Memorandum by the Building Societies Association
(LAI 30)
SUMMARY
— Building societies remain a safe and
remunerative home for a major proportion of all local authority
deposits.
— Local authority investment with building
societies keeps resources in local and regional economies, helps
to sustain finance for housing, and counters the dominance of
the City of London in UK financial markets. We ask the Committee
to add its support for this partnership.
— Building societies are regulated to the
same prudential standards - based on EU directives—as UK
banks, moreover they are prevented by law from engaging in risky
financial trading.
— The current guidelines on local authority
investment contain much that is sensible, apart from the over-reliance
on credit ratings, which may have contributed to recent losses.
— The Government's credit guarantee scheme
will help stabilise money markets in the short term, but the longer
term solution is for effective bank regulation to restore confidence,
not for all local authority cash surpluses to be redirected into
Government debt or supported by permanent Government guarantees.
INTRODUCTION
1. The Building Societies Association (BSA)
welcomes the opportunity to submit written evidence to the Committee.
The BSA represents all 55 building societies in the United
Kingdom. Building societies have total assets of £380 billion
and, together with their subsidiaries, hold residential mortgages
of £250 billion, more than 20% of the total outstanding
in the UK. Societies hold about £235 billion of retail
deposits, accounting for more than 20% of all such deposits in
the UK. Building societies also account for about 37% of all cash
ISA balances. Building societies employ over 51,500 full
and part-time staff and operate through more than 2,000 branches.
2. Building societies and local authorities
(LAs) have enjoyed a long and mutually beneficial relationship,
in which societies have offered LAs a safe, convenient and rewarding
home for their temporary cash surpluses, and LAs - by placing
those funds with societies—have helped sustain finance for
housing across the United Kingdom. Societies value the deposits
they receive from LAs and may well pay better rates for them than
the bigger banks. At the end of June 2008, LAs' aggregate investments
with building societies were around £ 12.5 billion:
relative to their overall share of the deposit market, societies
appear to take a higher share of total LA investment than banks.
More detail on the recent volumes of LA investments with societies,
and their proportion of total LA cash investments, is given in
the Tables in Appendix 1.
SUPPORTING LOCAL
AND REGIONAL
ECONOMIES
3. Building societies are all headquartered
outside London, and maintain a network of over 2,000 convenient
retail branches across the United Kingdom. This regional presence
provides a much-needed counterweight to the dominance of the City
of London, both in concentration of resources and in financial
sector employment. Building society branches provide simple, accessible
cash savings accounts which—as they cannot be overdrawn—help
budgeting and avoid debt problems, and are often favoured by consumers
who remain cash-based and do not use full banking facilities.
4. Building societies have only one principal
purpose permitted by law—that is, to use their members'
savings to make fully-secured residential mortgage loans, and
such lending must by law make up at least 75% of their business
assets. Societies therefore remain committed in the long term
to the prudent and responsible finance of housing in the UK, both
out of conviction, but also as a legal necessity. Nor is this
limited to owner-occupation: lending fully secured on social rented
housing qualifies within the core 75% and many societies lend
to housing associations to finance their new build programmes.
At a time when, notwithstanding low interest rates, the availability
of all housing finance is a concern, LAs depositing with societies
can know that their funds help maintain its availability, rather
than leaking out into speculative uses or overseas adventures.
Both societies and LAs take the long term view—neither is
after a quick buck—so societies make ideal investment partners
for LAs.
MUTUAL VALUES
5. Building societies are mutual institutions,
independent and owned by their members—they cannot be controlled
by other entities and they are not driven by stock market short-termism.
They are not in business to maximise profits but instead seek
to return consistent value to their members through better pricing
and service. The unique contribution of mutual institutions was
recently praised by the Communities Secretary, the Rt Hon Hazel
Blears MP, in the following terms when she spoke at the first
national Mutuals Forum on 4 December 2008;
"Over their long history, mutuals have made
a mark on many towns and cities across the UK. Many command a
degree of affection and trust that few plcs can. That's because
of the principles at the heart of mutuals: not just speculation,
but support; not just profit, but investing in the common good. The
[mutuals] "yearbook" reveals just how big a role mutuals
play in our economy and society, employing over 800,000 people,
with membership equivalent to one in three people in the UK, revenue
of £84 billion, and assets of £477 billion.
"Like any other business, mutuals are feeling
the strain of the financial crisis. But there's a silver lining.
Mutuals are better placed than many plcs to weather the storm.
Compare what has happened to the building societies who demutualised
and those who didn't over the past year or so. And at a time when
people are feeling insecure, and more aware of the limits of what
markets alone can deliver, there's a new hunger for solidarity.
Already co-operative and social banks are seeing more people keen
to invest. In a downturn, mutuals can make a huge difference.
Less vulnerable to the fluctuations of the market. More locally
responsive. And as employers, able to help people who would otherwise
be unemployed keep in touch with the world of work.
