Mutual Momentum: Advances in Building Society Regulation - speech by Charlotte Gerken

Introduction

It is a pleasure to be here today in Birmingham to mark such a special anniversary for building societies: 250 years since the foundation of Ketley’s Building Society. I would like to thank the Building Societies Association for inviting me to this conference.

I have had a look back to the Bank of England Court minutes for 1775. They don’t feature the founding of the first building society I’m afraid. And entries from the Governor’s diary suggest he was preoccupied with whom he had reprimanded each day and the cost of curtains. In 1775, the Bank had a national debt of around £12 million to manage, and was soon to advance more, as the American War of Independence started. Perhaps the Bank’s Directors were asking themselves if it had been such a good idea to bail out the East India Company two years earlier which was promptly followed by it dumping unsold China tea on the American market.^[1]

A meeting in a Birmingham pub and the launch of an 8-year war may seem worlds apart but 1775 looks to have been a year to inspire collective action, choice and independence – whether political or financial.

The immeasurable qualities of the mutual ethos and long-term thinking are as relevant now as they were at the start of the building society movement. Today my remarks will focus on some of the more measurable qualities, and on developments in our prudential regulation and supervision; as we adapt the regulation of the mutuals sector to help set up the Building Societies sector to thrive – possibly even for another 250 years.

Sustainable growth in the financial mutuals sector

The PRA’s statutory objectives underpin our approach to policy making and supervision. Our primary objective is to maintain safety and soundness, while our secondary objectives are to facilitate competition, international competitiveness, and growth. Growth in the mutuals sector has been highlighted as a government aim, and HMT has asked the PRA and FCA to report on the financial mutuals landscape before the end of this year.

To prepare this report, we have been engaging with the financial mutuals sector, including the BSA, building societies, credit unions, and mutual insurers. The report will provide an overview of the current landscape, outline potential challenges and opportunities, and highlight actions that could advance the health of this important sector and improve its capacity to support the UK economy.^[2]

Looking at what this means for mutual deposit takers, albeit in less depth than the report will cover, I would highlight four aspects regarding the state of the sector and its prospects for growth.

Balance Sheet, Capital, and Liquidity

Over the past three years, the building society sector has seen higher mortgage lending and deposit-led growth, resulting in significant balance sheet growth (chart 1 and chart 2). This has been achieved while maintaining sound prudential metrics, with strong capital (chart 3) and liquidity positions on average across the sector (chart 4). As societies grow, they are concerned about the cliff edges presented by regulatory thresholds. We have listened to those concerns and recognise the benefits of predictability for firms’ balance sheets and UK growth. To address these concerns, we have consulted on updating some thresholds to index for nominal GDP growth, such as the leverage ratio and MREL.^[3] ^[4] This approach aims to ensure that regulatory requirements remain aligned with economic conditions, providing a stable and predictable environment for firms.

Profitability and Capital Generation

Building societies’ profitability and capital generation depend on interest rates and net interest margin (chart 5 and chart 6). The concentration in residential mortgages brings benefits in specialisation in risk management. However, it presents challenges for some building societies, in generating sufficient capital to make the investment that will reduce their running costs (chart 7). We also observe many societies holding large management buffers over capital buffers, often motivated by their limited means of generating additional capital. The Strong and Simple framework assists firms to plan, by making capital requirements more consistent giving firms confidence to use surplus capital for additional lending or to invest in technology.^{^[5]} However, business model sustainability remains a concern for some mutual deposit takers, deterring investment in improving risk management and controls, and in executing key IT transformations. We also recognise the constraints faced by societies in raising external capital, which can limit growth in the sector. We are open to continuing the conversation on this issue and welcome the sector’s views on possible ways forward.

