What I Wish My Board Members Understood About Directing a Credit Union
Introduction:
Many years ago, I was a member of two credit unions. I thought I knew credit unions as well as
(okay better than) most. And I felt I
had enough human capital when it came to credit unions to give back to my
credit unions. I decided I could serve
as a board member. I proceeded to
volunteer – and run for an open seat on the board. I was naïve.
I thought that the best qualified person could – should – and would
win. But like all elections, the winner
is the one who brings the most members to the annual meeting (not the one with
the best résumé).
The credit union I had been a member of the longest had
their annual meeting first. It was a
large credit union (one of the largest ten in the nation). One of the current members of the board was
clearly tasked with discouraging me from serving which was easily done (because
of the way he went about it). I would
have been a good board member – and independent from those then serving (or now
serving for that matter). The board
members didn’t care. They wanted to make
sure they had quality (the median term of service among those then serving was
longer than ten years). But they didn’t
get to know me before discouraging me from service. The way they maintained high quality board
members was by discouraging all (except those hand-picked by current board
members). They told me about the
commitment of weekly meetings at a location 300 miles from my home (which was
higher than the other board members who lived closer). I withdrew my self-nomination.
The other credit union was headquartered much closer to
where I then lived (with their headquarters right in between where I lived, and
where I worked). One of the executive
team was someone I knew personally, and she was encouraged by my
self-nomination – until she found that I had NOT issued a general call to all
friends that I had to get me elected. On
this board, the most popular person won – not the hand-picked. In short – I lost both elections (by a
landslide if truth were told). And
decided that becoming a board member plays much more to the strengths of
extroverts than introverts like me.
I have since become a nationally recognized subject matter
expert on credit unions. I have written
about them, and I have researched them academically. I am not angry about losing. I understand politics, and representative
democracy (and its shortcomings). I have
also understood that many board members do not have the skills to oversee the
credit unions they direct. This last
observation can be borne out by a perusal of any Material Loss Report produced by the Inspector General of the NCUA.
Each of them states as a reason for a credit union failing as “ineffective
board oversight” as a cause for the institution’s failure.
I might add that one of the two credit unions, whose board
of directors I tried (unsuccessfully) to join, failed several years after my
failed election bid. I have often
pondered about my failed attempt, and whether my presence might have been
enough to save that credit union. The
question is of course irrelevant because I won’t ever bring sufficient friends
to win such an election. But since board
members represent me, I would like to use this blog entry to outline the things
I would like any board member to understand if they are to represent my interests
on the board of directors.
Basic Duties of the Board of Directors:
In 1983, Eugene Fama (Nobel Laureate) and Michael Jensen wrote about the separation of roles between management and board members. Their work considered all types of organizations. They saw decision processes as having four steps[1]:
- Initiation of projects, contracts, policies, and procedures.
- Ratification of projects, contracts, policies, and procedures.
- Implementation.
- Monitoring.
If the organization is to be efficient and effective, those
decision steps should be divided between managers and boards of directors. Most organizations give the responsibilities
of initiation and implementation to managers.
The board of directors is charged with ratifying projects, and
monitoring the ongoing implementation of those decisions.
As far as the NCUA is concerned, the board is “responsible
for the general direction and control of a … credit union. The board may
delegate operational functions to management, but not the responsibility for the
credit union’s direction[2].” In an official NCUA letter entitled “Duties
of Federal Credit Union Boards of Directors”, the remainder of the duties all
include monitoring – much of which is connected with financial monitoring
(which makes sense since a credit union is a financial institution).
Therefore, both academic and regulatory sources suggest that
the real work of boards of directors is to give high level direction about the
focus, values, mission, and vision of the institution. The initiation of specific projects can be
left to managers, as long as a mechanism exists for board members to ratify the
decision (especially high-risk decisions) of managers. Then the board’s primary duty is to
effectively monitor the execution of the implementation of the plans, projects,
contracts, policies, and procedures.
What All Board Members Should Know
I have spent decades researching credit unions. The past decade, I have spent creating, monitoring, and supervising curriculum leading to degrees in a College of Business. During that time, I came to appreciate the way curriculum is structured, and why we teach what we do (and in what order we cover it). For a board member to have the basic toolbox of knowledge to effectively meet the requirements of both academicians and regulators, I would recommend focusing attention of board members on the following areas:
- The Basics of Credit Union History.
- The Basic Components of a Viable Credit Union “Business Model”.
- The Fundamentals of Financial Statements (as a Basis for Monitoring a Credit Union).
- Application of Financial Ratios to Monitor OUR Credit Union’s “Business Model”.
- Application of Financial Ratios to Monitor our Primary Regulator’s Interests in the Credit Union.
The Basics of Credit Union History
This topic may seem purely academic, but it isn’t. There are several very good reasons to
discuss the historical background of cooperative lending. First, most people think binarily – true/false,
black/white, right/wrong, capitalist/socialist.
The real world is far more complex.
Cooperative lending began at an economic inflection point. Much of the world was shifting from a
monarchial political/economic model to a democratic/free-enterprise model. We tend to believe that the only viable
economic model in a democratic society is a capitalistic model (where everyone
is looking out for their own self-interest). But that is NOT the only model
that works (or ever has worked) in a democracy.
A history of cooperative lending is meant to broaden the mind of board
members to see other economic and governance models.
