Competition and choice in retail banking - Treasury Contents

Written evidence submitted by the Building Societies Association


—  Mutual lenders and deposit takers benefit the operation of the banking sector by nature of their ownership structure, which delivers diversity, lower risk, competition, democracy, high levels of service and trust, and a long-term perspective to the market.

—  Although mutuals have been affected by the financial crisis and recession, they have generally performed better than their plc competitors, and, in comparison, have drawn on very little support from the Government. However, current market conditions remain challenging for all financial firms, especially deposit takers.

—  In response to the events of recent years, mutuals have adapted their operations significantly, both by innovating and by reaffirming their core strengths. These have included controlling costs, continued focus on high-quality lending funded from retail sources, exploring shared services and continuing to improve corporate governance. Some mutuals have merged to create stronger institutions that are better placed to deal with the current market conditions and to grow in the future.

—  Regulatory changes should not discriminate against mutual institutions. It is essential that the Government ensure that amendments to the Capital Requirements Directive enable mutuals to raise external capital that is consistent with mutual ownership.

—  The Government should consider restricting the activities of banks that it owns so that markets are not distorted. The long-term payback from remutualising Northern Rock also merits consideration.

—  Substantial barriers to entry to banking exist. These include increasing regulatory requirements, networks of systems, branches and staff and, vitally, the need for trust.

—  Further changes to the banking sector need to be carefully evaluated so as not to cause unintended consequences, such as excluding groups of customers from the market or reducing stability.


1.  The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK including all 49 UK building societies. Mutual lenders and deposit takers have total assets of over £365 billion and, together with their subsidiaries, hold residential mortgages of almost £235 billion, 19% of the total outstanding in the UK. They hold more than £245 billion of retail deposits, accounting for 21% of all such deposits in the UK. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.

2.  This submission sets out the positive contribution that mutuals make to the banking sector in the UK in terms of competition and stability. Mutual lenders and deposit takers have not been immune to the financial crisis and recession of the last three years, and the effects of the financial crisis on mutuals are examined, and the sector's responses to these challenges are set out. The Government's role in banking is then addressed, before other aspects of the Committee's inquiry are covered, including barriers to entry, free banking and competition from foreign banks.


3.  There are a number of inter-related features of mutual financial service providers that enhance both competition and financial stability in the banking sector. These all follow from the organisations being owned by their customers.

4.  Firstly, mutuals add to the diversity of the sector. While publicly quoted banks might be expected to try to maximise returns to shareholders, mutuals pursue alternative strategies that are a consequence of the customer being the primary stakeholder. In a speech in 2009, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, highlighted the increased homogeneity of business strategies in the run up to the crisis, which reduced the resilience of the system as a whole[11]. A strong mutual sector with different incentives to plcs can potentially reduce herd effects.

5.  Mutuals also tend to take less risk than quoted banks. This is partly because it is difficult for mutuals to raise new capital (apart from via retained profits), but also because the majority of their members are savers, who are risk averse because they would not benefit from any upside, but could be subject to any downside from risky strategies. Mutuals have been less reliant on wholesale funding than plc banks, with more stable retail funds accounting for 70% or more of total funding. And the proportion of mortgage loans that is in arrears is typically much lower at mutuals than across the market as a whole.

6.  Competition in banking and mortgage markets is enhanced by the presence of mutual lenders and deposit takers. As they do not have to pay dividends to shareholders, mutuals can offer more competitive rates of interest on savings and mortgages than can banks. For example, Moneyfacts found that 73% of consistently high-paying savings accounts were offered by building societies[12]. Mutuals therefore impose a competitive constraint on the pricing activities of their bank rivals.

7.  Mutuals are accountable to their owners, their customers. Members of building societies can vote to appoint directors to the Board, so directing the strategy of the organisation. Furthermore, at mutuals customer feedback may command more direct attention than at quoted banks as it does not compete with the needs of external shareholders. Mutuals have made considerable improvements to their corporate governance in recent years, with greater disclosure of information (including the voluntary disclosure of directors' remuneration, which on average is approved by over 90% of members who cast their vote), increased proportions of members voting at Annual General Meetings, and deeper and more consequential direct contact between members and directors[13].

8.  Research has consistently shown that mutually-owned financial firms deliver higher levels of satisfaction and trust than plc banks. Research conducted this year showed that mutuals outperformed plc banks across eleven aspects of customer service (see chart)[14]. This is because the interests of customers are paramount at mutuals, and not in conflict with those of shareholders, as is potentially the case at other banks. Staff at mutuals are aware that they are dealing with an owner of the business, so the customer relationship is quite different from that at plc banks.

Source: GfK NOP survey of 1,968 adults, 11-16 March 2010

9.  Finally, the economist John Kay has noted that "the special value of mutuality rests in its capacity to establish and maintain relational contract structures" which are well suited to the long-term nature of mortgage lending[15]. The trusted relationships necessary in mortgage and savings markets can only be built up over a protracted period. Mutuals are not subject to the same short-term pressures that might apply to banks that must maximise returns to shareholders.


