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Banks turn up the heat against credit unions

Industries battle over tax, regulatory and membership issues

July 1, 1996


Banks turn up the heat against credit unions

There is little subtlety in this bumper sticker, with its white on red color scheme:

YOU pay income taxes,
Why don't Credit Unions?

The North Dakota Bankers Association (NDBA) distributed those bumper stickers to member banks, and the message has been generating conversation among bank customers.

Of course, it's not just North Dakota banks that are targeting the credit union industry. On April 15 this year, thousands of bankers from across the country sent their congressional delegation a postcard with this message: "My bank has paid its federal income tax. Did you know that credit unions do not pay any federal income tax?"

In a speech this spring before the Wisconsin Bankers Association's (WBA) annual meeting in Appleton, WBA's executive vice president, Harry Argue, gave a clear picture of the banking industry's unity and purpose on the subject of credit unions: "Dedicating top priority attention to stop abusive credit union competition is a goal that everyone in this room obviously endorses. So too have other state bankers associations, the American Bankers Association, Independent Bankers Association of America, and the S&Ls' national trade group, America's Community Bankers."

But credit unions see the current public relations flurry by the banks as little more than a smokescreen to shield what they say is most damaging to banks: that credit unions provide better financial service. Also, credit unions stress that they are granted a federal income tax exemption because they are nonprofit, member-supported institutions that pay no returns to stockholders, and whose goal is to return any profits back to members—either in the form of dividends or in better-priced products.

Larry Hanna, president of First Community Credit Union in Jamestown, N.D., cites the June 1996 study released by the Credit Union National Association (CUNA) and the Consumer Federation of America, which said that U.S. consumers could save billions of dollars by shifting their credit card debt and their deposit accounts to credit unions. "I think they should be looking in their own backyard," Hanna says about banks. Besides, he adds, if bankers think that credit unions have such an easy time in the marketplace, they should change their charters and become credit unions. "If a bank wants to become a credit union, it can," he says.

"Banks need a scapegoat," says Jerry Karbon, spokesperson for CUNA in Madison, Wis. He says banking trade groups are using the issue as a recruitment tool and to divert attention from their failure on other legislative fronts, such as the repeal of Glass-Steagall, the depression-era law that prohibits banks from engaging in the securities business. He also says that the banking industry has been performing very well in recent quarters—in some cases setting profit records—and so banks' efforts against credit unions are misplaced. "What more do they want?" Karbon asks.

Many consumers, who perhaps know little about the distinctions between credit unions and other financial institutions, may wonder what all the fuss is about. And that's part of the reason for the banks' campaign, say bank industry officials—to educate the public. Banks have always cast a wary eye toward credit unions—largely because credit unions are exempt from federal income tax and most state income taxes—but recently banking groups have planned extensive marketing campaigns to educate legislators and the public about the differences between banks and credit unions, and about why banks feel that credit unions should not only pay federal income taxes, but why they should also abide by the same regulations applied to banks.

"It's a hot button now," says John Cadby, executive vice president of the Montana Bankers Association, who says the issue has been growing in recent years because credit unions have begun to aggressively seek new members, and in so doing credit unions are unfairly competing with banks. Largely because of their federal income tax exemption, credit unions are able to offer better loan and deposit rates, Cadby says. "They're eating bankers' lunch in the marketplace," he says, adding that this is an especially important issue with community bankers.

The fedgazette's recent poll of Ninth District community bankers bears out Cadby's assessment: When it comes to legislative objectives, few of the bankers have interest in such "new powers" objectives as securities and insurance, which have long been debated in the halls of Congress; rather, over 90 percent of the respondents would like to see legislative action directed at credit unions. Specifically, community banks would like to see credit unions pay federal income tax and would have them subject to the Community Reinvestment Act, the 1977 law that requires banks to lend within their market area.

A credit union, by any other name, is still not a bank

While a bank can indeed change its charter and become a credit union, such a change would be in name only for most of the general public, according to those interviewed for this story. As noted above, the difference between a credit union and a bank—even among credit union members—is lost on many.

