From Building Society to Bank: the Allied of South Africa, 1970-1988

From Building Society to Bank: The Allied of South Africa, 1970-1988

Stuart Jones Universityof the B4twatersrand

The Allied BuildingSociety was formed in 1955by the mergerof two societiesfounded in the earlydays of goldmining in SouthAfrica, the Rand ProvidentBuilding Society and the AllianceBuilding Society. Fifteen years later the Allied absorbedthe JohannesburgBuilding Society and overnight becamethe third largestsavings institution in SouthAfrica. At this point therewas little signof the dynamismthat wasto be shownin the later 1980s andthe Allied wasa typicalEnglish-type building society, not veryaudacious in its pursuitof depositorsand somewhat reserved in itsapproach to lending, with prospectivehome owners being required to put downdeposits of 25% of the purchaseprice. Fundswere drawn by meansof a chainof branchesand agencies,with interest rates fixed by thebuilding society cartel, while lending wascentralised at the JohannesburgHead Office. By 1970the pressuresfor changewere onlyjust beginningto make themselvesfelt. For example,in 1966the Allied had embarkedupon its firstmoves into computerizationand duringthe stockexhange boom of 1969 the supplyof new fundsinto the buildingsocieties had almostdried up. Boththese developments were later citedas the main reasons for thechange into an equitybased general f'mancial institution.

The Background

Before the SecondWorld War the building societieshad been increasingtheir assets at a fasterrate thanhad the commercialbanks. In the yearsof post-wargrowth this changed and, in the period1961-1970, building societies'assets increased at a rate of 9.7% annuallyin constantprices comparedwith the growthof the commercialbanks' assets by 14.6% per annum [8]. The impact of technologyhad not yet seriouslyaffected procedures,despite the purchaseof a smallcomputer in 1966,and the main post-warinnovation remained the replacement of menby womenbehind the counters. Neverthelessthe failureof the buildingsocieties' assets to growas fast as thoseof other financialinstitutions reflected the failure of the building societiesto drawin adequatefunds during economic booms and their resort to restrictingthe numberof newmortgages they granted. In the pastthis mightnot have mattered, but by 1970two decades or moreof rapideconomic

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growthhad created the conditionsin whichthe demandsof prospectivehome ownersable to financebonds was larger than the volume of prospectivebonds in the handsof the the buildingsocieties. The societieshad beenable to cope with economicgrowth with stableprices; they could not copewith sustained inflation.In 1970this was only just beginningto becomea seriousproblem; yet it is likelyto havebeen the mainconsideration between the mergerof the Allied and the Johannesburgsocieties in 1970,as theysought to cut costsby reducingcompetition. If thatwas the purpose of the merger,it failed,for the new combinedsociety, that had doubledits shareof total buildingsociety depositsfrom 10.4% to 20%, couldnot hold on to them and it wasnot until 1988that the Allied regainedits relativeposition of 1970. The SouthAfrican backgroundto the dramaticchanges of the late 1980s,therefore, was the long- term declineof the societyand its increasinginability to competewith other buildingsocieties, let alonewith the banksand insurancecompanies. The world-widebackground was the movementtowards deregulation andthe blurringof the old Englishdistinctions between commercial banking, merchantbanking, hire purchasebanking, and mortgagelending that took placein the 1970sand reached their climaxin the late 1980swith the London "bigbang". In Britain, for example,the banksmoved in upon the building societiesin the early 1980s. In SouthAfrica, Bardaysalso led the way. In 1980 the British clearingbanks' share of new mortgageloans was next to nothing,in 1981,22%, and in 1982,40% (The Economist,22 May 1982). Already by then the Institute of EconomicAffairs had publisheda book attackingthe building societies'price cartel [4] and David Llewellyn of LoughboroughUniversity was accurately forecasting that competitive pressure from outsidetheir rankswould force them to be more competitivewith one another(The Economist, 1 March 1982). In SouthAfrica, government thinking responded early to changestaking placeabroad and preceded the firstreponse of the buildingsocieties, which wasto mergeand reduce competition. The firstmajor indication of thiswas the appointmentin 1977 of the De Kock Commissionto enquireinto the country'smonetary system. The interim report of 1982recommended that greaterfreedom should be allowed to allthe financial institutions and in 1985, at the time of the final report of the Commission,Parliament passed the FinancialInstitutions Amendment Act that permittedbuilding societies to competeon equalterms with the banksand to convertthemselves into equity- basedjoint stockinstitutions. In the 1980s,therefore, government policy was almost the reverseof that in the 1970s,when the Vorster Governmenthad attemptedto solvethe problemof buildingsocieties' lack of competitivenessby placingrestrictions on interestrates, credit ceilings on lendings,and by increasingthe tax free benefitsof placingmoney with buildingsocieties [7, 9]. In the 1980sthe market was to take over this function. The economicbackground to these changesin SouthAfrica was sustainedeconomic growth accompaniedby a seriousdecline in personal savings,both as a proportionof grossdomestic savings and as a proportionof personaldisposable incomes. For example,between 1970 and 1988, the Gross DomesticProduct rose from R12,518million to R206,804million, a sixteen 154

