SHARE YOUR INDEPENDENCE Rejuvenating Credit Union Collaboration with the Federated Model

A recurring theme in Canada’s credit union journey has been the tension between building roots in local communities and achieving the scale required

to stay competitive in an evolving marketplace. At a time when chartered banks are scaling back branch networks and slashing costs, credit unions

increasingly turn to local or regional presence as a strategic differentiator. However, due to tight margins and fierce competition, financial services

organizations also require scale – and this creates a challenge.

The credit union system across Canada faces growing pressures on many fronts that are straining organizations’ resources:

• Regulatory requirements grow more complex and demanding, and managing compliance — not to mention staying on top of developments — is a costly, time-consuming burden.

• New entrants are creating intense competition, while traditional banks’ marketing efforts are blurring the lines between themselves and the community-focused credit unions.

• Canadians, credit union members among them, are increasingly demanding digital services and products that make transactions as quick, convenient and easy as possible.

• Low interest rates require volume to generate profits and the narrow spread between lending rates and deposit rates is leaving credit unions with less and less room to manoeuvre as costs continue to rise.

These and other pressures have brought tremendous change to the credit union landscape across Canada. Today, there are roughly 300 credit unions — half the number from a little over a decade ago, and far less than the 3,000 active in the 1960s. The system is also dividing itself into distinct tiers, as the largest credit unions pull away to focus on their common issues, leaving those serving local, regional or niche markets to make their own way. This is intensifying the pressure on local and regional players – those credit unions headquartered in small towns and rural communities with small branch networks, comparatively modest assets and a constrained labour pool.

As the gap between the largest credit unions and the rest of the system grows, historical collaboration models need to be revisited. While provincial Centrals continue to deliver essential services and work to redefine their mandate to support credit unions, they may not have the capacity to take on additional functions.

For many credit unions, the right strategy for their members has been to merge with like-minded partners. However, others insist that remaining independent is a strategic imperative. How these credit unions will achieve scale and efficiency without merging is a pressing strategic issue. What’s the way forward?

The Status Quo Isn’t an OptionNo matter their strategy, it’s abundantly clear that the status quo is no longer an option for credit unions. With costs, competition, complexity and uncertainty on the rise, credit unions need to find ways to operate more efficiently and nimbly. Effective partnerships can enable credit unions to achieve the scale needed to control costs and the shared capabilities needed to serve members better.

While still small by bank standards, Canada’s largest credit unions are better positioned to leverage their revenue, resources and talent needed to respond to the competitive environment. Large credit unions can – and do – pool their resources to develop solutions to common issues such as mobile payments. In this regard they’re much like the Big Five banks, which regularly team up to develop shared solutions to issues that aren’t competitive differentiators, such as payments clearing.

For smaller credit unions the challenges are even greater. Canada’s local and regional credit unions have long relied on their Centrals for many services — from treasury and internal audit to payments. As large credit unions carve out their own paths and Centrals continue to evolve, smaller credit unions may find that the shared services on which they rely will increasingly suffer from reduced scale and increased costs.

Mergers and acquisitions are highly likely as small credit unions look to achieve a level of scale that allows them to address those back-end needs and remain viable. Many, if not most, small credit unions will refine their focus to serve highly specialized niche markets, or deliver highly specialized niche services, so that they can eliminate unnecessary costs.

But to do more than simply endure — to survive, thrive and prosper in a changing world — local and regional credit unions will need to become more efficient than ever before. And the most effective way a credit union can achieve the operational and cost efficiencies it needs is to move back-office processes that consume time and money into shared delivery models. IT, internal audit, product development, loan adjudication and more — anything that isn’t core or truly strategic — can be done centrally on behalf of everyone in a way that achieves economies of scale.

Evolving Collaboration ModelsCredit union collaboration is, of course, nothing new. Provincial Centrals and system-owned service providers have a long, successful track record of serving their credit unions. Many credit unions participate in group purchasing agreements and ad hoc cost sharing models, and a number of system-owned subsidiaries and CUSOs (Credit Union Service Organizations) provide essential services to their owners.