10.  Mutual lenders and deposit takers have obviously not been immune from the financial crisis and recession. At the height of the crisis, mutuals were the recipients of substantial deposit inflows from worried customers of banks. In the last year or so some of these deposits have since moved elsewhere as the banks (including those failed banks now supported by the taxpayer) have competed aggressively for retail funds due to the closure of wholesale markets and the need to roll-over many hundreds of billions of maturing wholesale funding over the next few years. Households are struggling to save, and the low interest rate environment causes them to seek higher returns from riskier investments. As a result deposits from households grew by just 2% in 2009. Mortgage lending has also fallen substantially across the market. In 2009 outstanding mortgage balances grew by just 1%. The low interest environment continues to put considerable pressure on profit margins at all retail banks, mutuals included. These pressures are added to by regulatory changes, including increased capital and liquidity requirements, and the levies of the Financial Services Compensation Scheme, which fall disproportionately on retail-funded mutuals.

11.  However, mutuals have generally been less affected by the financial crisis than publicly quoted banks. The FSA has observed that "although building societies, like banks, have been weakened by adverse economic and financial market conditions, the extent of that weakening has to date been less than that experienced by the banks mainly because of the lower exposure to wholesale funding and complex financial instruments"[16]. It is noteworthy that of the former building societies that demutualised, none remains today as an independent entity.

12.  Although the Dunfermline Building Society did require resolution under the Banking Act, the sector overall has called on very little direct assistance from the authorities during the crisis[17]. Instead, the sector has addressed any problems that have arisen itself, including a number of mergers between mutuals (though not all of these have occurred out of distress). There remain 49 separate building societies, and the brands of many merged societies also continue to be present on high streets, and there are several mutual lenders and deposit takers, including the combined business of Co-operative Bank and Britannia. Consolidation has helped to ameliorate some of the immediate issues facing certain societies, resulting in stable and secure institutions, such that the mutual sector continues to provide meaningful diversity and competition in banking markets.


13.  Mutuals have responded in a number of ways to the challenges of the financial crisis. As has already been mentioned, several mergers have occurred and there will doubtless be other societies that decide to merge in the future, but this is by no means a certainty for all mutuals, and there are likely to be limits to the benefits from increased size and scope in financial service providers[18]. Very many building societies, small and large, have performed well over the last few, challenging, years.

14.  This has been achieved by a number of approaches. Ongoing efforts to manage costs have intensified, with several societies taking difficult decisions to scale back activities in geographical or market segments that are not core to their operations. However, measures continue to be taken to ensure the high levels of service and trust that distinguish the mutual sector are preserved. Mutuals have reduced their use of wholesale funding, which peaked at 30% of funding, much lower than most banks. As stood them in generally good stead going into the crisis, mutual lenders are focussing on high quality assets and are pricing cautiously for risk.

15.  Mutuals are also exploring ways to work together to share services or to develop methods of pooled funding. Steps to improve corporate governance at mutuals continue to be made, with a working group chaired by the Financial Reporting Council investigating this issue. The BSA has also helped to share ideas and best practice in engaging members effectively.


16.  The Coalition stated in its Programme for Government that "we will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry."[19] The previous Government also stated its strong support for the mutual sector[20].

17.  The BSA would like to see this support translated into action in the European Commission's consultations on capital. One drawback of the mutual model is that it is difficult for mutuals to raise additional capital, particularly when market conditions are stressed. An extremely important consequence of this is that current consultations at a European level on what constitutes core capital must give due consideration to alternative organisational forms to the plc. The definition of core capital needs to be consistent with mutual ownership (and be marketable to investors) if it is not to disadvantage mutual firms. The BSA and its members have urged the UK authorities to take the initiative in the consultations in Europe to ensure diversity and competition are promoted[21].

18.  Banks that received direct State-backing during the crisis have subsequently distorted the operation of the UK's mortgage and savings markets, and now dominate these markets. The direct Government support gives deposits held with these banks an implicit guarantee. Conditions should be applied to these institutions' activities to limit unfair distortions to competition, at least, and we welcome the review by the Independent Commission on Banking into the future structure of the industry.

19.  If a long-term view is taken in relation to divesting the State's ownership of Northern Rock, converting the failed bank back to a mutual becomes a viable option. This could be achieved by arranging for Northern Rock to pay returns to the taxpayer over a number of years to repay the injection of capital[22]. Remutualisation would help to foster diversity and promote mutuals, and deserves serious consideration by the Government.


20.  There are significant barriers to entry and expansion in retail banking, and the BSA welcomes the OFT's review, to which we made a detailed submission[23]. In that submission, we drew attention to the principal importance of consumers' trust in financial services, since banking is relational rather than transactional, and this has implications for how barriers to entry and exit are interpreted. Consumers, and the wider public interest, would not be served by a proliferation of fly-by-night deposit takers.

