Councils bank on it: Accounting & Business

Councils enter the banking market

by Paul Gosling

The idea of a council having its own bank may sound far fetched – yet until 1976 the Birmingham Municipal Bank was exactly that, Birmingham City Council’s very own bank.

Now history could repeat itself as the impact of the credit crisis spreads. Some local authorities, including Birmingham, are looking to create their own banks. Many more are interested in going back to their old ways of lending mortgages: a common practice until about 30 years ago.

“Birmingham has a long tradition of innovation in municipal government,” explains Mike Whitby, leader of the city council. “This has included the provision of gas, water, electricity, public transport and housing. We once ran a municipal bank, and given the recent market failings, I think the time might be right for us to do so again. The credit crunch has put intolerable pressure on many small yet sound businesses, people trying to get on the property ladder and those seeking to invest in the city.”

The proposed ‘Bank of Birmingham’ has a key aim of helping-out local small firms – many of which could go to the wall as they lose credit lines from existing lenders. The city council is currently retendering its contract for banking services and running the municipal bank could become a requirement of the contract. Several banks have indicated their keenness to manage the facility for the council – perhaps ironically, given that the council is seeking to put right failures in the banking market.

But the city council is well positioned to set-up a finance function that could provide a lifeline to small firms and homebuyers. In recent years, constraints on local authorities’ legal powers have been lifted, creating a general ‘power of wellbeing’ to allow councils to do things of benefit for their community and through a prudential borrowing power, enabling them to borrow where there is a good business case for doing so.

Birmingham City Council believes that these powers allow it to be involved in activities to stimulate the local economy. Lending money to homebuyers could provide stability to the city’s housing market. Loans to inward investors for property acquisitions could encourage more to locate in the city. And buying and leasing back SMEs’ premises should provide working capital that could be the difference between small firms’ survival and collapse. At the same time, the bank could use these assets as securities for it to borrow against to finance the lending.

“BCC [Birmingham City Council] recognises that with the current risk averse banking sector, organisations that would previously have been eligible for reasonably priced investment funding are now finding it increasingly difficult to source,” explains the council’s chief executive, Stephen Hughes. “BCC is therefore looking at using its own borrowing capability to place investment opportunities in the market.”

Finance would be provided to “low risk organisations that can secure the funding against a tangible asset”, says Hughes. Exactly what assets would be eligible will be clarified as the scheme is worked-up and when the scheme is operational. “Each request will be individually assessed”, he stresses. Finance will be low cost, priced merely to cover the council’s costs and debt risk.

Birmingham is not alone in its ambition: Essex County Council is looking at its own banking scheme as part of a package of measures designed to assist local businesses and citizens cope with the recession. Under the council’s proposals, a ‘Bank of Essex’ could channel funds to small firms, while a county-wide Essex credit union would be a low cost savings and loans vehicle for individuals.

The Bank of Essex would be backed by the European Investment Bank, potentially allocating millions of pounds of support to the county’s SMEs. Funds would be directed to innovative firms, to help build a competitive, knowledge-based economy, using lines of credit or by brokering loans. In addition, low value loans of up to £20,000 might be provided through the development of Foundation East, a community finance initiative designed to stimulate the local small business infrastructure.

“Local government and our public sector colleagues are big players in the local economy,” says the leader of Essex County Council, Lord Hanningfield. “Local authorities in Essex will invest nearly a billion pounds supporting the county’s economy in 2008/09. It’s our duty to do whatever we can to assist in countering the effects of the economic downturn. I am delighted that the public sector in Essex has risen to the challenge and produced a set of practical proposals that will offer real help and assistance to Essex families and businesses.”

In previous recessions, it was Labour local authorities that attempted to intervene in their local economies by providing support for small firms. This time it is Conservative-led councils such as Birmingham and Essex that are making the running.

Chris Leslie is a former Labour minister who now heads the New Local Government Network, where he is working with another Conservative authority, Kent County Council, to develop its own banking inititive. Leslie believes it is not surprising that this time it is the Conservatives who are taking the lead.

“It’s partly because there aren’t that many Labour authorities!,” Leslie says. “But also it’s because a there is a lot of pressure around on local authorities to be seen to be acting and active, and there is a lot of innovation.” And, Leslie agrees, the current banking crisis is now hitting very hard at small firms, the heart of the Conservatives’ own political constituency.

