Dan Bates: Capitalisation directions are not the only tool for rebuilding finances

Dan Bates argues deep seated problems are contributing to a rush for capitalisation directions.

For some time now we have been reading that a number of councils are in discussion with central government about capitalisation directions. Reports have suggested a dozen councils are talking to officials, though the chief executive of CIPFA recently told a MHCLG select committee there may be up to 20 councils for which there exist “concerns over poor execution”. Last week, the first four directions were published, the recipients being Bexley, Eastbourne, Luton and Peterborough. Speculation now turns to how many more (and which) authorities will be added to the list.

So, what is a capitalisation direction? Put simply it allows an authority to fund revenue expenditure from capital resources including capital receipts and borrowing, taking pressure off usable reserves and allowing the authority to swerve a section 114 notice and set a balanced budget. It comes with strings, however, and each of the authorities in receipt has to ensure that it pays off the capitilisation over the next twenty years, via MRP; submits to an external assurance review and pays a 1% premium on any borrowing from the government. It is hardly the “taxpayer bailout” or “emergency government funding” reported in the press.

Secretary of state Robert Jenrick has cited both “poor management” and the “exceptional events of the past year” as reasons for the support. It seems clear that some of the authorities (from the first four as well as those to follow) were struggling with financial health prior to the pandemic but others have been suffered severe shocks as a result of Covid-19.

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Luton, for example, has the 30th highest level of usable revenue reserves as a proportion of expenditure of 150 social care authorities but has a heavy reliance on its airport dividend. There are 17 district authorities with lower levels of usable reserves than Eastbourne but which do not rely so much on tourism-based income.

It is a mistake though to lay the blame for reduced financial resilience solely on the pandemic and isolated poor decision making. To do so would be to ignore the deep-seated issues that need to be grasped if many more capitalisation directions, or worse still, Section 114s are to be avoided. Let’s have a look at some of these.

Fair Funding

It has now been nine years since any proper assessment of needs and resources has been undertaken. Over that period, the quantum of funding has not only reduced significantly but its distribution has undoubtedly impacted on those authorities that have low levels of council tax income and have not done as well from business rates localisation and new homes bonus. The fact that these are often the same authorities that have high assessed needs is a double whammy.

Government has recognised this more lately and is aiming to “level up”. The most recent local government finance settlement does show some attempt to equalise but this is more “levelling off” than it is “levelling up”.

The fair funding review is now desperately needed to direct the finite government funding to those areas that have the greatest need as well reintroducing resource equalisation to provide a counterbalance to differential abilities to raise council tax. Alongside fairer funding, greater certainty will be achieved by the re-establishment of four-year settlements.

Social Care

Others can do a much better job of explaining the need for progress on health and social care reform. I will just add that from a financial resilience point of view, it is no coincidence that the two section 114s to date, and the majority of capitalisation directions, will be from authorities that, among other things, are trying to manage social care pressures.

Capital Health

Northamptonshire and Croydon issued section 114 notices at the point when there were insufficient usable revenue reserves to make up for their budget shortfalls. The depletion of these reserves is an effect though, the cause of which is a complex combination of policies, decisions, actions and external factors. In terms of capital health, both Northamptonshire and Croydon have the highest debt to asset ratio of their authority types and servicing high levels of debt has clearly added to revenue pressures.

Capital health is an under-developed area. It is not sufficient to simply look at external borrowing and interest expense as determinants of resilience but rather take a deeper dive into the mechanics of the capital financing requirement and its relationship with asset values and the equity shown in the unusable reserves on the balance sheet. I, for one, will take up CIPFA’s invitation to improve the prudential framework and will be suggesting wider ranging measures than are currently used.

Commercialisation

And finally, one of the most contentious and widely reported issues in local government finances is the issue of commercialisation and particularly commercial property acquisition. Blaming these activities for poor financial resilience, whilst perhaps convenient, would be inaccurate, just as it would be complacent to use the often-reported deals gone wrong as a proxy for all commercial activity.

A review of Croydon’s problems reveals that social care problems contributed to a worsening financial position over a number of years; poor commercial decisions hastened the section 114 notice.

But for each example of poor decision making, there are many more authorities which have taken a more responsible approach to commercialisation ensuring that decisions are backed by sound business cases, with appropriate levels of due diligence, governance and significant subsequent monitoring and management.

I would like to see the government acknowledge and support sound commercial decisions as a viable alternative to the management of decline given funding reductions. I would also like to see a prudential framework which incorporates commercialisation but does so appropriately, recognising, managing and minimising the increased risks so that councils can make commercial decisions which are prudent, affordable and sustainable.

As we await the next round of capitalisation directions, there is so much more that the sector and government can do to ensure that councils regain a secure and sustainable financial footing which will help them to contribute to an aim that we can all sign up to, which is to build back better.

Dan Bates is the finance specialist at Local Government Improve. He has particular interests in fair funding, local government financial resilience and capital health.
Twitter: @danbates_LGi

Photo by Scott Graham on Unsplash