Policy
Dear Chancellor
The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK including all 52 UK building societies. Building societies have total assets of over £370 billion and, together with their subsidiaries, hold residential mortgages of over £245 billion, more than 20% of the total outstanding in the UK. Societies hold nearly £240 billion of retail deposits, accounting for more than 20% of all such deposits in the UK. Building societies also account for about 36% of all cash ISA balances. Building societies employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.
Executive Summary
In this submission we detail our concerns given the current economic environment, and present our policy suggestions for the forthcoming fiscal year. In summary, we urge the Government to:
- Conduct a thorough assessment of the aggregate impact of the various Government and regulatory initiatives designed to strengthen the financial services industry, with a view to a more realistic phasing of their implementation as economic conditions improve, and so as to reduce the risk of stifling growth and prolonging the recession;
- Take steps to mitigate unfair competition from public-owned and part public-owned failed banks and National Savings& Investments;
- Make efforts to avoid market disruption and distortion to competition as the Government exits from the various funding and support initiatives entered into in the last two years and as the failed institutions which required Government support return to the market cleansed of their bad assets and still backed by the Government, implicitly or explicitly;
- Encourage local authorities to remain active in the wholesale markets, providing funding for lending by financial institutions;
- Recognise of the plight of elderly savers that rely on their savings to supplement their income in the current low interest rate environment;
- Allow two-way transfers between cash and equity ISAs;
- Maintain support for the Child Trust Fund;
- Re-think plans for a ‘People’s’ Post Office Bank;
- Reform FSCS funding to make it more equitable to prudently run institutions;
- Expand the Support for Mortgage Interest scheme which has been shown to be effective in assisting borrowers experiencing temporary financial hardship;
- Extend the Stamp Duty holiday for properties under £175,000 to the end of 2010 and reform the ‘slab’ system;
- Give serious consideration to returning Northern Rock bank to the mutual sector.
Pre-Budget Report
The 2009 Pre-Budget Report will be delivered against a background of highly challenging economic conditions. In common with many other financial services providers, building societies and other mutual lenders have experienced a difficult 2009.
The low Bank Rate is making it difficult to attract retail deposits, and this has compounded funding constraints as wholesale markets remain off-limits for many. This has meant funding for mortgage lending has become more scarce and expensive, inevitably resulting in less choice for potential mortgage borrowers.
We welcome very much the Government’s support for, and confidence in, building societies and other mutual lenders expressed in its July White Paper “Reforming Financial Markets” . The BSA and leading societies have been active contributors to the expert stakeholder group convened by the Treasury. And we welcome similar expressions of confidence and support from the Financial Services Authority
In response to the banking crisis, there has been a raft of regulatory and banking supervisory initiatives, intended to promote a more prudent and robust banking system for the future. Whilst each is capable of being justified on its own merits, the cumulative impact of these initiatives at the present time is to make legitimate and prudent business activity increasingly difficult for building societies. To illustrate the problem, we have set out below details of the initiatives we have in mind.
- Substantial increases in effective capital requirements through the application of extreme stress-testing to firms’ existing capital position;
- Potentially significant increases in the cost of liquidity requirements flowing from FSA’s final policy;
- For building societies only, a “specialist sourcebook” that could endanger their ability to compete in the mortgage market; and ( curiously disconnected and arguably inconsistent with this )
- Major new regulation of aspects of mortgage lending.
Added pressure on retail margins, together with the increased costs associated with higher capital and liquidity requirements and FSCS contributions has already put profitability under strain and we anticipate that, for the second year running, several building societies will be posting losses for 2009. The above initiatives are all likely to have procyclical effect, whereas elsewhere the Authorities have realised that in principle, procyclicality should not be strengthened, rather reduced by counter-cyclical measures. There is, accordingly, a need to take stock and assess the impact in aggregate of the authorities’ various initiatives. The FSA has recognised this, at a theoretical level in its policy statement following the Turner review, and its latest DP 09/4. But all this needs to be put into practice: we need a commitment first, for effective “whole-package calibration”, and then, if necessary, to scale down the initiatives to a level at which legitimate business is able to continue and prosper.
