The Puzzle of Market Discipline in Credit Unions

TOPIC 15 – STAGE 5 – MICRO The US financial cooperative sector has been growing significantly during the last years. However, the evidence on the mechanisms behind investment in this sector or the real effects of its... [ view full abstract ]

TOPIC 15 – STAGE 5 – MICRO

The US financial cooperative sector has been growing significantly during the last years. However, the evidence on the mechanisms behind investment in this sector or the real effects of its activity is still scarce. We contribute to the literature on financial cooperatives (credit unions) by analyzing to what extent they are subject to market discipline. Using quarterly data from credit unions between 1994 and 2014 we find significant empirical evidence of depositor discipline in the credit union industry. First, total shares and deposits decrease when fundamentals deteriorate. Second, our analysis shows that insured deposits react negatively to indicators of risk, suggesting that the existence of the deposit insurance scheme does not fully eliminate depositor discipline. Third, our results suggest that depositor discipline takes time. Finally, we find evidence that investor financial literacy positively affects the degree to which the market disciplines credit unions. Our results have important policy implications regarding the effect of market discipline and financial stability.