Bernie Sanders wants to extend a 15% rate cap to all lenders in America. He cites the rate cap imposed on credit unions in 1980 as the basis for his policy:
In 1980, Congress passed legislation to require credit unions to cap interest rates on their loans at no more than 15 percent. And, that law has worked well. Unlike big banks, credit unions did not receive a huge bailout from the taxpayers of this country. It is time to extend this cap to every lender in America.
There is only one problem with this proposal: credit unions can charge much more than 15%. Under the terms of the Federal Credit Union Act, the rate cap can be, and has been, increased. The maximum rate has been increased to 18% since May 1987. Credit unions also offer a Payday Alternative Loan program (PAL), with interest rates up to 28% allowed.
Debbie Matz, Chair of the National Credit Union Administration board, says "If the rate ceiling was reduced, credit unions would be stressed to maintain PAL programs. If the rate ceiling was reduced to 15%, I know, from first-hand experience working in a federal credit union, it would be difficult to cover the costs of such short-term loans."
Sanders' rate cap would eliminate affordable credit options from millions of Americans. His proposal also ignores an inconvenient reality: credit losses and costs of providing credit are real.
Credit Unions Need a Vanguard, Not Rate Caps
Traditional, for-profit banks, have to satisfy three groups of people, with often conflicting interests: shareholders, customers and employees. Credit unions merge shareholders and customers. A credit union is member-owned and returns surplus income to members in the form of dividends. Employees still want their piece of the pie, but eliminating outside shareholders theoretically enables credit unions to pay higher interest rates on deposits and charge lower interest rates on loans. And many credit unions do exactly that.
But there is a problem. Most credit unions are very small. Consumer banking is a scale business. The larger the organization, the lower the unit costs become. Although many credit unions have good intentions, their unit costs are too high to unleash the full potential of their unique ownership structure.
That does not have to be the case. Just because you are a mutual does not mean you have to be small. An industry that has been disrupted is the fund management business. Paying high fees for mutual funds that regularly perform worse than the index was a way of life for years. But Vanguard changed everything. They had a simple mantra: keep costs low and invest in the index. But they also have a unique ownership structure. In the words of Vanguard:
Vanguard is structured as a "mutual" mutual fund company. Our interests are completely aligned with those of our clients. We never have to weigh what's best for clients against what's best for the company's owners, because they are one and the same.
Sounds a lot like a credit union. But there is a big difference. Vanguard is massive, with more than $3 trillion under management. Most people don't even realize that Vanguard has a different ownership structure. Vanguard competes head-on with shareholder-owned companies. And something magical has happened. Management fees across the industry started falling. Even shareholder-owned companies had to create products with dramatically lower management fees to compete with Vanguard. Regulators did not cap management fees in the fund management business. The market brought costs lower.
Today, most credit unions remain too small. Many credit unions behave like clubs, rather than competitors looking to steal market share (like Vanguard does). If the goal is to reduce the cost of borrowing for Americans, Sanders is misguided. Instead, he should remove rate caps from credit unions entirely. With their unique ownership structure, they could bring competition to an even wider range of customers.
In a best case scenario, several very large credit unions would emerge as viable competitors to large, traditional banks. Some of the larger credit unions, like PenFed, are already starting to do just that. As we have seen in the fund management industry, Vanguard brought down management fees across the industry. The same thing could happen in the lending market, without eliminating access to credit. But not with rate caps.