Page 5: Raising finance
Every business needs finance:
- As a plc, a bank raises part of its long-term capital from selling shares. It rewards shareholders with dividends. Funds also come from savers who are not usually shareholders.
- As a mutual, a building society”s owners and customers (members) are the same. Savers provide the society's long-term capital and its main source of funding for its mortgage services.
In both cases, people depositing money as savings expect to be able to withdraw their money at short notice. Lending money against the security of a property is long-term. In order to meet withdrawals from savings accounts, there must be enough cash readily available. Building societies keep about 20% of all money they raise in cash or in assets they can easily sell so that they can repay any savers who need to withdraw their savings.
Banks and building societies both raise money from wholesale money markets. This is where banks borrow and lend money between themselves. Building societies, by law, may borrow only up to 50% of their total funding from money markets. The average amount societies fund themselves from the money markets is around 30%.
Banks are not constrained in the same way. For example, in 2007 the Northern Rock bank had taken this ratio of borrowing to 75%. It faced collapse when the amount of credit available in the money markets dried up.
Building societies keep the margin between saving and borrowing rates narrow. This allows them to compete for funds and continue to offer competitive rates to their members.