Banking “Biodiversity” –
Traditional vs. Non-traditional Banking:
What are the Issues?
Gregory F. Udell
Indiana University
Non-traditional vs. Traditional
Banks
Non-traditional
Banks
Cooperative/Mutual
Banks
Gov’t-Owned
Banks
Traditional
Commercial Banks
Non-traditional vs. Traditional
Banks
Non-traditional
Banks
Cooperative/Mutual
Banks
Gov’t-Owned
Banks
Traditional
Commercial Banks
Non-traditional vs. Traditional
Banks
Our Focus
Non-traditional
Banks
Cooperative/Mutual
Banks
Gov’t-Owned
Banks
Traditional
Commercial Banks
Motivation
• Non-traditional banks are globally significant
- Represent about 40% of the global banking
industry (La Porta, Lopez-de-Silanes, and Shleifer
2002)
• They may behave differently, including
-
Efficiency
Social welfare
Ethics
Agency problems
• They are sometimes regulated differently
A Personal Note
• I’m a relative newcomer to non-traditional
banking – certainly relative to this panel!
• However, I’ve become quite interested in this
segment of the industry recently
- Recent work on cajas in Spain
- I have served one term as a member of the
supervisory sommittee of a medium-sized credit
union in the U.S.
- And, I was recently an expert witness in a large class
action lawsuit on a consumer pricing issue which
(arguably) pitted traditional banks against credit
unions
Are Non-traditionals Different?
What are the Research/Policy Questions?
• Are there differences in performance and efficiency?
• Is the existence of a non-traditional sector welfare improving?
• Are non-traditionals profit-maximizing?
- What does their objective function look like?
•
•
•
•
Are non-traditionals more “ethical”?
Are they less sophisticated?
Are they more easily “captured”?
Are there differences in providing access to credit?
- Do they behave differently during macro shocks?
• Are they affected by the same agency problems?
• Should they be regulated differently?
Are Non-traditionals Different?
What are the Research/Policy Questions?
• Are there differences in performance and efficiency?
• Is the existence of a non-traditional sector welfare improving?
• Are non-traditionals profit-maximizing?
- What does their objective function look like?
•
•
•
•
Are non-traditionals more “ethical”? More questions than answers!
– at least on some of these
Are they less sophisticated?
Are they more easily “captured”?
Are there differences in providing access to credit?
- Do they behave differently during macro shocks?
• Are they affected by the same agency problems?
• Should they be regulated differently?
Are Non-traditionals Different?
What are the Research/Policy Questions?
• Are there differences in performance and efficiency?
• Is the existence of a non-traditional sector welfare improving?
• Are non-traditionals profit-maximizing?
- What does their objective function look like?
•
•
•
•
Work by panelists on
Are non-traditionals more “ethical”?
many of these issues:
Are they less sophisticated?
e.g., Leonardo & Giovanni
Are they more easily “captured”?
Are there differences in providing access to credit?
- Do they behave differently during macro shocks?
• Are they affected by the same agency problems?
• Should they be regulated differently?
Presentation
• How should we think about non-traditionals?
- Their objective function
- Their governance
- Their behavior
• Two case study examples related to my work and
experience
- Spain
- U.S.
• These two cases will illuminate some policy and
regulatory issues
• Concluding comments
How Should We Think About Non-traditionals?
• The objective function of traditional banks
-
The dominant paradigm in corporate finance is shareholder
wealth maximization
-
However, there is a literature on the “economics of higher
purpose” within privately-owned stock companies (see Thakor
and Quinn 2014)
-
Individuals care about integrity, honesty, social identity and
reputation (e.g., Akerlof and Kranton 2010, and Benabou and
Tirole 2008)
-
Relative status (e.g., Akerlof and Yellen 1990, Goel and Thakor
2005, and Mui 1995)
-
Corporate social responsibility (e.g. Benabou and Tirole 2010)
-
Moral behavior (e.g. Benabou and Tirole 2011)
-
Intrinsic motivation (e.g. Benabou and Tirole 2003)
The Objective Function (cont.)
