The future of finance and banking: key issues for a green and fair recovery

On 28 July 2020, Lab CEO Jesse Griffiths presented to the All Party Parliamentary Group on the Green New Deal about the role of banking and finance in financing a green and fair recovery.  This is an edited text of his presentation.

The COVID-19 crisis has exposed a great weakness of our financial sector: it does not direct finance to the real economy, and badly serves small and medium enterprises. Over recent decades, the financial sector has grown considerably and relative to GDP is far larger than other major economies. At the same time it has moved away from financing investment in the real economy towards financing asset purchase, particularly housing, and finance for the financial sector itself. One estimate suggests that only ten percent of UK bank lending goes to the productive sector.

This lack of attention towards providing finance for business investment in the real economy created real problems when the government tried to use the banks to channel emergency loans to businesses in the wake of the COVID-19 crisis. The banking system was simply not geared up to do this. The head of the Federation of Small Businesses described the experience of small businesses applying for coronavirus support lending schemes, saying: “customer service has been poor, the application process has been arduous, and the wait times for decisions have been lengthy.”

One fundamental reason for this is the lack of diversity in financial institutions in the UK, in particular, the absence of a strong purpose-driven finance sector. The big four banks – HSBC, Lloyds, Barclays, and RBS, now rebranded as Natwest – have 75% of UK current accounts and 85% of business accounts. These are all shareholder owned banks, who see their primary responsibility as being towards their shareholders. Alternative models, including cooperative banks, credit unions and publicly-owned banks are very small in the UK. In Germany, by contrast, the banking sector is dominated by publicly and cooperatively owned banks and the top four private banks have only 16% of the market.

A larger purpose-driven financial sector in the UK would put social and environmental outcomes at the heart of decision-making. It would also help to build up a financial sector that serves local and regional economies. By focussing on relationship banking it would help to direct more finance to the real economy. Diversifying ownership and business models would help to build the resilience of the financial system reducing the likelihood of future crises. 

The need for much more active policy intervention to recover from the current crisis provides a golden opportunity to support the rapid growth of the purpose-driven finance sector to ensure a green and fair recovery. One key initiative that should be backed is the expansion of co-operative banking. Astonishingly co-operative banks were not legal in this country until 2014 – the Co-operative Bank was never itself a co-operative. The Community Savings Bank Association was created to establish a network of 18 regional cooperative banks in the UK. They are stymied by legal difficulties, including problems with competition law that make it difficult to run a regional network without falling foul of rules designed to prevent cartels. It is also particularly difficult to raise the high levels of required starting capital in the current environment. To support co-operative banking to get off the ground, the government could, for example, offer tax relief or even provide startup capital directly.

A second key initiative will be the (re)establishment of a publicly owned green national investment bank. This could do two things. First, it could manage the equity stakes taken by the government to help failing businesses come with conditions that ensure those businesses green their operations. Second, it could significantly scale up low-cost financing for green investment across the UK.

The mainstream financial institutions that dominate the UK finance sector will also need to shift their balance sheets significantly if we are to build back better. One study shows that Barclays provided $118 billion and HSBC $86 billion for fossil fuel companies in the four years after the Paris Agreement was signed, the two worst records in Europe. While Barclays has made some improvements to its policy in response to a ShareAction campaign, and Natwest has announced that it wants to become a purpose-driven bank, there is still a long way to go. It will take more than external pressure and internal leadership to make the shifts at the scale and speed required to meet climate needs.

There is a lot that the government could do. For example, it will be important to complete the first financial system-wide climate stress test before next year’s climate COP. The stress test was scheduled this year but has now been delayed until at least mid-2021. Better transparency and disclosure will also be part of the solution. Making the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) mandatory would be a first step, which the government has signalled interest in. The capital rules for banks are risk-weighted according to financial risks, but they should also be risk-weighted according to environmental risks. This would require the development of a classification of green versus dirty assets, building on the work the European Commission has done in this area. Finally, as the Lab argued in its Regulatory Compass report, financial regulators should embed social and environmental outcomes into their mandates, mindsets and metrics to ensure they focus their work on the ultimate purpose of the financial system – to benefit society and the environment.