Members and employees new to credit unions are often left scratching their heads when it comes to the industry’s distinctive vocabulary. This article will not focus on weighty matters of public policy, nor will it provide in-depth analyses of large amounts of data. Instead, please follow me on a more lighthearted tour through some of the historical roots of credit unions’ unique terminology.
In his 1935 book “CUNA Emerges,” the industry pioneer Roy Bergengren writes that the reason credit unions are not called cooperative banks is a coincidence of history. After all, the most succinct way to explain credit unions is to say that they are cooperative banks.
In 1909, Alphonse Desjardins, the pioneer of caisses populaires (people’s banks)—the French Canadian forerunner of U.S. credit unions—and Pierre Jay, the first Commissioner of Banking of Massachusetts (and coincidentally a descendant of John Jay, the first Chief Justice of the U.S. Supreme Court) drafted the first state Act to Incorporate Credit Unions.
However, the more straightforward name “cooperative banks” was already spoken for in the laws of Massachusetts. While mutually owned home mortgage lenders were called “building and loans associations” or “savings and loans” in many states, in Massachusetts they were referred to as cooperative banks. Thus, Desjardins and Jay instead used the term “credit unions.” Somewhat speculatively, Bergengren and others trace the term as far back as L’Union du Crédit de Bruxelles (the Credit Union of Brussels), founded in Belgium in 1848 as an early forerunner of cooperative banking.
Had their first state legislation been introduced elsewhere, credit unions in the U.S. (and probably elsewhere) might be known today by an entirely different name. In fact, the country’s first credit union did not even call itself a credit union. That maiden institution was launched—again with Desjardins’ help—in 1908, before the Massachusetts law, to serve the French-speaking community of Manchester, New Hampshire. Over the years, it went by the names of “Caisse Populaire, Ste-Marie,” “St. Mary’s Cooperative Credit Association,” and eventually “St. Mary’s Bank.”
Further, the name “credit union” initially led to some confusion. In one example, early industry promoters would ask businesses to sponsor new institutions for their employees, but some business owners worried credit union sounded too close to labor union, and retorted that they would only sponsor one if the word “union” could be dropped.
The structure of early credit unions was somewhat more akin to today’s corporations or mutual funds. Members who contributed funds actually purchased shares with a par value, with common values of $10 or $25 depending on the institution. By contributing $75, a member might therefore receive three shares. (It’s worth remembering that the financial commitment involved in buying credit union shares would have been far greater at the time. The purchasing power of $25 in the early 1900s would be equivalent to about $700 today.)
Early credit union shares differed substantially from those of today. Before they were federally or cooperatively insured, the rare credit unions that became short of liquidity could legally delay repaying shares to members or repay only a fraction of their par value. Each individual institution would also set aside a “guaranty fund” to ensure it would not be short of liquidity, and those whose guaranty funds were running short would typically vote to voluntarily liquidate before the value of their assets fell short of the par value of their shares.
These early shares also differed from those of other corporations. Members would not sell their shares to other parties in secondary markets, but could normally redeem them at their credit union. With the organization’s permission, members could also transfer their shares to other members. Further, unlike in other corporations, credit union members only received one vote in elections, regardless of the number of shares they held.
With the introduction of credit union share insurance (federal or cooperative) decades later, the term “shares” would endure, but funds contributed to credit unions in fact became far more like bank deposits. The amounts contributed were insured (up to an insurance limit) and were largely redeemable on demand.
Institutions also stopped accounting for funds as multiples of the par value of shares. Upon joining a credit union, members continued to purchase one “vestigial share” redeemable only when they discontinued their membership. Beyond that initial redeemable share, however, members contributing $75 now simply had $75 in their share balances.
Today’s credit union shares continue to differ from banks’ deposits in some key aspects. Members each still have a single vote in elections, regardless of their share balances, and also collectively own the reserves in their credit unions. Thus, in voluntary liquidations (and technically in involuntary ones), members are entitled to their pro rata share of the reserves remaining, if any, after loans and other assets are sold for cash, and all shares and other debts have been repaid.
