Introduction to Credit Unions
1
Introduction to Credit Unions
Learning objectives
On completion of this chapter you should be able to:
• define a credit union
• explain the main purposes of a credit union
• describe the founding principles of the credit union movement
• explain how credit unions developed in the United Kingdom
• explain the role of the World Council of Credit Unions (WOCCU)
• state the WOCCU nine principles.
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Credit Unions
What is a credit union?
A credit union may be defined as a mutual, democratic organisation that brings together
its members, linked by a common bond or common bonds, by pooling their savings and
making loans from that pool. In addition to these core services, many credit unions offer
additional financial services, either in their own right or through agency agreements
with other financial services providers.
The main purpose of credit unions, therefore, is to provide a home for personal savings from which
affordable credit can be obtained.
All financial institutions serve as a bridge between different types of customer and facilitate financial
intermediation. The majority of institutions deal with those who have money surplus to their current
needs and those who wish to borrow money.
Although the lines of demarcation between generic types of financial institution have become
increasingly blurred, it is the types of customers and the products and services offered that
distinguishes them. For example:
• the major retail banks accept deposits from the general public, businesses and the financial
markets and make loans available to personal customers and businesses
• the building societies offer share accounts to the general public and lend by way of mortgage
mainly for the purpose of enabling individuals and families to buy their own residential
properties
• NS&I (National Savings and Investments) (which operates through the Post Office and the
Internet) accepts savings and investments from personal customers and provides finance for
the government
• the life assurance companies accept premiums from policyholders and build a pool from
which claims are made.
Credit unions bridge the needs of (mainly) personal savers and borrowers, and their core services
overlap with similar products offered by banks and building societies. Yet credit unions are very
different to other types of financial institution for several reasons:
• although they have to make a profit to survive and grow, they plough all profits into the
business and do not pay dividends to external members (shareholders)
• they exist for the mutual benefit of the members
• they are totally democratic in structure
• their operations have a strong social dimension.
All credit unions are small compared with banks and many other financial institutions. While this
may appear initially to be a disadvantage, there are numerous benefits. Their products and services
are simple and straightforward, so by concentrating on these the credit unions can manage risk
in a very focused manner. It is perhaps significant that the credit union movement has avoided
scandals arising from corporate governance failings, while larger institutions have inevitably
experienced such problems. One immediate effect of the credit crisis that started in 2007 is that
many members of the general public lost their trust in the banking industry. Credit unions tend not
to suffer reputational risk, as they are operated by mostly local people, some of whom provide their
services on an unpaid basis. The strong ethical dimension that underpins credit unions inevitably
results in fewer trust issues.
Introduction to Credit Unions
Credit unions occupy a distinctive position in the financial services market. Their objectives include
the promotion of thrift, financial education, and debt management advice, which are clearly social
dimensions to their activities. While some banking organisations take it upon themselves to advise
on such matters, the social responsibility element is more embedded in the credit union movement.
While banks and some building societies have rationalised their branch networks, the heart of
credit union activities is in the community. This enables credit unions to fill a void created by branch
closures, offering basic financial products that can be conveniently accessed by the public. The old
model of opening branches according to population size and potential customer penetration no
longer works for banks, as their scale of operations enables them to deliver similar services online,
and the service offered by credit unions would be administratively cumbersome for them, but it
works perfectly well for credit unions. Although credit unions cannot offer the full range of services
that banks provide, the larger credit unions are able to enter into arrangements with banks in order
to offer a more complete suite of products and services.
Importantly, credit unions provide simple and affordable loans that offer a credible alternative to the
banks, who have retrenched in relation to small-scale consumer lending, finance companies (many
of which are subsidiaries of larger banks) and payday lenders. In particular, the recent proliferation
of payday lenders with products charged at rates of interest between 99% and 4,000% APR offers
an opportunity to the credit union movement. It is perhaps significant that while the original credit
union operational model saw these organisations lending only to established members, in the
recent past, some credit unions have started to offer loans to new members.