The BSA looks forward to working with the Government as an active member of the recently established expert group. This group will allow stakeholders to explore how building society governance can be improved, the future of capital requirements and how shared operating models could be of benefit to societies. We welcome this opportunity to identify and assist the implementation of advantageous reforms in the sector.
One barrier to the sharing of services is the potential additional tax burden associated with running a shared operating model. The Treasury should recognise the difficulties that building societies will face in claiming back Value Added Tax if they are to share services and the pressures this may cause in the current economic climate. A more sympathetic VAT treatment from the Treasury may help to reduce this barrier.
Help for savers and borrowers
The reduction of the Bank Rate to 0.5% has undoubtedly assisted borrowers in servicing their debts and has helped maintain arrears and possessions at relatively low levels. However, the very low interest rates have created a difficult environment for savers, especially for those who rely on interest payments as one of their main sources of income.
Even with interest rates currently so low, cash savings have performed well compared to other asset classes such as equities over the past 10 years. £1,000 invested in the FTSE 100 in 1999 would now be worth approximately £1,100, whereas the same amount invested in cash would today be worth approximately £1,500. But there is no doubt that the current very low interest rates are having an impact on the competitiveness of the retail cash savings market as a whole.
Across the total market, retail saving balances have increased by just £16.7 billion in the first nine months of 2009, compared to an increase of £43.0 billion in the same period last year. It is likely that the building society sector will see a net outflow of savings in 2009, and balances across the total market may struggle to rise by more than £20bn. With interest rates so low, the incentive to save has understandably reduced. Savers are reducing the amount they save each month or taking money out of their accounts to repay debt or supplement their income.
The Government can help savers during this difficult period by increasing the incentive to save via its fiscal policy.
ISAs
We welcomed the increase to ISA limits announced in the 2009 Budget. From 6 April 2010 all adults will be able to place £10,200, tax free, within an ISA wrapper. That should increase the incentive to save, although the low level of interest rates will continue to act as a drag on saving. We would, accordingly, urge the Government to take further steps to help savers. Among the measures we would like to see the Government take is to allow two-way transfers of ISAs, ie to enable transfers from stocks and shares ISAs to the cash product, as well as the other way round. The mini cash ISA has proved very popular with those on low incomes. In 2006-07, the latest year for which such HMRC figures are available, 81% of cash ISAs were subscribed by people on annual incomes of less than £30,000, and 63% were subscribed by those with incomes of less than £20,000 a year.
As well as representing a consistency of approach, enabling two-way transfers would make lifestyling of portfolios much easier. One-way transfers from cash ISAs to stocks and shares ISAs benefit only higher rate taxpayers: there is no tax benefit to those on lower incomes holding equities inside - as opposed to outside - an ISA. Cash ISAs give tax breaks to all taxpayers, including those on lower incomes.
Child Trust Funds
The Government’s continuing commitment to the Child Trust Fund (CTF) is welcome. The true value of the CTF will be seen only over the longer term, when it can be expected to generate benefits for individuals and society as a whole. As well as the financial boost it provides, the CTF will promote financial capability by ensuring all children gain the invaluable experience of operating an account and managing their finances. Also, the CTF helps engender the savings habit in all children - and eventually young adults. This is increasingly important as state and employer provision of pensions recede and all individuals are having to take more financial responsibility for their futures.
An equitable savings market
One of the main concerns of building societies currently is the unfair competition they face from public-owned and part public-owned deposit takers in the market for retail savings. Building societies generally behaved prudently during the boom years, and societies feel aggrieved that the bailed out institutions that behaved far less prudently than themselves are now benefiting from Government support. This has created an un-level playing field in a market now dominated by these state backed banks.
