Last week I posed the question whether mutual societies could be the saviour of the banking sector. Perhaps the answer lies with building societies? Built on firm foundations say, like rock, and perhaps located out of the City of London so that we can avoid the bad smells of the current economic crisis, lets make it 'northern'. We could call it the Northern Rock Building Society.
What, we've tried it already? Rats!
From 1986 to 2000, the UK saw the demutualisation of 10 of its building societies. Today, every one of these new banks has been taken over by larger banks or have been nationalised. After the apparent failure of the demutualisation experiment, now could be the time to reconsider the role of Mutuals in the UK's financial sector.
A new consideration of Mutuals has become especially pertinent in light of the recent global financial crisis, which was caused in part by the overly risky behaviour of commercial banks. Indeed, the aggressive lending policy pursued by a demutualised Northern Rock directly contributed its exposure to the sub-prime crisis and downfall.
There were reasons, of course, for the demutualisations in the first place, namely the problems building societies had with competing with the larger commercial banks that were able to access almost unlimited finance.
The need to compete in a marketplace increasingly dominated by commercial banks has seen a rapid reduction in the numbers of building societies in the UK. In 1900, there were 1,700 building societies; by 1986, when the Building Societies Act was passed, this had become 110. Today, the Building Societies Association (BSA) only numbers 52 members.
Now that swathes of the UK's banking sector are under state-ownership, however, there is a unique opportunity to re-order that sector along more responsible lines. Increased governmental support for a mutual ethos and building societies could be a way to achieve this.
Building societies are generally more conducive to 'safer' banking practices. Convoluted and risky financial activities are restricted by the limits on financing imposed by Mutual structures, while the diverse ownership structures of Mutuals may prevent the entire sector from making the same mistakes as previously occurred.
The representation of a multitude of interests in the sector that this diverse ownership provides can provide a more competitive marketplace. A proliferation of smaller, more local financial institutions can offer variety in services, which appropriately reflect differing regional needs.
Following the fallout of the risky practices of commercial banks, where limits on size and financing were considered a weakness of building societies, those limits could now be considered a strength.
Importantly, building societies are far more attuned to the needs of their customers than commercial banks, which often have to reconcile the divergent needs of customers and shareholders. The focus on the consumer, and the ability of Mutuals to provide lower-cost loans, could result in an improvement in access to finance for small and medium enterprises who have recently struggled to find new sources of funding.
The main candidate in the UK for mutualisation is Northern Rock, the previously demutualised nationalised bank.
The prospect of the remutualisation of Northern Rock, or other banks for that matter, is not entirely implausible. Treasury minister Sarah McCarthy-Fry has said: 'Nobody has ruled [mutualisation] out.'
Additionally, Government minister Lord Davies has noted that mutualisation is an option being considered by the Government. Notably, City Minister Lord Myners recently said: 'There is nothing I would like more than for a new Mutual to be created.'
But he did add that he could not think of a way to create a new Mutual out of state-owned banks that would not represent a large subsidy from taxpayer to new customers.
The creation of a traditional set of building societies through the mutualisation of nationalised banks is not necessarily a cure-all, however. The financial crisis saw several building societies fail or merge, such as the Dunfermline Building Society, Equitable Life, and the Cheshire Building Society.
These failures demonstrate the vulnerability of building societies to big changes in financial markets, particularly the house price boom. The boom saw the mortgages required by buyers far outstrip the funds provided by deposits, forcing building societies to seek out the riskier investments that they had previously been able to avoid.
Besides these potential hiccoughs, the Treasury must also consider its bulging budget deficit. A sale of Northern Rock would generate an £11bn windfall for the Treasury, whereas mutualisation would see a prolonged debt repayment period instead.
These are not insurmountable problems, however. Firstly, the Treasury may lose out on a windfall but it would achieve a risk-averse and consumer-friendly restructuring of the banking sector, as well as eventually recouping the loans it had lent.
The size issue is a slightly bigger problem. As suggested above, 'smallness' is an advantage but has contributed to problems coping with larger mortgages. This, however, appears to be a problem localised to the UK.
Elsewhere in Europe there are several successful 'Mutuals' Mutuals', whereby Mutuals act as customers to a larger conglomerate. Examples include Raiffeisen in Austria, DZ Bank in Germany, and Rabobank in the Netherlands. Indeed, Rabobank is incredibly successful, with AAA credit ratings from DBRS, Moody's, and Standard and Poor's. Rabobank is rated the sixth safest bank in the world by Global Finance.
Properly regulated, these Mutuals' Mutuals could offer small building societies the efficiencies and financing that were once exclusive to big commercial banks.
Yes, Mutuals did fail during the financial crisis, but these failures were not as large, numerous, or damaging as the trials and tribulations of commercial banks. The financial sector framework needs an overhaul to prevent a repeat of these past problems. There needs to be a serious debate on what form this framework should take, and a consideration for the need for responsible behaviour is paramount.
