With a little help from your friends

Building societies have gone back to basics by focusing on savings and lending once more, reports Joe McGrath

Yorkshire Building Society's plans to merge with one of its rivals – the Norwich and Peterborough – has reminded savers of the changing shape of the building society sector. Although the number of independent mutuals on our high streets is in decline, it appears to have had little effect on the number of savings options made available to consumers this year.

Building societies have made a much more competitive showing this season compared to last year by changing their individual savings account (ISA) rates and reacting to their competitors' new offerings in the run-up to the end of the tax year. As these more competitive deals become available, it seems the building societies are moving to stamp their authority on the cash ISA market, and nowhere more so than in the fixed-term bond ISA market.

Derbyshire Building Society – owned by the Nationwide – is offering a market-leading fixed ISA for four years with a 4.4 per cent interest rate. The minimum investment is only £100 and the interest term is fixed until the end of April 2015. This compares to a four-year account on offer from Halifax, owned by Lloyds Banking Group, which is offering the same rate, but insists on a £500 minimum deposit.

The Welsh mutual Principality is also near the top of the table, offering 4.3 per cent for a four year fixed ISA, requiring a minimum of £1,000 to qualify.

Patrick Connolly, head of communications at financial advisory group AWD Chase de Vere, says mutuals have become more competitive in the ISA market as they have whittled down their product ranges after the economic downturn to concentrate on their core markets. "We are finding that building societies now have their balance sheets more in order and are focusing on their traditional businesses, such as savings and lending," he says. "They are moving away from insurance and investment products they were once offering and we would therefore expect them to continue to be more competitive."

Meanwhile, Newcastle Building Society is offering up to 4.5 per cent if you are able to leave your cash tied up for five years, while the Cambridge Building Society will pay you 3.5 per cent to hold your money for three years.

Not quite so good is the rate on offer from the Cumberland Building Society, which at 3.25 per cent for three years is unlikely to appeal, given the alternatives on the market. Since a handful of providers are offering instant-access rates around the 3.2 to 3.5 per cent mark, these are more likely to command the interest of savers.

Santander, for example, is offering 3.3 per cent to new customers and 3.5 per cent to those that have an existing account with the bank, Barnsley Building Society is offering its e-ISA at 3.2 per cent and Nationwide Building Society is offering 3.1 per cent, including a 1.35 per cent bonus payable until July 2012 when the rate drops.

The Building Society Association (BSA) says the recognition of its members' enhanced competitiveness is deserved, but acknowledges that a more prudent operating model is behind the resurgence in market leading products.

Adrian Coles, director general of the BSA, says building societies are looking to lend once more and are reluctant to use the wholesale market to the extent that they might have before the credit crunch swept through the financial services sector. "It has been a re-education for the whole of the UK financial services sector. In the past, there was too great a reliance on wholesale funding and building societies have been included in that re-education," he says. "There has been a lot of pressure around the world to lend only what you can raise from depositors. Those that did that through the boom years are those that are still around today."

Coles stresses that the financial strength of the building societies remains intact after the credit crisis and that the high rates on offer are not a sign that these organisations are desperate for new inflows of cash.

"It doesn't mean building societies are raising nothing from the wholesale sector – a number have been successful from covered bond issuances but there has been a change in emphasis," he continues. "They are emerging from the dark days of the financial crisis. It is still quite difficult, but not as difficult [as during the crisis]. If you want to lend a bit more, you have to raise a bit more in funding. They had a number of months without significant inflows in savings terms, but now they have greater confidence."

The difficulty for savers looking for the best interest rate is that finding these deals might be trickier than you would imagine. For example, the top-selling ISA available for the terms that you require will not necessarily be at the top of the best buy tables on some price comparison websites. This is because the smaller organisations, such as regional building societies in particular, would not necessarily be able to handle the influx of enquiries if the whole of the UK knew they were offering the best rate. So, to be able to maintain their service standards at a respectable level, most decline the opportunity to be included on such listings, with the exception of some of the larger mutual organisations.

In addition, price comparison websites will not necessarily be entirely independent, meaning that they are sometimes paid to feature certain products higher up the rankings than others. "Price comparison websites are useful, but there are a number of caveats that need to go with them. Remember, these websites get paid if you buy products from them, so they have a vested interest in selling you a product. They are likely to get paid different amounts depending on what type of product you buy, so don't get enticed by headline rates. There is often small print below the rates and most have short-term bonuses attached that can leave you with an uncompetitive rate when they run out," explains Connolly.

Before making choices for this ISA season, savers may want to start with price comparison websites, but they would be wise to go through the adverts in local and national media to see what financial organisations are offering.

"Look at what your local building society is offering. For a small institution, if you get in the best buy tables, it can be difficult. Everybody has to take account of the levels of business that they can cope with," explains Coles. He suggests that savers should also consider the value of customer service and not just the rate.

"Mutuals offer enhanced levels of service as well as offering value for money, consumers are often willing to recommend to friends and family," he adds.

Of course, the internet can prove to be an exceptionally useful resource when researching the rates on offer from the various building societies. Rebecca O'Keeffe, head of investments at Interactive Investor, says the recent shift towards online ISAs mimics the online shopping trend and confirms that investors are increasingly confident about investing online. "Banks, having taken a real battering in the wake of the financial crises, are not the perceived safe haven that they once were – and neither are they necessarily the best option," she explains.

One of the big concerns of those squirreling money away in building society accounts in recent years has been the financial strength of the organisations. The significant number of mergers, demutualisatons and even a failure in the case of the Dunfermline Building Society have conspired to set some nerves on edge. However, investors should be aware that their savings up to £85,000 and £170,000 for joint accounts are protected by the government's Financial Services Compensation Scheme.

But beware, remember this level of protection is only for accounts with one provider. So, if you have accounts with two building societies and they merge together, the level of protection that you have will revert to £85,000.

In reality, of course, this is unlikely to be a serious concern for most ISA investors, but for the lucky few who have that sort of sum in the bank or building society, it should be a consideration.

With 48 building societies in the UK, it is worth directly phoning up your local branch or venturing out into the high street to check whether there is a more competitive rate available. For example, the smallest building society in the country – Century Building Society in Edinburgh – may only have £24 million in group assets, but it's still offering a quite competitive two-year, fixed-rate ISA at 3.75 per cent.

Kevin Mountford, head of banking at MoneySupermarket.com says the recent activity in the ISA market is great news for savers looking to maximise their ISA allowance for 2010/11. He explains: "The traditional ISA season has started earlier than previous years and in general, savings providers are being more aggressive than normal. It is interesting to see a number of building societies entering the ISA market compared to last year, where they had played a much more muted role."

The Building Societies Association website has a full list of the mutuals available across the UK so you can check you are getting the best rate, www.bsa.org.uk