A People’s Bank Explained
April 22, 2019
Banks are essential to a modern economy. Banks keep money flowing. Cash machines, direct debits, card payments, and other transactional functions. Then there’s savings, mortgages and loans – if you had to save up and pay cash, no one would ever be able to afford a house, and businesses would struggle to expand. The economy would grind to a halt overnight.
Banking went badly wrong in the 1980s, leading to the banking crash of 2007-8. It dragged down the world economy, and paved the way for the Conservative and Lib Dem governments to use it as an excuse for austerity. Austerity has devastated the prosperity of ordinary working people, we’ve seen the rise of foodbank Britain, an exponential rise in in-work poverty, slashed public services, all while the mega rich have made out like bandits.
Banks got greedy, and engaged in speculative banking, instead of sticking to bread and butter retail banking – such as current accounts, mortgages and business banking. Some of the people who ran the banks engaged in unethical and frequently illegal activities, and were encouraged to take risks by the promise of million pound bonuses. In Britain, we, the citizens, had to bail out the banks to the tune of £500 billion to stop the financial system from collapsing. (Compare that to £39 billion a year to fund all the UK’s schools).
Across the world, one kind of institution kept trading throughout the international banking crisis, largely unaffected. These were the regional mutually owned banks. The customers owned the banks, and the banks focused entirely on day to day banking (called retail banking), and did not engage in risky speculation. Sadly, these types of bank are common in other advanced economies, but not here. Germany has 1024 regional cooperative banks, and a much stronger small business sector as a result.
There are billions of pounds sitting in current accounts in our region, earning no interest, that are being transferred out of our region to be used anywhere in the banking system. The People’s Bank will recycle these funds into our region and nowhere else.
This is what I want to facilitate here, in the North East. It will give our regional economy a major boost.
How Do We Set Up A Bank?
Using the Mayor’s “functional power of competence” I will establish an independent cooperative to begin the process of establishing a bank owned by its customers – the people and the small & medium businesses of our region, based here and recycling the savings of our region into loans for our region.
A huge amount of work has been done, reviewed and paid for by others, that is available for a North East People’s Bank to licence. I’ve worked with a team of specialists and banking experts who are setting this model up across the UK, looking to licence a bank in each region. They’ve hired top accountancy firms like KPMG to advise and check the data, and commissioned and piloted the technology to make this bank work. Already, four regional banks in the UK are well advanced on this route (Wales, North West, South West, and Greater London), and have raised £millions to get their regional banks established. This lowers the risk for us.
My first step on this route after being elected would be to commission a due diligence report. An independent accountancy firm would look at all the numbers on the business model, and verify that everything stacks up. If it doesn’t, then no further public money will be committed to the project. This costs about £40,000 – so that’s the maximum initial risk: a tiny amount for huge potential benefit. If the plan passes due diligence, the mutual society will be established, and initial staff hired to guide through the start-up process. The Mayoral authority would commit to fund this stage of the operation, costing approximately £300k. This will take us through the stages of application and detailed business planning.
Once the first regulatory hurdles are cleared, an additional £2mn funding is required. By this stage, the model is proven, and the PRA and FCA want to see the bank capable of operations before granting the full licence. So initial staff are recruited, IT systems installed and premises acquired. At this stage, the risks are reduced, and investment partners will be invited from ethical investment funds. This implementation phase will take about a year, and if successful a banking license will be granted. At this point, the bank is operational, and the final tranche of capital is required in order to begin full operations. This is where most of the capital is required, another £18mn is needed, taking the total capital investment to £20mn. By this stage the risk is much lowered because the bank already has its licence, and all its systems have been proven by the regulators. Finding ethical capital investors will not be difficult – indeed, it will offer a better return than many public sector reserve investments.
The whole process will take two and a half to three years from commissioning the due diligence to being fully operational. Over the next five to six years the bank would grow to maturity, opening more branches and attracting more members and customers. After nine years, the bank would be highly profitable, serving tens of thousands of customers, and making around £20mn a year in profit, which the customers can vote to allocate – some to local good causes, some to support lending to start-ups and community enterprises, and some as a dividend to members.
It’s worth stressing again: the Mayor’s authority would not own this bank. It will, however, gain an annual return of 7.5% on any money invested in the bank once it is mature. So if the Mayor’s authority put in £2mn over three years, it would gain a return of £150k per year ever after – excellent value for the taxpayer.
Some Frequently Asked Questions
What will it offer?
A full range of banking services: current accounts, mortgages, cards, and crucially, business banking for small and medium enterprises (SMEs). It will have full online systems, by app and by browser, and will have physical branches. Relationship banking will be at the heart of it. You’ll get to speak to the bank staff, and there will be mutual trust built up. There will be no, “computer says no”. All customers will become members of the bank, getting one vote per person, and deciding on things like the directors’ pay.
Why does the bank need £20mn? Is that enough?
The £20mn is what’s called Tier 1 capital. It’s the money needed to make sure a bank has enough reserves to withstand a financial shock, such as if an unexpected number of borrowers all default at the same time. The Bank of England sets the amount, according to what is known as the Basel III accord – new rules put in place after the financial crash to stop banks going belly up in future. The regulators require a new bank to have 5mn Euros, but the model we’re looking at wants to be extra safe, and so will operate with £20mn. The bank will then have a license to accept deposit from local savers, protected by the Financial Services Compensation Scheme, and carefully lend this to local borrowers. So it will be able to lend out much more than £20mn, making interest on all of it. The bank will be able to lend over £400mn, and as it matures, its retained earnings will allow it to grow further. It’s a bit technical for this blog, but if you’re interested, look up Basel III Risk Weighted Assets.