Profitability
Credit unions do not maximise profit, and so their primary objectives differ fundamentally from commercial
joint-stock companies. Most financial services providers are owned by their external shareholders. Although
shareholders can exercise influence through the annual general meeting and other meetings, they often do
not do so as long as sufficient profits are distributed each year in the form of dividends, and in turn the size
of the dividend is determined by how much profit is made and the extent to which the directors decide to
distribute dividends or retain profits for development. Therefore, some profit is retained and ploughed back
into the business. Generally, commercial organisations exist to maximise external shareholder value.
It should be apparent from these crucial differences between the mutual model and the joint-stock model that
theoretically, mutuals should be able to either pay better returns to savers, charge lower rates to borrowers,
or both, as they have no shareholders to remunerate. This does not always apply in practice however, and
larger companies operating in the market place are quick to point out that their comparatively larger size will
result in economies of scale, enabling them to offer more attractive rates to customers.
Credit unions do not have external shareholders. It is impossible for a credit union to operate as a public
limited company, and therefore no credit union can obtain a Stock Exchange listing. The only persons to
benefit from distributions are the members, who are paid dividends on their savings. This is funded wholly
from the interest paid by those who borrow, and any other income generated.
It is usual for credit unions to make an excess of income over expenditure each year. Although this fits a
broad definition of profit, it is described by some credit unions as a surplus. This surplus, net of dividends
to members, is ploughed back into the credit union to provide more resources for lending in successive
accounting periods. As there is little difference, in a conventional accounting sense, between a surplus and
a profit, credit unions have become less reluctant in recent years to use the term ‘profit’ in their literature
and financial accounts.
The surplus must be adequate to pay corporation tax, interest rebate and fund future growth of the
credit union and build reserves in line with regulatory requirements.
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Credit Unions
Mutual benefit
The term ‘mutuality’ relates to the common interests of different people and groups in society. There are
several types of financial institution that are founded on mutual principles. As well as credit unions, these
include:
• building societies
• friendly societies
• industrial and provident societies
• some life assurance companies.
These institutions are owned by their members and are run exclusively for the benefit of their
members.
Democratic nature
Credit unions operate on entirely democratic principles. Every member has one vote, irrespective of
their financial stake in the organisation. This means that:
• no individual person can dominate the decision-taking process
• no interest groups have a greater say than others
• no vested interests can be pursued at the expense of the members
• without the members’ consent, no-one can force a credit union to be taken over or merge with
another organisation
• the constitution can be changed only with the consent of the members.
This direct accountability to the members is very important. It was a feature of the earliest credit unions
and continues to this day, despite many other types of mutual organisation becoming less democratic in
recent times.
A member of a credit union has four basic inalienable rights:
• a right to a dividend if declared
• a right to vote on any matter tabled for discussion at a general meeting, as well as other democratic
rights enshrined in the constitution of the credit union
• a right to information, such as the annual report and financial statements of the credit union
• a right to have capital returned (though this right is qualified to the extent that should the credit
union become solvent, the maximum guaranteed capital is that protected by the Financial Services
Compensation Scheme, currently £85,000).
Social dimension
The activities of credit unions have to be consistent with the social responsibility owed to both their
members and the community in which they operate. The decisions of the credit union are made in
the context of their impact on these groups.
More specifically, credit unions promote the education of members and the community at large. Few
would dispute that building up a pool of savings is a worthy purpose for any individual or family – the
virtue of ‘thrift’ has been accepted for over two centuries. Further, it is infinitely better for those who
need to borrow to do so at low cost and on terms and conditions set by the very members who provide
the funds, especially when the rate of interest paid will not be swollen by the need to remunerate external
shareholders.
Introduction to Credit Unions
In the recent past, political and social commentators have increasingly seen credit unions as a vehicle
by which affordable borrowing and responsible money management can be promoted. For example,
many individuals fall into a cycle of debt by borrowing from payday lenders, pawnbrokers and illegal
moneylenders. In 2013, the Archbishop of Canterbury announced a plan to fight the proliferation of high
interest rate lenders. In the same year, the government announced a package of measures constraining
the extent to which vulnerable customers can be exploited financially by payday lenders.
