How safe are building societies?

British savers were dealt another big blow to their confidence this week when Dunfermline Building Society, Scotland's biggest mutual, became the latest financial institution to collapse. So just how safe are building societies?

Unlike banks, building societies aren't companies. They are mutual institutions where most customers are members with rights to vote and receive information in much the same way as a shareholder would in a traditional company. The other big difference is that the amount of money building societies can raise from the wholesale money markets is limited to 50% of their funds. Banks aren't subject to the same limit, which is why they were hit harder by the collapse of interbank lending in 2007.

But that doesn't mean building societies were squeaky clean. Dunfermline ran into trouble after making big commercial property loans at the height of the boom, and buying dodgy mortgage securities from US lenders Lehman Brothers and GMAC. The government used new legislation called the 'Special Resolution Regime' to split the mutual's bad debts from the rest of the business, with the government (i.e. the taxpayer) taking on the former, and Nationwide buying Dunfermline's 34 branches, its deposits and its good loans.

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There is no change for Dunfermline customers Nationwide will run it as a separate business. Also, as the two societies will be operated under separate licences, the £50,000 Financial Services Compensation Scheme (FSCS) guarantee covers each building society separately. So you could have £50,000 with each and both deposits would be covered, although this could change in September when the Financial Services Authority reviews the FSCS.

So should savers with other building societies be worried? Realistically, probably not. Nationwide itself is in no worse position as a result of the merger. In fact, it now holds 11% of the savings market and is operating a very cautious lending policy only lending roughly the same as what it holds in savings accounts. And "barring an economic disaster, no other substantial building society is expected to need rescuing", says Robert Peston on the BBC.

John Goodfellow, chairman of the Building Societies Association, has refused to rule out the notion that one or two more members may need rescue deals. But even if another society runs into trouble, most building societies are much smaller than banks, so mergers and takeovers are a much more plausible solution to any problems. Since the start of the year Nationwide has also taken over Cheshire and Derbyshire, while Scarborough and Skipton Building Society have merged. And the government has made it pretty clear through other bail-outs that it won't let a British savings institute go bust. So by all means, take your money out of the building society if you find a better rate elsewhere, but otherwise it should be safe where it is.