3.5 Building societies

building society’s bankdeposit which was functioning as money, not a deposit with

the society itself.

As we shall see in the next section, competition between banks and building societies

drove their products closer and closer together during the 1980s. Eventually, the

Building Societies Act 1986 removed some of the formal distinctions. Most import-

antly it allowed building societies to issue cheque guarantee cards (so their own

deposits became instantly acceptable as means of payment), and it provided for

societies to ‘incorporate’ themselves as banks. At the time, building society deposits

were included in a measure of ‘liquidity’, ‘PSL2’, but not in M3. After the 1986 Act

this differential treatment of building society deposits became very difcult to sustain.

A change was nally forced by the decision of the Abbey National Building Society,

at the time the second largest society, to convert to banking status in 1989. This

would have meant an overnight increase in M3 of about 11 per cent. This large break

in the series persuaded the Bank of England to discontinue publication of the M3

measure and to treat M4, rst published in 1987 as a replacement for PSL2, as the

ofcial measure of broad money. Thus, from a monetary point of viewthe societies

have become indistinguishable from banks.

A brief history of UK monetary aggregates is provided in the appendix to this

chapter and the history of building society deposits in the 1980s is a good illustra-

tion of how ‘custom and practice’ determine what assets should count as money and

how this custom and practice is continually changing.

As Table 3.5 shows, at the end of 2004 building society assets totalled £243bn. This

was a sharp drop from their peak of £309bn in July 1995 and is explained by the

conversion of some major societies into banks (see Box 3.6). Prior to these mass con-

versions, and since 1998, the gures show an annual growth rate of 8–9 per cent p.a.

As Table 3.5 shows, ‘loans and investments’ which consist overwhelmingly of

mortgage loans for the purchase of property, amount to more than 80 per cent

of building society assets. The societies provide about 80 per cent of total lending

for private house purchase, though this gure has uctuated since 1981 as banks

entered, retreated from and then re-entered the mortgage market.

This concentration on long-term mortgage lending means that societies provide a

good illustration of the degree of maturity transformation that is possible. However,

Table 3.5Building societies – assets and liabilities (£m, end-2004)

AssetsLiabilities

Notes and coin	580	Retail shares and deposits	160,456
Sterling deposits with banks	18,162	Certicates of deposit	13,106
British government bonds	1,030	Commercial paper	27,783
Other liquid assets	25,067	Bank borrowing	922
Loans and investments	195,807	Bonds and other wholesale	21,528
Other	2,421	Other (incl. reserves)	19,272
Total	243,067	Total	243,067

Source:Adapted from ONS, Financial Statistics February 2006,table 4.4A

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Chapter 3 • Deposit-taking institutions

this should not be exaggerated. While a new mortgage loan may typically be for

twenty-ve to thirty years, societies hold a portfolio of existing mortgages at various

stages of maturity. They will obviously arrange their affairs so as to ensure a steady

stream of maturing loans. In addition, very few mortgages last their full term. People

sell and move house frequently. The average life of a building society mortgage is

about eight years. Until the early 1980s, societies commonly restricted their lending

on individual purchases to 84 per cent of the estimated value of the property. In

the increasingly competitive environment after 1983, this crept slowly upwards and

100 per cent mortgages became quite common by 1989. Following a collapse in

the UK housing market in the early 1990s, the normal ratio has since settled back to

90 per cent.

With the exception of ‘other assets’, comprising land, buildings and equipment,

building society non-mortgage assets are generally very liquid. ‘British government

securities’ consist of central government bonds, almost all with less than ve years

to maturity. More than one-half of ‘short-term assets’ are bank deposits. Under the

Registrar’s rules, societies are required to maintain a minimum ratio of 7.5 per cent

of liquid assets (roughly British government securities plus ‘short-term assets’) to

total assets. However, we can see from Table 3.5, the ratio in 2004 was nearly three

times the required minimum at 18.5 per cent. Indeed, societies have traditionally

operated with a liquid assets ratio in the range of 15–20 per cent. There are several

reasons for this. The retail, short maturity, nature of most building society liabilities

and the need to maintain public condence are obviously relevant. Less obvious, but

important, is the fact that because interest rate changes are administratively expens-

ive, building society interest rates are ‘sticky’ in comparison with those of some of

their competitors like banks and National Savings. Consequently the inow of funds

is sometimes erratic. If the inow falls short of mortgage lending plans, a generous

cushion of liquid assets can be run down in order to preserve a steady outow of

mortgage lending. In 2004 the net inow of funds was £23.6bn, including £13.2bn

of new shares and deposits and £7.8bn from wholesale sources.

Finally, the 1986 Act gave societies the power to seek ‘incorporation’, subject to

their giving adequate notice of their intention and subject to a vote by their mem-

bers. Incorporation would mean their becoming public limited companies. They

would then have shareholders, rather than members, and would be able to raise

additional capital for expansion in the normal commercial way by issuing additional

shares. They would, in effect, become banks.

The rst building society to make the change was the Abbey National in 1989.

Although other societies also announced their interest in conversion at the time, the

momentum did not fully develop until 1997, when the conversion of several major

societies in that single year led to a sharp, but temporary, contraction in the build-

ing society sector. A list of major conversions is provided in Box 3.6.

We have seen that the Abbey National Building Society was the rst to abandon

mutual status and convert to a plc in 1989 (and in 2003 changed its name again to

‘Abbey’). Several other major societies considered doing the same at the time, but

as Box 3.6 shows, it was not until the mid-1990s that ‘demutualisation’ either by

merger with an existing bank or by incorporation really gathered pace.

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