Competitive to the core: The easing of restrictions on building societies will allow them to take on banks - to the advantage of customers, says Richard Thomson

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The Independent Online
BUILDING societies have reason to be grateful. The Treasury has looked on the industry and smiled, signalling its pleasure by relaxing the restrictions on their access to funds and indicating its willingness to allow societies to diversify still further into financial services.

The revisions to the Building Societies Act published on Wednesday are a clear sign that the Government wants to nurture the societies as full-scale competitors to the high street banks when it comes to retail financial services. Perhaps most significantly, societies will be allowed to lend to small businesses and to own general insurance companies.

The market in small business loans could be enormous and readily available since many people who run small businesses will already have a mortgage with a building society. And insurance, probably the most rapidly growing of the societies' 'non-traditional' businesses, offers the potential of a lucrative new operation.

Although societies will continue in their traditional role as Britain's main suppliers of mortgages, the array of non-traditonal business - from cheque book accounts and credit cards to general insurance and pensions - is certain to grow.

The growth has already been impressive. In 1985, the income from non-interest earning sources, such as mortgage arrangement fees and other charges, averaged only 14 per cent of total income among the top 20 societies. Last year, however, the average ratio was 23 per cent, reflecting the recent rise in non-traditional business.

'I would say the ratio is set to accelerate - especially with the trend towards bancassurance,' says David Villiers, building society analyst at UBS. 'Going into non-traditonal business has allowed building societies to increase profit as well as build closer relationships with customers. Without it, they would have been marginalised as niche players.'

Even among the top 10 societies, the range of new business is hugely diverse with big differences in strategy and, ultimately, in where profits are earned. Alliance & Leicester (including the Girobank), for instance, earns 44 per cent of total profits from non-interest income, while Cheltenham & Gloucester earns only 14 per cent.

C&G, the sixth-largest society, has chosen the most individualistic course. By sticking to its knitting and staying away from most of the new areas opened to societies in the 1986 Building Societies Act, it has set itself apart from the other big players. It offers no credit or debit cards, no cash machines, no unit trusts or pension plans, no stockbroking service.

Contrary to the received wisdom of the late 1980s, this has proved a profitable strategy. On assets of pounds 16bn in 1992, C&G made a pre-tax profit of pounds 131m. In comparison, Alliance & Leicester - the fourth-largest society and one of the most diversified into new fields of activity - made profits of pounds 123m on assets of pounds 20.5bn.

Among the most striking differences between C&G and most other societies is its high proportion of relatively new investors. This is one of the problems that caused its original merger plans with Lloyds Bank to fall through: the scheme envisaged paying a bonus to all investors, including those of under two years' standing, but the building society takeover rules prevented it.

The reason for the high proportion of new investors is that C&G has grown at a break-neck pace over the past decade. Instead of using surplus cash to enter new fields of competition as most of its competitors have, C&G has concentrated on growing its core business, often by acquisition. In only two years since 1984 has its asset growth rate dropped below 16 per cent, and it has gone as high as 59 per cent in a single year. Halifax rarely manages to grow by more than 6 or 7 per cent a year.

The policy is fine, says Hugh Alderman head of financial services at the Woolwich, if C&G intends to merge itself with an organisation like Lloyds that can give it access to other services or if it can remain quick on its feet.

Woolwich has chosen the opposite course on the grounds that diversification is essential to keep abreast of the competition. 'It spreads risk. Retail savings, our core business, has been bad recently, but for the same reasons unit trust business has been relatively good,' Mr Alderman says.

The society has diversified more than almost any other society, with 30 per cent of profit coming from non-interest income. It sees itself as a financial services organisation centred on house buying - so it offers no credit or debit cards but does offer long-term investment products that are often central to family finances.

Like all societies, Woolwich will not divulge the profit it derives from each area of activity. 'They're all giving us a return at least as high as mortgage interest income, and usually higher,' Mr Alderman says, but the extra advantages from increased customer loyalty are hard to measure.

Unlike many in the industry, though, he is cautious about the future growth of non-traditional business. 'We have already entered most of the areas we find attractive. These may expand, but I doubt we'll be going into new areas from now on. Our financial services will not grow dramatically faster than our core business.'

One area likely to expand fast is insurance of all kinds. After early experiments in partnership with established insurers, several societies have broken off these relationships and continued on their own - as Nationwide, for example, has done with Guardian Royal Exchange. Insurance is not very capital-intensive, can be extremely profitable and is a proven way of drawing in new customers and hanging on to existing ones. Not surprisingly, the Government's decision to allow societies an even easier entry into this market through wholly-owned insurance companies was greeted with quiet satisfaction within the industry.

As the societies embark on more new business they are likely to be more easily distinguishable by their 'non-core' activities than by traditional mortgage lending business. But that will suit the societies, the Government - and, with any luck, the consumer, too.

----------------------------------------------------------------- A TALE OF TWO SOCIETIES ----------------------------------------------------------------- Contrasting approaches to new activities Cheltenham Activity Halifax & Gloucester Investment advice Yes No General insurance Yes Yes Number of estate agency branches 550 None Unsecured loans Yes No Secured loans Yes Yes Cheque book account and cheque card Yes No Credit card Visa No Debit card Switch No Number of ATMs 1600 None PEPs and unit trusts Yes No Pension plans Yes No Stockbroking Yes No Offshore/foreign services Jersey & Spain Guernsey Property development Third party only No Conversion to plc Not envisaged Merger planned with Lloyds Bank ----------------------------------------------------------------- Source: U BS -----------------------------------------------------------------

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