Britain’s struggling regional economies are long due a boost. The challenge now is how to deliver that through a form of progressive devolution. Well, there might be some seeds of inspiration from the structures which underpinned the start of our modern age.
The industrial revolution is often presented as a transformation in manufacturing practice. A celebration of steam, engineering and factory organisation. In truth though, it was also a revolution in finance.
The outpouring of creativity in the late 18th century required financial support from the establishment of Lloyds of London during the Restoration and its subsequent expansion. It needed the creation of the first merchant banks, provincial banks in the major cities (by 1784 there were over 100) and the first building society in 1775. Although centred on London, independent financial institutions were present in all the major population centres.
By the 1920s, however, the contours of today’s banking system were apparent, with a dominant big five and a marginalisation of other players. But there is an argument that a return to that previous model could make devolution work in the UK. In particular, the hope is that the creation of more local banks and financial institutions, similar to the Sparkassen movement in Germany, could revitalise regional investment.
It will not be a simple task. It is possible to legislate for a series of financial institutions with pre-defined boundaries, exemplified by the Credit Union Act 1979, but this leaves the policy effectively in the hands of central government. The creation of the Phoenix Fund in 1999 gave us Community Development Finance Institutions, or CDFIs, designed to support entrepreneurship in deprived areas across the UK, but these have struggled to reach sustainability. It was perhaps unsurprising when the coalition government moved away from regional solutions and launched the British Business Bank in 2012, which in turn launched the Northern Powerhouse Investment Fund in 2015 to support smaller businesses across the region.
What this exposes is that centrally regulated financial institutions will always be at risk of national capture. By contrast the two most prominent federalised nations – Germany and the US – operate a dual banking system. In reality this meant banking oversight and regulation was conducted at both a state and national level. So, are there blueprints here for Britain?
Despite similarities in the US and Germany, the German approach has been more consensual between the different levels of the state and is known as cooperative federalism. In the US, the constitution’s silence on banking has resulted in a contest for primacy between the state and federal level, hence it is known as competitive federalism.
Sparkassen are savings and cooperative banks, not dissimilar to building societies or the TSB and the Co-op Bank. The main difference is that while the building societies concentrated on mortgage credit – and until 1979 were prevented from law from offering a wider-range of banking services – the Sparkassen were also involved in local economic development.
Crucially, they worked with the state Landesbanken for strategic funding to help businesses within their area. Their rootedness in community, which is defined in law, ensures they are embedded in their area’s mittelstand – those icons of German small business prosperity – which facilitates patient capital investment. Following the 2008 financial crisis, the Sparkassen maintained their investment levels in smaller companies while other financial institutions in Germany were withdrawing credit. This is the kind of behaviour which keeps regional success stories successful.
By contrast in the UK, banks place greater emphasis on responding to market sentiment. That results in higher levels of short-term lending to businesses. This also means decisions are made for the good of the bank that may negatively impact on a specific community, with no local banking infrastructure in place to pick up the slack. The German model relies on banking regulation that restricts competition and the culture of a strong savings and anti-borrowing bias among the population, something which UK banking culture and conditions have served to dampen in Britain.
So, perhaps there is a better model in the US? Here, competitive federalism has enabled state legislatures to carve out the space to support local strategic businesses. They are also able, when necessary, to underpin struggling institutions.
Even today, with the pressure of consolidation and internationalisation of banking services, the US is home to over 4,000 community banks dedicated to serving the very specific needs of their home cities and states. Alongside this, the federal government introduced legislation and regulation to ensure the robustness of the banks and to protect consumers. Most significantly the Community Reinvestment Act 1977 sought to tackle racism in lending practices by forcing banks to publicly disclose their loans on a zip code basis. Not only have the banks changed their behaviour, the evidence of under-served markets has provided the impetus for the new generation of community development financial institutions dedicated to local economic development of some of America’s poorest communities and groups.
Hoping for a crisis
Although effective in enabling local economic development neither the German or American models can be easily transplanted to the UK. The societal and cultural differences shouldn’t be underestimated. Even if these can be overcome, policymakers still have to define the nature of federalism in Britain.
Of course a UK government can allow the devolved authorities to establish banking services, but this would be within parameters set by City watchdog the FCA and so subject to national oversight and ultimately control. If a regional bank in England drifted too far from national objectives it would always be at risk of being pulled back into line by the regulator and the Treasury.
A genuine form of federalism would require the UK government to surrender and transfer some responsibilities for the regulation of regional agencies. Given the historically centralised nature of the UK and the weakness of local government in this area, this would seem a highly unlikely outcome. But one lesson from Germany and the US is that this often comes about in response to crisis. One can imagine the FCA refusing to rescue one of the banks based in Scotland that the Scottish government would consider essential for the Scottish economy. The ensuing tussle between Edinburgh and Westminster could force the regulatory changes we would need.