Policy Issues Related to Credit Union Lending
Released: 2015-11-18T00:00:00

Summary:
Credit unions make loans to their members, to other credit unions, and to corporate credit unions that provide financial services to individual credit unions. There are statutory restrictions on their business lending activities, which the credit union industry has long advocated should be lifted. Specific restrictions on business lending include an aggregate limit on an individual credit union's member business loan balances and on the amount that can be loaned to one member. Industry spokespersons have argued that easing the restrictions on member business lending could increase the available pool of credit for small businesses. Credit unions also lack sources of capital beyond retained earnings, and alternative supplemental capital sources would allow them to increase their lending while remaining in compliance with safety and soundness regulatory requirements. Community bankers, who often compete with credit unions, argue that policies such as raising the business lending cap would allow credit unions to expand beyond their congressionally mandated mission and could pose a threat to financial stability.
Members of the 114th Congress have introduced legislation that would allow credit unions to expand their lending activities. H.R. 989, the Capital Access for Small Business and Jobs Act, was introduced and referred to the House Committee on Financial Services on February 13, 2015. H.R. 989 would redefine net worth for credit unions to include additional sources of supplemental capital. In addition, H.R. 1188 and its companion bill, S. 2028, the Credit Union Small Business Jobs Creation Act, would raise the current member business lending cap. H.R. 1422 and S. 1440, the Credit Union Residential Credit Union Loan Parity Act, would amend the FCU Act to revise the statutory definition of member business loans, further enhancing the capacity of credit unions (satisfying the net worth capitalization requirements) to make more member business and commercial loans. On April 13, 2015, the House-passed H.R. 299, the Capital Access for Small Community Financial Institutions Act of 2015, would amend the Federal Home Loan Bank (FHLB) Act to require the treatment of state-chartered credit unions as insured depository institutions, among other things; thus making it possible to harmonize FHLB-membership requirements for small banks and credit unions. The House included the language of H.R. 299 in an amendment to H.R. 22, the Surface Transportation Reauthorization and Reform Act of 2015, as passed on November 5, 2015. S. 1484, the Financial Regulatory Improvement Act of 2015, and S. 1910, the Financial Services and General Government Appropriations Act, 2016, also contain language similar to H.R. 299.
Small memberships limit the range of financial services that small credit unions can offer as well as their ability to accumulate enough retained earnings (capital) to substantially increase their commercial lending activities. Thus, the benefits to credit unions from legislative actions to enhance their lending ability may be greater for larger institutions. Larger credit unions, with the resources to offer a wide array of financial services to members, would also be expected to become more significant competitors with community banks operating in similar lending markets. Competition between credit unions and commercial banks, particularly those with over $1 billion in assets, would be expected to intensify.
Although total assets and membership in the credit union industry have risen over the past decade, the total number of credit unions has declined. The industry's assets are not evenly distributed. Some differences in credit union and bank regulation are unlikely to account for the competitive advantages that large credit unions enjoy relative to their smaller counterparts. These observations mirror the consolidation trends observed in the depository banking industry and are discussed in greater detail in the Appendix.

subsections: section_title: Introduction
paragraphs: Credit unions engage in financial intermediation , or facilitating transfers of funds back and forth between savers (via accepting deposits) and borrowers (via loans). Although other institutions (e.g., depository banks, insurance companies, pension funds, hedge funds) also engage in the financial intermediation matching process, this report focuses on issues facing the credit union industry.
The original concept of a credit union was of a membership-owned cooperative organization formed for the purpose of promoting thrift among its members and providing them with a low-cost source of credit. Congress passed the Federal Credit Union Act of 1934 (FCU Act; 48 Stat. 1216) to create a class of federally chartered financial institutions for the purpose of "promoting thrift among its members and creating a source of credit for provident or productive purposes." Given the numerous bank failures and runs that occurred during the Great Depression, Congress wanted to enhance the ability of these cooperative organizations to meet the credit needs of their memberships, who were unable to obtain bank credit. The credit union industry has evolved with marketplace changes so that many of the financial services that credit unions provide are similar to those offered by banks and savings associations. 
