Credit union advocates argue that if the credit union charter and its tax exemption offer such a big competitive advantage, why aren't banks lining up to convert?

Let me begin by saying I believe in charter choice. A financial institution should have the freedom to select the charter that best aligns with its business model.

However, a conversion of a bank to a credit union is extremely rare.

I know of only two instances where such a conversions took place in the last two decades — ESL Federal Credit Union and Thrivent Federal Credit Union. In both instances, the banks that converted to credit unions were mutual banks, which are similar to credit unions in structure.

The rarity of a bank converting to a credit union points out the difficulty — if not impossibility — of this event, especially for a stock-owned bank.

First of all, credit unions are financial cooperatives owned by their members, while most banks are owned by stockholders (my following comments will be focused on banks owned by shareholders).

A stock banking organization converting to a credit union would have to first compensate its shareholders for their ownership interests. This could effectively wipe out the capital of the entity that is converting to a credit union. Thus, the proposed credit union convert would not have enough capital to operate safely. So, this could make it difficult to convert from a stock entity to a credit union.

On top of that, bank balance sheets are in general fundamentally different from credit unions. Most banks are commercial lenders, while most credit unions are consumer lenders. A bank converting to a credit union would probably exceed the aggregate member business loan cap of 12.25% of assets and would need to shrink its business loan portfolio — most likely by shedding these loans (possibly at a loss) to comply with the law.

Furthermore, banks hold assets that credit unions are not allowed to hold. Once again, a requirement to divest these assets could mean that the bank could be selling these assets in an unfavorable environment at fire sale prices.

In addition, federal credit unions are subject to a national usury cap and may not put prepayment penalties in their loans. This could force a bank converting to a credit union to modify its loan terms and once again possibly divest loans that do not conform to legal requirements.

Another complication deals with common bond or field of membership. Banks are open to the public, while credit unions have a defined field of membership.

A bank converting to a credit union would need to consider whether its proposed field of membership meets legal requirements.

While a small bank in a limited geographic area may be able to meet the field of membership requirement, a larger bank would have difficulties.

Another common bond operational issue may require the converting bank to divest part of its customer base to comply with the field of membership requirements.

I suspect there are ways around the field of membership quagmire. A converting bank could form an association or become a partner of the American Consumer Council so as to qualify all its customers as members. But this would just make a mockery out of the field of membership requirements.

In summary, the process for a bank converting to a credit union is extremely difficult. A bank faces numerous hurdles ranging from capital to balance sheet to field of membership issues that must be cleared for this conversion to occur. It is my opinion, such conversions will remain very rare.

Keith Leggett is a retired economist for the American Bankers Association and a frequent blogger on credit union issues.