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The NLGN's plans for a council bank are trying to solve a problem we do not have, says Sean Nolan As one famous East Sussex resident [Winnie the Pooh] once said: ‘I am a bear of very little brain, and long words bother me'. I feel a bit the same about Chris Leslie's ‘England's councils mutual bank' idea. At best, it is a complicated way to solve a problem we do not have, and at worse, it could also open up significant risks. Let's get the problem we do not have out of the way first. Councils can already lend to each other, and issue bonds, if they so choose. But more fundamentally, they have absolutely no difficulty getting loans, even with the credit crunch. Indeed, interest rate terms have never been better, and local authorities are able to access the Public Works Loan Board (PWLB) which – despite the Dad's Army connotations in the name and some of its arcane rules – is still one of the most sensible capital borrowing tools for local government ever invented. Even if we could not access the PWLB, councils have no difficulty in securing competitive loans from elsewhere because we are the type of true ‘triple A' borrower which most lenders would give all their ‘honey' to deal with. A major fact concerning any borrowing, regardless of who we borrow from, remains the ability of the individual council, and its council taxpayers, to meet the revenue cost of financing that borrowing. Mr Leslie's idea does not alter this reality. Now, turning to why his specific idea could be quite risky. Almost all councils have positive cashflows, amounting to some £15bn in total. This means virtually every council is looking to deposit cash somewhere safe, hopefully, and accessible, and only then at a reasonable return. So imagine if ‘only' a proportion, say £3bn, of this positive cashflow was given to this new bank on day one – where does this new bank actually put it in the short term, or until it is used for some longer-term purpose? It will not be able to place it with any other institution which is safer than any individual council currently could, and it certainly would not be able to get better rates without taking more credit risk. Anyway, for the time being, most councils will want really ready access to all their deposits. His idea is not a safe haven for council reserves in the short term. Of course a key part of Mr Leslie's idea is for councils also to borrow long term for their capital needs from this new bank. Therefore, this new bank is using shortterm deposits from councils to fund longterm loans back to local government, or to others, while also seeking some competitive differential between the interest paid by the borrower and the interest earned by the depositor. This in itself is not wrong but the proportions matter. Beyond solving a problem we do not have, there are a lot of critical challenges one could bring to bear on all this but perhaps the most significant is as follows. Councils are already suffering a massive reduction in income from interest on their reserves, and they are not going voluntarily to make that worse. So what happens in the future when economic conditions improve and base interest rates rise? Councils will want to move their deposits elsewhere but this new bank will presumably have already lent out a sizeable proportion of this cash as longterm loans to other parts of local government. The new bank would not be able to cope. Fundamentally, local government is very fortunate to have the PWLB as a source of long-term loans and we undermine it at our peril. To make matters even worse for this new idea, I do not foresee many councils taking out much new borrowings for some time. Instead, for the next few years, individual councils are going to find it more cost effective to use their own positive cashflows to finance capital spending, until some degree of normality returns to markets. While unconvinced by his specific council mutual bank idea I do believe Mr Leslie deserves credit for raising the broader notion of local authority interventions. Some of us are very interested to understand how local or regional partnerships of local authorities, local enterprise operations and banks – could make meaningful intervention's to help revive our local economies. This is a completely different type of honey from the one Mr Leslie is selling – but even this may need the participation of other strong companies and financial institutions to work. Sean Nolan is deputy chief executive and director of corporate resources at East Sussex CC

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FINANCE

This bank idea is a honey trap

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