An Economic Theory of a Credit Union

THE majority of research to date on CUs has been empirical (cf. Cargill [1] and Kidwell and Peterson [7]), yet there is serious need to develop a theoretical framework of CU behavior that incorporates their unique characteristics. A CU is essentially a financial intermediation cooperative. However, the standard theoretical treatments of financial intermediaries (cf. Meyer [8]) and cooperative enterprises cannot be directly applied to model credit union behavior. There are two principal characteristics of CUs that prevent this: First, in a CU (and cooperatives in general) the members are both the owners of the organization and the consumers of its output or suppliers of its input. One cannot simply assume that the members seek to maximize the profit generated by their transactions with the CU irrespective of the price and quantities of those same transactions, thus models of a financial firm based on profit maximization cannot be directly translated to a CU environment. Second, in a CU the membership provides both the demand for and supply of loanable funds. The CU then intermediates between its member-savers and member-borrowers. This heterogeneity is an inherent source of conflict between members. Clearly, a CU cannot simultaneously maximize its dividend rate for savers and minimize its loan rate for borrowers. Since most theoretical models of cooperative enterprises assume a homogeneous member objective, they are not generally applicable to CUs. There are two basic requirements for a framework to model CU behavior. First, the specification of the objective function should focus on the value of CU participation to the members. This value should include the prices and quantities of transactions as well as any profit that results. Second, the analysis should explicitly consider the possibility of conflict among members, and the resolution of that conflict being a preference to either the borrowers or savers. The existing literature on CUs contains a wide variety of objective functions. Hempel and Yawitz [5] ignore the owners-are-consumers issue and simply contend that CUs, like other financial intermediaries, should maximize profit. Most writers, however, recognize that profit-maximization would be a somewhat incongruous objective for an organization that typically labels itself not-for-profit. Murray and White [9] use cost minimization subject to an output constraint. Keating [6] employs the managerial discretion approach by maximizing the manager's utility function subject to minimum member benefit constraints. Taylor [11, 12] suggests that the CU should minimize the difference between its average loan rate and savings rate paid. Smith [10] argues that the CU should