‘Better governance and greater transparency’ could help improve financial decision making

Alison Ring writes ‘a restoration of trust’ is needed in the ability of local authorities to make the right decisions and to manage public money.

We’ve seen a number of councils getting into financial difficulties in the past few months, most notably Croydon which issued a section 114 notice in November. Other councils in England are said to be in similarly precarious situations, with many more reportedly in discussions with central government about how they can plug holes in their finances.

Action is needed to help councils repair their balance sheets so that they can continue to provide the essential services on which communities rely.

The coronavirus pandemic has driven a tornado-like path of financial destruction through local public finances. Councils have not only had to deal with people and businesses struggling to pay council tax and business rates respectively, but have seen a significant drop in other sources of income including from car parking, leisure centres, markets and commercial properties. Although additional funding has been provided to cover many of the incremental costs incurred, central government has limited the amount it has provided to replace lost income.

This follows a decade of austerity-era cuts in funding for local government that ate into reserves, saw cuts in services and made the sector more vulnerable to external pressures.

For some councils it will be touch and go as to whether they can make it to the end of the financial year without running out of money and having to issue a section 114 notice.

Funding model

Many of the emerging stories of councils in financial difficulties have featured governance concerns. It has been reported that councillors and management teams did not fully comprehend the financial situations they faced, and failed to understand the risks they took when making key financial decisions, such as the use of debt to finance investments in the property market.

It is important to stress that the strains in local authority finances have not just been driven by weak financial management. Councils have to contend with a funding model for local government that remains misaligned between income and expenditure, such as in a social care system that continues to place increased pressure on local taxpayers.

We hope that the long-awaited government review of social care funding will help address some of the pressure on local authority finances in addition to improving social care provision.

Similarly, the ongoing review into business rates not only needs to consider improving this tax, but also how it can provide a more reliable source of funding for local government.

It is perhaps not a surprise that many councils sought to diversify their sources of income over the past few years.The business cases for debt-financed investments in commercial property must have been very persuasive given how many councils chose to follow Spelthorne Borough Council along this path.

But investments—in the public and private sectors— can go down as well as up, as the councillors in Luton will tell you given how their investment in Luton Airport has performed in the face of a collapse in international travel.

Governance

Not all of the problems at Croydon arose from poor financial management. Cuts in central government funding over the past decade and pressures from looking after a larger number of unaccompanied child asylum seekers than average, among many other demands, meant that it was already in significant financial difficulty.

However, actions Croydon took to make the pounds go further, for example through the use of a housing development company, increased its vulnerability at a time when cash reserves were already low.

Repairing council balance sheets will not be easy, but there is a lot the Ministry of Housing, Communities and Local Government could do to support local authorities beyond pressing the Treasury for extra money.

Building on the recent additional funding for external audit, it could help councils invest in strengthening finance teams and improving the education of councillors on financial matters.

Relatively modest investments in better governance and greater transparency could make a big difference to the quality of financial decision-making.

For example, councils could have independent members on their audit committees who are trained to ask the right questions. There also needs to be a more prominent role for internal auditors in going beyond transaction probity to look at the viability of local authority business models and risk management.

The pandemic has highlighted the importance of good governance and strong financial management in how councils operate, even more important at a time of financial difficulty.

Improving financial resilience will require funding to build up reserves from their current base, but the Government also needs to consider how local government can play its full part in rebuilding the economy and delivering the levelling up agenda. That will require a restoration of trust in the ability of local authorities to make the right decisions and to manage public money effectively.

Alison Ring OBE FCA is Public Sector Director at ICAEW (the Institute of Chartered Accountants in England and Wales)