Mutuals may stimulate such behaviour and must attract serious attention as a viable framework for the future.
What, we've tried it already? Rats!
From 1986 to 2000, the UK saw the demutualisation of 10 of its building societies. Today, every one of these new banks has been taken over by larger banks or have been nationalised. After the apparent failure of the demutualisation experiment, now could be the time to reconsider the role of Mutuals in the UK's financial sector.
A new consideration of Mutuals has become especially pertinent in light of the recent global financial crisis, which was caused in part by the overly risky behaviour of commercial banks. Indeed, the aggressive lending policy pursued by a demutualised Northern Rock directly contributed its exposure to the sub-prime crisis and downfall.
There were reasons, of course, for the demutualisations in the first place, namely the problems building societies had with competing with the larger commercial banks that were able to access almost unlimited finance.
The need to compete in a marketplace increasingly dominated by commercial banks has seen a rapid reduction in the numbers of building societies in the UK. In 1900, there were 1,700 building societies; by 1986, when the Building Societies Act was passed, this had become 110. Today, the Building Societies Association (BSA) only numbers 52 members.
Now that swathes of the UK's banking sector are under state-ownership, however, there is a unique opportunity to re-order that sector along more responsible lines. Increased governmental support for a mutual ethos and building societies could be a way to achieve this.
Building societies are generally more conducive to 'safer' banking practices. Convoluted and risky financial activities are restricted by the limits on financing imposed by Mutual structures, while the diverse ownership structures of Mutuals may prevent the entire sector from making the same mistakes as previously occurred.
The representation of a multitude of interests in the sector that this diverse ownership provides can provide a more competitive marketplace. A proliferation of smaller, more local financial institutions can offer variety in services, which appropriately reflect differing regional needs.
Following the fallout of the risky practices of commercial banks, where limits on size and financing were considered a weakness of building societies, those limits could now be considered a strength.
Importantly, building societies are far more attuned to the needs of their customers than commercial banks, which often have to reconcile the divergent needs of customers and shareholders. The focus on the consumer, and the ability of Mutuals to provide lower-cost loans, could result in an improvement in access to finance for small and medium enterprises who have recently struggled to find new sources of funding.
The main candidate in the UK for mutualisation is Northern Rock, the previously demutualised nationalised bank.
The prospect of the remutualisation of Northern Rock, or other banks for that matter, is not entirely implausible. Treasury minister Sarah McCarthy-Fry has said: 'Nobody has ruled [mutualisation] out.'
Additionally, Government minister Lord Davies has noted that mutualisation is an option being considered by the Government. Notably, City Minister Lord Myners recently said: 'There is nothing I would like more than for a new Mutual to be created.'
But he did add that he could not think of a way to create a new Mutual out of state-owned banks that would not represent a large subsidy from taxpayer to new customers.
The creation of a traditional set of building societies through the mutualisation of nationalised banks is not necessarily a cure-all, however. The financial crisis saw several building societies fail or merge, such as the Dunfermline Building Society, Equitable Life, and the Cheshire Building Society.
These failures demonstrate the vulnerability of building societies to big changes in financial markets, particularly the house price boom. The boom saw the mortgages required by buyers far outstrip the funds provided by deposits, forcing building societies to seek out the riskier investments that they had previously been able to avoid.
Besides these potential hiccoughs, the Treasury must also consider its bulging budget deficit. A sale of Northern Rock would generate an £11bn windfall for the Treasury, whereas mutualisation would see a prolonged debt repayment period instead.
These are not insurmountable problems, however. Firstly, the Treasury may lose out on a windfall but it would achieve a risk-averse and consumer-friendly restructuring of the banking sector, as well as eventually recouping the loans it had lent.
The size issue is a slightly bigger problem. As suggested above, 'smallness' is an advantage but has contributed to problems coping with larger mortgages. This, however, appears to be a problem localised to the UK.
Elsewhere in Europe there are several successful 'Mutuals' Mutuals', whereby Mutuals act as customers to a larger conglomerate. Examples include Raiffeisen in Austria, DZ Bank in Germany, and Rabobank in the Netherlands. Indeed, Rabobank is incredibly successful, with AAA credit ratings from DBRS, Moody's, and Standard and Poor's. Rabobank is rated the sixth safest bank in the world by Global Finance.
Properly regulated, these Mutuals' Mutuals could offer small building societies the efficiencies and financing that were once exclusive to big commercial banks.
Yes, Mutuals did fail during the financial crisis, but these failures were not as large, numerous, or damaging as the trials and tribulations of commercial banks. The financial sector framework needs an overhaul to prevent a repeat of these past problems. There needs to be a serious debate on what form this framework should take, and a consideration for the need for responsible behaviour is paramount.
Mutuals may stimulate such behaviour and must attract serious attention as a viable framework for the future.
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