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Should Regulators Include Credit Unions When They Analyze Bank Competition?


William R. Emmons
Saturday, January 1, 2000

In many parts of the United States, credit unions are a growing part of the retail financial landscape, prompting the question, "How much competition are credit unions to commercial banks and thrifts?" In our recent research, senior economist Frank Schmid and I used county-level data for each year during 1989 to 1996 to investigate the extent to which banks and credit unions are direct competitors in local deposit markets.

The Evolving Structure of Local Deposit Markets

During the 1980s and '90s, mergers among depository institutions and the steady expansion of credit unions have been two hallmarks of the U.S. financial landscape. Since 1988, the number of U.S. commercial-bank charters has declined between 3 and 5 percent annually, resulting in the cumulative disappearance of more than one-third of all bank charters during this period. Mergers accounted for about 80 percent and failures for about 20 percent of these disappearances.

During this period, however, local deposit-market concentration among banks and thrifts actually declined slightly, indicating that competition remains fierce. This is important when you consider that regulators ignore credit unions when they measure market shares in local deposit markets.

One important measure of market concentration is the Herfindahl index, which is expressed in values between zero and one. In the hypothetical case of perfect competition, this index is marginally above zero; on the other hand, in the hypothetical monopoly case, the index takes on its maximum value of one.

During the decade ending in 1997, average deposit-market Herfindahl indexes in metropolitan statistical areas fell from 0.20 to 0.19, and those in non-metropolitan counties fell from 0.43 to 0.41; however, these figures include only commercial banks and some thrifts.[1] We found that credit-union membership actually grew more than 38 percent in the decade ending in 1996, while the country's population grew only about 10 percent.[2]

Economic Analysis of Competition

In previous research, we also found links between the concentration of local commercial-bank deposit shares, credit-union efficiency indicators, and risk-taking levels. Higher commercial-bank deposit concentration was associated with higher household participation rates at credit unions—the fraction of those who are both eligible and choose to join. Thus, competitive conditions among banks appear to influence the behavior of credit unions and their potential members. It has not been clear, however, whether the effects also run in the other direction—that is, whether credit unions affect the structure of local deposit markets that are dominated by commercial banks and thrifts.

Our latest article develops a model of competition between banks and credit unions that makes two predictions. First, during a given year, some households will respond to increased consolidation among local banks by moving their deposit accounts to credit unions, all else being equal. Second, an increased participation rate at credit unions during a given year will cause higher concentration in the commercial-banking market during the next year, all else held constant. In essence, if credit unions gain market share, banks will be more likely to undertake consolidation.

Both predictions of our theoretical model are supported by the empirical findings. The results indicate that commercial banks and credit unions are direct competitors in the local household deposit market. We suggest, therefore, that depository institutions and their regulators include credit unions when they analyze competition in local deposit markets.

A longer version of this article, co-authored by economist Frank A. Schmid, appeared in the May/June 2000 issue of the St. Louis Fed's The Review.


  1. See Berger, Allen N., Rebecca S. Demsetz, and Philip E. Strahan. "The Consolidation of the Financial Services Industry: Causes, Consequences, and Implications for the Future," Journal of Banking and Finance (February 1999), pp. 135-94. [back to text]
  2. See United States Treasury Department. Credit Unions, U.S. Government Printing Office, 1997. [back to text]