Geraint Talfan Davies urges Wales to push beyond the present consensus in favour of an investment bank

January 24th, 2013

A Labour Business Minister in the Welsh Government appoints a former Conservative candidate and academic to head a task force looking into business finance in Wales. Commendably ecumenical. Meanwhile, a Plaid Cymru Economic Commission is looking seriously at the prospects for creating a bank for Wales, an idea that has been floated in this column more than once (Here). The Welsh Conservatives are, too, promoting more local banking institutions. At the London end both Ed Miliband and Vince Cable are keen on a new investment bank, although George Osborne has been slow to come up with the necessary.

So, on the surface, one might think it possible to get a cross-party consensus on what needs to be done. Many will say, don’t hold our breath. But could it be different this time?

Consider this. A Bank of Wales has never been a nationalist enterprise. It was first conceived by a Labour-supporting entrepreneur, Sir Julian Hodge, with the overt backing of a Labour Prime Minister-to-be, Jim Callaghan. The deeds to the title of the now defunct bank are currently held in a drawer in Lloyds – effectively a nationalised bank – having been the victim of industrial consolidation: bought (and closed) by the Bank of Scotland, that then become HBOS before disappearing into Lloyds.

Edwina Hart, the Business Minister, Professor Dylan Jones-Evans, the task force chair and Adam Price, who heads Plaid’s Economic Commission, will have no shortage of reading matter on the issue. There have been countless reports in past decades on the lending gaps for SMEs.

One was authored by the former managing director of the private equity group 3i, Welshman Chris Rowlands. He studied the issue for Gordon Brown who, in 2009, promised to establish a Growth Capital Fund. The CBI has called for the re-creation of the Industrial and Commercial Finance Corporation that was set up after the Second World War. At the UK level last year a Small Business Task Force for the Labour Party, led by Nigel Doughty, chair of one of Europe’s largest venture capital groups, called for much the same thing, this time based on the model of the American Small Business Investment Company.

No-one disagrees that there is a need. Nothing seems to have been able to induce our current banks to raise their game and back British industry. What has been missing is urgency in building the right institutions, the proper scale in assessing the money needed and, thirdly, due attention to the spatial dimension of investment across the UK – the will to re-balance the UK economy by tackling areas outside the south east of England. The only person who can claim credit for addressing the last of these issues is Lord Heseltine, whose recent report aimed at England called for a massive decentralisation of funding to Local Enterprise Partnerships to “reverse a century of centralisation”. The applause from his own Government seemed muted.

Those seeking better, decentralised solutions will be cheered by the paper produced by Joe Cox for the Labour-aligned pressure group, Compass, on what Britain can learn from the German recovery, and particularly its first chapter on local banking.

Cox argues that “British banks aren’t just too big to fail, they’re too big to exist, or at least exist and function effectively”, and that this is “a fundamental reason why even part nationalised banks (RBS and Lloyds Banking group) are ill-equipped to fund SMEs. Lending and speculation based on computer models requires less expertise and fewer structural costs per transaction so universal banks are not incentivised to serve communities and business.”

The lesson he draws from German practice is that “Capital is embedded at a local level in over 400 public savings banks, known as Sparkassen, and 1,258 credit cooperatives operate according to local banking laws which ensure that these banks satisfy the credit demands of local business and pursue a business strategy that serves their geographical community.” This is in the form of a ‘public legal obligation’ Some have labelled the Sparkassen as ‘municipal mutualised banks’. They cannot be sold, and all surpluses are used to build financial buffers and to pursue wider social objectives. Their ‘dual bottom line’ means that they seek to make a profit, while satisfying the credit demands of local business. They also pay local corporate taxes.

In 2010 43 per cent of all loans to SMEs were provided by Sparkassen, whereas in 2002 our own Competition Commission found that 90 per cent of services to business were provided by the big four banks. That figure is almost certainly larger today.

In line with the conscious and beneficial tiering of banking in Germany, the Sparkassen exist not instead of but alongside a government-owned investment bank, KfW Bankengruppe, that has been in existence since 1948. Significantly, it is only 80 per cent owned by the federal government, with 20 per cent owned by the German regional governments, the Lander. The middle tier of Landesbank are linked to the Sparkassen.

