On the margins

Celent recently released the report On the Margins: A Comparison of Banks and Credit Unions by Asset Tier, where community institutions of the same size are compared across a number of performance metrics, mainly efficiency ratio. One of the most interesting findings is that credit unions are becoming less efficient at a faster rate than banks of the same size. Efficiency ratios measure how much it costs an institution to create one dollar of revenue. Looking at the data in previous sections, credit unions are increasingly spending more money to generate as much revenue as banks of the same size. Efficiency ratio can be dependent on a number of factors, but as a way to look at simple margins, it´s one of the more useful industry metrics. At a glance it seems counter-intuitive. Credit unions are generally more customer-centric and have higher technology adoption. They use real-time systems, simpler product lines, invest in labor saving technology, and leverage community involvement like CUSOs and shared services to drive down prices. But there are obviously distinct business model differences, where credit unions, being member-owned, generally run thinner margins, returning more benefit back to the customer in the form of better interest rates and/or lower fees. Although this is an intentional business decision reinforced by member-centric charters, it leaves the institution with fewer resources than similarly sized banks that may take a more profit-driven approach. So what’s the issue here? It comes down to the effects of digitalization. Celent sees three challenges that may affect the credit union market going forward:

1. As the complexity of business demands in financial services grows (e.g., technology), the resource requirements may present a challenge for credit unions (and all community institutions) running thin margins. Since raising capital is limited to retained earnings, non-profits need to be more intentional about how they prioritize tech investment.
2. Banks in recent years have seen a significant shift in how they view customer service. Once a key point of differentiation for the CU market, banks are now coming on board to make customer centricity the new operating model, increasingly driven by the digital experience. While customer centricity is healthy for the industry as a whole, it’s unclear to what extent it indicates an erosion of credit unions’ key value proposition.
3. As technology breaks down geographical barriers of financial services, customers are given more options, and the competitive landscape widens based on the availability of channels. Switching financial services providers is no longer a high-friction process, and the selection is wider than ever. Digital is also redefining what it means to be a part of a community, and it’s increasingly being decoupled from physical proximity. This puts pressure on institutions that have previously enjoyed relative isolation in well-defined localities.

To be clear, these challenges aren’t all specific to credit unions. Financial services are increasingly becoming a game a sufficient scale, and community institutions of all size are feeling the pinch. Yet credit unions, given are the average institution size and business models, are disproportionately affected. With the complexity and demands of financial services putting more pressure on the bottom line, will this difference adversely affect credit unions’ (and community institutions) ability to stay competitive?