A brief history of building societies
I really enjoyed learning about building societies this spring, which are a classic British banking institution I was unfamiliar with before I crossed the pond. Here are some (edited) notes I took during my studies offering a short history of building societies, and why they are so interesting. These notes rely heavily on the following sources, which are not always appropriately cited:
Davies, Glyn A., Building Societies and their Branches: A Regional Economic Survey (London: Franey & Co., 1981)
Hotson, Anthony C., Respectable Banking: The Search for Stability in London's Money and Credit Markets Since 1695 (Cambridge: Cambridge University Press, 2017)
Needham, Duncan J., and Anthony C. Hotson (eds) Expansionary Fiscal Contraction: The Thatcher Government’s 1981 Budget in Perspective. “Financial sector deregulation and monetary control, 1979-86”. (Cambridge: Cambridge University Press, 2014)
Offer, Avner, Property and Politics 1870-1914: Landownership, Law, Ideology and Urban Development in England. “Mortgagees”. (Cambridge: Cambridge University Press, 1981)
Building societies formed as a type of friendly society in the late eighteenth century. Their purpose was to provide members with homes by pooling member savings deposits to provide mortgage loans for tenured members, many of whom were working class. Friendly societies were recognized legally in 1793 and were considered separately under the law from joint-stock corporations, who were limited at the time by the 1720 Bubble Act. Building societies were treated as a type of friendly society under the law until they were officially recognized in the 1836 Regulation of Building Societies Act. In the first fifty years of their existences, one estimate suggests that there were about 250 building societies (Davis 1981), most concentrated in the Midlands but beginning to spread to other regions. Most of these early building societies were “terminating societies” that dissolved as soon as all members had been given a house and all mortgages had been paid back.
The 1836 Regulation of Building Societies Act exempted building societies from stamp taxes but provided little further regulation. This led to wide variation in building societies and to some predatory practices. For example, some building societies would charge outrageous fines if a member broke a rule, while other building societies were just informal gatherings at public houses. From 1869-1874, building societies were standardized and centralized by the formation of the Building Societies’ Protection Association, the circulation The Building Societies’ Gazette, and by the 1874 Building Societies Act. The 1874 Act incorporated all future societies and placed them under control of the Chief Register of Friendly Societies. It also privileged permanent societies over temporary ones and made mergers between societies difficult.
From 1874 through the 1890s, building societies increased in popularity to around 2700 societies. The low interest rates brought about by the weak economy made building societies an attractive investment, and working classes could gain the right to vote by becoming homeowners. In this period, the additional flow of money to the societies due to this increased demand made them more speculative, competitive, and risky. In the event of an occasional collapse, like the Sheffield and Yorkshire Building Society collapse in 1886, other building societies would step in to support the depositors of the failed society.
However, two major collapses before the war led to changes in the legal environment of building societies, as well as to a decrease in public confidence in building societies. The Liberator Building Society failed with Balfour’s Bank in 1892, facing about 8 million pounds in losses and the imprisonment of its directors. When the society began in 1868, it was conservative and relied on the elderly and religious leaders for its membership base. As it became more successful, it became more speculative, leading to its failure. The 1894 Building Societies’ Act responded to this major failure by requiring building societies to keep better accounting and have regular audits; by increasing the powers of the Chief Registrar of Friendly Societies, especially the power to dissolve societies; by requiring that building societies only give first mortgages; and by ending the Starr-Bowkett system of balloting for priority in mortgage allocation. Second mortgages were common at this time but were too risky to be handled by building societies and banks due to fluctuating food prices, changing the value of agricultural lands, and due to changes in property prices, especially in London.
The second major collapse was the failure of the Birkbeck Building Society in 1911, which failed because it had experimented with combining the building society business with normal banking activities. Birkbeck was a non- incorporated society that invested heavily in gilts. They faced a run on deposits when the Charing Cross Bank failed in late 1910. Then they suffered a slow decline, made worse by the depreciation of gilts, and suspended payment in 1911. The Bank of England, which did not intervene to save the Liberator Building Society, came to the support of the Birkbeck depositors to prevent a larger financial crisis. While these high-profile failures hurt the reputation of building societies, they also reaffirmed the importance of conservative, permanent societies that can safely pool deposits. After the war, most of the societies remaining were decidedly non-experimental and had been around for more than half a century.