Simply put, a bank is an institution that accepts demand deposits and makes loans. Of course, a credit union does the same thing, but banks are owned by stockholders who provide assets to operate the bank, while a credit union is owned by members who share a common field of membership, such as where they work or live. Essentially, banks can do business with anyone, while a credit union's business is limited to its members. Both banks and credit unions are regulated by federal agencies, and institutions in both industries contribute to a fund that insures deposits up to $100,000.

Like other commercial businesses, a bank works to earn a profit and to provide a return to its stockholders, and this profit is taxed by the federal government and most state governments. A credit union is a nonprofit cooperative that is exempt from federal income tax and most state income taxes. US credit unions first appeared in the early part of this century and were based on the 19th-century European idea of "people's banks." By 1935, 39 states had credit union laws and in that same year, Congress passed the Federal Credit Union Act, which permitted credit unions to be formed anywhere in the United States.

Today, there are about 10,000 banks in the United States and about 12,200 credit unions. The numbers of both banks and credit unions have been shrinking in recent years, mainly due to consolidation. Measured by total assets, though, both industries have grown in recent years: Bank assets grew, on average, by 5.08 percent annually from 1991 through 1995, while credit union assets grew 7.52 percent, averaged annually, over the same time.

However, even though credit unions have more offices than banks and have been growing at a faster rate over the past five years, a large gap still remains between the total assets of banks and credit unions. As of year-end 1995, banks had a total of about $4.3 trillion in assets, compared to about $317 billion for credit unions; in other words, the average credit union is much smaller than the average bank.

Banks say this, credit unions say that

But the total size of banks vs. credit unions is not the issue, bankers maintain; the real issue is the competitive impact on Main Street, U.S.A., of two financial institutions—one a credit union with a broad field of membership and one a community bank—that are often competing for the same business and that operate by different rules. What follows are the banking industry's main arguments against credit unions, with responses from the credit union industry.

1. Size and membership

In about half of the states, a credit union would rank among the top 10 banks in the state, according to the American Bankers Association. Although many credit unions are still very small, the trade group claims that the larger ones have abandoned credit unions' original purpose: to serve select groups of people and to provide deposit and loan services to "people of small means."

The top eight credit unions in Wisconsin are larger than 90 percent of the banks, says J. Stephen Hamilton, president of the State Bank of La Crosse, Wis. There are 12 credit unions in La Crosse, and four of those now have a field of membership that includes anyone who lives in La Crosse, he says. "That's my market, too."

Field of membership and "common bond" are also sore points with bankers. Common bond refers to the common characteristic that members of a credit union share; for example, they might all work for the same employer or attend the same church. But a credit union's field of membership may include more than one common bond. As some credit unions have consolidated and as others have requested changes to their common bond status, their membership has grown. "They used to be small mom-and-pop stores for employee groups," says Larry Jochim, president of Flathead Bank of Bigfork, Mont.

In a paper completed this spring, James Schlosser, executive vice president of the North Dakota Bankers Association, expressed the banking industry's frustration with the common bond issue: "The common bond, once the hallmark of the credit union industry, has been stretched beyond recognition. Once, members of a credit union knew each other, and pooled their resources to provide credit for their co-workers and neighbors. Under today's interpretations, the common bond allows hundreds of unrelated groups to belong to the same credit union, and geographically based credit unions can serve entire states."

Further, Hamilton says that credit unions no longer play second fiddle to the more sophisticated banks; credit unions are building new facilities, offering products that are similar—if not identical—to banks, employing state-of-the-art technology and luring good workers with better salaries. Consequently, he says credit unions are shopping for more sophisticated customers. "The concept of credit unions serving the small guy is no longer valid," Hamilton says.

Don't tell that to Debra Mathern, president of the Fargo Public Schools Federal Credit Union, which is an $8.5 million asset institution with over 2,000 members that still gives out $100 or smaller loans for such things as college textbooks—with little regard to the personal wealth of the loan applicant. "Everybody gets one chance," Mathern says.

