This is just one of the stories from our “I’ve Always Wondered” series, in which we answer all of your questions about the business world, no matter how big or small. Have you ever wondered if recycling is worth it? Or how do private labels compare to well-known brands? More information about the series can be found here.
Listener Tom Dudzinski from Colorado asks:
When I hear the many reports of bank failures, I can’t help but feel smugly safe that I do all of my private banking with credit unions (including mortgages, credit cards, car loans, and certificates of deposit). Do credit unions actually fail and we just don’t hear from them because they’re too small? Or is the way credit unions are structured and function inherently different, making them significantly less likely to fail? Is my smug security misplaced?
Rest assured Tom. Credit unions are generally safe.
These financial institutions are not-for-profit cooperatives owned by their members that focus on the needs of their communities, while banks are for-profit corporations.
Experts tell us that credit unions fail, as do banks (which are generally safe too), but rarely. And deposits up to $250,000 with government-insured credit unions are guaranteed, just as they are with banks.
Angela Vossmeyer, associate professor of economics at Claremont McKenna College, said data from the National Credit Union Administration shows that an average of six to seven credit unions have entered the conservatory or liquidation phase each year since 2017. A credit union comes under its control due to operational problems, while a liquidation means the credit union has closed.
In all, there are approximately 4,800 federally insured credit unions in the United States
Vossmeyer pointed out that since 2017, an average of two to three of the more than 4,100 banks have gone bankrupt each year.
So banks are generally safe too, but as we have seen in recent history, there are periods of instability that expose their vulnerabilities. Bank failures increased during and after the mortgage-related financial crisis. In 2007 there were only three bankruptcies, in 2008 there were already 25. In 2009 and 2010 a total of around 300 banks collapsed.
This year, Silicon Valley Bank closed after a surge in deposits, followed by Signature Bank and First Republic. As the crisis has subsided, Wall Street investors have expressed concern about the state of the country’s regional banking system.
The differences between credit unions and banks
In context, the default rate is low for both types of institutions. One advantage of credit unions, however, is that they make less risky investments.
“Credit unions still manage complex balance sheets like banks. So if a certain asset class loses value, it can hit both banks and credit unions,” explained Vossmeyer. “But in general, credit unions are more risk-averse.”
Before the 2007-08 crash, more than 23% of commercial bank mortgages were subprime mortgages, which are risky because they are issued to people with poor credit ratings and carry higher interest rates. In comparison, only about 4% of mortgages from credit unions were subprime mortgages.
“On the assets side, you can see very different risk profiles,” said Vossmeyer.
“Banks are trying to maximize their return on equity, and that can lead them to take greater risks with their loans or investments,” said Luigi Zingales, finance professor at the University of Chicago’s Booth School of Business.
“Today, you usually get paid a lot less at a credit union, so you don’t have a lot of incentive to take that much risk because you don’t get much benefit,” Zingales said.
He pointed out that a credit union’s failure could be due to incompetent management or theft — there have been instances of employees absconding with the facility’s cash.
Could a credit union face a Silicon Valley bank collapse?
Bank failures dominated the news earlier in the year after the collapse of Silicon Valley Bank, which suffered a run that forced it to sell its long-term securities at a loss. The signature in New York soon followed.
Here’s what happened: When the Federal Reserve raised interest rates, older bonds lost value because newer bonds paid higher interest rates, hurting the investments made by those banks. Fearing for SVB’s viability, depositors panicked at mounting investment losses and withdrew their funds. In order to pay people money, SVB had to sell their long-term bonds. But why would potential buyers pay for these low-yielding bonds when newer bonds offer more attractive interest rates? As a result, SVB had to sell these assets at a discount.
The SVB was vulnerable to depositor exodus as corporations and wealthy savers held millions of dollars in their accounts with the bank, exceeding the Federal Deposit Insurance Corp’s coverage limit. exceeded $250,000. Because of this cap, 94% of SVB deposits were uninsured. The fear spread quickly.
“If you’re a depositor at Silicon Valley Bank and you recognize these issues, and you know that most of your deposits are uninsured, you have an incentive to exit, which kickstarts the liquidation,” Vossmeyer said. “On the other hand, if you’re a customer of a credit union, there’s really no incentive to run.”
Deposits with federally-insured credit unions are also guaranteed up to $250,000, but the National Credit Union Share Insurance Fund provides coverage. Because these institutions cater to individuals and households with smaller accounts, 90% of deposits at credit unions are insured, Vossmeyer said.
Shortly after the collapse of the SVB, the National Credit Union Administration tried to convince people of the stability of their institutions.
“The credit union system remains well capitalized and on solid foundations,” NCUA Chairman Todd Harper wrote in a press release. “The National Credit Union Administration continues to oversee the performance of credit unions through both the review process and external monitoring, and will continue to do so in the future.”
When looking for a financial institution, Vossmeyer says verifying that the bank or credit union is insured should be one of your top priorities.
And if you’re considering a mortgage or new credit card, credit unions tend to offer more generous terms than banks, according to Zingales. Mortgages can be offered at lower rates, credit card fees can be lower, and many offer free checking accounts with no minimum balance.