Recently I suggested that the juggernaut progress of some of the large, multi-product banks might be neither as inevitable, nor as irresistible as it once seemed. The advantages they gain from massive scale in customer services, IT and consolidation of customers’ assets, may be waning – or in some areas, turning into liabilities. However the same technological and regulatory shifts that will so greatly affect the large banks will also have an influence upon other, smaller players in the financial sector. One of the most interesting groups to consider here are the UK Building Societies, for which the changes may present a major threat or, as I will argue, offer an opportunity for increased prosperity. For those readers outside the UK who are perhaps unfamiliar with Building Societies – and for those in the UK who may need a quick refresher course in these, often overlooked, entities, let me quickly explain what they are, and why they are of interest.
UK Building Societies can best be considered as a specific type of Savings and Loan, structured as mutual organisations owned by their members. Importantly they are constrained in their lending and borrowing in that a minimum of 75% of their activity must be in providing residential mortgages; most of the funds they lend comes from their depositors and there is a limit on how much they may borrow from the market. Long established and with a staunchly loyal customer base, the 45 remaining societies provide approximately 21% of UK mortgage funds and have an18% market share in customer deposits. The sector is widely respected and broadly seen as buoyant in the wake of the credit crunch, yet it is not without its problems: access to capital, limitations and costs of branch networks and technology expenses have meant that there have been few opportunities for fast growth. In this article I will leave the capital question aside and focus on the technology issues facing building societies, especially in the changing market for financial services – although, as we will see, changing technology will have an impact on all aspects of Building Societies’ business models.
The Building Societies are used to facing competition. Over the years they have had to respond to increased threats from the large high-street banks, the emergence of challenger banks like Virgin Money and Metro Bank and the entry of large retailers like M&S, and Tesco into the banking business. Not all of such banks offer mortgages but all compete with Building Societies in taking deposits from the individual customer. Recently we have seen the entry of another group of competitors: the ‘digital first’ banks like Starling Bank and Atom Bank. This latest threat, while currently small, may be the advance guard of the most serious threat yet. To understand why this might be we have to look at changing technological and regulatory environment for banking in the EU.
The two areas of Technology and Regulation may seem strange bedfellows but in the next few years they will be inextricably linked. Both the Payment Services Directive (PSD2) and new digital and mobile applications would, taken separately, cause major upheavals in the financial services sector. Taken together they are likely to create a tsunami of change. PSD2 will open up the payments sector to non-bank application providers and force all banks and others making and receiving payment instructions to provide application interfaces allowing third parties to act for customers in transactions. The threat to Building Societies is obvious: one of their greatest assets, their relationship with their customers, may be intermediated by emerging service providers whose digital applications may be able to provide users with access to many financial and banking services. Additionally many other deposit-takers, like the new ‘digital first’ banks will be able to compete for customers’ funds with simple ‘click and connect’ technology available on customer’s computers or mobile devices. The local base of many building societies, which is now seen as a strength, will likely come increasingly come under threat from virtual banks which do not need to carry the expense of branches and can attract customers from all over the country. While the lending side of the Building Society business may be more difficult to assail, if deposits are put under pressure, this too will be threatened. The attraction of the residential mortgage business to the Challenger Banks is already apparent and by taking advantage of PSD2 to provide more products to a wider audience such players will seek to entice mortgage customers away from Building Societies. Yet I still believe that the Building Societies will be net beneficiaries of the changes in regulation and technology, not because I am a cock-eyed optimist but because the Building Societies have some particular advantages, which will serve them well in the coming shake-up.
Unlike the large high street banks which may see their multi-product offerings being picked off by specialist providers using new digital applications under the provisions of PSD2 to reach the banks’ customers; Building Societies’ specialisation will become a major strength. These businesses will be well placed to expand their role as specialist providers of residential mortgages, where they have expertise, track record and quality brands. However this will not happen unless the Building Societies embrace the opportunities offered by digital technology to reach more potential customers. To rely on their existing local branch networks will surely not provide a long-term defence against digital competition.
In the past, technology has been a problem for Building Societies; few of them have felt able to compete with high street banks’ spending on large integrated systems. However this situation is changing. As the ‘digital first’ banks have shown, the lack of cumbersome (and often un-amortised) legacy technology is a clear advantage. The very fact that few Building Societies have made large investments in on-line digital products means that they can now take advantage of the new generation of applications which can present their specialist products to a wider audience. Digital customer management tools, account visualisation applications and secure transaction modules are now available which can reside on the customer’s computer or mobile devices. Services that, only a few years ago, would have been considered far to expensive to role-out to Building Societies customers are now widely available at much lower cost. By embracing this digital future the Building Societies can not only protect their deposit-taking side, but also make their lending products available to a wider group of potential customers.
There are clearly challenges ahead for the Building Societies; maintaining individual identity and customer loyalty will be paramount. However I believe that the best way to do this is to embrace the new digital technology rather than see it as a threat. The Building Societies have survived so far because their products and reputations are sound; this will give them an enormous advantage in the new age of financial services.