Warrington Borough Council has taken a 33% stake in Redwood Bank, a challenger bank that this week received its licence to operate from regulators. Danny Mather describes the rationale for this innovative initiative and the rigorous due diligence and risk mitigation the council has undertaken.
A principle, and very real, outcome of the economic situation since 2008 has been the reduction in the amount of money made available for lending purposes to individuals and to small businesses by the traditional mainstream banks.
This is of significant concern to local authorities, evident by the number of councils who now lend directly to the business sector and, according to a report by the New Local Government Network, over 70% of council leaders are now interested in playing a bigger role in banking for the benefit of local communities and residents.
It is also evident that the proposed development of a bank by the council has anticipated emerging government and opposition party policy, as well as growing recognition of the vital need to re-establish a local banking which understands and responds to local needs, and is accountable locally. This has been a key lesson learned during the recent banking crisis. This view has been given even greater credence following the publication of the final report of the parliamentary commission on banking standards in June 2013 Changing Banking for Good.
The main reason Warrington has invested in this new bank is to increase SME lending in the borough and nationally. This follows a policy directive by members in 2013 and the results of a local business survey carried out in 2013.
Diligence
The council carried out a thorough due diligence exercise before making its investment in the bank. This followed a full appraisal being made of various alternative options to deliver a lending model. The banking option was considered to be the best and was chosen for the following main reasons:
- Strong governance structure.
- Incorporates strong banking / lending management and board experience as well as expertise the council did not have.
- Risk averse secured property lending model.
- Commercial approach.
- Maximises potential lending available with funding raised from SME deposits.
- Attractive investment return for the council that can be used for investing in front line services.
A full due diligence exercise has been carried out by council officers. The new bank’s regulatory business plan has been stringently reviewed by the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA), as part of the process of granting a banking licence.
In addition, the council has had the business plan independently reviewed by a Big Four accountancy firm and the council’s external auditors. Legal advice has also been sought from both a firm of solicitors and a leading QC.
A full risk and sensitivity analysis was carried out and incorporated in the bank’s business plan. These risks and sensitivities have also been scrutinised in detail by the PRA and the FCA. The key risks and mitigations associated with a bank of this nature are:
- Failure of businesses to repay loans: all loans will be fully secured.
- Governance: the bank’s governance structure will be approved and then monitored by the PRA on an ongoing basis.
- The economy goes into recession: relatively low risk appetite of the bank and this scenario included in the sensitivity analysis within the business plan.
- Competition: assessed within the business plan. The bank’s planned volumes will be small. The bank will be flexible and able to react quickly to changing market conditions
- IT system failures or cyber attacks: modern systems will be purchased that will incorporate the most modern technology, which do not have the legacy system problems of the current big banks.
- Loss of the council’s capital investment due to poor performance: the bank’s performance against its business plan will be closely monitored. The council’s investment is not all upfront, but instead is being staggered over three years to ensure the risk is mitigated.
- The council could face a challenge from: a member of the public, auditor, European Union (over state aid) or judicial review. Extensive consultation has taken place in respect of the council’s investment in the bank. Professional accounting advice was obtained and an independent review of the business plan has been carried out by a Big Four accounting firm. Legal advice, covering state aid, has also been obtained from a firm of solicitors and a leading QC. The council’s auditors have been fully briefed on the bank project and have been supplied with all key documentation.
- Reputational risk to the council of the bank failing: the bank’s business plan is prudent and has been subject to significant stress testing. The bank is subject to a stringent and transparent governance structure.
The bank will now go through “mobilisation” and is due to be open for business during the summer of 2017. This model offers similar opportunities to all councils to introduce and promote SME lending in their own regions.
Over time the bank could be added to councils’ investment counterparty lists, creating a truly integrated local authority / private sector lending model. This would drive both local and national SME growth and economic prosperity. This is a unique public-private partnership that heralds a return to community banking in the UK.
Danny Mather is corporate manager at Warrington Borough Council.
