Chris Jones says we should emulate American-style credit unions to kick-start business finance in WalesAugust 28th, 2010
Capitalism is built on the flow of money, as Karl Marx acknowledged. In turn, this puts the levers of power in the hands of the bankers who are in a position to control the flow. How money is used, and how it flows is key to unlocking our economy and enabling the social and public service agenda to which we aspire.
An over-riding constraint on the Welsh economy is the inability of money to flow to business, the so-called credit squeeze. This lack of business finance is due to business’s over reliance on globalised high street banks such as Lloyds TSB, HSBC, Barclays and the like. Nobody in their right mind should consider banks to be business friendly. They may spout the fine words but, in the last two years, their actions – and inactions – have spoken volumes.
So what can business do? What suitable business finance models are there for the businesses of Wales? I believe that a better business finance model already exists in the USA where business is routinely financed by credit unions.
During the great depression in America credit unions were established to act as conduits for New Deal federal funds used to build dams, roads, electrification and other forms of basic infrastructure. Some of these have flourished and still survive. The basic fact is that many businesses in the USA get their finance, not from high street banks but from various types of credit unions.
A crucial dimension of American-style credit unions is that they are ‘locality’, or regionally based. They are professionally managed, and often capitalised by Federal and State payroll money flow. Although interest rates and credit scoring are comparable to those of high street banks, the difference is that, being regionally based, credit union managers have more knowledge of local economic situations and much more responsibility and discretion about how they manage their lending.
Critically, a highly beneficial aspect to business of US credit union lending is that it is generally tied to some form of a turnover model of repayment. This means that repayments are geared to the performance of business. At its most basic, if there is no turnover there is no loan repayment. For example, a business may have a bad month of trading where its turnover goes below an agreed threshold that would normally trigger a loan repayment. In this case, the loan payment is rescheduled automatically until the agreed threshold is reached. Alternatively, the loan term period is extended. A variety of penalty-free agreements can be negotiated.
In contrast UK businesses that borrow from a high street bank have to meet their monthly repayments, regardless of the economic situation. In addition, the penalties for default are often sufficiently onerous to cause businesses to fail.
Of course, the credit unions we are familiar with in Wales bear no comparison with American US-style credit unions. Welsh credit unions are fine for the purposes for which they have been set up, to provide small loans and act as a savings vehicle for a local populace. However, they are not designed or set up for a business finance role as they are in the US.
National business support organisations, such as the Federation of Small Business, the National Farmers’ Union, and even the Post Office have a credit union entity associated with their organisation. However, the fact remains that very few businesses are aware of their existence or use their services in the same way as is done routinely in the US. Yet, there are no legal or constitutional impediments to converting an existing local credit union or those attached to organisations such as the Federation of Small Business into one that uses the more business friendly American model.
The main barrier to be overcome is the scale of capitalisation. In order to lend to business, a credit union needs to have a capital base that is much larger than currently available to small Welsh-style credit unions. How can this be achieved? This is where national and local government needs to play a part and where the concept of money flow needs to be understood.
To illustrate how a credit union can be capitalised so that it can afford to be managed professionally and have sufficient funds to lend on a business scale, let us look at the following – highly simplified – example. In America, it is often a condition of employment for federal or state employees to have a credit union account in addition to their ordinary high street bank account.
A large institution, such as a health authority or police force, will have a monthly payroll in the order of many millions of dollars. This payroll is paid into an employee’s credit union account. Before the employee can withdraw this money the union has sight and nominal use of this money. As a result it has funds to the tune of hundreds of millions of dollars regularly channelled through its systems each and every month. Money can be earned from this money flow and contributes to the credit union’s lending fund availability. Over the past year 14 per cent of Americans have moved their bank accounts to credit unions.
The other side of the coin is the turnover-based model for business lending. Assuming that a credit union is sufficiently capitalised by money flow from institutional payrolls, it then has a fund to lend to businesses. The business asks for a loan for whatever business purpose (in rural areas for instance it may be a farmer buying seed against a future crop). A condition of the loan is that the business turnover must be passed through the credit union. This requirement enables the borrower to benefit from favourable and structured repayment agreements geared to turnover. Meanwhile, the lender can monitor the financial performance of the business and the day-to-day risk involved.
The financial model provided by US credit unions has made an important contribution to the astounding success of the area in North Carolina known as the Research Triangle Park. Some 30 years ago this area, incidentally the size of Carmarthenshire, was a huge snake-ridden swamp containing legions of insects, flotillas of monster large-mouthed bass and populated by a few banjo playing, gun-toting residents who would not have been out of place in the cast of the movie Deliverance!
Today, this small area generates more wealth and GDP than the entire economy of Wales. In Wales we should study this model. Federal and State governments seeded the area, with their institutions channelling payrolls through the local credit unions. These developments required roads and basic infrastructure to be built across the swamp, and helped set up a business environment that has led to a transformation from wilderness to economic powerhouse in just three decades.
All it needs is for just one Welsh county council to pass its payroll through one properly constituted US-Style credit union to initiate a fundamental and beneficial change in Welsh business financing at the local level. Wales could be part of the quiet Move your Money revolution currently sweeping America. Instead of stringing the bankers up, people and businesses are bypassing Wall Street and Main Street and returning to financial systems that survived the great depression and are far more suited to their individual localities. Here is a model for Wales to follow.
This article first appeared in the summer 2010 issue of the IWA’s journal, Agenda