Early credit unions did not legally commit to pay a monthly interest rate on shares, but instead had revenues (e.g., interest charged on loans and fees) and operating expenses, and at the end of the fiscal year would compute their net income. From that net income, funds would be set aside into a statutorily required guaranty fund to protect against loan losses. (These guaranty funds were eventually redubbed “regular reserves.”) Accounting rules eventually also required setting up separate reserves for predictable loan losses, which in time were renamed as allowances for loan losses.
Mirroring both the terminology and accounting practices of today’s corporations, early credit unions also allocated some of their net income to pay dividends to members. Further, institutions could also retain a portion of funds as undivided earnings, i.e., voluntary reserves in addition to their guaranty fund.
Credit unions referred to their payments to members as “dividends” for several reasons, primarily because they were payable on shares. Additionally, unlike interest on bank deposits, their amounts were not preannounced and could vary depending on how well the organization had performed across the previous year.
Over time, it became common for credit unions to offer somewhat predictable dividend rates. For many, the volatility tied to the institution’s overall performance would not result in cuts to these rates, but would instead be absorbed by variations in how much money flowed into undivided earnings.
To recap: Early credit unions computed net income as (1) interest earned from loans plus (2) other operating (noninterest) income (from fees) minus (3) operating (noninterest) expenses, without deducting from their net income any (4) payments to members on their shares (dividends), (5) contributions to guaranty funds or (6) not-yet-then-existing provisions for loan losses (or additions to the allowance for loan losses).
Types of shares, deposits, and dividends
Before the advent of share insurance, the inflation of the 1970s and several pieces of deregulatory legislation, many credit unions offered only a single type of share. These generally had a par value (e.g., of $25), paid dividends once a year, offered no checking rights and often required that members make an appointment in order to redeem them. These share redemptions could also be delayed, for instance, until the next the day when borrowers made monthly interest payments.
During the 1970s, credit unions began broadening their share offerings and with these naturally came a wider array of distinctive designations. Shares became “regular shares,” and much like banks’ savings accounts, they could now pay dividends on a monthly basis at pre-announced rates. Harking back to their own history, many credit unions today continue to pay annual extraordinary, or patronage, dividends, in addition to preannounced dividend rates, depending on their financial performance for that year.
Credit unions also started offering distinct classes of shares featuring varying dividend rates for different maturities (e.g., from three months to five years). Similar to banks’ certificates of deposit (CDs), these accounts were named “share certificates.”
Additionally, institutions began to offer accounts with checking rights under the name of “share drafts,” and when banks introduced “money market deposit accounts” to mirror “money market mutual funds,” credit unions responded with “money market shares.”
Even before share insurance, some credit unions offered both shares and “deposits,” but early deposits were not identical to those of today. They did bare some resemblance in that they could involve odd amounts (e.g., $3.11 instead of having to be multiples of the par value of a share), and could also have pre-announced interest rates and pay interest monthly.
However, early credit union deposits were perhaps more spiritually akin to preferred stock in today’s corporations. Deposits had more legal protections than shares. Credit unions that became short of liquidity could not make payments on shares until they fulfilled all redemption requests on deposits. That said, if they were in fact short on liquidity, institutions could legally delay repayments of both shares AND deposits.
The key difference between credit union shares and deposits today is that shares are restricted to consumers within the organization’s field of membership, i.e., for members, and thus convey the right to vote and collective ownership of reserves. Deposits, meanwhile, are offered to non-members (from outside the field of membership) and therefore do not convey those additional rights.
What Lies Ahead?
Hopefully this tour through the historical roots of a few key credit union terms was of interest (or should I say paid dividends), and succeeds in helping new employees and members better grasp some of the basic vocabulary surrounding the industry.
Financial terminology is constantly evolving, with newly relevant terms steadily being added to the lexicon. A deeper understanding therefore of this language and its origins offers not only a window onto the credit union industry’s history and growth, but perhaps may also provide a glimpse of what’s to come.