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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
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
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