Will Nationwide be forced to become a bank?


Sorry to harp on about this dispute over how much and how fast Nationwide and Barclays need to raise capital to meet a new leverage ratio (see my recent blogs on this), but there is one implication I may have under-cooked.

Which is that it is very bad news for the future of mutual building societies.

The point is that Nationwide has important, totemic status among the mutuals, in that it is the biggest of them by far, and it battled through the great crash of 2007-08 relatively unscathed.

Which is one reason why many politicians and commentators posited that mutuality - ownership by customers rather than by conventional investors - might be the way forward for retail banking.

The recent financial woes of mutually owned Co-op Bank, and its forced decision to obtain a listing on the stock market, show that reports of a mutual revival were premature, to say the least.

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The Prudential Regulation Authority's ruling that Nationwide has too little capital, the regulator is Judge Dredd for the Nationwide, the law, he who must be obeyed”

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And Mervyn King's last act as Bank of England governor, which was to encourage the unexpected decision of the Prudential Regulation Authority's board in favour of early introduction of a tough new leverage ratio, is another blow - perhaps a mortal one - to the mutual movement in finance.

Problems, problems

Imposition of a 3% leverage ratio, and the possibility that this could be increased at some point to 4% - which is what the Vickers Commission wanted - poses both a short-term and a long-term problem for Nationwide.

Before continuing, I need to explain what I mean by a leverage ratio, since not all of us talk about this financial arcana over breakfast (can't think why not).

This is the ratio between a bank or building society's capital, or the money set aside to absorb losses, the institution's shock absorber, and its gross lending.

As you may have heard many times before, the higher the leverage ratio, all other things being equal, the safer the bank - because said bank has more capital to protect savers from the impact of losses.

Now this is where it gets technical, tricky and tedious (the three "Ts" of banking regulation).

All banks also have to meet what is know as a capital adequacy ratio, set by the notorious Basel Committee, which is the ratio between loss-absorbing capital and loans weighted by risk.

As I am sure you know (you do, you do), loans made by the Nationwide and other building societies are primarily prime residential mortgages, which are seen by regulators as low risk.

So although Nationwide has £136bn of mortgages on its books, these have a "risk-weighted" value under the Basel rules of just £16.9bn.

All of Nationwide's loans and investments have a gross value of £190.7bn and a Basel risk-weighted value of £44bn.

So under the Basel methodology, as adjusted by the Bank of England's Prudential Regulation Authority, Nationwide is a sound bank if it holds capital equal to 7% of its £44.4bn of risk weighted assets - after allowing for possible future losses and other stresses (to use the hideous jargon).

The Nationwide passes that test with room to spare. It is sound, on the Basel view of things.

Belt and braces

However, if Nationwide's belt is holding up its trousers, its braces are too loose and threadbare: Nationwide has flunked the leverage test, because it doesn't have capital equivalent to 3% of its gross assets of £190.7bn, after provisions for those hypothetical stresses.

Or to put all this another way, the Nationwide's capital hole is due to the fact that its balance sheet consists largely of mortgages, which have a particularly low weighting under the Basel rules.

Now the Nationwide argues that the low weighting of its balance sheet is justified because its mortgages are very low risk, or so it argues.

Others, such as Mervyn King, would say that what looks like a low-risk loan today could become a hideous loss-maker, if interest rates were to rise sharply (which is not such a ludicrous idea, in the wake of the recent sharp rise in arguably the world's most important interest rate, ten-year loans to the US government, following the public musings of the US central bank the Federal Reserve about a possible end to the creation of cheap money next year).

Anyway, whatever the justice or not of the Prudential Regulation Authority's ruling that Nationwide has too little capital, the regulator is Judge Dredd for the Nationwide, the law, he who must be obeyed.

And since the regulator says Nationwide has a leverage ratio of just 2%, which is 1 percentage point less than the new minimum, Nationwide either has to obtain loss-absorbing capital equivalent to 1% of its gross loans, viz just under £2bn, or it has to somehow offload tens of billons of pounds of loans.

New capital

In an ideal world, the Nationwide would want to do a bit of both - shrink and raise new capital.

