Banks vs. building societies
If banks are the corporate beasts of the financial world, then building societies are often seen as their cuddly counterparts, acting in the interests of customers rather than greedy shareholders.
Recent research conducted by GfK NOP found that building society customers were more satisfied than customers of other financial service providers.
The research – admittedly commissioned by the Building Society Association (BSA) – revealed that 68% of building society customers felt they were treated fairly, compared with 55% of bank customers.
Meanwhile, a poll on moneywise.co.uk conducted earlier this year found that 55% of you trust building societies, but just 5% trust banks.
The reason for this bias towards societies is largely down to the fact that, unlike banks, they are mutual institutions, free from external stockmarket pressures to maximise profits and pay dividends to shareholders.
Instead, their customers are 'members' and as such have the right to vote and speak at general meetings.
Richard Hall, spokesperson for Newcastle Building Society, explains: "Building societies and other mutuals are fundamentally different to plc financial service providers as they are owned by their members and not shareholders.
"This model helps ensure members' needs are the main priority by offering something different in the market."
This unique status also means it costs, on average, 35% less to run a building society than a bank. As a result, organisations are often able to offer competitive interest rates – especially when it comes to savings products.
Of course, attention-grabbing introductory rates can be a false economy, with many savings providers slashing returns once new customers are through the door.
But in a Moneyfacts survey of the most consistent savings accounts, conducted in January 2010, building societies took an impressive 73% of the top spots.
"As building societies are owned by their members it's in their best interest to play fair," says Michelle Slade, spokesperson for Moneyfacts. The 'local' focus of building societies also tends to curry favour with customers.
Linda Will, marketing and sales director at Stroud & Swindon, says: "Building societies are often very regional, offering a presence in areas that big banks would find difficult to service in person.
"Through their branch networks they also offer a more personal type of service; building society branch staff are well known in their communities, often because of their society's community support programmes."
In the post-credit crunch world – in which banks have been exposed as too big, too risky and too greedy – trust and genuine products are increasingly important to customers.
But building societies have not been immune to the events of the past few years, and changes to regulation and the banking sector as a whole mean their future remains uncertain.
There have been eight building society mergers since 2007, with smaller mutuals turning to their larger peers to shield them from the fallout. The Dunfermline, meanwhile, collapsed after suffering extreme cash-flow problems.
This consolidation, while ensuring the survival of building societies, isn't necessarily good news for customers as less competition means less choice. It also reflects the tough conditions facing both building societies and banks alike.
Funding is another big issue. While not so long ago there were numerous options available to raise capital – borrowing on the wholesale market, for example – banks and building societies are now reliant on savers' deposits to fund their lending activity.
However, the all-time low Bank of England base rate is putting pressure on margins. For some time now savings providers have been vying for savers' money in order to bolster their flagging balance sheets.
But in order to get into the best-buy tables, they need to pay six or even seven times the base rate, which has been just 0.5% for more than a year now.
At the same time, more and more mortgage borrowers are remaining on standard variable rates (SVRs) when their fixed or tracker deals come to an end.
Once upon a time, this would have been an ideal situation for lenders, as SVRs have traditionally been a lot higher than new mortgage deal rates.
However, because they are largely priced according to the base rate, SVRs are no longer bringing in any cash – and with the housing market still depressed, banks and building societies can't count on new lending activity to offset these losses.
Problems with mutuals
Mutuals are also suffering their own unique problems. "The very nature of member ownership makes raising additional capital hard to do without compromising the whole structure of societies," explains Hall.
On the plus side, security concerns have been less of a worry for societies, which tend to be viewed by consumers as 'safer' than banks.
The fact that the majority of the banks hit the hardest by the credit crunch – Northern Rock, Alliance & Leicester and Bradford & Bingley – were former building societies, has highlighted the potential dangers of the plc model.
However, since the government stepped in to stop the 2007 run on Northern Rock with a 100% deposit guarantee, societies say they have been losing out.
