The Labour Manifesto proposes to establish a National Investment Bank and a network of regional development banks. The goals are to support lending to small businesses, particularly coops, and to contribute to “transforming our financial system”.

Like many things in the Manifesto, this has a pleasantly radical feel, yet can also be sold as just what “normal” non-radical governments already do elsewhere. Public ownership of a major bank sounds radical, as does the support for alternative forms of ownership. Yet, as the Manifesto hints, it could be seen as just replicating Germany’s Kreditanstalt für Wiederaufbau (KfW) or the Nordic Development Bank. These are not terribly radical institutions.

Indeed, we already have the state-owned British Business Bank, supporting finance for small businesses, and the Green Investment Bank, currently being privatised, although both are tiny. We also already own part of a public investment bank that has been investing around 7 billion euros a year in infrastructure, schools and housing in the UK: the European Investment Bank (EIB). Post-Brexit, there is certainly an argument for a new or expanded public investment bank, if only to replace the EIB lending we will probably lose.

So is the manifesto commitment to set up a new National Investment Bank really a radical proposal? In the following I want to discuss what a public investment bank is, what has been proposed so far, some problems with the model proposed, and what might make it into something really transformational.

There is some confusion about the focus of the proposed bank. In the Manifesto and an earlier report to the Shadow Chancellor, it appears to be focused solely on lending to small businesses, with lending for infrastructure and housing the preserve of the “National Transformation Fund”. I think the case for a public bank investing in infrastructure and housing is much simpler, while plans to support lending to small businesses require some more thought. In this piece, I work on the assumption that the National Investment Bank will just be for lending to small businesses.

What is a public investment bank, and what makes it better than a private one?

In any country, the entity with the cheapest borrowing costs is usually the government. Domestic private sector banks usually have to pay higher interest rates to bond holders and depositors. This creates an arbitrage opportunity. The state can set up a public bank, putting up public money as capital and guaranteeing its liabilities, explicitly or implicitly. This bank then lends to the real economy, alongside the private sector, but enjoys the same low borrowing costs as the state. In this way, a public investment bank can offer cheaper loans than private sector banks yet may also be rather profitable, returning a dividend to the state or building up its capital over time.

By offering cheaper loans than the private sector, a public investment bank may enable a greater volume of investment on aggregate, raising GDP levels and the rate of growth. It can also constitute a powerful and selective policy lever, allowing a cheaper financing costs to be targeted at sectors such as renewable energy or small businesses.

The case for having some kind of public investment bank is therefore strong. The reason we don’t have a big one already is perhaps ideological. Many public investment banks were founded in the post-war heyday of Keynesianism before state intervention and industrial policy become dirty words. The UK missed that opportunity. In the neoliberal decades, public investment banks in other countries have survived, largely, by keeping a low profile. The mantra has been that they don’t ever “crowd out” the private sector and that they just address occasional market failures, financing investment that “wouldn’t otherwise have taken place”.

These claims are only partly true. Public investment banks can make extra investment happen, but they may also take over existing business from the private sector. Indeed, that may be mostly what they do in many cases. The question is: is this really a bad thing?

The “crowding out” argument pretends that public investment banks are the beneficiaries of a subsidy of public money, giving them an unfair cost advantage versus an otherwise more efficient private sector, and leading to a loss of efficiency overall. But this picture is false.

The risks of financial intermediation are ultimately carried by the public, one way or another, as the financial crisis has shown. For the private sector, market competition is supposed to provide discipline, ensuring that banks are well-managed. But competition implies that sometimes banks have to be allowed to fail, and this means that financial intermediation by such banks is relatively expensive: savers and investors – who are supposed to bear all the risk – have to be compensated for the risk of bank failure.

What happens in practice, is that the state comes to the rescue of failing banks anyway, and investors know this. This is a real public subsidy. It is a transfer of risk on to the public, only imperfectly offset by regulatory oversight. It may actually make things worse by creating “moral hazard”; the possibility of real failure is no longer there to keep banks honest.

The third option is publicly-owned banking. It is superior to both of the above. The risk is carried by the public, as in the second option, but the public gets direct democratic accountability in return, removing the moral hazard problem. At the same time, this is a more efficient, lower cost model than the first because it does not necessitate the costly practice of occasionally letting banks go bust as a lesson to others.

