Wanted: alternative banking system

Nationalising the banks is a a good first step - but then what? What would a genuine people's bank be like? Sargon Nissan of the New Economics Foundation looks at local, international and historical experience to find answers

May 21, 2009 · 13 min read

The global scale of the current crisis represents a novel problem for civil society and NGOs which have challenged the dominant form of globalisation. To prevent a return to business as usual, civil society efforts against financial liberalisation internationally must now find common cause with the grass-roots movement of local investment and financial alternatives on their doorstep and together capture the collective imagination about what went wrong and what needs to be done.

In the UK, financial alternatives to failed banks include non-profit models of local lending and banking such as credit unions and community development finance institutions (CDFIs), modelled on Southern microfinance as lenders to individuals and small businesses in disadvantaged communities. They also include more familiar entities such as the Post Office and mutual building societies that have endured despite political hostility and regulatory neglect. The significance of these varied institutions is not simply due to their value as an alternative to a financial monoculture that built banks supposedly too big to fail; it is in their ability to point to a future financial system that serves people’s needs rather than returns to business as usual.

Deregulation and de-mutualisation

The variety of local finance institutions in the UK are partly a response to the way liberalisation has played out. As the political tide turned in the 1980s, the financial sector was a key arena to test Thatcherite principles of deregulation. American financial institutions were attracted to the City of London as a financial ‘Guantanamo Bay’, where practices not permitted in the US could be conducted.

The entry of new players triggered a wave of consolidation in the banking sector. Deregulation also helped to stimulate a housing boom and bust. Banks continued to merge and grow across borders, applying a one-size-fits-all approach, where that one size was invariably Extra Large.

In poorer communities across the UK, bank branches were shut down as costs were cut. Bank managers who had personal relationships with their borrowers became an anachronism and communities became disconnected from the wider economy as finance for their needs was channelled into speculation. This retrenchment means that the combined number of branches of every bank and building society in the country is now less than the post office branch network. The government recognised this problem when it convened the Social Investment Task Force in 2000 and instituted measures to tackle financial exclusion. Yet according to recent figures from the Treasury, 2.1 million people remain without access to a bank account in the UK.

Financial exclusion is the consequence of an unseemly race that emerged in the banking sector in the 1990s. Banks competed to re-focus their activities away from the tedium of orthodox banking and toward the profitable speculation of the City. Meanwhile people excluded from the credit bonanza were increasingly preyed upon by our very own equivalent of sub-prime lenders. The biggest, Provident Financial plc, calls its market niche ‘non-standard’ rather than sub-prime, while advertising an APR for personal credit of 189.2 per cent. While financial companies have had billions wiped off their share value or gone bankrupt, during 2008 Provident Financial plc’s share price rose, reflecting expectations that it will benefit from the exclusion the credit crunch has exacerbated.

The contorted logic of financial liberalisation is most clearly shown by what happened to the mutual sector, where building societies were encouraged to abandon their cooperative roots in search of greater profits. Thanks to their mutual model of ownership, in which depositors are also owners of the company, building societies operate a more conservative and local model of lending. The deregulation in the 1980s included the 1986 Building Societies Act, which sought to enable building societies and banks to encroach on each other’s business areas. Banks were keen to break into the booming mortgage finance sector that had been dominated by building societies.

Starting with Abbey National in 1989, one society after another sought to de-mutualise and become a plc in order to profit from borrowing more heavily and lending more aggressively. Members were enticed to vote for de-mutualisation by the offer of windfall payments. In 1997, £36 billion in cash and shares was paid out to members of de-mutualising societies, which eventually included both Northern Rock and Bradford & Bingley. Both are now bankrupt.

The 2006 inquiry by the all-party parliamentary group for building societies and financial mutuals found that this process had little benefit for customers and that windfall payments typically under-valued members’ stakes. Northern Rock had blithely insisted to the same inquiry that ‘its success over the [previous] eight years would not have been possible under the old mutual model’.

According to the Building Society Association, the period between 1995 and 2000 also saw a branch closure rate of 24.1 per cent by de-mutualised banks, as opposed to 2.4 per cent among societies that remained mutual.

