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Maximizing Efficiency of Operations: The "New Currency"

Operational efficiency is a necessity for credit unions looking to drive profitable growth while strengthening financial stability. The following overview explores economy of scale though an analysis of 585 credit unions to identify characteristics of top performing institutions.
  • Mike Higgins Managing Partner at Mike Higgins & Associates

Banking is Fundamental but Only the Most Efficient Will Survive

Banking as a basic utility has been around for millennia—its history dates to 2000 BC when merchants provided grain loans to farmers. The oldest modern era bank is Banca Monte dei Paschi di Siena in Italy, which has continuously operated since 1472. For context, that bank was 462 years old when the Federal Credit Union Act was passed in 1934. Times have changed, but the basic utility has remained constant—it’s as fundamental to our lives as food, water, sleep, and shelter.

Another constant that has transcended time is competition. To conjure Charles Darwin, certain credit unions survive because they have the characteristics that prevent them from being eliminated, those lacking such are merged out of existence.

To survive, a credit union requires two critical traits. The first is market relevance (affinity, convenience, features, security, value proposition, etc.) and the second is financial sustainability (enough rate of return to maintain adequate reserves). Relevance and sustainability can be a vicious-virtuous cycle. Those who struggle financially cannot invest in market relevance, which threatens ongoing sustainability—a vicious cycle. Those who succeed financially can invest in market relevance, which moves them beyond survival and into prosperity—a virtuous cycle.

Financial institutions must adapt to their shifting environment and rapid change has occurred in the past 24 months. Credit unions are getting hit on all sides: expense, revenue, asset quality, liquidity, and capital. Specifically:

  • Inflation brought about by fiscal stimulus is driving up operating costs.
  • The Federal Reserve response to inflation is squeezing net interest margin.
  • Negative press on "penalty fees" is putting pressure on non-interest income.
  • Asset quality is reverting to the mean after a period of historically low levels of losses.
  • Quantitative Tightening (QT) and the inability to sell securities are straining liquidity.
  • Secondary sources of capital are being used to reinforce depleted levels of net worth.

Because of this, the weak are being exposed.

Only when the tide goes out do you discover who’s been swimming naked.
Warren Buffett

However, you can also see those who are not—the ones who have a survival characteristic called efficiency of operations which equips them to handle change and competitors. It’s a sustainable advantage too because it cannot be copied or purchased, it must be earned. In simple terms, efficiency of operations can be thought of as a cost advantage where output per dollar of input exceeds that of others.

Credit Union Economy of Scale Analysis

In this study, we analyzed 585 credit unions, using NCUA Call Report data, to determine the characteristics and similarities and differences in financial performance based on the economy of scale ratio. We gained insights, specifically, relating to: loan balance, relationship share balance, non-interest income, net loan spread, operating ROA, and net worth.

Our findings revealed the benefits of economy of operations, which are four-fold:

  1. Competitors can't take it away from you. It must be earned.
  2. You can provide better pricing and generate a higher rate of return at the same time.
  3. You are better equipped to blunt competitive threats and ride out economic turbulence.
  4. You can invest more in operations for market relevance (product, promotion, delivery, security, etc.).

In the following sections, we’ll lean into economy of scale, addressing what it is (and is not), traits of high performers, and considerations to think about going forward.

Economy of Scale

Defining Economy of Scale

Economy of scale is a misunderstood term. To many, it’s simply scale—if you have a lot of assets, you are winning the battle! They forget “economy” is part of the equation. Sears, JC Penney, and K-Mart all had scale. What they lacked was economy (among other things) to compete with the likes of Wal-Mart and Amazon.

From a definitional perspective, economy of scale occurs when cost savings are derived from higher levels of output.

If you think about it, economy of operations may be a more fitting term because when cost savings are derived from higher levels of output, economy is realized regardless of scale. Later in this publication, we’ll highlight some credit unions that are realizing more economy on less scale than larger cohorts, but we’ll stick with the term economy of scale because of its familiarity in business lexicon.

What Economy of Scale is Not

Let’s address what economy of scale is not because it’s a mistake to use a proxy metric (correlation is not causation). It’s important to avoid diagnosis that leads to the wrong remedy.

  • The Expense to Assets Ratio (non-interest expense as a percent of assets) is not economy of scale. Why?
    • Not all assets have equal value. The expense to asset ratio treats them as if they do.
    • It ignores the funding side of the balance sheet which is equally important as the asset side.
    • It included expense to produce non-interest income but ignores the output!

Case in point: We identified a group of credit unions with an expense to asset ratio exceeding 4% which would rank them among the worst performers, yet they had a return on assets in the top 20th percentile. The reason? This group generated non-interest income at the 95th percentile.

  • The Efficiency Ratio (non-interest expense as a percent of net interest and non-interest income) is not economy of scale. Why?
    • A high/rising net interest margin (part of the efficiency ratio) does not mean productivity is strong/improving, while a low/falling margin does not mean productivity is weak/waning. 
    • Member favorable pricing (a cooperative principle) purposefully worsens the efficiency ratio.
    • It can be misleading relative to non-interest income. A line of business with a 10% profit margin and no capital requirement is a financial home run! It's also a 90% efficiency ratio (misdiagnosed as unfit).

Case in point: We identified a credit union with an efficiency ratio of 86% that would rank them among one of the worst performers. Why did they perform so poorly? They did a member give-back (shows up as expense) that was equivalent of 0.60% ROA!