So if public banking crowds out the private sector, it is just because it is a more efficient solution to the problem of financial intermediation, and we should welcome it.

What exactly has been proposed so far?

But before we get too carried away with the possibly radical potential of setting up a big new public investment bank, let’s look at what is on the table at the moment. Without knowing what has been discussed in Labour’s inner circle, the best guide is perhaps the rather underwhelming external experts’ report to John McDonnell, A National Investment Bank for Britain: Putting dynamism into our industrial strategy.

According to this report the new bank would:

• Lend ₤250 billion over ten years to financial intermediaries to support lending to small and medium sized enterprises.
• Be overseen by a supervisory Board made up of a government minister, seven representatives of devolved national/regional governments, two representatives from trade unions and two from business, with regional branches overseen by regional boards that would also include both government and other stakeholders.

While this report goes into rather premature detail on some issues, it completely fails to discuss some of the major questions raised by such a business model, questions raised by the experience of similar existing institutions. So let’s do that here.

No public investment banks that I know of actually lend directly to small businesses. Such lending is labour intensive. It’s typically done by retail banks with local branches that are able to get to know their business clients over time, building up a relationship. This is where the real value-added lies.

So when existing public investment banks do “lending for SMEs”, what they really do is lend to banks. The idea is that by giving slightly advantageous loans to commercial banks, the latter will increase their lending to their SME clients. This is the model used by banks like KfW and by the British Business Bank, and it’s not so different from the existing Funding for Lending scheme or the Bank of England’s Term Funding Scheme which, as the rightly report states, have not changed much for SMEs.

This is the model proposed for the National Investment Bank and there are a couple of big problems with it.

The fungibility of money problem

Lending to another bank “for on-lending to SMEs” is like pouring money into a big pot. Out of that pot, the intermediary bank does lend to SMEs. But money from the same pot also gets invested in large corporates or government bonds, or used to pay dividends and bonuses. So how do public investment banks know that their money has gone to SMEs? Clearly they don’t know this; money is fungible.

One approach is to demand that intermediary banks draw up list of all the loans to SMEs that have been issued with the public money. This is then the basis for saying that so-and-so many SMEs have benefited, and so-and-so many jobs have been supported. But, of course, the real question is whether these loans would have happened anyway. And this we simply don’t know. Even if the lending behaviour of the bank changed over time – even if it increased lending to SMEs – it is rather hard to tell what would have happened without the cheap loan from the public bank. In fact, as a rule, no attempt is even made to try to find this out.

What we are left with is a public subsidy of commercial banks. In fact it doesn’t much matter whether you offer banks cheap loans, public guarantees of their business loan portfolio (another approach used) or just make clear that the public will rescue them if they risk going bust. The effect is basically the same. In theory – in a world of efficiently equilibrating markets – such a subsidy will lead to an expansion of banking activity, which will include expanded lending to SMEs. Theoretically, it will raise bank profits, but only temporarily, in the process of attracting more capital to the banking sector. This involves rather a lot of wishful thinking. There may be better ways to get commercial banks to lend more to SMEs, but we should be aware of exactly what “business as usual” entails.

The funding gap mantra

The report repeats the assertion that there is a “long-term funding gap” for SMEs. This is the mantra repeated by all public investment banks to justify their lending to banks “for SMEs”, a very important line of business. While otherwise perfectly neoliberal in their now dominant ideology, public investment banks, to justify their existence, must identify suitably large market failures, whereby huge disequilibria open up, where there is a huge demand for funding but no supply. It is only on this basis that they can claim that they neither distort the market nor crowd out the private sector, but merely fill in the gaps, enabling lending that wouldn’t otherwise have taken place.

But the evidence for these claims is basically not there. Outside of real liquidity crises in the banking sector, there is no yawning gap.