Among the many legacies of the bank failures of 2007 and 2008 is a heightened awareness by savers of safety issues surrounding deposits. Public-owned and part public-owned deposit takers continue to benefit from the Government guarantee of all deposits (explicit for some institutions, such as Northern Rock and NS&I and implicit for others, such as RBS and Lloyds, notwithstanding the recently announced divestments) and this has created a distortion in the savings market to the detriment of those institutions that do not benefit from the Government guarantee.
Competition for retail deposits over the past year has increased significantly as lenders seek alternate sources of funding to wholesale money markets. State owned banks are also being encouraged to expand their mortgage books, further increasing the demand for funding.
Building societies obtain more than 70 per cent of their funding for mortgage lending from retail deposits, and are heavily and increasingly reliant on this source of funding for the viability of their business. Increased competition from state-sponsored banks, low interest rates and distorted market conditions are making it difficult for building societies to secure funding at sensible levels, and this is reducing the availability of mortgage finance. Building societies largely operate on a regional basis, and such reductions in mortgage availability are likely to affect local communities disproportionately.
A further source of concern is the Government’s pursuit of the concept of a ‘People’s Bank’ which utilises the Post Office network. The Post Office is already a spirited competitor in the retail savings market. The Bank of Ireland, which sells its products via the Post Office network, benefits from the halo that it derives from that association – and its customers could be forgiven for being unaware that its deposits are subject to Ireland’s deposit guarantee scheme, rather than the UK’s Financial Services Compensation Scheme – and the implications that this may have for the safety of their deposits. A People’s Bank would inherit the Post Office’s network of 11,500 branches which would instantly create an unfair advantage compared to competitor institutions. The regional reach that a Post Office based bank would provide is already offered by the mutual sector which provides banking and investment products tailored to the needs of local communities. We remind the Government of its long-standing aim of supporting the UK mutual sector to thrive and serve a wider section of the community. We suggest the establishment of another state-run institution would undermine this commitment.
The Government has acknowledged to some extent building societies’ concerns about unfair competition. It is welcome, for example, that National Savings and Investments has a zero financing target for 2009/10. Given that savings balances across all UK deposit takers are likely to increase by less than £20 billion this year, an increase of less than 2%, the NS&I’s zero funding target in fact represents quite an aggressive policy. This month NS&I have announced a significant interest rate rise across their product range made possible by dropping the value added measure. This will further add to the distortion of the savings market when coupled with the explicit Government guarantee of NS&I deposits. Building societies and other deposit takers will find it difficult to match the high interest rates being offered in an already extremely competitive market. It is therefore essential that a zero funding target at least is maintained for 2010/11. Indeed, after a year in which many building societies will see a decline in savings, a negative target for NS&I would be a welcome recognition of the pressures faced by private sector institutions.
A similar target should be required of Northern Rock if the nationalised bank is not to continue to create unfair distortion of the retail savings market. We also urge the removal of the unlimited Government guarantee of the deposits at this state-owned bank. These measures will help restore fair competition, and reduce confusion, allowing consumers to compare products on a like-for-like basis.
FSCS
The BSA supports the proposed review of the Financial Services Compensation Scheme (FSCS)
funding model in 2010/11. The Review is in response to concerns raised by the building society sector about the unfairness of the current funding arrangements for the FSCS, whereby building societies which operate a generally prudent business model bear a disproportionate share of the costs of compensating the depositors of failed banks, when compared to the high risks taken by other institutions leading up to the recession. A more equitable mechanism for funding the Scheme is required that also takes account of risk exposure to determine subscription rates.
Wholesale funding
The amount of funding held with building societies by local authorities stood at £5.0 billion at the end of September 2009, compared to £12.1 billion a year earlier . The withdrawal of this funding, at a time when other sources of funds are very expensive, further limits the lending activity of building societies. The BSA urges the Government to encourage local authorities to remain active in the wholesale market.
