It is often said that journalists write the first draft of history. But, when it comes to the UK’s version of the global banking crisis, it is MPs who have produced one of the earliest and most relevant analyses. And our movement should be very grateful that its collective authors – the House of Commons Treasury Select Committee – is chaired by Labour/Co-operative MP John McFall and its membership also includes prominent Labour/Co-op MP Andy Love.
McFall’s and Love’s outlook is apparently shared by the rest of the committee, because its latest report – Banking crisis: dealing with the failure of the UK banks – argues that much of the catastrophe results from demutualisations and the marginalisation of building societies within the financial services sector.
The fundamental critique will be familiar to regular readers of the News. “We have experienced a comprehensive failure of the banking system at all levels,” said McFall. “The banks have failed to govern themselves effectively: senior managers failed to understand the investments being made in their name; risk management and due diligence were seemingly ignored; and the non-executive directors, often eminent and hugely experienced individuals, failed in the proper scrutiny of the banks’ activities.”
All News readers will by now be well aware that every single one of the 10 demutualised building societies has subsequently ceased to be an independent business, with four of them (Halifax, Bradford & Bingley, Alliance & Leicester and Northern Rock) having effectively gone bust. But it is equally striking to look at the facts from the other end of the telescope.
Four banks had to be rescued by the Government from collapse. Three of these – Northern Rock, Lloyds/Halifax and Bradford & Bingley – were destroyed by the hubris of demutualised societies. Only the Royal Bank of Scotland was capable of self-destruction without the aid of demutualisation – in its case the main factor was its disatrous and overvalued takeover of Dutch banking giant ABN-Amro.
It is therefore as relevant to blame Thatcher’s deregulation of building societies for the current crisis in the UK as the Thatcher/Brown deregulation of financial services.
The report is also important for its examination of the collapse of institutions, particularly Bradford & Bingley. This thrived for 149 years as a mutual, holding a loan book of £18.4bn and retail savings balances of £15.5bn when it demutualised in 2000. It lasted a mere eight years of demutualisation before the Government had to bail it out. By then, its residential portfolio held loans of £41.3bn, partially funded by deposits of £24.5bn.
In the interim, B&B expanded by buying securitised loan books from GMAC (which, unfortunately, the West Bromwich Building Society has also done, using a special purpose vehicle subsidiary), with comparitively high rates of default, and through buy-to-let and self-certified mortgages. By the time of its collapse, B&B held 20% of the UK’s buy-to-let market, secured on assets of fast declining value, which made up 60% of B&B’s new business. Another 20% of B&B’s new business was on self-certified mortgages – borrowers told lenders how much they earned and, surprise, surprise, many of them lied in order to get a loan.
This picture of B&B is not merely of an institution that changed its ownership structure. It also fundamentally changed the character of its business operation. In doing so, it ceased to operate in a market of long-term profitable stability, but began operating in one of extreme risk.
Moreover, while building societies have the legal capacity to finance up to half their borrowing from outside their own savings base, the select committee reports that in practice they mostly raise under 30% of their lending exposure on this basis. And those funds are overwhelmingly held in cash to meet regulatory liquidity requirements, not committed to long-term lending. (It was the use of short-term money market funding to finance long-term, often fixed rate, loans that undid the demutualised building societies.)
The fundamental argument for giving mutuals a strong place in the banking market was put to the committee – though not necessarily intentionally – by the former chairman of the Royal Bank of Scotland, Sir Tom McKillop. “[It] is a kind of given, that [shareholders] would always be pushing the organisation to perform better…. the drift from most institutional shareholders was to increase the dividend, share buybacks, return capital, do not sit on capital and run a very efficient balance sheet,” he said.
In other words, if you want banks to operate as ‘utility businesses’ – an operation that moves money from one place to another, with security and sustainability – those banks (or a core of them, anyway) should run as mutuals.
This is broadly the conclusion reached by the committee itself. While the big banks refuse to see themselves as utility businesses, the committee seems drawn to the view that their high street operations have traditionally been utilities. It is bringing the high street clearing banks together with high risk investment banking operations that – together with demutualisations – brought banking to its knees. But expert witnesses told the committee it was doubtful that the utility and high risk ends of the banking sector could now be separated.
There were also strong warnings issued to the MPs about the impact on consumers of the loss of competition brought about by the mergers of banks as part of rescue packages. Co-operative Financial Services told the committee that, in particular, the Lloyds takeover of Halifax Bank of Scotland brought “long-term risks to the effective operation of key UK banking markets.”
The committee is clear that it wants a stronger role for mutuals in the future. It wants to see new building societies, raising also the question about whether some of the failed institutions might be remutualised. The MPs expressed concern that while the Ecology Building Society was formed in 1981, it would now be much more difficult to set-up a new building society. They asked the Government to review what changes in law might be needed to increase involvement in financial services by mutual organisations.
Ann Cryer’s campaign against the penalisation of building socities, by disproportionately charging them for protection from the Financial Services Compensation Scheme, was also implicitly backed by the committee. “It is entirely inappropriate that institutions that are recognised as having a safer funding model enshrined in legislation in order to protect their depositors, should be required to contribute more to the industry’s insurance scheme than competitors with funding models that have failed in the current crisis,” concluded the MPs. Instead, they said, the FSCS levy should be related to the risk exposure of an institution, not the size of its depositor base.
A submission from the Financial Inclusion Centre to the select committee called for measures that would assist increased involvement by mutuals in the financial services markets. These might include boosting credit unions and community development finance institutions (CDFIs). That call to strengthen and extend the role of CDFIs was simultaneously taken up by Andy Love and fellow Treasury select committee member Jim Cousins MP, who publicly called (along with other key figures in the social enterprise sector) for more support for CDFIs from the Government.
Whether the call to strengthen CDFIs and other mutuals will be accepted by this government (and the next one) we will have to wait to see. But the Treasury select committee has further opportunities to present their case. This is just the first in a series of four reports it is producing on the banking crisis.