Credit union charters are granted by federal or state governments on the basis of a "common bond." There are three types of charters: (1) a single common bond (occupation or association based); (2) multiple common bonds (more than one group each having a common bond of occupation or association); and (3) a community-based (geographically defined) common bond. Individual credit unions are owned by their memberships. The members of a credit union elect a board of directors from their institution's membership (one member, one vote). Given that credit unions are financial cooperatives that return profits to their memberships, members' savings are referred to as "shares" that earn "dividends" instead of interest. Credit union loan and investment powers are more restricted than those of commercial banks. Credit unions can only make loans to their members, to other credit unions, and to credit union organizations. The investment authority of federal credit unions is limited by statute to loans, government securities, deposits in other financial institutions, and certain other limited investments.
The National Credit Union Administration (NCUA), an independent federal agency, is the federal regulator and share deposit insurer for credit unions. Typically, the Office of the Comptroller of the Currency (OCC) charters and supervises national depository (commercial) banks; the Federal Deposit Insurance Corporation (FDIC) provides deposit insurance and liquidates failed banks; and the Federal Reserve provides lender-of-last-resort liquidity to solvent banks via its discount window. The NCUA, by comparison, serves all three functions for federally regulated credit unions. The NCUA also manages the National Credit Union Share Insurance Fund (NCUSIF), which is the federal deposit insurance fund for credit unions. 
Numerous financial entities experienced distress during the 2007-2009 recession, including the credit union system. In response, the NCUA has adopted enhanced capital requirements for credit unions, which is intended to increase the resiliency of the credit union system to insolvency (failure) risk and to minimize possible losses to the NCUSIF and ultimately taxpayers. Some credit unions may need to curtail lending until they fully adjust to the increased requirements. In addition, Congress is considering legislation (e.g., H.R. 1188 and S. 2028 , the Credit Union Small Business Jobs Creation Act; H.R. 989 , the Capital Access for Small Business and Jobs Act) to enhance the lending ability of the credit union industry as part of its efforts to spur economic growth. H.R. 1422 and S. 1440 , the Credit Union Residential Credit Union Loan Parity Act, would amend the FCU Act to revise the statutory definition of member business loans, further enhancing the capacity of credit unions (satisfying the net worth capitalization requirements) to make more member business and commercial loans. These policies are discussed in this report. The balance sheet terminology defined in the box below will be used throughout this discussion.
section_title: Enhanced Capitalization Requirements
paragraphs: The credit union system, which largely facilitates residential and consumer lending, inherently faces financial risks, some of which were realized in the recent financial crisis. For example, the NCUA reported that the corporate credit unions faced liquidity pressures and placed five of them into conservatorship in 2008. Corporate credit unions operate as wholesale credit unions, meaning that they provide financing, investment, and clearing services for natural person (retail) credit unions, which interface directly with customers. The corporates accept deposits from, as well as provide liquidity and correspondent lending services to, retail credit unions. This reduces the costs that smaller institutions would bear individually to perform various financial transactions for members. Given that retail credit unions are cooperative owners of corporate credit unions, they are also federally insured by the NCUA. The NCUA chairman reported that the five corporates under conservatorship had represented approximately 70% of the entire corporate system's assets and 98.6% of the investment losses within the system at that time. A Temporary Corporate Credit Union Stabilization Fund (TCCUSF) was established by Congress in May 2009 to accrue and recover losses from the corporate credit unions. The TCCUSF borrowed from Treasury to help cover the costs of conservatorship, and the NCUA also raised assessments on all federally insured credit unions, including those that did not avail themselves of corporate credit union services.
