abstrakt-sinThe Government's Coalition Agreement is committed to diversity in financial services: We want the banking system to serve business, not the other way round. We will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry. (The Coalition: our plan for Government, 2010, p. 9)

This Report sets out a detailed and realistic strategy for achieving these goals.

Diversity of ownership types and business models creates a corresponding diversity in forms of corporate governance; risk appetite and management; incentive structures; policies and practices; and behaviours and outcomes. It also offers wider choice for consumers through enhanced competition that derives in part from the juxtaposition of different business models. However, the UK financial services sector is dominated disproportionately by a single business model, namely the large, shareholder-owned plc. This domination of the shareholder ownership model – whose purpose is to maximise financial returns to the shareholders – proved a lethal combination with the financial deregulation, the creation of new financial instruments and the subsequent rising levels of debt over the past twenty years. Ever greater risks were taken to drive up financial returns and 'shareholder value', culminating in the global credit crunch of 2007-2008 which in turn created the first global recession since the 1930s, during 2008-2009, from which the UK and global economies are only slowly recovering. As the Bank of England's latest Financial Stability Report notes:

Policy action is needed to reduce the structural problems caused by banks that are too important to fail (TITF). Larger UK banks expanded much more rapidly than smaller institutions in the run-up to the crisis and have received disproportionate taxpayer support during this crisis. That reflected a misalignment of risks on TITF banks' balance sheets, due to implicit guarantees on their liabilities.

This has left a legacy problem which is likely to constrain bank lending for some time. Alongside the macroeconomic costs, the interests of individual consumers were sacrificed by managers of shareholder-owned companies focussing on shareholder value – now dubbed by one of its champions, Jack Welch, as 'the dumbest idea in the world'.

The credit crunch, which was caused by the activities of private sector banks, resulted in the UK Government giving them a bailout of perhaps L80bn. In addition, the Government borrowed in order to provide the fiscal boost that was co-ordinated internationally to prevent a slide into global depression. These costs, along with the additional hit to Government finances that a recession causes, as tax receipts fall and unemployment benefits and other such payments rise, have combined to create the fiscal deficit and accumulated debt that we are all having to pay for through increased taxes and cuts in services. Given the financial, economic and social costs of that credit crunch and concomitant recession, a key priority for policy needs to be to put in place measures to prevent a reoccurrence in the future. Otherwise such problems may well recur, whether that be in 10, 20 or 30 years time.

In a situation of uncertainty and unpredictability, we cannot know which model will prove to be superior in all possible future circumstances, so we ought to be rather cautious before destroying any successful model. The global economy is a complex system. An important point about complexity is that many complex systems are intrinsically unpredictable, even if we know everything else about them. Thus, the problem is not just that the economic future is uncertain, but that it is fundamentally unpredictable. As The Economist notes:

Just as an ecosystem benefits from diversity, so the world is better off with a multitude of corporate forms. (The Economist, 2010, p. 58)

The loyalty that mutuals show to their locality will often be reflected in local sourcing, which means that mutuals may contribute more to the local and regional economies than do private companies. In addition, many mutuals deliver goods and services that would simply not be provided at all by plcs. And because of the social purpose inherent in many mutuals, they tend to give, proportionally, greater support to local charities and other such bodies than do plcs, with the mutual sector giving well over one per cent of its surplus to the local community, beating the generally accepted benchmark for good corporate governance; this is not just in terms of cash, but also various support 'in kind', such as the use of premises, and encouraging staff to spend time supporting local charities and other initiatives.

The UK context: a lack of diversity
For the market as a whole to benefit requires that the various corporate models each enjoy the necessary critical mass, defined as the degree of market share necessary to enable that model to operate successfully and thus to provide real competitive pressure on the other players within the market. Other European countries tend to have several co-operative banks, which tend to be important lenders to the SME sector, whereas in the UK there is only one. The UK's 500 credit unions have total assets of around half a billion pounds – far short of what would be necessary to provide serious competitive pressure on the high street banks. The mutual insurance sector in the UK, at 5 per cent of the total insurance market, compares badly to the 30-40 per cent typical of the other large insurance markets globally. And the demutualisations of the 1980s and 1990s reduced the mutual building society sector below the critical mass to really deliver what a more diverse financial system would offer.

There is a fundamental attitude problem within the UK amongst the media and regulators, with the shareholder owned company being regarded as the 'normal' or 'natural' way of doing business. Other ownership models may be accepted, yet all models tend to still be judged against criteria appropriate for the shareholder ownership model. And the large plc, at that. Thus, for example, on the issue of raising capital, the Financial Services Authority (FSA) appear, at times, to view all companies as if they were, or should be, large plcs.

There is a bias against the mutual corporate form. At least in part, this is because of its inability to easily raise capital, despite the fact that this reduces their risk appetite and thus means that a financial services sector with a strong mutual sector will have a greater diversity of risk appetite, which is a positive outcome in terms of creating a stable and robust financial services sector – as reported in IMF and other research.

Measuring diversity
For Government to achieve its aim of enhancing diversity it needs to measure the degree of diversity over time so that progress can be measured, and assurance can be given that the risks of a future credit crunch are indeed being reduced over time. This might include geographical diversity, to promote a greater local and regional spread of such institutions.