The KfW is not unlike the Small Business Administration in the USA, the Business Development Canada and the Nordic Investment Bank set up in 1975 jointly to serve Sweden, Norway, Denmark, Iceland and Finland. The NIB’s total assets in 2011 stood at €24 billion, with outstanding loans of €14 billion for a block of counties of only 25 million people. Indeed, Britain is the only member of the G8 not to have a similar organisation. According to Cox, “KfW does not  pick winners, it provides an interest rate subsidy to commercial lenders who then deal direct with the borrowers.”

The KfW has an asset base of €442 billion and in 2010 made €28.6 billion available to German SMEs – most loans being for 10 years or even 20 years. This rather dwarfs  anything that George Osborne, or even Vince Cable, currently have in mind for this country. The Regional Growth Fund that operates across England has £2.6 billion at its disposal, while the Green Investment Bank is scheduled to have £3 billion available, although it will not have its full borrowing powers until 2015, and then only if public sector net debt is falling as a percentage of GDP. It is notable that while lending to business was falling in the UK, after the 2008 crisis Sparkassen lending to SMEs was increasing.

A consensus of a kind has emerged in the UK, but in classic British fashion it largely favours a centrally dominated institution with no local institutional roots and on a scale considerably smaller than the gravity of the situation demands. A World Bank report in 2003 found that the USA had 10,500 banks, Germany had 3,220 and the UK 452 – the UK figure will have included many London-based banks who do not operate at the retail end and often serve other parts of the world.

It is impossible, therefore, to argue that in the UK there is no space to create banks that have a regional focus. The issues should now be technical: defining the remit and the rules, the organisation and financial structures. We have already waited too long.

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Geraint Talfan Davies is Chair of the IWA.

4 Responses to:“Investment bank needs local Welsh roots”

  1. Peter D Cox says:

    One of the joys of no longer running a business is not having to deal with banks: on two occasions big four banks pulled funding just as the business was hitting its forecasts (getting out while the money is there, but breaking every moral contract); I ended up with finance from Handelsbanken (http://www.guardian.co.uk/business/2012/sep/14/handelsbanken-sweden-customers-first) who were a joy to deal with and as article explains, highly ethical.

    That there is still a need for what is proposed is so self-evident it doesn’t need a commission, just dial any SME in Wales at random. Friends in England recently spent 10 months – guided to two govt schemes as they were announced – negotiating a five year expansion plan that creates jobs. They gave up when the amount being offered was so small it was easier to ask friends.

    A local, ethically structured, community-owned investment and business bank is one of the ways in which Wales’ economy can jump ahead of England. Politicians would be mad not to seize this opportunity – but they don’t have great track record, do they?

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  2. A Banker Says says:

    I would like to echo GTD’s comments, especially those regarding the economy Minister’s broad-church approach to the enquiry into business funding and for that matter a number of other topics. Mrs Hart has confounded a lot of people by securing the support of the business community which has been particularly attracted by her willingness to listen and act decisively.

    It is a well known fact that the locally distributed market structure of the German banking sector, allied to a supportive long-term perspective has been hugely significant in sustaining its export focussed SME sector.

    But this approach provides just one road map for economic success. As anybody involved in a start-up with accelerated growth prospects knows – why bother talking to a bank. Too often you will have difficulty getting staff to understand your business and there is a strong possibility the only security you can offer is the equity in a personal property. Also debt is not the optimum form of capital for a start-up. Quite simply the cost of servicing it affectively amounts to a fixed cost during the pre-revenue phase. It is important to acknowledge that generally the primary purpose of a bank does not include the servicing of start-ups. This is especially important because all the data shows new and small firms as opposed to existing large firms are the most significant source of new jobs.

    Funding start-ups has traditionally been the role of risk-capitalists. It was the reason why the ICFC, which morphed into 3i, was originally founded. Sadly 3i gradually withdrew from its role as a VC institution to concentrate on the world of private equity. One only has to look at data published by the British Venture Capital Association to realise the flow of risk-bearing funds into start-ups has slowed down to a trickle. This is not an asset class that institutions want to back right now.

    So what is to be done? Well one possibility would be to look at North America to learn lessons from the pioneers of the risk capital industry such as Kleiner Perkins, Sequoia and Celtic House Investment Partners. One feature of these organisations is they were founded and staffed by engineers, by which I don’t mean those of the balance sheet variety. These people offer a unique insight into all the challenges facing would be entrepreneurs in the value creation process for the simple reason they had faced the same challenges themselves. Furthermore the objectives of the VC investment houses are strongly aligned with those of the founders. VC funders cannot afford to walk away when things get tough.

