Banks' gripes with big credit unions are gaining momentum

Bloomberg News

NEW YORK — Consumer advocates and banks often disagree on financial regulation, but both groups and their allies in recent months have renewed calls for federal policymakers to apply greater scrutiny towards credit unions, especially as the tax-exempt firms continue to buy banks.

"Credit union acquisitions of community banks diminish tax revenues, consolidate the industry though tax subsidies, grow the publicly subsidized sector of the financial services industry, and increase the portion of the industry exempt from Community Reinvestment Act oversight," said Michael Emancipator, senior vice president and senior regulatory counsel at the Independent Community Bankers of America. "A Congressional hearing is necessary to ensure that the tax exemption is still being used as intended."

The sector enjoys exemption from key financial regulations applied to banks — as well as tax-free status — premised on the unique nature of credit unions. 

However, over the last decade credit unions have grown larger and more concentrated, have loosened restrictions on membership and acquired dozens of tax-liable institutions. Banks and their allies — including at least one member of Congress — have since called for Congress to review credit union regulation and taxation.

Speaking to a crowd at the American Bankers Association annual convention in late October, New York Congresswoman Claudia Tenney expressed support for Congress holding a hearing on the disparate regulation and tax burdens between banks and credit unions. 

In response, credit u nion industry leaders including the New York Credit Union Association President William Mellin and America's Credit Unions President Jim Nussle sent a joint letter to Rep. Tenney pushing back on the member's stance.

"We strongly disagree with the notion that credit unions are somehow less regulated than banks. Similar to its counterparts in the banking sector, the National Credit Union Administration (NCUA) oversees federal credit unions and ensures they adhere to a comprehensive set of rules and regulations designed to maintain the safety and soundness of the credit union system," they wrote. "Your statement highlights the importance of ensuring members of Congress are sufficiently informed on the subjects for which they are legislating."

Modern credit unions came to fruition after the Great Depression with the passage of the Federal Credit Union Act of 1934. The law established a special category of federally chartered financial cooperatives to take member deposits — known as "shares" — and, among other things, provide low-cost loans to members.

As nonprofit institutions, credit unions are exempt from paying federal income taxes at the corporate level, though they are still subject to paying some taxes like local property taxes and payroll taxes.

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Jesse Van Tol, President and CEO of the National Community Reinvestment Coalition, said that the rationale for such special privileges was predicated on credit unions being unique, community-centric institutions, and many modern credit unions don't meet that standard. 

"Credit unions started out as a movement — sort of written into the mission — intended to serve people with modest means," he said. "I think there are great credit unions out there, particularly sort of low-income community development credit unions that have stayed true to their roots … but there are also now a great number of credit unions that are virtually indistinguishable from banks."

While credit unions also face certain special obligations — for example, they are subject to limits on the interest rates they can charge on credit they extend to borrowers —- some credit unions have grown and eroded those community-based lending norms while continuing to enjoy certain exemptions from regulatory requirements banks face.

The amount of assets at credit unions has more than doubled — from $1.02 Trillion to $2.17 trillion — in the last decade, even as the total number of credit unions has declined by 30% over the same period. Additionally, in many cases, credit union membership is no longer limited to small and local customer bases. 

While most credit unions offer services to a specific field of membership, sometimes the field is exceedingly broad. The nation's third-largest credit union — Pentagon Federal Credit Union or PenFed — even has a rare "open charter," which means there are no restrictions on its membership, allowing anyone nationwide to join.

Van Tol notes that while the sector is not a monolith, a significant group of such not-for-profit institutions have begun to appear more and more like profit-driven financial institutions.

"You have the CEO of PenFed buying himself a corporate jet to fly around and CEO pay … seems to now be inching closer to being in line with the banking industry," said Van Tol. "We now have a credit union's name on the Washington [Commanders] football stadium. These things all make them look much more like banks than mission-driven lenders serving the membership."

The banking industry has long expressed concern with the credit union industry's tax exempt status, as all but the smallest banks are considered for-profit institutions and pay corporate taxes. However, despite the bank industry's ongoing pleas that Congress revise credit unions' tax-free status, bank policy analyst Isaac Boltansky of BTIG says it is highly unlikely that legislation altering that status gains traction anytime soon. 