and a half-foldincrease in eighteenyears, compared with a lessthan twelve- fold increasein the assetsof the permanentbuilding societies, from R3,072 millionto R35,967.The depositsof thebuilding societies, including what they euphemisticallycalled "shares",increased at about the same rate as their assets,which of courseis whatone would expect, as the growthin homeloans was dependentupon their abilityto draw in deposits.Sustained economic growthhad createda climate of opinionfavorable to deregulationand increasedcompetition among financial institutions, while at the sametime inflationwas impairing the abilityof the man-in-the-streetto saveand favoring equity-basedsaving schemes that were being aggressively marketed by the life insurancecompames. Personal savings as a proportionof grossdomestic savingsfell rapidlyfrom 36% in 1971 to 3.8% in 1982,before recoveringa little to 7.4% in 1988(Table 1). Thoughthis collapse in personalsavings was to an extentcounterbalanced by an increasein corporatesavings, this did not helpthe buildingsocieties.

Table 1. PersonalSavings in Currentand ConstantPrices and as a Percentageof Gross DomesticSavings and of PersonalDisposable Incomes, 1970- 1988

Year PersonalSavings PersonalSavings As Percentage As Percentage Current Prices Constant Prices of Gross Dom- of Personal esticSavings Disposable Incomes

Rand million Rand million % %

1970 879 879 30.9 10.2 1971 1,153 1,102 36.3 11.7 1972 1,479 1,322 37.5 13.4 1973 1,270 999 25.4 10.2 1974 1,153 778 18.3 7.9 1975 1,908 1,114 26.9 10.9 1976 1,241 629 16.9 6.6 1977 2,287 1,016 24.0 10.5 1978 1,866 754 16.8 7.9 1979 3,641 1,292 23.6 12.7 1980 4,306 1,328 19.9 12.2 1981 2,383 642 11.9 5.9 1982 635 151 3.8 1.4 1983 893 191 3.9 1.7 1984 2,622 518 19.9 4.2 1985 4,327 744 14.4 6.1 1986 1,844 267 5.6 2.3 1987 4,423 556 11.7 4.5 1988 3,361 319 7.4 2.9

Source: SouthAfrican ReserveBank, QuarterlyBulletins 155

Indeed,the collapseof personalsavings in the early1980s was probably the singlemost importantfactor pushingthe Allied Building Societyinto abandoningits traditionalrole andinto moving into commercial banking. In 1982,three years before the collapseof therand, personal savings fell to 3.8% of GrossDomestic Savings and to 1.4%of PersonalDisposable Income. This collapsein savingscontinued into 1983. In real terms the situationof the buildingsocieties was critical. In constantprices personal savings had held up in the 1970s.It wasin the 1980s that havoc was wroughtupon South Africa's ability to finance its own development.In 1981personal savings fell to half their 1980level and in 1982 they fell to a quarterof their 1981 level. Nor was the recoveryof 1984 and 1985strong enough to pull themback to their levelof 1980. Whenthe growth of both populationand the economyis taken into account,the failure of personalsavings to keeppace is evenmore pronounced.The SouthAfrican economy,therefore, was becoming more dependent upon external sources of investmentcapital at the verytime that the Bothagovernment was doing its bestto makethis impossible. While this collapsein personalsavings was no doubt a rational responseto the economicmismangement that was taking place, it spelledthe doomof the traditionalbuilding society. It alsomade it possiblefor the commercialbanks to encroachupon the territoryof thebuilding societies, for in the 1980sthey were succeedingin mobilisinggreater resources than their ownbusiness warranted--hence the exampleof the Englishbanks in moving into the home loan business.