Regulatory barriers to diversity
The Government has announced that it will create a Prudential Regulation Authority (PRA) as a subsidiary of the Bank of England, and a new Consumer Protection and Markets Authority (CPMA) which will take on the FSA's responsibility for consumer protection. This recasting of the UK's financial regulatory structure presents a rare opportunity to ensure that the issue of diversity is properly accounted for. In terms of responsibilities, what should these new regulatory bodies look like if they are to prove useful partners for the mutual sector, enabling the mutual sector to achieve critical mass, and thus creating greater corporate diversity?

One of the problems in the past with UK policy making is that mutuals have often been an afterthought. This can result in opportunities being missed and in wrong-headed policies being pursued. There is now an opportunity to formalise a relationship between policy makers and the mutual sector that could avoid these costly mistakes. A formal, longer-term relationship is needed.

A strategy for financial diversity
Within the new regulatory framework, there needs to be a clear responsibility in the regulator's charter to promote diversity of ownership. In the past, the objection to taking this step is that it would require legislation. But now there is going to be legislation in any case, and there is going to be a new regulator, so this is the moment to ensure that the regulator is given proper responsibility towards fostering diversity and promoting mutuals. So, firstly, the regulator must have a responsibility and a requirement to demonstrate that they are taking diversity into account.

Secondly, the regulator needs to have somebody within the organisation who is at a senior level defined as a head of mutuals policy and who is therefore charged with demonstrating that regulation does not prevent mutual organisations from competing on an equal basis with nonmutual forms. (There is no-one with that remit currently, and thus there is no particular incentive for anyone in the organisation to think beyond the standard plc model.)

Thirdly, regulation needs to be proportionate. Regulation and the demands it makes represents a powerful competitive advantage for large incumbent players because they can absorb that cost. The resource costs and the monetary costs impact more heavily on smaller players, constituting a barrier to entry – you have to comply with regulation before you have done your first deal – and it stops the smaller people thriving in a way that would provide meaningful competition to the big incumbents. On the whole that disadvantages mutuals, and it is certainly a barrier to greater diversity. Ironically, it actually favours the 'Too Important to Fail' banks that are part of the problem.

Fourthly, on the PRA and CPMA:

  • i. 'promoting mutuals and fostering diversity' needs to be in their objectives;
  • ii. they should both be committed to take account of diverse business structures;
  • iii. there needs to be a mutuals' policy function in both the CPMA and the PRA: these bodies need somebody on the inside who understands the difference at the grass roots of producing policy in diverse sectors.

Fifthly, the Bank of England:

  • i. needs to have its accountability improved along with its increased powers;
  • ii. should be required to explain what the impact of major policy decisions would be on mutuals and on the degree of diversity of the financial services sector; and
  • iii. should also be required to report on diversity in the sector, producing an annual review of diversity and how its actions have promoted it.

Thus, good, strong and transparent regulation is required that takes account of the particular structures within the mutual sector. To achieve this would require a mutuals policies function within the PRA and CMPA, with them reporting on the success of their efforts to promote diversity, and also commenting on the impact on diversity and on mutuals of each individual significant regulatory proposal.

The Coalition Government has already shown a strong degree of interest in mutuals, and this is likely to prove important to a range of government functions. A Minister for Mutuals – similar in status to the Minister for the City – would be able to deal across the various government departments that have to deal with the mutual sector. A Minister for Mutuals would be responsible for all types of mutuals in all sectors – in manufacturing, retail, health, education, non-financial services, football clubs and so on, as well as for the financial services sector. Given the weight of business, this would need to be a Treasury minister – suitably supported by sufficiently qualified and senior officials – that also had a responsibility in BIS and crosscutting responsibility across Government as necessary. Fundamentally, the Minister for Mutuals would ensure parity of esteem for the mutual and proprietary models, which is a principle of public policy and which should set the agenda for regulators.

Government must not allow the UK's financial services sector to return to the 'business as usual' model that has proved so costly to the economy and to public finances. Already we have seen a return to the bonus culture, which is fuelled by profits boosted by the increased market power of banks which have been rescued by the taxpayer. It is vital that the banks face competition from mutuals, which would also reduce the risk of the credit crunch being repeated.

Keeping a reformed Northern Rock independent of the big banks will be good for competition. Northern Rock could be converted to an assetlocked public interest mutual. As a mutual committed to its core business, a remutualised Northern Rock would help the Government by supporting competition and diversity through the maintenance of a strong mutually-owned financial sector.

There are plenty of examples of the positive role that mutuals can and do play, but these positive impacts could be greatly enhanced given the right environment and political goodwill. The benefits of creating a more diversified financial services sector include greater stability, more accountability to consumers, reduced systemic risk, and better access to financial services. The research suggests that mutuality appeals to consumers. But consumers do need to be given the choice – and that choice needs to be preserved rather than allowing mutuals to demutualise or to be crushed by the everincreasing costs of staying in business. Positive words count for little if the downward trend in the number of mutual organisations in financial services is allowed to continue. There is an urgent need to translate positive words into substantive actions.


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