Demutualisation and Credit Unions
Kevin 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 wellbeing.
 “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 nonmonetary 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 outsiders
Decline in social capital role reduces
opposition to expropriation
The Board’s Lament
or
Mutually Assured Destruction
Demutualise, demutualise
It really is the best
A few bucks for the members
And we’ll take all the rest.
Of course, we wouldn’t say that
We’re really not that crass
We’d say the world is changing
And must get off our ass
We’ve grown so big and lost our bond
The members, they won’t care
This talk about our special role
They know is all hot air
We run the shop, we take our chop
We know just how it works
No governance by members
Let’s maximise those perks
It is a tough decision
We could be forced to go
Stockholders may be critical
Of how we run the show
That risk we’ll face, and tough it out
Because we’re sure you know
We’ll put in place large payouts
In case we’re forced to go
Weighing up the choices
Principles or pay
Unfortunately, principles
Have long since had their day
The CEO is for it
We’re sure it isn’t greed
He’s working for the members
Let us do the deed
But Hark, the ghosts of members past
Are crying in dismay
Their legacy of wealth and trust
Should not be spent this way
But they’re not here to stop us
Our consciences aren’t torn
The current members can be bought
The 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?
 Demutualisation
Can 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 finance
These functions can be separated in the
modern financial environment
Why 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 role
But 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 role
Maximise involvement rather than
membership or balance sheet size