Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by The Building Societies Association


  1.  The Building Societies Association is the trade association for the UK's building societies. All 65 building societies in the UK are members of the Association. Collectively, their assets amount to around £180bn. Building societies hold about 20 per cent of outstanding mortgages and about 17 per cent of outstanding deposit savings. Over the last few years they have been particularly successful in the savings market, accounting for 35 per cent of the flow of new savings. They have also taken this share of the mini cash ISA market. In addition, their share of new mortgage business regularly exceeds their share of outstanding balances. Building societies operate through just over 2,000 branches, and through the post, telephone and internet. They employ about 31,000 staff.

  2.  Building societies' business is concentrated on the deposit and residential mortgage markets. They undertake relatively little business with small and medium sized enterprises, although a number of societies lend to businesses such as pubs, hotels and nursing homes, which are able to offer buildings and land as security. Many building societies offer investment and insurance products and a few own estate agency subsidiaries. Six societies offer cheque book accounts, although only three of these offer a full service current account. About 15 societies offer credit cards, although all but one of these is undertaken through an agency arrangement with another financial services provider.

  3.  This submission concentrates on building societies' mutual status, the contribution which they are able to make to promoting financial inclusion, and issues relating to the Banking Code. Virtually every building society subscribes to the Banking Code. The Association, along with the British Bankers' Association and the Association for Payment Clearing Services, is one of the three sponsors of the Code.


  4.  An accompanying document, the Association's newsletter Building Society News—April 2002, describes a wide variety of research backing up the belief that building societies typically offer higher savings rates, lower mortgage rates and a better standard of service than their plc competitors. At the heart of their approach to business is their constitutional form. Building societies do not have external shareholders; rather they are owned collectively by their members—ie their investors and borrowers. Societies' mutual status provides both opportunities and incentives to service customer needs above all else. The opportunity arises because building societies do not need to pay dividends to shareholders. Financial results from the mortgage banks show that typically dividends add around 35 per cent to the costs of running such an organisation. Building societies do not face this cost and accordingly are able to operate on much narrower margins between their savings and mortgage rates than their competitors. This means better interest rates for their savers and borrowers. A number of pieces of research in the newsletter confirm this point.

  5.  The incentive to serve customers lies in the fact that customers are the ultimate owners—albeit in a collective sense—of the society. There is no separate group of shareholders seeking to influence management; management is totally accountable to investing and borrowing members. Managements of banks face an impossible conflict between the interests of shareholders and customers—delivering shareholder value can easily conflict with customer care.

  6.  The accountability of building societies is apparent in the market place—members withdraw their savings or take their mortgage business elsewhere if building societies are not competitive—and in their constitutional arrangements; dissatisfaction with the performance of a building society can result in members, for example, voting against incumbent board members, or possibly for a hostile takeover bid by another institution. (There is a statutory requirement for retiring directors seeking re-election to be positively endorsed by the membership, even if the number of candidates is equal to the number of vacancies.) No such dis-satisfaction has been apparent, but in recent years, voting turnout at building society AGMs has risen rapidly. In 2001 the average vote was 22 per cent; some societies had turnouts in excess of 30 per cent, a figure that is comparable with recent local authority and European Parliament elections.


  7.  The Treasury Committee's fifth report, Banking and the Consumer, makes a number of recommendations in relation to financial exclusion.

  8.  The BSA agrees with the recommendation that banks and building societies providing banking services should include, in their annual reports, information on the number and distribution of their retail outlets, both via automatic teller machines and over the counter, although it may be more appropriate for customers for such information to be published in more accessible documents than the annual report.

  9.  Building societies have introduced a wide range of methods which their customers can use to contact them. These include postal, telephone and internet based accounts, as well as traditional branch based accounts, accessible through, in some cases, agents and intermediaries. Nevertheless, building societies firmly believe that many customers wish to undertake financial services transactions face to face, rather than remotely—as is implied by the newer forms of distribution. Accordingly they have, broadly speaking, maintained their branch networks over the last five years, in comparison with very sharp cuts elsewhere. The table below shows changes in the number of bank, building society and post office branches in the five years to 2000—the latest statistics available.

