Paper on the Costs and Benefits of Building Society

At the beginning of this century there were more(prenominal) than 2000 construct societies, fiercely independent correlative arrangements, formed in the spirit of Victorian self help. There be at familiarize just 71. Some of these that fall in disappeared were terminating societies with a fixed wind up date. The last terminating society was the Fist Salisbury which wound up in 1980. Other societies guard been swallowed up in take up-overs or converted into banks in the great 1997 demutualisation.This assignment will discuss this trend with particular reference to the potential costs and benefits in the short and long term. This assignment will examine the costs and benefits to the create societies as well as those to the members and staff.The Costs and Benefits to the create SocietyConversion to plc status is seen as having the major prefer that there would be remedydom from the set upations imposed by the grammatical construction Societies execute 1986, 1997 the st atutory framework for the Building Society industry. The restrictions the Act impose include the pursual1) 75% of all lending has to be secured against residential propertyThis means that Building Societies are limited in their participation in the more risky, besides more rewarding unsecured lending. At the moment, Societies quarter make unsecured personal loans up to a limit of 15,000 per customer, whereas there is no ceiling for Banks. Building Societies with less than 100m of assets are not permitted to make unsecured loans.2) No more than 50% of bullion may be raised on the sell marketsThis limit was previously 40% before the revised 1997 Building Societies Act.Building societies squander eagerly taken the opportunity to raise money in the wholesale markets, which make water frequently proved to be the cheapest source of wholesale funds (Wholesale funds are large deposits placed by companies and financial institutions, bearing an gratify send in line with the market calculate rather than base grade). They have used these funds to even out any shortfall in the inflow of retail funds to meet the mortgage demand.Banks have no ceiling on raising wholesale funds, which are usually cheaper than retail funds. Building Societies may besides rein themselves at a disadvantage in access to wholesale funds at competitive range. As only 50% of funds can be raised from the wholesale market only the very largest societies can maintain the necessary standing in the international capital markets which allows wholesale funds to be tapped on the finest terms. Equally, the capacity to cope with the volatility of the wholesale markets and the risks they pose, requires Treasury management teams on an increasing sophistication to which only the largest societies can aspire.3) in the beginning the 1997 Act, edifice societies could only crack cocaine temporary or occasional overdrafts tocorporate customers. Now building societies can establish subsidiaries to lend to business customers, still have not yet become significant lenders to industry. This is in contrast to banks who are verymuch regarded as lenders to businesses. As a result of the Building Societies Act 1997, building societies are now withal able to a) make unsecured loans to incorporated businessesb) to own a everyday insurance company which could write trapping related policies (buildings, contents and mortgage gestatement protection insurance).Building Societies are limited in raising capital. Until 1991 building societies could only raise capital by means of retained profits. Now larger societies, to increase capital, can issue Permanent Interest Bearing Shares (PIBS). This is in contrast to plcs who are free to raise capital in the market by issuing assigns and bonds if they plan to expand. An example of this is Barclays 1987 rights issue to raise 921m to pay growth.Building societies cannot in general engage in take-overs of, or mergers with other types of financ ial institutions in order to expand their breadth of operations, and retain their mutual status. Banks have this freedom and can finance mergers and acquisitions through the issue of in the raw covers, whereas building societies can only finance acquisitions with cash.Efficiency is also an issue as a plc profit making organisation is perceived as having greater efficiency than a mutual organisation. However competition has proved a spur to efficiency at least as effective as the disciplinary effect of a public quotation (PRIMA). As a result of the break up of the societies cartel arrangements for setting interest grade, the banks have made successful inroads into the mortgage and savings markets and hence competition is today very strong.There are many costs and disadvantages associated with building societies converting to banks includingThe new plc will be regulated by the Bank of England, rather than the building societies commission. The plc will operate under the Banking Ac t 1987, compared to the Building Societies Act 1987, 1997. The plc may find it difficult and time consuming, at least initially, to deal with the new method of regulation. The Governments planned new super regulatory body may also provided further legislation that has to be adhered to.2) Need to pay out dividends and ability and pay competitive interestThe plc will find itself under stuff to pay out growing dividends