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Determinants of Credit Union and Commercial Bank Failures: Similarities and Differences, 1981-2005

In this report, James A. Wilcox, deftly presents the first large-scale, long-term (1981–2005) econometric analysis of individual commercial bank and credit union failures.

Executive Summary

You have become accustomed to reading Filene Research Institute studies on the future of the credit union charter, examining exciting innovations, new strategic frameworks, and emerging consumer behaviors. Why, then, you may be asking yourself, do we present this seemingly downbeat study that investigates past credit union and commercial bank failures? Good question. We believe studying poor financial institutional performance is a superb way to enlighten readers about the qualities of safe and sound credit unions—and, for that matter, commercial banks. In this report, James A. Wilcox, Filene Research Fellow and Professor of Financial Institutions at the University of California, Berkeley, deftly presents the first large- scale, long- term (1981–2005) econometric analysis of individual commercial bank and credit union failures.

What is the research about?

Using a newly constructed database of credit union and commercial bank failures, Professor Wilcox estimates and compares statistical models of failure of credit unions and commercial banks and makes the following key discoveries.

The likelihood of failure rose at credit unions and commercial banks that had:

  • Fewer assets.
  • Higher ratios (to their assets) of net loans, commercial and industrial loans, delinquent loans, or non interest expenses.
  • Higher unemployment rates in their states.
  • Lower returns on assets (ROA) or capital ratios.

The estimated sizes and the significance of the effects of many of the failure factors differed:

  • Between credit unions and commercial banks.
  • Across asset size ranges.
  • Over certain time periods. For instance, having more residential mortgages tended to increase the likelihood of credit union failures but reduce the likelihood of commercial bank failures.
  • Although the overall failure rates of credit unions were generally higher than those of commercial banks, credit unions failure rates were typically lower than those of commercial banks in the same asset size range.
  • Over the past two decades, financial strength has improved much more at small banks (those with less than $25M in assets) than at small credit unions.
  • Using an estimated probability of failure within one year (EPF) for individual institutions, Professor Wilcox finds that among small institutions (those with less than $25M in assets), the percentage of credit unions exceeding the 0.1% Basel ceiling (44%) was more than twice that of banks (21%). By contrast, among medium-sized institutions (those with $25M–$250M in assets), fewer credit unions (3%) than banks (9%) had estimated EPFs of more than 0.1%.

What are the credit union implications?

One of the most interesting and practical conclusions of this study is that the behaviors and operating procedures that foretell credit union failures differ from those that foretell bank failures. While I doubt this is what industry watchers have in mind when they talk about “the credit union difference,” the implications are potentially profound. Wilcox promotes the idea of regulators (and policymakers by proxy) using this research to assess how altering balance sheet and income statement variables might reduce failure risk for individual credit unions and banks. Put another way, the figures and statistics presented in this study are potential raw materials for regulatory relief.

In addition to utilizing this study as a tool to promote a more nuanced regulatory environment, small institutions (those with less than $25M in assets) and medium-sized institutions (those with $25M–$250M) can delve into the contributing factors leading to failures in banks and credit unions to better understand (and manage) the early warning signs of institutional failure. While larger credit unions (those with more than $250M in assets) experienced no failures over the studied time period, they too can utilize this study to become aware of the factors that contribute to institutional failure.

Finally, this seemingly downbeat subject has a silver lining beyond the two practical suggestions listed above. Over the entire study period, assets in failed credit unions and losses to the insurance fund comprised a small percentage of credit union assets and, most recently, failure rates at both credit unions and banks have declined significantly