Leslie believes there is broad support for the public sector leading the rescue of the economy. He suggests that councils need to be at the centre of theses moves, because of their intimate links with local communities and local economies.

“There is a context to this,” says Leslie. “If government’s first strand of support was to shore-up banks and now to underpin the mortgage market and the securities market, then the next wave of responses, I think, needs to be around other public agencies and how they can intervene in a more active way to support businesses and residents. Local government is well positioned to do this.”

But this is by no means local government’s only concern. Councils have potentially lost nearly £1bn from their reserves through investments in Icelandic banks – and the figure is probably far higher if investments by local government pension funds are included, whose losses ultimately will have to met by sponsoring councils. Local authorities were sucked into the Icelandic deposits because of the high rates of interest offered. Now councils, led by Kent (which held £50m in Icelandic banks), are asking if there is an alternative, safer, way of achieving high returns on their reserves.

Kent wants to establish a municipal savings bank that would attract reserves from across England’s local authorities, maximising opportunities for high rates of interest. Research conducted by the New Local Government Network suggests that about 80% of councils would be interested in using the facility. NLGN hopes that at least a quarter of authorities’ total £15bn to £20bn of reserves could be attracted to the facility.

Peter Gilroy, Kent County Council’s chief executive, says: “What is clear is that the public interest principles of running a bank would be great for business and would sit well alongside other work KCC and other councils are doing to support local economies. With that in mind, we will be working with the New Local Government Network and other councils on the idea of a ‘Councils Bank’.

“This could be a win-win situation. With local authorities as shareholders you have the chance to use dividends for investing in services or returning money to the taxpayer. It also reinforces the message that we want to keep taxpayers’ money in the UK banking system – and the ‘Councils Bank’ develops that idea one step further.”

The level of risk exposure for the councils remains unclear: Leslie says there will be a discussion in the coming months about how the funds would be used. Some is likely to be placed with the Government’s Debt Management Office. A minority could be invested in councils’ own infrastructure development, through the Private Finance Initiative.

PFI funding has substantially declined in recent months as the banks faced their liquidity crisis. Moreover, those banks that are willing to lend are now less likely to provide funds for such long term periods, such as the 25 years that can be required for PFI schemes. A councils’ mutual savings bank could be a solution to these problems.

There are concerns, though, about whether local government has the power to set-up banks, particularly in the case of Kent’s proposal, which would benefit not only its own residents and businesses. Stephen Cirell, a partner at law firm Eversheds, is advising NLGN and Kent County Council. He is optimistic. “It might well be possible,” says Cirell. “It depends entirely on how it might be structured.” Leslie adds that a local government bill currently proceeding through Parliament provides the opportunity to clarify legal powers – an option he is discussing with ministers.

Meanwhile, the Local Government Association has given its support to greater economic intervention by councils and is calling on central government to recognise the importance of their role in stimulating local economies. Central government, too, is supporting councils’ direction of travel on this, with communities secretary Hazel Blears praising councils such as Essex for their initiatives.

But local authorities have a reputation for responding slowly to events. So could the recession be over before any banking initiatives come to fruit? Birmingham’s chief executive, Stephen Hughes, is reassuring. “There is a lot of work currently in progress and we are expecting to launch a service in the first half of this year,” he says. “This will be less than six months after we first introduced the idea of recreating a banking service – an unprecedented lead-in time for financial services, reflecting the commitment we are placing on delivering a real solution.”

In times of trouble, leadership is called for. Just possibly in this recession, councils could again justify their claims of being the leaders of their communities.

Box

The Birmingham Corporation Savings Bank was established in 1916 by the city’s Lord Mayor, Neville Chamberlain – who later became prime minister. Chamberlain wanted a secure financial institution that workers could put savings into. Branches were established at the Austin and Wolsley car factories, the GKN factory, the gas works and the tram depot. Its headquarters were in the water department – also part of the council.

After the First World War it was renamed the Birmingham Municipal Bank and continued as a council-owned facility until 1976, when it became the Birmingham Municipal Trustee Savings Bank. Subsequently it formed part of the Trustee Savings Bank which was privatised and then purchased by Lloyds Bank.