The second reason to review the history of credit unions is
to consider the scope of what cooperative lending institutions do. The first cooperative lenders were
established to provide funding for small businesses with limited access to
financial markets. That is not how
credit unions are seen today. Even in
the 1920s, credit unions in the US held far more real estate loans than they do
today. Throughout their history,
cooperative lenders have used the needs of their members – not the exigencies
of politics – to determine their loan portfolios.
The history of credit unions is filled with heroic
people who dedicated time, reputation, and personal wealth to a cause they
truly believed in. If people want to serve
on a board of directors, they need to know that they must stand (and work) on
the shoulders of giants. This is not
just a résumé stuffer.
And credit unions are not an “industry” they are a “movement”.
The Basic Components of a Viable Credit Union
“Business Model”
All organizations have what I would call a “business
model”. It is the operational model that
explains how they continue to operate.
It explains who demands their goods/services, and how those good/service
are funded. It also explains how the
organization is perpetuated. Even if an
organization is not a business, it therefore has what I would call a “business
model”. If it doesn’t, it is not a
permanent organization – it is a project, or perhaps a meeting.
US credit unions have legal and economic pressures
which force them to act in certain ways, and have caused them to follow certain
trends. For instance, US credit unions
(contrary to cooperative lending institutions in many other countries) are
exempt from income taxes. Commercial
bankers see this fact as a competitive advantage, but it comes with its own set
of restrictions and costs. Credit union
board members need to understand both the plusses, the minuses, and which set
of tax-exempt rules their institution needs to adhere to.
Economically, credit unions many credit unions have
been consolidating to take advantage of economies of scale. At the same time, other credit unions have
not been growing or seeking any economies of scale (due in large part to their
common bond, or agreements with a sponsoring entity). But those who have been growing have
experienced drastic changes to internal culture, as the number of professional
employees has swelled, and the sophistication of administration has
increased.
Board members need to be aware of trends and economic
changes, to maintain a viable “business model” that achieves the objectives of
their owners/members. And unlike a
commercial bank, whose objective is assumed to be the maximization of its
shareholders’ wealth, credit unions do not all have the same ultimate
objective. Their “business models”
therefore may differ from one institution to the next. This topic should challenge individual credit
unions to articulate their objectives, and to describe the model of how the
institution sets out to achieve those objectives.
Understanding Credit Union Financial Statements
In a 2011 letter to federal credit union boards ofdirectors, NCUA Chairperson Debbie Matz required all federally chartered credit
union board members to receive training to be able to read financial
statements. The reason she gave was so
that the board could give proper oversight to managers. The NCUA holds board members accountable for
the actions of the managers who ultimately report to them. As a credit union member, I want my board
member to keep the institution from having problems with its regulator (because
an angry regulator will complicate my life too).
However, the biggest reason I want each member of the
board to be able to read a financial statement is so they can tell how well the
institution is 1) following the model they have set up (as described in the
last section), and 2) meeting my objectives for the institution (as described
in the last section).
Financial statements are numerical representations of
a business model. As such, they can be
used (if properly understood) to verify that the organization is on the course
plotted by management and the board of directors. It is far easier to see how well the
institution is doing if movement wide norms are used to gauge the progress of
the institution (as long as the board also takes into consideration that not
all credit unions have the same objectives).
How to Use Financial Ratios to Monitor our Credit
Union’s Business Model
Only after a board of directors has clearly
articulated their business objectives and the business model they are using to
obtain those objectives – and only after they can use financial statements to see
an overall numerical model that represents their business model – only then,
can we begin to discuss financial ratios which taken together show how all objectives
need to mathematically fit into an overall model of the credit union. In
an earlier blog post, I suggested using a DuPont type of analysis to help
board members assess how well the institution is doing in obtaining its
objectives.
In order to fully assess how well the credit union is
doing in achieving its objectives, most of these ratios should be assessed against
other credit unions of the same size.
Ideally, we would like to compare other credit unions with similar “business
models” and similar cost structures, but we can’t get everything we want. Using what I call a Bauer analysis, we can
assess what the credit union would need to do in order for it to better achieve
its objectives (as long as we have clearly described what those are).
How to Use Financial Ratios to Monitor our Credit
Union’s Relationship with its Regulators
Although the primary consideration of all board members should be
their members, it is also in the board’s (and members’) best interest to stay off
their regulator’s “naughty list”. At the
least, all board members should understand the required capital ratios required
by their regulators. But beyond that,
they should gain a deeper understanding of the CAMELS system applied by their
regulators to their credit union.
Many of the analytical areas specified by the CAMELS system have corresponding financial ratios that the regulators use to assess part of those components. If the board member understands the overall CAMELS system, and how financial ratios inform the regulators rating system (along with the softer analysis that yields the rating) they can more fully understand how to use the other analyses mentioned above to better monitor the credit union, and the work of the executive team they have hired and oversee.
Summary
I have been a fan of cooperative lending most of my life. I understand it well. But I'm not likely able to win an election to the board of my local credit union. I would like the members of the board of my credit union to understand their role in managing the credit union, and I would also like them to possess certain strategic and financial analysis skills to better align the actions of the credit union to its ultimate objectives.
[1]
Fama, Eugene and Jensen, Michael C. Separation of Ownership and Control. Journal of Law & Economics, 26, 1983, pp.
301-325.
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