What Are Credit Unions, How Do They Work, And Why They Matter?

13 min read
It is best to plant the seeds of change early. Financial management is essential to democratic empowerment.

As we consider the role of democracy in our daily lives, we must look at how our money is managed and whom our financial institutions seek to benefit.

Quick Summary

  • Traditional banks are for-profit entities focused on profitability and return of value to shareholders.
  • Credit unions are member-owned “non-profit” (civil society organizations) that seek to satisfy the needs of their members.
  • Credit unions have proven time and again that they can sustainable serve communities that are abandoned by traditional banks.
  • Credit unions are under-represented, but resilient even in times of crisis.
  • Credit unions pave the way towards democratizing the financial sector and we should learn more about them.

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Traditional banks concentrate power and benefits with corporate shareholders

Most of the world’s finances are concentrated within the traditional banking system. This system is dominated by big banks such as Goldman Sachs, Wells Fargo, and JPMorgan Chase & Co. These banks are for-profit businesses, meaning that the many services they offer to their customers ultimately benefit corporate shareholders who take all major decisions.

In these major corporations, the shareholders form the minority of the population. Traditional corporations practice “shareholder democracy”: one share, one vote. Sometimes, “shareholder democracy” results in oligarchies or plutocratic oligarchies (for more on this topic, see this article).

Given the incentives structure, one of the key goals of traditional banks is to ensure the enterprise’s profitability and return on investments for their shareholders. 

Credit unions are democratic financial institutions

Fortunately, there are promising alternatives to the traditional banking system. Credit unions are a form of democratic financial institutions which have different ideals, interests, and structure compared to conventional banks.

These institutions are unique in their philosophy: credit unions do not have customers, they have members. Each member is part-owner of the organization. A policy of equality underpins their operation. Each member has one vote in all major decisions. This one member, one vote policy, ensures that every member is an equal part owner to every other member, regardless of the size of their assets.

This is in contrast to the “shareholder democracy” model, one-share, one vote. 

Credit unions are designed to serve local and sometimes specific communities, so their membership is not open to everyone. Each credit union has distinct membership requirements: some are based on geographic location, such as the Philadelphia Federal Credit Union which serves people in the greater-Philadelphia area, and some are based on career fields and associations, such as the Navy Federal Credit Union which serves people with ties to the United States Armed Forces. These membership qualifications ensure that all the members have a common bond, which is intended to create a community and trust among members.

The idea of this common bond extends back to the earliest credit unions, which evolved from cooperative financial projects in mid-19th century Europe. One of the earliest true credit unions was organized among farmers in Germany in 1864. This so-called credit society was built around the ideals of cooperation, community, and representation in management which continue to guide credit unions today.1“International Credit Union Day.” World Council of Credit Unions, www.woccu.org/education_and_networking/icuday/icuday_history

In 1908, the first credit union in America was started in New Hampshire. It was called “La Caisse Populaire, Ste-Marie” (The People’s Bank) and it still operates today under the name St. Mary’s Bank. The original members were predominantly Franco-American mill workers looking for a way to save and borrow money.2“Our Story.” St. Mary’s Bank, www.stmarysbank.com/nav/about-us/history/our-story.

In the century since credit unions came to the United States, thousands have serviced people with the same philosophy of financial cooperation and member-ownership. 

The primary goal of credit unions is to serve their members

Credit unions operate similar to banks. They are financial institutions that earn their revenues through lending to borrowers. In this case, the borrowers are members of the credit union.

Credit unions also offer checking and savings accounts, like regular banks. Members and earn interest on their deposits.

To become a member, typically there is a membership fee that credit unions charge. This is usually a onetime fee. Credit unions are different from conventional banks as they are non-profit organizations, which means they exist to serve their members, not to make a profit.

While civil society organizations (also referred to as non-profits – a term we try to avoid as it defines something by negating it) do make money off of their business activity, those profits (surpluses) are used first to pay the salaries of their employees and the remaining revenue is put back into the business.