Credit unions, like all financial institutions, are susceptible to the usual risks associated with lending or the financial intermediation process. Safety and soundness regulation includes the requirement to hold sufficient capital reserves, which is intended to reduce the insolvency (failure) risk of financial institutions. Although higher capital requirements may not prevent adverse financial risk events from occurring, more capital enhances the ability of financial firms to absorb greater losses associated with potential loan defaults. The enhanced absorption capacity may strengthen public confidence in the soundness of these financial institutions and increase their ability to function during periods of financial stress. 
In May 2012, the NCUA issued a Supervisory Letter regarding large concentrations of 30-year traditional fixed rate mortgage loans held in portfolio by some credit unions, which could develop into an adverse financial event in the future. Credit unions that made large amounts of mortgage loans during the current low interest rate environment could find themselves receiving lower amounts of revenue relative to what may be necessary to pay share depositors if interest rates increase in the future. Furthermore, the interest rate risk may grow into a systemically important crisis or "too many to fail" event if numerous credit unions simultaneously became insolvent. The NCUA guidance requires vulnerable credit unions to submit plans outlining the measures that will be taken to reduce or manage interest rate risks.
On January 23, 2014, the NCUA announced increases in capital requirements for a subset of natural person credit unions that will be designated as complex . A complex credit union was initially defined by NCUA to have at least $50 million in assets. On January 27, 2015, the NCUA revised the initial proposed rule, amending the definition of a complex credit union as having at least $100 million in assets. On October 29, 2015, the NCUA finalized the risk-based capital rule. Some of the specific requirements of the rule include the following: 
A new asset risk-weighting system is introduced and would apply to complex credit unions, and it will be more consistent with the methodology used for U.S. federally insured banking institutions. A new risk-based capital ratio (defined using the narrower risk-based capital measure in the numerator and total risk-weighted assets, which are computed using the new risk-weighting system, in the denominator) of 10% is now required for complex credit unions to be well-capitalized under the prompt corrective action supervisory framework. The risk-based capital ratio is designed to be more consistent with the capital adequacy requirements commonly applied to depository (banking) institutions worldwide. Complex credit unions must comply with the risk-based capital ratio requirements as well as the existing statutory 7% net-worth asset net worth ratio by January 1, 2019, to avoid NCUA supervisory enforcement actions. Non-complex credit unions with assets below $100 million would not be required to comply with the new risk-weighting system, and they would no longer be required to risk-weight their assets. Instead, non-complex credit unions must comply with the existing statutory 7% net-worth asset ratio. 
According to the NCUA, 1,455 credit unions (or 22% of all credit unions) reported having at least $100 million in total assets as of December 31, 2013, representing 89% of all assets held in the credit union system; 19 of those institutions would need to raise capital to avoid being undercapitalized. The ability of undercapitalized credit unions to continue lending would arguably be constrained until they become compliant with the higher capital buffer requirements. 
section_title: Increasing the MBL Cap: Implications and Optional Policy Tools
paragraphs: There was no commercial lending cap on the amount of member business loans that credit unions could make until 1998. In response to a Supreme Court decision, Congress passed the Credit Union Membership Access Act of 1998 (CUMAA; P.L. 105-219 ), which among other provisions, established a commercial lending cap. 
First, the CUMAA codified the definition of a credit union member business loan (MBL). An MBL is any loan, line of credit, or letter of credit used for an agricultural purpose or for a commercial, corporate, or other business investment property or venture. Second, the CUMAA limited the aggregate amount of outstanding business loans to one member or group of associated members to a maximum of 15% of the credit union's net worth or $100,000, whichever is greater. Third, the CUMAA limited the aggregate amount of MBLs made by a credit union to the lesser of 1.75 times the credit union's actual net worth or 1.75 times the minimum net worth amount required to be well-capitalized under the prompt corrective action supervisory framework. Finally, three exceptions to the credit union aggregate MBL limit were authorized for (1) credit unions that have low-income designations or participate in the Community Development Financial Institutions program; (2) credit unions chartered for the purpose of making business loans (as determined by the NCUA); and (3) credit unions with a history of primarily making such loans (as determined by the NCUA).
