WINDFALLS, SHORTFALLS AND BRANCH CLOSURES

First appeared in Mortgage Finance Gazette in March 2006.

Introduction

Two new reports have been published recently that re-emphasise the key differences between plc banks owned by, and operated in the interests of, their shareholders and mutual building societies owned collectively by, and operated in the interests of, their members/customers.

First, in February, three academics (Andrew Leyshon, Paola Signoretta and Shaun French) from the University of Nottingham published the results of their research into the geography of British bank and building society networks.  The report points out that the closure of bank and building society branches can have significant consequences for customers who may have to travel further to transact financial business or obtain face-to-face advice; furthermore, branch closures “in engender a sense of loss and abandonment within local communities”.  The most important conclusion from the research is shown in the table below.

Rate of Closure of Branches 1995 – 2003

What were the reasons for these branch closures and why are there such substantial differences between banks and building societies?  The authors say that “banks in particular were anxious to drive down costs by closing branches in the face of investor pressure.  This long run process of closure is also a product or a more competitive market for retail financial services, which forces all firms to seriously appraise costs against revenue.”  The authors point out that “Government considers the branch to be an important bulwark against financial exclusion.”

It is clear from the report that corporate governance places a particularly important role in explaining the rate of branch closure.  For example, the average yearly rate of closure for former building societies that converted into banks quadrupled from 0.6% per annum between 1989 and 1995 to 2.4% per annum between 1995 and 2003 – of course, most conversions took place in the mid to late 90s, suggesting that branch closure rates are linked at least in some way to the switch from member to shareholder ownership.

The authors say that “one interpretation of the faster rate of closure [in banks than in building societies] is that public companies are under more pressure to make cost savings as they are driven by the necessity of producing value for shareholders “such pressures, some of correspondents argued, led to banks closing not merely branches that were merely losing money, but also branches that were profitable, but just not profitable enough [authors’ italics].”  In contrast, as one organisation (it is not clear from the report whether this is a bank or a building society) is quoted as saying “the general view among building societies is that the branch network is valuable for member relations… customers value the personal contact.  That’s not universally so, but it tends to be the case that building societies… keep their branches open for both financial and non-financial reasons.”

This theme is continued in the March publication from the All Party Parliamentary Group for Building Societies and Financial Mutuals – Windfalls or Shortfalls?  The True Cost of Demutualisation.  This cross-party group of MPs concluded from the evidence that it took that “mutuals, both in the building society and life assurance sectors, performed better than their plc rivals on a variety of financial performance indicators… they pass these cost advantages on to consumers in terms of better rates.  This was clearly backed up by any study of “best buy tables.””  Interestingly “the enquiry also found that there had been substantial increases in remuneration enjoyed by directors of those institutions which had demutualised in the 1990s, but no corresponding improvement in performance”.

In evidence to the enquiry, Mick McAteer, Senior Policy Advisor at Which?, told the enquiry that if you looked at “average rates over ten years on a mortgage, you find that building societies will charge about half a percent a year less than the banks.  The long-term average on a cash ISA is about 0.2% or 0.3% higher on savings rates as well.”  A further contributor of evidence to the MP’s research, Professor Nigel Waite, Director of the Financial Services Research Forum at the Nottingham University Business School showed that between 1977 and 2003, mutuals operated “more cost effectively than plcs in a number of key areas”. Indeed, this was not just the UK experience, but reflected in a survey of mutual and plc insurers across Europe. 

Similar to the University of Nottingham research that formed the first part of this article, the MPs points out that the scale of the cuts in branch networks over the past nine years have meant considerable cost savings for the banks, but “at the expense of many communities”.

Overall, the two reports seem to provide conclusive evidence that demutualisation results in the worsening of interest rates and of service provision.  In contrast, mutual institutions continue to offer better interest rates, better service provision and a greater understanding of the needs of communities.  As shareholder pressure on plcs becomes ever more intense, the MPs’ report is unlikely to be the last word on the true costs of demutualisation – it seems like that a further report in five years would show further substantial costs, which we can only currently guess at.