Banks on the other hand, are for-profit organizations, which means their primary goal is to maximize profits and return on investments for their shareholders. Rather than investing profit back into the operations of the organization, most big banks give that money to shareholders through dividends.3Heaslip, Emily. “Nonprofit, Not-for Profit & For-Profit Organizations Explained.” CO, U.S. Chamber of Commerce, 30 Mar. 2020, www.uschamber.com/co/start/strategy/nonprofit-vs-not-for-profit-vs-for-profit#:~:text=There%20are%20three%20key%20differences,have%20a%20separate%20legal%20entity.

This distinction between civil society (“not-for-profit”) organizations and for-profit organizations is key to understanding the different services and benefits provided by credit unions and banks. Since surpluses made by credit unions are reinvested into their organization, they can generally impose fewer fees on their members while maintaining higher savings rates on deposits and lower interest rates for borrowers than banks. 

Credit unions offer opportunities for community development

Given the reinvestment of capital into the organization, credit unions can provide members with unique financial benefits, especially in low-income communities.

Some credit unions are specifically designed to service members of a lower-income level; these organizations are called community development credit unions (CDCU). Just as the name implies, CDCUs are uniquely focused on ensuring that their services improve the communities where they reside.

Credit unions can serve low-income communities more effectively than traditional banks in-part because of the profits reinvested from their status as civil society organizations (non-profits). In traditional banks, profits would have been distributed among its shareholders, who may not have any connection to the community. On the contrary, community members retain control of the credit union and in turn support the local economy. 

This kind of community support and development is exemplified by the Lower East Side People’s Federal Credit Union, which was started by residents of New York City’s Lower East Side in 1986 after the last bank branch in the neighborhood closed its doors, leaving a financial services void. As a CDCU, the credit union serves a largely immigrant community, and in its first 5 years, they loaned more than $1.8 million to low-income borrowers, most of who are Black or Hispanic.4Mayo, Ed, et al. “Life Saving.” New Economics Foundation, 5 July 2003, neweconomics.org/2003/07/life-saving. The credit union has lent more than $100 million to date and has provided financial services to a community that was abandoned by a traditional bank.

Credit unions demonstrate they can thrive in areas that traditional banks leave.

Former CEO of the Lower East Side People’s Federal Credit Union, Linda Levy, who has been involved with the organization since its inception, said that when assessing loan applications, they consider the potential community impact, not just profitability. This consideration has become especially important in recent years, as the area has been affected by gentrification due to an influx of wealthier businesses and residents.

Their loans are able to help long-term, lower-income residents earn “a foothold in a transforming economy.”5Savitch-Lew, Abigail. “NYC’s Credit Unions Give Mom-and-Pop Stores a Chance, Despite Gentrification.” Yes! Magazine, 2 Oct. 2015, www.yesmagazine.org/economy/2015/10/02/new-york-city-credit-unions-mom-and-pop-stores-gentrification/. The credit union still operates today and has served over 30,000 people over the years.

Credit unions offer banking to the unbanked

For many struggling communities, credit unions offer the only real opportunity for widespread potential economic development. Low-income communities, such as those on the Lower East Side, are often not adequately serviced by traditional financial institutions. When the Lower East Side People’s Federal Credit Union opened, it was the only bank in a 100-square block area.6Savitch-Lew, Abigail. “NYC’s Credit Unions Give Mom-and-Pop Stores a Chance, Despite Gentrification.” Yes! Magazine, 2 Oct. 2015, www.yesmagazine.org/economy/2015/10/02/new-york-city-credit-unions-mom-and-pop-stores-gentrification/.

According to the Federal Reserve, over 24% of adult Americans were either unbanked, meaning they were not served by a bank, or underbanked, meaning they may not have sufficient access to traditional financial services and often rely on alternative financial services such as money orders or payday loans.

People who are unbanked and underbanked are more likely to have low income: while only 2% of those with an income between $40,000 and $100,000 are considered unbanked, 14% of those with an income less than $40,000 are considered unbanked.7Board of Governors of the Federal Reserve, 2019, Report on the Economic Well-Being of U.S. Households in 2018-May 2019, www.federalreserve.gov/publications/2019-economic-well-being-of-us-households-in-2018-banking-and-credit.htm.