"So it's time for mutuals to be ambitious. Shout
about your successes. Make sure everyone knows about the "cooperative
advantage." And as a Government I promise we will continue
to listen and learn, trying to create the right framework to help
you grow."
For more coverage of this Forum ,see the Association's
December e-newsletter "BSA Newsbite" at
http://www.bsa.org.uk/publications/newsbite/december_08.htm.
6. The Association welcomes these remarks
and submits that they are relevant to LAs' decisions about where
to invest their surplus cash, and to the Government's guidelines
on LA investments.
Prudential Soundness
7. Building societies have an unparalleled
record of investor safety. No investor (retail or wholesale) has
lost money invested with a building society at least since the
Second World War. Although the recent crisis has exposed imprudent
behaviour elsewhere, the building society sector remains sound
and secure for several reasons.
8. First, the statutory framework of the
Building Societies Act 1986, last substantially revised in 1997,
enshrines a relatively prudent business model. Societies must
raise the majority of their funds (at least 50%) from their members'
savings, and the vast majority of their business (at least 75%)
must be fully secured residential mortgages. There are also statutory
restrictions on the riskier forms of financial trading: societies
cannot trade in currencies or commodities, they cannot make markets
in securities, and their use of financial derivatives (such as
interest rate swaps) is limited to the management of their own
risks.
9. Second, all building societies are "credit
institutions" for the purposes of the EU Banking Directives,
and are required to meet the same standards for capital adequacy
and risk control as UK and other EU banks. Societies have, moreover,
not needed to be "recapitalised" at the taxpayers' expense.
Societies face the prospect of increasing arrears and some losses
on their core mortgage business, and a few—like some LAs
and the Audit Commission—unfortunately may lose part of
some modest deposits with Icelandic banks. (Societies therefore
have every sympathy with their colleagues in LA treasuries.) More
seriously, all building societies are compelled to pay substantial
levies to the Financial Services Compensation Scheme towards the
cost of bailing out the depositors with a string of failed banks—Bradford
& Bingley, the Icelandic banks, and recently London Scottish
Bank. Notwithstanding all of these pressures, societies remain
resilient.
10. Third, where occasionally a society
has encountered difficulties, a merger with a stronger society
has ensured that both retail savers and wholesale depositors experience
no uncertainty or interruption to service. The building society
sector has continued to support intra-sector mergers, which require
no taxpayer funding, as a confidence measure and this has again
been demonstrated in a few recent cases.
Current LA Investment Guidelines
11. The Association was pleased to offer
comments in January 2004 when the draft of the current guidelines
was consulted on by Government. We supported the new framework
of statutory requirements and guidance in place of the previous
regime of "approved investments" specified in regulations.
And we supported the Government's general objective of encouraging
LAs to invest prudently, with the emphasis on security and liquidity
rather than yield. However, we challenged the emphasis placed
on high credit ratings in determining what qualifies as a "specified
investment". We said that such reliance on credit ratings
(for which most building societies otherwise have no need) would
operate to the competitive disadvantage of smaller and specialist
institutions including most societies. We explained in our 2004 comments
that obtaining, and then maintaining, a credit rating involves
significant management time and costs which does not make it a
sensible choice for smaller societies.
12. Notwithstanding this disadvantage, LAs
continued to invest since 2004 with building societies both
with and without ratings: the Tables in Appendix 1 show that
for a time this increased in both absolute and relative terms.
LAs used to deposit for longer periods where this suited their
own cashflow needs, and societies have been pleased to offer good
rates for such periods. More recently, however, deposits tended
to be placed for shorter periods. Feedback from our member societies
also suggests that some previously good deposit relationships
between LAs and some smaller societies have suffered, as LA treasurers'
departments have felt constrained to place funds only with the
biggest, rated, entities. (And a few LAs have, we understand,
ceased to deposit with the building society sector altogether.)
With hindsight, we suggest that the overall outcome may in fact
have been less safe for those LAs. We understand that the Chartered
Institute for Public Finance and Accountancy criticised over-reliance
on credit ratings in March 2008. Icelandic banks appear to have
enjoyed high ratings until a late stage in the banking crisis,
even after the point when some commentators, perhaps emboldened
by hindsight, now suggest that the Icelandic bubble was visibly
unsustainable. Nor were credit ratings of much use in predicting
the collapse of Northern Rock or Bradford & Bingley, or the
need for Government-funded recapitalisation of other major banks.
13. We note, in passing, that the current
guidelines treat LA investments made with any other local authority,
or parish council, or community council, as "specified investments"
without any requirement for credit rating, recognising perhaps
that in these contexts credit ratings add little if any value.
We would expect smaller LAs, parish and community councils to
look especially to their local LA contacts to source funds. The
Association advocates a strengthening of relationship-based placing
of LA funds with all societies, and especially with local and
regional societies, using sensible counterparty limits, as an
alternative to exclusive reliance on the credit ratings of what
may otherwise be little-known counterparties.
Future Role for Central Government
14. The Inquiry's terms of reference raise
three issues concerning the future role of central Government.
