The Most Important Credit Union Performance Metric No One Is Tracking
It's time to change the way success is defined in the credit union industry by understanding an institution's true impact on members.
What does it mean to be a successful credit union? Having worked in the industry for close to fifteen years I’ve found that, while individual credit unions may measure and track several key performance indicators, success appears to be generally defined as achieving ten percent asset growth and one percent return on assets, while maintaining a net worth of eight percent.
I am here to tell you those numbers are not a true representation of success.
I have gotten into the habit of explaining this to people with the following exercise: imagine you (the reader) and I (the author of this article) are the only two members of a credit union. At the end of the year the credit union has made $100 in net income, and we are given the option of each receiving a $50 dividend or having the credit union spend the $100 to attract a new member.
If you believe most people are both self-interested and myopic, as I tend to believe, then we would each choose to receive the $50 dividend (I know I would). Put in simpler terms, credit unions often do not focus on growth because they are structured to serve their existing members rather than concentrating on potential members.
Why Credit Unions Should Focus on Growth
So, why should credit unions focus on growth at all? There are many answers. The two I hear the most are survival and economies of scale. While I think these two answers are correct, I also believe there is a more compelling argument—because it is our moral imperative.
Credit unions should focus on growth because doing so literally will make the country wealthier and more equitable. The reason I don’t hear this answer as much is because I don’t think most credit unions truly understand the impact their financial products have on their members’ lives or their communities. That, we need to change.
Credit unions need to start quantifying their impact. By impact, I do not mean charitable giving or activities, but rather the impact of the credit union’s core function—providing financial services to its members.
How many jobs has your credit union created in the communities you serve? How much have you contributed to your local economy? And, most importantly, how much more money do your members have in their pocket thanks to your services and how has that additional money impacted their lives?
I only am aware of a single credit union that has even tried to quantify some of these factors, and it has more than $30B in assets.
A New Approach to Measuring Success
To address this gap, we have developed two specific metrics to track a credit union’s impact. The first is a risk-based member benefit calculation that quantities precisely how much more money each individual member has in their pocket as a result of their relationship with a credit union. The second—which I’m even more excited about—is a ratio we have named “Member Benefit Impact.”
“Risk-based member benefits” measure the economic value provided to credit unions as the result of attractive pricing of loans and deposits. The benefits are calculated using the sum of deposit benefits and risk-based loan benefits.
Deposit benefits are a measure of the degree to which interest rates on deposits at credit unions are higher than at banks. Analysts typically compare the average interest rate that credit unions and banks charge. Then, they multiply the difference by the amount of the deposits each has. Usually, they compare those figures for each type of deposit: checking, savings, money market, etc.
Risk-based loan benefits are a measure of how much lower interest rates on loans are at credit unions compared to banks. In the past, measures of loan benefits did not take into account the extent to which some credit unions have members with incomes or credit histories that differed from the national average.
That means analysts should not compare the interest rate charged by a credit union to a member with weak credit with the national bank average. Nor should they compare interest rates for credit unions that focus on members with weak credit with the national bank average. That, quite simply, is not an apples-to-apples comparison.
Instead, the interest rate charged by a credit union for a loan to a weak member should be compared with the interest rate that person would be charged at a bank.
Member benefit impact measures the impact that member benefits have across income levels.
We compute member benefit impact the following way: Risk-based member benefits divided by member income. This could be calculated for an individual credit union member, or an entire credit union. There are two ways that an entire credit union measurement may be calculated. First, total member benefits could be added up and divided by the sum of income across all members, or average member benefits could be divided by average member income.
This calculation demonstrates that $500 of benefits have a larger impact on the life of a member with an annual income of $30,000 than on a member with an annual income of $300,000. Focusing on member benefit impact allows credit unions to ensure that benefits flow to a large number of members, including those with lower incomes who have small loan and deposit accounts.
True Success Is a Balancing Act
Credit unions must balance the interests of all stakeholders. It’s much easier to calculate bank performance using net income, return on assets (ROA), dividends and stock prices. Banks can focus on maximizing profits and pay attention to a single group: stockholders.
On the other hand, credit unions, as democratic institutions, must balance the potentially conflicting interests of multiple stakeholders: borrowers with incomes high and low, borrowers with credit scores high and low, depositors small and large, financial consumers who mostly use services other than loans and deposits—such as payments—and current vs. potential members. Many credit unions attempt to do this through a scorecard approach in which they simultaneously track multiple measures of performance.
However, too many credit unions using the scorecard approach focus too much on the same metrics used by their for-profit cousins: ROA, capital ratios, and growth. Credit unions must instead focus on maximizing the benefits they provide to their stakeholders over time. Of course, to do so, they must strike a balance between benefits that are as large as possible today and ensuring that the credit union can continue to sustainably serve all its stakeholders in the future.
Again, to assess the benefits they provide, credit unions must consider members’ credit histories and incomes so they do not unduly focus on prime, wealthier members. Credit unions also must balance the interests of current members today and the interests of current and potential members in the future. Considering the interests of potential members requires balancing providing benefits to current members vs. member acquisition efforts; for instance, through investments in new branches, employees, and marketing. Considering the interests of members (current and potential) requires balancing not only benefits and investments, but also capital ratios.
Ultimately, credit unions that provide larger benefits to their members and that invest in member acquisition will grow faster. Providing large and growing benefits to current and potential members should be the key hallmarks of credit union success. Successful credit unions simply balance providing benefits today, investing in the future, and maintaining ROAs that are high enough so that as their assets grow, their capital reserves also grow. Note that ROA is not a goal in itself. ROAs need only be as high as required to maintain sufficient capital ratios in the face of growth.
To recap, credit unions succeed by serving the credit needs of their whole communities through high loans per assets ratios and portfolios that actively include members with weaker credit. Such portfolios yield more interest revenues. In turn, credit unions with larger interest revenues can simultaneously afford larger risk-adjusted benefits for both borrowers and depositors, larger investments in member acquisition, and set aside sufficient capital reserves. Such credit unions attract more members and more of their funds, and can have high enough ROAs that their capital grows in line with their assets.
Balancing benefits, investments in the future, and ROAs ensure credit unions’ long-term financial sustainability. Further, they ensure that credit unions can continue to provide large benefits to future members.
CUCollaborate's AnalyzeCU software already gives credit unions the ability to measure these numbers and soon will allow for benchmarking against peers.
Learn more about these metrics and how they can help quantify your true impact by requesting a demo with our team below.