The changing environment of the building societies

Building societies

The primary purpose of building societies has been to provide finance for residential housing, and as such they provide a large proportion of the fi­nance for house purchase within the UK. As a consequence of the need to raise funds to do tills, they are also major participants in the market for savings, particularly retail savings. In more recent years, however, they have started to provide a range of other services, to make loans for purposes oilier than house purchase, and to reduce their dependence on the retail savings market by raising an increasing proportion of their funds from wholesale sources.

Two of the significant changes in the environment facing building societies in recent years - the ability to make loans for purposes other than first mort­gages, and to make extensive use of wholesale funding - were a consequence of the Building Societies Act 1986. The 1986 Act gave rise to two other significant changes in the societies' environment, the abilities to:

- Convert from being mutual organisations to public limited companies;

and

- Provide a much wider range of financial services.

In order to convert to a public limited company, a society requires the permis­sion of its members. This permission is defined as a 75% majority amongst the lending members who vote in the ballot on conversion, where this 75 % is achieved from a minimum of 20% of the lending members who are entitled to vote. It also requires a simple majority of the borrowing members who exercise their vote and the approval of the Building Societies Commission. This is designed to ensure that members' interests are protected during the conversion process.

Since a building society that achieves pie status will have shareholders and will no longer be a mu tual organisation, it cannot be a building society; in practice, it becomes a bank, and therefore authorisation from the Bank of England to become a bank is also a necessary part of the process for conver­sion to plc status.

Although at the time of writing only two building societies (Abbey National and Cheltenham & Gloucester) have converted to pie status, several of the other large building societies are planning to do so in 1997. In fact the Cheltenham & Gloucester, as part of the conversion plan, was immediately acquired by Lloyds Bank, and in August 1996 the National & Provincial was taken over by Abbey National. In 1997, Halifax, Woolwich. Alliance & Leicester and the Northern Rock all plan to become pies (although not necessarily in that order), while Bristol & West proposes to be taken over by Bank of Ireland. Of these societies, only National & Provincial has lost its identity, although the Leeds Permanent was purchased by the Halifax in 1995 as part of its move to a plc, and all the Leeds' branches are now closed or bear the emblem of the Halifax.

The major advantage of conversion to plc status was considered to be freedom from the restrictions of the legislative framework of the building society in­dustry, the 1986 Act. The restrictions which were seen to be particularly harmful to the future prosperity of the building societies were the limits on

- Unsecured lending;

- Lending to corporate and overseas customers;

- The ability to increase capital only by means of retaining profits;

- The ability to take over or merge (apart from paying cash) with other finan­cial institutions in order to add to the range of financial services offered;

- The range of financial services which building societies are permitted to offer:

- The ability to offer profit-sharing schemes in the form of share distributions to their staff.

By the mid-1990s, however, there was a new reason for the urge to convert to pie status. A number of the largest societies saw conversion as the only way to continue to grow in size, because the housing market was dormant and the banks were gaining a large market share of new mortgage business. Pie status was the route away from a declining/stagnant mortgage market to the expanding markets of financial services.

Substantial though these constraints may be, the fact that some building societies strenuously assert their opposition to pie status implies that there are disadvantages also. These are seen to include the:

- Supervisory requirements of the Bank of England;

- Need to pay dividends to shareholders and the danger of being pressured into short-term responses to strategic issues;

- Possible eventual concentration of shareholdings into the hands of a lim­ited number of investors, with the chance of increased shareholder influence on strategy;

- Possibility of takeover bids; and the

- Adverse impact on the image of a building society that its move away from mutual status would bring.

It has also been suggested that the more competitive environment into which a building society would move upon conversion would raise its operating costs as a consequence of having to recruit appropriately qualified staff.

The 1986 Act allows societies to:

- Provide a much wider range of financial services;

- Take equity stakes in both general and life insurance companies;

- Take equity stakes in stockbroking firms:

- Establish and manage personal equity plans and unit trusts through as­sociated bodies: and

- Undertake fund management.

Thus, building societies are able to offer a much more complete set of retail financial services, although it has been argued that this is still too narrow to allow the building societies to compete with banks on an equal footing. Fur­ther powers are available for societies to incorporate in their constitutions, after approval by the members at AGMs, and these include insurance and the formation of subsidiaries to lend to small businesses. Some societies now have these powers, but they have yet to enter these new markets.

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