Legislation has been introduced in the 114 th Congress that would allow credit unions to enhance their member business lending activities. H.R. 1188 , the Credit Union Small Business Jobs Creation Act, was introduced on March 2, 2015; the companion bill, S. 2028 , was introduced on September 10, 2015. H.R. 1188 and S. 2028 , would amend the Federal Credit Union Act (particularly 12 U.S.C. 1757) to gradually increase the current business lending cap to 27.5% of the total assets of the credit union from the current 1.75 times of the actual net worth or 12.25% of the total assets, whichever is less. The bills would also require credit unions that make MBLs to have net worth and risk-based capital ratios that satisfy the requirements to be well capitalized . In addition, a credit union would need to demonstrate a minimum of five years of experience of sound underwriting and servicing of member business loans.
Although the volume of credit union member business lending has increased over time, member business loans continue to account for a small share of lending in the credit union system. In other words, the total amount of MBLs provided by the credit union system may be constrained by the current cap. Credit unions collectively provided a total of $43.42 billion of MBLs in 2013, which equaled 4.08% of total credit union assets; approximately 85% of MBLs were secured by real estate, with some credit unions heavily concentrated in agricultural loans. 
subsections: section_title: The Importance of Asset Size and Market Purview
paragraphs: If the MBL cap were raised, smaller credit unions attempting to originate and increase their holdings of MBLs in portfolio would have to increase their net worth holdings substantially, which arguably would be challenging if the membership base is small. Small credit unions typically offer a limited range of services, such as a few savings products and specialized consumer lending products such as (subprime) personal and automobile loans. These credit unions would be unlikely to increase their presence in the commercial lending market substantially because it would not be cost effective for them to invest in the necessary underwriting systems for the volume of commercial lending that they would feasibly be able to do. Hence, credit unions with assets under $10 million would be less likely to become more substantial providers of MBLs. 
By contrast, increasing the MBL cap would benefit credit unions that already enjoy a presence in the commercial lending market or a sufficiently large asset base. Lifting the MBL cap would allow credit unions already operating close to the current statutory limit to increase their presence in the commercial lending market. These credit unions may also already have the capacity to offer a broader range of consumer financial products and services. Some of the larger credit unions, therefore, could become more important competitors with small community banks as well as some midsize and regional banks.
Although the ability to originate and keep large loans in portfolio until fully repaid is highly dependent upon the size of a credit union, the credit union system as a whole can support increased member business lending by increasing its use of participation (syndicated) loans . Loan participations are used by financial institutions to provide credit jointly. A loan originator, who often structures the loan participation arrangement, typically retains the largest share of the loan and sells smaller portions to other institutions. This practice allows the originator to maintain control of the customer relationship (including the loan servicing) and overcome funding limitations. In addition, all of the institutions involved in the participation loan use their individual portions of the loan to diversify their asset (loan) portfolios, which can be a cost-effective financial risk management tool. Only credit unions with MBL programs are allowed to enter into MBL loan participations given that all participants must have the ability to and are responsible for performing underwriting due diligence. 
Since 2007, the number of credit unions purchasing loan participations increased 15%, and the dollar value of loan participations on credit unions' balance sheets grew by more than 40%. If the MBL cap is raised, then both small and large institutions may purchase portions of these loans and distribute the risk throughout the system, similar in practice to how the banking industry distributes its risks. The credit union system could, therefore, become a more prominent competitor with the banking system in commercial lending markets.
section_title: Insolvency Risks to the NCUSIF
paragraphs: Proceeds from the National Credit Union Share Insurance Fund are used to pay share depositors if member institutions fail. In the event of many simultaneous credit union failures, the risk of insolvency of the NCUSIF increases and may require congressional action to replenish the fund. Credit unions can be particularly vulnerable to failure, given that their membership affiliations are restricted to a particular industry or geographical area that could be disproportionately affected by an adverse economic event. For example, an increase in unemployment that is concentrated in a particular industry or geographical location may trigger numerous loan defaults if such an event adversely affects the majority of a credit union's membership.
