BUILDING SOCIETY OPERATIONS
ASSIGNMENT 1
QUESTION 1
(1) The main purposes of the Building Societies Act 1997 were the following:
- To remove some legislative restrictions on their commercial activities, following the general deregulation of the financial services industry.
- To remove some of the complexities and inadequacies of the 1986 Act.
The Act set out:
- To replace the restrictive regulations with more permissive ones.
- To remove any statutory constraints they were superfluous to needs.
- To implement a prudential and supervisory framework relevant to modern day.
- To promote best practice regarding accountability between boards and building societies members.
The main provision of the Act were on the following areas:
·
Principal purpose- limits
The main purpose remains the same. They must lend on land for residential use and raise their funds mainly by the investments of the members and depositors. The limits imposed now are that they must raise at least 50% of funds from retail sources and trade 25% of their commercial assets, as they want.
· Criteria for prudent management
Some of the criteria have been extended, like the security issue. A new criterion has also been added, involving balance sheet risk management.
(2) The implications of the Act for
·
Diversification of building society products and services
A building society is able to offer a whole range of additional products to the customer in addition to mortgages like:
i. banking
ii. insurance
iii. investment
iv. land
v. trusteeship
vi. executorship
Building societies can use 25% of their commercial assets that fall outside the principal purpose definition (mortgage lending) in any way they want, although they may not act as market makers or trade in commodities.
The Building Societies Commission is the “watchdog” of building societies.
They must raise at least 50% of share and deposit liabilities from retail sources.
·
Regulation and supervision
The regulation and supervision of Building Societies is done by the Building Societies Commission but only under the overall responsibility of the Financial Services Authority (FSA). The Commission can:
- Impose conditions on authorization.
- Direct a transfer of engagements as a measure to rescue a society that is in trouble.
- Give directions following revocation of authorization.
- Enter a building society’s premises to obtain information.
Even though the functions of the Commission remain unchanged, the change in some limits by the 1997 Act (e.g. criteria for prudent management) requires a much more careful and close monitoring.
·
Balance Sheet Risk management
There is a specific provision for building societies to have systems in place to manage balance sheet risk. Until then, societies raised their funds at variable interest rates and made advances also at variable rates. With the introduction of fixed-rate lending, this has led to greater risk exposure, because the cost of funding mortgages can increase while rates of interest on some mortgages remain fixed.
Also the 50% retail-funding limit, gave much more freedom to building societies to extend to the wholesale money market, which in its turn, is much riskier. There is also the problem with “carpetbaggers”, who can have voting rights together with their deposit accounts. That’s why societies introduced accounts with minimum balance requirements or agreements to covenant windfall shares to charity.
533 words
QUESTION 2
(1)
The
first known building society was established in 1775. The earliest societies
were ‘terminating building societies’.
They had a specific number of members who would contribute an agreed
subscription. When sufficient fund had been accumulated, an agreed number of
dwellings would be erected and a ballot of members held to decide which of them
would be lucky enough to own these houses. The process would continue with all
members continuing to subscribe, until every member had his own property. Its
purpose having been fulfilled, the building society would cease to exist and it
would be wound up.
The new movement was formally acknowledged by
the Benefit Building Societies Act 1836. The activities of societies were
brought within the control of a government official called the Certifying
Barrister, whose main aim was to register the societies and confirm that their
Rules were ‘wholesome and proper’.
During the early nineteenth century, the permanent role of the society was
introduced. Societies could fulfil an ongoing role, where they could accept
subscriptions on an open-ended basis and from an ever-increasing number of
members. Later on they changed their method of operation to making mortgage
advances to members.
A system of regulation was put in place, like
Building Societies Acts of 1874 and 1894. They basically confined societies to
what was perceived to be their only function - that of raising retail funds and
making advances to members for house purchase. Very little freedom to diversify
was permitted. The Building Societies
Act 1960 followed, after the collapse of a small society, basically to restrict
societies in terms of large mortgages and advances made to corporate bodies.
The Building Societies Act 1962 was the last before the 1986 Act, to put in
place all the other laws that had gone before.
(2)
The
differences between shares in a building society and shares in companies
registered under the Companies’ Acts are the following:
|
Building Society
Shares |
Limited Company
Shares |
|
The
capital value does not change |
The
capital value may change in connection with market conditions |
|
Part
shares may be issued |
Part
shares may not be issued |
|
Ownership
is usually witnessed by a passbook or ATM card |
Ownership
is usually witnessed by a share certificate |
|
Shareholders
receive interest, which depends on the interest rate structure charged to
borrowers and the operating costs of the society |
Shareholders
receive dividends, depending on the profitability of the company and the
decision of the directors on the distribution of profits. |
|
New shares
can be created by opening new accounts and existing shares can go out of
existence by closure of accounts |
New shares
can be created only by a new issue and they can go out of existence only if
the company wounds up. |
|
New shares
can be created on an open-ended basis. |
There is a
finite limit to the number of shares that a company may issue. |
|
Advice on
most classes of shares is not regulated by the Financial Services Act 1986. |
Investment
advice on company equities is regulated by the Financial Services Act 1986. |
|
Each
shareholder has one vote |
The voting
power of shareholders is normally determined by the size of shareholding in
the company. |
|
Shares may
usually be transferred quite easily |
Transfers
of shares have to be registered |
|
Protection
in the event of insolvency through the Investor Protection Scheme. |
No
protection in the event of insolvency |
560 words
QUESTION 3
It is necessary to have a system of regulation and supervision in place, irrespective of the type of financial institution. This serves several purposes like:
(1) It ensures that depositors are protected.
