in defence of mutuality

In Defence Of Mutuality

Thomas Clarke

`̀ There was something a little unseemly about how the building societies intending todemutualise did so by encouraging their members to vote in favour with the inducement ofsignificant payments in shares''. Should one have no regard for the intentions of those whoproduced the present capital accumulation, or for the idea of holding reserves in trust forfuture members? The author is DBM Professor of Corporate Governance at Leeds BusinessSchool, Leeds Metropolitan University, Calverley Street, Leeds LS1 3HE.

I n the Spring of 1997 the UK mutual Build-ing Societies appeared an endangered

species. The decision of the Halifax BuildingSociety to convert to a public limited com-pany agreed on 24 February, together withthe rush to abandon mutuality by severalother of the largest building societies, seemedto suggest that a corporate form which hadlasted for almost two centuries was nearingthe end of its useful life.

Sustaining competitiveness will be depen-dent upon developing successful manage-ment strategies, but also upon dispelling anypublic sense that the mutual building societiesare weaker in corporate structure or govern-ance than the societies that have converted topublic limited company status. The identity,confidence and integrity of mutuality has to bere-established. Reconceptualising its missionwill be a vital part of any mutual society'ssurvival strategy. David Robinson of theScottish Provident put the fundamental ques-tions every mutual society is now confront-ing: `̀ Its attitude to mutuality will be crucial.Is it comfortable with its constitution, or doesit feel itself to be an anachronism in the con-temporary commercial environment? Does itbelieve that its special relationship with itsmembers gives it an advantage, or is it simplymaking the best of what it sees as anoutmoded and limiting corporate structure?In short, is it happy with what it is?'' (MoneyManagement November 1996:5)

The Financial Services Industry

The UK financial services industry employs2.5 million people and contributes nearly 18%

to GDP (Money Management January 1996:40).Traditionally the UK personal financial ser-vices industry has comprised three principalsectors:

. building societies, which received customers'personal savings and supplied mortgageloans for home ownership;

. banks, which offered deposit accounts,current accounts and loans to personalcustomers;

. and life assurance companies, which pro-vided life policies to their customers,initially to make financial provision in caseof death, but more recently to provide longterm investments.

Gradually, the boundaries between thesesectors have become less distinct. In recentyears, a significant number of buildingsocieties and banks have added life assur-ance, pension and unit trust products to theirportfolios. At the same time, a number ofmajor insurance companies have started tooffer banking services. (Halifax 1997:13)

Society depends upon the efficiency andprobity of the financial services industry tofacilitate the financial well-being of people.This relationship of trust requires consider-able confidence in the long term stability andintegrity of the industry. However, financialinstitutions have to survive in a competitivemarket economy, and as the financial sectorhas grown remarkably in recent decades ithas also experienced considerable turbulence.Financial markets have become characterisedby their immense profitability, combined withtheir volatility and unpredictability (Cohen1997). Internationally the financial marketsare associated with constant risk, which is

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compounded by speculative activity (Nieder-hoffer 1997). Deregulation and the strongequity market of the 1980s released enormouscommercial energy in the sector, but therecession in 1991 saw a rise in inflation, andcollapse in house prices. Misselling of en-dowment mortgages, insurance policies andpersonal pension schemes left the public witha cautious approach to the personal financialservices sector. (Money Management February1996:63)

The UK mutual building societies with astrong capital base, long standing customerrelationships and conservative managementpractices emerged from this period relativelyunscathed, and many managed to preservetheir image as offering rock-like stability in anuncertain financial world. Diversification intoestate agency had exposed the buildingsocieties, however, to a new level of risk.

The significant losses incurred by the build-ing societies in the 1990s from their estateagency activities, led a number of societies toleave this business as hastily as they hadentered it. The search for a strategic formulathat would allow the building societies toescape the confines of their traditional busi-ness and pursue growth, diversification andflexibility in the marketplace continued, andby 1995 the forces for conversion of the largermutual building societies into public limitedcompanies seemed almost irresistible. Beforeexamining the arguments for the abandon-ment of mutual status it is instructive toremember the origins of mutuality.

History and Philosophy of Mutuality

Building societies came into existence in themid-18th century and were known as theTerminating Societies. Members pooled theirsavings until there was enough to purchaseland and build a home. A ballot decidedwhich member received the home, and thesocieties were wound up only when everymember was housed. The societies were ameans by which working class people couldbecome home owners and avoid slum dwell-ing, and represented a major example of theVictorian ideal of self-help. The PermanentSocieties were created from the mid-19thcentury as the modest savings of workingpeople were insufficient to afford construc-tion of enough houses for all members. Fundswere supplemented from those who werewilling to save, but did not wish to buy ahome. By 1900 there were 2,286 permanentsocieties covering most of the country.

