To mark the publication of I.O.U.K.: banking failure and how to build a fit financial sectornef‘s new report on banking – the nef triple crunch blog is staging a debate. Sargon Nissan, one of the authors of the report, kicks things off. Replies from our special guest bloggers will be posted below.

Banking unfit for purpose

Bookmark and ShareSargon Nissan is a researcher in nef‘s Access to Finance team.

When Lord Mandelson said, last November, ‘It’s completely unacceptable to the Government and to business in this country for banks indefinitely to stop functioning as banks.’, he inadvertently revealed policy makers’ confusion over what to do amidst this unprecedented crisis of banks and the financial system.

They’ve recogI.O.U.K.: The failure of banks and how to build a fit financial sectornised banks have stopped functioning (who hasn’t?) but not that they’ve become unfit for purpose.

Our banks have become far removed from their roots as lenders and investors in communities and businesses, as we reveal in our new report, I.O.U.K.: banking failure and how to build a fit financial sector. Decades of banking sector consolidation have been encouraged by lax regulation. There are now fewer bank branches than post offices in this country – and the number is set to drop still further. Meanwhile, Community Development Finance Institutions (CDFIs) have been starved of support while attempting to address this failure directly.

Increasingly desperate Government bailouts – witness Monday’s £260 billion underwriting of Lloyds and Barclays now reportedly ‘mulling’ the Treasury’s offer to underwrite its toxic assets –  are having little effect bar robbing the taxpayer.

The Government is throwing good money after bad.

Now the Government has scrapped the scheme it previously used to support lending to small businesses in favour of a £1 billion Enterprise Finance Guarantee – geared towards helping big banks lend to larger companies.,

Banks need to be broken up and re-focused on supporting small businesses and local communities. These are the motors of recovery from recession; small businesses alone provide 59% of private sector jobs.

Two case studies in the report reveal why banks are unfit for the purpose of lending to small businesses and supporting local economies. In the case of Eco-Logic, banks’ strategic emphasis on bigger businesses threatened their growth. Aston Reinvestment Trust (ART), a CDFI based in Birmingham, was able to see what the banks could not: here was a viable company with important links to the local economy.

In Devon, Blue Seafood was under threat of bankruptcy because a local bank manager was over-ruled on a loan approval. Head office was desperate to repair the damage of reckless lending and reined in even good loans, pulling the plug on Blue Seafood. The business was saved only when a consortium of CDFIs, including Wessex Reinvestment Trust, recognised the value of such a business to the local community.

Banks are not geared to supporting key components of our economy. Previously they neglected our crucial small businesses because they were seeking super-profits via speculation on financial markets. Now banks neglect the lending needed to kick-start the economy by hoarding the cash provided to them by the taxpayer. The real meaning of Lord Mandelson’s comment was that banks are using public money to act in their own interest but at the economy’s expense.

Policy makers do not seem to have learned any lessons. Quantitative easing seems to be another brilliant wheeze for banks to take our money cheaply and then lend it back to us far more expensively.

Apart from reforming the Enterprise Finance Guarantee to make it more useful for CDFIs and small businesses, a grant scheme to support CDFIs, credit unions and local investment should be implemented. It could be modelled on the US Treasury’s CDFI Fund which has dispersed over $800 million dollars in fifteen years.

Attempting to return to business as usual is pointless, that is what got us here in the first place. To get a fit banking system we need to de-merge banks that became too big to fail. That would mean a diverse banking sector, with banks exposed to different sectors and regions and more able to support the local economy.

Government continues to shower these failing institutions with public money. It needs to think about what that money is for: saving banks or saving the economy?

Why it’s time to support Britain’s hidden lenders

Bernie Morgan is Chief Executive of the Community Development Finance Association.

It is good to see nef championing community development finance institutions (CDFIs). The Government and other stakeholders must also recognise the vital role they can play during the financial crisis and beyond.

CDFIs provide loans and support to people, businesses and social enterprises that cannot access mainstream finance. Unlike high street banks, they don’t operate to maximise commercial returns; they recycle their finance into their communities. And they maintain the kind of close personal relationship with their customers that is lacking from modern banking. Our 75 members – the majority of CDFIs in the UK – have created or sustained more than 86,000 jobs since 2003.

Now is the time for Government to turn to CDFIs. Its efforts to unlock credit from the banks have so far had limited success. If a fraction of that public money were directed to CDFIs, it would very quickly be used to provide finance in deprived areas. It would not be a bailout but an investment, with a guaranteed social return.

CDFIs are the UK’s hidden lenders. They must not remain hidden any longer.

Supporting small business with appropriate finance

Paul Sander-Jackson is Executive Director of the Wessex Reinvestment Trust.

We are seeing many businesses that need finance to support growth – or to replace vulnerable debt finance such as overdrafts.

Many of them meet the crucial criteria of contributing to the development of a low carbon local economy . Examples from just this week – a community run shop, a locally sourced healthy school meals service, a low carbon sawmill operation . These businesses should be the cornerstone of local investment.

But the Government seems to have lost serious interest in CDFI’s – having supported their development in the short term in the early 2000’s. The delegation of responsibility to the Regional Development Agencies has had patchy results, and in some areas the consequences have been little short of disastrous. The SWRDA has not assisted CDFI’s with any capital for lending since it took over responsibility.

And we should not be diverted by the “sustainable in three years” argument. There is a reason that banks don’t lend to the CDFI client group – transaction size is frequently too small to be economical, and risks don’t meet their lending criteria for banking services – ironic in light of the toxic risks from their investment banking arms, and trivial in comparison to that exposure. If CDFI’s are to do their job, and serve the market they were designed for, they need specific underwriting of their risk.

Wessex feels that we cannot afford to wait. We need to take the lead in developing and resourcing local community banking infrastructure that can offer re-investment potential for local enterprise funding, raising that investment from individuals , local business. Alongside this we need to enable the direct flow of local investment into enterprises and assets – like affordable housing, renewable energy, community shops, workspace and land for local food growing. This does not absolve the public sector from a need to support this provision, but hopefully it will be shamed into at least matching that locally raised investment.

A much needed starting point

Dr Steve Walker is Chief Executive of the ART (Aston Reinvestment Trust).

I.O.U.K. is a much-needed starting point for action to offer real help to small businesses. It’s time the government recognised that whatever they do to assist the banking sector, it will not translate into increased support for start-up and smaller businesses.

Community finance evolved to address banks’ withdrawal from more disadvantaged areas of the UK and what they considered to be riskier smaller business loans. Government-backed policy support was planned to be long term. Yet, just when it is needed more than ever, funding is under threat and there seems to be a lack of national support to the sector, especially promotion. The sector is designed to complement the banks and only go where they are unable or unwilling to go in terms of cost and risk. It is ideally placed to help with the current economic situation.

If Government channels targeted funding through Regional Development Agencies (RDAs) to CDFIs and other alternative providers, support is more likely to reach where it is most needed

Each RDA can decide on delivery based on local knowledge and priorities – but support for a common offer of loans up to £50,000 in line with the business support simplification programme should be the beginning. The sector needs a consistent universal offer to realise its full potential.

I agree we can pick up the better ideas that work in the U.S. We can take the best of the Community Reinvestment Act which compels banks to work with CDFIs – at minimum through referring cases where they are unable to help to someone who can. This will hopefully encourage people to re-approach the banks, as far too many would-be entrepreneurs and small business owners are becoming both bank- and risk-averse. This does little to help the UK recovery.