to shareholders. This reduces retained earnings, thereby reducing the plcs ability to pay competitive interest rates. In the past building societies have been able to operate on a narrower margin than banks between their rates to the depositors and borrowers becausea) their low management cost (due to their less complicated specialist business)b) no requirements to pay dividendsc) low capital requirements due to the low risk nature of their assetsd) because the banks tended to subsidise their money transmission service by their deposit accounts, which lessens their abi lity to struggle in the savings market.3) The plc becomes open to possible take-over bidsThe change of status may have adverse effects on the institutions image with customers. This may adversely affect its ability to compete with Building Societies.Building Societies are generally regarded as friendly institutions, concerned first and foremost with the customer. A comprehensive moot of public perceptions of different financial institutions conducted in 1987 showed that building societies enjoy a positive rating of 85%, compared with only 51% for the high street banks (Personal pay & The Future of the fiscal High Street, Research Associates, March 1988). Building societies have traditionally been seen as a safe depository for the savings of working concourse. Building Societies are safe and a principal reason why is that interdependency has restricted them to safe, low risk activities. This safety and friendliness have strong customer appeals, which may be lost if conversion to plc status takes place.In general building societies have low levels of bad debt relative to banks. The lower levels of bad debt can be put down to the loaning restrictions set down by the Building Societies Act 1986, 1997 (e.g. 75% of loans must be secured against residential property).In 1997 a number of building societies decided to give up their mutual status in favour of plc status. These conversions and take-overs resulted in a number of windfall payments to society members. These windfalls were in the form of cash or free shares. The size of windfall varies from society to society, provided investors due to observe windfalls from all the building societies that surrendered their mutual status during 1997 (Halifax, blue Rock, Alliance & Leicester, Woolwich, Bristol & West) can expect shares worth an average total of about 6,000 (IC vol. 120/1524 page 34).This is clearly a short term benefit to members but it is argued that as plcs these causation mutuals will in the long term not be able to offer such attractive interest rates for borrowers and savers. Christopher Rodrigues, Chief Executive of the Bradford & Bingley argues The one off benefit of plc conversion is here today, gone tomorrow. The higher savings rates and lower loan rates of mutuality are for life not just for flotation day. Mr Rodrigues points out mutuals dont have to consider the demands of shareholders particularly for high dividends or share price growth so profits can go to members via reveal interest rates on savings accounts for example.Which?, the respected Consumers Association magazine has also criticised these conversions and claims the new banks will be forced to squeeze customers for maximum profitability. Which? Argues that mutuals offer better interest rates for savers and borrowers.This case of mutuals offering better rates is problematic to prove in practice as there are so many financial intermediaries, products, min balances and interest rates available. For examp le, the Which? Report only examined both products over a narrow period of time. Most of their mortgage research is based only on the 12 months to March 1997, a period when the converting societies knew they could stick away with charging windfall seeking customers more than their rivals.Over the longer term Money Facts, a savings rate specialist, claims mutuals record in savings rate exceed buy tables is poor. Each year Money Facts publishes details of how much money you would have if you had invested with each of the 90 or so Tessa providers 5 historic period previously. Just one of the five largest mutual building societies made it into the top 25 Tessa providers. The same was true last year. A quick look at the mortgage market tells a similar story.Research conducted by myself paints a similar picture. Investors Chronicle, a weekly investment magazine published by the Financial Times, carries a weekly updated table of highest deposit rates ( appurtenance 1). As at 29 January 1998 out of 36 financial intermediaries listed on this table offering the best deals on various products (e.g. Tessa, Instant Access up to 2500) only 13 of them are mutual.In recent months, there has been a rush of new entrants to the banking bowl that offer better deals than the mutuals and established high street banks. Insurer, Legal & General (60 Day Notice Minimum 2500 7.65%) and supermarket, Safeway (Instant Access Minimum 1000 7.3%) (Appendix 1), for example, both offer excellent interest rates on savings accounts. Equally, Scottish Widows mortgage products are very cheap.Even if believed that mutuals offer better savings and mortgage rates it is a long wait for building societies to de put outr the same return as there converting counterparts. One case that illustrates this point is a saver that had 5,000 in an instant access account run by Nationwide whose members rejected conversion this summer would earn more money than he would at the Woolwich (see Appendix 2). Howeve r even if you were a non taxpayer, it would take more than 50 years to make 1500 (Woolwich windfall approx. 