We address in particular (i) whether LA money should be invested
only in Government debt? and (ii) whether LA investments should
be guaranteed by the Government? We oppose both suggestions, for
the reasons given below.
(i) LAs to invest only with Government?
15. Local authority cash holdings are substantial,
and provide a significant element of the funding base of both
building societies and banks, as the Tables in Appendix 1 illustrate.
We appreciate that the suggestion has the superficial attractiveness
that LAs would be able to invest free of any credit risk. The
immediate effect of any such diversion of funds would be to increase
the scarcity of funds for banks and societies in the market, and
widen the already sizeable differential between market deposit
rates and the rates offered by the Government's Debt Management
Office (provided the DMO remains true to its remit of minimising
Government financing costs), so LAs' income from deposit interest
would fall further. This would clearly have an impact on LAs'
total income, and so on council tax bills, but we do not attempt
to analyse this further. Rather, we make the general point that
it is not healthy for the wider economy, in the medium to long
term, for more and more sources of funds to be redirected into
Government debt—both by wholesale investment in Government
securities and through National Savings, which remains a significant
force in the retail savings market. At a time when the Government
wants banks to continue lending to business, and building societies
to continue lending to homebuyers, taking away a substantial part
of their funding base would be entirely counterproductive.
(ii) LAs to get Government guarantee?
16. We recognise that in the short term,
some level of Government support—for instance, via the Credit
Guarantee Scheme announced in October—may be needed, to
stabilise the money markets after the unprecedented turbulence
and liquidity hoarding of the last few months. But we do not think
providing the LA sector with permanent Government guarantees is
the right answer, just as it is clearly not sustainable for the
Government to continue the present implicit 100% guarantee for
all retail deposits in banks. To do so in the longer term will
create or exacerbate moral hazard (that is, banks will be incentivised
to run greater risks as they are underwritten by the Government),
and (if properly priced) will add unnecessary costs. The CGS,
which we note only stays open for initial utilisation for six
months from the date of announcement, has quantified the cost
of adding a Government guarantee to bank or building society debt
that is already of high quality, and we suspect that cost will
deter actual use of the Scheme. Surely the right longer term outcome
is to have a diversity of prudently run deposit-takers in which
investors can have confidence, rather than central Government
taking on a new role of universal intermediation?
17. As to the role of central Government
(or other bodies) in providing guidance to LAs, we support the
present arrangements for statutory guidance, but continue to challenge
one aspect of its content, on credit ratings. We also suggest
that, after the primacy of security and liquidity, LAs should
be entitled to consider, alongside yield, whether the proposed
investment is likely to promote the availability of funds to finance
business or consumers, either in their locality or region, or
in the United Kingdom generally.
A Better Solution?
18. As indicated above, the Association
considers that the desirable longer-term outcome is for the United
Kingdom to have a diversity of prudently- run domestic deposit-takers
in which both retail and wholesale investors can have confidence,
and which can perform the necessary economic function of financial
intermediation, providing funds both to industry and to housing,
without being pre-empted or crowded out by Government. But we
recognise, following the recent crisis, how fragile that confidence
is. So we think, as a minimum, that the Authorities need to recalibrate
their collective risk appetite for bank failure. The Financial
Services Authority, in its 2003 paper Reasonable expectations
: regulation in a non-zero failure world distanced itself from
any notion of a zero failure regime. The events of the last few
months suggest that deposit-taking does after all require something
closer to a zero-failure regime, and we think this should be openly
acknowledged. While much attention has been given to the various
tools for dealing with the aftermath of failure—the Special
Resolution Regime, and cover provided through the Financial Services
Compensation Scheme—the Association contends that prevention
is better than cure. The Association has argued in other submissions
that what is needed is not new tools, but better, more focused
use of existing tools viz. prudential regulation.
Conclusion
We urge the Committee to support the continuation,
and deepening, of the deposit partnerships between building societies
and local authorities, and for this to be reflected in revised
Government guidance in place of an exclusive focus on credit ratings.
APPENDIX 1
Table 1
LOCAL GOVERNMENT DEPOSITS WITH BUILDING SOCIETIES
| | Inflows, net of repayments
£ million
| Balance outstanding
£ billion
|
| 2004 | 1,103 | 7.6
|
| 2005 | (233) | 7.5
|
| 2006 | 1,634 | 9.1
|
| 2007 | 2,623 | 11.8
|
| 2008 (to Q2) | 705 | 12.5
|
| |
|
Table 2
LOCAL GOVERNMENT INVESTMENTS: BUILDING SOCIETY SHARE
| | | Building societies
| Banks | Total (inc other)
|
| 2006 | £ billion
| 9.2 | 17.6 | 32.3
|
| % | 28.2
| 54.5 | 100 |
| 2007 | £ billion | 11.9
| 19.2 | 36.6 |
| % | 32.2
| 52.7 | 100 |
| Q2 2008 | £ billion
| 12.5 | 19.4 | 37.5
|
| % | 33.3
| 52.0 | 100 |
| Source : Financial Statistics, Table 1.3D |
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