Of course, this is not to say that small businesses do not face all kinds of challenges. It is not to say that funding is not something that small businesses struggle with; that they would not like loans that were larger, cheaper, with lower collateral requirements or with longer repayment periods. But this is not evidence of the kind of gap implied. The ECB’s SAFE survey of small businesses in the eurozone in fact currently shows that access to finance is the least important of six concerns everywhere but Greece. Outside Greece, little more than 10% of SMEs reported difficulties with obtaining finance. This might still sound significant, but even in the best circumstances it is not to be expected that all SMEs are credit-worthy and able to get all the finance they would like. There will always be some firms that are struggling and that shouldn’t be entrusted with more money until they can show their prospects are better, so this is not evidence of a gap waiting to be filled. Another survey by the EIB that also covers the UK shows similar results.

The truth is that financial markets are awash with liquidity, in the midst of a global savings glut compounded by quantitative easing. Interest rates have been compressed towards zero, even for long-term bonds, and everyone is looking for some way to invest that brings non-negligible returns. The complaint aired by commercial banks is that they would love to do more, but that there are not enough good SMEs asking for the money. In this context, the subsidy provided by loans from a public investment bank may enable private sector banks to lend marginally more to SMEs, but it’s not much. Given banks’ current profitability problems, the more tangible effect may simply be on banks’ profits.

We also need to think about the ambition of getting an extra ₤250 billion lent to SMEs. ₤25 billion a year is about 1.3% of UK GDP (which doesn’t sound that much) but is 8% of UK investment and 14% of UK business investment. Furthermore, if we note that SMEs make up about 40% of businesses by value-added, and that they actually fund around 80% of their investment from retained earnings, then ₤25 billion a year could end up being more than the entire existing external financing for SMEs.

To get UK SMEs to invest an extra ₤25 billion a year – perhaps a 20%-25% increase on their current investment – would be a good thing. It’s also not, in itself, completely unrealistic. The UK investment rate is very low as a % of GDP (17%). Raising that to 18-19%, mostly through extra investment spending by SMEs, would be something worthwhile to aim for. But it is not really reasonable to expect that a very marginal reduction in bank’s funding costs, possibly passed on to SMEs, will on it’s own cause SME borrowing to double. ₤250 billion might eventually be absorbed by banks, but it would probably just fund existing lending, with little change to the total. Indeed, the report on a National Investment Bank is perceptive enough to put in a footnote: “Steps will need to be taken to prevent banks from calling in current loans and using NIB funding to raise profits on what are really existing loans but reported to the NIB as new loans.” But it doesn’t say what steps these might be. And indeed, the question is not whether or not loans are really “new”, but whether or not they are extra loans that would not otherwise have taken place.

We need to stop thinking of finance as the single magic bullet that makes investment happen. It is rarely the limiting factor. It may surprise people, but public investment banks, such as those operating in Europe, do not face great piles of loan applications to sift through, to select the very best investment projects. What they face are lending targets, and they typically have to work hard to find enough acceptable ways to get rid of the money. This is true for infrastructure projects, and here the big problem is really the lack of will and inability of public authorities to plan strategically for the future, to define the need for long-term investments, and to carry through the slow process of project preparation.

With small businesses, the problem is really demand. They won’t step up their investment plans unless they see future demand outstripping their capacity to supply. It’s also a question of innovation: new ideas and technologies (often coming out of public research) drive investment by creating opportunities to get ahead. And it’s also again a question of planning: planned expenditure on, say, public housing, creates predictable demand and can drive private sector investment.

The problem of capital flight

If public investment banks often have trouble shifting enough money, it’s partly because the world has become a tougher place for them. With even long-term bond yields pushed down towards zero, the arbitrage opportunity that these public banks exploit is just not as large as it once was. The implicit state guarantee that now exists for “too-big-to-fail” banks doesn’t help either. A new public investment bank may actually have little competitive advantage, offering very little in the way of a policy lever.

And if the public investment bank model may be squeezed, from one side, by the low borrowing costs of commercial banks, it may be squeezed from the other by any rise in the borrowing costs of the state. This is where the whole model becomes vulnerable in the face of open, deregulated, cross-border capital markets.

I was tempted to give this section the title “Is there a magic money tree”. The response of many post-Keynesian activists since the election has been to point at the Bank of England and say “Yes there is.” This is relevant because Corbyn’s original leadership election pitch, back in 2015, included the idea of “People’s quantitative easing” to fund a National Investment Bank, though linked at this time to infrastructure.

