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Credit Union Governance -
Unique Challenges
Brian Branch and Christopher Baker, Summer 1998
Nexus, Number 41
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Member ownership and control is a hallmark of credit unions. Operating on
the basis of one-member, one-vote, credit unions have always been
socially-minded and democratic financial institutions. They are also
traditionally savings-led. Yet these very strengths can easily be
impediments to the effective governance that credit unions require to expand
and compete in the financial market place. Brian Branch and Christopher
Baker of the World Council of Credit Unions offer the following insights to
the unique challenges that credit unions face in balancing the potentially
competing aims of owner participation in decision-making and professional
management.
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In commercial institutions potential conflicts of interest between managers
responsible for making decisions and owners who bear the consequences of
these decisions are mitigated by Boards of Directors. Elected by the owners,
Directors of the Board retain ultimate supervisory control over the
management; to carry out this responsibility effectively, they should be
qualified individuals skilled in various areas of decision-making and policy
that they oversee. Credit unions are no different; their structure - the
Annual Meeting, Board of Directors and Manager - have the same mechanisms
for separating decision-making and decision-monitoring and ensuring member
control.
But credit unions are different on two fronts:
(a) the Directors are elected by democratic vote; and
(b) the owners are also the clients.
Each of these distinguishing features of credit unions pose its own
challenges.
The democratic election of the Board of Directors creates problems in credit
unions due to
(a) inaccurate representation of owners;
(b) unqualified
personnel in decision control; and
(c) confusion of decision making versus
decision-monitoring roles.
Because credit union directors are elected from the general membership on a
one-person, one-vote basis, those elected do not necessarily own a major
proportion of the invested savings or shares in the credit union. Theirs may
be a small percentage of the wealth of the entire member pool. If this is
the case, they do not fully represent the owners as their decisions may
affect them significantly less than the majority of credit union members. In
the event of crisis or poor decisions, a credit union board member can have
less at stake than a comparable bank or stock company director.
The democratic one-person, one-vote governance process has been maintained
over the years to make credit unions responsive to their owners. Yet, this
rule of governance is a problem when the individuals elected do not have the
expertise to make sound judgements. The ability of directors to fulfil their
role as a monitor or control depends upon their business acumen or
management skills. Often this problem only emerges with the evolution and
maturation of the credit union.
Often formed by local community leaders who are generally better educated
than the rest of the citizens, credit unions begin among a small, sometimes
closed group, and depend upon volunteers for operations, governance and
member representation. The involvement of volunteers maintains low operating
costs when the business volume is not large enough to afford professional
staff. Where boards are dominated by non-professionals, directors can be
very responsive to local social issues but fail to manage the financial
business aspects that become increasingly complex as the institution grows.
With growth, credit unions generate sufficient income to hire specialised,
professional staff to manage more sophisticated operations. Volunteer
owner/representatives are less involved in operational matters and shift to
decision-monitoring roles. As credit unions move to this level of
professional operation, problems occur if volunteer board members engage in
decision-making such as determining expenditures, directing department heads
or making loan approval decisions rather than limit themselves to decision
monitoring.
The second feature distinguishing credit unions from other financial
institutions and creating a unique governance challenge is that the owners
are the customers. That the owners can be savers and or borrowers poses a
unique challenge for management. The institutional governance system must
respond to two sets of owners/clients who have different and somewhat
conflicting interests. For most financial institutions the owners, or
principals, represented at the Board of Directors are primarily interested
in the profitability of the institution. In credit unions, however,
profitability is not the primary concern of all the owners.
It is the simultaneous presence of savers, who provide the funds, and the
borrowers, who borrow the funds, which forms the basis for a self-sufficient
or balanced financial intermediary. However, conflicts of interest are
inherent in this balance. Borrowers want low loan rates, low transaction
costs and lax discipline while savers demand high deposit rates and strong
prudential disciplines. The savers have strong incentives to see the
institutional viability strengthened by profitability and protected by
financial discipline. Yet, the borrowers' short-term incentives favour
conditions - lax discipline, low loan rates, easy access to loans - which
adversely affect the financial stability of the credit union.
Management decisions may favour one group or the other, depending on the
credit union's business/social mission, the nature of the membership, and
the balance of borrowers and savers serving on the Boar of Directors.
What are the possible responses to these unique challenges?
First, the clear specification of institutional rules, which define
the roles and responsibilities of the actors involved in the governance of
the credit union can address the conflicts of interest between contacted
management, elected directors and members.
Second, credit unions need to counter the tendency of borrowers to dominate
their governing Boards. Regular and updated services must attract more
savers to join credit unions while incentives are needed to attract savers
to serve on Boards. The presence of net savers on Boards will lead to more
effective pressure upon the management and for prudent governance that will
protect the interests of savers and help ensure the long-term sustainability
of the credit union.
Finally, external supervision must serve as the ultimate check. Governance
problems can still occur where structural rules are clearly specified and
services are updated. Supervision not only establishes the rules for
behaviour and responsibilities of actors but also monitors performance and
enforces a prudent financial management framework, which protects the
members and their savings.
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Source
This article is an excerpt from a longer paper by the authors entitled:
Overcoming Governance Problems - What does it take? To obtain a copy of the
full paper, contact:
Information Services Manager, World Council of Credit Unions (WOCCU), PO Box
2982, 5710 Mineral Point Road, Madison, WI 53705, USA or visit:
www.woccu.org
Nexus is the quarterly magazine of Small Enterprise Education and Promotion
Network (SEEP). They can be contacted C/o Pact, 777 United Nations Plaza,
New York, NY10017, USA or e-mail: seepny@undp.org
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