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Banks vs. Building Societies: Which Are Safer?

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How do banks and building societies size up against each other? We examine the differences - and safety of the two models here.


If you're concerned about the safety of your savings, you've probably still got some questions that need answering. But, whether it's which banks belong to which institutions, or how safe your own bank is, we've tried our best to keep you in the know.

However, another question many Fools have asked is: 'Where is it safer to put your money, in a bank or building society?'

Banks and building societies have traditionally stood opposite each other in terms of core principles and how each is run. You only have to think back to Nationwide's annoying `brand new customers only' campaign to see how building societies rant about the superiority of their products and customer service levels.

But, perceptions aside, what are the real differences between the two?

Defining differences

Let's get back to basics. Banks are companies usually listed on the stockmarket, and hence are owned by, and run to the benefit of its shareholders.

Building societies on the other hand have no external shareholders. Mortgage borrowers, savers and current account holders are 'members' who vote on decisions that affect the society. And, as building societies don't need to pay dividends to shareholders, this enables them to offer better rates of interest on savings and mortgages.

During the 80s, the government shook things up by allowing banks to lend mortgages. Up until that point, mortgages had been the preserve of building societies. 

At the same time, building societies were given the green light to offer traditional banking products such as current accounts, and could even demutualise into banks if members agreed.

This raft of new freedoms changed the face of banking as we knew it, and as a result, over the next 20 years, several building societies - such as Northern Rock, Bradford & Bingley and Halifax - decided they want to borrow more of the cheap money available on the wholesale money markets, and so turned themselves into banks.

However, Bradford and Bingley's demise closed the book on this demutualisation era, as the last-standing building-society-to-banking convert was broken up and part-nationalised in September.

Dispelling the myth

There's a lot of confusion as to the differences between banks and building societies in terms of how they're run, and perceptions that building societies rely 100% on customer saving deposits are wrong.

There are, however, strict limits imposed on the proportion of funds a building society can raise from the wholesale money markets - where traditionally funds are available to lenders at the cheapest rates. However, this all changed recently, and the markets became very expensive for banks to borrow from - hence the term 'credit crunch'.

So what are the limits? Building societies may not raise more than 50% of funds from the wholesale markets. This means they are far less keen to fund themselves this way than banks. According to the Building Societies Association, the average proportion of funds raised on the money markets by building societies is just 30%.

In contrast, more than 75% of Northern Rock's funding came from wholesale markets, a greater proportion than any other lender - and we all know how that story ended...

Banks' sub-prime losses and their subsequent troubles have been well documented. Back in September, Lloyds TSB gobbled up struggling rival HBOS in a deal that has yet to be finalised. 

As October approached, most major lenders signed-up to a £50bn rescue package that saw the government step in to guarantee loans to try and stimulate lending. That same month Brown and Co. bought stakes in RBS, Lloyds and HBOS, turning it into a major shareholder in some of the UK's biggest banks.

Building society blocks

In terms of building societies, while most have sheltered themselves from wide sub-prime exposure, there are a few that have become victims of the credit crunch.

Trouble for building societies came when they tried to dip their fingers into too many risky pies. And, while they may have less exposure to the money markets, they were not totally immune to the sudden sharp increases in the cost of borrowing.

For example, Cheshire and Derbyshire building societies ran into trouble because of their less than perfect debts. A total of £1.4bn of Derbyshire's £7.1bn loan book was `near prime'. As a result, the building society expected a £17m loss for the first half of the year. And Cheshire's problems came about after it dived into risky property transactions that tipped it into first-half losses of £10.5 million. 

With risky finances placing a strain on their respective balance sheets, both approached building society giant Nationwide, which stepped in to save the day.

Most recently, Barnsley Building Society was taken over by its local rival Yorkshire Building Society, after it revealed that it had approximately £10million invested in the melted Icelandic banks.

Losses like these may seem trivial when you compare them to the billions written off by some banks. But relative to size, these are pretty big bites out of the minnows' profits. And, as Cliff D'Arcy saw in his crystal ball, other small players may yet be taken over by bigger rivals.

What about Nationwide?

The UK's largest building society dwarfs all competition, and is larger than all the 58 other building societies put together. As rivals stumbled, Nationwide became the institution of choice for many, with the building society attracting £2.6 billion of customer deposits during the first half of the financial year.

However, Nationwide has not remained immune from the credit crunch. It gets 31% of its funding from the money markets, relatively high for a building society but in proportion for its  size -- and still low in comparison to many banks. 

Still, this does mean it too was burnt by higher borrowing costs. What's more, between 2007 and 2008, its subsidiaries UCB Home loans (which no longer offers loans to new customers) and The Mortgage Works doubled their exposure to the buy-to-let and self certification markets from £6.5bn to £14.1bn. In addition, the society wrote off £102.2m in securitised investment vehicles -- a type of `toxic' debt.

It was also the only building society to sign up for the government's £50bn rescue package mentioned above, although the society has not taken any money from the Government and insists it only signed up for peace of mind, as opposed to any major funding issues.

And, having said all this, the nation's biggest building society remains robust and strong, and I would have no worries placing my savings within its vaults.

If you prefer a bank to a building society, another safe bet in my opinion is the Co-operative bank. Again, the bank is no stranger to risk, with £6.4 million exposure to structured investments. But, with a highly diversified business and an extremely strong retail base, this is the HSBC of the much smaller, ethical world, and has an extremely robust balance sheet.

I would love to talk individually about all the banks and building societies, but I'm afraid I've run out of space! In the mean time, whether it's the complex world of credit default swaps, or the latest merger news, we'll be sure to keep you informed and on the ball.

Finally, although I think it is interesting to compare the relative safety of banks and building societies, do bear in mind that as long as you keep within the £50,000 Financial Services Compensation limit, it shouldn't matter where your savings are. They will always be 100% safe.

More: Find Out How Safe Your Bank Is / Spot Banks Before They Go Bust

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