Jeff Salway: Indiscriminate regulation may be final nail in coffin for mutuals

Published on Wednesday 18 November 2009 19:33

THE Building Societies Association's annual lunch last week was a subdued yet defiant affair, by all accounts. The sector is shrinking and it must have been tempting to speculate how many societies would be around for next year's gathering.

Building societies are under huge pressure in the face of one-size-fits-all regulation, competition from state-owned banks and a savings environment that makes it difficult to attract the deposits with which they can lend competitively.

At last week's lunch, BSA chairman Graham Beale, the Nationwide chief executive, warned that the capital requirements set out by the Financial Services Authority (FSA) for both banks and building societies pose a serious threat to mutuals. The BSA is increasingly vocal in its opposition to the FSA's requirements, which Beale describes as "anti-mutual".

It has every right to be. There is no doubt that mutuals were hit hard by the credit crunch, but they have not required taxpayer funding to stay afloat, unlike several banks. What did happen was a wave of consolidation as a number of building societies were snapped up by bigger rivals in low-cost rescue deals.

Nationwide was particularly prominent, buying the Cheshire and Derbyshire building societies, while the Barnsley and Yorkshire societies joined forces, as did Skipton and Scarborough and the Britannia and Co-operative Financial Services. The only society requiring state intervention was the Dunfermline, which paid the price for risky property market investments.

On the whole, building societies have survived because they have stuck to their core functions and resisted the temptation to diversify into lucrative but risky activities.

Take the Scottish Building Society as an example. Its retail inflows were 40 per cent ahead of target in the first half of this year, giving it a solid base from which to lend. The society steers clear of risky lending, such as the commercial loans that were the undoing of Dunfermline, and its latest savings product, the Tartan bond, is one of the more competitive available. But sticking to core activities – lending the money generated from savers – apparently counts for little as far as the watchdog is concerned.

The FSA admits that while mutuals have not been immune to the credit crunch, the model had "stood up well". That view is not reflected in its one-size-fits-all approach to regulation, however.

The biggest concerns are the funding requirements, under which all financial institutions have to hold more money in low-return liquid assets, and Financial Services Compensation Scheme fees that have risen sharply in order to prop up banks that took on excessive risks.

The funding requirements ignore the limitations of mutual status when it comes to raising funds, as, unlike banks, they cannot tap up shareholders for more money. Not only that, but in a low-interest rate environment, building society savings margins are also increasingly squeezed as they seek to attract more deposits. As a result, mutuals are unable to compete on mortgages and now levy the highest standard variable rates around.

So the funding requirements could be the final straw. BSA head Adrian Coles recently warned that as the publicly-owned bodies distort the competition in the market, building societies will suffer disproportionately. He pointed to the improved savings deals on offer from Royal Bank of Scotland, Bank of Scotland and Northern Rock. It could get worse next year, when the latter has 8 billion of government money with which to lend.

This unlevel playing field and the extra funding burden will be too much for some of the smaller, community-based societies. In the short term, building societies will have to pass their higher costs on to customers through higher charges and less competitive and more expensive products. Inevitably, however, more will be absorbed by bigger rivals.

Having been prudent enough to survive the downturn, they will now fall victim to indiscriminate regulation.

Plans to make it easier for mutuals to share back-office functions – to be unveiled in the Pre-Budget Report next month – are positive. But unless the FSA eases the burden on building societies, more names will disappear at a time when the back-to-basics model associated with mutuals is being touted as the answer to the woes of UK banking.