Checking the pulse of the UK’s goal-driven banking ecosystem
Does the UK financial services industry exist purely to generate profit for shareholders? Can we build deeper social and environmental goals into our financial institutions? The booming goal-driven banking sector in the UK is essential to ensuring a sustainable, democratic and resilient system for all, but how can we ensure that it continues to grow in the face of unique regulation and the absence of term capital? Driving awareness will be the first step.
At the Finance Innovation Lab’s virtual event, ‘Building Purpose-Driven Banking’, industry experts gathered to check the pulse of the UK’s goal-driven banking industry, explore key barriers to its growth and reflect how to overcome them.
In December 2020, Finance Innovation Lab published a work document, written by Dr Gemma Bone Dodds, who defines goal-oriented banks as financial institutions driven by a positive social or environmental mission, and which have incorporated this philosophy into their ownership, governance, culture and leadership practices – in other words, meeting environmental, social and governance (ESG) criteria.
The paper highlights five types of institutions in the UK that today meet the definition of goal-oriented banks, namely:
- credit unions,
- community development financial institutions (CDFI),
- construction companies,
- sustainable banks, and
- mutual banks.
Each of these types of institutions were represented at the Finance Innovation Lab event, where experts discussed how to overcome some of the key challenges for the continued growth of the UK goal-driven banking ecosystem. Uni – including a single regulation. , lack of capital and scaling up.
In a post-event interview with Finextra, Neil Sellers, Head of Credit Risk, Triodos Bank UK, said updating existing banking regulations was essential to ensure that the UK’s nascent banking sector, focused on goals, continues to grow.
“The regulation has taken a one-size-fits-all approach,” Sellers said. “The same regulation that aims to prevent further RBS-type crises – and which targets banks with massive and complex balance sheets, huge footprints and impact costs – applies to entities like Triodos Bank, with our £ 1 billion balance sheet and 800 borrowing clients. Regulations need to take a tiered approach and implement sandboxes for nascent goal-driven financial institutions. “
Founded in 1980 in the Netherlands, Triodos Bank is a sustainable financial institution, whose banking approach is inspired by the anthroposophical philosophy of Rudolf Steiner. In a practical sense, this means providing sustainable financial products that enable individuals and organizations to deploy capital in ways that benefit the environment and society as a whole. In 2020, for example, Triodos Bank financed green electricity from 561 energy projects for 700,000 households around the world, thus contributing to the decarbonisation efforts of a number of economies.
There is, however, more to be done in the UK to support entities like Triodos Bank in their work. Speakers at the event agreed that the regulations need to be updated to meet the needs of goal-oriented banks. This sentiment is reflected in the 2018 Finance Innovation Lab report, “The regulatory compass: towards a goal-oriented approach to financial regulationWhich argues that instead of being neutral, banking regulation is currently being designed around the large shareholder-driven companies that dominate the UK market.
However, a positive regulatory change could be on the horizon. The UK government has already discussed
plans to create a new regulatory regime for small banks – recognize the need for different types of regulation for different types of financial institutions.
In addition, the goal-oriented banking sector has garnered support from the House of Lords. On February 22, 2021, Lord Chris Holmes spoke out in favor of improving the rights of small and medium-sized enterprises (SMEs) at the committee stage for the Financial Services Bill – highlighting the power imbalance that is occurring between small businesses and large traditional financial institutions.
Another solution to supporting goal-oriented banks could be to reform competition law, experts suggested at a workshop organized by Finance Innovation Lab on March 19, 2021: “Competition law prevents networks from trading. ‘smaller institutions, such as mutual banks, to collaborate. to achieve economies of scale. “
Clearly, UK banking regulation needs to be re-examined and specialized.
Lack of long-term capital
Until then, Triodos Bank is able to support other financial institutions determined for specific purposes by providing capital for loans. One of its grantees, a CDFI called Responsible Finance, was represented at the event by Eleanor Pughe, who argued that strong traditional banking support and securing long-term capital would be essential to ensure the industry continues. to grow.
