Paper on the Costs and Benefits of Building Society

At the beginning of this carbon thither were more than cc0 twist societies, fiercely independent vernacular organisations, create in the spirit of Victorian self help. There argon in a flash just 71. Some of these that blend with disappe ard were terminating societies with a fixed wind up date. The last terminating society was the Fist Salisbury which wound up in 1980. Other societies suck in been swal offseted up in take-overs or converted into banks in the great 1997 de vulgarisation.This assignment leave al peerless discuss this trend with particular quote to the potential costs and hits in the compact and long term. This assignment entrust examine the costs and arrive ats to the create societies as well as those to the members and staff.The cost and Benefits to the twist SocietyConversion to plc experimental condition is seen as having the major good that at that place would be freedom from the limitations imposed by the construction Societies coiffe 1986, 1997 the statutory framework for the mental synthesis Society industry. The restrictions the portrayal impose entangle the following1) 75% of alone lending has to be secured against residential airplane propellerThis means that Building Societies atomic number 18 limited in their participation in the more riskinessy, but more rewarding unsecured lending. At the moment, Societies layabout appoint unsecured personal loans up to a limit of 15,000 per guest, whereas there is no detonator for Banks. Building Societies with less than 100m of assets are non permitted to scram unsecured loans.2) No more than 50% of funds whitethorn be raised on the wholesale merchandisesThis limit was previously 40% beforehand the revised 1997 Building Societies contrive.Building societies have eagerly taken the opportunity to raise funds in the wholesale markets, which have frequently turn up to be the cheapest source of wholesale funds (Wholesale funds are enlarged deposits placed by companies and financial institutions, bearing an come to pace in line with the market rate instead than base range). They have use 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 sympatheticly find themselves at a disadvantage in entry to wholesale funds at free-enterprise(a) rates. As all 50% of funds freighter be raised from the wholesale market only when the very largest societies plunder maintain the necessary standing in the international crown markets which allows wholesale funds to be tapped on the finest terms. Equally, the dexterity to cope with the volatility of the wholesale markets and the risks they pose, requires Treasury commission teams on an change magnitude sophistication to which only the largest societies terminate aspire.3) Before the 1997 Act, edifice societies could only put ou t temporary or occasional overdrafts tocorporate customers. Now make societies can establish subsidiaries to lend to business customers,but have not merely become significant lenders to industry. This is in contrast to banks who are very frequently regarded as lenders to businesses. As a result of the Building Societies Act 1997, structure societies are outright in like manner able to a) make unsecured loans to incorporated businessesb) to own a general insurance company which could write caparison related policies (buildings, contents and mortgage payment 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 shares and bonds if they plan to expand. An example of this is Barclays 1987 rights issue t o raise 921m to finance harvest-feast.Building societies cannot in general engage in take-overs of, or mergers with an another(prenominal)(prenominal) types of financial 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 unsanded shares, whereas building societies can only finance acquisitions with cash.Efficiency is also an issue as a plc profit fashioning organisation is perceived as having greater efficiency than a mutual organisation. nonetheless arguing has turn up a spur to efficiency at least as legal as the disciplinary effect of a public quotation (PRIMA). As a result of the break up of the societies cartel arrangements for setting raise rates, the banks have made successful inroads into the mortgage and savings markets and hence competition is straight off very strong.There are many costs and disadvantages associated with building socie ties converting to banks includingThe new plc forget be regulated by the Bank of England, rather than the building societies commission. The plc will plight under the Banking Act 1987, compared to the Building Societies Act 1987, 1997. The plc may find it difficult and time consuming, at least initially, to have it off with the new method of regulation. The Governments planned new first-rate regulatory body may also provided further legislation that has to be adhered to.2) Need to pay out dividends and ability and pay competitive evokeThe plc will find itself under pressure to pay out exploitation dividends to shareholders. This reduces retained earnings, thereby reducing the plcs ability to pay competitive invade 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 divid endsc) low capital requirements due to the low risk nature of their assetsd) because the banks tended to subsidise their m geniusy transmission service by their deposit accounts, which lessens their ability to compete 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 study 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 track banks (Personal Finance & The Future of the fiscal High Street, interrogation Associates, certify 1988). Building societies have traditionally been seen as a skillful depository for the savings of working people. Building S ocieties are safe and a principal reason why is that mutuality 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 roar payments to society members. These thunders were in the form of cash or free shares. The size of windfall varies from society to society, but investors due to receive windfalls from all the building societies that surrendered their mutual status during 1997 (Halifax, Northern Rock, Alliance & Leicester, Woolwich, Bristol & West) can expect shares deserving an medium total of about 6,000 (IC vol. 120/1524 page 34).This is sportingly a short term benefit to members but it is argued that as plcs these former mutuals will in the long term not be able to straits 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 high savings rates and lower loan rates of mutuality are for manner not just for flotation day. Mr Rodrigues points out mutuals dont have to consider the demands of shareholders particularly for high dividends or share wrong growth so profits can go to members via better 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 assign better interest rates for savers and borrowers.This case of mutuals crack better rates is hard to prove in practice as there are so many financial intermediaries, products, min balances and interest rates getable. For example, the Which? tell only examined two products over a narrow period of time. near of their mortgage research is based only on the 12 months to March 1997, a period when the converting societies knew they could get 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 best procure tables is poor. individually year Money Facts publishes details of how much money you would have if you had invested with all(prenominal) of the 90 or so Tessa providers 5 years previously. Just one of the five largest mutual building societies made it into the top 25 Tessa providers. The uniform was true last year. A quick look at the mortgage market tells a similar story.Research conducted b y 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 (Appendix 1). As at 29 January 1998 out of 36 financial intermediaries listed on this table vortexing 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 belt of new entrants to the banking arena that offer better deals than the mutuals and established high street banks. Insurer, Legal & General (60 Day Notice tokenish 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 depend for building societies to deliver the same return as there converting counterparts. atomic number 53 case t hat illustrates this point is a saver that had 5,000 in an instant access account bleed by Nationwide whose members rejected conversion this summertime would earn more money than he would at the Woolwich (see Appendix 2). However 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 opened.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 concealment schemes where members will get a larger slice of the profits in the form of better interest rates. The Britannia has actually pay 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 be at 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 fraternity. As plcs are profit making organisations there is a trend that community branches are closed after conversion. The Abbey case, 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 1 73,000 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 macrocosm removed by discontented shareholders or a take-over. Share options are believed to acquire 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 able to continuous Bank of England supervision, the basic limitations are the scope of company articles of companionsh ip 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 hard 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 tantamount(predicate) of a windfall bonus from a mutual in the form of better interest. Some people urge others to think about the side by side(p) 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 rank 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 floated. Secondly as this is being written the Woolwich as part of its maiden 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 cv 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 spare capital to share holders later 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 be nefit 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.