That said, the regulator's chief executive, Andrew Bailey, has said he won't accept any plan to meet the target which involves reducing the credit provided by Nationwide to households and businesses.

And although the Nationwide may be able to sell some of its assets to other financial institutions, it is safe to assume that it will have to raise well over £1bn in new capital and maybe as much as £2bn.

Which would be a pain and expensive for Nationwide even if it was a conventional bank with a stock-market listing.

But finding £2bn would be excruciating and perhaps prohibitively pricey for a mutual - since Nationwide can't sell normal shares to investors and will instead have to flog them bonds which behave like shares (by absorbing losses), funny paper which investors don't tend to like very much,

Here is the thing.

If Nationwide raises this capital by flogging this funny paper - and it is not clear that there is a deep enough market for this stuff - its costs will go up sharply, because it will be paying a high rate of interest on the funny paper.

And that in turn would impair its profitability, by putting up its costs, and probably forcing it to increase the cost of mortgages, which would reduce demand for its mortgages.


To put it another way, the rise in the leverage ratio makes it harder and more expensive for Nationwide to remain as a mutual.

All of which can be ameliorated a bit by the new governor of the Bank of England, Mark Carney.

He could, for example, put a bit of pressure on the regulator to set a deadline of the end of 2014 for imposing the new leverage ratio, rather than the end of 2013.

But all that would do is ease the short-term problem for the Nationwide.

It means Nationwide could raise perhaps a couple of hundred million pounds of the needed capital by retaining profits.

That said, it would still need to sell some of the expensive funny paper.

So almost whatever the date for meeting the leverage ratio, its mere existence puts pressure on Nationwide's board to abandon its cherished status as a mutual and become just another big bank listed on the stock market - because as a bank, its funding costs would probably be lower, and it would have greater flexibility in respect of the breadth of its activities.

Here is perhaps Mr Carney's first challenge: Can he help Nationwide to remain as a mutual, and thereby give hope to those who believe in mutuality?

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 81.

    It was the banks that went bust not the mutuals.

    Any building society errors at the time were mopped up by the industry, not the taxpayer. There is no virtue attached to becoming a bank.

    The process by which policy moves from no regulation to effective regulation seems to include the destruction of the mutuals. I smell but cannot prove the heavy presence of banking ignorance at work: again.

  • rate this

    Comment number 80.

    Banks screwed up, they need tighter regulation and new rules. Mutuals, be definition, would never take the same risks that bankers took so it's unfair that prudent mutuals are being forced into becoming banks, to meet banking regulations.

    Choice for consumers reduced, the new small banks will end up being snapped up by the bigger banks, and too big to fail gets ever larger.

  • rate this

    Comment number 79.

    Mutuals used to operate like credit unions, so that loans matched assets. Which is why I preferred them. But deregulation changed that (I think Brown put that through), and oh dear, look what a subsequent mess it has caused. Grim.

  • rate this

    Comment number 78.

    We've lost about 38 Building Societies in the last two or three decades.

    A few demutualised, the rest merged with larger Societies.

    We've 45 left. If the largest (Nationwide) goes the rest will struggle to survive another decade.

  • rate this

    Comment number 77.

    Holding a portfolio of residential mortgages are much safer than commercial property. There is a huge overhang of commercial property - in my town there is 100 years supply of office accommodation. Businesses need less office space. So any bank that holds a lot of commercial mortgages is especially at risk. Guess which banks hold the most commercial mortgages?

  • rate this

    Comment number 76.

    Well those people who have their rose tinted glasses on about Nationwide and BS should have a look at just how far these friendly societies have moved away from their members,top management raking in a fortune for running a mutual and paying less interest than some banks at the same time trying to sell extras to customers,they have been a bank in all but name for some years.

  • rate this

    Comment number 75.

    The PRA effectively killed the co-op when it demanded 1.5bill, but arguably the co-op wanted that big number, so it could justify not keeping it's debt promises. The nationwide doesn't want to be killed but a by product of the co-op murder is to knock them all over. I'm no fan of the mutual model (look at the co-op West Brom building society for why) so more power to the PRA.