Increasing the lending cap arguably may allow the credit union system to increase its MBL holdings, possibly resulting in more diversification. If, however, participation lending were to become a more customary practice used to finance MBLs, then losses on loan participations could also pose a "too many (small institutions) to fail" risk to the NCUSIF, given that multiple credit unions are involved in the lending arrangements. The NCUA also reported that participation loan charge-offs increased by more than 160% over the same period that credit unions increased their purchases of participation loans. The NCUA has subsequently provided more rules for participation loans to mitigate risks to the NCUSIF while still attempting to maintain the viability of this diversification tool for individual credit unions.
section_title: Updates to MBL Rules and Definition
paragraphs: On July 1, 2015, the NCUA proposed updates to the MBL rules to remove "prescriptive" requirements and adopt "principles" based approach. The prescriptive approach required credit unions that wanted to originate MBLs to submit waivers to NCUA for approval, among other requirements. The NCUA reported that the prescriptive approach took significant time and resources from both credit unions and NCUA, resulting in delays in processing MBL applications. The principles approach, by contrast, is intended to streamline the MBL underwriting process by granting credit unions more flexibility and individual autonomy. Credit unions are still expected to comply with prudential underwriting practices and commensurate net worth requirements. Furthermore, credit unions with a concentration in commercial lending in access of 50% of their total assets will be required to hold higher amounts of net worth to abate the higher levels of concentration risk.
In light of the greater autonomy associated with the principles based approach, the NCUA also provided more detailed guidance for distinguishing between commercial loans and MBLs to help credit unions better determine which loans to count toward the MBL cap. Despite the distinguishing features, the net worth requirements for both commercial and MBLs would still be identical. H.R. 1422 and S. 1440 , the Credit Union Residential Credit Union Loan Parity Act, would amend the FCU Act to revise the statutory definition of MBLs, further enhancing the capacity of credit unions (satisfying the net worth capitalization requirements) to make more MBLs and commercial loans. 
section_title: Alternative Tools and Policy Options
paragraphs: The MBL cap is not the only policy tool that can be used to influence the lending ability of the credit union industry. From an economics perspective, a lending cap imposes an arbitrary limit that may be too high for some credit unions and too low for others, thus resulting in MBL shortages in the latter situations. For those credit unions that provide very few or no MBLs, a cap is irrelevant. Those credit unions facing an active MBL market must abruptly cease this type of lending when the volume of activity reaches the cap, which some may argue is set "too low," given that they can no longer satisfy the financial needs of their memberships. Hence, a lending cap is arguably a blunt instrument to the extent that it imposes the same requirement on all institutions without taking into account differences in asset size and market purview. 
Policy tools with a greater focus on the costs to originate MBLs would still impose restraints on credit unions without directly capping their lending ability. For example, increasing the asset risk weights for MBLs imposes costs without resulting in an abrupt discontinuation of this activity for those credit unions approaching the cap. As previously discussed, the NCUA has narrowed the definition of net worth and introduced a risk-weighting system, which is more consistent with the capital adequacy requirements used by the banking system. Another policy tool having a similar effect would subject the net income derived from member business lending activities (particularly for credit unions over a certain asset size) to unrelated business income tax (UBIT) for tax-exempt organizations. In short, policy tools that operate through cost disincentives instead of quantity restrictions (at a fixed level) may still allow those credit unions with a presence in this market to increase their member business lending activity.
section_title: Other Proposed Lending Enhancements
paragraphs: In addition to revising policies associated with member business lending, other legislative actions have been introduced in the 114 th Congress to facilitate credit union lending, discussed below. 
subsections: section_title: Supplemental Capital
paragraphs: Because credit unions do not issue common stock equity, they do not have access to capital sources beyond retained earnings. Hence, if alternative sources of capital, referred to as supplemental capital, can be used in addition to retained earnings (net worth), then credit unions would be able to increase their lending while remaining in compliance with their safety and soundness net worth requirements. 
