The future of co-operative and mutual banking is keeping it local

The future of banking will be fundamentally different to both the past and present incarnations. While the focus at present is on regulatory and structural reform, stress testing...

The future of banking will be fundamentally different to both the past and present incarnations. While the focus at present is on regulatory and structural reform, stress testing and business lending, the more transformative drivers of change are ones of innovation.

Innovation drivers in banking include the role of data, for example in pricing risk, and technology in services, allowing for disintermediation and direct contact (such as consumer to consumer, ‘peer to peer’ lending, or consumer to business, debt (loan) or equity ‘crowd funding’) in a context where the traditional role of banks has been as an intermediary. In this context, customer-owned models ought to be well placed to understand and respond to changing customer demands. So, where might this lead to mutual innovation and where is the member-owned co-operative form well suited to the trends in hand?

One answer is that the future is local

Co-operatives have a competitive advantage in the provision of loans, because they do not have to provide a return to outside shareholders. It is that advantage that saw the steady progress and the formation of many large mutual building societies, which had grown by accumulating surpluses over the long term. It is not clear now that the same strategy is possible.

Retaining and accumulating surplus on the same scale as before demutualisation would take a very long time. Doing so at the same time as competing with the big banks is also less feasible as long as those banks are able to chase speculative returns with the implicit underwriting of the taxpayer – and so earn high returns with low risk. Where there are large-scale mutual financial institutions, such as Nationwide and a number of other building societies, they can also compete on other advantages of the mutual model – being well-placed to carry consumer trust and to understand and respond to changing customer need. For new mutuals, though, the opportunities seem stronger in the field of more localised banking.

There is an emerging body of work that points to the potential for a renewal of local banking. In part this reflects frustrations with the UK banking market, which, with honourable exceptions, including building societies and credit unions, has long been more centralised than many other countries.

In part, it reflects a more recent combination of policy change, which has focused on reducing barriers to entry in the market, and technology innovation in the form of the concept of a ‘bank in the box’. The bank in a box approach packages a set of services that are compliant in terms of regulation and adaptable for local use without incurring the development costs that would otherwise have been the case and thus reducing the cost of entry into the banking market.

These services, typically software based, allow the local bank to put their own wrapper on a service, whether banking products, card management or back office functions, such as cheque processing. With lower costs of set up for the basic infrastructure, the local bank can then focus on creating value through its distinctive marketing reach as a place for local deposits reinvested at a local level. In that context, mutuality would seem to be an advantage, as it removes the cost of external shareholders and builds in a local responsiveness and accountability that dovetails with the essential proposition.

This would be even more so if the bank in a box services were themselves constructed as a secondary mutual for the local banks, which comes close to the expansion plans and ideas that the credit union association Abcul has started to develop for its members. There are still the upfront capital costs to start with, but there are routes towards this, whether it is existing organisations that see the potential to add deposit taking to their services, community development finance initiatives that grow to scale or new banks set up with support from local authorities.

The Hampshire Community Bank, which Professor Richard Werner of the University of Southampton has spearheaded the development of, for example, has seed funding from public sector sources, with an intention of focusing on enterprise lending and energy efficiency, and plans to expand into community based retail banking by offering services to local households using back office technology provided by the German savings bank network. The opportunity, as he sees it, is to open up to mutual membership from the Solent region, and to build a mutual network of local banks, drawing on the support from local municipalities in Hampshire and neighbouring counties.

There is scope for intelligent policy action to make this approach somewhat less challenging. In Germany, the KfW state bank provides annual funding support to the small banks as part of the government’s annual budget. This takes the form of subsidised liquidity funding which enables the cooperative and community banks to compete with their larger competitors. When the UK government introduced the temporary “Funding for Lending” scheme, it was only utilised by the big five banks, which have used it as a source of cheap funding. The rules were too complicated and the restrictions too great to have any value to smaller operators in the banking market – but this does not have to be the case and indeed as the scheme has matured it was been increasingly utilised by building societies.

Local banking doesn’t have to be limited to deposit-taking

It could be co-operative currencies. The WIR (the ring) complementary currency system was set up in Switzerland 1934 by Werner Zimmerman and Paul Enz, as a creative way to provide low-cost inter-trading and mutual credit for enterprises. Now a full co-operative bank, the WIR’s success has proved to be enduring. Today this economic trading circle of members provide finance of $2 billion annually for over 75,000 small businesses, based on an interest-free savings-and-loan system aimed at helping its members secure mutual credit at fee rates of 1.5% to 2.5%. More recently the WIR mutual credit model has been introduced in Belgium.

