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My Lords, building societies are a vital part of the United Kingdom’s financial services sector, and the Government are committed to ensuring that their legislative framework remains fit for purpose. This order is the latest step in the Government’s programme of updates to the Building Societies Act 1986 to ensure that it continues to align with company law, where appropriate, and that the Act’s funding framework operates to support financial stability and strong prudential standards among building societies.
The order before the Committee makes two targeted changes, and I will take each in turn. First, the order modernises requirements on building societies when executing legal documents. At present, building societies are required to execute certain legal documents, such as deeds, by affixing a common seal. Companies, by contrast, have greater flexibility under the Companies Act 2006: they may execute documents either by using a common seal or by the signature of authorised signatories.
This order aligns the position for building societies with the company law framework. It provides that a building society will be able to choose whether to execute documents by affixing a common seal or by having the document signed by authorised signatories. Those authorised signatories will include directors and the secretary of the society, and the order also provides for execution by a director in the presence of witnesses. This is a practical and proportionate modernisation: it will reduce unnecessary administrative burdens and it reflects the Government’s broader commitment to keep building society law aligned with company law, where that is appropriate.
The second element of the order concerns building societies’ wholesale funding limit. Under the 1986 Act, building societies must raise at least 50% of their funding from members’ deposits. That requirement is central to preserving their distinctive mutual model, which means that building societies are owned by their members. I want to be clear that this order does not change that fundamental principle.
Instead, the order makes targeted changes to the ways that wholesale funding is calculated. It specifies certain sources of funding that are to be disregarded for the purposes of that calculation. These include funding from specified Bank of England liquidity facilities, debt instruments issued to meet the Bank of England’s minimum requirements for own funds and eligible liabilities, and certain sale and repurchase agreements using high-quality liquid assets that are being held to meet prudential requirements.
The purpose of this change is straightforward. It is inappropriate to treat funding that supports prudent liquidity management or compliance with prudential regulation in the same way as ordinary wholesale funding. Doing so can distort the calculation and, in some cases, in effect, double-count funding.
That outcome is not consistent with the objectives of UK prudential regulation; nor should the funding limit create unintended disincentives for building societies to use Bank of England liquidity facilities. The order ensures, therefore, that the funding limit operates in a more appropriate way by exempting those sources of funding from the calculation. It supports the objectives of prudential regulation, protects financial stability and gives societies greater funding flexibility, while preserving the statutory requirement that at least half of their funding must come from members.
In conclusion, this order makes focused, practical and positive changes. It modernises the legal framework for building societies, supports prudent liquidity management and helps ensure that building societies can continue to compete effectively while maintaining their mutual business model. For those reasons, I commend this order to the Committee and beg to move.
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My Lords, the Minister is exactly right, of course. Building societies and mutually owned banks are absolutely crucial to our economy. They hold some 29% of all outstanding residential mortgages, and that figure is growing. They are especially significant for first-time buyers as conventional banks are less active in this market. So, as we try to solve the housing crisis and restore economic growth, both the capacity of the sector to grow and its lending matter—but so, too, does the stability of the sector.
As the Minister said, the Building Societies Act 1986 requires that a building society must raise at least 50% of its funds from individual member deposits, with the consequence that funding from wholesale markets cannot exceed 50%. However, this order changes the way in which the 50% is calculated to specify that certain funding sources will be excluded from the wholesale calculation. The examples given include specific Bank of England liquidity facilities, loss-absorbing instruments—we would typically cite MREL—and specific repo agreements. This is clearly of importance to the larger societies. It sets them on a more level playing field in competing against banks, as well as increasing their lending capacity. However, even though I support this change, I have two questions.
First, have the Government assessed the impact of increased wholesale funding in times of interest rate volatility? I point out to the Minister that there will be an increase in wholesale funding, if one is not going to be highly technical, because MREL, for example, is raised in the wholesale markets, as are the repos. A number of the instruments that are covered and will be excluded from the calculation are, in fact, wholesale market transactions.
Funding short—the characteristic of the wholesale funds—and lending long, at a fixed rate, was the curse of HBOS when it failed. Once, in a conversation with me that discussed such a situation, Warren Buffett’s number two, Charlie Munger, talked of funding short and lending long as living proof of the walking dead. It is a riskier strategy because of the duration mismatch. I am not suggesting that these changes are going to lead to those extreme outcomes, but it is clear that the squeeze on margins that comes from greater wholesale funding can end up inhibiting lending—and does so exactly at the time when the economy typically needs new liquidity and lending the most.
My second question is slightly different. Is there any risk of diluting the mutual identity by, in a sense, changing this weighting of wholesale versus membership funding? Building societies are much more community-driven than conventional banks. If that link were weakened by the need to respond to the pressures from wholesale lenders, we would all be losers, frankly. I would appreciate the Government’s comments on that.
The other issue in this statutory instrument, offering choice on how to execute documents, strikes me as simple common sense. Frankly, I had no idea that common seals are still in use. Indeed, I may be the only person in this building who has actually closed contracts by using a seal. That was under armed guard, because it had to be removed from the vaults and every movement was observed, because the seal was of such extraordinary value. I really thought that those days were over, and I am pleased that building societies are now going to be relieved of the burden.
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My Lords, I am very grateful to the Minister for setting out the purpose and effect of the order. We on these Benches welcome it. It is a broadly deregulatory measure, and it should reduce unnecessary constraints on building societies and make their day-to-day operations easier.
