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How banking came back from the brink

26 September, 2019William A Allen
Banking back from the brink 2
In the second part of our Time Machine   series, William A Allen continues his discussion about the 1930s economic crisis and the role building societies played in a volatile financial climate. 

The policy of accumulating gilts served the clearing banks badly. When gilt prices fell as the economy revived and the threat of war grew in the second half of the decade, the banks suffered losses. The fall in prices was sufficient at one stage to wipe out the whole of their published capital and reserves.

It is fair to point out that the clearing banks supported many companies whose survival was endangered by the depression. Nevertheless, they did not, on the whole, conduct themselves in a manner likely to help general economic recovery.

Building societies compete

The building societies, in contrast, behaved in a highly competitive manner. They were mainly financed by shares, which were in practice only a little less readily available than bank deposits, and they attracted funds in the 1930s by offering better interest rates than the banks and by advertising. Much of the inflow was ‘bad money’, which could be expected to be withdrawn in short order if better savings opportunities appeared.

The societies’ mortgage lending increased rapidly and steadily throughout the 1930s, by a total of £419m between the end of 1929 and the end of 1938. The average annual increase was about 0.8% of a year’s GDP. Their other assets, held to provide liquidity, did not by any means keep pace, and the ratio of cash and government securities to shares and deposits fell from 7.1% to a meagre 3.7%.

Moreover, they engaged in doubtful lending practices. They extended high loan-to-value mortgages that were partly secured by claims on a pool of assets maintained for the purpose by housebuilders. The government thought that was illegal because building societies were supposed to lend on mortgages only, and was reduced to panic when it found out about it in 1938. The taking of security by building societies was further regulated by the Building Societies Act of 1939. 

Housing boom

The building societies, therefore, behaved aggressively and imprudently. Yet their bad behaviour financed a massive boom in private house construction. The number of houses built went up from 184,000 in 1930 to 332,000 in 1938. The figure for 2017–18 was a mere 167,000. 

Housebuilding made an important contribution to the recovery of the economy. It is true that the societies were greatly helped by the cheap money policy and by permissive land-use rules, but it is hard to imagine that if the clearing banks had dominated the mortgage business, there would have been a comparable housing boom in the 1930s.

Financial stability

The cartelisation of the banking industry in the 1930s probably contributed to its financial stability. None of the Big Five clearing banks was ever even suspected of being in distress. But it was just as well that the building societies were around to help the economy rebound.

Read more in our Time Machine series

William A Allen is a visitor at the National Institute for Economic and Social Research, London. He worked for the Bank of England from 1972 to 2004 in a wide range of functions, including monetary policy and financial market operations, and was a specialist adviser to the House of Commons Treasury Committee from 2010 to 2017.