Report On The Costs And Benefits Of

A Building Society Converting To A Plc Essay, Research Paper

REPORT ON THE COSTS & BENEFITS OF A BUILDING SOCIETY CONVERTING TO A PLC

Introduction

At the beginning of this century there were more than 2000 building societies, fiercely independent mutual organisations, formed in the spirit of Victorian self help. There are now just 71. Some of these that have 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 have been swallowed up in take-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 building societies as well as those to the members and staff.

The Costs and Benefits to the Building Society

Conversion to plc status is seen as having the major advantage that there would be freedom from the limitations imposed by the Building Societies Act 1986, 1997 the statutory framework for the Building Society industry. The restrictions the Act impose include the following:

1) 75% of all lending has to be secured against residential property

This means that Building Societies are limited in their participation in the more risky, but more rewarding unsecured lending. At the moment, Societies can 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 funds may be raised on the wholesale markets

This limit was previously 40% before the revised 1997 Building Societies Act.

Building societies have eagerly taken the opportunity to raise money in the wholesale markets, which have frequently proved to be the cheapest source of wholesale funds (Wholesale funds are large deposits placed by companies and financial institutions, bearing an interest rate in line with the market rate rather than base rates). 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 also find themselves at a disadvantage in access to wholesale funds at competitive rates. 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) Before the 1997 Act, building societies could only offer temporary or occasional overdrafts to

corporate customers. Now building societies can establish subsidiaries to lend to business customers,

but have not yet become significant lenders to industry. This is in contrast to banks who are very

much regarded as lenders to businesses. As a result of the Building Societies Act 1997, building societies are now also able to :

a) make unsecured loans to incorporated businesses;

b) to own a general insurance company which could write housing 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 plc s 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 to raise 921m to finance growth .

Building societies cannot in general engage in take-overs of, or mergers with other 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 new shares, 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 rates, 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 including:

1) Different regulator

The new plc will be regulated by the Bank of England, rather than the building societies commission. The plc will operate 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 deal with the new method of regulation. The Government s planned new super regulatory

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