An NCUA working group has developed three general sources of supplemental capital, all of which would be repaid in the event of the liquidation of an insolvent credit union and after reimbursement of the NCUSIF. Credit unions could raise 
voluntary patronage capital (VPC) if (non-institutional) members of a credit union were to purchase "equity shares" in the organization. VPC equity shares would pay dividends; however, a VPC investor would not obtain any additional voting rights, and no investment would be allowed to exceed 5% of a credit union's net worth. mandatory membership capital (MMC) if a member pays what may be conceptually analogous to a membership fee. MMC capital would still be considered equity for the credit union but, unlike VPC, it would not accrue any dividends. subordinate debt (SD) from external and institutional investors. SD investors would have no voting rights or involvement in the management affairs of a credit union. SD would function as a hybrid debt-equity instrument, meaning that the investor would simply be a creditor with no equity share in the credit union while it is solvent and would not be repaid principal or interest should the credit union become insolvent. SD investors must make a minimum five-year investment with no option for early redemption. 
Net worth for credit unions is defined in statute; therefore, Congress would need to take legislative action to permit other forms of supplemental capital to count toward their net worth requirements. H.R. 989 , the Capital Access for Small Business and Jobs Act, referred to the House Committee on Financial Services on February 13, 2015, would redefine net worth for credit unions to include additional sources of supplemental capital in a manner consistent with the three forms discussed in the NCUA white paper. H.R. 989 may arguably complement bills H.R. 1188 and S. 2028 , but these bills are not dependent upon concurrent enactment. H.R. 989 would allow credit unions to increase all types of lending (including MBLs) as long as overall net worth, which would then be able to include supplemental capital, grows proportionately.
section_title: Federal Home Loan Bank Membership
paragraphs: The Federal Home Loan Bank (FHLB) System provides secured loans to banks, credit unions, and insurance companies engaged in housing finance as well as in agricultural and small business lending. Membership in the FLHB System generally requires institutions to hold at least 10% of their total assets in mortgage-related assets. Co mmunity financial institutions , however, are exempt from this eligibility requirement. According to the Federal Home Loan Bank Act (FHLB Act; P.L. 72-304, 47 Stat.128), community financial institutions are defined as having less than $1 billion in assets and deposits insured by the Federal Deposit Insurance Corporation (FDIC). This definition allows for some small banks, particularly those designated by the U.S. Treasury as Community Development Financial Institutions (CDFI), to qualify for the exemption; but it excludes NCUA-insured credit unions.
H.R. 2642 and its companion, S. 1491 , the Community Lender Regulatory Relief and Consumer Protection Act of 2015, along with H.R. 299 , the Capital Access for Small Community Financial Institutions Act of 2015, would amend the FHLB Act to require the treatment of a state-chartered credit unions as insured depository institutions, among other things; thus making it possible to harmonize FHLB membership requirements for small banks and credit unions. In addition, H.R. 2473 , Preserving Capital Access and Mortgage Liquidity Act of 2015, would redefine community financial institution to include either a federal or state credit union. The House passed H.R. 299 on April 13, 2015, and its language was included in an amendment to H.R. 22 , the Surface Transportation Reauthorization and Reform Act of 2015, which was passed in the House on November 5, 2015. S. 1484 , the Financial Regulatory Improvement Act of 2015, and S. 1910 , the Financial Services and General Government Appropriations Act, 2016, also contain language similar to H.R. 299 .
subsections: section_title: Credit Unions, Community Banks, and Competition
paragraphs: Community banks, which are commonly defined as financial institutions that hold less than $1 billion in assets, are arguably similar to credit unions with respect to their business models. For example, community banks and credit unions engage in "relationship banking," which involves developing close familiarity with their respective customer bases. Community banks typically provide financial services within a circumscribed geographical area. The development of close relationships helps community banks understand idiosyncratic lending risks in their local areas that may not be easily understood using a computerized underwriting methodology. Similarly, credit unions provide financial services to their restricted memberships. The development of close relationships helps credit unions tailor product offerings to their unique memberships. Both credit unions and community banks also rely primarily upon deposits to fund their assets (loans). In other words, community banks and credit unions borrow primarily from their depositors to obtain the funds necessary to provide customer loans rather than from the short-term financial markets that the larger banking institutions access more frequently. 
