Councils close lending gap by acting as banks

The prospect of a return to municipal banks run by councils edges closer this month. Essex is launching its Banking on Essex initiative in conjunction with Abbey in the next two weeks and will stump up £50m to boost the local economy by offering short-term loans and overdrafts to local firms.

Council chiefs in Birmingham are pushing hard to create a Birmingham Bank to boost the local economy. Bolton, Lambeth and Portsmouth councils are also looking at their options.

Local authorities were big in the mortgage market back in the 1970s and early 1980s, lending 100,000 mortgages a year before Mrs Thatcher cracked down on their activities. The 1985 Housing Act made it uneconomic for councils to lend as they could only do so at the national standard rate, which was set higher than commercial lending rates.

With banks currently scared to lend, and the national standard rate falling to 3.93 per cent last month, councils are grabbing at the chance to relaunch their banks.

Why? They say part of their remit is to ensure the economic wellbeing of residents. The Local Government Act 2000 charges councils with responsibility for the economic, social and environment wellbeing of their communities. Councils can use that law to argue they must lend to small businesses to stimulate theeconomy and offer loans to residents who would otherwise struggle to find finance.

Council chiefs clearly want to be seen to be helping – at the very least it's a potential vote winner.

Lord Hanningfield, the leader of Essex County Council, says: "I am passionate about supporting local businesses through the downturn, as they truly are the backbone of our local economy."

Birmingham Council leader Mike Whitby says: "We once ran a municipal bank, and given the recent market failings, I think the time might be right for us to do so again."

There is little to stop councils lending money. The Financial Services Authority says councils, Housing Associations and other social lenders do not require regulatory authorisation to offer mortgages. But they would need a banking licence to go that step further, which could take months and would need government support. It's why many council chiefs will be looking to the Budget for indicators of the Government's sentiment.

Chris Leslie, the director of the New Local Government Network, a left-wing think-tank, says: "It should fall to the public sector to ease liquidity and offer mortgage finance to the public. Councils know their patch, are familiar with the calibre of property in their area and have every incentive to see householders prosper."

But as Steve Reed, the leader of Lambeth Council, says: "This isn't something councils can do alone. They will have to work with financial experts and mortgage professionals."

Factor in the mortgage advisers twiddling their thumbs because of the collapse of the lending market and there is an army of experts to advise councils.

Alan Cleary was the managing director of the specialist lender Edeus in the boom days and now runs the mortgage business Exact. He says: "Reinstating local authorities as mortgage lenders would mean the Government can bypass bank red tape and get cash back in the hands of people who want to buy houses. There are half a dozen mothballed lenders who could start lending next week if we had the funding."

Essex's tie-up with Abbey is a small first step towards municipal banks, but the fact a major lender is prepared to support the scheme is a good sign. The next step is for the Government to get behind it.

As Mr Cleary says: "If Government is serious about boosting the cash available to borrowers in the street, why don't they give some of their billions to local authorities to lend to consumers?"