This idea should no longer be seen as particularly radical. The ECB has been buying up all kinds of bonds, including those of KfW and the EIB, for a while now, depressing their funding costs. But I remain skeptical of the argument that the state can always maintain demand at full-employment levels, sustainably and without inflation, through the expedient of borrowing in its own currency or through monetary financing. I suspect John McDonnell has been wise to have been cautious in this regard.

The problem is capital flight. The problem is having borrowing costs more or less dictated to us by the capital markets. The whole point of a National Investment Bank would be to stimulate investment by lowering borrowing costs, but if it made us a target of the rating agencies and the bond markets, the effect might rather be the opposite.

This is a real problem. I do not imagine for a moment that the markets are going to be sanguine about a Labour victory. I expect that government borrowing costs will rise sooner or later, not because a default is fundamentally more likely, but because bond and currency traders know that the herd behaviour of the markets can bankrupt countries, and they don’t want to be the last one to join the stampede. Bond yields don’t measure a country’s ability to pay, they measure the risk that the markets themselves will precipitate a default by denying a country the liquidity needed for the routine rolling over of its debt. And monetary financing is no automatic cure for this problem either. The leading central banks could do quantitative easing because there has been vast appetite for safe-haven dollar, euro, yen and pound denominated assets, but this only works so long as market consensus remains that these are safe. Ultimately, as long as we have a significant trade deficit, we are exceedingly exposed to market sentiment.

None of this means that we shouldn’t have a National Investment Bank. It just means we must be strategic. Smaller lending volumes that are targeted at making a real difference may be better than creating a ₤250 billion contingent liability for the government, in order to fund lending that would mostly have happened anyway.

It is also a reminder that if we really want to reject austerity and put in place an active industrial and demand management policy to address the appaling weaknesses and injustices of our economy, then we may have little alternative but to wrest back control from global capital markets. This is a matter of sovereignty, and one to rival any compromises we have made with our fellow Europeans. If we have not so much noticed the rule of the markets, it is because our governments have been so craven before them, presenting every act of acquiescence as our own choice, as a natural economic necessity, and as just good housekeeping, even as they have presented every European intergovernmental agreement as a massive affront to our national dignity.

Of course, the two are not unrelated. Part of the European project has been a neoliberal effort to lock in obeisance to the market through constitutional rules. While the left in Europe works to overturn that agenda, Brexit potentially offers the UK an opportunity – as argued elsewhere in New Socialist – to pioneer a return to a system of rationally managed capital flows and managed trade.

So what would make a National Investment Bank really transformative? It is clear that “business as usual” isn’t really an option, even the “business as usual” of a publicly-owned investment bank. But a new National Investment Bank would offer certain opportunities to support a real process of transformation and democratisation in our economy. We should make sure we exploit those opportunities to the full. I would emphasise three things: supporting the coop sector, not being afraid to crowd out the private sector and “being the change you wish to see in the world”.

Get serious about supporting coops

Supporting the cooperative sector is one of the tasks set for the National Investment Bank in the Labour Manifesto. Likewise, Labour’s Digital Democracy Manifesto proposes that the bank will be used to support platform cooperatives. In the report to the Shadow Chancellor, however, there is just a footnote to the effect that “enterprises” should be taken to include “appropriate non-profit or third sector organisations”; coops are not explicitly mentioned at all.

The manifesto commitment clearly takes precedence. But nonetheless, there is a danger here: the bank might end up doing little more than paying lip-service to the goal of supporting coops. If some loans by some intermediary banks just happen to go to coops, is that enough to tick the “supported coops” box? This is the kind of “business as usual” approach that won’t be good enough.

This is also about being able to know that the bank actually makes a difference. Public investment banks (that don’t usually want to make life difficult for themselves) have a tendency to push for very broad objectives. Hence the term “Small and medium sized enterprises”, which often becomes “SMEs and midcaps”, so actually including firms with several hundred employees. The broader the target, the easier it is to shift money. And the broader the target, the more likely it is that the public investment bank is just funding loans that would have happened anyway, and the more difficult it is to tell whether that is the case.