Table 1


Reduction per cent
All banks
(Of which mortgage banks)
Post offices
All building societies

  Source: British Bankers' Association, Banking Business: An Abstract of Banking Statistics, 2001.

  10.  It can be seen that in the five years to the end of 2000 the banking sector closed almost one in five of its branches (19 per cent) and converted institutions closed 24 per cent of their branches. The number of Post Office branches fell by 5.6 per cent while the number of building society branches was down by 2.4 per cent.

  11.  Building societies cannot commit to never closing a branch. Clearly it would be ridiculous for branches that did not attract any customers to remain open. Nevertheless, building societies remain of the view that the branch is an integral part of providing financial services; moreover, for those that have less confidence in running their financial affairs, have relatively few or no accounts and who are perhaps suspicious of financial services organisations, personal contact is an important component of bringing those customers into the financial world. The financially excluded are unlikely to use internet, telephone or postal arrangements to run their financial affairs. Research undertaken for the Association at the University of Newcastle has shown that building societies are especially likely to retain their branches in inner urban and rural areas deserted by other institutions.

  12.  Five sixths of those without any financial services account are tenants of social landlords. It has seemed appropriate to some building societies to work closely with housing associations in order to alleviate financial exclusion. The New Horizons scheme introduced by the Cambridge Building Society in the late 1990s has been built upon by a number of other building societies. The Cambridge scheme is designed to provide attractive rates of interest on extremely small savings, while at the same time offer unsecured loan opportunities at rates of interest hugely below those charged by door-to-door money lenders. In concept the scheme is very simple. In the Cambridge example the Cambridge Housing Society, a registered social landlord, invested £20,000 in the Cambridge Building Society. Tenants of the Cambridge Housing Society are able to open savings accounts with £1 or more, and earn a rate of interest as though they were investing £20,000. Tenants are able to apply for unsecured loans of up to £500 at a rate of interest of 6.2 per cent. The loans are unsecured as far as the individual borrower is concerned; if, after the borrowers' and building society's best endeavours, there is a default, the building society can cover the loss by drawing on the housing society's investment—which acts as a guarantee fund. The Cambridge scheme covers about 2,000 tenancies.

  13.  Following this pathbreaking initiative, a similar scheme has been launched by the Darlington Building Society. This involves 11,000 tenants of five different housing associations. In this case the associations made a £50,000 deposit. The Dunfermline Building Society in Scotland is introducing a similar initiative and, in Kent, the Kent Reliance Building Society is working with the Swale Housing Association and Swale Local Authority on similar ideas.

  14.  Much more detail on these initiatives is included in a joint BSA/Housing Corporation/University of Cambridge publication, Partnerships for Financial Inclusion: Housing Associations and Financial Institutions, which will be available by the end of May 2002. The publication describes research at the University, funded by the Association and the Corporation, which evaluates the schemes jointly undertaken by housing associations and financial institutions—mostly building societies. A copy of the executive summary of the report will be sent to the Clerk to the Committee.


  15.  As pointed out above, the Association is one of the three sponsors of the Banking Code. The Association fully supports the Code and backs the role of the Banking Code Standards Board, created in October 1999, as the appropriate institution to assess institutional compliance with the Code and take disciplinary action in the absence of compliance. The Association also backs most of the recommendations in the Julius Report on the operation of the various codes in the financial services sector. (The Director-General of the Association served on that Committee.)

  16.  The fifth Report of the Committee, Banking and the Consumer, identified the practice of paying lower interest on older accounts, in the hope that customers will not notice, as unacceptable. The Committee recommended that the Banking Code Standards Board should report on the elimination of such bad practices, and enforce the Code's provisions about superseded accounts rigorously. The Association agrees with this recommendation.

  17.  It is perhaps worth saying a word about the background to superseded accounts. Take a very simple world in which there are two deposit takers, and that each offer an identical savings account paying, say, 6 per cent. Suppose the institution A wishes to increase its market share of new savings. One obvious ploy would be to reduce the rate of interest on the existing account to 5 per cent and introduce a rate of 7 per cent for new customers—perhaps under the guise of a slightly different account. Financial journalists would recommend its new account as a best buy and it is likely that it will attract a significant inflow. Institution B is likely to be criticised for not offering a competitive account.