Operational Resilience and Digital Transformation

From an operational perspective, as well as financial, IT transformation is one of the most pressing challenges for the sector. Successful IT change is crucial for improving operational resilience, delivering services that attract and retain customers, and reducing costs. Not investing in IT infrastructure is a massive risk, but undertaking transformation is also fraught with risk: well planned, carefully executed IT change is easy to say but difficult to achieve; but it is critical to sustainable growth in the sector.

Economies of Scale

The size of a mutual – whether a building society or a credit union (CU) – does not necessarily indicate resilience. But having or not having economies of scale, is a significant factor affecting capacity to grow. In the CU sector, we have seen Credit Union Service Organisations (CUSOs) emerging as one potential way of addressing the economies of scale challenges. The PRA aims to provide clarity on the regulatory treatment of CUSOs, entities owned by CU that provide shared services, offering economies of scale benefits. In recognition of the potential benefits of CUSOs in facilitating CU growth, we propose to consult on amending our rules, together with guidance to ensure that risks associated with a CU (part) owning a CUSO are managed prudently.

Underpinning all four areas, effective governance and risk management are unchanging foundations for sustainable growth and I’ll come back to our expectations there later on.

Regulatory Developments

In changing our policy and supervisory approach to be more proportionate to the business models and risks in the mutual deposit taking sector, I would like to discuss today three areas in which we are adapting our regulation and supervision: the development of our strong and simple framework, a recent consultation by the Bank of England on resolution strategies; and a consultation on the building societies sourcebook.

Tailoring Prudential Requirements as part of Strong and Simple

Firstly, the Strong and Simple framework represents a significant step in tailoring prudential requirements to the needs of the UK market. By adjusting these requirements to the size and complexity of firms, we will ensure that smaller, less complex institutions, including many building societies, are not unduly burdened, whilst retaining the current level of resilience in the system. We are optimistic that this new approach will enhance resilience and support long-term growth, making the sector stronger and more adaptable.^[6]

The framework is designed to provide a clear and straightforward regulatory environment that allows building societies to focus on their core mission of serving their members while maintaining the necessary safeguards for financial stability. The Strong and Simple framework took effect at the start of 2024 and already 52 Small Domestic Deposit Takers (SDDTs), including 32 Building Societies, have opted in to the new regime. Given our estimate that 35 Building Societies meet the SDDT criteria, that’s a good, 91% take-up rate so far, indicating the attractiveness of the Strong and Simple regime (chart 8).

The BSA’s members who have chosen to become SDDTs should be seeing the effects of the simplifications we have already delivered. These include a significant reduction in the volume of liquidity reporting requirements: we’ve removed the requirements for these firms, which are mainly retail funded, to report the net stable funding ratio (NSFR) and we’ve deleted four of the five reporting templates in the Additional Liquidity Monitoring Metrics (ALMM) returns. We have also removed the requirement for SDDTs with no listed securities to make Pillar 3 disclosures.^[7]

Further simplifications are to come. In our Strong and Simple Consultation Paper published in September 2024, we proposed material simplifications across all aspects of our capital framework, including Pillar 1, Pillar 2A, capital buffers, the calculation of regulatory capital, and a tailored reporting regime for capital. The consultation closed on 12^th December last year, and we are now reviewing the responses to assess whether any changes to the policy are necessary.

Ensuring Proportionate Resolution Strategies

The UK financial sector is dynamic, with firms entering, growing, and exiting the market. To realise the benefits of growth and competition, firms of all sizes need to be able to exit in an orderly way.

Ketley’s Building Society, like other early building societies, was temporary and resolved itself once all members were housed. Legislative changes in 2007 allowed permanent building societies to merge. Under recovery options, mergers have been effective within the sector through well-managed transfers of engagements.

We expect firms to take responsibility for their own orderly exit, not relying on others, by undertaking solvent exit planning.  The aim of PRA’s policy is to ensure firms can, if necessary, cease regulated activities responsibly and exit the market without disruption. Our requirements for solvent exit planning come into effect in October. Our most recent CU Supervisory Statement also asks the biggest CUs to prepare a credible solvent wind down plan.