“Purpose is the deepest dimension within us – our central core or
essence – where we have a profound sense of who we are, where
we came from and where we’re going. Purpose is the quality we
choose to shape our lives around. Purpose is a source of energy
and direction.”
Leider (1997)
“I was drawn by the power that savoring a simple cup of coffee
can have to connect people and create community.”
Howard Schultz, founder of Starbucks
“Great companies must have a noble cause. Then it’s the leader’s
job to transform that noble cause into such an inspiring vision
that it will attract the most talented people in the world to want to
join it.”
Steve Jobs, as narrated by John Sculley.
Taken from Thakor and Quinn (2014)
The Objective Function (cont.)
• A recent model provides insight into the economics
of principals and agents driven by both wealth and a
higher purpose (Thakor and Quinn 2014 – “TQ”)
-
Based on extant models of agents working for principals
who pursue a “higher purpose” (Delfgaauw and Dur 2007,
Handy and Katz 1998, Glazer 2004, and Nyborg and Brekke
2010)
-
-
Agents work harder/invest more than strictly wealth
maximizers
Complimentarity in TQ
-
Principals motivated by “higher purpose” relax budget
constraints
The Objective Function (cont.)
• TQ model is not motivated by banking (i.e., it’s not
specific to non-traditional banking)
• But, applying TQ to cooperatives seems logical
-
Depositors would be principals
-
Needs exploring though. Useful research exercise.
The Objective Function (cont.)
• TQ model is not motivated by banking (i.e., it’s not
specific to non-traditional banking)
• But, applying TQ to cooperatives seems logical
-
Depositors would be principals
-
Needs exploring though. Useful research exercise.
-
From my credit union:
The Objective Function (cont.)
• TQ model is not motivated by banking (i.e., it’s not
specific to non-traditional banking)
• But, applying TQ to cooperatives seems logical
-
Depositors would be principals
-
Needs exploring though. Useful research exercise.
-
From my credit union:
It depends on what this
means, e.g., max
consumer surplus ala
Hesse and Cihak (2007)?
The Objective Function (cont.)
• But, are we missing something?
• Answer: Yes!
- Governance, conflict of interest, the contracting
environment and regulation
- No market for corporate control
- Cooperatives/non-traditional banks still nested in
layers of conflicts of interest associated with
layers of contracting.
SMALL BUSINESS CREDIT AVAILABILITY AND RELATIONSHIP LENDING: THE
IMPORTANCE OF BANK ORGANISATIONAL STRUCTURE
From Berger and Udell (2002)
SMALL BUSINESS CREDIT AVAILABILITY AND RELATIONSHIP LENDING: THE
IMPORTANCE OF BANK ORGANISATIONAL STRUCTURE
Replaced with bank depositors –
which changes the nature of the
conflict of interest
From Berger and Udell (2002)
Governance et al.
• The performance of non-traditionals likely ultimately
depends on the solutions to these problems
- An abundance of empirical evidence that the
equilibrium for state-owned banks is not a good
one
- But, the evidence suggests that, globally, the
story may be different for cooperatives (e.g.,
Becchetti, Ciciretti and Paolantonio 2014)
• So, how should we think about this empirically?
Governance et al.
• A good starting point:
-
Laeven and Levine (2009)
-
First cross-country empirical study connecting risk-taking,
governance (i.e., ownership structure) and national bank
regulation
-
Focuses on conflicts between managers and owners over
risk in 48 different countries (250 banks)
-
Finds that the relationship between bank risk and capital
regulations, deposit insurance policies and restrictions on
bank activities depends on governance including, in
particular, ownership concentration (more concentration =>
more risk)
Governance et al. (cont.)
• Key question: Can we adapt this analysis to non-traditionals, and
specifically cooperatives?
- Cooperatives may be different: exploitation of the deposit
insurance put may be dominated by expense preference
behavior or other inefficiencies
-
There are studies analyzing differences between cooperatives
and traditional banks (e.g., Becchetti, Ciriretti and Paolantonio
2014, Altunbas et al. 2001)
-
But studies looking at differences (in governance ala Laeven
and Levine 2009) within the cooperative sector seem lacking
-
e.g., studies like those that link risk taking and risk management
governance ala Gopalan and Yerrimilli (2011)
-
e.g., degree of implicit/explicit government involvement
Some International Perspective:
Two Case Studies
• For a non-Italian perspective let’s consider two cases:
-
U.S.