  • rate this

    Comment number 74.

    Doesnt the government ever learn?
    The demutualising of the Building Scoieties into banks was the biggest mistake of its era.
    There is far more stability in Mutuals than there ever would be in a bank. The 'greed' factor of reporting to shareholders disappears

  • rate this

    Comment number 73.

    Is it is just me or is the fact the PRA are forcing a mutual to change its status inherently wrong?

    As I understand it the customers of a mutual own it and surely its therefore their call if they want to change? So long as they all know the risks involved in having a lower ratio than recommended I dont see a problem.

    After all, a mutual isnt too big to fail as its owners are bearing all the risk

  • rate this

    Comment number 72.

    69: As a Bank, if it goes wrong they cost Pension Funds money.
    Pension Funds and Assurance Companies still own the most Shares.
    So, the Workers subsidise Bankers failures through their Pension Funds ?
    Better to leave as a Mutual which has to get its sums right !

  • rate this

    Comment number 71.

    @69 Bob
    '. Hopefully as a public company they would be more respectful of shareholders than they are of members.'

    Bob you can always put your money in LLoyds, Barclays transfer your mortgage to these publicly owned institutions, but once Nationwide becomes a bank.....
    can't help feeling that the members of Euroclear and Clearstream have a hand in all this.

  • rate this

    Comment number 70.

    One hopes that even those who believe in mutality don't see it as an end in itself. If their argument is that (all) mutuals are (magically) better run, then Nationwide shouldn't be one if it isn't.

    As Robert points out, they are vulnerable to a rate shock, which these past few years has also included the inevitable return to more normal rates. If Nationwide didn't see that, they're not well run.

  • rate this

    Comment number 69.

    As a member for nearly 50 years I say turn it into a bank. People should always be suspicious of anyone who repeated tells them they are "on your side" in practice Nationwide is run for the benefit of a small cabal of directors not the members. Hopefully as a public company they would be more respectful of shareholders than they are of members.

  • rate this

    Comment number 68.

    It would be interesting to learn what Nationwide thought about this. Is this headed to another government policy failure should the Nationwide have to declare itself a bank and join the finance Mafia. Carney - let's see what you are made of, King is history. What exactly could the PRA do if Nationwide decided to downsize its loan book which is probably more robust than the corporate banks?

  • rate this

    Comment number 67.

    "Are PIBS the "funny paper" referred to in the Article or something else. "

    No the Basel Committee decided that they weren't loss absorbing enough. Instead Banks are being forced to issue so called co-cos (contingent convertible bonds) which automatically convert to shares in a crisis. The equivalent for a building society is something called a PPDS (Profit Participating deferred share).

  • rate this

    Comment number 66.

    63: Ask the Bradford and Bingley PIBs holders (mainly Pensioners) how they feel.
    B&B's mugging and firesale to Santander wiped out all the PIB holders and other Shareholders in the Bank.
    The Banks valuation was quite suspect.

  • rate this

    Comment number 65.

    as a member of the Nationwide of many years longstanding......
    with both good and bad memories of customer service (too many customers not enough staff), but now at a branch where one cashier has the skillset worthy of a IFA


  • rate this

    Comment number 64.

    Why are the establishment so anti mutuals ?
    The American Way isn't the only Way, no matter what the Goldman people would have everyone believe.
    Mutuals and Building Societies were a strong and useful part of the British economy for hundreds of years before the circus of casino banking arrived.
    If anything, retail banking needs to act more like the mutuals....

  • rate this

    Comment number 63.

    Are PIBS the "funny paper" referred to in the Article or something else.

    Although described as "permanent", they aren't. The issuer can offer to buy them at face value and then cancel the Share. You have the option of declining.

    I'd rather have Shares than PIBS but Nationwide needs to decide.

  • rate this

    Comment number 62.

    The calculation has to be could Nationwide stand a 30% downward readjustment in house prices against its loan book. If the answer is no then more capital is needed. If the answer is yes then leave it alone. There are many other financial institutions who would tumble first in such a scenario bringing irreparable damage to the financial system.


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