Grass-roots alternatives

The reality of grass-roots alternative financial institutions in the UK remains modest. CDFIs account for less than £300 million in lending. Credit unions, which accept deposits and provide loans, account for just under £400 million in savings. Though they have received some public funds and policy backing, policymakers remain blind to the true potential of these initiatives.

In contrast, the United States has a community finance sector worth billions of dollars. Legislation such as the 1977 Community Reinvestment Act (CRA) ensured the involvement and support of mainstream finance for CDFIs. In the US, the CDFI sector includes local development banks, social venture capital, enterprise lenders and credit unions. Since 1994, over $800 million has been provided to the sector from federal funds, which have stimulated 27 times that amount in matching private investment, according to the US Treasury.

President Obama’s stimulus package includes $100 million to the sector, not to bail out failures but in recognition of community finance’s capacity to counter exclusion and stimulate the economy. Despite some recent claims to the contrary, poorer housebuyers and homeowners borrowing under CRA agreements have been far less likely to default than the packaged-up sub-prime mortgages that are now worthless and were often designed to avoid scrutiny under CRA requirements.

International dimension

The international dimension of financial globalisation is, if anything, even more in thrall to the perverse logic of globalisation. The implication for poorer countries and their citizens is correspondingly graver. Despite the origins of the current crisis and regardless of high-profile cases such as Iceland, it is developing countries that are most vulnerable. The International Institute of Finance predicts that investment flows to developing countries will collapse in 2009 to $165 billion from a high of almost $1 trillion in 2007. The costs of borrowing are also rising disproportionately for developing countries as investors become increasingly risk averse and seek to retract their capital. This puts these countries at risk of currency and banking crises that would send them back into the clutches of the International Monetary Fund and the World Bank.

Despite the clear lessons of the crisis, multilateral agreements and the Bretton Woods institutions of the World Bank and IMF seem oblivious to the need to reform the process of liberalisation. The recent meeting in Doha saw the US and EU renew their efforts to push through the General Agreement on Trade and Services (GATS) without accepting the need to challenge its imposition of greater financial liberalisation.

Other forums, such as the G8 and G20, lack the legitimacy of multilateral bodies but remain the crucible of global reform agreements. Looking beneath the surface shows that the prospect of genuine reform and inclusion of Southern countries is as distant as ever. One critical body determining international financial rules is the Financial Stability Forum. The FSF is not an official body but is supported by the G8 countries to shape international financial regulation policies of G8 members without any responsibility or accountability to other nations.

As all eyes turn to the meeting of the G20 nations to be hosted in London on 2 April, the idea that this global crisis summit should incorporate the concerns of every nation affected is effectively ignored. Roubini Global Economics estimates peak losses of up to $3.6 trillion dollars. Half of that loss is estimated to fall outside the US. Following the so-called Nixon shock in 1971, which ended the link between gold, the US dollar and global currencies, President Nixon’s treasury secretary toured finance ministries around the world to inform them that ‘it’s our currency but it’s your problem’. Little seems to have changed.

Bank of the South

One effort to alter this dynamic is the Bank of the South (Banco del Sur), proposed by Venezuela and Argentina to replace the role of the World Bank in Latin America. It is an explicit challenge to the one-size-fits-all neoliberal model. It reflects a similar conceptual challenge as mutuals do to the idea that the evolution of banking and finance inevitably leads to a system of consolidated, profit-seeking international behemoths.

The Banco del Sur is an attempt at financial regionalisation proposed on the basis of one member one vote, unlike the governance models of the World Bank and IMF, which operate under a US veto and privilege the richest countries. Nevertheless, efforts are being made to model the Banco del Sur on the Bretton Woods institutions rather than on a cooperative principle, implying that what is needed is merely a technical improvement rather than a political challenge to the dominance of Washington-based institutions and their philosophy.

As outrage at banking practices grows, civil society needs to demonstrate that the perversity of rewarding bankers’ recklessness and greed at taxpayers’ expense is no more bizarre than the terms of IMF bailouts and loan conditionality. Through the imposition of severe restraints on social spending to pay off reckless international lenders (who often lent to undemocratic regimes), internationally it is the poorest who have been subsidising the global finance industry’s errors for decades, not just in the wake of the credit crunch. Exclusion and politically-sanctioned abandonment of marginalised communities in the name of free-market competition has direct parallels to the one-sided multilateral agreements made in the name of ‘free’ trade in financial services.