The membership of credit unions is offered on the basis of open and voluntary membership. The low
entry cost, represented by an entrance fee (where applicable) and minimum accepted investment,
ensures that anyone who wishes to join a credit union may do so. This is in contrast to many other
types of financial institution, where the minimum opening deposit or other criteria may act as a
barrier to entry.
Credit unions are non-discriminatory in that their membership is drawn from the community at
large, provided the members lie within the common bond or bonds as defined by the constitution.
Quick question
What do you think led to credit unions first being established?
Write your answer here before reading on.
The origins and development of credit unions
The United Kingdom was the first country in the world to experience an industrial revolution. This acted
as a catalyst for many groups in society to form associations through which their mutual interests could be
promoted.
In the second half of the eighteenth century, the friendly societies and the building societies made
their first appearances. These were run on entirely mutual lines, with committees of volunteers
providing direction and administrative services for their members.
The friendly societies provided self-help services to those who moved to the newly-industrialised
cities and towns, offering regular savings facilities in order to provide a ‘nest egg’ for the family.
Some were set up as little more than burial clubs, ensuring that breadwinners could leave sufficient
funds to pay for their own funerals and a modest financial buffer to protect their dependants against
destitution.
The building societies of that time were very different to those of today. The earliest societies had
a closed membership and remained in existence only until all of the members had achieved their
aspiration of owning their own homes, funded by regular subscriptions for shares.
Both types of mutual institution evolved rapidly: the so-called terminating building societies were
replaced by the ‘permanent’ model which accepted savings and made loans on an ongoing basis; the
friendly societies became providers of savings, investment and insurance services.
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During the nineteenth century the cooperative movement developed. This had its origins in
Rochdale, Lancashire in 1844 and its legacy remains to this day in the form of the Cooperative Society,
the Cooperative Bank and the Cooperative Insurance Society (CIS). The Cooperative Permanent
Building Society was an additional arm of this movement; this became Nationwide Building Society
in the 1970s.
The early cooperative movement had many practices that remind us of mutuals today:
• members made regular subscriptions in the form of shares
• this entitled members to buy provisions at the lowest prices and to interest on their shares
• a dividend was paid to members, the amount depending on the value of expenditure in the previous year
• the constitutional rights of members were based on the principle of ‘one person, one vote’.
Ironically, the developments described above probably inhibited the growth of credit unions in the
United Kingdom. The credit union movement was well established in other countries before the first
credit unions were formed well into the twentieth century.
The earliest roots of the credit union movement can be traced to various initiatives by enterprising
individuals:
• a cooperative credit society was founded in Germany in 1850; the model evolved into the
concept of ‘peoples’ banks and by 1882 there were over 3,500 such institutions in Germany
• a parallel initiative established a Credit Union Federation in Germany in 1877, largely aimed
at providing services to farmers; by 1883 there were 425 cooperatives founded on this model
• the first cooperative bank appeared in Milano, Italy in 1865; this stimulated others to form
similar associations with the result that over 700 societies were formed in that country by 1900
• the first credit union on the North American continent was formed in Canada in 1900
• the first credit union in the USA was formed in New Hampshire in 1909 (though the movement
did not develop significantly until twenty years later)
• in the second half of the twentieth century the credit union movement achieved a significant
foothold in the Republic of Ireland, with many credit unions being founded for particular small
communities or specific occupations (today the credit unions representing public transport
workers (CIE) boast several thousand members).
The most famous surviving name from the original credit union movement in Europe is Raiffheisen
Bank, a large full service bank with operations in many countries. The founder was Friedrich Wilhelm
Raiffheisen, who created the first rural credit union in 1864 as an alternative to them falling into the
hands of unscrupulous moneylenders. Although details no longer exist, it is known that similar
informal initiatives pre-date Raiffheisen’s venture by several centuries, including arrangements by
some religious orders as early as the fifteenth century.
The first credit union in the United Kingdom was founded in Wimbledon, south-west London in
1964. By this time, both the Post Office Savings Bank (the forerunner of NS&I) and building societies
had achieved a dominant position in the personal sector savings market. This probably accounted
for the slow growth of credit unions in the next twenty years.