It's that kind of service that typifies a credit union and is still a very important part of what it means to serve as a credit cooperative, she says. "Banks should not really feel threatened by credit unions," she says of those bankers who say that credit unions are infringing on their market share. Many of the loans that credit unions provide are not necessarily the loans that banks are interested in, according to Mathern. Fargo has over 30 financial institutions, 14 of which are credit unions, and many of those are so small that they have just one employee.

Mathern does say that credit unions offer more products than in the past—such as mortgages—but it's because their members demand those services. Besides, all financial institutions have to grow and change with the times, she says, or they will fail, and it was never intended that credit union services should be limited. The demands of change can also bring difficult challenges for credit unions, according to Mathern. Credit union members—like other financial institution customers—want speed and certain technology from their financial services provider, but Mathern's credit union can't even afford to install ATMs; and the only way her credit union could afford to provide the convenience of a branch is to share the cost with another credit union, she says.

Mathern has praise for many banks in Fargo that she says not only work to provide the best loan and deposit rates—"they give us great competition"—but that are also very involved in the community, especially the schools. "I give the banks credit for those efforts," she says. Mathern says that both banks and credit unions have their place in the community and, in the end, she finds it difficult to believe that so many banks are so concerned about the presence of credit unions.

It's not the small credit unions that concern bankers, according to those interviewed for this story, it's the larger ones with fields of membership that include such geographical borders as cities, counties and states. "We do not have standing to object to the expansion of common bond," NDBA's Schlosser says.

In some states, banks are challenging common bond expansions in the courts. In one long-running case in Montana, a group of banks has asked the US District Court for the District of Montana to render a summary judgment ruling that the National Credit Union Administration (credit unions' federal regulator) acted illegally in granting a charter expansion for Missoula Federal Credit Union. In the meantime, an attorney representing NCUA has asked the court to dismiss the case in favor of the NCUA, arguing that the agency's actions were within the allowances of the Federal Credit Union Act.

Harry Argue, who represents Wisconsin's bankers, points out a particular ad for the CUNA Credit Union in Madison that includes the following: "And you'll become a member as soon as you understand the strict qualifications for joining CUNA Credit Union: 1. You have to live somewhere. 2. Murray, the CUNA Credit Union monkey, has to like you. (Don't worry, Murray likes everyone.)"

"Credit unions have exceeded the boundaries of common bond," Argue says.

Nonsense, says Jerry Karbon, CUNA's spokesperson. Common bond was never intended as a means of limiting credit union membership, but was intended to help credit unions get started and remain viable. Viability was also the reason that the NCUA, in 1982, allowed credit unions to serve multiple fields of membership, according to a CUNA policy statement: "This policy change is fully consistent with the Federal Credit Union Act. As a result, many credit unions were able to survive recessionary periods and provide their members with affordable financial services exactly when they needed help the most."

For Russell Plunkett, president of the 45,000-member St. Paul Postal Employees Credit Union, there is one reason that explains the growing membership in credit unions—it's the service they provide, and it's a service that he thinks should be open to all. "Anyone should have a right to belong to a credit union," Plunkett says. "Their [bankers'] concerns are misguided. It's just that we're an easy target."

2. Regulation

When bankers talk about regulations for credit unions, they are usually referring to the Community Reinvestment Act (CRA). According to NDBA's Schlosser, credit unions that are expanding their common bond and offering full financial services should at least have to comply with CRA, which was passed to ensure that banks lend to their entire market, including low-income areas.

"Even credit unions with a geographic common bond—whose field of membership is based on a town, a county, or even an entire state—have no obligation to serve low- and moderate-income neighborhoods in their service area," writes the American Bankers Association in "Credit Union Reality Check," a publication that describes the banking group's complaints about credit unions.

The CRA issue is a "total red herring," says CUNA's Karbon. CRA was passed because some banks were redlining—that is, not lending to certain areas—and therefore CRA is a "bank-created problem," Karbon says. "Credit unions weren't redlining," Karbon says. He adds that if banks are unhappy with CRA they should work to have Congress change the law, rather than trying to pass it to other financial institutions. Credit unions, he adds, are formed to serve the needs of their members, who are their community.