National membership body for responsible finance providers, Responsible Finance aims to create a fair financial system in the UK by helping to grow the community development finance industry. As a non-profit, shareholder-less organization to generate returns on, responsible finance fills the funding gap for individuals, businesses and social enterprises who are unable to obtain loans from traditional lenders. .
Some businesses, for example, may be unable to borrow because they are new to the market; have recent business losses; or lacking assets to serve as loan collateral. Indeed, 90% of CDFI’s business loans go to those that have already been rejected by another lender, Pughe explained.
Social enterprises, on the other hand, may find it difficult to access finance as they are seen as an unworthy investment by for-profit lenders. Individuals, on the other hand, who have defaulted on a loan in the past, but are on a more stable financial footing and cannot reflect this in their credit score, will also find it difficult to qualify for a loan from a financial position. traditional bank.
CDFIs like Responsible Finance are used to support these types of clients, by thoroughly reviewing loan applications and basing their lending decision on a number of factors – as opposed to a simple credit score or recent business history. In addition, shareholder return is not a priority for CDFIs, which means that the potential positive impact of the loan is taken into account, instead of the pure profit that can be derived from it.
This model has powerful implications. In 2020 alone, Pughe revealed, CDFIs helped protect 7,000 jobs in the UK through the Coronavirus Business Interruption Loan Program loan.
Yet despite this potential, many CDFIs require additional investment to improve their work. To address this lack of long-term capital supply, experts at the event agreed that using public finances to support the UK’s goal-driven banking ecosystem was a viable option – as this has been successfully demonstrated in countries like Germany, where more than 60% of its banking activities are determined by targets.
It will also be essential to stimulate the flow of private capital to the sector – whether through tax breaks or guarantees, for example.
Growth, however, can bring a number of unique challenges. For example, how should a goal-oriented bank – which is built on its close relationships with clients, clients and the local community – evolve, while retaining the human angle so fundamental to its work?
This human-centered philosophy was a common theme during the Finance Innovation Lab event. The vendors said this was essential to achieve effective sustainability: “Fintechs can be too tech-focused, instead of valuing the human perspective. For example, while satellite data can be effectively deployed to identify areas of land suitable for agriculture, it does not take into account the skills of the potential farmer. This is arguably the most significant variable. “
Despite this, vendors also recognized that partnering with certain fintechs can be a way that goal-oriented banks can meet the inevitable technological demands associated with growth, while still staying close to customers.
Perhaps this idea can be put to the test by the small number of mutual banks that are starting to emerge in the UK.
Northern Irish mutual bank Northern Mutual represented its co-founder, Dr Bridget Meehan, at the event, who explained that all of her investments go to the region. As such, mutual banks focus on supporting small businesses and local farmers, who are typically overlooked by traditional banks in the region.
This type of bank produces a halo effect within the financial institutions themselves. Indeed, it is much easier to create a motivated group of colleagues within a bank if they can see positive impacts occurring in communities as a result of the work they do, rather than, for example, to report solid turnover.
Promoting financial inclusion and reducing the focus on profit, mutual banks like Northern Mutual are growing steadily across the UK. However, as the vendors point out, the real challenge will be staying close to the community, while developing new technologies to stay competitive, efficient and support growth.
The main obstacle to the continued growth of the UK’s goal-oriented banking ecosystem appears to stem from a lack of understanding of its nature and objectives – a problem that stems from the underdevelopment of the sector and the dominance of traditional banks. Whatever the cause, these factors have contributed to misaligned regulation, slower customer acquisition, and limitations on the extent to which goal-driven financial institutions can work together.
In the future, more educational initiatives will need to be launched, perhaps even as early as business schools and universities – where sustainable or goal-oriented business models are not yet widely taught. If that happens, we may be able to transform the UK banking sector which, unlike many other European countries, is mostly made up of shareholder banks.
The UK has seen some promising developments in targeted banking in recent years, but we still have a long way to go.