Secure reserves in a new Council’s Bank

January 15, 2009

Chris Leslie, Director, NLGN
The MJ

Until recently, little attention has been paid to the nature or potential of local authority financial reserves. For several decades the banking sector has provided adequate deposit facilities with the necessary flexibility sought by local councils in England, who have been content to trust their holdings in the hands of a financial services industry which – with the exception of the BCCI debacle in the 1990s – offered relatively strong protection.

However, the financial services hegemony was severely shaken in 2008 when the Icelandic banking system froze an estimated £1billion of holdings from companies, authorities, charities and other public bodies in the UK.

We should not underestimate the policy and political ramifications that have flown as a consequence of this predicament, particularly when one ruminates on recent developments at Local Government House. The local authority sector has been forced to fundamentally reassess its attitude to risk and the stewardship role it plays on behalf of the council tax payer. Although it is highly likely that depositors will recover their funds, the reputational damage was felt not only by the ratings agencies who advised on the viability of Icelandic bank
investments, but especially by local councils who bore the brunt of the media wrath in the autumn of 2008.

The situation creates an opportunity for the local government family to put its own house in order. As part of this, the New Local Government Network – together with local councils eager to progress the concept and other specialist partners – is currently working on an outline business case for the creation of England’s first council mutual bank. Having surveyed of a wide range of local authority directors of finance, we have detected significant support for the initiative – over 80% – and we estimate that if this level of support were repeated across the country a fund of between £389million and £2.8billion might be a viable proposition, larger than the combined assets of the UK’s credit union holdings at present.

Just as councils were grappling with the consequences of the Iceland banking situation, it was becoming ever more apparent to council regeneration teams, transport engineers, planning departments and infrastructure managers across the public sector that the tap supplying a steady flow of available capital to fund their local projects was slowly beginning to turn off. The lack of trust in the interbank market is being felt in public-private partnership schemes where private finance is – at the very least – far more choosy of where it agrees to commit, if at all. Due diligence timescales are extending, investors are querying even the most basic public sector income stream covenants, and this at a time when PFI is already becoming less attractive because of the reversion to on-balance sheet treatment as a consequence of
changes to the international accountancy rules. In short, local authorities are finding it harder to find available capital to continue their public investment plans – a fact borne out in our survey of local authority finance directors, 64% of whom predicted a greater than usual shortfall in capital finance for local projects over the coming three years.

The twin challenges of security of reserves and available capital finance mirror one another and an obvious opportunity presents itself for local authorities to change their reserves strategies, obtaining greater control and certainty over their holdings, while mutually supporting the prospects for improved public infrastructure here in this country.

The Icelandic crisis revealed that very substantial council reserves are held in random and uncoordinated funds worldwide, which could be better applied to more productive benefit here at home. Intuitively the case for a pooling of council reserves to be reinvested in projects yielding a modest but stable return would match the expectations of many authorities. With estimates of total council reserves of between £15-£20billion today, even a fraction of
this sum invested in a cooperative manner could yield millions of pounds of capital, regardless of the state of the private interbank market’s willingness to lend. And if local authorities were in the driving seat of such a fund, any returns or profits could be reinvested in the sector – a model attractive across both ends of the political spectrum.

Significant questions remain about how such a fund would operate, where the skill set would be found to ensure a high calibre of investment and regulatory compliance, and whether there could be a read across to other council fund management activities such as the local government pension schemes. Nevertheless, the circumstances councils are facing should spur efforts towards new collective solutions. Out of the banking liquidity crisis may yet spring new ingenuity in the public sector – and a local authority mutual fund to apply a portion of reserves to the noble purpose of improved public facilities could be one such innovation.


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