A Royal Commission of 1872 reported that:`̀ A building society with its money secured

on freehold land and leasehold property,and a constant incoming of repayments bymonthly instalments may be fairly preferred. . . to a bank.'' The question of status wasresolved with the 1874 Building Societies Actwhich stated that they should be treated asfriendly societies rather than as banks orcompanies, friendly societies being distinct inthat they were formed on membership ratherthan on capital (Balmer & Wilkinson 1991:20±1). William Morris celebrated the senseof fraternity of this and similar cooperativemovements of the period: `̀ I knew once morehe that doeth well in fellowship, and becauseof fellowship, shall not fail'' (1986:54). Thiswas a different model of capital accumulationfor improving outcomes in the market place,a form of incremental capital accumulationparticularly suited to the needs of those onlower incomes with a capacity to plan aheadand persevere (Davis & Worthington 1993).The philosophy of mutuality, the mutualcreation and distribution of surplus and ofequitable ownership, and participation in theaffairs of the society proved robust andadaptable, and was at the heart of theachievement of a property-owning democ-racy. However, mutuality appeared to haverun out of steam by the mid-1990s and to becollapsing under the impact of a compellingcommercial logic.

Arguments For Conversion

The arguments for conversion of a mutualbuilding society into a public limited com-pany were most extensively set out in thetransfer document sent to members by theHalifax. The rapid pace of change in the UKfinancial services industry and the regulatoryregimes and corporate structures of bankswould allow them more freedom than thatavailable to building societies to satisfycustomer needs. The company would benefitfrom a regulatory regime which did notrequire it to have its principal purpose asmaking loans which are secured on regula-tory property. Historically the majority ofcustomers were members. However, therewas a growth of products and services whichdid not confer membership, such as currentaccounts, credit cards, personal loans, lifeassurance, pensions and personal equityplans. Having members as owners was nolonger appropriate, the Halifax Board argued:`̀ The owner of a business is concerned withmatters such as whether the business is beingeffectively and efficiently managed, whetherpolicies are in place to develop the businessand whether the return received on his or her

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investment is adequate. In contrast, theconcerns associated with being a customerof a business are different. The customer isconcerned mainly with quality of service,convenience of distribution outlets, price andwhether or not products meet his or herneeds. Customers and owners have differentpriorities and the Board believes that thisshould be reflected in the constitutionadopted by Halifax'' (1997:15). New businessinitiatives and diversifying into new marketswould require new sources of funding; equitycapital would allow quicker response to fast-moving markets. Conversion would allowimproved access to wholesale funds fromoverseas investors and to risk managementinstruments.

The weight of this kind of analysis had by1995 convinced eight of the largest buildingsocieties to convert, promising the creationof 16 million shareholders in the UK. Themutual life assurance societies have experi-enced similar pressures to the buildingsociety mutuals. FS Assurance, ScottishMutual, and Provident Mutual have alreadydemutualised, and Norwich Union hasdecided to become a stock market listedcompany. The process of demutualisationinvolves setting up a new proprietary com-pany owned by the shareholders and trans-ferring to it the mutual's assets and liabilities.The transfer requires court approval, but isnot subject to the detailed rules laid downbefore approval can be given as in the case ofthe building societies. One estimate is thathalf the larger mutual assurers will attemptto convert to public limited company statusby the end of the century (Money Management,February 1996).

To understand the implications of de-mutualisation, it is necessary to appreciatethe basic differences between mutual andproprietary companies. Proprietaries havethe flexibility to raise extra capital, but mustpay dividends which attract shareholders.Mutuals must generate their own capital,but do not have to worry about paying divi-dends to shareholders. Mutuals must balancepolicyholder returns against the growth of thebusiness. If it grows too fast it will have totake too much from policyholders to build upits capital and will perform poorly for them. Ifit grows too slowly it could also run intoproblems, but only if its costs increase as aresult. But the proprietary company mustbalance its policyholder returns against itsshareholder returns, rather than its owngrowth. If the shareholders demand toomuch, it will perform poorly for the policy-holders irrespective of the rate of growth ofthe business (Money Management, April 1996).

Questions Confronting the Mutuals

Inescapable questions now confront themutuals, the answers to which will determinewhether independent mutual societies have afuture or not: whether there is a distinctiverole which the mutual building societies arecapable of continuing to play in the personalfinancial services sector, in a context ofrapidly changing markets, products, tech-nology and processes? What are the mostattractive competitive strategies available toindependent mutual building societies de-pendent upon economies of scope, localknowledge and close customer relations?Does mutual status possess any advantagesin terms of accountability, releasing value formembers and customer relations compared tothe public limited company?

