Municipal Banks? Or Municipal Banking?

The Chris Cook Economics 3.0 column

Municipal Banks? Or Municipal Banking? After the Lehman insolvency in September 2008 there was a brief flurry of interest in the possibility of municipal banks being set up in the UK, and apparently both Birmingham and Essex County Councils remain interested, albeit their proposals have stalled for differing reasons. In Scotland, Municipal Banks never went away, and five still remain: North Lanarkshire, West Lothian, North Ayrshire, Clydebank, and East Dunbartonshire.

Municipal Banks are extremely limited in their operations and may not offer services to individuals other than to pay interest on deposits, which are typically those of council employees and pensioners. They can’t lend to individuals – as a Credit Union may – and while they may technically lend to virtually any type of organisation, in practice, the Treasurers of the relevant Council are the sole customer and use their captive Banks as a source of reasonably cheap funding.

Municipal Banks, like Credit Unions, essentially do what everybody thinks commercial banks do – they take in deposits and lend a matching amount to borrowers. But if you think about it, if that were all that commercial banks did, then there could not be any new money. Commercial banks are therefore known as Credit Institutions who have the privilege of creating credit on the base of an amount of regulatory capital prescribed by the Bank of International Settlements in Basel.

Such credit creation is now increasingly scarce and expensive, and this is the business that Councils really need to enter in order to adequately stimulate the local economy. As Ellen Brown points out today in the Huffington Post, this is not only possible but has been going on in North Dakota for 90 years to the great benefit of the citizens of that State.

However, public sector credit creation is unacceptable for politically dogmatic reasons, and no change to banking legislation would be likely against the organised resistance of the banking industry against “unfair” municipal competition – to wit, the freedom from paying returns to rentier shareholders.

Introducing the Guarantee Society

My concept of a “Guarantee Society” was introduced by the Scottish LibDems in March 2004 in order to solve the problem faced by small businesses in meeting public sector procurement criteria.

It essentially allows businesses to mutually guarantee their collective performance, supported by provisions made into a suitable fund, insurance, or both. The policy appears tohave fallen by the wayside, although there is increasing evidence that the major firms with whom Councils are prepared to engage are now routinely engaging in “subbie-bashing” and imposing upon sub-contractors delayed payment, spurious claims to avoid payment, or both.

Be that as it may, it is in fact quite straightforward for such a collective guarantee to be extended to credit provided to Guarantee Society members. This occurs routinely on the continent in respect of bank loans : the European Mutual Guarantee Association membership extends to 17 countries across Europe.

Peer to Peer Credit

The innovation I propose is to extend collective guarantees to the interest-free trade credit provided directly by trade sellers to buyers as ‘time to pay’. While this credit is interest-free, both the seller and the buyer will make a provision into a default fund, which would be held by a Municipal Bank as a Custodian.

This guaranteed trade credit may be settled in conventional money, but there is also the possibility of alternative forms of settlement whereby the seller may agree to accept all or part of the balance in money’s worth (ie barter) from the buyer instead.

Service-Providers-Formerly-Known-As-Banks

In North Dakota, the State owned bank works in partnership with local banks, and the form of municipal banking I advocate would be little different. Service providers are necessary to set and maintain “Guarantee Limits” for both sellers and buyers; maintain accounting records; monitor the system; and handle defaults in accordance with the Guarantee Society’s policies.

This is of course a classic banking role, the only difference being that the bank no longer puts its capital at risk by creating credit based upon it, but instead acts for a fee as a service provider managing the bilateral creation of credit among the membership which is supported by a pool of funds in common ownership.

Municipal Banking

The Guarantee Society model described may be straightforwardly achieved by using the simple but infinitely flexible UK Limited Liability Partnership as a framework for the guarantee, with any funds being held by Municipal Banks as Custodians and conventional banks or credit unions acting as service providers.

The outcome will be to enable the credit necessary for the circulation of goods and services, and for the creation of productive assets, to be simply created “at cost” without the payment of unnecessary returns to rentier shareholders. Investment, and long term funding of productive assets, such as affordable housing, or municipal infrastructure, is another story, and represents another opportunity for banks to reinvent themselves.