21.  The establishment of trust and reliability are in addition to other substantial set-up costs relating to systems, branches and staff, and are more fundamental than simply investing in a new brand. Trust is built on consumer perceptions and moral judgements, which can be developed only over a prolonged period of time.

22.  Therefore, while consumer inertia does exist, this may reflect the necessity of long-lasting trusted relationships as much as consumer confusion. There are now more ways than ever before for consumers to find out about products, and the wide range of options available often represent features tailored in response to demands from specific market segments rather than providers' desire to obfuscate.

23.  Regulation is another significant and growing barrier. As well as increased capital and liquidity requirements, there is the Mortgage Market Review, changes to the Financial Services Compensation Scheme (FSCS), and just for building societies, a Specialist Sourcebook. It is not at all clear that the cumulative effects of all these regulatory changes have been assessed. Nor is it apparent that the potential trade-offs between competition, financial stability, distribution (reducing financial inclusion, for example) and supporting economic growth have been actively managed.

24.  For example, new regulation to preserve stability has tended to favour large incumbent organisations, protecting them from competition, with additional prudential regulation typically representing a greater proportionate cost to small firms. As a result, in 2009 Lloyds Banking Group had a 24% share of new mortgage lending and 28% of the increase in deposits, and Santander, which combined Alliance & Leicester and the savings business of Bradford & Bingley banks with its Abbey brand, took an estimated 18% share of new lending and 23% of the increase in retail deposits in 2009. And some small societies are inclined to interpret the increased regulatory burden as being driven by a hidden agenda for the consolidation and marginalising of smaller institutions.

25.  Another regulatory barrier is the FSCS. The BSA is extremely concerned about the requirements proposed by the European Commission to build up a deposit guarantee fund (equivalent to 1.5% of eligible deposits) at a rate that would be crippling for the entire existing retail banking sector, and would pose an additional barrier to potential entrants. The Government needs to ensure any changes to deposit protection can realistically be achieved.

26.  The wider mutual sector incorporates credit unions, which can now offer basic banking services. Credit unions are not subject to the European banking directives and therefore it is much easier to establish a new credit union than, for instance, a new building society. It may be appropriate to increase the coverage of the Building Societies (Funding) and Mutual Societies (Transfers) Act to facilitate the transfer of engagements between credit unions and other types of mutual so that expansion is not constrained.


27.  Account terms and conditions and charges should be reasonable and presented clearly to consumers, and the OFT has been working with current account providers to improve the transparency of charges, as well as the account switching process. Mutual financial service providers offer simple products, primarily through branches, with many savings accounts that can be opened with just one pound. And mutuals have tended to keep their branches open to a greater extent than banks.

28.  However, when considering policy relating to the pricing of banking services, it is important to consider the potential distributional effects of any changes, as alternative fee structures may increase financial exclusion. It is likely to be especially helpful to those on low incomes if, by keeping their account in credit, they are able to operate a bank account for free.


29.  Although several foreign-based lenders may have left the UK market following the credit crunch, it is not clear that foreign-based deposit takers have been so deterred. Many of the most competitive savings interest rates currently available are offered by institutions based in other countries, and often outside the EU. The role of foreign-based banks is complicated by potential issues such as instability if increased competition from abroad results in a greater amount of entry and exit from the market, and also the risk that foreign-owned banks enter to attract the most profitable customers, with the possibility that less profitable customers are excluded. It is also pertinent to question whether foreign-based deposit takers that compete for UK savings then play their part in providing credit to UK households or businesses, or whether the money is deployed overseas, possibly at greater risk (as the Icelandic banks episode demonstrated).


30.  The mutual sector provides a valuable alternative to the large plc banks, and mutuals have responded to the economic challenges to ensure that they continue to do so in the future.

31.  We welcome the Coalition Government's support for mutual financial service firms, but this needs to be translated into action. This is most pressing in the need for the definition of core capital consistent with the mutual model. And in policy making mutuals should not be considered merely as an afterthought to the hegemony of shareholder (and Government) owned banks.

September 2010

11   "Credit is Trust" Haldane, A, Bank of England, Back

12   Moneyfacts press release, 19 January 2010 Back

13   "Conversations with Members", BSA, 2010: Back

14   "Customer service at mutuals is better than at banks", BSA, 2010: Back

15   Kay, J, 1991, "The economics of mutuality" Annals of Public and Co-operative Economics, 62, 3 Back

16   Specialist Sourcebook For Building Societies, FSA, Back

17   No building society received any public money under the Bank Recapitalisation Programme nor took part in the Asset Protection Scheme. Use of the Credit Guarantee Scheme and the Special Liquidity Scheme by building societies was relatively modest. Back

18   "The $100 billion question" Haldane, A, Bank of England: Back

19   Coalition Programme for Government: Back

20   "Reforming financial markets" HM Treasury, Back

21   The BSA's submissions relating to capital can be found via these links:
HM Treasury:

22   "Converting failed financial institutions into mutual organisations", BSA, 2009, Back

23   BSA submission to OFT review into barriers to entry: Back

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Prepared 2 April 2011