By Kevin Foster-Keddie
The crisis in the financial services industry will re-shape the competitive landscape for decades to come. What can past financial crises teach us? How can credit unions survive this transition period? What will the new environment look like?
The world is experiencing the first global financial crisis in modern history. While there are no roadmaps to guide us, historical records can provide some perspective and even a range of scenarios with which to plan. In the broadest terms, financial crises have one element in common: speculation. This propensity of human beings to be overly optimistic about future plans has resulted in widespread speculation in the past and has led to the crisis we face today.
In what is sure to become a classic of modern economic analysis, the University of Maryland's Carmen Reinhart and Harvard University's Kenneth Rogoff completed a study of past financial crises that is startling in its simplicity and sobering in its conclusions. While Reinhart and Rogoff do not predict the ultimate outcome of the current crisis, even a casual reader can draw their own conclusions.
Unemployment will surpass 11 percent and last close to five years (or longer), equities prices will drop at least 55 percent and begin recovery only after three years (or more), and housing pricing will not recover for at least 6 years with an average drop in value of 35 percent (or more). The worst-case scenarios (Download Table) are based on historical record. Because the current event is worldwide in scope, a more severe scenario than average is a distinct possibility–-even a probability.
Chaos and Survival: the Transition Period. In the scientific world, the term "edge chaos" is sometimes used to describe an environment that exists between randomness–-chaos–-and a stable equilibrium. As a metaphor for the current state of the financial services environment, it helps to illustrate our current rapid pace of evolution–-and the uncertainty in the ability to predict the future equilibrium.
During this transition, credit unions can expect conditions that will create real threats to the survival of our institutions. While there are also great opportunities in a marketplace so unstable, most credit unions will seek survival over growth.
Balance sheet management is the primary objective of most financial institutions–-indeed most companies–-today. For CUs, capital preservation is the dominant concern. Many institutions should, or already have, implemented strategies to shrink the size of their institutions and increase margins as much as possible.
For credit unions whose past strategy has been price or technology leadership, such an adjustment may be difficult. Pricing to improve margins is very different from pricing that seeks increased market share and stimulates growth. Likewise, maintaining technological leadership during a severe contraction is difficult to justify.
Perhaps the biggest challenge for growth-oriented credit unions is accepting the idea that the transformation of financial services includes a contraction in the size of the entire industry. Growth for most individual financial institutions will only occur after the industry as a whole is "right-sized" to the needs of the marketplace. Those marketplace needs will be much smaller than they are now.
The hard wisdom of past industry transformations is that a survival rate of 60 percent is a good outcome. Perhaps credit unions will fare better than other financial institutions during this transition period. Perhaps not.
What will be the criteria for determining survival? Many factors will play a part, but it is a credit union's capital that will be most important. Does your credit union have sufficient capital to withstand its losses and to replenish the insurance fund for the losses of other credit unions as they fail?
The Aftermath: What will the New World Look Like? While it is impossible to predict how and when all the moving pieces will settle in the drama enveloping the financial services world, some broad elements can be identified as the chaos begins to subside.
First, there will be far more government involvement in financial services. During the transition, certainly, a pattern of government actions–-for example the introduction of "Making Home Affordable"-–will require immediate action by individual credit unions. Responding to this stream of new requirements will restrict credit unions' ability to move forward on internally generated priorities. And, after the transition, additional resources will be needed on a permanent basis to comply with the new regulations.
While increased government involvement in financial services will be a challenge, expect fewer players, less competition and higher margins. The number of financial institutions will fall. The ways in which these competitors will compete will be different. For example, Washington Mutual is gone. WAMU was a tough competitor in Washington State because it emphasized service. JP Morgan Chase is not as service oriented as WAMU. Margins will be higher because federal policy makers will need to create an operating environment to repair bank balance sheets. Also expect less innovation in financial institutions: The government will be risk-averse and seek to control and restrict risk-taking activities to a great degree.
Kevin Foster-Keddie is president/CEO of $1.3 billion WSECU, Olympia, Wash.
Considering a variety of scenarios for the future can help you succeed even in chaos. See what you think of the four scenarios outlined in the just-released 2015 Scenarios for Credit Unions in North America.