Conventional banks focus on profitability and avoid extending services to those they consider higher risk. Often people with low incomes do not fit the “cookie cutter” in terms of their credit history, home ownership, financial literacy, or collateral.8Tansey, Charles D. “Community Development Credit Unions: An Emerging Player In Low Income Communities.” Brookings, 10 May 2017, www.brookings.edu/articles/community-development-credit-unions-an-emerging-player-in-low-income-communities/. This aversion to riskier low-income customers leaves many communities devoid of access to financial institutions and stunts their potential for economic development. 

Credit unions’ community-based mission makes them more willing to extend loans to individuals otherwise excluded from financial markets. The focus is on meeting the needs of their members and not the maximization of profits.

Credit unions value their members as owners and partners, not as customers who contribute to their bottom line. 

Rossy Caba, a Dominican immigrant and resident of Lower East Side in New York City, experienced the helping hand of credit unions. When she sought to open her dream bakery on the Lower East Side she was given financial support from the Lower East Side People’s Federal Credit Union.

They offered her several loans when her applications at traditional banks were rejected and they even helped her negotiate her rent with her landlord.9Savitch-Lew, Abigail. “NYC’s Credit Unions Give Mom-and-Pop Stores a Chance, Despite Gentrification.” Yes! Magazine, 2 Oct. 2015, www.yesmagazine.org/economy/2015/10/02/new-york-city-credit-unions-mom-and-pop-stores-gentrification/. Credit unions offer smaller loans than traditional banks just to meet the needs of their members.

Credit unions’ unique philosophy empowers individuals and cultivates relationships between the organization and its members. The credit union is designed to support its members in achieving their goals and serving their needs.

Beyond their philosophical motivation to extend loans to low-income people, credit unions also support affordable housing. Many of the loans offered by the Lower East Side People’s Credit Union, for example, go towards low-income housing; they are involved in an affordable housing program run by the City of New York called HDFC which creates relatively price-controlled housing cooperatives to offer members a chance to build equity and wealth.10Strozniak, Peter. “CEO Profile: A Small CU Survivor, Maureen Genna.” Credit Union Times, ALM Media Properties, 26 Apr. 2019, www.cutimes.com/2019/04/26/ceo-profile-a-small-cu-survivor-maureen-genna/.

Credit unions are involved in solving key issues that community members face: housing and livelihood.

The transformative benefits of credit unions are globally evident

The benefits of credit unions are not just unique to the United States. There are similar examples from across the world. A 2009 report by the World Council of Credit Unions (WOCCU) stated that credit unions can expand access to financial services and combat “financial market imperfections that perpetuate poverty.”11Crear, Peter. World Council of Credit Unions, 2009, Cooperative Banks, Credit Unions and the Financial Crisis, www.un.org/esa/socdev/egms/docs/2009/cooperatives/Crear.pdf.

According to that WOCCU study, which surveyed thousands of credit union members in Colombia, Kenya, and Rwanda, nearly half of those surveyed were first-time users of formal financial services. Unsurprisingly, the low-income communities that are largely excluded from traditional financial institutions and have the most to gain from CDCUs are vulnerable groups in society such as women, minorities, and people living below the national poverty line.

The data collected by the WOCCU about the demographics of credit union members shows this:

  • one-third of credit union members live in rural areas;
  • half live below the national poverty lines in their respective countries;
  • 24% of respondents live on less than $2 a day;
  • one in four have a primary school education or less12Crear, Peter. World Council of Credit Unions, 2009, Cooperative Banks, Credit Unions and the Financial Crisis, www.un.org/esa/socdev/egms/docs/2009/cooperatives/Crear.pdf.

The United Nations recognized the unique capacity of cooperatives, including economic cooperatives, to “promote the fullest participation in the economic and social development of all people, including women, youth, older persons, persons with disabilities and indigenous peoples” and how they are contributing to the “eradication of poverty.”13General Assembly Resolution 64/136, Cooperatives in social development, A/RES/64/136 (11 February 2010), available from http://undocs.org/A/RES/64/136. In these regions, credit unions extended the benefits of economic democracy to people otherwise disempowered by the holes in the traditional financial system.

Credit unions are resilient in times of crisis

Credit unions, like many other forms of cooperatives, have a long history of thriving in times of crisis or economic turmoil because of their unique, underlying values.14Brookings, 10 May 2017, www.brookings.edu/articles/community-development-credit-unions-an-emerging-player-in-low-income-communities/.

