Examination of Witnesses (Questions 241-259)
MR JEREMY
PALMER, MR
GUY SEARS
AND MR
RICHARD WARNE
9 FEBRUARY 2009
Q241 Chair: Welcome to this afternoon's
evidence session. I note there are two representatives of the
IMA.
Mr Sears: That
is correct.
Q242 Chair: Can I start with the
question which, in the first instance, is addressed to Mr Palmer
about the benefits to local authorities of investing in building
societies rather than banks. Can you explain whether you think
building societies offer local authorities more secure investments
than the banking sector and whether that comes at the cost of
lower yield?
Mr Palmer: Rather than trying
to say that buildings societies are more secure than the banking
sector we would like to argue that building societies offer broadly
a safe and remunerative home for local authority deposits. On
the question of relative security, I would like to draw on something
that was published today by the Financial Services Authority in
their financial risk outlook where they talked about building
societies being less affected relatively by some of the recent
turmoil than many of the banks and remaining resilient. Among
the things we would argue in favour of building societies is the
essential business model is low risk and relatively prudent because
it is concentrating on secure residential lending, drawing the
funding from retail savings and not being involved in some of
the more exotic forms of financial trading. To begin with I rest
the case there. On the question of returns, one thing I noticed
in some of the written evidence given to the Committee was the
question of whether some local authorities, particularly ones
with smaller amounts to invest, are getting acceptable returns
when they approach the very large institutions. Building societies
on the whole welcome smaller deposits and I think in general would
be happy to quote for them so that is another factor in their
favour.
Q243 Chair: Looking at the data we
have been given as a Committee from your memorandum, the percentage
of local authority investments in building societies has gone
up slightly from 2006 to 2008 and slightly down in banks. There
is no evidence that local authorities are not investing in building
societies.
Mr Palmer: The latest information
we have from the third quarter of 2008 up to the end of September
is that there is a very slight reduction in the total. I think
it has fallen from £12.5 billion to about £11.7 billion
and in percentage share it has gone to around 30%. It is a very
slight reduction and that is up to September. We do not see that
as necessarily very significant but we are very keen that the
long tradition of local authorities depositing with building societies
should continue.
Q244 Sir Paul Beresford: This is
a naive question, but where do building societies invest the money
that is invested with them and why should not the local authorities
go straight to those people the building societies invest in?
What do you think of the idea of Essex setting up effectively
its own building society for mortgaging?
Mr Palmer: Dealing with your first
general point, what building societies do with the money in general
is to use it for making home loans. That is their principle purpose
and essentially has to be the core of their business. At least
three quarters of the asset side of their balance sheet has to
be in the form of loans fully secured on residential property.
They will do some other things with the money; they have to hold,
at the moment particularly, quite high liquidity. To answer your
question in that sense, if local authorities wanted to go direct
to the end product that would mean becoming mortgage lenders themselves.
Q245 Sir Paul Beresford: Which many
of them do?
Mr Palmer: Many of them have done
in the past and may wish to do again. We would submit that building
societies are used to doing it, they do it quite well, it is what
they are there for and therefore that is quite a good home for
what, in local authority terms, are temporary cash surpluses.
Q246 Sir Paul Beresford: What about
the Essex idea?
Mr Palmer: Again, if that works
for Essex we would be entirely supportive. We have building society
members in our association who equally feel that they would serve
Essex and other counties well as lenders.
Q247 Chair: Can I ask the same question
about banks versus building societies of the IMA?
Mr Sears: The importance is to
say that of course building societies should be part of the product
range that should be considered by local authorities. I do not
think there is any doubt about that but banks should be as well.
The real question is, as ever, what are they actually doing which
may be linked to Sir Paul's question? What is the business model
of that particular building society or bank and what risk is it
exposing it to?
Q248 Mr Hands: I have a question
about an alternative asset class. I think I know what your answer
would be but what about the other option of government stock?
Do you think local authority money should be invested in short-term
or long-term government stock and what effect would it have on
the banking and building society sector if you were to see a significant
shift in local authority business towards placing it with central
government?
Mr Sears: Again, for us it is
a product that local authorities should consider but, at the risk
of sounding a little harsh about it, whether or not there is then
a consequence in the wider economy is not necessarily something
I would put on the shoulders of council members and local authorities.
I think they choose where they need to invest for their purposes
and security. It is absolutely right if there are consequences
to do with inter-bank liquidity and the money markets that these
are matters the government should be considering with the Bank
of England. In a sense the counter-factual, should they not put
anything in there because otherwise it might have an impact in
some other area, I am not sure is one I would support.