The ExperienceOf The Allied, 1970 - 1986

Traditionalbuilding societies, hamstrung by a plethoraof restrictive regulationsimposed by the governmentand by theirown innate conservatism, were not at first in a positionto make a dynamicresponse to changing economiccircumstances [1, 2]. Theyneeded to be placedon an equalfooting with the commercialbanks in the competitionfor savings,to be freed to developnew lines of business,and to undergoan internalentrepreneurial revolution.The changes,placing the buildingsocieties on an equalfooting with the banks,occurred in the mid-1980sand the Allied BuildingSodety respondedto the challengemore quicklyand in a morefar-reaching way than any of the otherbuilding sodeties. Thisdynamic response of theAllied was not heralded by the experience of the societyin the 1970s,when its proportion of totalbuilding society assets declined.Only after 1980did thisproportion begin to growand only after 1982 did the Allied'sproportion of total advancesbegin to grow (Table 2) and in 1987 they had not yet recoveredto their level of 1970. This raises somequestions about the benefitsderived from the 1970 mergerwith the JohannesburgBuilding Society and also about the prospectivebenefits to be derivedfrom the 1991merger with the United BuildingSociety, the largestin SouthAfrica, VolkskasBank, and the SageInsurance Group. Viewedin terms of the new mortgageloans the mergerof 1970was an even greater 156 failure,for in 1985,in real terms,at 1970price levels, the new mortgage loansgranted by the Allied amountedto onlytwo thirdsof thoseof 1970.

Table 2. The Advancesof theAllied BuildingSociety, their Proportionof Total Building SocietyAdvances, and New MortgageAdvances of the Allied in Currentand Constant Prices, 1970 - 1988. Year ending Advances Proportion New MortgageLoans 31 March of the Allied of Total Current Constant

R million % R million R million

1970 224.3 10.7 165.9 165.9 1971 499.1 20.1 167.0 159.7 1972 540.1 19.5 152.1 136.0 1973 622.0 19.5 200.6 157.7 1974 747.2 19.4 304.1 205.2 1975 838.0 19.1 280.6 163.9 1976 990.0 19.6 312.7 158.4 1977 1,101.5 19.4 294.1 107.1 1978 1,172.7 19.1 258.3 104.4 1979 1,271.7 18.9 389.7 138.3 1980 1,443.6 18.3 599.1 184.3 1981 1,768.3 17.5 616.0 166.0 1982 1,923.2 17.1 457.1 108.4 1983 2,204.1 17.6 770.1 165.0 1984 2,806.0 18.1 1,177.7 232.8 1985 3,045.3 17.9 636.8 109.5 1986 3,528.0 18.0 * 1987 4,414.0 19.3 1,950.3'* 245.0 1988 5,638.0 20.3 2,478.6 270.1

* In 1986 new mortgageadvances ceased to be published ** In 1988 the annualreports gave figures of new advancesthat presumably included those of the bank.

Sources: Registrarof Banks,AnnualReports; Allied BuildingSociety, AnnualReports; South African ReserveBank, Quarterly Bulletins

The experienceof the liabilitieswas similar. After 1970the Allied's proportionof totalbuilding society share capital and total depositsdeclined. Only in 1987did the Allied'sproportion of buildingsociety "share capital" climbabove its 1970levels. In depositsthey surpassed their earlierpeak in 1984,but theycould not holdon to themand in 1986the Allied's proportion of buildingsociety deposits was well below that of 1970. In real terms, though,in 1988both the combinedshare capital and depositsand the total new mortgageloans and advanceswere closeto three timesthose of 1970. 157

Table 3. ShareCapital and Deposits of the Allied andtheir Proportionof Total Building SocietyShare Capitaland Deposits, 1970-1988

