Community banking and SMEs: a needed engine for growth

  • 20 October 2020
  • Blog | Fintech and Innovation in Banking | Blog

SMEs account for 60% of UK private sector employment and 52% of turnover. Could community banking turn them into an engine for economic recovery? 

Professor Richard Werner is Professor of Banking and Finance at De Montfort University, Leicester, and a past member of the European Central Bank (ECB) Shadow Council. He believes SMEs are the key to a sustainable economic recovery but that the current structure of the banking sector in the UK is an obstacle to providing the financial support they need to survive and thrive in the face of a sudden and dramatic existential crisis. 

Werner argues that SMEs need to be able to invest in the implementation of new technologies to increase productivity and drive economic recovery, but that money is unlikely to come from the big banks, who will naturally lean towards lending to larger businesses and big customers such as hedge and private equity funds due to the efficiencies and scale effects involved.  

“SMEs have been starved of funds by the fact that the UK has one of the most concentrated banking systems in the world,” Werner argues. “The trouble is we cannot expect the megabanks to lend to microfirms. It does not make economic sense for them.” 

For Werner, the solution lies in the establishment of a network of small, not-for-profit community banks based on the model in his native Germany. 

To this end, Werner set up the Local First Community Interest Company to promote and facilitate the creation of local community banks run by experienced SME banking professionals. The first fruit of that initiative, the Hampshire Community Bank, is currently in the process of applying for a banking licence through the PRA and FCA and has recently completed its Challenge Session with the regulators.  

As well as being deliberately small in scale and locally focused, the Local First banking model is aimed at creating long-term sustainability through a stakeholder model focused on long-term, not short-term profits, and the elimination of wrong incentives for mis-selling, such as commissions and bonuses. Half controlled by a charitable foundation acting for the benefit of the people in the geographically restricted area in which the community bank is active, such local banks would redistribute profits to the local community and would also be protected from the threat of takeover which could lead to renewed concentration of the sector over time. 

Werner believes that as policymakers review the last decade, they are beginning to learn the lessons from the last crisis and its aftermath; specifically, the need to ensure measures reach beyond the asset markets to penetrate all sectors of the real economy. He claims that with sufficient political will a network of community banks could be set up within a year, seeded with a 50/50 mix of local authority reserves and university money and central government funding. 

He believes that it would even be in the interest of the big banks to help in the establishment of such locally-focused small banks, since the call for monetary reform and the likely move by central banks to compete with banks means that the government could threaten the big banks in an unprecedented way. While they would have no public support to survive, community banks would, and thus would provide the argument against the proposed abolition of banking per se. 

“The British Business Bank would be acting responsibly and would maximise the impact of any use of public funds if it agreed to match the founding capital of community banks,” he comments. 

According to Werner, community banks would resolve the issue of low productivity and drive significant growth: by his estimates, launch capital for a typical community bank of £18m could be turned into £300m within three to five years through judicious lending to SMEs. 

“Once we have community banks in place we shall see just how much banks can in reality support businesses,” insists Werner. “The asset stripping of viable small firms to maximise big bank profits will become a horror story of the past.” 

Richard Werner is Professor of Banking and Finance at De Montfort University, Leicester, and a past member of the European Central Bank (ECB) Shadow Council. Hear more from Richard in the Summer 2020 issue of Chartered Banker magazine