The total assets of the building societiesso far committed to remaining mutual exceed£100 billion. A survey conducted in January/February 1996 jointly by solicitors HammondSuddards and Mortgage Finance Gazette of thefuture of the building societies received re-sponses from 59 chief executives or seniordirectors of the 80 remaining BuildingSocieties which confirmed the view that themajority intended to continue.

There is accumulating evidence to supportthe business case for remaining mutual. Thecase for conversion has two principal ele-ments: the attainment of regulatory freedomand access to capital, and securing a clearerownership structure. However, with regardto regulation, the building societies now enjoya more permissive regime and diversificationis possible. The building societies since 1989have been allowed more flexible funding, andhave utilised only approximately half of the40% statutory limit on wholesale fundingsince then. Building societies had fully re-stored their capital position by the mid-1990s,and the only reason they could want furthercapital is if they intended major acquisitions.

On the question of ownership and account-ability, the building societies can claim to bewell managed in their members' interests.They have lower costs due to simpler productranges and smaller branch networks. Build-ing societies have limited bad debts. Thebuilding societies contest that they do offerthe equivalent of dividends in better serviceand lower pricing. Similarly Bank of Englandfigures revealed that building societies con-sistently paid higher interest on savingsaccounts than comparable accounts offeredby banks. Over a ten year period from 1984 to1994 the building societies paid out over £24billion extra interest compared to equivalentbank rates (Wrigglesworth 1997:9).


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Customer Relations

In 1996 the Building Societies Associationcommissioned the market research companyBRMB to conduct a survey of customers'perceptions of the different financial insti-tutions, and from a sample of 1,051 adultsover 15 years of age the following resultswere derived (Table 1):

There is little doubt that over the years thebuilding societies have been able to convey totheir customers a more accessible image thanthe banks. Though they tend to offer morelimited financial services than banks, theservices the building societies do offer areoften conveyed in a more supportive manner.Most visibly the building society branchesbecame quite welcoming places years ago,while many bank branches remained austereand a little intimidating.

The Moral Case For Mutuality

There was something a little unseemly abouthow the building societies intending todemutualise did so by encouraging theirmembers to vote in favour with the induce-ment of significant payments in shares. AsMike Blackburn of the Halifax admitted, thisalone accounted for the public enthusiasm for

the transfer to company status: `̀ Of course, allarguments for conversion are fairly arcane asfar as our members are concerned. The singleargument that will convince them is therelease-of-value argument. Members ownthe Society. At any point in time they candecide to release the accumulated value ofits reserves. Frankly, I struggle to under-stand those who say that this is in some way`wrong'. The way in which the value is dis-tributed among members ± the `fairness'debate ± is certainly a tough one to tackle,but the actual release of value is a decisionwhich should always rest with the members.I cannot go along with the argument thatreserves belong to `past, present and future'members. I can find no such philosophyexpressed by the founders of the movement''( 1995:6).

However, at the Special General Meeting ofthe Halifax to vote on the transfer to companystatus, held on 24 February 1997, of the 30speakers taken from the floor of the meetingmost raised precisely this moral problem. Thedirectors of the Halifax could be fairly relaxedin their response, in the knowledge that therewas already gathered a vast postal vote infavour of conversion by members keen to seetheir `free' shares.

John Wrigglesworth of the Bradford &Bingley has set out the moral case against

Table 1 Survey of Customer Perceptions of Financial Institutions

Financial InstitutionsBanks Insurance

Companies*BuildingSocieties

% % %

Always deal with you fairly 41 25 54Do not always deal with you fairly 33 34 12Balance 8 79 44

Are more understanding if you have financial problems 29 8 38Are not so understanding if you have financial problems 34 27 12Balance 75 719 26

Take complaints seriously 44 32 45Do not take complaints seriously 23 25 11Balance 21 7 34

Offer competitive returns for savings 19 16 59Do not offer competitive returns for savings 44 25 13Balance 725 79 46

*Insurance companies includes proprietary companies and mutual societies.