Their relative success and stability compared to banks was evident in the global financial crisis of 2007 and 2008. As most commercial banks in America cut back lending during this period, American credit unions increased their loans, particularly to small businesses: credit unions increased their small business lending by 10% in 2009, as big banks shrank their overall business lending by 22%. Additionally, from the start of 2009 to mid-2010, American credit unions added 1.5 million new members and increased their deposits by 10%.15Mitchell, Stacy. “Credit Unions Hang Tough, See Surge in Deposits.” HuffPost, 25 May 2011, www.huffpost.com/entry/credit-unions-hang-tough_b_621081.

The successful performance model of credit unions is reflected in larger credit unions, such as the Navy Federal Credit Union, and smaller organizations, such as the Student Federal Credit Union (SFCU) which was founded by students at the University of Pennsylvania in 1987 and is entirely student-run to this day. Based on the credit union model, the SFCU has offered rates that are 25% lower than their leading competitors, while also providing their community consistent personalized services.16“About the SFCU.” University of Pennsylvania Students Federal Credit Union, www.upennsfcu.org/about/about.html. These two examples show that credit unions can operate at a large scale, such as the Navy Federal Credit Union, the largest credit union in the world with over 9 million members, and also by young students as with the SFCU.

The potential of credit unions has not yet been fully realized

If credit unions are so good, why are more people not members? Why have they not taken over the role of traditional banks?

Partly, the answer resides in the nature of the credit unions. Credit unions are typically community-oriented banks that serve their members needs and interests. The size of the community will impact the size, which in turn will impact the amount it can invest in deploying the latest digital technologies to better serve its members.

Despite the democratic empowerment offered by membership in a credit union, the industry remains relatively small. When combined, American credit unions hold roughly $1.5 trillion of assets, while traditional banks have around $20 trillion in assets.17“Banks & Credit Unions Industry Profile.” First Research, 7 Dec. 2020, www.firstresearch.com/Industry-Research/Banks-and-Credit-Unions.html#:~:text=The%20US%20banking%20industry%20includes,and%20credit%20unions%20%241.75%20trillion.

We look at credit unions as a form of democratic financial institution not just because of their performance in the industry, but also because of the potential they represent as viable alternatives to democratize the financial industry.

Credit unions offer a formidable challenge to the traditional banking industry and signal a shift in values of their customer base. A Guardian article following the 2008 financial crisis hailed credit unions as beneficial to all members of society as they show to big banks what the public expects: “a more egalitarian financial system that benefits the majority of people rather than generating profit for those at the very top.”18O’Hagan, Ellie Mae. “How the Banking Crash Sparked a Credit Union Boom.” The Guardian, Guardian News and Media, 8 Oct. 2012, www.theguardian.com/commentisfree/2012/oct/08/banking-crash-credit-union-boom.

Speaking of alternatives to the financial industry, the rise of blockchain technology, cryptocurrency and the latest fin tech (financial technology) trends can help democratize access to banking and finances for the underserved. However, these endeavors will be the same question: who will own these new technologies and whose interests they will serve?

In the case of traditional banks, the philosophy has not changed. Between early-2016 to mid-2018, the biggest banks in America gave $224 billion to its shareholders.19Bove, Richard X. “Big Banks Should Quit Giving so Much Money to Shareholders and Try Making More Loans Instead.” CNBC, 9 July 2018, www.cnbc.com/2018/07/09/big-banks-should-quit-giving-so-much-money-to-shareholders.html. Participation in traditional financial institutions continues to benefit large shareholders, as individual customers lose any opportunity for representation or empowerment. This is an example where “shareholder democracy” seeks to further oligarchic and plutocratic trends.

On the contrary, it is through credit unions that financial power is shifted back to members. The impact of becoming financially literate, having a voice in the management of our money and our communities, and receiving financial services in an egalitarian way cannot be understated. Credit unions infuse democratic principles into the financial sector, and we can see the measurable positive effects it has on individuals and communities. 

Action Steps I Can Take

Theory without practice is meaningless. Here are some next immediate and long-term steps to take to further the democratization of the financial sector:

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