The period of deregulation that started with the change of government in 1979 saw many financial
institutions seeking to benefit from the newly competitive market place. One of the effects of this
was a re-definition of the purposes and objectives of many organisations.
Introduction to Credit Unions
The retail banks began to turn their backs on smaller savers, preferring to fund their operations
from the wholesale markets. Over-the-counter savings were discouraged as these tended to increase
administration costs. One effect of this was the reduction of interest rates paid to small savers to
minimal levels.
The building societies came under increasing pressure, especially from the so-called ‘carpet-baggers’
who sought the benefits of share distributions brought about by the conversion of societies to public
limited companies. As a result, many societies decided to impose minimum savings thresholds that
were out of the reach of those on lower incomes or with more modest wealth.
In short, many personal customers with requirements for simple savings and loan products became
less important to the larger players in the market place. The bigger financial institutions with national
networks of branches found it less cost effective to offer their services for what was perceived to be
little contribution to profit. High transaction accounts were relegated to the impersonal medium of
the automated teller machine and in some cases savers were actually charged for banking if their
balances fell below stated threshold levels. At the same time, many high volume lending services
were streamlined and consigned to the equally impersonal process of computer-based credit scoring
systems.
These developments resulted in a gap in the market place for the credit unions. Until deregulation
came along, there was little prospect of the credit unions gaining any foothold in the market. With the
abdication of their dominant position in the savings market, the banks, building societies and NS&I
left the door open for the emergence of the credit union movement in the United Kingdom.
World Council of Credit Unions (WOCCU)
WOCCU is an international trade association for credit unions and other mutual financial
institutions. The credit union model has been embraced in countries across most continents, and
WOCCU works with governments and agencies in order to improve legislation and regulation. Its
primary aim is:
‘To be the world’s leading advocate, platform, development agency and good
governance model for credit unions.’
WOCCU represents over 57,000 credit unions in 103 countries, with composite membership of 208
million members.
The nine operating principles of WOCCU are:
Democratic structure:
• open and voluntary membership
• democratic control
• non-discrimination.
Service to members:
• distribution to members
• building financial stability
• service to members.
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Social goals:
• ongoing education
• cooperation among cooperatives
• social responsibility.
Industry structure and recent developments
The Prudential Regulation Authority produces annual statistics on all financial institutions within its
terms of reference. As many credit unions have a year-end of 30 September, the statistics produced
are time lagged, so the latest figures available at the time of writing are for 2014.
From 31 December 2014, the British credit union sector had:
• around 362 credit unions across England, Scotland and Wales employing more than 1,500 staff
• 1,197,293 people using the sector, including 120,080 junior depositors
• total assets of £1.26 billion
• total loans of £718 million
• total deposits of £1.07 Billion
• annual turnover of £26 million (year to 30 September 2014)
• 22 credit unions across the UK now offering current accounts
• more than 35,000 people with their current account with a credit union
• some credit unions offering mortgages, cash ISAs and insurance products.
(Sources: PRA unaudited quarterly figures, December 2014 and ABCUL)
In the year to December 2014, the sector grew:
• membership by 7%
• assets by 11%
• loans by 6%
• deposits by 13%
• turnover by 8%.
It can be seen from these statistics that the credit union movement in the UK is relatively small.
Credit unions have a tiny customer base compared with the banks and building societies, but as a
consequence the scope for expansion is considerable. For reasons explained above, other types of
financial institution are unlikely to seek greater market penetration in relation to products that form
the core services of credit unions. Fairly small scale savings accounts and loans, delivered on a local
and personal basis, are not seen by larger institutions as prime areas for potential growth.
Experience in other countries has demonstrated that credit unions can be highly successful.
The financial services sector in the United States of America is fragmented for historical reasons,
and as such has a very different profile to that of the UK. For many years, financial institutions in
most US states were forbidden from opening branch offices, and as a result of this many small scale
savings and loan companies were set up as well as local credit unions. The property crash in the
country saw a massive downturn in the business of banks and savings and loan companies, as many
of them were confronted by mortgage losses. By contrast, credit unions were less affected as their
degree of exposure to secured real estate loans was comparatively insignificant.
