I wonder how many subscribers to Co-operative News are also readers of the Financial Times. Not enough is my guess.
It is not, though, my purpose here to increase the circulation of the FT – which, in any case, is doing pretty well without my assistance. Rather it is to spread knowledge of a recent idea put forward in the paper and which I believe merits a wider airing within the specialist world of mutuality.
Let me start by spelling out my working assumption – one that is shared by the FT’s banking specialists. Some financial mutuals have had a difficult time recently and more will do so in the time to come.
Although it was the banks that caused the mess that our economy has descended into, the impact has spread (self-evidently) beyond those banks that were most to blame. That is because with the lack of inter-bank lending, many institutions have lost their access to short-term capital.
We can add to that other vulnerabilities that have afflicted particular building societies. The Chelsea appears to have fallen victim to sophisticated fraud; Barnsley invested heavily in Icelandic banks; several loaned too much to sub-prime and buy-to-let borrowers and on commercial property at peak prices. Much of the financial mutual sector shared the flawed thinking of the demutualised building societies that – contrary to the evidence of history – that property prices would only ever go up.
None of this compares with the scale of the errors made by large banks such as RBS (buying ABN-Amro at an inflated price); Lloyds (buying Halifax without properly checking out the business and its liabilities); Halifax (in lending on weak business plans and on excessively large loans to value on homes); Northern Rock (again excessive lending on loan to value, as well as lending long-term on short-term financing); and AIG (guaranteeing securities that it failed to understand).
Yet there is a significant irony. The shareholders have suffered, the borrowers have suffered and taxpayers have suffered in bailing-out the banks. Yet the overall shape of banking PLC will not be much affected in the long run. They have run to the governments and they have made new share issues, raising extra capital.
These options are, broadly, not open to the mutual sector – at least not while remaining mutuals – and consequently the total number of financial mutuals may reduce to a much greater degree (proportionately) than the banking sector. The recent proposal from the Building Societies Association to remutualise Northern Rock is unlikely to be supported by a government so short of funds. While the Government brokered a rescue of the Dunfermline Building Society, it could only do so by reducing the total number of trading building societies and merging it into the Nationwide.
West Bromwich was rescued through a different device that allows it to issue a quasi-shareholding – but many people have concerns about the use of hybrid formats for mutuals. My understanding is that the downfall of one previously successful co-op came when it unsuccessfully adopted a bybrid structure.
Without being able to make rights (new share) issues, financial mutuals have to find other ways of meeting the increasingly strict solvency requirements – which have just been made even more demanding at a meeting of G20 finance ministers.
The solvency argument is entirely justified. Banks and insurers should not engage in reckless activities without having the capital base to meet the consequent liabilities if the undertakings go bad.
But the decision is unfortunately very difficult for building societies and other financial mutuals to comply with. Building societies have consistently performed well in the best buy tables because they operate on low margins, without the need to pay shareholder dividends. Many building societies are finding this approach increasingly difficult.
The reason for this is that they must now build-up capital buffers to meet the new solvency obligations. Increasing trading margins and retaining a larger proportion of surpluses is the only way they can meet the stricter solvency requirements.
This is where the Financial Times proposal comes in. A recent FT article – ‘Mutual Suspicion’ – suggested an alternative that, in effect, could enable building societies to learn from the example of the recently enlarged Co-operative Financial Services.
As Neville Richardson explained in a recent interview with this column, the Financial Services Authority sees CFS as operating a separate business model – neither building society nor PLC. It is a business model that is less risky, not only because CFS has consciously adopted a lower risk strategy, but also because it has a strong shareholder base through the ownership structure as part of the Co-operative Group.
Building societies are essential ‘one trick ponies’ and have no obvious means of spreading their risk across a wider operating base. But the FT suggests a method of doing this. Under the FT’s suggested way forward, a shared operating reserve could be established across the building society sector. This would enable the sector to spread risk and meet collectively the solvency requirements.
As the FT explains, through what it refers to as a “co-operative umbrella” the societies would also have the opportunity to access cheaper capital because of the economies of scale.
This approach is not unique: it is already used in parts of continental Europe, including in France, Germany, the Netherlands and Austria. It is not without its risks: it could lead to dilution of identity, increased pressures to merge and the adoption of hybrid structures that could rid the sector of its true mutuality. I believe that the FT is correct in its belief that these risks can be mitigated.
It is a suggestion that deserves serious consideration.