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According to analysis from Moody’s Analytics in September 2022, the average American household needed to spend an additional $445 per month to buy the same goods and services compared to a year earlier. This represents approximately 8% of the median household income of $70,000 per year, resulting in a significant erosion of purchasing power by inflation.
The impact is even more pronounced for households below the median income level. These households allocate a large portion of their income to essential items such as food, energy, rent, health care, and child care.
When the prices of these necessities increase, it further strains the already fragile financial well-being of these individuals and families.
Consequently, individuals are tapping into their savings and relying more on credit cards to meet their basic needs. This partly explains the significant decrease in the personal savings rate, which has halved compared to pre-pandemic levels.
Moreover, total outstanding credit card loans, which declined during the pandemic as people used stimulus money to pay them down, are now on the rise.
Inflation has mixed implications for credit unions, necessitating effective risk management practices to mitigate the negative effects.
High interest rates caused by inflation can increase the interest income credit unions earn on new loans and other interest-earning assets. Credit unions, driven by their mission to serve members, consistently offer more affordable interest rates on loans compared to for-profit financial institutions.
CUNA’s analysis of credit report data from Equifax reveals that credit unions raise rates on auto and mortgage loans at a slower pace and to a lesser extent after the Federal Reserve begins tightening monetary policy. This translates into substantial savings for members, particularly those with lower credit scores, over the life of the loan.
Consumers will find credit unions a better partner for their financial needs as they search for affordable rates in this high interest rate environment.
However, inflation can also prompt members to seek higher returns for their deposits to protect their savings. This increases the cost of funds, impacting credit unions’ lending capabilities. Additionally, inflation leads to higher expenses, such as employee wages and operating costs, thereby reducing net income.
Members who face challenges with the high cost of living may struggle to keep up with their loan payments. This reduces asset quality and interest income.
As a result, credit unions may need to increase loan loss provisions, which further erodes net earnings. Fortunately, recent data on credit union delinquency rates indicates that members are paying their loans on time relative to borrowers at other financial institutions.
Mortgage delinquency rates remain low, as many members secured affordable interest rates during the pandemic. Delinquency rates for auto loans and credit cards have gradually increased from their low levels during the pandemic. But they still remain below or close to pre-pandemic levels.
Rising interest rates also introduce risk to financial institutions, as their assets and liabilities don’t reprice equally. High levels of interest rate risk increase liquidity risk and reduce the value of fixed-income investment portfolios, leading to capital erosion. For this reason, NCUA identifies interest rate risk as a supervisory priority in 2023.
The failure of Silicon Valley, Signature, and First Republic banks was partly caused by interest rate risk, as they held a large share of long-term bonds in their investment portfolios, which declined in value. These institutions also held a large share of uninsured deposits that led to bank runs and their subsequent failure.
Credit unions, however, have lower exposure to the kind of risk that caused the failure of these banks. As of December 2022, the median credit union had only 5% of its assets in long-term debt securities, and 95% of deposits as percentage of assets were insured.
Inflation has presented significant challenges to the economy in recent years, affecting consumers and financial institutions alike. The Federal Reserve raised short-term interest rates by 500 basis points within 15 months to tame inflation. This introduces risk to financial institutions.
Effective risk management practices will be essential for credit unions to navigate these challenges successfully and continue serving their members in a changing economic landscape.
DAWIT KEBEDE is a senior economist at Credit Union National Association. Contact him at dkebede@cuna.coop.