The Ire Against Member Business Lending

Last year, the NCUA proposed an overhaul of all the Member Business Lending (MBL) regulations.  We anticipate these will be in place sometime at the end of the first or beginning of the second quarter of this year.  I have been asked why the MBL change is taking so long compared to other regulatory changes.

One of the reasons, is the large number of comment letters.  The MBL change generated more comment letters than the popular risk based capital regulatory changes.  In fact, it is a record.  Many of these letters came from bankers as organized by the American Banker Association.  The tone of all those letters is to not allow MBL regs to change as the banks feel it will lead to an expansion of business lending from credit unions.

I have worked for both sides during my career.  Typically the grievance on the bank side comes from the credit unions tax exempt status.  They think this is an unfair advantage for the credit union.  Actually, credit union earnings are taxed once we pass these on to members in the form of dividends and interest.

But did you know that many banks are set up in the exact same tax structure, in effect, as credit unions?  In 1997, Clinton signed the Small Business Job Protection Act, which allowed commercial banks to become chartered as a Subchapter S Corporation.  The S Corporation has no taxation at the corporate level, but all profits are passed through to owners who then are taxed.  Sounds the same as the credit union tax structure, right?

By 2014, over 35% of all banks in the US were chartered as S Corps.  This represented around 5% of total bank assets, but it grows to 20% of total bank assets, when removing the top 50 banks.  So most of S Corps are smaller banks.

If the credit union tax advantage structure (and that of 35% of US banks) were a large advantage in obtaining lower costs of funds, one would expect this to equate into credit unions holding the lion’s share of assets in the industry.  But this is not the case.  In mid-2015, reports from the FDIC and NCUA show that large banks hold 74.8% of all banking assets, small banks hold 18.2% of the assets and credit unions hold 7%.  Total assets for CUs are around $1 trillion.  There are four banks in the US that each have asset sizes larger all combined CUs:  JP Morgan Chase, Bank of America, Wells Fargo, and Citibank.

What is even more interesting is the trend.  In 1992, the division between large bank, small bank and CU stood at 41.1%-53.3%-5.6%.  Now this stands at 74.8%-18.2%-7%.  The story is not how tax exempt status has helped CUs grow so unfairly large, as I was told two decades ago from banking brethren.  The story is how the small community banks have become rarer in their market share due to increasing regulatory cost, advances in technology, and other factors.  We have also seen the rise of the “too big to fail” banks that must be preserved to make sure the economy is progressing.

So now, enter the current resistance to MBL as portrayed by our banking brethren.  Changing MBL regulations to bring it more in line with other business lending regulations will not cause a massive land shift of business from the banks to CUs no more than a CU having a tax advantage against banks that are no chartered as an S Corp.  In my opinion, overt resistance from the ABA is a waste of energy.

First, on the commercial and agricultural lending side, banking is built on relationships.  Business owners want a trusted financial advisor with their banker, whether he work for a credit union or a bank.  Owners want to believe that their banker makes their business better and they don’t just want someone who can complete the next transaction for them.  The first place a bank should look if they lose a business client to a credit union is in the mirror.  A post-mortem is necessary to find out what they could have done better to keep the relationship.

What is in the best interest of the citizenry and the economy is to allow a wide range of choices for businesses to be able to obtain credit—whether a credit union, bank, or other lender.  A more level playing field should be in place, which is what the new regulation seeks to accomplish.

Next, the bank’s negative attitude toward credit union business lending, takes away focus on areas that cost banks far more money than the small 7% of the market held by credit unions.  This culprit is excessive regulations.  Not only do you have the general alphabet of regulations from the OCC, NCUA, and FDIC; add in RESPA, TIL, BSA, FRCA, FinCEN, FRB Regulations A-NN, just to name a few.  We even face a government department devoted to regulating anything that appears to harm the average consumer, in their eyes.  This institution also falls outside the constitutionally established structure to fund government agencies.  Perhaps if less focus were spent on the animosity between the bank-credit union camps and more energy were placed at the excessive high and burdensome cost from governmental regulation, both sides of the aisle would be more profitable.

Finally, the ABA’s errant focus, helps them ignore many other non-financial companies that are competing for banking services.  The 10 largest non-financial companies Forbes’ list, have assets exceeding $3 trillion.  Each of these companies, has at least one product that competes directly for financial services that are provided by banks.  Whether it is the bank inside Wal Mart, a Chevron credit card, or financing with GE Capital, all these companies and more, compete directly for business that exclusively belonged to banks and credit unions in the last century.

It is also easier for non-bank companies compete for business customers with the new delivery channels that do not require a large investment in brick and mortar.  Bankers should realize that to focus solely on the small 7% of the market held by credit unions may cause to miss more business that is being taken away every day from business loan advertisements at Office Depot, to equipment finance at GE Capital, to deposit dollars being placed on a Starbucks card.  In the end, the lack of good relationship building, excessive regulations, and non-bank (and non-CU) competition will do more damage to the bank’s balance sheet than the entire CU industry will.