Demutualisation and Credit UnionsKevin Davis

Commonwealth Bank Chair of Finance

University of Melbourne

and

Chairperson,

Melbourne University Credit Union

Overview Why did financial mutuals evolve?

Why are financial mutuals disappearing?

Is this a risk for the credit union movement?

What are the alternatives for the future?

Why did financial mutuals evolve?

An Economic Perspective May be more efficient form of organisation

No owner-depositor conflict Common goals of members Information advantages regarding

members But potential disadvantages of

Depositor-borrower conflict Imperfect governance

» managerial autonomy and entrenchment

Why did financial mutuals evolve?

A Social Perspective Part of “Social Capital”

Institutions Relationships Attitudes Values

which contribute to societal well being

Social Capital

There is growing interest in the concept of ‘social capital’ and its ramifications for community well-being.

“Social Capital: Reviewing the Concept and its Policy Implications” Productivity Commission Research Paper 2003.

Who Said This?

“The view I am putting is that there are non-monetary things that add to the wealth of a society. Civic engagement and the values which it promotes like trust and tolerance are some of those things. You can call them social capital if that is conceptually easier. It might help with the idea of building them up, running them down, adding to our wealth, or detracting from it. But a society which has these things should be careful not to let them run down. Once they are gone it takes a lot of effort to get them back again.”

Why did financial mutuals evolve?

A Social Perspective Part of “Social Capital”

Institutions , relationships, attitudes, values which contribute to societal well being

Communal Needs – access to financial services

Communal Goals – fair, equitable treatment

Reciprocated “cross subsidisation” – mutual self help

Why are Financial Mutuals Disappearing?An Economic Perspective

No longer have efficiency advantages Other forms of customer protection Competition induces behaviour akin

to profit oriented firms Disparate membership creates

divergent goals Information advantages diminished Widespread easy access to

adequate financial services??

Why are Financial Mutuals Disappearing?A Social Perspective

Evolution - reduced social capital role Partly due to government regulation

»Based on economic rationalism »maintaining social capital - “too hard”

Partly due to governance structure unsuited to evolutionary path »changing emphasis in objectives and

activities due to• Increased manager professionalism • Remuneration structures

Why are Financial Mutuals Disappearing?Social and Economic Factors

Predators (Carpetbaggers)Growing accumulated communal wealth“Easy” expropriation target - conversion into private wealth by demutualisation

Conversion incentive – even if no performance gains

Predators can be insiders or outsidersDecline in social capital role reduces opposition to expropriation

The Board’s Lament

or

Mutually Assured Destruction

Demutualise, demutualiseIt really is the best

A few bucks for the membersAnd we’ll take all the rest.

 Of course, we wouldn’t say that

We’re really not that crassWe’d say the world is changing

And must get off our ass

 We’ve grown so big and lost our bondThe members, they won’t careThis talk about our special role

They know is all hot air 

We run the shop, we take our chopWe know just how it works

No governance by membersLet’s maximise those perks

 It is a tough decision

We could be forced to goStockholders may be critical

Of how we run the show 

That risk we’ll face, and tough it outBecause we’re sure you know

We’ll put in place large payoutsIn case we’re forced to go

Weighing up the choicesPrinciples or pay

Unfortunately, principlesHave long since had their day

 The CEO is for it

We’re sure it isn’t greedHe’s working for the members

Let us do the deed

 But Hark, the ghosts of members past

Are crying in dismayTheir legacy of wealth and trust

Should not be spent this way 

But they’re not here to stop usOur consciences aren’t torn

The current members can be boughtThe future ones aren’t born

 

The time is nigh, let’s do our duty

We’ve worked out all the sums

Demutualise and claim the booty

‘Fore the Carpetbagger comes.

Demutualisation: A Risk for Credit Unions?

Undoubtedly Erosion of common bonds

» Less inherent advantages» More flawed governance structure» Diminished social capital role

Increasing size and capital base» Increased size of “booty” for

carpetbaggers• Makes predatory efforts

worthwhile

Capital is the Achilles Heel of Credit Unions

Why is Empire Building Occurring?

Partly driven by scale economies But commitment to social capital role might

see other ways of achieving economies Flawed governance model

Managerial objectives dominate Member involvement miniscule

Lack of resolve in small institutions to persist Increasing cost of maintaining social capital

» Compliance costs for smaller institutions

» Legal liabilities» Knowledge requirements

What are the Prospects for the Future?

DemutualisationCan Boards resist?

»What is the best interest of members? ‘It is for the board of a society to decide whether

to recommend a takeover to its members. The overriding duty of the board is to reach a view having regard to what is in the interests of the members as a whole, both present and future, borrowing members as well as shareholders…’

UK Building Society Commission’s Transfer Procedures Guidance Note of April 1998

A Politically Unacceptable Proposal Membership of Industry Associations

should require Credit Union Boards & Management to sign declarations that they will not receive shares in, or profit from, any demutualisation of their credit union.

Benefits: separate considerations of personal

financial gain from welfare of current and future members in making such decisions

strengthen resolve against carpetbaggers

What are the Prospects for the Future? Mutual Holding Companies:

partial demutualisation - occurred in US Demutualise, allocate 51% of ordinary

shares in operating company to mutual holding company, rest to members Restrictions on holding company

»Reinvest dividends in operating co.»Prohibit sale of shares etc

Members get 1 share in mutual holding co. Capital growth still limited by “profits”, Permits Expropriation and Entrenchment

What are the Prospects for the Future? Alternative Capital Instruments that

Qualify as regulatory capital Enable distribution of franking credits Don’t impact on governance

Probably only feasible for large credit unions Issue costs and minimum size

requirements Further facilitates empire building

What are the Prospects for the Future? Restructuring ownership & financial claims UK requirement of some building societies that

new members sign away benefits from conversion to charities

Alters expropriation incentives but doesn’t improve governance

Return to offering non-transferable withdrawable shares (rather than deposits) with dividend determined at year end

May induce more member activism in governance - trade-off between higher returns versus “profit” retention for capital accumulation and growth

What are the Prospects for the Future?

Adapting a “Community Bank” Model Individual credit unions act as franchisees

for “parent” organisation» Achieve economies of scale,

compliance etc» Issues of

• Price setting and “profit” sharing• Independence and control

Already partly in place! Securitisation MyCard

What are the Prospects for the Future? Refocus on facilitating and advising rather than

provision of financeThese functions can be separated in the

modern financial environmentWhy use balance sheet measures as a

measure of credit union success? Providing finance - capital required

Capital = Archille’s Heel of credit unions Facilitating and advising fits with the credit

union ethos and a social capital roleBut regulatory requirements can be onerous

Conclusion Expect some demutualisations

automatic expulsion from the credit union movement ?

Industry level responses do little to alter the evolutionary path of credit unions“bigness bias”part of “economic capital” rather than (or as well as) “social capital”

Opportune time to refocus on the social capital roleMaximise involvement rather than membership or balance sheet size