Your Local Bank: public alternatives to the private banking system?

October 24, 2008

By Chris Leslie and Stephen Cirell
Public Finance

Declarations of “accessibility”, “trust” and “transparency” have been thrown around without much thought in the commercial banking world for generations – littering glossy adverts and brochures enticing eager investors. Yet it has only been over the past few months that these abstract concepts have crystallised into critical tests, which it now appears that some in the banking sector have been unable to pass. We have taken for granted the regular exchange of savings, loans, contracts and promissary notes for generations – but many people are beginning to pause and question whether there really can be security and genuine guarantees underpinning transactions in the 24-hour global finance system.

Confidence in the private banks is exceptionally delicate, as we know from the public’s attitude to Northern Rock last year when there was even a mere hint that savings may not have been secure. Rumours and speculation can strike fear right across society – and not only for individuals. Private companies and public bodies also need to have confidence in the banking system; running a going concern means maintaining cash flows to cover payroll and reserves for unforeseen contingencies. Local authorities are currently under the spotlight because of reserves invested in the Icelandic banking system. If councils, like private individuals, feel that there is uncertainty about their savings in the internationalised banking system, then they will rationally withdraw these funds and seek a safer haven. The last thing the banks need is a run on their funds, especially from the wider public sector – and so the Government is going to have to act as a guarantor of final resort.

In a world where confidence and trust has been severely undermined, local authorities may actually have a far more crucial role to play than might currently be imagined. Perhaps we should look beyond the current short term thinking that will do no more than protect our current fragile investments, and look towards a longer term and more radical solution.

In the meantime, though, we need to cover all bases. There will be a multiplicity of different things to do as a result of the vulnerability of investments, so cruelly exposed by the situation in Landisbank, Kaupthing and Glitnir which unravelled last week. Some of the investments were short term, and the consequences are more serious; others, are more long term, but with no less painful consequences. The question that must be resonating round local government – who next? This means that each local authority needs to conduct a thorough, and urgent, review of its various investments. It needs to revisit credit ratings (which may be done on different bases) and check the terms and conditions of the products accepted. Many authorities will be taking advice on whether they can withdraw deposits now and planning next steps. This would be a wise strategy for every authority to adopt.

There is a real danger, though, that as we mimic the rabbit standing in the headlights, we fail to see the bigger picture. We have to commence a national local government debate on how financial matters might be better co-ordinated, and local government’s role refocused to help communities through the next few difficult years.

This work is already underway. Over the summer, the New Local Government Network and several local authority leaders called on the Treasury to encourage a revival of public sector banking, specifically to encourage a renaissance of council mortgage and remortgage availability. Whereas trust between the private banks dried up, the gilt-edged markets were still open to governments, both local and national. Councils have access through prudential borrowing rules to capital which can be offered to their residents in the same way as a bank could offer a mortgage. Secured loans from councils to prime householders in need of mortgage finance could even provide a strong return for the council tax payer over the typically 25 year lifespan of the loan, as the interest payments would supplement the capital repayment. Any risk of default could be secured against the property in question in the normal way, and councils would have a particularly close interest in adding value and appreciating the prosperity of the neighbourhoods in question.

In short, local authority mortgages still could help offer some of the much needed liquidity which the housing market so desperately requires. Councils do not need the permission of HM Government to offer mortgages, having existing legal powers to do so. The key flexibility that local authorities might wish to seek is the suspension or abolition of the standard national interest rate at which all council mortgages must be set, a rigidity put in place over twenty years ago when the then Government sought to shift all home finance into the private banking sector.

But the role of local authorities at times of international stress and anxiety may be even greater still. There is a changing mood across society, sceptical about the integrity of the global banks who slice up, sell on and trade in what used to be straightforward savings and loans. The old-fashioned virtues of the original British banks, grounded in their communities and lending only those sums which their deposits could afford, may yet return to favour. With the ownership of today’s banks nearly impossible to discern, spread across the world and separated from their clients, it is no wonder than many people may be questioning whether they truly know where their life savings are held.

These fundamental desires for transparent governance, local scale rather than bewildering complexity, and a rootedness in the real world may lead to a renaissance of local banking. The building societies that sprung up during the twentieth century were fundamentally localist organisations, built on a not-for-profit basis and in dialogue with their investors. Credit unions have been slowly growing in popularity because of their ability to reach into those neighbourhoods most in need of small scale credit. Local authorities, too, should be considering a new future, encouraging sturdy community-based savings and loans institutions designed to serve their customers rather than shareholders, and perhaps also looking to use their own position of trust in the community to help facilitate credit.

Without credit, no modern society can function. The credit crunch is putting at risk not just householders facing repossession but also businesses unable to pay their wages and regeneration development schemes unable to get off the ground because of the housing market collapse. If the ‘power of community well being’ means anything, it means ensuring that local communities have access to affordable credit. In the absence of a functioning banking sector, local government – just as with national government – has a duty to intervene.

Active local government should be thinking beyond its traditional service offering and considering whether it could be using it’s ‘triple A’ rating to access resources which their residents, on their own, may struggle to obtain. The trading powers which local councils have in law may allow local authorities to establish arms-length banking activities, with stewardship of savings as well as basic credit and mortgage facilities. Such arrangements could, for example, fund the whole programme that is currently privately financed through mechanisms such as PFI, with the benefits flowing back to the authorities concerned, rather than private sector banks.

Local authority banking would of course need to comply with the regulatory regime, and probably import skills from outside the current set of capabilities available in-house at present. But at a time when people are sceptical about where to place deposits or borrow funds, the local council could well rank as a more trustworthy source than most. In this way, the current crisis my have a silver lining, showing us that there is a better way, and encouraging the government to let us find it. Local authorities nationally, acting together, are an extremely powerful and well funded body, and one that rivals the power of the large financial institutions. Is this the answer?

We cannot yet foresee where the collapse in banking confidence will lead and we must hope that some level of normality resumes soon. Yet when trust breaks down it takes a long time to repair, and in the meantime lives may suffer as a result. Local government has the same obligation as national government to think creatively and act decisively. The best councils will be those which roll up their sleeves and help their residents through this difficult time.


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