Drivers of depositor discipline in credit unions

Abstract

In this paper, we analyze whether credit unions are subject to market discipline by their (member) depositors and examine the drivers of such discipline. We first provide descriptive evidence of depositor discipline in credit unions: shares and deposits as well as savings interest rates react to variables that reflect the financial health of the credit union and its asset risk. We show that this discipline is long‐lasting and that it is mediated by the existence of a deposit guarantee scheme and by the strength of the relationship of members with the credit union. We then use proxies of the capability of members to process financial information to show that discipline is heavily influenced by member financial sophistication. Our results suggest that a type of market‐based discipline acts as a complement for regulation in controlling credit union risk taking, thus contributing to overall financial stability.