But imagine you just target very narrowly, like just microenterprises or just coops, then your lending may be very large in relation to the targeted sector and it is difficult to meet your lending targets without a lot of real extra investment taking place. Shifting the money then takes a lot more effort, but you can be a lot more confident that the effort actually has an effect.

So there is a need to focus on achieving real transformation, not just on lending a certain amount of money. Lending ₤250 billion over ten years shouldn’t itself be the goal. There is a need for a market-shaping mission-oriented approach to policy that sets a goal of achieving real change and mobilises all the interventions needed to achieve that. Doubling the size of the coop sector, as set out in the Manifesto, is the kind of goal we need to set. Then we can look at what is needed – legal changes, support institutions, finance, etc. – to make that happen. As part of such a mission, the National Investment bank would be charged with making sure the necessary financing is available. It would be challenged to find ways to address the particular financing needs of coops and mutuals, such as new capital instruments, funding worker buyouts or nurturing new banking support networks or “shelter institutions” as discussed in the Alternative Models of Ownership report.

There can be different goals, and I am not against making life easier for small businesses. Raising investment spending by small businesses by £25 billion a year above it’s current rate (requiring that we look at all the drivers of such investment, not just finance) would be an ambitious goal. Within small business financing, we could also prioritise green investment (energy efficiency improvements, etc.) and innovation (although this term is dangerously broad). But for me, perhaps the greatest opportunity for catalysing change lies in targeted support for the coop sector, driving forward the progressive democratisation of workplaces in the UK.

Dare to crowd out the private sector

One striking recommendation of the report to the Shadow Chancellor is the assertion that the National Investment Bank should specifically and exclusively adopt the approach of lending to banks for “on-lending” to SMEs, to “avoid any direct competition with conventional banks”. Even if this is partly about getting around European State Aid rules, it is ideological nonsense. It is about posing no commercial challenge to the existing private banking sector, whilst providing them with an effective state subsidy, as I described above.

We need to challenge the neoliberal story about crowding out. Public banking is just a more efficient way of doing financial intermediation and risk mitigation than a privately-owned banking sector. It is also the only way in which the public can get effective democratic accountability in return for bearing banking risk. So we need to be cautious about using private sector banks as intermediaries, demanding new levels of accountability as a minimum. But going further, we should be developing the capacity of the public sector to do the full job of financial intermediation itself. Instead of subsidising private sector banking, we should be replacing it.

This is not a simple matter. Much lending to SMEs draws on the relationships that are built up between local bank branches and their business clients. A local branch network with a large and experienced staff is needed to successfully appraise the loan applications of businesses, as well as to advise them. This cannot be built up overnight. Nonetheless, it is another example of the kinds of high impact outcomes that we should be working towards.

One interesting option relates to the Royal Bank of Scotland, currently in public ownership. The Labour Manifesto has already pledged to consult on how this might be broken up “to create new local public banks that are better matched to their customers’ needs”. Perhaps, the RBS could become the basis of the new National Investment Bank, with a national network of local branches, federated at the regional level.

The Manifesto has also pledged to “change the law so that banks can’t close a branch where there is a clear local need”. Perhaps the solution here is to nationalise branches that banks want to close, bringing them into the public network. This would not even be crowding-out; it would be a simple case of a public institution providing a public good that the private sector refuses to provide, because it cannot internalise, and thereby profit from, all the value created for the community. On this basis, a certain amount of public subsidy, to keep some branches open in the public interest, would clearly also be justified.

Creating a local branch network also creates important synergies. Because these branches would be publicly run, they could work closely with other public services such as advisory services for small businesses and coops, coop support institutions, public research institutions driving innovation, public planning authorities, and so on. This would cut the costs of getting to know small businesses and lead to better loan appraisal. Together, these institutions could work with businesses to identify their real needs and provide the support they need, including bank finance where that is appropriate.

Such a banking network could really make a difference in addressing small business needs. It could demonstrate the viability and advantages of public banking, beyond the arm’s-length approach of the on-lending model. And if there is a true level playing field – which is to say that private banks are not given the subsidy of a blanket state guarantee without the matching accountability or obligation to provide a public service – then we might find that such a bank is actually rather competitive in relation to the private sector, and might expand, and we might ask ourselves whether we really need private sector banking at all.