Spain
• May illuminate some of the issues that we noted before
-
Performance and efficiency
Welfare issues
Objectives
Ethical behavior
Regulatory capture
Access to credit
Nature of agency problems
Regulation/deregulation
The U.S. Case:
Cooperative Banking in the U.S.
• Market structure
• History
• Performance
• Regulation/deregulation
The U.S. Case: Market Structure
Commercial Banks
S&L and Savings Banks
Credit Unions
Total
1995
77.2%
17.4%
5.3%
100.0%
2007
80.5%
13.9%
5.5%
100.0%
2013
86.9%
6.7%
6.4%
100.0%
The U.S. Case: Market Structure
Commercial Banks
S&L and Savings Banks
Credit Unions
Total
1995
77.2%
17.4%
5.3%
100.0%
The Cooperatives
2007
80.5%
13.9%
5.5%
100.0%
2013
86.9%
6.7%
6.4%
100.0%
The U.S. Case: Market Structure (and some history)
• Market structure – 3 types
-
Savings and Loan Associations (S&Ls)
-
-
-
Mutual Savings Banks
-
-
Initially mostly cooperatives
However, many demutualized (e.g., Washington Mutual in 1983)
Tax exempt if 85% invested residential mortgages
Asset/Liability mismatch by 1979 due to prohibition
against ARMs
Led to the S&L crisis
And product deregulation – 1982 Garn St. Germain Act
Origins in the Irish/English building societies
Many were local and ethnic in origin (e.g., Chicago’s Polish
American Building and Loan)
Located in the northeast U.S.
Mostly limited to consumer loans
Credit Unions
-
Historically limited on both spatial and product dimensions
The U.S. Case: Market Structure (Assets)
Traditional banking growing
while cooperatives shrinking
Commercial Banks
S&L and Savings Banks
Credit Unions
Total
1995
77.2%
17.4%
5.3%
100.0%
2007
80.5%
13.9%
5.5%
100.0%
2013
86.9%
6.7%
6.4%
100.0%
The U.S. Case: Market Structure (Assets)
Traditional banking growing
while cooperatives shrinking
Commercial Banks
S&L and Savings Banks
Credit Unions
Total
1995
77.2%
17.4%
5.3%
100.0%
2007
80.5%
13.9%
5.5%
100.0%
2013
86.9%
6.7%
6.4%
100.0%
Mortgage lending by S&Ls replaced by
lending from government banks (FANNIE
and FREDDIE) and securitization
The U.S. Case: Market Structure (Assets)
Traditional banking growing
while cooperatives shrinking
Commercial Banks
S&L and Savings Banks
Credit Unions
Total
1995
77.2%
17.4%
5.3%
100.0%
2007
80.5%
13.9%
5.5%
100.0%
2013
86.9%
6.7%
6.4%
100.0%
Credit Unions, however, growing:
- 10% of household savings
- 9% of all consumer loans
- 13.2% of non-revolving consumer loans
- 6.2% of mortgage originations
The U.S. Case: The Credit Unions
• Good news – and bad news!
• The bad news
-
Expense preference behavior in the mutual segment of the
S&L industry before the S&L crisis (Mester 1989)
-
-
Credit unions appear to have become less efficient recently
(Wheelock and Wilson 2009)
-
-
but not after (Mester 1993)
Less cost-productive between 1989 and 2006
Small credit unions worse
- scale inefficiencies affecting many small credit unions
(Wheelock and Wilson 2010)
Sometimes vulnerable because of a lack of sophistication(?)
-
Penn Square fiasco in the 1980s
- Oil patch lending
Corporate Credit Union fiasco in 2010 (potentially ultimately $50
billion in losses)
- Private label subprime MBS
The U.S. Case: The Credit Unions (cont.)
