This year's bank failures show credit union difference

In the wake of the Silicon Valley Bank failure earlier this year, should credit union board members be alarmed? What can you do given banking industry challenges? 

Until recently, few directors asked these questions.

I attend a lot of credit union strategic planning sessions and didn’t hear any discussion of banking system safety last year or early in 2023.

Of course, general anxiety over the Federal Reserve’s inflation fight was an all-consuming topic because that battle was being fought with historically unprecedented increases in short-term market interest rates. 

Worries about the prospects of recession, rising unemployment, and the possible erosion of asset quality were common. Loan growth was strong in 2022 (nearly 20% at credit unions) and saving growth was weak (just over 3% at credit unions), so loan-to-share ratios were rising significantly. 

Liquidity was (and is) tight. Discussion of these issues dominated our meetings.

But conversations changed dramatically in March when the $210 billion asset Silicon Valley Bank (SVB) failed. 

SVB concentrated its business in venture-capital-backed start-ups, mostly in the technology sector. At the time, the bank’s collapse marked the second-largest depository failure in U.S. history after Washington Mutual’s in 2008. 

Then, in rapid succession, Silvergate Bank, a cryptocurrency industry-focused bank with $11 billion in assets, announced plans to wind-down operations, followed soon after by the failure of $110 billion asset Signature Bank, which catered to high-net-worth customers. Other banks were obviously teetering. 

Fortunately, the Fed, U.S. Treasury Department, and FDIC quickly responded, instituting aggressive policies aimed at stabilizing markets and restoring confidence. Those actions seemed effective. 

While federal policy responses tended to calm nerves, material weakness at many large depositories persisted. Common characteristics of the troubled banks include:

• A lack of loan diversification and a significant deterioration in asset quality. For example, the cryptocurrency industry specifically and the tech sector generally suffered big declines in 2022. 
• High concentrations of debt securities, which incurred progressively more significant unrealized losses with each Federal Reserve interest rate hike. At year-end 2021 the banking industry reported a system-wide total of $10 billion in unrealized losses on debt securities—but those unrealized losses ballooned to nearly $700 billion by the end of the third quarter 2022.
• Substantial exposure to big concentrations of large uninsured deposits. SVB, for example, had one depositor that self-reported a $3 billion deposit in the institution. 

Overall, the bank’s year-end 2022 average deposit totaled $2.5 million—well above the regional bank average of $177,000 and the banking industry average of $7,700. That’s well above the $250,000 per-account FDIC limit.

Recently, deep concern over financial system stability was reignited when on May 1 First Republic Bank failed. The $212 billion asset bank catered to high net-worth individuals—and more than two-thirds of the bank’s deposits were uninsured. 

The failure knocked SVB from its unenviable perch as the second largest bank failure ever to the third largest.

At a basic level, these banking industry challenges increase the risk that the U.S. will suffer recession—perhaps deeper and longer than current consensus expectations would suggest.

Banks have generally tightened underwriting standards in the wake of the failures described above, and more failures would undoubtedly cause more significant reactions. As it stands, some now suggest that tighter underwriting may have the economic equivalent effect of a 50-basis-point drop to a 100-basis-point increase in the federal funds interest rate.

More broadly, the financial system is built on confidence. And confidence can be frighteningly fragile. NFL coaching great Vince Lombardi put it best: “Confidence is contagious. So is lack of confidence." 

This fragility has always been a component of our depository insurance system, but it seems especially concerning today. Internet and social media age narratives (true and untrue) are shared and repeated extensively, and many can be damaging and downright dangerous.

Pundits, bloggers, podcasters, and other “influencers” with large audiences have joined the ranks of equity analysts in using the Securities and Exchange Commission, FDIC, and other publicly available data to opine on the health of both individual banks—and the banking system as a whole.

Large, publicly traded banks have thousands of stockholders, and any diverse investor base is apt to include at least a handful of those with big bets on failure rather than success. The ability to short bank stocks means investors can profit from bad news.

This, combined with recent accusations of insider trading—both within banks and within the ranks of policy makers—has almost certainly colored the average consumer’s perception of the system.