"This is a holy war that has been fought for a long time now, and will be fought for a long time into the future, but it is exceedingly difficult to envision any scenario where the tax treatment of credit unions is altered," he noted. "For every lawmaker that the banks will highlight as being willing to change the tax treatment there is, there is a credit union-favored lawmaker to oppose them, and so the battle will wage on."

Size and membership aren't the only ways in which credit unions have shaken their original founding spirit. Consumer groups and banks alike have also raised concerns about credit unions' violations of consumer protection standards. 

In October, the Department of Justice secured a $6.5 million settlement from Citadel Federal Credit Union over allegations it denied credit services to Black and Hispanic individuals on the basis of race. While the settlement technically did not require the credit union to admit culpability, the settlement is the first of its kind against a credit union. In 2023, Navy Federal Credit Union, the nation's largest credit union, was reported to have rejected more than half its Black conventional mortgage applicants and another credit union, VyStar Credit Union, just last week settled allegations from the Consumer Financial Protection Bureau for $1.5 million over the "botched" rollout of its digital banking platform.

"[Such penalties] demonstrate the consumer risks posed by credit union regulatory exemptions," said Emancipator. "[The National Credit Union Administration] Chairman Todd Harper has noted that approximately 90% of the tax-exempt credit union industry's assets are managed by third-party service providers with no NCUA oversight—further illustrating the risks these regulatory exemptions pose to consumers."

Redlining activities, such as those the DOJ alleged at Citadel, violate the Equal Credit Opportunity Act because they are explicitly race-based discrimination. However, consumer advocates like Van Tol notes that credit unions are fully exempt from another consumer protection law meant to protect marginalized communities — using income, rather than race as a proxy — known as the Community Reinvestment Act.

Van Tol argues the two consumer financial anti-discrimination laws compliment each other and that extending CRA to cover credit unions would both improve oversight and drive new capital into neglected communities.

While the chances that Congress would roll back the sector's tax-exemption doesn't seem likely, Boltansky says the ongoing trend of credit unions buying banks could get some attention on the Hill.

"I think that remains an area where bankers do have good reason to be concerned, and I think that that gives them more cachet on Capitol Hill to plead their broader case," he said. "I think when you have the credit union regulators up on Capitol Hill, that they're going to face more questions on this [and] ultimately you're going to see that the pace and size of credit union deals in the bank space slow and shrink, in part because it is eating into some of their political capital on the hill."

Many argue acquisitions of banks — mostly smaller, community banks — by tax-exempt credit unions is a form of regulatory arbitrage, whereby banks decide the relatively lighter regulation of the credit union charter provides them business advantages.

Credit unions also largely buy banks in cash, which is a bonus for community banks who are typically family-owned or have a modest number of shareholders. While credit unions cannot buy banks outright, they can pay a premium for the bank's assets without assuming the charter. That's particularly feasible for them because they don't have to worry about the tax implications. 

The ICBA recently referenced Tennessee-based Y-12 Federal Credit Union credit union acquiring Kentucky-based First Bank of the Southeast — one of over a dozen such acquisitions in 2024 — as evidence favoring greater Congressional scrutiny. The ICBA also has advocated that lawmakers consider imposing an "exit fee" on these kinds of acquisitions to capture the value of the tax revenue that is lost once the business activity of the acquired bank becomes tax-exempt.

"This is a matter of national importance, and ICBA has long said that taxpayers are entitled to know more about how the subsidy they fund is being used to underwrite financial services consolidation," said Emancipator. "Congress should focus hearings on the impact of credit union-bank acquisitions on consumers and the role of the credit union tax exemption and lax NCUA oversight in facilitating these deals."

Congress alone can alter the credit union charter, but as consumer groups and industry voices alike continue to call for leveling the regulatory playing field between banks and their not-for-profit counterparts, the administrative state is already taking notice. The Federal Deposit Insurance Corp. recently approved a new statement of policy on bank mergers that for the first time explicitly states that additional scrutiny may be needed for deals involving credit unions.

"Multiple commenters discussed a need to increase the scrutiny applied to acquisitions of banks by nonbanks such as credit unions," the Final SOP noted. "The Final Statement does not address the evaluation of credit union acquisitions of [Insured Depository Institutions] specifically; however, it does indicate that a credit union may need to provide additional information to enable the FDIC to evaluate the convenience and needs statutory factor, as credit unions are not subject to the CRA."