• The good news
-
-
Credit unions discipline banks in small local markets (Feinberg
2001)
Large credit unions appear to have become a bit more scale
efficient (Wheelock and Wilson 2009)
Anecdotal evidence that credit unions behave more “ethically”
- All big banks changed their overdraft policies in the early
2000s to increase number of overdraft items per event
-
-
Banks typically charged $30.00 per item overdrawn
To exploit this, large banks changed check processing from
smallest to largest to largest to smallest
Credit unions did much less of this than banks
-
16.3% of credit unions processed largest to smallest
27.7% of banks processed largest to smallest
53.7% of the largest banks processed largest to smallest
- Including JPMorgan Chase, BoA, Citigroup and Wells
Fargo
The U.S. Case: The Credit Unions (cont.)
• Regulatory issues
-
Tax exempt status an ongoing political issue
Credit unions significantly deregulated (relatively recently)
- Effectively no longer constrained by the “common bond”
requirement
-
-
The Credit Union Membership Access Act of 1998 allowed
credit unions to accept members from unrelated groups
Massive consolidation followed: from 1969 peak of 23,866 to
8,662 in 2006
Credit unions significantly deregulated on the product side
- Initially limited to short-term consumer loans
- Now almost completely deregulated on the product side
-
Last barrier to full range commercial banking: commercial
lending
- Limited to 12.5% - proposed legislation to raise to
25%
The U.S. Case: The Credit Unions (cont.)
• Regulatory issues
-
Tax exempt status an ongoing political issue
Credit unions significantly deregulated (relatively recently)
- Effectively no longer constrained by the “common bond”
requirement
-
-
The Credit Union Membership Access Act of 1998 allowed
credit unions to accept members from unrelated groups
Massive consolidation followed: from 1969 peak of 23,866 to
8,662 in 2006
Credit unions significantly deregulated on the product side
- Initially limited to short-term consumer loans
- Now almost completely deregulated on the product side
-
Last barrier to full range commercial banking: commercial
lending
- Limited to 12.5% - proposed legislation to raise to
25%
The U.S. Case: The Credit Unions (cont.)
• Regulatory issues
-
Tax exempt status an ongoing political issue
Credit unions significantly deregulated (relatively recently)
- Effectively no longer constrained by the “common bond”
requirement
-
The Credit Union Membership Access Act of 1998 allowed
credit unions to accept members from unrelated groups
Massive consolidation followed: from 1969 peak of 23,866 to
8,662 in 2006
-
Credit unions significantly deregulated on the product side
- Initially limited to short-term consumer loans
What is the effect on credit
- Now almost completely deregulated on the product side
unions and their sense of
- does
Last barrier to full range commercial banking:
community? (i.e., How
this affect their objective lending
function?)
- Limited to 12.5% - proposed legislation to
25%
commercial
raise to
The U.S. Case: The Credit Unions (cont.)
• Regulatory issues
-
Tax exempt status an ongoing political issue
Credit unions significantly deregulated (relatively recently)
- Effectively no longer constrained by the “common bond”
requirement
-
-
The Credit Union Membership Access Act of 1998 allowed
credit unions to accept members from unrelated groups
Massive consolidation followed: from 1969 peak of 23,866 to
8,662 in 2006
Credit unions significantly deregulated on the product side
- Initially limited to short-term consumer loans
- Now almost completely deregulated on the product side
-
Last barrier to full range commercial banking: commercial
lending
- Limited to 12.5% of assets - proposed legislation to
raise to 25% (effectively unconstrained at this level)
The U.S. Case: The Credit Unions (cont.)
• Regulatory issues (cont.)
-
Arguably weaker prudential supervision
- State regulators in the U.S. more lenient than federal
regulators (Agarwal, Lucca, Seru and Trebbi 2014)
-
-
Nationally chartered credit unions have a national regulator
(National Credit Union Administration - NCUA)
-
-
State regulators supervise about 40% of all credit unions
Not clear whether NCUA is a strong regulator
Corporate credit union scandal suggests not
- Corp. credit unions invested in the lowest quality
subprime MBS on behalf of credit union customers
- Without NCUA intervention as many as 1,000 credit unions
could have failed
Will a combination of potentially weak regulation and
deregulation be problematic for the U.S. Credit union industry?
- Spain my provide an answer!
