Does Knowing Your Members Really Make a Difference?
One of the very first mantras I learned when I became a full time resident of credit union land was that credit unions really know their members. The implication, of course, is that credit unions make better loans than their commercial banking counterparts because of these personal relationships. But does the personal touch really make a difference?
Recently, University of Kansas business professor Robert D. Young reported on findings based on a ten year review of Small Business Administration (SBA) loans made by banks. His findings suggest that the answer is a resounding yes.
Young and his colleagues reviewed indexes of social capital, which are generally measures of how integrated people are in their community such as participation in religious and civic groups. They found that “SBA loans between banks and borrowers in high-social-capital towns are 20% to 25% less likely to default than SBA loans made where social capital is low.” The theory is that in tight knit communities it is easier for lenders to gather information about borrowers and borrowers tend to be a better risk. His findings also suggests that social indexes are actually a better indicator of default risk than are a business’ credit score. A couple of quick points about this research.
First, it is certainly an area rich with possibility for credit unions. One of my favorite stories from a long time credit union executive is how he learned the basics of lending by going around with his father to collect loans owed by firemen. His father knew most of his borrowers personally and at the end of the day if they weren’t able to make the occasional payment he knew that they would pay it back when they could. The more that hard research can back up these anecdotes with hard statistics, the easier it is for all credit unions to make the case for expanded lending powers.
Politicians and judges have done a lousy job balancing lending flexibility with anti-discrimination laws. Everyone says they love George Bailey’s approach to lending, but as long as lenders can be held liable for lending decisions that have the effect of discriminating against a minority group, the use of soft underwriting criteria is implicitly discouraged. It’s actually safer to use a computer program with set criteria and apply it across the board.
Finally, these findings suggest that social capital lending criteria works best in small communities. We all know that banks are growing larger and that credit unions are the only true remaining community banks. But, as credit unions get larger, how do they ensure that they balance the need for growth against the need to continue to really know their members.