Development banks for the local economy

Nick Harriss sets out the case for a new breed of financial institution – one that’s inclusive, locally owned and more tuned in to the needs of small business

The UK economy has suffered its worse downturn since the Great Depression and there appears to be little light at the end of the tunnel. The government has implemented a policy of austerity to avoid the difficulties faced by the likes of Greece and Ireland, while the US government, facing a similarly difficult economic environment has followed a policy of major fiscal and monetary stimulus; neither policy has proved successful in kick-starting recovery.

The reality is that the damage inflicted upon the financial system has created a millstone around the neck of economic recovery, and those areas and people with the most existing difficulties are being hit the hardest.

With the variety of macroeconomic measures failing to work, it is time to look at an alternative, one that focuses on the local level and builds from the bottom up rather than the current top-down approach. The core to this would be the establishment of a new style of locally owned and operated financial institutions that would recirculate the savings of the local community into creating locally owned and operated businesses, that in turn would create local jobs, the economic benefit of which would return to the local community.

The model is called Paraconomy (short for ‘parallel economy’) as it is designed to create a complementary economic and business system running side by side in a local area with the mainstream economy, not replace what already exists.

A different approach
Paraconomy recognises the current financial system has a number of strengths, but also identifies one of its key weaknesses; the financial system is far more global in its approach than most people who are looking for a home for their savings. For most individuals and small businesses, their economy is more local than global; they live, work, shop, trade and spend their leisure time predominantly in one town or city.

Paraconomy proposes the establishment of a new type of locally owned and operated mutual financial institution – called Development Trust Companies (DTCs) – to provide an alternative. It should be remembered that the UK financial sector has not always been dominated by the global giants with unaccountable shareholders and distant directors that exist today. Local building societies were prominent in most towns until the 1980s, as were local trustee savings banks until the 1970s. In addition, local co-operative societies provided a more direct channel for people to channel their savings into local businesses for over a century. Local banks can still be found across America.

DTCs would be different to the existing types of financial institution in a number of ways and would not simply be conventional retail banks owned and operated on a local basis. Instead, they would have a remit more akin to international development banks such as the World Bank and African Development Bank, but operating in a local economy. Although much of the criticism regarding high street banks for not lending to small business is justified, the standard funding model of these banks – that of using short-term deposits and wholesale borrowing to finance longer term loans to what are usually illiquid small business customers – is fundamentally flawed; the banks behave conservatively in order to avoid liquidity issues and to maintain regulatory capital ratios.

The whole business model that these banks work on is unsuited to lending to small business from the point of view of internal management, shareholder returns and regulatory oversight. In contrast, the DTC funding model will be more appropriate to the ‘development bank’ role. In the conventional economic system, small growth businesses are offered short-term loans, whereas what they really need is long-term growth capital; this is what the Paraconomy model will provide.

While it is easy and in many ways justified to criticise both the government (current and past) and the financial system for the economic difficulties we find ourselves in, we as individuals also have to take responsibility, both for the past and the future. If we want our local areas to develop, we have to play an active part. The DTC model is designed to ensure that everybody in the area can play a part, whatever their circumstances, and that everybody can benefit.

A catalyst for local business growth
The DTC would provide a structure for channelling local savings, external investment, local workers and the efforts of the broader community to develop job-creating, value-adding local businesses. These businesses would in turn be structured in a quasi-mutual fashion so that the entrepreneurs, workforce, capital providers and the community all received and equitable slice of the economic ‘pie’ created. As much as possible of the value added by the businesses would be retained within the local area.

The businesses the DTC invests into will receive significant managerial and administrative assistance from the DTC to ensure they are both able to grow their businesses without distraction and ensure any warning signs are identified before they become a problem. The management of these investments would always be conducted on a long-term basis.

Economic security for all
DTCs are not designed to attract short-term deposits in competition with existing banks, building societies, credit unions or National Savings. Instead they offer an opportunity for people to build their long-term savings by building a diversified exposure to a variety of local businesses. Friendly societies and industrial life assurance companies (e.g. Prudential, Co-operative Insurance and Pearl) historically provided an easy and convenient and simple way for the for people to build a capital sum over the long term, but changes to the financial services sector has seen them decline sharply. There is a greater variety of financial products available than ever, but the level of trust and satisfaction with them is at an all-time low. This in turn has contributed to people falling far short of providing for their retirement.

The DTC will provide a number of options for people to save over the medium to long term into a broad spread of local businesses. Although they vary in their risk/return profile, they are all based on the fundamental principles of long term, non-speculative investment into a diversified portfolio of local businesses with a quasi-mutual structure. It is also designed to bring the savers close to the businesses in which their money is put to use, not some distant multinational with which they have no connection.

Delivering quality jobs
Attracting and developing businesses is clearly the foundation of a programme of economic regeneration, but that only goes so far if the jobs created are low paying or temporary; long-term economic development of an area requires well-paying permanent jobs. The structure provided by the DTC is designed to foster such an approach, including a significant element of employee ownership, good pension provision and high levels of job security. At the same time it also delivers the flexibility and development that modern business requires; the DTC would provide the workforce to the individual businesses, with people moving between the different businesses as needed, and all employees being contracted to the DTC.

The DTC model is also designed to integrate those people currently on the periphery of the economic system into the mainstream. Economic exclusion has to date been seen as something that can only be addressed by public sector investment, but this model addresses the issue in a different fashion, not driven by electoral cycles and sound bites

The recent economic difficulties have had various contributing factors, but it is all too easy just to point the finger of blame at governments, banks and regulators; we can certainly learn lessons but in many ways they were the inevitable consequence of the globalised, free-market system that had been created. This is a system that has many benefits and the alternatives have all proved to have their own failings, but it is also clear that many people and locations can get left behind. The DTC system is designed to bring together those who are currently ‘losing out’ in such a way that this is no longer the case.

The businesses created and expanded would all operate within the normal market economy but their internal structure and financing would be designed to foster a more equitable and long-term approach to business and its risks and rewards than is currently the situation; this in turn should improve the economic position of the locality.


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