Written evidence submitted by the Building
Societies Association
EXECUTIVE SUMMARY
— 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.
INTRODUCTION
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.
MUTUALS' CONTRIBUTION
TO THE
BANKING SECTOR
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.
THE EFFECTS
OF THE
FINANCIAL CRISIS
ON MUTUALS
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.
RESPONSES BY
THE MUTUAL
SECTOR
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.
THE ROLE
OF GOVERNMENT
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.
BARRIERS TO
ENTERING THE
MARKET
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.
FREE BANKING
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.
FOREIGN-BASED
OPERATORS
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).
CONCLUSION
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, http://www.bankofengland.co.uk/publications/speeches/2009/speech400.pdf Back
12
Moneyfacts press release, 19 January 2010 http://www.moneyfactsgroup.co.uk/press/pressreleases/displaypressrelease.asp?id=727 Back
13
"Conversations with Members", BSA, 2010: http://www.bsa.org.uk/docs/publications/conversations_with_members.pdf Back
14
"Customer service at mutuals is better than at banks",
BSA, 2010: http://www.bsa.org.uk/docs/consumerpdfs/customerservice.pdf 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, http://www.fsa.gov.uk/pubs/cp/cp09_17.pdf 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:
http://www.bankofengland.co.uk/publications/speeches/2010/speech433.pdf Back
19
Coalition Programme for Government: http://programmeforgovernment.hmg.gov.uk/files/2010/05/coalition-programme.pdf Back
20
"Reforming financial markets" HM Treasury, http://webarchive.nationalarchives.gov.uk/20100407010852/http://www.hm-treasury.gov.uk/d/reforming_financial_markets080709.pdf Back
21
The BSA's submissions relating to capital can be found via these
links:
HM Treasury: http://www.bsa.org.uk/policy/response/capital_related_issues_response.htm
CRD4: http://www.bsa.org.uk/docs/policy/prudentialandfinreg/CRD_4.pdf
Basel: http://www.bsa.org.uk/docs/policy/prudentialandfinreg/basel_164_and165.pdf Back
22
"Converting failed financial institutions into mutual organisations",
BSA, 2009, http://www.bsa.org.uk/docs/presspdfs/remutualisation.pdf Back
23
BSA submission to OFT review into barriers to entry: http://www.bsa.org.uk/docs/policy/OFT_B2Ebanking.pdf Back
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