2000) extra in interest payments. The lure of the mutual building societies is not so compelling as it is often presented.Some building societies have recognised that they need some sort of scheme with which they can compete with the attractions of windfall bonuses. The Nationwide, Bradford & Bingley and Yorkshire have all announced cash back schemes where members will get a larger slice of the profits in the form of better interest rates. The Britannia has actually paid cash bonuses worth 35m to members. However the average payout to members was 35.Another aspect of consideration is the treatment the customer receives. Mutuals almost always squash banks in surveys on customer friendliness. Building societies staff are perceived by customers, according to market research, as more friendly, more pleasant and more interested in their jobs than those of banks and other financial institutions. (PRIMA).Many building societies have branches in estate agents in small communities. These branches are not usually prolifically profitable, but provide a valid service to the community. As plcs are profit making organisations there is a trend that community branches are closed in(p) after conversion. The Abbey National, for example, closed 1000 community branches after conversion and all 200 of National & Provincials when it took it over. This is a great cost to those who live in these communities. Many are old people who are now faced with travelling long distances to get their money.Plc pay is generally higher than mutual pay for the senior managers of a building society. Peter Birch, Abbey Nationals, Chief Executive, pay has increased from 173,000 pa in 1987 to 450,000 pa in 1996 and he now owns shares worth 1.8m. This is in contrast to the Chief Executive of Halifax whos pay did not increase by anywhere as much and was unable to receive share options. There is a clear benefit to the senior mangers of a converted building society, but in the long run they are also more open to being removed by discontented shareholders or a take-over. Share options are believed to produce more motivated and committed staff.In conclusion there are potentially more benefits to the Building Society than costs. The major benefit being the escaping from the limitations imposed by the BSA. The Building Societies Act 1986, 1997 excluded building societies from potentially more profitable, if riskier business. The regulatory constraints on a plc are less onerous than those on a mutual basis therefore although banks are area to continuous Bank of England supervision, the basic limitations are the scope of company articles of association whereas building societies must comply with highly specific requirements of the Building Societies Act 1986, 1997 on such matters as the permitted proportions of wholesale funding, unsecured lending and advances by class of asset.In general, members also have potentially more benefits than costs. In the short-term members of converting societies have the benefit of windfall payments. In the long run it is claimed that members will lose out in less competitive interest rates, however this is very fleshy to prove. Even if it can be proved, the savings and mortgage rates offered by the mutuals will only be marginally better than those offered by the non-mutuals. It will take years to earn the equivalent of a windfall bonus from a mutual in the form of better interest. Some people urge others to recall about the next generation and that one day there will be no mutuals left, but at present most of the best rates are offered by the new entrants to the banking arena (e.g. Safeway).Any member who retained their membership of a converted society through retaining their share allocation, at present would be benefiting even more. The reason for this is that the share prices are higher today than when the societies flo ated. Secondly as this is being written the Woolwich as part of its amah full year results announced a fresh 100m windfall for Woolwich investors. A 6.5p special dividend added to the total year dividend of 9.5p will put 105 in the pockets of hundreds of thousands of former Woolwich members who received the average windfall package of 657 shares. The Woolwich will also seek authority to return a further 100m to 200m of excess capital to share holders later(prenominal) this year in share buy backs.There is a clear cost to those members who relied on a community branch, however have these usually retired people examined the alternative technology available (e.g. telephone banking, cheques, debit cards etc.).Staff (particularly senior management) will benefit as a plc is able to offer share options which are believed to produce more motivated and committed staff. Senior management will also usually have greater increases in pay. These people are not FAT CATS they do a complex job and are paid the going market rate. In the long run senior managers of a plc are easier to remove from the company if their performance is poor.All in all the benefits of conversion outweigh the costs. This is true for all the interested parties, i.e. the building society, the members and the staff.