNION DIFFERENCE
Credit unions differ from large banks in scale, business model,
capitalization, and funding. They rely more on lending activity
than do banks, which have a higher share of non-interest
income. Credit union lending practices tend to be far less cyclical than those of major banks. For instance, one study found
that credit unions’ aggregate loan portfolios were about 25 per
cent less sensitive to changes in economic conditions than those
of banks.1 The tendency is for banks to compete aggressively
for business when the economy is doing well but to quickly
withdraw from the market when the economy deteriorates.
Credit union lending is much less cyclical.
Credit unions are owned by their member/customers
whereas banks’ shareholders may differ substantially from their
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June 2014
customers. Member ownership is good in the sense that credit
unions know their customers, which reduces risk. But a reliance
on members to capitalize the institutions and to fund growth
constrains the ability of individual credit unions to participate
in Saskatchewan’s growth.
By their nature, credit unions have limited exposure to capital markets and the inherent risks of capital markets’ funding
and asset-holding activities. Credit unions’ risks are more
related to their role as deposit-taking institutions, their relatively small scale, and their focus on specific geographies.
THE CREDIT UNION BUSINESS MODEL AND GROWTH
In growing economies like Saskatchewan, individual credit
unions are often faced with a situation where the loan demand
growth exceeds deposit growth. This creates funding challenges
for individual credit unions that affect their ability to respond
to loan demand. Banks deal with this situation by drawing in
deposits from other markets and by attracting capital through
capital markets, options that are limited for credit unions.
Credit unions’ relatively small scale and heavy reliance on
physical branches makes it difficult for them to compete, especially in a low interest rate environment. They rely heavily on
earning margins based on the spread between short deposit
rates (interest paid to depositors) and long lending (e.g. mortgages) rates. A low interest rate environment has created a narrow spread between these rates. This is why banks have moved
to other revenue streams like service charges to earn revenue.
Credit unions need to evolve to remain competitive. They
will not remain viable if they simply provide customers with
1
See Smith and Woodbury, Withstanding a Financial Firestorm.
high-cost cash services while not reaping income through lending. Saskatchewan’s credit unions have, indeed, been changing.
They are consolidating operations and becoming larger in the
process. But policymakers and members probably want to see
credit unions maintain some of their unique features (in terms
of service and access) and compete. Hence it is important to
have a policy environment that helps credit unions compete
with traditional banks.
POLICY MATTERS
Federal and provincial policy may facilitate change or impede it.
Saskatchewan’s credit unions are being buffeted by a series of
recent policy initiatives that, taken together, are likely to reduce
the participation of credit unions in Saskatchewan’s future growth.
The provincial regulator, the Credit Union Deposit Guarantee
Corporation (CUDGC), has adopted Basel capital adequacy standards, which focus on Tier 1 common equity (CET1). Furthermore, Basel III introduced the concept of a “conservation buffer.”
This requires an additional 2.5 per cent to CET1, a 30 per cent
increase in eligible capital to support risk-weighted assets.
The emphasis on CET1 is especially problematic for credit
unions. In Saskatchewan, credit union member shares, at this
time, do not qualify as equity because they are redeemable by
members (so they are Tier 2 capital). That leaves credit unions
disadvantaged when building the sort of high-quality capital
required by the Basel III rules.
This means that credit unions will need higher earnings to
support lending. Yet other policies have the effect of reducing
their earnings. For instance, federal tax policies have increased
taxes on Saskatchewan’s credit unions. We calculate the impact
of actual and possible tax changes on Saskatchewan’s credit
unions. The 2013 federal changes will cost Saskatchewan’s credit
unions between $3 million and $4 million per annum.
Saskatchewan has chosen not to follow the federal lead because
it recognizes the unique contributions made by its credit
unions. Had the Saskatchewan government chosen to follow
the federal lead, Saskatchewan’s credit unions would have been
faced with a further tax increase of around $7.6 million, for a
total impact of $10.6 million per annum.
These taxes come directly out of Saskatchewan credit unions’
earnings. Given that the credit unions are heavily reliant on
their earnings for capital, there will be a knock-on effect in
terms of their assets. Had the province followed suit,
Saskatchewan credit unions’ assets would have been reduced by
about $100 million per annum, because they leverage their
retained earnings roughly 10 times.
Saskatchewan chose not to follow the federal lead. By doing
so, it has effectively allowed the credit unions to retain $7.6 million in capital and around $76 million in assets every year. The
federal moves will reduce capital by roughly $3.6 million and
assets by $36 million per annum.
A WAY FORWARD
Saskatchewan’s credit unions have to continue to evolve if they
are to remain a viable and relevant competitor to Canada’s
banks. They will have to continue to develop scale through various means.
Provincial policies should accommodate the evolution of
Saskatchewan’s credit unions. Provincial regulatory policy
should help Saskatchewan’s credit unions develop alternative
sources of capital beyond retained earnings. Capital adequacy
regulation and supervisory practice should be “right sized” to
the credit union business model.
Although it is unlikely that the federal government will
change the direction of recent tax increases, it should consider
some tax provisions to recognize the increased downloading of
costs from other federal regulatory initiatives such as antimoney laundering regulation. The federal government also
needs to review its policies on federal Crown corporations,
most notably Farm Credit Canada, which competes directly
with credit unions in the agricultural market. n
To access The Conference board of Canada’s full report on “Positioning
Saskatchewan’s Credit Unions for Growth” visit www.conferenceboard.ca/SI.
June 2014
Saskatchewan Business Magazine
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