(2)
It maintains confidence of the
general public and other institutions.
(3)
It
reduces the likelihood of fraud.
Most regulation of financial institutions is
concerned with investor protection, to ensure that there is a little chance of
any financial institutions going out of business and thus investors loose their
money.
Regulation takes place at several levels:
(1) Statute law
All groups of financial institutions
have a body of primary legislation in place to determine the scope of their
operations and impose a regulatory structure. The main Acts of Parliament
affecting Building Societies are: The Building Societies Acts 1986 and 1997,
the Consumer Credit Act 1974, the Financial Services Act 1986 as well as the
directives and regulations of the European Union legislation.
(2) Secondary legislation
Since statute law is inflexible and
the legislative process takes several years, there is a need to make some
changes to the Act. So amendments are made by secondary legislation. An example
for Building Societies was the 20% limit on wholesale funding, which was raised
to 40% and later to 50%.
(3) Self-regulation
The concept was introduced by the
Financial Services Act 1986, when the SIB (Securities and Investment Board) was
introduced, now called the FSA. Its aim was to protect investors and provide a
system of authorization and control over investment products. The Act provided
the establishment of three self-regulatory organizations (SROs) - the Personal
Investment Authority (PIA), the Investment Management Regulatory Organization
(IMRO) and the Securities and Futures Authority (SFA).
(4) Codes and statements of practice
They are voluntary statements of
minimum standards that can be expected by customers from the financial
institutions that subscribe to them. For example the Code of Banking Practice,
the Mortgage Code.
(5) Policies of the Financial Institutions
A minimum requirement of all
financial institutions is to have a written policy in place for all key
activities such as lending and funding. For building societies such policies
are reviewed and changed by the Building Societies Commission.
362 words
QUESTION 4
The regulatory changes introduced by the Building Societies Act 1986 were the following:
(1) The introduction of a new commercial asset structure:
Class1: fully secured loans to individuals by way of first mortgage on land for residential use
Class2: fully secured first or second mortgages, mainly to commercial or semi-commercial concerns
Class3: unsecured or partly secured loans or equity in subsidiary or associated bodies.
(2) The power to provide financial services outside their primary
purpose in the following six areas:
i.
Banking
ii.
Insurance
iii. Investment
iv. Land
v.
Trusteeship
vi. Executorship
(3) The permission to transfer their
engagements to an existing limited company or to a new limited company.
(4) The permission to set up subsidiary
limited companies and to invest in associate companies like LINK networks
(5) The permission to operate through
subsidiaries outside the
(6) The Building Societies Commission
was given responsibility for the regulation and supervision and the Central
Office role was changed to purely administrative.
(7) The introduction of seven criteria
for prudent management for the maintenance of:
·
Adequate
reserves
·
Structure
of commercial assets
·
Liquidity
·
Requisite
arrangements for assessing the adequacy of securities for advances secured on
land
·
Accounting
Records
·
Direction
and management
·
Professional
skills
The Building Society Act 1997 revised the
criteria for prudent management as follows:
(1)
The
importance of the compliance with principal purpose and nature limits is
emphasized due to the higher risk mainly due to the greater freedom.
(2)
The
criterion applicable to assessment of security is strengthened and now requires
a society to have requisite arrangements in place to assess willingness and
ability of a borrower to repay a loan.
(3)
A
new criterion - to have system in place to manage balance sheet risk.
(4)
The
obligation of Buildings Societies Commission to issue “statements of
principle”, giving guidance on how it proposes to interpret the criteria of
prudent management.
321 words
QUESTION 5
(1)
The
main features of Building Societies Investor Protection Scheme are the
following:
It is required for Building Societies to become
members of the Scheme under the 1986 Act. They may also belong to additional
voluntary contribution schemes.
Building Societies Investor
Protection Board administers the Scheme.
All authorised building societies
are asked to make contributions to the Fund in an event of insolvency of a
building society in proportion to their asset size.
At present, the maximum payment that
can be made to an investor is 90% of the balance held, subject to a maximum
balance of £20,000. Both shareholders and depositors are covered.
(2)
Building
Society Investors who are not entitled to receive payments are those who hold:
- Deferred shares
- Permanent Interest Bearing shares
(PIBS)
- Any deposits which would be paid
after the shareholders
- Any deposit evidenced by
Certificate of Deposit or other negotiable instrument
- Any other liability of which proof
of debt cannot be produced by the investor.
(3)
The
Building Society Investor Protection Board may decide not to make a payment
either in full or in part to the investor in a failed society when it is felt
that the person had contributed in some way to the insolvency, such as anyone
from the society’s demise or directors of the insolvent society itself. The
Board may also refuse to make payments to anyone who does not carry proof of debt.
(4)
The
priority of various parties in respect of claims on the society are the
following:
·
Creditors
have priority over shareholders. Deposits are generally treated as creditors,
either to individuals or corporate.
·
After
depositors have been paid in full, preference shareholders come next, even
though they are extremely rare in building societies.
·
Ordinary
shareholders are the next to be paid.
·
Claims
for deferred shares can be made at this stage.
314 words
[TOTAL: 2100 words]