As Pat Conaty, a Co-operatives UK associate, reports, “members includes both businesses, voluntary organisations and consumers.This has provided a solid platform for rapid expansion and RES today has 5,000 business members and 100,000 plus consumer members in the co-operative money system which operates as both a co-operative bank and a co-operative marketplace. The co-operative currency is only electronic, based on debit cards/mobile phones, linked to the Euro and turnover has reached 35 million Euro equivalent.” It is not just banking which can be effective by being mutually-owned, it is, by degrees, the whole small business sector.

It could be local stock markets

As with local banks, the idea of mutual stock markets may sound like it is back to the past rather than the future. After all, at one point most stock markets were organised essentially as MFIs. They were associations of enterprises who would agree to abide by common rules in order to establish a platform for trading and investment. The arrival of the stock market as a separate investor-owned company came much later. But if it is a good idea that allows for trust and mutual action, then it may be an enduring idea that will come back in new forms. At present, the clearest disruptive innovation in financial services is the upstart field of ‘peer to peer’ finance. It is these new models that, as they move out of the market niche of early adopters, might turn to electronic platforms to match what the incumbents enjoy, for all that they may be disliked, which is sufficient trust among mainstream consumers that things won’t go wrong. A pioneer for this may be the initiative ETHEX, which offers itself as an exchange for direct ethical investments, such as bond issues, alongside the Microgenius site, established by Co-operatives UK and Locality, which supports growing numbers of peer to peer equity raising in the form of  ‘community shares’.

It could utilise local guarantees

In other countries in Europe, there are consortia co-operatives of small businesses for finance, operating through the use of guarantees. Working together, they can then negotiate a better deal from banks, while for the banks the underpinning of the co-operative guarantee provides partial security on otherwise unsecured enterprise lending. The risk is lower, so the price of money is lower. The deal flow is greater, and underpinned by peer review from small entrepreneurs, so access to capital is easier. Alongside this are the potential of technology platforms for peer to peer finance, which serve to reduce the barriers to participation. While, to date, these work on a point-to-point rather than a reciprocal, mutual basis, the underlying model is of relevance and could reduce the costs and timescales for growth that have faced continental guarantee societies over past decades.

But, it will also be mobile

It is sometimes said that banking and finance is as much, if not more, about data, as money. In reality it is of course about both, but we have entered the era of ‘Big Data’ and ‘social networking’ and mobile banking, using ‘banking apps’ on mobile ‘smart phones’ has the potential to replace cash and plastic cards at the centre of the retail (including ‘on-line’) payments systems.

As I noted earlier, traditional bank lending is increasingly competing with new providers of peer to peer lending and crowd financing and other related financial services (e.g. invoice discounting for small firms). The advantage of local banking and finance is access to local knowledge to better cater for the needs of local communities and enterprises; but ‘plain vanilla’ mass market services rely on large data sets to provide cheap payments services and basic access to credit and the like, where credit scoring may be appropriate.

Those financially excluded by the mainstream providers will ideally be able to turn to local mutual providers for access to finance, rather than ‘pay-day’ lenders. Peer to peer and crowd funding lending circles pursuing mutual and wider social objectives, as well as a financial return, could be formed through social networking technologies already in use. The increased uptake of mobile banking and payments is likely to further reduce reliance on cheques and bank branch usage.

Many older people, whilst they remain physically mobile, will still want to visit branches (and use cheques) and are less likely to adopt internet and mobile banking. As the sight and/or hearing of some people fades with age or health and they become less mobile, not only will visiting branches become more difficult, but so too will their ability to use computers and phones of any kind.

Local financial institutions should thus consider providing a ‘home banking’ service involving visits to older customers and ‘sweep accounts’ that ensure balances are not left to accumulate in low interest bearing accounts, but are instead automatically swept into higher interest bearing savings account, and back to the current accounts as bills become due, if needs be.

Banking, currencies, small business lending, stock exchanges: these are the innovations that could start local and aptly operate on a mutual basis. Give it time and a fair wind, rather than being marginal to the financial services market, they sound very much more like the next mainstream.

• This article is the final part of six. Read the previous five articles here. This series has been commissioned by Co-operatives UK in the run-up to ‘Co-operation: How?‘ – the 2014 participative Congress that is exploring the scope for a co-operative economy, from banking to farming.

 

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