A convenient alliance? Mutuality and the opportunity for local authority banking
28 November, 2008

Chris Leslie, Director, New Local Government Network
Public Finance

There is no doubt about it – the Icelandic banking debacle has dented the reputation of local government, somewhat unfairly, at a time when councils are already under the cosh. To a certain extent local authorities were a victim of their own success; the transparency of this sector ensured that the media found it far easier to expose details of frozen Icelandic holdings than they might in the private sector or in other unelected bodies. Yet arising from this misfortune may come a new concept to rescue the reputation of local government, namely the notion of a mutual fund of council reserves. With latest figures suggesting that English local authorities have seen non-school reserves rise from £5.6 billion in 1997 to £12.5 billion today, with unallocated reserves also rising from £2.2 billion to £3.4 billion and schools holding around £2 billion, serious questions are being asked about where local public finance policy should go next. The trade unions have already expressed hopes that these reserves will be spent on staffing and no doubt businesses and council taxpayers will also have an eye to repatriating some of this money. In truth, it is perfectly rational for local authorities to set aside prudent reserves, not just for that proverbial rainy day but also to cope with variable cash flow scenarios. The more important aspect of policy is this: should these reserves be scattered around the global banking system, prone to periodic risks from Icelandic wobbles or BCCI collapses? Or should a more strategic approach now be taken by the local government family to the security of these reserves and the more beneficial effects that they could yield on the domestic scene?

At a time when private financiers are asking tougher questions and raising the due diligence burden on PFI projects – causing several to be delayed or even postponed – local authorities and other public bodies are in the market for new funding options. With PFI already on borrowed time following changes to international accountancy rules, a resurgence of public sector capital finance is likely – spurred on by a Keynesian desire at the national level to see high employment construction projects delivered more speedily. The Treasury and Public Works Loans Board are the principal port of call for classic funding, but might there be an alternative in the form of a Councils Mutual Fund?

The basic model would be terrifically simple. If only a quarter of the £15-£20 billion of reserves were invested in such a ‘Councils Bank’ and in turn reinvested with absolute priority in English public infrastructure projects, millions of available capital could be released regardless of the stickiness of private interbank lending. A local authority mutual fund would be owned and operated by the local government sector itself, separate from the Treasury, whose Debt Management Office is the current place of safety preferred by many shaken local authorities. With local authorities themselves as sole shareholders, interest returns could be maximised and dividends reinvested or returned to the local taxpayer. And while this model may be perceived as a humdrum savings and loan facility limited to domestic local institutions only, in the swirling vortex of international risk a safe haven such as this – whose role would be to supply liquidity where others may not – should be highly coveted. It would be a sign of the local government sector’s maturity if such a mutual fund were up and running soon. To help the process along, at the New Local Government Network we intend to pull together an Outline Business Case over the coming weeks to explore the regulatory and operation requirements – and potential interest – in the idea. Anecdotal discussions with Treasurers and Directors of Finance suggest there may be considerable interest, though undoubtedly there would be hurdles along the way. For instance, how best would such a fund cope with the need for instant or short-term access to these reserves? How could local government contract in the appropriate investment and actuarial skill set to achieve a robust investment strategy? Would there be a read-across to the work of local government supperannuation fund management?

Whether councils dip their toe in the waters of collective investment schemes or not, the face of capital finance is changing fundamentally. Many local authorities are thinking creatively about the active role they can take to ameliorate the effects of recession for their residents, with mortgage rescue, SME support and economic development interventions emerging across the country. But perhaps the biggest step that councils could take would be to club together and use their mutual strength to ensure that much needed regeneration and infrastructure schemes still have a hope of proceeding. The problems of banking illiquidity are forcing ingenuity in the public sector – and local authorities joining forces should be part of this new story of innovation.