Introduction to Credit Unions
In Canada it is estimated that about one in three people belongs to a credit union or caisse populaire.
Canada has 308 credit unions with over 5.3 million members. Assets exceed $170 billion, of which
$145 billion are loans. These are backed by $150 billion in deposits. The movement employs over
27,000 staff.
The credit union movement in the Republic of Ireland developed much earlier and more strongly
that its UK equivalent. Ireland has a small population (less than 6 million people), but is characterised
by strong communities in relatively small-sized towns and villages. It is common to see local credit
unions in larger villages where a very high proportion of the population are members. This strength
is not confined to geographical common bonds, however, as many large employers have credit
unions for their staff, and in many cases saving is facilitated by group savings schemes, with regular
instalments deducted from wages or salaries. According to the Irish League of Credit Unions, there
are over 500 credit unions in Ireland serving nearly 3 million members. Savings balances exceed 12
billion euros. Irish credit unions employ over 3,500 staff, supported by over 9,000 volunteers.
It has been argued that the growth of credit unions in the UK has been hampered by the presence
in the market of building societies and post office savings facilities. However, the experience in
Australia would weaken this argument, as there was a very strong building society movement in
Australia, yet credit unions are both well established and successful. Australian credit unions hold
over $45 billion in assets, serve 3.5 million customers and employ over 7,000 staff. Many Australian
credit unions have diversified from the core savings and lending products to offer card products,
insurances, mortgages and money transmission services.
In order to enable credit unions to remain competitive and build on the services they already offered,
the government enacted reforms with effect from 2012. The changes were brought about under the
Legislative Reform (Industrial and Provident Societies and Credit Unions) Order. This included
several measures which released credit unions from restrictions that constrained their operations by:
• amending the requirements for membership of a credit union
• reforming restrictions on non-qualifying membership of credit unions
• permitting credit unions to admit corporate bodies to membership
• permitting credit unions to pay interest on deposits
• removing the statutory limit on dividends
• removing restrictions on certain withdrawals of shares by members
• permitting credit unions to charge market rates for the provision of certain ancillary services.
These reforms are explained further in chapter 3.
Quick question
What do you think the future holds for credit unions?
Write your answer here before reading on.
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Prospects for credit unions
Despite the increased sophistication of the market for personal sector financial products and services
in recent years, the need for more community-based organisations with relatively straightforward
products has, if anything, increased in the last ten years.
On the savings side of the business, although consumers know that they can achieve higher returns from
market-related investments, these returns do not come without risk. Today, many mature customers
recall the harsh lessons that followed ‘Black Monday’ – the day in October 1987 when the world’s stock
markets crashed. This caused many individuals and families to re-focus their attention on preserving
wealth by having sufficient funds in capital guaranteed accounts that would not be eroded by the whims
of the market.
These concerns were rekindled by the collapse of the Bank for Credit and Commerce International
(BCCI) in 1991. This left many thousands of savers with their savings at risk. Non-personal investors
lost most of their money altogether. By contrast, credit unions provide virtually guaranteed return
of capital to the saver, together with dividends for the period invested.
Later in the 1990s, the demise of many so-called ‘dot.com’ companies led to a reduction in confidence
in information technology-driven markets. This was another salutary lesson to investors that, with
potentially high returns offered by speculative investments, also come significant risks.
As far as borrowing is concerned, both the demand for loans and the range of products available
have increased markedly in recent times. Some commentators have stated that the United Kingdom
has become a nation of borrowers, while in 2003 one national newspaper led with the headline
‘Drowning in a sea of debt’. For those who wish to borrow, the possibilities are endless – mortgages,
credit cards, personal loans, term loans and so on.
The financial crisis that started in 2007 created many new challenges for financial institutions and their
customers. Many banks, including some of the larger players in the market, encountered difficulties,
and some had to seek financial support from the government in order to avoid insolvency. The
practical impact on their customers was that it became more difficult for personal borrowers and
small traders to borrow, as lending policies became more restrictive. Banks had to introduce more
conservative policies. One consequence of this was that those seeking to borrow relatively small
sums of money could no longer obtain overdrafts and personal loans as readily as before. Borrowers
of small amounts for short periods, however, were now able to turn to the products of payday
lenders, who started to make loans more readily available, but at interest rates of several hundred
or even thousand percent.