Transferring to the Co-op

The need to create a new shared identity in opposition to financial globalisation, incorporating the impact on social exclusion and inequality in industrialised countries, is reflected in the fortunes of both the Co-operative Bank and the euphemistically titled ‘non-standard’ lenders such as Provident Financial.

Investors looking to profit from the crisis have bought Provident Financial shares. However, depositors with the Co-operative Bank have also benefited from record levels of new customers transferring their accounts to the Co-op.

In 2008 this increased at a rate of 65 per cent. While most banks are panicking over how to rebuild their capital, the Co-operative Bank has increased its personal deposits from £2.7 billion to £3.8 billion. Business lending, generally retracting due to banks’ nervousness, has grown and is expanding across the UK. Meanwhile government ministers publicly beg the bailed-out high street banks to re-start lending to businesses.

The positive fortunes of two such different companies sit in stark contrast to the £1.5 trillion liability to underwrite the banking sector that the government has just announced. It also reveals the indeterminate future of the financial system and its impact on the economy and society. As the Co-op demonstrates, cautious banking based on traditional virtues with a strong social ethic can beat the financial giants on their own terms.

Yet the policy world remains committed to returning to business as usual – but with years of ballooning deficits that will hinder any recovery. This heightens the likelihood of greater exclusion and more communities unable to participate fully in the UK economy. It also suggests that the resurgence in the relevance of Bretton Woods institutions will not come with reforms to governance and policy approaches that have failed developing nations so badly.

Forging a new financial system

What has not been properly contemplated is the prospect, and possible inevitability, of wholesale nationalisation and what that would mean for forging a new financial system built to be transparent, stable and equitable. There is little chance of the toxic assets banks hold recovering in time to salvage their businesses. Those banks will be insolvent and nationalisation becomes unavoidable, as in Northern Rock’s case. Debate has focused on how to achieve an outcome that could allow governments to minimise the time they own banks or avoid it altogether. Sweden’s response to financial crisis in the early 1990s has been taken as a model for the temporary nationalisation of insolvent banks in order to separate the toxic assets and re-privatise the rump of a viable firm.

Instead of taking a similar approach in order to return to business as usual, governments should be pressed to separate the banks from each other’s embrace, not just from their toxic investments. In the wake of the Great Depression in the 1930s, President Roosevelt enacted the Glass-Steagall Act, which separated investment banks from retail outfits. The Banco del Sur, grass-roots finance models and the consequences of a single model of globalisation show the need for diversity in both the scale of banks’ operations and in their functions.

The Glass-Steagall Act was repealed in 1997, a decision repeatedly blamed for contributing to the current crisis by allowing over-consolidation and conflicts of interests to fester in the banking sector. However the successful assault on the legislation was achieved not simply through friendly senators and banks’ closeness to the White House. The operation of unaccountable and deregulated financial centres overseas, not least including the City of London, had fatally undermined the usefulness of such regulation by allowing US banks to bypass the law abroad.

Policymakers need to grasp the nettle by nationalising and de-merging the banking sector. A finite period of public stewardship will be a failure if the opportunity to de-merge over-consolidated and conflicted banks is not taken. Complex cross-border holdings, and the demise of Glass-Steagall in the US, necessitate that such an approach be part of a multilateral process but it can start at home by re-specifying the role of high street lenders.

The point of finance alternatives, including grass-roots models, building societies and even postal banks, is that they are an attempt to re-assert local and democratic sovereignty over economic decisions. Local financial innovations do not represent a panacea and in some respects reflect coping strategies necessitated by the impact of liberalisation. Their diversity is more akin to an ecology that permits different solutions to prosper according to different local, national or international needs as opposed to the imposition of a self-serving and rapacious monoculture.

The time has come to re-assert the shared interest of citizens in rich and poor countries alike. The G20 meeting is already the focus of huge interest. Advocacy must incorporate the understanding that it is not simply a moral question or philanthropic impulses that connect us to the concerns of those in poorer countries. The endurance of alternative financial institutions represents a wealth of solutions shaped to address the common problems caused by a dominant financial sector that serves nobody’s needs but its own.

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