Year ShareCapital Proportionof Deposits Proportion ending Total Share of Total 31 March Capital Deposits

R million % R million %

1970 132.7 10.1 134.2 11.1 1971 295.3 19.1 302.3 20.7 1972 348.9 19.2 284.1 19.2 1973 432.9 19.0 307.1 19.3 1974 498.9 18.6 376.2 19.1 1975 539.6 18.7 436.6 19.0 1976 591.1 18.8 537.5 19.1 1977 663.4 18.8 586.1 19.4 1978 715.6 18.7 635.3 18.9 1979 785.9 18.3 751.6 18.3 1980 921.5 17.4 852.3 17.8 1981 1,053.9 17.1 1,060.6 17.7 1982 1,042.9 17.3 1,333.9 17.8 1983 1,187.5 18.0 1,768.4 18.4 1984 1,267.0 17.7 2,065.4 23.6 1985 1,216.3 18.0 2,543.8 22.8 1986 1,394.7 17.5 2,551.7 17.6 1987 2,046.3 22.3 2,961.5 17.7 1988 6,428.0 (share capital and deposits)

Sources: Registrarof Banks,Annual Reports;SARB, QuarterlyBulletins; Allied BuildingSociety, Annual Reports

From thesefigures we may concludethat in the 1970sand early 1980s the businessof the Allied was expanding,but not as rapidlyas that of the otherbuilding societies. Also in contantprices there hadbeen no growthin newmortgage lending. Only in boomyears, 1974 and 1980,following rises in the price of gold, and in 1984 did the Allied increasethe volume of new mortgageloans. For most of theseyears the volumeof new lendingwas belowthe levelof 1970,notwithstanding growth of the economyand the very significantgrowth of population.

The Responseof the Allied

In August1986 the Allied BuildingSociety announced that it had boughta bankinglicence [3, p. 27] andthat it wasgoing to convertitself into a bankholding company along the linespioneered by the New York banksin the 1970s. At the sametime the Allied wouldchange its structurefrom that of a mutualsociety into an equitybased one in order to implementthis new 158

strategy.This movewas a responseto the relativefailure of the Allied in the 1970s and early 1980s both within the framework of the South African buildingsociety movement and alsowithin the wider contextof the f'mancial sector as a whole. We may identifynine main developmentsthat fuelledthis moveinto banking,of whichsix were.external and three internal. The externalones were: the continuesravages of inflation, the world-widetrend towards privatisationand deregulation,the world-widetrend towardsthe creationof largefinancial conglomerates, political and fiscal constraints, competition from the life insurancecompanies, and competitionfrom the commercialbanks. The internalones were: the increasingcost of technology,the increasingcost of maintainingan extensivebranch network, and the dynamicresponse on the part of the management. Inflationwas particuarly harmful because the functionsof the building societieshad been perfectedin a non-inflationaryenvironment and because of governmentcontrol over interest rates, which were frequentlynegative in red terms in this period. Since the time of Verwoerd, South African governmentshave constantly interfered in financialaffairs, either by plating ceilingson banklending, or by placingrestrictions on the interestrates that societiescould pay on their deposits.Government policy, therefore, worked in the directionof market distortionand, in the long-run,by restrictingthe flow of mortgagefunds into the societies,harmed both the institutionsand the peopleit wassupposed to be helping.Two generations of sustainedeconomic growthwas the drivingforce behind both the movestowards de-regulation and privatisationand also the trendtowards bigger economic units that neededthe serviceof everbigger financial institutions. The movesto de-regulationmay have occurred earlier in South Africa than in other countries as a result of the excessivedegree of regulationthat alreadyexisted in SouthAfrica. Certainly the appointmentof the De KockCommission pre-dated the electionvictories for Mrs Thatcherand PresidentReagan and led the way to the legal changes that permittedthe Allied'smove into bankingin 1986. The politicaland fiscal constraintscomprised: limitations on the investingpowers of the buildingsocieties at a time of doubledigit inflation that held down the rates of interestwhich they could offer; government pressureto keep interestrates low, especiallybefore general elections; and governmentattempts to solvethe problemby makingsome deposits tax free. But even some of these tax free depositswere yieldingnegative rates of interest,at a time when the life insurancecompanies, able to investin equities,did not feel the effects of fiscaldrag. The cardswere stacked against the traditionalbuilding societies. Competitionfrom both the insurance companies and the banks hurt the Allied. The PublicRelations Manager of the Allied, in the firm'scentennary booklet,places great emphasis upon the unfair competitionfrom the life insurancecompanies in the battleto mobiliseresources. Deans also points out that the price-earningsratio of the more innovativelife insurance companies(read Liberty Life) were generally three or fourtimes those of the commercialbanks [3, p. 25];but he doesnot explain why the mutual insurance companieswere more dynamic than the mutualbuilding societies, nor why 159