3. Tax-exempt status

This is the granddaddy of bank vs. credit union issues. A 1953 headline in the Florida Credit Union League's monthly newsletter read: "Bankers Attack Credit Unions' Tax Exemption."

CUNA uses that newsletter example in one of its papers to show how the banking industry has always had it in for credit unions' federal income tax exemption. But that doesn't mean that credit unions should relax, CUNA warns, acknowledging that the latest effort by the banking industry is more intense than 43 years ago and involves the courts, the arena of public opinion and Congress.

Much has changed over those 43 years to raise bankers' concerns, Schlosser argues in his recent paper. The introduction of federal insurance for credit union deposits in 1971, changes in the interpretation of common bond through the 1970s and '80s, congressional authorization to make mortgage loans in 1978 and transaction (checking) accounts in 1980, have all served to blur the lines between credit unions and banks and means that large credit unions should at least be required to pay federal income tax, Schlosser says.

In a letter last year to Montana Congressman Pat Williams, Flathead Bank's Larry Jochim detailed his concerns about the tax exemption issue. He described how a credit union and a bank would have the same costs in providing a $10,000 loan, but the credit union would only have to charge 10 percent interest to net $1,000 on the deal, while a bank would have to charge 17.16 percent interest—the extra 7.16 percent would be needed to pay state and federal income taxes. "We have lost opportunity on credit products because of the tax rate differential," Jochim says. He says his bank pays 6.75 percent state income tax and 35 percent federal income tax and must build those tax payments onto its loan rates—competing credit unions pay zero corporate income tax. "It's contrary to the free enterprise system," Jochim says.

"We recognize the 'sacred stature,' and the political environment protecting credit unions," Jochim wrote to Williams, "however, common sense is common sense. Please review this matter in light of 'What is fair!'"

And what is fair about taxing the members of a nonprofit cooperative? asks Simon Hellermann, president of Melrose Credit Union, Melrose, Minn. "We have 17,000 stockholders, they're our members," Hellermann says about the $110 million asset institution, adding that credit union members already pay their own taxes. "Credit unions have merited this tax status and continue to deserve it because we're nonprofit and democratic. We'll still make a $25 or a $50 loan."

Hellermann worked for 18 years with Commercial State Bank in St. Paul before joining the Melrose Credit Union, and he has praise for his former bank employer. After joining the credit union, though, he realized that the "member-owned" status is particularly appealing to people and that is why credit unions are growing. "Members know us, we know them," he says.

The banking industry is also suggesting to Congress that credit unions should be taxed to provide some relief for the national budget. If credit unions were taxed, about $1 billion would be added to the federal government's budget. During this era of budgetary constraint, the federal government has to consider the credit union exemption as a revenue loss, Jochim says.

The battle is joined

Banking officials, who are veterans of legislative battles in both the state houses and Congress, know that any attempt to change laws pertaining to credit unions will not be easy and will take a long time. According to Harry Argue, who chairs a credit union task force for the ABA on this issue, the banking industry has a three-step plan:

  • Launch a "massive" educational effort.

  • Introduce a credit union taxation bill in Congress at the appropriate time. This bill would, possibly, require federal income taxation for all credit unions over $25 million in deposits or any sized credit union with a community-based charter.

  • Introduce legislation at the state level according to the "needs and political realities" of each state.

"We must go beyond just deeming this a top priority and expecting 'someone else' to deliver it. Every one of us must commit to going the extra mile for the next several years, not just months, to ultimately succeed," Argue told Wisconsin bankers this spring.

And the credit unions are ready to wage their own educational effort, according to Jerry Karbon of CUNA. A recent report from CUNA, "Credit Unions: The Consumer's Choice," fires back at the banking industry. "Banker attacks against credit unions are unprovoked, unjustified and without merit," states the report's executive summary. "Still, the banks persist."

Response to this article:
Letter to the Editor, fedgazette, October 1996
Not all credit unions are alike