Building societies play an important role in our financial system and in local communities, as the Minister said in his very clear introduction. Indeed, as the noble Baroness, Lady Kramer, said, they are also very important for first-time buyers. I certainly got my first mortgage from a building society: the Bedford Building Society. Their mutual model helps to promote diversity and competition, and they remain significant providers of mortgages and saving products. It is right that the law should preserve the distinctive character of building societies without requiring them to operate under legal and regulatory arrangements, which have failed to keep pace with developments elsewhere.
The first part of the order is a practical modernisation. It brings the rules governing common seals—not the seals I saw on the Norfolk coast during my recent holiday—and the execution of documents by building societies more closely into line with company law. In future, a building society may have a common seal, but it will no longer be required to have one. Documents will also be capable of execution using authorised signatories. The order also, interestingly, makes corresponding provision for deeds, powers of attorney, the position under Scots law and the use of official seals abroad.
The changes to the funding limits are, however, the more economically significant part of the order. The requirement that at least 50% of a building society’s funding liabilities should be derived from members’ shares is an important safeguard of mutuality. It distinguishes building societies from wholesale-funded banks and helps to ensure that they remain rooted in their members.
At the same time, the framework must recognise that modern prudential regulation imposes requirements which were not envisaged when the original funding limit was designed. It would make little sense for a building society to be pushed closer to that limit simply because it had used a Bank of England liquidity facility or issued debt in order to meet MREL requirements, or to comply with PRA liquidity rules. By excluding those liabilities from the wholesale funding limit calculation, this order should make it easier for societies to meet modern regulatory requirements, issue MREL-eligible debt and make appropriate use of liquidity facilities.
I would, however, be grateful if, in addition to answering the very good questions from the noble Baroness, Lady Kramer, the Minister could address some of mine. First, to what extent does the Treasury expect the changes to improve the competitiveness of building societies relative to banks? The Explanatory Note says that no significant impact is foreseen, and no full impact assessment has therefore been produced. That is disappointing, since the Treasury’s financial services impact assessments are usually very good and very helpful to us in this House. It would therefore be good to understand what practical or economic benefit the Treasury nevertheless expects the order to deliver and to know of any hidden costs to businesses.
Secondly, will the benefits be distributed evenly across the sector? The exclusion for secondary non-preference debt would appear particularly relevant to the larger societies, which are subject to MREL requirements. Does the Treasury expect smaller societies to benefit?
Thirdly, has the Treasury estimated whether the additional flexibility created by the order could support greater mortgage lending or investment by building societies? How will it monitor whether the reforms release capacity, which is then used to support customers and the wider economy?
Fourthly, Article 4 requires the Treasury to review the order within five years and at intervals of no more than five years thereafter. What metrics will be used? In particular, will it examine the effect on competitiveness?
Finally, does the Treasury regard this order as the final stage in implementing the reforms enabled by the 2024 Act, or are further measures being considered to modernise building society legislation?
Subject to these questions, we regard the order as a positive and proportionate measure. It removes outdated administrative rules, supports compliance with PRA and Bank of England requirements, and gives building societies greater flexibility without undermining the important principle of mutuality.
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I thank noble Lords for their consideration of this order. I have listened carefully to the interventions made and will try to respond to them, if I can.
One was on the interest in common seals. Until I read this SI, I also had not realised that building societies were so constrained. There was then a series of questions about borrowing short and lending long, which is of course central to building society and bank operations; that is why you can have a run on a building society or a bank and why we have the Bank of England to deal with that and give confidence so that a run does not take place. Clearly, in the changes that are being made, which are relatively small changes associated with highly liquid instruments, deposits and dealings with the Bank of England, there is not a huge difference in the duration risk that we see today and the duration risk that we will see in future. The aim is to make building societies more equivalent and similar to banks so that they can be more competitive.
As regards what the effects of this will be, the noble Baroness, Lady Neville-Rolfe, asked a good question about greater mortgage lending. I did in fact go back and ask whether a calculation had been made on that. The answer I got, which I thought was quite a good one, was that the reduction in constraint does not immediately mean that a building society will change what it does because there are many other considerations in how it expands its balance sheet. Therefore, there is not a number on that one. I feel quite comfortable that there is not a number, but we create a level playing field. As for a review in five years’ time, I do not know what would be included in such a review; I think that it might be impacted by events from now and going forward.
In terms of the impact of interest rate volatility, as raised by the noble Baroness, Lady Kramer, the changes have been designed to help with periods of market instability, including interest rate volatility. I did inquire about the additional mortgage lending. I did not get an answer, but I think that I did not get an answer for quite a good reason.
As I set out my opening speech, this order should make targeted and practical changes to the Building Societies Act, modernising requirements and specifying certain sources of funding to be exempt from the wholesale funding limit calculation. It should ensure that the legislative framework for building societies remains proportionate and aligned with wider company law and prudential regulation, while preserving their fundamental mutual model. I hope that I have answered the questions raised.
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That is very helpful and I am grateful to the Minister for answering the questions about likely changes in mortgage and investment. There are a couple of strands I would like to emphasise. One is that I am very concerned that we should help smaller building societies as well as bigger ones, which I hope he agrees with, and that competitiveness is an important factor. The one thing he perhaps could answer, either now or in a letter, is whether this is the end of the road or whether there are more changes coming in SIs on building societies.
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On both those questions, may I write to the noble Baroness? My understanding is that this is the end of the road for this set of legislation, but I cannot predict whether further legislation may come forward. On small and big building societies, might I simply write to the noble Baroness?