In a survey conducted between March 16-20, the Associated Press-NORC Center for Public Affairs Research found that only 10% of U.S. adults say they have high confidence in the nation’s banks and other financial institutions. That’s down from 22% in 2020.

Separately, on May 4 Gallup published research results that reveal more than half of consumers say they’re concerned about bank deposits. That’s on par with the level of worry measured during the financial crisis in 2008 when financial institutions previously believed to be “too big to fail” collapsed.

Declining confidence and the possibility of contagion and spillover effects grow against the backdrop of a steady drumbeat of negative press.

NEXT: How credit unions compare

How do credit unions compare?

As noted earlier, credit unions, like all financial institutions, have experienced tight liquidity and many are concerned about Federal Reserve interest rate increases. Unrealized losses on investments securities have grown. That’s simple mathematics. 

But credit unions are unlike big banks in a number of important respects. Unlike big banks, credit unions don’t have stockholders. Stockholdings in these institutions aren’t actively traded on exchanges and few investment professionals spend any time “following” them.

This alone reduces the risk of bad press which should arguably help to buoy confidence in these segments of the depository arena. 

A fundamental concept in economics is that incentives matter. Incentives drive behavior and behaviors influence outcomes. Big bank CEOs are under almost constant pressure related to quarterly earnings calls. And big banks CEOs are more likely to both be compensated with so-called “high-powered” compensation (variable pay-for-performance) and have higher proportions of high-powered compensation compared to CEOs of similarly sized credit unions. 

As a consequence, big banks are more likely to take on more risk to maximize annual compensation.

Significant differences between banks and credit unions are clearly reflected in the prevalence of uninsured deposits. Bank uninsured deposits dwarf those observed in the credit union arena. 

The typical bank reports 25% of deposits are uninsured, whereas the typical credit union reports just 3% of deposits are uninsured.

CUNA’s review of FDIC data at year-end 2022 shows that 799 federally insured banks report at least 40% of their domestic deposits are uninsured. These banks represent 17% of the nation’s 4,713 banks. 

The average asset size of these institutions is $19 billion and the median asset size is $822 million. Collectively, these banks hold 64% of banking industry assets: $15.2 trillion in total.

In contrast, NCUA data at year-end 2022 shows that only 11 credit unions report at least 40% of their shares and deposits are uninsured. These credit unions represent 0.2% of the nation's 4,758 credit unions. 

The average asset size of these institutions is $51.4 million and the median asset size is $41 million. Collectively, these credit unions hold only 0.02% of credit union industry assets: $397 million in total.

What can board members do?

Credit unions have been uniformly positive about how consumers are behaving and interacting with them. Specifically, they’re reporting few instances of members inquiring about the safety of their deposits and, more importantly, reporting high levels of deposit retention and modest though healthy growth in deposit balances.

CUNA’s 2023 National Voters Poll, conducted in January, reveals that 90% of credit union members trust their credit union. Overall, so-called “high intensity” results that focus on those that are most likely to say they trust their institution (i.e., those that are not just “positive” but “very positive” that they trust their institution) show that credit union members are 1.6 times more likely than nonmembers to reflect this level of certainty. 

The CUNA team—in cooperation with our state league partners—has consistently made supportive comments about the health of the system generally and of the National Credit Union Share Insurance Fund in particular.

We’ve built a page on our website here that outlines that credit union deposits are insured, safe, and secure, insured up to $250,000 per individual depositor—the same level as any federally insured financial institution. 

Furthermore, credit union members have never lost a penny of insured savings at an insured credit union. And we urge visitors to learn more about the credit union difference at YourMoneyFurther.com. The page also includes media kits and messaging guidance. 

As an engaged director, encourage your credit union to use these resources. It’s critically important to ensure your credit union continues its messaging around your institution’s safety and soundness. 

In addition, ask good questions. Whether in full board meetings or in committee meetings, be sure that your credit union provides valuable information around general risk trends including reliance on uninsured deposits, access to liquidity, and interactions with members. 

In an uncertain operating environment when confidence matters most, that’s not just what you should do—it’s what you must do.

MIKE SCHENK is deputy chief advocacy officer and chief economist at Credit Union National Association.