Protection for savers extended
The City watchdog has extended the additional protection put in place to protect savers’ money should their building society flop.
Unlike banks, building societies that merge are legally required to operate as a single entity with just one Financial Services Authority (FSA) license. The Financial Services Compensation Scheme (FSCS) rules that the £50,000 deposit protection it offers only covers customers per FSA license. However, the spate of mergers seen across the mutual market in 2008 prompted the FSA to introduce new rules in December, which allowed building societies to merge and retain their separate compensation limits.
This additional protect for building society savers was only intended to remain in place until September 2009. However, the FSA has proposed an extension of 15 months to December 2010, and is also widening the rules to include building societies that merge with another mutual organisation. This would cover the merger between Britannia Building Society and the Co-operative.
Brian Morris, head of savings policy at the Building Society Association, says: “It would not be appropriate if moves, such as mergers, designed to reassure and protect members led to a reduction in the levels of FSCS protection for members who have savings in both entities.”
Since the rules were originally introduced, building societies savers were shocked with the news that the Dunfermline, Scotland’s largest mutual, was folding amid serious cash-flow problems. Although Nationwide agreed to bring the 140-year-old society’s savers under its wing, it raised concerns over the safety of building societies.
One of the most serious concerns is the toxic debt on building society’s balance sheets. At the height of the housing boom, many firms bought mortgage books off specialist (including sub-prime) mortgage lenders. Now, with more borrowers defaulting by the day, many mutuals face a potentially explosive problem.
Some, such as Britannia, Cheshire and Derbyshire, are merging with bigger players. Only time will tell whether the others have the financial assets to cover the debt, or whether more will fall.
The extension to the compensation rules for building societies should offer savers reassurance that their money is safe. But does it also suggest the FSA is concerned about the financial stability of the mutual sector?
Jon Pain, retail markets managing director at the FSA, says the rules are being extended until December 2010 because by that time it should be clear what changes will be made to the EU Deposit Guarantee Schemes Directive. “We will then be able to put in place permanent arrangements which will take account of any new EU requirements,” he adds.
The European Union Deposit Guarantee Schemes Directive should be introduced from 31 December 2010, and will see all savers offered a common deposit protection limit of €100,000.
Meanwhile, the FSA says it is looking at introducing new guidelines to building societies to ensure they are "diversifying away from traditional business models" and have systems in place to ensure they do not take undue risks and can operate safely.
It also warns that those organisations that can't prove they are adapting to the new climate may be forced by the FSA to "steer to a simpler business model".
Pain explains: “Our approach is very simple; the more diversification, the higher the level of management skills and systems and controls the FSA will demand from the firm. Building societies will still be free to innovate and diversify, but not beyond the limits of their risk management skills.”
The FSA is concerned that some building societies have diversified into risky areas, including sub-prime and buy-to-let lending, without having the requisite skills and systems to manage the associated risks.
The compensation rules for building soceities
* It is up to the the successor building society to decide if it wants the savers from the combined society to receive the extra protection
* Only existing savers that were with both/all the societies before the merger took effect will benefit from additional protection
* The rule only applies when the dissolved building society continues to operate under its former name
* The FSA says it will publish the names of any building societies that have been given separate £50,000 limits
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).