Ad HocProvincial

Central CUSO Federated MBCU Fully Merged

One-off partnerships (e.g., two credit unions share an internal auditor)

Statutory (e.g. shared liquidity) and shared infrastructure (e.g., payments processing)

Credit Union Service Organization: System-owned subsidiaries for specific purposes (e.g., core banking, wealth management)

Multiple credit unions with common and uniform back- end services

Multi-Brand Credit Union: Merged credit union with a common back- end but operating multiple legacy brands

Conventional credit union merger

Collaboration / Merger Continuum

Loca

l Con

trol

Le

ss E

ffici

ency

Collective Control M

ore Efficiency

The federated model has helped independent hardware stores survive as big box stores moved in. Home improvement chain Home Hardware was formed to combat this disruption. As a cooperative owned by 1,100 dealers across Canada, it has not only survived but thrived for over 50 years. Marketing, IT, purchasing, warehousing and distribution, merchandising and store planning and design are just some of the shared, centralized “federated” functions and services delivered to all dealers. This reduces costs and improves efficiency for all, while allowing individual stores to focus on serving their communities and growing their business.

Mergers continue to be an effective tool for achieving scale. While conventional mergers are the most common option, the multi-brand credit union (or “First West”1 ) model of merging into one charter with a common infrastructure and multiple legacy brands has gained traction. However, mergers are not always a viable option. Large credit unions have reached the scale where the only mergers that make sense are with other large peers. Mid-sized credit unions may find that the supply of available partners is limited, while smaller credit unions may conclude that the cost and complexity of a merger of equals will not result in sufficient gains.

The other evolving model that melds the scale advantages of merging with the independence of separate charters is one that’s highly collaborative but not as well known: the federated network model.

The Federated ModelNot to be confused with a federal cooperative banking charter, the federated model is a tight integration of credit unions characterized by common back-end services delivered uniformly across participants and governed by the member credit unions under a model of shared sovereignty. Variations of the federated model are in place, in development or under discussion in every province. Quebec’s Desjardins Group has operated under a “federated architecture”2 for over a century and the practice is common across Europe and Australia for both financial and non-financial cooperatives.

This model of a hub-and-spoke structure with a shared back end and local execution has a number of unique characteristics that we outline in this whitepaper. This model could bring flexibility and a different way to collaborate.

• Participants share a common hub of centralized products and / or services

• Joint ownership by the participants

• Activities performed in the hub are not duplicated by the participants

• The hub does not bid for the business or compete with other firms

• The hub organization operates independently under a standalone reporting structure

• Participating credit unions get a voice and a vote on the governing committee

• Unanimity is not required and all participants agree to adopt decisions once a suitable majority is achieved.

The federated model involves relinquishing elements of each credit union’s business strategically, to reduce costs, improve efficiency, invest in common infrastructure, develop new products and services and so on — for the greater good of all federation members and their communities. The back-office functions over which the federation assumes control (e.g., regulatory compliance and IT services) are unlikely to be those that give credit unions a strategic advantage. Yet centralizing those functions relieves individual credit unions of the burden of having to do it themselves and provides the scale needed to tackle these essential areas of the business as efficiently as possible. While the negotiation and execution of a federated model can be quite complex, a well-designed and well-run federation will provide superior member service and improve financial returns.

1 The term “First West Model” was popularized by First West Credit Union to describe the unique format of their 2010 merger between Valley First and Envision Financial credit unions. http://www.firstwestcu.ca/first-west-model-overview

2 http://www.did.qc.ca/media/documents/en/positionnements/DID-CharacteristicsCoop-May2005.pdf

Facing Page:

3Source: MNP analysis

4Source: MNP analysis

This in turn, allows credit unions to return to their roots and focus more of their time and energy on building deeper relationships with their members and communities. They can engage with their members more often and more effectively to understand their current and emerging needs — and relate that insight back to the federation to potentially develop new products and services that can benefit the entire network. Credit unions can work more closely with civic and community leaders to tackle local priorities, making a positive, lasting contribution to the community and enhancing their reputation.

One of the chief concerns about the federated model is that decisions will be imposed on credit unions from a distant central authority and not reflect local community needs. Yet as long as each credit union member of the federation has a seat at the table, each will have a voice in any decision affecting the entire federation; it’s simply a different role for individual credit unions and a different way to exert authority. And local doesn’t need to be hyper-local to be relevant to a credit union’s members. As an example, a decision made on behalf of a federation of dozens of one province’s credit unions is highly likely to be relevant and useful to all involved, because of common underlying needs and issues.

