Economies of diversification in the US credit union sector

Abstract

Summary Significant scale economies have been recently cited to rationalize a dramatic growth in the US retail credit union sector over the past few decades. In this paper, we explore another plausible supply‐side explanation for the growth of the industry, namely economies of diversification. We focus on the fact that credit unions differ among themselves in the range of financial services they offer to their members. Since larger credit unions tend to offer a more diversified financial service menu than credit unions of a smaller size, the incentive to grow in size may be fueled not only by present scale economies but also by economies of diversification. This paper provides the first robust estimates of such economies of diversification for the credit union sector. We estimate a flexible semiparametric smooth coefficient quantile panel data model with correlated effects that is capable of accommodating a four‐way heterogeneity among credit unions. Our results indicate the presence of non‐negligible economies of diversification in the industry. We find that as many as 27–91% (depending on the type and the cost quantile) of diversified credit unions enjoy substantial economies of diversification; the cost of most remaining credit unions is invariant to the scope of services. We also find overwhelming evidence of increasing returns to scale in the industry.

Income structure, diversification strategy and owners’ benefit in cooperative financial institutions

“…McKee and Kagan (2016) also find that small credit unions are unable to diversify away their core business because they experience significant resource constraints and a low capacity to effectively adopt new technologies, process new loan applications and distribute the fixed costs of regulatory compliance. Malikov et al (2017) further find that larger credit unions tend to provide more diversified financial services and the average costs that credit unions incur decline as their scope of services increases.…”

Cooperative banks and local economic growth

“…Consequently, they maintain that competitive pressures among credit unions and from other types of depository institutions are likely to encourage further growth in the average size of this group of banks. Malikov et al (2017) provide evidence in favor of economically and statistically significant economies of diversification among US retail credit unions between 2001 and 2006, so that the integration of business could notably reduce credit union costs. Besides, their analysis confirms the presence of increasing returns to scale in the industry.…”

Determinants of Credit Union Benefits to Members

“…Looking at risk-adjust and non-risk adjusted ROA and ROE as performance measures, they found that small CUs did not benefit from increased non-interest income activities while there is some benefit to larger CUs. On the other hand, Malikov, Zhao, and Kumbhakar (2017) find that diversified credit unions enjoy significant economies of diversification. Goddard, McKillop, and Wilson (2008b) find that charter types and other competitive repositioning of CUs are not beneficial and that other factors such as management and asset portfolios likely have more to do with CU performance.…”