“Be the change you wish to see”

We are talking here about setting up a brand new public institution. So there is no need to design it like a throwback to the 1950s. We need to learn from experience and explore new public service models that move away from top-down command management and foster accountability to workers and the communities served.

The governance model set out in the report to the Shadow Chancellor could be worse. It would allow for some high-level accountability to elected politicians across the country, avoiding the dominance of Westminster. But it is also really the minimum, lacking in ambition. The idea of operationally autonomous “regional” branches in Scotland, Wales, Northern Ireland and the English regions is also a step in the right direction, but a small step.

In fact, it is the idea of going beyond regional branches, to have local branches, that really opens up possibilities for new models of governance and democratic accountability. We should not envision a monolithic, top-down institution, but a network – or federation – of local banks embedded in the municipalities they serve. At this level, we can look at different ownership and governance forms, as set out in the Alternative Models of Ownership report. Local municipal banks cannot have the complete autonomy of worker coops as their liabilities must be guaranteed by the public and the public therefore needs to have a say in how they are run. However, municipal ownership is an option, as would be certain models of locally-led ownership such as community businesses or development trusts. The key point is to embed these banking institutions in local communities to foster direct accountability. It may also make them harder to privatise by a hostile national government.

Internally, we should examine whether these institutions could not be run more like coops. Whilst the community would have to oversee what these institutions do (i.e. their lending priorities, the types of service offered and the quality thereof), it should be their workers that oversee how they are run. It is going to be the workers that best understand the internal challenges of running such institutions and achieving their goals. Communities should decide “What?”; workers should decide “How?”.

At the regional and national level, one option would be to have an institution (or institutions) that is more conventionally state-owned, providing services to local banks, particularly fundraising on the capital markets (although local branches could also fund though deposits – a vital part of providing a local banking service). In this case, accountability to regional and national governments, ideally boosted by worker representation, would be required.

Another option could be to make these regional and national institutions into something like second and third tier cooperatives accountable to the local municipal banks. So the National Investment Bank would be a fund-raising, service-providing cooperative owned by its members, the regional banks, which in turn would be owned by the local banks. In such a system, each local or regional bank would clearly have a narrow self-interest in gaining resources and autonomy, but each would also clearly have an interest in the responsible behaviour of all members, so the idea is that mutual oversight would serve to ensure the responsible functioning of the federated network as a whole. Nonetheless, in return for a state guarantee, it would be wise to also set up an independent public institution, accountable to the national government, with responsibility for monitoring and auditing, to build and maintain confidence in the financial soundness of the network on behalf of the general public.

Such a decentralised, democratically run banking network would be a radical step in the direction of a democratic, socialist financial sector.

Seeking room for manoeuvre for radical change

Perhaps this article risks getting carried away with what might, one day, be possible. A Labour government will not be in a position to take abstract blueprints off the shelf, to implement them as it wishes. The question is rather one of what such a government might be able to achieve within the bounds set by “capital”, particularly the internationally mobile variety, the power of which does not rest on the results of elections.

Part of the intent behind the Manifesto proposal for a National Investment Bank lies in a desire to implement a significant Keynesian stimulus programme through investment spending. This is not, in itself, anything anticapitalist and there may well be room for manoeuvre in this direction. It would be very welcome, helping to reverse some of the damage done by austerity. But nonetheless, I am not sure that lending to banks in the hope that they lend more to SMEs should be a priority for this stimulus programme.

At the same time, the National Investment Bank is also being seen as an opportunity to effect a more radical, yet gradual, transformation of our financial system. Here what matters is not quantity but quality. What matter is that we use the opportunity we may have – even if the numbers are much smaller – to target first steps in a process of fundamental change in the nature of our economy. Support to the cooperative sector seems key here. But so is the idea of making the bank a real public alternative to the private financial sector, from the local branch level upwards, even if this has to start from small beginnings. Lastly, if we are to set up a National Investment Bank, we can use this as an opportunity to pioneer new approaches to public ownership and democratic accountability.