theywere more enterprisingthan the commercialbanks. Legal constraints uponthe buildingsocieties were probably the main reasonfor their failureto competeeffectively with the insurancecompanies. Yet in the 1980sthe main threatto the buildingsocieties came, not from the life insurancecompanies, but from the commercialbanks. The formerhad successfullycompeted with the buildingsocieties for funds;the latter, whenthey movedinto the home loansbusiness, threatened their sourceof earnings.In the early1980s the rise in interestrates hit the buildingsocieties hard, when they experienced a loss of R300million on theirinvestments in governmentstock, just at thetime that thebanks were moving into the upperend of thehome loan market. By 1989 thebanks, that had once been so fearful of lockingup theirfunds in long-term loans,had snatcheda quarterof the homeloan businessaway from the buildingsocieties. This doubleonslaught upon the traditionalbuilding societies, that hit both their sourceof fundsand their income,coincided with rapidlyincreasing costsin runninga multi-branchedmono-functional financial institution. As long ago as the 1960sthe Canadianbanks were complainingabout costs of maintaininglarge numbers of uneconomicbranches, but they dare not close them in case they lost businessto competitorsthat did not close their branches. The same applied to the South African building societies, notwithstandingthe statementof Tim Hart, the executivedirector of the Associationof BuildingSocieties in October1986 that one of the two great advantagesof the SouthAfrican building societies was that theywere national and not regional (FinancialMail, 14 October 1986). In 1985 the Allied possessed170 branches and over 300 agencies.Not onlywere these branches expensive,but they did not earn money. Their functionwas to take in depositson whichinterest had to be paid,while the incomegenerating part of their businesswas confinedto centralisedhome loan departments. To make the branchesprofitable the buildingsocieties needed to increasetheir rangeof functionsand to convertthem into incomegenerating units. The heavycost of the branchnetwork was rising rapidly in the 1980sand wasto a greatextent responsible for the changesof 1986. Associatedwith the risingcosts of an extensivebranch network was the rising cost of modern technology. In practicethis meant the cost of computerisation.This wasthe reasonput forwardby the Allied [3, p. 26]. The Allied had installedits first computerin 1966but this had not had any significantimpact on the workof the society.This changed in the 1980swith the appearanceof Automatic Teller Machines and the accompanying investmentin computertechnology. Already in January1984 the Allied was announcingthat 50 Automatic Teller Machines would be operationalby April (FinancialMail, 27 Jan.1984). The capitalinvestment for thishad begun in 1977and grown rapidly from 1981 onwards reaching a peakof R23million in 1986and it seemslikely that it wasthe Allied'sinvestment in Burroughs computersthat helpedblock the proposedtie up with Nedbankin 1984,for that bank had investedin IBM technology. The effectupon management expenses was dramatic. As a proportion of total incomethese had climbedto 21.4% in 1974,before falling for four yearsto 15.7%in 1978. Their renewedgrowth coincided with the rise in the 160