What’s a Banking Licence?
To be a bank, a business has to undertake an extensive application process. This takes anything up to two and a half years. It is overseen by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). Once granted, a bank has unique powers – it has a Bank of England reserve account. It can accept deposits for savers, it gains interest on its reserves, and can borrow at base rate from the Bank of England.
Until recently, it was very hard to establish a new bank, and all but impossible to establish a new mutual bank. In August 2014 a change in the law made it possible for Cooperative banks to raise capital without giving away voting rights, so it’s now possible to raise the capital much more easily.
What’s the difference between this and a credit union or a building society?
Credit unions are excellent institutions, offering savings and loans to local communities, and providing a real alternative to payday lenders. They are typically very small in scale, and often have a limited range of capabilities, such as not having direct debit facilities. They are extremely unlikely to offer mortgages or business banking, limiting their size.
Building societies are, in one sense, very large credit unions, although they almost never serve local communities in the same way.
Building Societies are there to primarily provide mortgages for residential property. Few offer current accounts or are focused on the needs of Small and Medium sized businesses.
They are owned by their members, although participation in decision making is almost non-existent, and there are sometimes issues with “fat cat” pay – for example, one CEO was getting £2.25mn a year! Because they don’t have shareholders, they can sometimes offer good deals on mortgages and savings compared to PLC banks. They don’t have full banking capabilities, though, such as a Bank of England reserve account, and don’t offer business banking.
Is the Mayor allowed to do this?
Absolutely. The Mayoral Authority has what is known as “Functional Power of Competence”, which means it can do anything an individual can do, even if it’s not been done by a local authority before. That’s why we need a Mayor who understands the law, and has the visions for what is possible, and how we can make the best use of public money to bring prosperity to our region. In debates, my opponents have dismissed the idea, making a series of factually incorrect objections: they haven’t done their homework.
In 2017 Redwood Bank opened, a highly successful specialist bank that lends to SMEs. It gained 33% of its funding from Warrington Borough Council. The Welsh government, and at least six other local authorities are already well advanced down the route to opening regional banks on and identical model to the one I propose. They have raised £millions between them.
Who will run the bank?
Not me! To be the chief executive or chair of a bank you have to be personally approved by the regulators. I might be highly knowledgeable as a layperson, but this is a job for a professional with years of experience at a senior level. It’s a case of hiring the right person, who is looking to build a bank based on solid principles of mutual trust and responsible banking. A great many people in the banking profession subscribe to these values.
Will you look after the staff?
The bank will be a model employer. Everyone will be paid at least the Real Living Wage, and there will be a maximum pay ratio of 10:1, meaning the highest paid gets no more than ten times the lowest paid. Employment contracts will adhere to the best standards, the bank will be a champion of diversity, and there will be zero gender pay gap.
Once it’s fully mature, we’d expect the bank to employ around 100 people.
Why is it good for the local economy?
In short, it keeps money here. When people borrow from banks, money leaks out of our region in two ways. First, the bank is usually headquartered far away, so most of the jobs it supports are not here. Secondly, a large amount of their profits are paid to the shareholders as dividends. Often, these shareholders are in turn holding companies. Even at today’s historically low rates, you’ll end up paying 60p in interest for every £1 you borrow. For a typical homeowner, that’s 12% of your entire take home pay leaving our region. Keeping that money here creates spending power here, creating more jobs and more prosperity.
Local businesses will get interest on their current accounts, and more access to the finance they need. There’s about £1.4bn in business lending to SMEs in the NE postcode area alone. The interest on this lending goes to banks based outside our region, with shareholders needs placed above the customers’. We do have some building societies here, but they can’t have business banking, because they do not have the same legal form as a bank.
The bank will also support local community causes once it’s mature and in profit, and of course, create high quality jobs here.
Is banking profitable?
Retail banking is astonishingly profitable. A bank can access money cheaply, and lend it out at a higher rate – the difference between the two is called the interest margin.
Have a look at the table to see how much the main banks make in profit – typically £1bn profit for every £3bn income!
Smaller banks are even more profitable – they’ve largely been unaffected by the banking scandals like PPI insurance, and so don’t have to pay out compensations for historical misdeeds.
Germany has 1024 successful banks that run on this model.
Wasn’t the Northern Rock like this?
No. The Northern Rock formed in 1965, after the merger between the Northern Counties Permanent Building Society, founded in 1850, and the Rock Building Society, founded in 1865. After 147 years of successful trading, through recessions and world wars, it demutualised and became a bank and a PLC in 1997. Within 10 years it went belly up, and had to be bailed out by us, the tax payer.
How can we protect it?
A wave of building societies were “demutualised” in the 1990s. In effect, they were sold from under their members’ noses in return for £500+. The law was later changed, and no more have been demutualised. We’ll be writing stronger legal safeguards into the bank’s constitution, known as an “asset lock”.
What about Atom Bank?
Some people have made mention of Atom Bank, based in Durham. This is a totally different financial model. Atom Bank is a digital only bank, available through an app and offered only savings accounts and mortgages. It has no branches and no business banking. They decided to set up all their own IT systems, instead of licensing technology from other institutions. In order to expand quickly, they offered very high rates to savers, and very low rates to mortgage borrowers – a loss leader. They grew their loan portfolio from £0.1bn to £1.1bn in a single year! In other words, they made a deliberate decision to lose money in order to expand very rapidly. In order to raise capital to bolster their reserves, they sold a controlling stake to the Spanish Bank BBVA. I wish them luck – if we can have a successful business located here in the North East, great! But it’s not a model we will be following.