The Spanish Case: The Cajas
• Cajas were the Spanish savings banks
-
Essentially a form of cooperatives
Appear to have been relatively efficient before deregulation
Key component of the domestic Spanish banking system
before the crisis
The entire industry failed creating a fiscal disaster for Spain
The Spanish Case: The Cajas
• Cajas were the Spanish savings banks
-
Essentially a form of cooperatives
Appear to have been relatively efficient before deregulation
Key component of the domestic Spanish banking system
before the crisis
The entire industry failed creating a fiscal disaster for Spain
-
Key point:
A potential lesson regarding the deregulation of the the nontraditional banking sector in an environment characterized
by a weak regulatory infrastructure and a weak and
vulnerable goverance mechanism.
The Spanish Case: The Cajas
• Cajas were the Spanish savings banks
-
Essentially a form of cooperatives
Appear to have been relatively efficient before deregulation
Key component of the domestic Spanish banking system
before the crisis
The entire industry failed creating a fiscal disaster for Spain
Key point:
What does this tell us about U.S.
credit union deregulation?
A potential lesson regarding the deregulation of the the nontraditional banking sector in an environment characterized
by a weak regulatory infrastructure and a weak and
vulnerable goverance mechanism.
The Spanish Case: The Cajas (cont.)
• Pre-Crisis History
- Existed for 100 years
- Established by
-
local governments
churches and/or
welfare societies
- Private foundations with no owners
-
either retain profits, or
pay “social dividends”
- Purpose:
-
promote savings by middle- and working-class people
provide lending to small businesses from the same city
or province
The Spanish Case: The Cajas (cont.)
• Cajas were nearly 50% of the Spanish banking system
– The cajas were a colossal disaster
– The majority of the 2010 and 2011 European stress test failures
were cajas banks
– Failed cajas were bailed out and force-merged, e.g., Bankia a
conglomeration of 7 cajas
– 43 of 45 cajas (in existence in 2009) restructured (only 2 small ones
remain independent)
– All SBs had to convert to banks
– Gov‘t hoped-for synergies illusory
– Continued revelation of massive losses swamp any synergies
– Estimated total SB losses range as high as 153 billion euros
– Bankia former board members all prosecuted for fraud
– Now creates a TBTF problem
The Spanish Case: The Cajas (cont.)
• The cajas are a very interesting experiment
– In theory depositor-controlled, but gov‘t-controlled in practice
• After spatial deregulation, cajas expanded rapidly
– Beginning in 1975 and ending in 1988 spatial scope extended
from state level to provincial level to nationwide
– Expansion associated with explosive growth in lending to real
estate and construction firms
• Expansion was associated with a significant increase in risk in
lending portfolios, particularly in real estate (Illueca, Norden and
Udell 2014)
- Weak governance played a role
- Facilitated by political influence
- Specifically, increased political influence resulted in:
- higher ex ante risk
- higher ex post risk (i.e., default)
- Led to cross-border bottom feeding instead of cherry picking
17 regions, 52 provinces
Deregulation Led to Shift in Governance
Depositors
Local governments
Founders
Employees
Depositors
Regional governments
Local governments
Founders
Employees
Deregulation Led to Shift in Governance
Depositors
Local governments
Founders
Employees
Diffuse
Consolidation of control: for
50% of SBs, one regional
government had a stake on
average of 20%
Depositors
Regional governments
Local governments
Founders
Employees
The Spanish Case: The Cajas (cont.)
The Spanish Case: The Cajas (cont.)
Risk: higher for firms borrowing
from cajas out of home region and
higher yet if cajas politically
influenced (same party in both
regions)
Conclusion
• Compelling research on the performance of cooperatives/savings
banks compared to commercial banks
- Suggests that cooperatives are efficient on average compared
to traditional banks
- Suggests that cooperatives add value in traditional banking
activities
• I think there is room for more theoretical and empirical work on the
issue of the “economics of higher purpose” as it relates to
cooperatives
- Possibly based on Thakor and Quinn (2014)
- More evidence on ethical behavior (e.g., overdraft charges in
U.S.)
• Room for more research on differences across institutions within
the cooperative/savings banks sector
• Lessons from the Spain and the U.S.
- Particularly concern over regulation and deregulation