Despite widespread political support, the credit union sector in the UK still pales into insignificance in economic terms when compared with many other countries. In new NEF research, out today, we ask: what can be done to change this?
Credit unions are a form of local cooperative bank that place a particularly strong emphasis on social objectives, such as working with people who mainstream financial institutions will not bank. Although credit unions exist worldwide, the size and scope of the sector varies considerably from country to country (see graph below). Only 2% of the UK’s economically active population are a member of a credit union, for instance, whereas just next door in Ireland membership is much higher at 72%.
Credit union membership in selected high-income countries (2011)
Source: World Council of Credit Unions
There are a number of reasons for their uneven spread. As well as differences in history, geography and regulation, one of the most important factors is whether or not small local credit unions have been able to achieve economies of scale. This goes a large way toward explaining why community finance has yet to really take off the ground in the UK.
As the trend for mainstream banks merging and taking over one another took off over the past century, banks that wanted to stay local started to struggle to compete. This is because small institutions cannot individually achieve the economies of scale enjoyed by larger institutions, for example by spreading the costs of IT systems, advertising and marketing, and regulatory compliance departments over a larger number of customers, or being able to access better terms for lending and borrowing in financial markets. Nevertheless, in many countries, smaller banks gradually developed an innovative way to circumvent these problems: by collaborating with one another and pooling together certain activities they have found themselves able to operate at a financially viable scale.
This tactic has proven so successful that almost all continental European and North American local banks, be they cooperatives, public banks, or credit unions, now exist as part of very large networks. These networks are generally coordinated by a central institution which enables them to achieve economies of scale in a wide variety of activities. For instance, they can share the costs of the multi-million pound I.T. investment needed to access the payments system (the network that major banks use to transfer money to each other). They can also club together on systems and product development, public relations, marketing, risk and liquidity management, training programmes, lobbying efforts and gaining access to interbank trading markets.
Such central institutions have existed in Canada since 1938, and have been fundamental to the success of Canadian credit unions. Centrals for credit unions in the US are called ‘corporates’, and have been around since the 1970s. Australian credit unions first started pooling liquidity in 1964, and have been sharing ATMs and joint-access to the payment systems and inter-bank lending markets since 1991. Finally, credit unions in South Korea have enjoyed joint access to the payment systems since 2000, and joint IT infrastructure since 2008.
The mismatch between the success of credit unions in the UK and South Korea is particularly interesting, as credit unions were established in both countries at roughly the same time (unlike, for example, Canadian credit unions, which have been around for over half a century longer than their UK counterparts). Credit unions are now notably more prevalent and successful in Korea than in Britain – with 17% membership compared to 2% here. The World Council of Credit Unions has attributed the strong growth of the sector in Korea to its excellent internal collaboration.
As a result of this network model, Canadian, US, Australian and Korean credit unions are able to offer customers a large suite of financial products to customers, including cheques, credit cards, debit cards, and money transfer services. Such products and services are not really financially viable in countries without local banking networks, such as the UK, because of this crucial challenge of achieving economies of scale.
For example, most British credit unions currently can’t afford to offer current accounts, because accessing the UK payment systems requires millions of pound worth of IT investment. Without current accounts, a financial institution cannot realistically appeal to the general public and become financially self-sufficient. This is evident in the fact that many British credit unions are significantly dependent on grant funding or support from local authorities, with 80% of community-based credit unions having received some form of grant. In addition, many customers are currently faced with the out-dated situation whereby they have to actually visit their credit union in person to be able to withdraw money, because their credit union can’t provide access to ATMs.
Attempts at creating a centralised infrastructure for credit unions in the UK are being made, however. The Department for Work and Pensions (DWP) recently awarded £38 million to ABCUL, the trade group representing British credit unions, to help modernise and grow the credit unions sector, including by developing a central IT platform. Unfortunately even this worthy attempt at creating some centralised infrastructure will leave British credit unions well short of the central liquidity services, mutual guarantee schemes, access to wholesale banking markets, and product development expertise that many of their overseas counterparts enjoy.
Of all the functions provided by central institutions, the UK is in most pressing need of allowing credit unions, and other smaller institutions, direct access to the payment systems. Our conversations with industry sources indicate that the latter could bring payment costs down from 20p to 3p per transaction. This would make all the difference to smaller institutions trying to compete with much larger counterparts. Access to the payment systems is the single biggest barrier to entry in UK banking, and it is not yet clear if ABCUL’s project will full overcome it. In addition, we should obviously not have all of our eggs in one basket. The government should allow other organisations to bid to create such a platform, which not just community finance institutions, but also other new entrants to the banking market, could all plug into. Allowing credit unions to offer the full range of current account services on a level playing field with the big high street banks could be the disruptive change required to finally give British customers the wider range of banking choices enjoyed by their counterparts in other countries.