    So yes the Welsh economy does need more liquidity but it also needs to be a variety of debt and equity. I really hope Mr Jones-Evans’ task force does not become fixated by a narrow debt focussed approach. Finally as far as new banking institutions are concerned Wales is lucky to have Finance Wales, the data shows it is still investing. FW may require a few changes, a few seasoned entrepreneurs to compliment staff with a background in finance would be good, but let’s work with what exists. As for the prospects of creating a new Welsh banking institution I would hazard a guess there is a better chance of changing Goldman Sachs’ bonus culture than there is of convincing banking industry regulators to grant a new licence and raising the regulatory capital required under Basel 3.

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  3. John R. Walker says:

    Ironically, I was also going to suggest the Swedish Handelsbanken model of autonomous local management (up to certain financial limits after which they still have to pass funding requests up the line) as being a better model than most of the UK banks.

    But the article misses the point that the bulk of businesses in Wales are not SMEs but micro-businesses which arguably have even greater difficulty accessing affordable business development finance on terms which I would call ethical. Specifically the almost universal requirement of banks to take legal charges over the borrower’s home and the disproportionately high arrangement fees charged to furnish relatively small loans. The potential for GDP multiplication from micro-businesses is probably higher than from SMEs. If every micro-business could take on one employee the economy would be transformed but the banking industry seems to make it as difficult as they possibly can. Though it’s hardly a recent problem!

    This recent Stepwise survey suggests that the self-employed are drowning in personal debt – which means they are working to prop up unethical banks and fincos, not their own businesses and families.

    http://www.stepchange.org/Mediacentre/Pressreleases/selfemployeddebtproblems.aspx

    The same fate applies to many directors of small private companies and SMEs who are still required to provide ‘personal guarantees’ and/or to ‘sign over’ their homes despite the so-called benefit of limited liability. The banks seem to be bleeding the life out of businesses rather than contributing to their success… So I would seriously question whether YAB (yet another bank) is the solution unless it operates in ways totally alien to the banking industry and the other greedy fincos as we have come to know and despise them. And I doubt if the regulators would allow that – the growing burden of regulation is passed on to the customers anyway. And it certainly must not operate like WEFO – which has been a bureaucratic disaster.

    There are several other ways to fund business expansion which do not involve banks – though sadly they do usually involve the so-called credit reference agencies which seem to get almost as much wrong as they get right.

    My preferred borrowing solution now would be peer-to-peer (P2P) business finance where the banks and ‘the suits’ are simply excluded from the process. The market leading P2P business funding source is currently Funding Circle

    http://www.fundingcircle.com/

    but you can also access limited funds via Zopa and Ratesetter.

    I have been lending on P2P markets for some time and the system works. I would suggest that credit-worthy individuals and ‘small businesses’ would be better off doing their sums, with advice if they need it, and then they should seek the funding they need by pitching direct to other like-minded individuals rather than to bankers or, heaven forbid, to clueless public officials who have no experience of running a business, even though they may have had substantial budget responsibility within the public sector.

    There are other routes to private finance but the P2P route is just a few mouse clicks away to evaluate from your own perspective, and it gives you a degree of control you will seldom get from a bank. It is a particularly good way to borrow if you find you can repay ahead of time as it is penalty free to do so. It’s not right for everybody – but it’s worth looking at if the usual suspects have been giving you the corporate ‘blank stare’.

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  4. Robert I Chapman says:

    Geraint,

    I perused your article the instant it was issued but have been distracted by other priority matters since then to offer a contribution. At the time, I tweeted that I found it to be one of the most potent articles I had read for some time. Let me explain why?

    As I write, the news is alive today with yet another bank scandal: the miss-selling of interest rate swops. I guess this is part of the ongoing residual remnants of the Casino Economy http://www.iwa.org.uk/download/file/Agenda38_Economy_2.pdf which Professor Kevin Morgan so eloquently talked about in the IWA Summer agenda issue 2009. Kevin appositely suggested that banks should be ‘servants of their communities rather than masters of the universe’, and should value the importance of assets such as ‘local knowledge and community trust’. These are highly relevant to your article about ‘regionality’ or should I say banking subsidiarity!!