priceof gold,until, in 1981,they hit 23.0%. Thereafterthe heavyinvestment in computertechnology paid off and the burdenof managementexpenses declinedsharply to 14.9%in 1986. In 1987,when the costof convertingthe buildingsociety into a bankbegan to bite, the percentagerose to 18.1%. The influenceof top men at the Allied alsoseems to haveinfluenced the courseof events. Alan Tindall is reportedto havesaid as early as 1983 that the way of the future was into banking[3, p. 25] and his viewsseem to havebeen reflectingthose of the buildingsocieties' top executives,for, in a strategicplanning exercise early in 1984,the decisionwas made to sendtop managersto businessschools in CapeTown, Johannesburg, and Manchester. Tindall, the Allied'sexecutive director in chargeof finance,was then sentto the ManchesterSchool of Banking. The Allied waspreparing for the move into bankingfor at leasttwo yearsbefore the publicannouncement in 1986. Shortly afterwardsthe other leadingbuilding societies either followedthe exampleof the Allied or were takenover by banks.While impersonalforces were pushingthe Allied in the directionof becominga bank, it was the decisionof individualsthat madeit possiblefor the Allied to lead the way. Prominentamong these were Alan Tindall,the f'mancedirector, and Paxton, the chairmanand managingdirector.

Conclusion

Sustainedeconomic growth accompaniedby double digit inflation createdan increasinglycompetitive environment for the traditionalbuilding societies.In the 1980sthey began to experiencea classicscissors squeeze at a time when personalsavings were falling rapidly in SouthAfrica. Other financialinstitutions, but principallythe life insurancecompanies, competed effectivelyfor the limitedvolume of savingsavailable, while the commercial banks moved into their traditional home loan business. This sounded the deathknell of the traditionalbuilding society; their move into bankingspelled the end of their independence. Within the Allied, the increasingburden of maintainingan expensive branchnetwork, together with the increasingcosts of installingmodern office technology,provided the catalystfor change. Managementseized this opportunityto changeboth the strategyand the structureof the society.The decisionwas made to move into bankingand to becomean equity-based institutionquoted on the JohannesburgStock Exchange and all the major buildingsocieties followed the lead set by the Allied. However,the sameforces that led the Allied to changetheir strategy and structurewere also actingupon the other financialinstitutions and, as SouthAfrica wasalready "over-banked", banking strategy has been to takeover other financial institutions and to convert the former commercial banks into bank holdingcompanies. These, in turn, are controlledby life insurance companies.The new structurerequired in a more competitiveenvironment madeit possiblefor the banksto takeover the formerbuilding societies and, by the endof 1990,two of the big four buildingsocieties had already tied up with banksand the future of the Allied as an independentinstitution was in doubt. Whether the innovative executives of the Allied foresaw this in 1983 161

is not clear. What is clear is that the top men of a hithertofuddy duddy financialinstitution responded with vigor to the opportunitypresented by the deregulationof financial institutions. Their customersgained from this developmentas the figuresfor new lendingin 1987 and 1988 in constant pricesare largerthan those for anyyear since1970 and two and a half times thoseof the early 1980s. Competitionhad onceagain shown itself to be the friend of the consumer,amply justifying the new strategyand structurethat had been adopted.

References

1. D.G. Alston, "BuildingSocieties in SouthAfrica," in A. Hammersmaand N. Czypionka, Eds., Essayson theSouth African Financial Structure (Johannesburg, 1984). 2. HBuildingSocieties," in H.B. Falkena, L.J. Fourie, and L.J. Kok, Eds., The Mechanicsof the SouthAfrican Financial System (Johannesburg, 1984). 3. BryanDeans, •The ExcitingEighties", Horizons, Johannesburg, Allied Group (1988). 4. T.J. Gough and T.W. Taylor, The BuildingSociety Cartel, London Institute of Economic Affairs (1979). 5. Stuart Jones"The Apogeeof the Imperial banksin SouthAfrica: Standardand Barclays, 1919-1939",English Historical Review, (Oct. 1988),p.899. 6. __, Ed., Bankingand Business in SouthAfrica, (London,1988). 7. __ ,•FromBuilding Society to Bank: The Allied 1970-1988,"in StuartJones, Ed., FinancialEnterprise in SouthAfi¾ca since 1950 (London,1991). 8. Stuart Jonesand Andre Muller, The SouthAfrican Economy, 1910-90 (London, 1991), chapter 22. 9. ICA. Munro, "Monetary Policy, Commercial Banking and the Political Imperative 1965-1985,Hin StuartJones, Ed., Bankingand Business in SouthAfn'ca, (London, 1988).