Mr Palmer: From the building society
point of view we very much value the deposits we currently hold
from local authorities. It is a modest part of the total balance
sheet, about one eight of the total of wholesale funding that
all societies have at the moment and as a proportion of the total
balance sheet it is about 4 to 5%, but it is valued. It has been
a stable source of funding so we argue, in our submission, against
the proposition that all local authority surpluses should be directed
into government debt. I notice that a number of other witnesses
in their evidence commented that that would have a significant
effect on the return they would achieve. We would also argue that
it is not a good idea for the government to have to be the universal
financial intermediary. That is why we have banks and building
societies and we submit they should be well regulated but allowed
to get on with their job.
Q249 Mr Hands: Do you think local
authorities have placed too much reliance on credit ratings and
the credit rating agencies in recent times and what specific evidence
have you got to support that?
Mr Palmer: We believe they have.
We argued against excessive reliance on ratings in 2004 when the
current guidance was consulted on. From reading a number of the
other pieces of written evidence there seems to be a general consensus
that perhaps mechanistic reliance was placed on credit ratings.
We would argue, because a number of our member societies do not
seek credit ratings but are nevertheless quite strong credits
although smaller, that it is a bad idea to concentrate too much
on credit ratings. It has a slightly anti-competitive effect because
there are a number of institutions who can provide a safe home
for local authority deposits but who are not of the scale and
do not issue the tradable debt for which a credit rating is particularly
appropriate.
Q250 Mr Hands: How many building
societies have a credit rating out of your members?
Mr Palmer: Different ones have
ratings from one or more of the three main agencies. Probably
about a dozen or slightly more may have one rating or another.
Q251 Chair: How many building societies
are there?
Mr Palmer: There are 55.
Q252 Chair: Are they the bigger ones?
Mr Palmer: Typically it is the
largest societies that have ratings and they use the ratings because
they issue debt securities.
Q253 Mr Hands: Clearly you think
that local authorities have been deterred from the building society
sector because of their mechanistic reliance on credit ratings.
Mr Palmer: The figures show that
the aggregate deposits with the building society sector have not
fallen significantly. Within the sector there is some evidence
that our members have given us that the smaller societies, who
are typically unrated, have lost out more recently because of
the ratings issue.
Q254 Mr Hands: The smaller ones have
lost out recently since the Icelandic bank fiasco because they
do not have a credit rating so if anything the Icelandic situation
has driven local authorities into more reliance on credit ratings.
Mr Palmer: It is difficult to
say where the money has gone as we do not have access to all the
information. What a number of our smaller member societies tell
us is that over those few months even established relationships
with a local authority that used to be content to deposit with
them are under pressure and in some cases people are no longer
placing or renewing.
Q255 Mr Hands: Do you think that
is due to the credit rating issue or to a more general flight
to quality of the larger institutions?
Mr Palmer: A bit of both.
Q256 Anne Main: Can I pursue the
credit ratings argument somewhat? Without a credit rating you
say that some local authorities have been happy to place funds.
How would you suggest that a local authority, if it was to suddenly
start going towards building societies, would be able to choose
amongst you?
Mr Palmer: We suggested that where
local authorities might consider depositing with unrated societies
that they would start doing it on a relationship basis; in other
words they might consider which societies are local to them, which
ones do they know about, which ones would they like to get to
know, look at their financials, become comfortable with them,
agree a modest exposure limit so everything is sensible and then,
if that is felt appropriate and is agreed by the relevant committee
at the local authority, to make a deposit.
Q257 Anne Main: Do you believe there
is a mechanism in place with local authorities to be able to do
all that relationship building?
Mr Palmer: Some of it happens
at the moment. Some of our members tell us they have good relationships
with some local authorities who are happy.
Q258 Anne Main: Who would take the
responsibility within a local authority to foster that relationship?
Mr Palmer: I would imagine it
would start at the level of the treasury, whatever treasury function
within the local authority, but also our members would be very
happy to take the initiative to build those relationships where
that is not felt to be unwelcome.
Q259 Anne Main: Can you accept that
the reason credit ratings have possibly been utilised by so many
authorities, and followed slavishly some might say, is because
there is not the degree of expertise within local authorities
to actually make decisions without relying on some sort of advice,
whether it might be retrospective via a credit agency or proper
advice coming in that is more real-time?
Mr Palmer: I appreciate that particularly
when dealing with large numbers of institutions which cannot be
familiar to the local authority then a credit rating is a valuable
tool. We are arguing that in particular where local authorities
may well have an awareness of building societies who are local
to them or regional to them they may be happy to make the effort
to get to know them, understand them, analyse them and then, in
modest quantities, deposit with them. To some extent this must
happen already because a number of our unrated member societies
do attract deposits.
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