Credit Unions: Eliminate Intermediary Friction Between Members and Markets

Credit unions are the financial intermediaries between their members and the financial markets.

We take in deposits and pay for the use of the money. We use that money to make loans to our members and invest the excess in investments. As intermediaries there is a certain amount that we take from our members to run our businesses, operating expenses. Those operating expenses are the friction that we as intermediaries cause between our members and the financial markets. How can we measure this friction? One of my favorite measures is the efficiency ratio. Using three ratios from the Ratio Analysis page on the NCUA’s website you can do a quick calculation of your efficiency ratio. The three ratios are Operating Expenses/Avg. Assets (OE); Net Interest Margin/Avg. Assets (NIM); and Fee & Other Op. Income/Avg. Assets (FEE).

The calculation is OE/(NIM + FEE). Using the December, 2009 numbers for the peer group for my credit union the calculation is 4.17/(3.40+1.50)=85.10%. What does that mean? It means that for every dollar of net revenue the average credit union is producing they are spending 85 cents. Part of that is probably due to the NCUA corporate assessment. But look back to 2007. What is the efficiency ratio? 80%. How about 2004? Try 75% on for size. Granted, net interest margins have been squeezed. In 2004 NIM was 3.56% vs. 3.40% in 2009. But what astounds me is that operating expenses were 3.63% in 2004, jumped to 3.97% by 2007 and were 4.17% by 2009. Let me give you a clue, the efficiency ratio in the average community bank is closer to 50% and it’s falling not rising. Yes, banks do typically charge higher fees but they are also extremely cost conscious. Fortunately for the credit union movement we have two big advantages. First, our members really like us because we provide outstanding customer service. And secondly, we have that tax exemption thing.