In the interwar period, there were a number of programs encouraging home buying after lending had slowed due to WWI. These included the 1918 Homes for Heroes campaign, the 1919 "Addison" Housing Act, and the 1923 "Chamberlain" Housing Act. These programs led to a housing boom as around 4 million new homes were built, about two-thirds of which were financed by building societies. The revival of the building society sector led to excessive lending, as the building societies competed for deposits with the clearing banks. Though still conservative institutions, loan-to-value ratios and repayment periods both increased, and self-regulation in the sector was difficult due to the large number of societies spread across the country. Eventually, the Building Societies Associaiton (BSA) was created in 1939 to set a cartelized lending rate and to establish norms reducing competition.
After WWII, building societies grew larger while the number of societies declined. Many of the terminating societies terminated between 1945 and 1960, which artificially decreased the number of societies. But even from 1960-1981, the number of permanent societies declined as building societies grew ever more consolidated. Many mergers occurred between societies in the same region, and Halifax came to dominate up to one-fifth of the market. Unlike bank consolidation, these mergers did not cause alarm. Building societies were less imposing because of their structures as mutual societies and because of their affinity with the working class. Inter-society competition also might have made the pattern of mergers less noticeable.
Throughout this post-war period, the BSA operated as a cartel, keeping the mortgage lending rate low relative to the wholesale market rate. This was essential to the stability of building societies from the 1950s to 1984. The cartelized lending rate prevented competition between societies on the lending rate or on loan-to-value ratios, and ensured that building societies were unable to fund aggressive lending through wholesale markets. Building societies continued to play their traditional role in the banking sector, offering exclusively first mortgages which clearing banks and other institutions found too risky to engage in. Their slow-adjusting lending rate also enforced the Bank of England's monetary policy by stemming lending if deposit inflows fell, though this occasionally led to members of building societies waiting in queues to get a mortgage. The conservative lending practices of the building societies, and the competition on branding, branching, and customer service instead of on lending rates, allowed the building societies to securely offer long-maturity loans despite their lack of liquidity and capitalization.
In 1979, the Thatcher government abolished exchange controls, permitting UK banks to avoid regulations through offshore disintermediation. Clearing banks were thus able to compete with building societies in the first mortgage market, and specialist mortgage lenders also joined the field. Unlike building societies, clearing banks and specialist mortgage lenders had the advantage of being able to raise funds in wholesale markets. The BSA first responded by raising their mortgage lending rates closer to the wholesale rates and by lending more often. However, to remain competitive, the BSA had to begin agitating for deregulation of their industry.
The 1986 Building Societies Act gave the building societies the tools they needed to compete with clearing banks and specialist mortgage lenders but fundamentally changed the building society model. It permitted building societies to raise up to 40% of their funds on wholesale markets and allowed them to convert from building society status to bank status. This encouraged building societies to become more like banks, focused on assets instead of deposits. Some building societies began offering current accounts, and Nationwide was the first building society to pay interest on deposits. The deregulation led to an expansion in the home loan market and easier loan ratios.
Major clearing banks also became more like building societies, attempting to borrow short in retail and wholesale markets but to lend long in first mortgages. This issue of maturity mismatch had been solved in the past by the BSA's recommended lending rate, encouragement of standardized, conservative lending, and reliance on retail instead of wholesale funding. The newer banking models attempt to handle maturity mismatch by pooling withdrawal risk among banks in order to fund illiquid home assets with liquid deposits, which requires a larger role for the central bank as a lender of last resort and for state-sponsored deposit insurance. In the present day, it is difficult to distinguish building societies from banks and credit unions, as all of these financial institutions offer similar services with different emphases. There are only 45 building societies left in the UK, and of these the only large society is Nationwide.