Ten years ago, 38% of all local authorities’ assets under management was with banks. In the last quarter it was under 15%. What happened?
A major structural shift in the way local government manages its cash appears to have taken place in the past ten years – but like the story of the frog being boiled alive, that change seems to have been steady rather than sudden.
At the end of March 2015, total local authority investments were £38.2bn with £14.4bn in bank deposits, according to Department for Levelling Up, Housing and Communities (DLUHC) data derived from the monthly and quarterly borrowing forms submitted to the department by all local authorities. In the most recent quarterly figures, as at the end of March 2024, total investments were £43.5bn, with just £6.4bn in bank deposits.
That means 37.8% of all local authorities’ assets under management was with banks nearly a decade ago, with just 14.7% in the most recent data. While cash levels have, broadly speaking, been rising in that time, £8bn has come out of UK banks.
There are good reasons for this shift though. Not only have local authorities changed – becoming much more savvy financially – but banks have changed too.
Innes Edwards, principal treasury & banking manager for the City of Edinburgh Council, notes that ten years ago banks offered “really good” rates but that has changed over time, for a number of reasons.
He says: “One, I think they had a lot of cash for a few years and simply didn’t need cash. And two, there were regulatory changes in terms of the value of accounts with local authorities, they didn’t really score against regulatory capital in the way that was needed. As a result, the banks aggressively cut their rates on offer to well below our benchmark.”
City of Edinburgh Council, for one, has gone from using banks “to hold quite a large amount of liquidity, more than we actually needed” to a position where it has “virtually nothing” in them anymore.
Khadija Saeed, head of corporate finance at Lancashire County Council, cites the greater availability of information, more awareness at councils of financial circumstances, and a situation at many councils “where they are looking for every single rate in which they can generate income return without affecting frontline services” as reasons for the shift away from bank deposits.
“Think of all the different people within local authorities who have been making decisions on treasury management; people making separate decisions to come to that overall outcome,” she says. “Local authorities are being a bit more savvy than they had been because of the austerity that they have been under to find income return. The movement away from banking has been part of this move towards improving return.”
Economic impact
The decline in bank deposits should also be seen in the context of the wider borrowing and investment environment, with DLUHC’s Quarterly Borrowing & Investment data revealing some startling statistics.
Local authorities have taken on an additional almost £50bn of borrowing between the end of March 2015 to the end of March 2024 – £91.8bn compared to £139.37bn.
There has been a drop in assets under management of £8.4bn (£51,906m to £43,473m) from the end of March 2023 to the end March 2024, the latest figure. Extending the range to two years, the gap widens to nearly £17bn. Does this represent an extraordinary capital loss?
Meanwhile, local authority borrowing shot up by £5bn in Q4 2023/24, compared to Q4 2022/23, for a net movement of around £13bn.
The wider economic and interest rate environment explains much of this data, according to local authority financial advisors Link and Arlingclose.
“We went from a historical low level of bank rate to a period of rapid increase in bank rate from December 2021; this in turn also saw borrowing rates escalating and becoming more expensive. In light of this, local authorities have run down cash and increased their levels of internal borrowing as opposed to taking external borrowing,” explains Nazmin Miah, director Link Market Services at Link Group.
At some point this will unwind as borrowing rates fall and local authorities look to externalise their borrowing, Miah points out, with investment balances then starting to increase again. So the reduction of cash balances “has no reflection or implication that there is or has been a capital loss – this is just treasury management”.
One unintended consequence of the drop in long-term borrowing in favour of short-term borrowing, though, is that this could lead to a sector-wide position of under borrowing, something which concerns Edwards.
Arlingclose director David Green argues that the increase in net borrowing simply takes the sector back to a long-term trend of an around a £5bn a year increase. He notes that cash balances were higher during the Covid years, and so net borrowing was lower, with the government throwing “lots of cash at local authorities” – a situation that “has now been fully unwound”.
It’s partly the same story explaining why local authorities have reduced cash rather than borrowing new loans, with cash balances having grown during Covid. “But also its down to long-term interest rates being much higher than in recent history, so there’s a reluctance to lock in to what appears a high rate for the long-term,” he says.
Attractive alternatives
So where does this leave us in relation to the shift away from bank deposits? The Covid impact is clear in a closer look at the DLUHC data, which shows that while there was a gradual decline in bank deposits between the end of March 2014 and the end of March 2019 (£16.5bn to £11.1bn), there was then an increase at the end of March 2020 (£12.4bn), 2021 (£13.2bn), and 2022 (£14.8bn), before dropping to £10.2bn at the end of March 2023 and £6.4bn at the end of March 2024.
And as we have seen, bank rate cuts have played a significant role, coupled with treasury managers being increasingly financially savvy.
Then there is the relative strength of alternatives such as money market funds, which have held up well in recent times and increased significantly in importance in the last decade, especially when compared to bank deposits.
At the end of March 2014, local authority investments in money market funds totalled £3,812m, peaked at £13,222m at the end of March 2022, and were at £10,356m at the end of March 2024. Cash is flowing out of banks but not out of money market funds.
“We’ve seen that interest rates of instant access bank accounts haven’t risen as quickly as rates on money market funds have,” says Green. “So money market funds continue to tick all the boxes on security, liquidity and yield and remain the short-term investment of choice for most authorities.”
This reaffirms Miah’s point about borrowing becoming too expensive. “Cash balances are falling due to internal borrowing and therefore maintaining cash liquid for cashflow purposes, which money market funds are best suited for,” she concludes.
Edwards agrees that money market fund rates offer better value, and notes that short-term rates from major banks are “still below” those that can be found in the Debt Management Account deposit facility (DMADF).
Indeed, the City of Edinburgh Council is using the DMADF in preference to banks for short-term borrowing.
Once upon a time local authorities relied on banks to a large extent, but that is no longer the case, with pooled funds proving tastier than that boiled frog. It might take a princess to kiss that frog of bank deposits and make him a dashing prince again.
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