Woodhurst Opinion: Building Societies Act 1986 (Amendment) Bill

May 10, 2024

The first Building Society can be traced back to Ketley’s founded in 1775 which was the first institution of its type in the world. Since then, Building Societies have continued to play a huge role in British communities and the economy. These unique financial institutions are owned by members and foster a sense of community with shared interests for the Society and members which set them apart from traditional banks (Source).

On 06 December 2023 Julie Elliot MP proposed an amendment to The Building Societies Act 1986, in this article we review the changes being considered and what they mean for Building Societies and their communities.

The Building Societies Act 1986

The Building Societies Act 1986 states that Building Societies must raise at least 50% of funding from their members’ deposits in savings accounts. The remaining 50% of funding from other sources is referred to as wholesale funding, and usually comes from the market. Together, this is referred to as the funding limit.

The 50% wholesale funding limit is in place to ensure member-centricity is at the forefront of the Building Societies purpose and that sources of funding are diversified. Funding limits are not a requirement for high street banks, which some say has hindered competition within the Building Society sector who are far more restricted when it comes to external funding. The proposed amendments to the act look at changing how the funding limit is structured.

The funding limit

The funding limit plays an important part in how a Building Society operates as exceeding the limit leaves Societies vulnerable to liquidity issues if market conditions change. However, the chart below illustrates the amount of wholesale funding held by Building Societies operating in the UK over the last 20 years. In recent years, Building Societies steer clear of sourcing the full 50% of funding from the wholesale market, taking 2018 as an example, Building Societies only held approximately 27% in wholesale funds.

In general, Building Societies avoid exploiting all available wholesale funding to leave a buffer in cases where they are in urgent need for external funding from the market, typically received from the Bank of England.

(Source: https://researchbriefings.files.parliament.uk/documents/CBP-9922/CBP-9922.pdf; https://www.bsa.org.uk/statistics/sector-info-performance/sector-information)

What’s changed

On 06 December 2023, Julie Elliot MP introduced an amendment to The Building Societies Act 1986 to Parliament. While there are no changes to the funding limit itself, the changes to the Act allows UK Building Societies to remove certain types of wholesale funding from counting towards the funding limit. Most notably, the amendment disregards funds which a Building Society may receive from the Bank of England in exchange for collateral referred to as ‘liquidity insurance facility.’ This change gives Building Societies access to additional funding from the Bank of England without affecting the funding limit by providing financial support in times of crisis.

Banks and Building Societies have been long standing competitors in the mortgage lending market however, the funding limit has hindered Building Societies competitiveness. The government has recognised the need to address the disparity with this amendment designed to help Building Societies gain access to additional funding from the wholesale market. As banks are not required to adhere to a funding limit, this change could in theory help Building Societies compete better in the mortgage lending market, although it is unclear if this will happen in practice.

What the industry thinks

While the amendment to the Building Societies Act 1986 has been positively reported in the media, we explored the topic further with several industry players. These discussions revealed 3 key themes:

Wholesale funding affects membership: Purpose-led Societies are intended to be owned by and run for their members, if the Society relies more on external funding, decisions could be influenced by the wholesale funder rather than the traditionally aligned interests of members. It’s important for Building Societies to carefully manage their sources of funding to balance the need for external funds with the preservation of member interests and benefits while delivering on their purpose.
Affordable Capital Instruments: Without a doubt, the proposed amendment will offer Societies more wholesale funding options. However, many of the Building Societies we spoke to highlight the need for affordable capital instruments is far greater.These are essential for the long-term financial health, growth and member value for Building Societies.
Investing in digital front ends: Technology Investment: On the other side of the coin, instead of increasing levels of wholesale funding, a Society could invest in their digital front ends to drive sustainable growth through increased member deposits. Driving funding through technology upgrades would be cost-effective and sustainable in the long run whilst ensuring the Society remains member focused.

Conclusion

From our research, it’s clear that this amendment will mean different things to different Building Societies across the UK. This article tries to bring the different views to the surface and highlight that the funding bill isn’t enough to level the playing field in its entirety, however, it’s encouraging to see the bill progress through Parliament. This emphasises the vital role that Building Societies play in the economy but also the importance of legislative recognition and support for these invaluable institutions.

Arguably, this amendment has gone some way to help Building Societies to compete with banks but work still needs to be done to help the sector. Affordable capital instruments and better digital front ends are required for Building Societies to continue to be successful and deliver for their members for many years to come.