Are credit unions and building societies a viable alternative?

In recent years there has been ongoing speculation as to why Australian financial institutions emerged from the Global Financial Crisis (GFC) in a stronger position than their overseas counterparts.

The cause of the GFC has been widely debated, with the two most accepted contributors being deregulation and subprime lending. Deregulation by manyoverseas national governments encouraged excessive economic risk taking in an environment where access to credit was easy. The trigger was a liquidity shortfall in the US banking system, which resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world.

But the more interesting question is why Australia came out of the GFC in a more fortunate position than most Western economies, managing to avoid dipping into recession.

Unlike the US, Australian Authorised Deposit Taking Institutions (ADIs) were well regulated and accordingly the risk appetite of ADIs was far less excessive. Australia's relatively small financial system and limited participants helps ensure that each ADI runs prudently and transparently given the increased scrutiny on it. That is, the regulator has a better chance of picking up isolated or systemic issues in the system before they can fully take effect.

Subprime backed securities did make it to our shores but only in amounts that did not cause systemic damage. Australian ADIs and mortgage brokers did not reduce or remove lending policies to the point where people with no job, income or assets could attain a loan, as was common practice in the US.

Cheap money helped fuel the bubble in home prices in the US and Europe, but in Australia, homes were simply never inexpensive enough to attract an onrush of buyers. China's growth over the past decade has benefited Australia by becoming a key commodity export market after Japan, who along with China is hungry for Australia's rich supply of iron ore and one of the few economies to show significant growth through the GFC.

When credit markets became illiquid for ADIs to access funding, the Australian Government assisted by instituting a three-year $1m capped bank deposit guarantee in November 2008 and with deposits over $1m eligible for the guarantee subject to payment of fee. Many commentators attributed this measure, along with others implemented by the Government as key to the banking system in this country emerging from the GFC in such good shape.

One of key side effects of the GFC within Australia's finance industry was that it effectively killed competition in the sector. The big four banks dramatically and significantly increased their market share as consumers looked for safety and security, and saw size as a key measure of this. In the wake of the GFC, the big four banks held more than 85% of the home lending market, and more than 75% of deposits.

In the period following the GFC, competition in the finance industry began to emerge as a key issue with consumers reacting adversely to decisions being made by the big banks. The most common objection related to the behaviour of many banks in increasing home loan interest rates above the rises set by the Reserve Bank of Australia (RBA).

With bank profits soaring and consumer discontent growing, in December last year the Federal Government again stepped in and flagged its intention to introduce a reform package to promote greater competition in the sector. For the mutual banking-sector, who had been lobbying the Government for increased regulation to promote competition, the announcement was long overdue.

The centrepiece of the reform package was the creation of a fifth pillar, made up of Australia's credit unions and building societies (CUBS). The announcement met a mixed reaction from commentators and industry experts alike, with some still to be convinced as to whether CUBS could fill the role that had been assigned to them.

CUBS consist of about 115 organisations and serve more than 4.5 million members around Australia. They have more branches than the Commonwealth Bank and own one of the largest ATM networks in the nation, rediATM. On face value, they are more than equipped to take on the title of the fifth pillar.