This section discusses some similarities among and differences between credit unions and community banks. Both industries serve similar types of consumer markets, and larger institutions appear to enjoy some advantages relative to their smaller counterparts. There are some regulatory differences in fair lending and taxation between credit unions and banks. These differences may be less important for small credit unions and small banks that operate in very narrowly defined markets, as discussed below. By contrast, both the credit union and banking industries are experiencing similar consolidation trends. Membership size and the ability to offer a full range of financial services may ultimately explain any comparative advantages that large credit unions (and large banks) enjoy relative to small credit unions and small banks. These issues are examined below.
Differences in Fair Lending Requirements
Congress enacted the Community Reinvestment Act of 1977 (CRA; P.L. 95-128 ) in reaction to perceptions that banks were not sufficiently addressing the credit needs of low- and moderate-income (LMI) neighborhoods. The CRA requires that federal banking regulatory agencies evaluate how regulated institutions meet the credit needs of their entire communities. No statutorily set rules are imposed; banking institutions, however, typically receive CRA credits after providing LMI loans (subject to existing federal prudential regulations for safety and soundness) or other financial retail services in their communities. CRA credits become important when a bank seeks permission from its regulator to move offices or to merge with another financial institution. 
Credit unions are not subject to the CRA. Given that banks may accept deposits from all individuals in a community, CRA provides them with a reciprocal obligation to meet credit needs, as much as possible, of their communities at large. CRA credits are useful to banks when they apply for charters, branches, mergers, acquisitions, and other applications that require approval from their regulators. By contrast, credit unions are not awarded credits that would allow them to expand beyond the common bonds defined in their membership charters. Instead, a credit union may add an underserved area in its field of membership and provide financial services in that designated area.
If, however, the CRA did apply to credit unions, some of them may enjoy a competitive advantage in terms of achieving its policy goals, particularly if their membership consists predominately of minority groups and the credit unions' financial services can be tailored to these groups. Not-for-profit institutions generally may enjoy a cost advantage providing higher risk, unsecured loans at lower rates and fees relative to for-profit banks. In other words, credit unions seek to make enough money to continue operating their organizations, but they are not necessarily incentivized to make a return for equity investors. For example, a credit union affiliated with a faith-based organization that specializes in small-dollar lending may find it less costly (relative to banks or larger credit unions) to devote resources to monitor the repayment patterns of a small group of borrowers that might otherwise remain unbanked or underbanked. Low-cost payday lending to individuals and micro-business lending, which is the granting of small loans between $500 and $35,000 to small businesses with 5 or fewer employees, have been viable businesses for some credit unions. Thus, smaller financial institutions generally may enjoy cost advantages to provide services to riskier consumer markets, and such advantages may be even greater for small not-for-profit credit unions. As of 2012, there were 180 banking institutions with minority ownership; 150 of them would be considered community banks with assets less than $1 billion. In contrast, there were 809 credit unions with over 50% minority membership as of 2012.
Differences in Tax Treatment
Given that credit unions are not-for-profit financial cooperatives, the institutions are exempt from federal income tax. Share deposit holders pay taxes at individual tax rates when they receive interest (referred to as "dividends") on their share deposits, as do bank equity shareholders; but the credit union does not pay taxes at the corporate level. Some credit unions, however, may still pay unrelated business income tax (UBIT) for tax-exempt organizations. For example, if a credit union were to provide financial services (e.g., check-cashing) to non-members, any revenue generated from those activities would be subject to UBIT. 