  18.  Institution B now has a dilemma. It does not wish to break faith with existing investors; and yet it is finding it difficult to compete for new investors. Its market share of new savings flows will decline sharply. It may be tempted to follow the obsolete account approach of its competitor.

  19.  Of course, the savings market is much more complicated than this. Well over a hundred different retail institutions compete, offering a wide range of different savings accounts with many different features. There are, however, rewards for institutions that are prepared to downgrade existing accounts—they can more easily offer attractive rates on new accounts, increase their market share of new business, and appear frequently in best buy tables. (It is interesting to note that, as pointed out in the accompanying edition of Building Society News, the International Institute of Banking and Financial Services, based at the University of Leeds, says that building societies consistently offer the best rates of return for savers' money in both instant access and notice accounts "without the excessive levels of savings product turnover which is apparent in non-mutual organisations". This research was not commissioned by the building society sector.)

  20.  The solution to this problem may well be that the Banking Code Standards Board enforces the Code's provisions about superseded accounts rigorously, as suggested in the fifth Report of the Committee. However, the superseded account provisions of the Code have not proved easy to interpret, either for institutions or the BCSB, especially in the light of the wide variety of terms and conditions available on the multiplicity of savings accounts that now exist. Moreover, institutions have not always found it easy to simultaneously comply with the Banking Code and the Unfair Contract Terms regulations while satisfying themselves that they would not be open to a complaint that might ultimately be endorsed by the Financial Ombudsman Service.

  21.  This triple regulation of the structure of interest rates within an institution has encouraged building societies to emphasise another part of the Treasury Committee's recommendation in this area. Recommendation (c) states "when banks pay lower rates of interest on older accounts, they hope that their customers will not notice." It is possible that the right solution to this problem is to significantly increase the probability that customers will notice a change in rates. Many building societies—but by no means all—now write to their customers following every rate change. (The Banking Code currently requires institutions to write only to customers not conducting their business through a branch—that is postal, telephone and internet based accounts.) This is of course a costly procedure. It typically costs about 30 pence to write to a customer, including postage and internal administration. Around a third of building society accounts have £100 or less in them. A 0.25 per cent change on the interest earned is equivalent to 25 pence a year. The notification of the change costs more than the change itself. For this reason, the Association suggests that there should be a de minimis level of £1,000 and that letters should be written only when interest rate changes do not match bank base rate changes—which receive widespread media publicity. Also, it would not be appropriate to write to customers in fixed rate accounts, or in tracker accounts where the institution has explicitly promised to change the rate of interest in line with bank base rates. The Association believes that greater and more effective provision of information might be a better solution to the problem of obsolete accounts than the current superseded account provisions within the Banking Code. It may, of course, be sensible to undertake market research to establish consumers' views of how they would like this information distributed, and whether opt-outs would be possible.)

  22.  Building societies also believe that a commitment by the Financial Ombudsman Service to agree that it takes no action on consumer complaints about interest rates, providing it is satisfied that information has been sent to customers in line with what building societies hope will be the revised Banking Code requirements following the current review, and the institution has complied with the Unfair Terms in Consumer Contracts Regulations. This would simplify the compliance regime considerably.


  23.  In conclusion it is worth reproducing the final paragraph of the article in Building Society News accompanying this evidence

  24.  "Overall, building societies are able to focus on their members because they have no shareholders seeking dividends. Their margins are lower than their plc competitors and their commitment to the customer more pronounced. It was building societies two years ago that defended the right, not only of their own customers, but also bank customers, to access their money through cash dispensers free of charge. It is a building society that has chosen to offer all of its customers the benefit of lower mortgage rates, following an Ombudsman decision. The society disagreed with the Ombudsman, but has nevertheless accepted the `referee's' decision as final, and applicable to all the relevant customers, unlike its plc competitors. If those plcs eventually do decide to move all of their customers to a lower mortgage rate those customers will have the building society partly to thank for their reduced rate. Competition, not only between plcs, but also between organisations with profoundly differing approaches to doing business, is the key to ensuring proper attention to customer needs in the future."

30 April 2002

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