Payday lenders do not seek to compete with credit unions, as their interest rates and charges are
much higher, but they offer the compelling opportunity of ‘money now’ with relatively few questions
asked. The demand for finance is a derived demand, in that the borrower does not want a loan at
all, but wants to solve the problem or meet the need that the loan will fulfil. To many in low income
groups, and particularly vulnerable customers with short-term cash flow difficulties, the payday
loan will defer the issues even if it does not solve them. The government and debt counselling
agencies are hostile to payday lenders, many of which are subsidiaries of US companies domiciled
in states where payday lending is illegal or more restricted, and see credit unions as a more desirable
alternative. However, it will be necessary for resources to be invested in consumer education, as well
as a change in the mindset of the target customer base, to bring about change in the medium term.
The credit unions offer an additional option but with numerous benefits. The person borrowing for
a holiday can do so by way of further advance against the private home, but in many cases this will
mean that interest is paid for 15-20 years or even longer.
Introduction to Credit Unions
The personal loan typically charges a rate of interest that is virtually double that of a mortgage.
Credit cards and store cards usually cost considerably more. The rate of interest offered by the credit
union is rarely higher than these options, and even if it is (for example with some mortgage deals),
the overall interest paid is likely to be less.
The credit unions address the financial needs of these customers by offering easy-to-understand
products at reasonable rates of interest. The saver takes little or no risk, while the borrower knows
that their future income will not be eroded by the large interest payments associated with other types
of borrowing.
Credit unions provide a personal service in which the member is an individual and not an account
number. They avoid the prescriptive approach to customer fulfillment often seen elsewhere in the
use of automated messaging and impersonal call centres.
The future of credit unions is promising. The products and services offered do not generally carry the
risks described above while fulfilling most of the needs of personal customers. Many credit unions
offer more. Although we have focused in this chapter on the core activities of savings and lending,
many credit unions are expanding their range of services, facilitating a ‘one-stop shop’ for numerous
needs supplied by a single institution. Crucially, credit unions also give their customers a real say in
the way that the business is run.
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Credit Unions
Review
Now consider the main learning points which were introduced in this chapter.
Go through them and tick each one when you are happy that you fully understand each point.
Then check back to the objectives at the beginning of the chapter and match them to the learning points.
Reread any section you are unsure of before moving on.
A credit union is a mutual, democratic organisation that brings together its members,
linked by a common bond or common bonds, by pooling their savings and making loans
from that pool. Many credit unions also offer additional financial services, either in their
own right or through agency agreements with other financial services providers.
The main purpose of credit unions is to provide a home for personal savings from which
affordable credit can be obtained.
Credit unions are different to other types of financial institution in that, although they
have to make a profit to survive and grow, they plough all profits into the business
and do not pay dividends to external members; they exist for the mutual benefit of the
members; they are totally democratic in structure and their operations have a strong
social dimension.
Credit unions originated from the friendly societies, building societies and the
cooperative movement.
The first credit union in the United Kingdom was founded in Wimbledon, south-west
London in 1964.
Developments such as deregulation, retail banks starting to ignore smaller scale savers
and pressure on building societies resulted in a gap in the market place for the credit
unions.
World Council of Credit Unions (WOCCU) is an international trade association for
credit unions and other mutual financial institutions.
Experience in other countries has demonstrated that credit unions can be highly
successful. Credit union movements exist, for example, in the USA, Canada, Ireland and
Australia.
The future of credit unions is promising. The products and services offered do not generally
carry the risks of other types of financial institution while fulfilling most of the needs of
personal customers.
Introduction to Credit Unions
Key words in this chapter are given below. There is space to write your own
revision notes and to add any other words or phrases that you want to remember.
mutual, democratic organisation
personal savings
affordable credit
friendly societies
building societies
cooperative movement
World Council of Credit Unions
Legislative Reform (Industrial and Provident Societies and Credit Unions) Order
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