    Let me pause for breath for a moment before anyone gets the wrong impression. Yes, I understand the importance of financial services (and associated professional services) which make a contribution to the regional economies of the UK (see bullet points below) http://www.thecityuk.com/financial-services-in-the-uk/ – indeed, Cardiff happens to have the one and only Enterprise Zone in the UK dedicated to financial services
    • Over two million employed in the sector, two-thirds of them outside London.
    • Its 14.5% share of UK economic output.
    • Its £47.2bn trade surplus, larger than the combined surplus of all other net exporting industries in the UK.
    • Its £63bn tax contribution, larger than any other sector.
    However, as Kevin’s 2009 article suggests there is nothing to stop banks becoming ‘too big to fail’ again in the future. That is why the ‘localism’ thread in your article caught my imagination. I was thinking of Schumacher’s seminal book (‘Small is Beautiful: a study of economics as if people mattered’ http://en.wikipedia.org/wiki/Small_Is_Beautiful) and how local banks or local banking in the guise that you suggest (i.e. Sparkassen – a kind of municipal mutualised bank) could make a tangible difference in embedding capital at the local level because they would know: (i) the locality; (ii) the people and (iii) the cultural dimension. As you suggest, such a scenario could have a significant impact on the spatial dimension of investment across the UK, thereby addressing in part what regeneration practitioners know as ‘uneven development’. In particular, in Wales I could envisage such an arrangement making a tangible difference to lending to microbusiness and SMEs – the backbone of the Welsh economy. Decisions would be taken locally based on ‘local knowledge and community trust’, rather than decisions at a local level being taken by executives in the ‘out of touch’ South East. As per research by the New Economics Foundation, some would argue that this would help to plug the leaky bucket http://www.neweconomics.org/projects/plugging-leaks and would lead to greater resilience, a topic which deservedly is receiving much greater attention http://www.cardiff.ac.uk/cplan/research/economic-crisis/about-the-study Certainly, the search for a more sustainable banking model is now on the agenda, with recent research by McKinsey (January 2013) suggesting that banks must fundamentally transform their economics, businesses, and cultures to secure future growth http://www.mckinseyquarterly.com/Financial_Services/Banking/The_search_for_a_sustainable_banking_model_3045

    Your reference to the World Bank report in 2003, whilst dated, nevertheless underscores the paucity of the banking offer in the UK (the UK has the lowest number of banks), in comparison with the number of banks in other worldwide countries. The same is the case in Wales except that we do have Finance Wales: effectively a ‘ring-fenced’ but relatively autonomous arm or body of the Welsh Government. This organisation is attempting to address the issue of spatial investment here in Wales (and elsewhere). It is a model that is plugging the gap at the moment in the absence of proactive local lending based on decisions by local decision makers. Incidentally, my own experience of Finance Wales is positive despite the gripes I hear and read about. My own micro-business (1-9 EEs), a service company, was given a loan by Finance Wales in the early 2000s and this was a crucial lift up the ladder for our business at that time. The loan was paid back within a few years.

    More recently, as a member of the microbusiness task-and-finish group reporting to the Minister for Business on the development of a MicroBusiness Strategy for Wales, access to finance was identified as a key issue http://tinyurl.com/bvhxvos As a consequence, a £6M fund was made available to micro and small business via Finance Wales to overcome the challenge of accessing finance (see http://www.financewales.co.uk/what_we_do.aspx and http://www.walesonline.co.uk/business-in-wales/business-news/2012/03/01/minister-unveils-6m-fund-for-micro-business-91466-30435282/).

    Interestingly, as part of a wider debate on the function of a local bank, lessons from France suggest that investment in infrastructure has been boosted by public investment bank, the Caisse des Depots. Such banks employ experts who understand local circumstances and who can therefore make a tangible difference to the local economies. http://www.regen.net/news/1166338/Five-lessons-French-teach-British-planners/?DCMP=ILC-SEARCH – another reason then for a local investment bank.

    In conclusion, with the advent of devolution in Wales, there must be an opportunity to facilitate the creation of an Investment Bank for Wales, one which is perhaps similar to the German model (working alongside others) in that it would give strength and resilience to the local economy and the scope for sustainable economic development.

    Robert

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