Lending restrictions for building societies could be lessened, Government announces

Under building society legislation, firms must ensure that 50% of their funding in made up of retail deposits from their members. In addition, at least 75% of their lending must be secured on residential property.

In a discussion document (24-page / 306KB PDF) setting out its plans for the future of building societies, the Government said that it would consider the changes if these existing restrictions were found to "unnecessarily constrain institutions in their ability to serve their customers".

The plans outlined in the document, which also indicate how forthcoming banking reforms will apply to building societies, will help create "a more level playing field" between building societies and banks, the Government said.

"The Government has committed to increasing choice and diversity in financial services," Mark Hoban, Financial Secretary to the Treasury, said. "We believe that building societies can play a vital role in this. The proposals we are setting out today provide a real opportunity for societies to expand their services and attract a new generation of consumers."

Building societies are mutually-owned financial services institutions that provide savings and mortgage facilities to around 25 million customers in the UK, according to industry figures. Of the 47 firms operating in the UK one, Nationwide, comprises 60% of the sector by proportion of assets and is considered to be one of the "systemic" institutions on which the Government is focussing its reforms.

A number of the largest building societies, including Abbey National and the Halifax, 'demutualised' in the 1990s, primarily as a means of avoiding what was considered to be an "excessively restrictive legislative regime", according to the paper. However, none of these institutions remains in operation as an individual entity. Building societies survived the financial crisis "in better health" than the banking industry, in many cases due to their lower risk profile and focus on the interests of members rather than shareholders.

The potential removal of the restrictions applying to building societies would, the Government said, allow some to "expand their business models further" by allowing them to lend to small businesses to a greater extent. It would also allow them to "compete fairly in the future world of financial services", while still offering a "distinctive approach".

"Where legislation places barriers on building societies' ability to compete and grow, the Government is committed to taking a hard look at whether those barriers can be lifted; where legislation is vital to maintaining the distinctive nature of building societies, Government is committed to keeping it in place," the paper said.

Graham Beale, chief executive of Nationwide, welcomed the Government's "recognition" of the benefits of a "mass-market, mutual challenge to the banks".

"We want to continue this vital role, expanding carefully over time into new areas such as [small and medium-sized enterprises] banking," he said. "The Government's commitment to review and revise building society legislation to support these aims – whilst maintaining the low risk approach that has served our members well throughout the crisis – is a positive step forward."

As part of the paper, the Government proposes to amend the main law governing building societies so that prohibitions applied to ring-fenced banks, as proposed by the Independent Commission on Banking (ICB) last year, will also be applied to building societies, This will be done by removing them from banks legislation but applying equivalent rules to them separately. Building societies will also have to comply with the same loss-absorbency requirements as ring-fenced banks of a "similar profile".

The Government said that this will be done by "carving the entire building societies sector out" of the ring-fencing legislation that will apply to banks, instead making appropriate amendments to the laws governing building societies by way of secondary legislation. The nature of the proposed bank ring-fence has "significant overlap" with the rules that already apply to building societies, the paper said.

In cases where the new approach is "more liberal" than the existing laws the Government proposes taking "the best from both regimes" such as, for example, allowing building societies to offer an expanded range of simple derivative products or offer foreign currencies to their members above the current £100,000 limit.

Draft legislation is due to be published this autumn which will 'ring fence' "critical banking services" from banks' riskier investment activities in order to protect them from wider economic shocks. The ring-fence, as recommended by the ICB, will ensure that retail banking activities are provided by a separate subsidiary of a wider banking group.

Only ring-fenced banks will be able to accept deposits from and provide overdrafts to retail customers, and they will not be able to carry out certain pre-defined activities including international and wholesale and investment banking services and dealing in investments as principal.