Consumers can choose banks or credit unions for mortgages, auto loans and other financial services. Differences between these institutions include not only interest rates but also the extent of risk tolerance and subprime lending. Credit: Designer491|Dreamstime.com.
Female CEOs in the financial sector are exceedingly rare, making up only 5% at banks around the world. When Jordan van Rijn (AAE PhD’18) heard that 52% of credit unions have female leaders, he was dumbfounded.
“That was my first inkling that credit unions might be a different type of financial institution,” says van Rijn, an AAE assistant teaching professor and associate director of the VISP and MSPO programs.
Unlike banks, credit unions are nonprofit organizations and member-owned cooperatives whose membership eligibility is defined by shared occupation, geographic area or religious affiliation. Their stated goal is the financial wellbeing of their members, who are encouraged to participate in the firm’s operation and management. U.S. credit unions have experienced significant growth, and today’s 4,800 institutions serve about 138 million members.
For his dissertation, van Rijn examined how the management style of incoming female credit union CEOs differs from that of male CEOs. That spurred his interest in exploring other differences between credit unions and traditional banks, a surprisingly understudied research topic. One such difference involves the 2007-2009 Great Recession, the worst financial crisis between the Great Depression and the Covid-19 pandemic.
Van Rijn teamed up with Kangli Li (AAE PhD’21) to understand why credit unions fared much better than banks during and after the Great Recession. With a similar baseline number of each type of institution, the differences were striking: 7.3% of bank vs. 2.0% of credit union mortgages were delinquent; 331 banks vs. 64 credit unions failed; and 710 banks received more than $236 billion in public assistance, compared to 48 credit unions receiving $69 million.
The Great Recession started with a burst of the housing market bubble that resulted in a 33% reduction of home values and 4 million recorded foreclosures in 2009. That year’s unemployment rate reached 10%, and many of those who lost their jobs also fell behind on their mortgage payments. The reasons for this economic downturn are complex and multifactorial, but most economists agree that a wave of credit expansions in the years leading up to the Great Recession played an important role. This was a time when credit unions also behaved very differently from banks.
In 2006, for example, 23.6% of bank but only 3.6% of credit union mortgages were “subprime.” This means the borrowers had at least one of the following characteristics: low credit scores; debt of more than half of their annual income; down payments below 10% of the home sale price; and previous records of delinquency, foreclosure or bankruptcy.
When a bank offers subprime mortgages, it believes that the additional income from a higher number of borrowers and, most importantly, a continued increase in home values will outweigh the greater risk of delinquency. During an economic boom, these predictions often pan out, helping banks make a greater profit than risk-averse credit unions—just like riskier private investments tend to have a higher rate of return in good times. But a housing market crash may turn high-risk loans into hefty losses.
The researchers wanted to know if the different firm structures (for-profit vs. nonprofit/cooperative) explained the differences in risk tolerance after accounting for many other factors that distinguish banks from credit unions. “Our hypothesis was that the Great Recession may have affected banks more than credit unions because of their inherently different incentives,” says van Rijn. “Banks aim to maximize short-term profits to boost both stock values for the shareholders that oversee them and bonuses for their CEOs and loan officers while credit unions focus on the long-term financial welfare of their members. This might mean they are less likely to offer high-risk mortgages.”
To answer their question of interest, the researchers assembled annual home mortage data from almost 6,500 banks and 2,500 credit unions over a 14-year period. They tested whether firm structure was a significant predictor of (i) the proportion of high-risk loans from 2004 to 2017 and (ii) the change in this proportion from 2004 to 2009.
The analysis accounted for other differences that affect loan decisions. For example, average assets were $553 million for banks and $386 million for credit unions, even after removing banks whose assets exceeded $10 billion. Commercial loans made up 27% of the portfolio for banks and 4% for credit unions, compared to 5% and 46% for consumer loans. Despite similar average incomes, borrowers took out higher average mortgages from banks than credit unions ($220,000 vs. $120,000).
The researchers found that banks offered significantly more subprime mortgages than credit unions under normal economic conditions, with an especially strong growth in the share of these high-risk loans from 2004 to 2009. This suggested that the difference in incentives was indeed the most likely explanation for the greater impact of the Great Recession on banks.
The study’s conclusions are relevant for policymakers and consumers. “The financial sector’s regulation is largely designed to reduce the risk of failure, and our results show that the business model of credit unions already discourages excessive risk-taking,” says van Rijn. “That argues for banks requiring more regulation and also supports the longstanding exemption of credit unions from the federal corporate income tax.”
Credit unions typically offer lower interest rates for home mortgages and auto loans. This, notes van Rijn, makes them an appealing choice for consumers, especially those who prefer a long-term trust-building partnership over higher short-term profits and are more comfortable with low-risk financial decisions. “I believe credit unions are a better fit for people who care about shared values and connections with their local community,” he says.