The resolution regime was established in the Banking Act 2009 and Resolution is the authority and responsibility of the Bank of England. Recognising that deposit takers, including building societies, of any size can fail, the Bank has developed proportionate strategies and tools for resolution, including bail-in, transfer, and modified insolvency. A key tool is the Minimum Requirement for Own Funds and Eligible Liabilities (MREL). When a larger bank or building society fails and enters resolution, MREL can be used to absorb losses, recapitalise the business, and support restructuring, ensuring the taxpayer does not bear the losses.

Without MREL the costs of resolution would need to fall elsewhere – on the firm’s uninsured depositors and other creditors, or on the rest of the banking industry through contributions or compensation payments to insured depositors made by the Financial Services Compensation Scheme which are funded by the banking sector. The Bank recently consulted on its approach to setting MREL, and received good industry engagement, including from the BSA. The Bank is currently considering responses and plans to publish the outcome of the consultation in the summer.

Consultation on Withdrawal of the Building Societies Sourcebook

The third development I would like to discuss concerns the Building Societies Sourcebook: This afternoon, the PRA will publish a consultation paper proposing the withdrawal of SS20/15 – “Supervising building societies’ treasury and lending activities.” This consultation paper outlines the PRA’s intention to delete SS20/15, also known as the Building Societies’ Sourcebook, in its entirety. This proposal to withdraw the Sourcebook will have a significant impact in enhancing competition and supporting growth in the UK. The Sourcebook was originally introduced to achieve alignment between risk appetite and risk capability in building societies following failings identified in the financial crisis. While the statutory restrictions on the business model of societies still result in concentrated business models and constrains their access to external capital, we assess risk management in the sector as having improved to the extent that detailed supervisory expectations have served their purpose.

We considered a range of options, including updating the Sourcebook to incorporate lessons learned from regulatory insights and market developments in recent years. However, many of these points would also be applicable to banks. We judge that setting detailed expectations only for building societies, which are already subject to legislative restrictions in the Building Societies Act (1986), would be a disproportionate approach.

In preparing our consultation proposal, we have needed to be satisfied that we can continue to advance our primary objective, while also removing regulatory barriers in pursuit of our secondary objectives. We are confident that the PRA has the right regulatory and supervisory tools to assess building societies’ safety and soundness, and to act on weak areas we identify If a society’s risk management and governance needs to be improved, we take steps to ensure its board and senior managers address these issues. Our consultation reinforces the principle of senior management responsibility, and we expect boards and senior management to maintain and enhance their risk management practices

So, what is next? The consultation window will be open for three months, closing on 8 August. We encourage building societies to engage with the consultation, and we look forward to seeing your responses.

Conclusion

Whether through formal consultation or other dialogue, my concluding message is to encourage collaboration between firms, their trade bodies and advisors and the regulator. It is crucial in order to respond to emerging and increasing risks, adapt our policies and supervise effectively. Firms’ business models and risk management practices need to respond to a changing world; so does our regulation, to maintain safety and soundness and to advance competition, international competitiveness, and growth.

On this side of the Atlantic, the Ketley’s members went for evolution, rather than revolution – making a difference through putting by small amounts into a fund. Our changes will also accumulate – hopefully rather faster - to help remove regulatory hurdles and enhance competitiveness in the UK market. Our guiding star will continue to be a supervisory approach following three key principles: being judgement based, forward looking and risk-based.

I look forward to continuing to work with building society boards, senior management and the BSA to ensure the mutuals sector is robust, vibrant and continues its vital role to support members and the UK economy.

Thank you.

I would like to thank Danny Fikret, Caitlin Curtis, Sian Williams, Michael Griffin, Sana Siddique, StJohn Mckenzie-Boyle, Clare Edwards, Monica Dutt, Simon Jackson, and Simon Debbage for their help in the preparation of these remarks.