Source: Building Societies Association, BMRB Survey 1996

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conversion thus: `̀ Members do have owner-ship rights, specifically voting rights fordirectors and for mergers, but they do notown an equity share of the reserves (net value)of societies. The idea that a member who has£100 in a building society can immediatelylay claim to his share of the reserves (typi-cally £500) is absurd. Reserves have beenbuilt up over 150 years, mostly by pastmembers, many of whom are now dead.Current members do not own them. The board ofa building society holds the reserves in trustfor the benefit of both current and futuremembers''( 1997:13). Geoffrey Fitchew, of theBuilding Societies Commission, at the Build-ing Societies Association annual conferenceon 18 May 1995 supported this interpretation:`̀ Building Societies' reserves, which havebeen built up out of savings and mortgageinterest payments of past members of thesociety, are there not only for the benefit ofpresent members, but to maintain the con-tinuity of the society for the benefit of futuregenerations of members as well. The com-mission's view then is that societies' boardsneed not feel that they are under an absoluteobligation to `realise value' for the presentmembership. It is a perfectly valid decisionfor a society's board to make that it wishes tokeep its reserves for the benefit of futuremembers.''

Conclusion

It is a sad irony of the times that generationsof patient collective capital accumulationshould have been replaced by a sudden urgefor individual distribution of equity shares.The description of these shares as `̀ windfalls''is quite misleading when they representdecades of careful financial management. Ahard-headed financial analysis might suggestmembers have simply voted with theirimmediate interests. But if these membershave mortgages with de-mutualised societiesthey will see the interest payments rise tosatisfy the dividend demands of the newcompanies shareholders. If the members havesavings accounts with the de-mutualisedsocieties they will see their interest rates fallover the long term for the same reason. Ofcourse it can be argued that if they retain theirshares, these people will be in receipt of astream of dividend income. However, thoughshare retention is increasing, thirty per cent ofpeople dispose of their shares immediately,and many others over the medium term.

Given that the business case for conversionis not as strong as is often made out, themotivations of the directors of mutuals

determined on conversion can also be ques-tioned. On a charitable explanation, their en-thusiasm for company status is part of apost-privatisation drive for greater manage-rial and entrepreneurial freedom, but whowill benefit most from the exercise of these?

The 1997 Building Societies Bill was movedwith all-party support in Parliament. TheEconomic Secretary intended the legislationto create a level playing field between themutual societies and the converted com-panies. In particular, converting societies willlose their 5-years protection from take-over ifthey wish to engage in acquisition of otherbuilding societies themselves. However, theexisting mutuals cannot afford complacency.`̀ No organisation, no matter what its pedigreeand its size, has a right to exist without con-stantly proving its relevance in the contem-porary market. The corporate financial giantsdwarf all but the largest of the mutuals andcould squeeze them out of the market. With-out financial strength and confident manage-ment that has set well reasoned and realisticobjectives, some mutuals could find the nextmillennium an unforgiving place.'' (MoneyManagement, November 1996:6).

References

Balmer, M.T. and Wilkinson, A. Building Societies:Change, Strategy and Corporate Identity, Journalof Corporate Management Vol 17, No 2, 20±33.

Blackburn, M. (1995) Mutuality - A Museum Piece?Ernest Sykes Memorial Lecture, London: TheChartered Institute of Bankers.

Cohen, B. (1997) The Edge of Chaos: Financial Booms,Bubbles, Crashes and Chaos, Chichester: JohnWiley.

David, P. and Worthington S (1993) CooperativeValues: Change and Continuity in CapitalAccumulation, Journal of Business Ethics, 12,849±859.

Dewhirst, J.P. and Thwaites, D. ( 1996) Diversifi-cation into Estate Agency: Entry Strategies byUK Building Societies 1987±1992, Journal ofGeneral Management Vol 22 No 2, 36±55.

Ennew, C.T., Wright, M., and Watkins, T. (1990)The New Competition in Financial Services, LongRange Planning. Vol 23 No 6, 80±90.

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Kay, J. (1993) Foundations of Corporate Success,Oxford: Oxford University Press.

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McGoldrick, P.J. and Greenland, S.J. (1992) Com-petition Between Banks and Building Societies inthe Retailing of Financial Services, British Journalof Management Vol 3, 169±179.


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Morris, W. (1986) A Dream of John Ball, in, ThreeWorlds by William Morris, London: Lawrence andWishart.

Niederhoffer, V. ( 1997) The Education of a Specu-lator, New York: John Wiley.

Royal Commission on Friendly and Benefit So-cieties (1872) Second Report, Parliamentary PapersVol XXXVI London: HMSO.

Speed, R. (1990) Building Societies: New Strategiesfor a Competitive Era, Service Industries JournalVol 10 no l, 110±23.

Wrigglesworth, J. (1997) Examining the BusinessCase for Remaining Mutual, Bradford and BingleyBuilding Society.

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