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Working within the business cycle

Curriculum Topics
• The business cycle
• Boom
• Recession
• Recovery

Introduction
Building societies are an integral part of UK financial services,
offering mortgages and savings as their main products. The name
‘building society’ stems back to the late 1700s when the first
society was formed. Small groups of people pooled their savings
to buy land and build houses. Today building societies are the
greatest direct competitors to banks for personal customers.
The Building Societies Association (BSA) is the trade association
that represents all of the UK’s 52 building societies.
profits made. Banks therefore try to maximise their profits in the
interests of their shareholders.
Building societies operate in a very different way from banks.
Since building societies do not have shareholders, they can focus
instead on providing more benefits for their members. These might
be in the form of cheaper mortgages or better rates of interest on
savings. They also focus on providing high levels of personalised
customer service. This can give them a competitive advantage,
attracting customers to use their services instead of banks.

This case study illustrates how building societies manage their

A building society is a mutual organisation, which means it is
collectively owned by its members. This means that members have
the right to receive information, speak at meetings and vote at an
annual general meeting (AGM) – in other words, they have a say in
how the society operates. Every member has one vote. Each
building society has a board of directors, who run the society on
behalf of the members. Anyone who has a savings account or a
mortgage with a building society is a member. Members deposit
money into their accounts as savings and the society then uses a
proportion of this money to offer mortgages to other members.
In contrast, banks are limited companies. They are listed on the
Stock Exchange and owned by shareholders. The banks’
shareholders expect to receive dividends, which are shares of the
business during the various phases of the business cycle.
The business cycle
Economic activity fluctuates over time and follows a general but
irregular pattern where periods of strong economic growth are
followed by weaker growth or even periods where economic
growth falls. This pattern is known as the business cycle and it
affects all economies over time. Within the UK the level of
economic activity changes depending on factors such as levels of
business investment, technology innovation and government
policies. Gross Domestic Product (GDP) measures this level of
economic activity. GDP is the total value of all of the goods and
services produced by business organisations within the UK.

Direct competitor: Organisations Mutual organisation: Organisations Stock exchange: Marketplace in which Business cycle: Fluctuations in demand
GLOSSARY

producing similar products that appeal
to the same group of consumers.
Trade association: Independent body
made up of members from an industry
that represents that industry as a whole.
owned by their members and with no
shareholders - traditionally established
by groups of people to provide a range
of services that serve the interests of
their members.
stocks or shares are bought and sold. for goods and services creating a
sequence within the economy from
boom, to recession, to recovery, to
another boom.

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When GDP increases over time, this represents greater economic increase their investment during a boom phase and many new
activity and is defined as economic growth. During periods of businesses start up. However, during this time there may be an
growth, consumers spend more and businesses produce and sell increase in inflation as prices rise in response to greater demand
more goods and services. This raises the total level of economic and increased costs.
output. A period of relatively rapid economic growth is known as a
boom. Eventually the growth of economic activity reaches a peak
after which the economy begins to slow down, as businesses 6 Unemployment rate % RHS 12
decide they do not need to take on any more employees or that 10
4 8
investment opportunities are less attractive. The boom is then 6
2 4
followed by a downturn, and eventually a recession. This is a fall in
2
the level of economic activity over time (although not every 0 0
economic cycle involves a reduction in activity – sometimes there -2
GDP growth %
-2 -4
Qtr on Qtr LHS
is only a reduction in the rate of growth). The economy -6
-4 GDP and Unemployment -8
experiences negative economic growth as GDP begins to fall.
-10
When a recession reaches the bottom (or trough), businesses are -6 -12
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likely to lay off employees and produce fewer goods and services.
Some companies may go out of business. However, once
recovery starts, businesses invest more and consumers increase For building societies, a boom is an important period. As wages
spending. This helps GDP to rise. increase, many customers wish to save more. This results in
building societies being able to lend more to their members. People
Economic
have more confidence and are willing to borrow to buy property.
Activity The Business Cycle
Boom In boom years, house prices can increase so rapidly that some
potential homebuyers find houses become unaffordable. Building
Recession Recovery
societies understand that getting onto the housing ladder in this
period is difficult and therefore societies aim to offer more services
for first-time buyers. For example, they can offer new ways in
Trough Time
which customers can buy their own homes, such as the provision
of shared-ownership schemes. This sort of service has been
The activities of business organisations both drive and reflect the developed through work with government and local authorities.
business cycle. As an economy goes through its various stages, This means people need a smaller deposit and have a smaller
business organisations have to manage their activities within each mortgage at the outset of the purchase.
phase. Since building societies do not have to make profits for
shareholders, they can respond to the business cycle in ways that
provide the best possible outcomes for their members, whatever
the circumstances.

Boom
During a boom, there are high levels of economic growth. A boom
has a number of characteristics. Employment levels are high and
wages may rise as businesses try to attract employees. Consumer
confidence is strong and consumers have a positive outlook on
the state of the economy. This then causes an increase in demand
as people spend more on goods and services. Businesses tend to
GLOSSARY

Economic growth: The value of goods Inflation: A rise in the general level of
and services produced by an economy prices of goods and services over a
increases over a period of time. period of time.

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Although building societies grow during a period of boom, they

have to behave responsibly. It would be wrong to offer mortgages
to those who would not be able to afford the repayments over the
long term. Building societies are therefore careful about who they
lend to. Building societies take this responsibility seriously as too
much debt could destabilise their balance of savings and lending.