Community banks are for-profit financial institutions that may accept deposits and provide lending services without any restrictions on their customer base. Community banks generally are publicly owned and issue common equity shares, so their depositors do not necessarily have to be equity shareholders. Community banks generally pay taxes at the corporate level and the shareholders pay taxes on their equity dividends at the individual tax rates; thus, the corporate profits are taxed twice. In 1997, however, small banks meeting eligibility requirements were allowed to become "S corporations," meaning that their income is taxed only once (at the individual income tax rates). As of 2013, the FDIC reported that 2,210 insured banking institutions were organized as S corporations; thus, these institutions are taxed in a manner similar to credit unions. Small banks organized as S corporations would not experience a tax disadvantage relative to credit unions. The difficulty of converting to an S corporation increases for larger banks if much of their equity is held in Individual Retirement Accounts, which are not allowed to hold equity in S corporations. 
The difference in tax treatments of credit unions and banks that are not organized as S corporations would need to be determined on a case-by-case basis. As previously noted, a necessary first step would be to determine the nature of competition. For example, the difference in the tax treatment of a faith-based credit union offering a very limited range of financial services is likely to have a negligible impact on the activities of a nearby community bank. A large credit union able to offer a full range of financial services to a regional or national market, however, may arguably benefit from the difference in tax treatment relative to banking institutions of similar sizes that serve similar markets. The nature of competition in terms of size and market, therefore, determines whether a cost advantage exists. 
Similarities in Consolidation Trends
Using data from the NCUA, Figure 1 illustrates the total number and total asset holdings of U.S. credit unions over the 2003 to 2012 period. Total credit union assets have risen while the total number of credit unions has been shrinking over time. Credit union assets increased from $610.1 billion in 2003 to $1,021.7 billion by 2012. The total number of credit unions, however, declined from 9,369 to 6,819 over the same period. Furthermore, industry assets are not evenly distributed. The largest 197 credit unions with over $1 billion in assets held 51.2% of total industry assets in 2012 compared with the 29.4% share held in 2003. Loan and membership growth rates were positive for credit unions with assets exceeding $100 million; the highest growth rates were observed for institutions with $500 million or more in assets. By contrast, institutions with $100 million or less in assets saw negative loan growth; institutions with less than $10 million in assets also saw negative membership growth. These trends are similar to the consolidation trends observed in the depository banking system.
For the sake of comparison, Figure 1 also includes the total number and assets of community banks. As of 2012, there were approximately the same number of community banks and credit unions, 6,421 and 6,819, respectively. The community banks, however, collectively had approximately $400 billion or 37.3% more in assets than the credit union industry. When compared with credit unions of similar size (less than $1 billion in total assets), community banks collectively have approximately $904 billion or 181.7% more in assets. Hence, the assets of most credit unions are on average much less than the assets of most community banks.
Although community banks collectively have more aggregate assets relative to the entire credit union industry, total credit union assets in Figure 1 appear to have slightly greater trend growth relative to the total assets of community banks. This trend is driven by growth of the large credit unions, which are holding a greater share of industry assets over time. On November 5, 2011, which became known as Bank Transfer Day, thousands of consumers moved their (deposit) accounts to credit unions due to their frustration with large bank fees. Based upon the trends in asset and membership growth, the migration of customers from (large) banks appears to have benefitted larger credit unions able to offer more financial services relative to small credit unions or small banks (with less than $1 billion in assets).
Regulatory differences that are unrelated to safety and soundness may also present comparative advantages, particularly for smaller institutions. For example, recent restrictions placed on the amount of debit interchange fees that can be collected by large banks and credit unions may reduce revenues that could be used to cross subsidize some of the costs associated with providing other financial services, thus creating a competitive advantage for institutions not covered by the regulation. Differences in the reporting requirements related to consumer protection regulations may create cost advantages for smaller financial institutions, especially those that provide services to financially riskier customers. By contrast, compliance with various or a multitude of regulations may place a higher cost burden on small institutions relative to those with size and transaction volume advantages, which generate substantial fee revenue for larger institutions. Hence, regulations that provide cost advantages for one set of financial firms may be offset by cost advantages generated by other regulations that favor another set of financial institutions.