The Economy of Scale Ratio

Recall from our definition that economy of scale occurs when cost savings are derived from higher levels of output. Stated another way, economy of scale is realized when the net cost per unit of output decreases over time. So, we have two items to look at in the form of a ratio. Net Cost (top number, numerator) and Unit of Output (bottom number, denominator).

Net Cost is non-interest expense minus non-interest income. Unit of Output is loan balance plus relationship share balance (draft, regular, money market, and health savings). Loans are the most valuable and strategically important asset. Relationships shares are the most valuable and strategically important funding source (long-lived, lowest cost, and reduces interest rate risk).

Stated more insightfully, the economy of scale ratio is the net cost to produce a unit of greatest strategic value. The credit union with the lowest net cost producing the most high-value items has a competitive advantage.


Using NCUA 5300 Call Report data, we examined the financial performance of credit unions in relation to their economy of scale ratios in order to gain insights and a better understanding of the characteristics, similarities, and differences among credit unions with the least, middling, and greatest economy of scale. Our sample comprised of 585 credit unions with annual non-interest expenses ranging from $20 million to $220 million during the four quarters ending September 30, 2023. In total, this group constitutes $1.1 trillion of credit union assets, with individual assets size ranging from $300 million to $12 billion.

The economy of scale ratio (net cost per unit output as previously defined) was computed for each credit union. Next, the population was sorted by economy of scale ratio from greatest to least economy of scale. Since we are measuring net cost per unit of output, the smaller the ratio, the greater the economy of scale being realized. Finally, credit unions were aggregated into three groups of 195 each: Greatest, Middling, and Least Economy of Scale.

Since the economy of scale ratio will be a new number to most readers, it is helpful to have a reference point of what a good versus bad number looks like. Just remember 1.30% and 1.60%. A number below 1.30% would place you in the Greatest Economy of Scale group. A number above 1.60% would place you in the Least Economy of Scale group. A number between those two points would place you in the Middling Economy of Scale group.

Research Findings

Not surprisingly, credit unions with the greatest economy of scale had the most output per dollar of expense input—because that is the very definition of it. What’s interesting is the magnitude of difference among the groups.

  • The Greatest Economy cohort holds 28% and 48% more loan balance per dollar of non-interest expense than the Middling and Least Economy cohorts respectively.
  • The Greatest Economy cohort holds 24% and 47% more relationship share balance per dollar of non-interest expense than the Middling and Least Economy cohorts, respectively.
  • The Greatest Economy cohort generates 16% and 30% more non-interest income per dollar of non-interest expense than the Middling and Least Economy cohorts, respectively. 

Realizing economy of scale not only provides benefit to members because the credit union is operating in a cost-efficient manner, but also reduces reliance upon net interest margin to cover operating expense. One way to look at this is via net loan spread, which is loan yield, less net charge-offs (to factor risk-based pricing), less dividend rate. The smaller the spread, the more “member-friendly” the margin.

  • The Greatest Economy cohort takes 12% and 16% less net loan spread than the Middling and Least Economy cohorts respectively.

What about return on assets (ROA) and net worth? Surely, if a credit union is taking less net interest spread, one would think their ROA and net worth would suffer as a result, placing their financial sustainability at risk. In fact, the exact opposite is true.

  • The Greatest Economy cohort generates 0.29% and 0.64% more Operating ROA (replacing provision expense with actual net charge-offs) than the Middling and Least Economy cohorts respectively.
  • The Greatest Economy cohort has 8% and 13% more net worth than the Middling and Least Economy cohorts respectively.
It's Not a Fair Fight

The Greatest Economy cohort uses its productivity advantage to take less margin from members, while producing a higher ROA and holds more regulatory reserves. Member happy. Board happy. Examiner happy.

Wait a minute, are credit unions in the top third also the largest—so you are just saying larger is better? Yes and no.

Yes, they are larger, and it’s easier to leverage fixed costs as you grow, but they are also realizing Economy of Scale.

  • Greatest Economy Cohort = $2.8 Billion Average Assets
  • Middling Economy Cohort = $1.5 Billion Average Assets
  • Least Economy Cohort = $1.1 Billion Average Assets

No, there are smaller credit unions in the Greatest Economy cohort and there are very large credit unions in the Least Economy cohort.

  • 20% of the Greatest Economy cohort had less than $1 billion in assets—the smallest being $270 million—which demonstrates that economy can be realized on less scale (i.e., efficiency of operations)
  • 42% of the Least Economy cohort had more than $1 billion in assets—13% were between $2 and $9 billion—which demonstrates that scale does not guarantee economy

Key Considerations

Efficiency of operations provides a cost advantage that helps credit unions withstand changes and competition. Listed below are ten tactics to acquire the sustainable benefits of economy of operations, such as being able to provide better pricing and invest more in operations.

10 Takeaways to Consider:

  1. Banking is a utility that is not going away.
  2. Meet the utility; don't exceed it (don't mess it up beats vanity).
  3. Some investments are table stakes (required, cost of entry).
  4. Remaining investments should reduce/eliminate expense (including headcount) or drive revenue growth.
  5. Avoid the trap of operational cadence (input and output growing at same pace); establish leverage goals (1.5–2.0x).
  6. If you lack efficient operations, your only options are a high net interest margin and/or superior asset quality.
  7. It might not be a matter of having enough resources, it's where they are directed. It's difficult to be everything to everyone.
  8. Be prepared to make hard decisions; reprioritize.
  9. If lacking economy, then affinity (of lack of competition) is critical because low ROA constrains ability to grow, limits investment in operations, and lessens ability to win market share via pricing.
  10. There is a shrinking margin for error; expenditures must produce results.

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