A period of boom does not last forever. During this period it

becomes difficult to sustain growth. The demand for goods and
services simply outstrips the ability of all of the businesses within the
economy to supply all of the goods and services that consumers
would like. This is known as overheating - inflation accelerates and
the government may intervene by increasing taxes or interest rates.
Growth slows and a downturn begins to take place. recession in 2008/9, the Bank of England reduced interest rates
in an effort to stimulate the economy. The BSA felt that this
Downturn and recession punished savers and did not help encourage people to save.
It therefore campaigned against such low rates. Although rates
A downturn reflects a slowdown in economic activity as rates of were cut to 0.5% in March 2009 – the lowest rate on record -
growth fall. This might be triggered by the government acting to the Bank of England stopped short of dropping the interest rate
try to control inflation or in the case of the latest recession, by to zero.
disturbance to the world financial markets. As the downturn takes
hold it may lead to a recession. Recession can technically be Depressed economic conditions mean that the profits of banks
defined as two successive quarters of negative growth. Fewer decline. It also makes building societies less able to pass benefits
goods and services are demanded and created within the on to their members. Their balance sheets may shrink in size.
economy, leading to a rise in unemployment. With people losing For many building societies this simply means standing still for a
their jobs, mortgage arrears may rise and house prices fall as year or two, for example, not making as many mortgage loans.
fewer people are confident they can afford to buy their own home. However, they also need to plan to retain their members so that
they are ready for recovery.
House prices and GDP (Q4 %age change year on year)
30.0
House 8.0 In recent years some banks made subprime mortgage loans.
25.0
prices These are loans to higher risk customers in return for higher rates
20.0 6.0
15.0 GDP of interest. High risk customers may already have debt or a
4.0
10.0 history of missing repayments on credit cards or loans. When
5.0 2.0 many of these borrowers (particularly in the USA) missed their
0.0 0 debt repayments and went into arrears, it sparked the recent
-5.0
-2.0 global financial crisis.
-10.0
-4.0
-15.0
During this difficult time building societies have worked hard to
-20.0 -6.0
support their members. They do not want them to go into arrears
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House prices source: Nationwide Building Society
During a downturn consumers may not have as much money to
save. Building societies use savings to fund mortgage lending to
other customers. Therefore, as saving falls, building societies have
less money to lend and the mortgage market shrinks. During the
as this does not benefit either the member or the society. Instead
they provide help. For example, members are asked to contact
their societies if they think that they might not be able to pay their
mortgage. A survey conducted for the BSA showed that 97%
of people who went into arrears were able to retain their own
homes.
GLOSSARY

Negative growth: A contraction in a Interest rates: The rate charged by a Balance sheets: Financial documents Arrears: Debts that are overdue.
country's economy, evidenced by a bank or other financial organisation for that show what a business owns
decrease in its gross domestic product borrowing money. (assets) and what it owes (liabilities) at a
during any quarter of a given year. particular moment in time.

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Although the level of mortgage arrears in the UK has been rising in the
recent recession, the level of arrears as a proportion of total lending by
building societies is low compared to the market as a whole.

Arrears as % of total balance Total market Building societies

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0% services as members’ needs begin to change in response to the

2008 2008 2008 2008 2009 2009 2009
Q1 Q2 Q3 Q4 Q1 Q2 Q3 new conditions. The actions of financial institutions have a knock-on
effect for the economy as customers invest in new homes or

The Times Newspaper Limited and ©MBA Publishing Ltd 2010. Whilst every effort has been made to ensure accuracy of information, neither the publisher nor the client can be held responsible for errors of omission or commission.
Source: The Financial Services Authority

borrow for other major purchases. All must still exercise care when
Recovery considering the affordability of the mortgage products they offer.

A recovery follows a recession. Recovery is a time when the

economy becomes stronger and there is an upturn in the
business cycle. More jobs are created and more goods and
services are supplied by businesses. Unemployment begins to fall
and, very cautiously, consumer spending starts to increase.
Recovery can occur for a number of reasons. In order to stimulate
economic activity the government may intervene by, for example,
increasing its level of spending or reducing taxes. In December
2008, the standard rate of VAT in the UK was temporarily reduced
(until January 2010) from 17.5% to 15% in an effort to encourage
consumers into the shops. Firms that had run down stocks of
goods during the recession may increase their production, placing
orders with their suppliers and taking on more staff. Increased
investment in the UK by both domestic and foreign firms can
also boost consumer confidence. This can create jobs and
stimulate greater business activity in the economy.
In this phase of the business cycle building societies will attract
customers. As new customers place their savings with building
societies, this will in turn kick-start the societies’ ability to provide
Conclusion
According to the Office for National Statistics, the UK came out of
recession in the fourth quarter of 2009. However, recovery is slow
and could be bumpy. The Bank of England has indicated that it
could be 2011 before the UK economy will be back at the point it
was before the recession started. Some commentators are also
worried that recovery may take place too quickly as this could
cause inflation. Preventing inflation could lead to a second
downturn in the business cycle.
Recovery is a delicate phase for the UK economy. It is a time of
optimism but it is also a time for caution. As recovery moves
forward, building societies will be able to assess the best ways of
providing for the interests of their members.
1. Using an example, describe the main difference
between the operation of a bank and a building
society.
2. Explain why a boom period is a good time for building
QUESTIONS

societies and their customers.

new mortgages. During the recession building societies have 3. Using examples, analyse the impact of the latest
offered their members the best value possible in difficult market downturn on:
conditions. For example, a recent survey showed that, of the most • individuals with savings
consistent performing savings accounts on offer in January 2010, • holders of mortgages
73% were provided by building societies. • organisations that lend.
4. Evaluate the trends that a) business organisations and
Building societies have a huge responsibility as the UK emerges b) households might see during recovery.
from recession. They need to provide a range of products and
GLOSSARY

VAT: A tax added to the price of a Investement: Putting funds to use in

product at a given percentage rate. the expectation of favourable returns
relative to the risk involved.

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