Building societies' systemsare too slack, says FSA chief

The head of the Financial Services Authority criticised building societies yesterday for slack management and told them to overhaul their systems and governance if they are to withstand shocks from the credit crunch.

In a wide-ranging speech full of stark warnings for the mutual lenders, Hector Sants, chief executive of the FSA, said societies had not upgraded testing of their processes and systems in light of the near-collapse of Northern Rock in September.

Boards of societies need to check their internet sites and branches can cope with increased capacity, he said. Northern Rock customers panicked when they saw queues appearing outside the bank's branches and found they could not get on to the bank's website, accelerating the run on the bank. "Many of you have not modelled sufficiently extreme stress scenarios. A constructive approach for boards would be to ensure they understand the circumstances both financial and operational under which their institution would fail and determine whether that is an appropriate risk to take," Mr Sants told the Building Societies Association.

The mutuals were also in danger of being complacent about their capital strength and the potential for bad debts to jump, Mr Sants added. He warned that the societies did not have the option of rights issues or raising money from sovereign wealth funds, like the big banks. Retaining surplus funds to support capital would be harder than before because of funding shortages and rising bad debts.

"In the retail mortgage market, these [bad debt] provisions may be slower to emerge than some of the writedowns the large investment banks have posted recently but the impact will last longer. And those firms operating in the sub-prime or buy-to-let market can expect heavier losses," Mr Sants said.

Other areas of concern for the watchdog include societies continuing to buy books of mortgages even when gaining funding to support the loans is difficult, and showing poor understanding of commercial lending.

With mortgage borrowers struggling to repay and repossessions rising, Mr Sants told lenders to treat customers fairly when they were in difficulty. His warnings could come as a shock to savers with building societies, seen as safe and reliable institutions, which have seen record inflows of deposits from former customers of the stricken Northern Rock.