"It's difficult for building societies to compete with government-backed banks for retail funding when these enjoy an explicit or implied guarantee of 100% deposit protection, while building societies receive £50,000," says Adrian Coles, director general of the BSA.
Most societies also failed to hit the critical size requirements needed to access the government's support schemes aimed at financial institutions during the height of the banking crisis, although the playing field is evening out.
As of May 2010, Northern Rock savers no longer receive 100% deposit protection.
But new challenges lurk on the horizon. Regulations imposed by the Financial Services Authority (FSA) demand that building societies set aside more capital to protect against any future financial problems.
Coles says societies are turning to the expensive retail money markets to find this capital – which in turn is putting pressure on mortgages, traditionally a core product for building societies.
Large mutuals such as Nationwide have long been able to slug it out with banks when it comes to mortgages, but David Hollingworth, mortgage expert at London & Country, reports that in recent months banking giants such as Santander and HSBC have upped their game and now consistently offer strong mortgage products.
Kevin Mountford, head of banking at Moneysupermarket.co.uk, warns building societies risk getting left behind.
"When it comes to cash ISAs, for example, building societies are struggling to compete with the big brands," he explains. "Santander and Barclays have blown them out of the water."
This puts societies in a difficult position. "Building societies need to either focus more on winning their heartland business or differentiate if they wish to play on a bigger, national scale," Mountford says.
However, many believe building societies should stop acting like banks and focus on what they're good at – offering high levels of customer service alongside consistent and good-value products.
Should mutuals get back to basics?
In the years leading up to the 2007 credit crunch, several building societies diversified away from their core products of savings and residential mortgages, and dipped their toes into the dangerous worlds of buy-to-let, commercial and even sub-prime loans.
But this flirtation with the riskier side of banking came at a price. The West Bromwich Building Society, for example, was an active player in the buy-to-let market, but was forced to turn to the Treasury for a rescue deal in 2009 after suffering losses.
The FSA wants to ensure that building societies do not repeat the mistakes of the past. It says societies that "demonstrate the necessary risk-management systems and skills" will have complete flexibility to run their business. Those that cannot will have to stick to simpler business models.
Regardless of the direction building societies decide to take, however, Hall is confident that they will continue to have a role to play: "Despite the challenges we all face, we foresee a successful future for building societies."
How safe are building societies?
Like banks, building societies benefit from the Financial Services Compensation Scheme (FSCS) that protects the first £50,000 of a customer's money for each institution with a separate Financial Services Authority (FSA) licence.
But until recently, building societies that merged were legally required to operate as a single entity with just one FSA licence – something they argued put them at a disadvantage to banking groups, which are able to hold multiple licences.
However, in December 2008, the FSA introduced new rules that allowed building societies to merge but still retain their separate compensation limits. This additional protection for building society savers will remain in place until December 2010.
The rules also include building societies that merge with another mutual organisation – so the merger between Britannia Building Society and the Co-operative is covered.
Is carpretbagging dead?
For around two decades, one key attraction of saving or borrowing through a building society for many people was a money-making tactic known as 'carpetbagging'.
The term derives from the American Civil War and was the name given to Northerners who moved to the defeated South with their carpetbags to profit from the unsettled conditions there.
Following the demutalisation of several building societies back in the 1990s (including Abbey National, Halifax and Alliance & Leicester), carpetbagging became a popular way to make short-term gains; numerous people opened accounts in building societies with the sole aim of receiving a cash or share windfall should the society convert to a plc.
Bradford & Bingley was the last society to float, back in 2000. However, six years later, carpetbagging made a comeback as numerous building societies decided to merge.
For example, thousands of Portman Building Society members received £200 each when their society merged with Nationwide in 2006.
The internet became home to dozens of carpetbagging forums, with users eagerly debating the next society likely to merge.
Since the credit crunch hit in late 2007, there have been eight building society mergers – but this time with a difference, as societies have exercised a clause that means they do not have to pay members any cash incentive.
In addition, many mutuals now state that members must have been with the society for a certain length of time, and have a minimum amount deposited, before they can benefit from any future financial windfalls.
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.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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).