Government Support Schemes
During the past twelve months or so the Government launched a range of initiatives such as the Credit Guarantee Scheme and Special Liquidity Scheme to support the financial system and encourage the flow of mortgage lending. These were certainly required and provided important support for some financial institutions. However, as this support is temporary we recommend that measures are put in place now, to ensure there is a smooth exit from the schemes for the affected firms. This may mean that further interim measures are required as full withdrawal of all financial support could have the effect of causing future instability in the mortgage market.
The mortgage market
Support for Mortgage Interest (SMI)
The BSA considers that the SMI currently excludes many borrowers who are facing financial difficulty and a fundamental overhaul to SMI is required to ensure that it provides appropriate support to all borrowers who require assistance. We recommend that the SMI is de-linked from other employment benefits and made available to households who have suffered a reduction in income and not just a loss of income.
We would support the continued extension to SMI of the reduced 13 week waiting period (previously 26 or 39 weeks), and the doubling of the capital limit from £100,000 to £200,000. However, we would also recommend a further review of SMI to provide greater certainty to borrowers in difficulty. We believe that SMI could be tailored depending on the circumstances of the borrower. The Government should also look to amend the rate of interest paid to reflect the interest rate charged on the mortgage. This will ensure that borrowers paying a higher rate obtain adequate support.
Stamp Duty
The current Stamp Duty holiday for properties costing less than £175,000 is very welcome and is providing much-needed assistance, particularly to first-time buyers, and we would like to see it extended until 31 December 2010. We would urge the Government to use the period until the end of 2010 to undertake research in to how the system could be reformed to reduce the distortions from the current “slab” structure of the tax. The current system results in the bunching of transactions at prices just below the thresholds for different rates.
Mortgage Market Competition
Similar to our concerns about unfair competition in the retail savings market, the BSA is concerned with competition from state backed banks in the prime lending market at a time when lenders are facing increased costs and compressed margins. If banks such as Northern Rock lend in competition with private-sector lenders it should not abuse its privileged, state-funded, position by squeezing margins to a level at which the private sector cannot compete. We would expect the Government to encourage state funded lending in markets which private-sector lenders have deemed too risky but a demand for loans, and social need, still exists.
Northern Rock
The BSA urges the Government to consider seriously returning Northern Rock bank to the mutual sector following its restructure that the EC recently approved. A financial system with diverse ownership and governance structures is better able to weather the strains of the business cycle than one which is plc-dominated, and a stronger mutual sector will counter-balance the short-termist pressure of the City. Mutuals also help reduce the concentration of financial sector resources and employment in the City, dispersing wealth and welfare to regional and local economies. Keeping a reformed Northern Rock independent of the big banks would be good for competition. A remutualised Northern Rock would help the Government to meet its policy objective of supporting competition and diversity through the maintenance of a strong mutually-owned financial sector. A re-launched and remutualised Northern Rock could still repay the tax payer over time while achieving optimum value bearing in mind these other policy objectives. We have taken the lead by commissioning and publishing an independent report analysing this proposition in more detail, with input from leading academic economists and other thinkers, and were pleased recently to talk through this report with Treasury officials. We continue to commend the remutualisation proposal to the Government.
Conclusion
The BSA urges the Government to take stock of the various regulatory and other initiatives introduced in response to the banking crisis, and their effect on the legitimate and prudent business activities of building societies and mutual banks. The mutual sector also urges the Government to ensure the savings market remains competitive by removing the deposit guarantee from state backed institutions. This will benefit all private-sector deposit takers and their customers. The Government should also take further steps to help savers during this period of low interest rates by allowing the two way transfer from stocks and shares ISAs to Cash ISAs. We support the Government’s continued commitment to CTFs and acknowledge the long term benefits such products will deliver. With rising unemployment and many households facing added financial pressures it is important for the Government to continue the extension of, and ultimately to review, SMI to help borrowers that might struggle to meet their mortgage payments. Continued support for home buyers is necessary, and a review of the stamp duty tax should be undertaken to prevent unnecessary distortions to the housing market.
Yours sincerely
Adrian Coles
Director-General