The federated model, then, isn’t about taking away all decision-making authority from individual credit unions and reducing them to little more than traditional bank branches. The federated model is instead about individual credit unions coming together in a deep, highly strategic collaboration — centralizing costly, common, non-core business functions and decisions to achieve scale and improve overall capability for the entire network. It’s a new kind of sovereignty for Canada’s credit unions, but it’s one that reflects modern realities.

Credit Union 1 Credit Union 2 Credit Union X

GovernanceBranch OperationsMember ServiceSales & MarketingCommunity Impact

GovernanceBranch OperationsMember ServiceSales & MarketingCommunity Impact

GovernanceBranch OperationsMember ServiceSales & MarketingCommunity Impact

Federation

Product DesignSales SupportDigital BankingTechnology & Operations

Human ResourcesTreasury & SyndicationInternal AuditFINTRAC and Regulatory Compliance

Illustrative Federated Model Division of Responsibilities

Is the Federated Model Right for You?Local and regional credit unions entering into a fully federated model can expect to see dramatic results:

• Efficiency ratio improvements of 10%-20%3

• Asset growth improvement of 1-5% annually4

• Reduced time to market for products and services

• Improved member satisfaction

• Reduced risk profiles

• Increased lending and syndication capabilities.

Mandatory Decision

Threshold:50% of members

50% of assets

CU1

CU2

CU3

CU4

CU8

CU7

CU6

CU5

The numbers provided are for illustrative purposes only.

In addition, management and staff of federated credit unions can expect a number of improvements:

• Less time spent on regulatory compliance

• More time spent attracting and serving members

• Increased operational automation

• Offloading of non-strategic operations and decision-making

• Federated scale makes it easier to attract and retain specialized staff

The trade-off, of course, is a lack of control over certain operational decisions. If this sounds scary, that’s because it is. Credit unions that wish to retain their own charters must get comfortable with the idea of shared sovereignty over common services. Giving up control over some of your operations may seem like a loss of independence, but the net benefit to your organization and to your members far outweighs any costs.

Is your credit union ready to consider a federated model? Ask yourself these questions:

• Is it important for our members that we keep our credit union charter, with a local head office and locally-delivered member services?

• Do we need a collaboration model that can be customized for our local markets?

• Do we have difficulty bringing new products and services to market?

• Are we spending too much time on compliance and other non-value-added services?

• Are we willing to trade operational decision-making for a seat at the shared governance table?

To Thrive, Credit Unions Must EvolveMany credit unions are reluctant to adapt and respond to their new environment, determined to hold on to 20th-century notions of what a credit union should be. Yet the structures that enabled the credit union system to grow and thrive are inadequate to tackle today’s complexity and competitiveness. Those that fail to act risk a slow decline, irrelevance, or worse.

Local and regional credit unions can stay vibrant and healthy — if they take bold action and accept the need to evolve. By exchanging operational independence for increased efficiency and effectiveness, credit unions working together in federated models will be positioned to serve their members and their communities well into the future.

ABOUT MNP

MNP is a leading national accounting, tax and business consulting firm for Canada’s Credit Unions. We have invested more time and resources into understanding credit unions and their dynamic landscape than any other firm. Proudly serving more than more than 135 credit union across Canada, MNP has developed a diverse suite of services designed to strengthen credit union leadership, knowledge and financial position. By delivering personalized solutions from a local perspective, MNP is committed to helping credit unions succeed across the country.

Praxity AISBL is a global alliance of independent firms. Organised as an international not-for-profit entity under Belgium law, Praxity has its executive office in Epsom. Praxity – Global Alliance Limited is a not-for-profit company registered in England and Wales, limited by guarantee, and has its registered office in England. As an Alliance, Praxity does not practice the profession of public accountancy or provide audit, tax, consulting or other professional services of any type to third parties. The Alliance does not constitute a joint venture, partnership or network between participating firms. Because the Alliance firms are independent, Praxity does not guarantee the services or the quality of services provided by participating firms.

Visit us at MNP.ca

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To learn more about how MNP can help evolve your collaboration model, contact:

Doug Macdonald, MBA, PMPCredit Union Consulting LeaderT: 1.877.251.2922E: doug.macdonald@mnp.ca

Annette Bester, CPA, CANational Credit Union LeaderT: 1.877.500.0778E: annette.bester@mnp.ca

David Baxter, MBA, PMP, CIPMFinancial Services ConsultingT: 778.374.2162E: david.baxter@mnp.ca