Tag: banking

The Mondragon bank – an old model for a new type of finance

Oscar Kjellberg

A new type of institution is needed to handle non-debt finance. It should help promoters plan their projects and then find outside investor-partners in return for a share of each project’s income rather than its profits. This is essentially how the Mondragon co-ops’ bank used to work.

Imagine yourself as a bank manager in a small community 50 years ago. Your friends and neighbours have their current and savings accounts with you and when they need to borrow they come to tell you about their ideas. You know most of the locals and it is not difficult for you to tell whether a proposal is going to work. Your decision is based not only on the idea’s potential commercial viability but also on the individual’s personal ability, skill and support network. 

But times have changed. Bank managers in small communities do not have the authority to give bigger loans any more. Instead, the bank that owns the branch channels the community’s savings into what it believes to be the most profitable segments of a near-global capital market. It will only lend to the people in the community if it can get a safe mortgage charge over their houses but, even here, the bursting of the housing bubble has made the bank wary about their ability to repay. On average today, people, companies and governments carry much more debt than in the past. 

Banking worked very well as long as there was steady economic growth and customers were not too heavily in debt. However, economic degrowth will make it much harder for banks to find customers with a good chance of being able to repay the loan with interest in due time. 

The coming energy crunch will lead to volatile prices and an overall long-term economic contraction. The opportunities for banks to lend in this environment will shrink for two main reasons. The first is that peak oil will change the relative prices of land, labour and capital and make our contemporary society uneconomic because it uses too much energy. All our capital assets will lose value because they are energy inefficient. That will force everybody to reduce their debts much more than we have so far during the current financial crisis. The second reason is that the price volatility will make the risk of losing money on new investments much higher than in the past, especially as the process of developing a new technological and institutional structure and a new way of organising production is inescapably unpredictable. 

So, the Golden Age of banking lies behind of us, and yet we are facing the biggest need for investment in history in order to make the transition to a sustainable way of life. But if that need cannot be financed by the existing banking system, a new non-debt system for saving and finance has to be developed. 

In principle, this new system should do the exact opposite of what ordinary banks are doing. They try to avoid risk by forcing entrepreneurs to bear as much of it as possible. That will not be possible in the future. The higher level of risk has to be shared by all, under arrangements that make savers and entrepreneurs partners in their investments —for profit or loss. 

Two sorts of arrangements along these lines have been discussed in this book already. Under one, savers could exchange their money for a bond that promises to deliver real things like electricity when it matures (Douthwaite). Under the second, savers could become equity partners with the entrepreneurs (Cook). It is, however, not an easy task to knit partnerships like these together and somebody needs to have the knowledge, skill and time to do it. In other words, we need a new type of institution that would arrange the “meeting” between savers and entrepreneurs where they can develop their relations and discuss their ideas. We need professional, trustworthy and respected financial experts who can help us find sound financial solutions and create the partnership agreements. 

It is not possible for existing banks to shift from making loans to building profit-and-loss partnerships; they are much too big and too disconnected from local communities. Moreover, they are tightly regulated by the state, particularly after recent events, and they have a bureaucratic risk-avoiding outlook that does not equip them well to become members of a risk-sharing partnership.

The institutions I envisage would work in much the same way as did the bank at the heart of the Mondragon co-operatives in the 1960s. There, if a group wanted to start their own business as a workers’ co-operative, one of the group would join the bank staff, on normal pay, to work on the business plan with a ‘godfather’ — someone who specialised in helping new businesses start up. Then, when the godfather judged that the plan and the group were ready, he (they were all men in those days) put the project to the bank board and funding would be approved. The godfather then helped the new business establish itself, perhaps by advising on equipment and making sure the accounting system was running well. The money the group received from the bank was nominally a loan, so the business knew how much it was expected to pay its partner each year; but in reality the risk was shared and the bank’s agent, the godfather, and the members of the group were equally committed to the project’s success. No projects failed under this arrangement.

In its modern form, the institution we need could be a mixture of a (non-debt) savings bank and a meeting place for all the savers and entrepreneurs in a community. Instead of being a “credit union” it could be called an “investment union” (IU) to emphasise its co-operative character. The job of those running the IU would be to help an entrepreneur develop his or her idea, until the IU had sufficient confidence in it, and in the people involved, to be able to recommend that savers put up the required capital in exchange for a specific share of the project’s income. The IU would be paid for its efforts by taking a share of the income itself, as would the entrepreneurs. This would ensure that all the partners were fully committed to the project’s success. Once the project was running, the IU would make a market in the shares and, while savers would be allowed to sell whenever they wished, the IU and the entrepreneurs would only be allowed to reduce their holdings with the consent of everyone else involved.

Some investment unions could be purely local and deal with a wide variety of projects. Others could be more specialised and work over a wider area. For example, they might confine themselves to energy projects and build up a lot of technical expertise. Some might be akin to unit trusts, so that every member had a stake in everything. Others might allow savers to decide on their investment portfolio themselves.

Whatever form they took, investment unions would need to perform their social financial process continuously — because a continuous flow of saved money is required to help entrepreneurs finance their continuous stream of projects. Equally, savers need to be able to get frequent access their money to build their houses, to educate their children and to spend in old age. This continual process would be an incredible learning opportunity for the local community, over the years, as a stream of investment projects began as ideas were evaluated, financed and launched and then evaluated again and again while in operation. Apart from the incomes, much knowledge would be accumulated and strong personal ties, the bedrock of every community, would be developed.

A three-step emergency plan for Ireland

by Richard Douthwaite

STEP 1 Introduce non-debt money

The country is trapped by its debts. Its immediate goal has to be to escape and achieve a much greater degree of financial freedom. The current strategy for doing so relies on running a large surplus of exports over imports for a decade or more and making repayments and meeting the interest charges out of that. In essence, this means earning money which people in other countries have borrowed and using it to decrease Irish borrowings. This is going to be a very difficult trick to pull off even if the global economy grows strongly for the foreseeable future because strong global growth is almost certain to increase Ireland’s energy import costs, thus eroding its export surplus. Moreover, as the growth could also increase the interest rates payable on its debts, the country would be forced to try to run up a descending escalator. Two other possible strategies have a much better chance of success.

1. Collective action within the eurozone

All eurozone countries have debt problems — even Germany’s ten biggest banks were reported in September 2010 to need €105bn in additional capital to buttress their solvency. This common debt problem creates the slim possibility that the European Central Bank will be persuaded by increasing social unrest to create money out of nothing by quantitative easing and, totally abandoning its orthodoxy, to give it to governments in proportion to their populations so that further public spending cuts can be avoided and their national debts reduced. Private debts need to be reduced too so every EU citizen should be given some of the ECB money to reduce their borrowings. People with no debt would be required to invest their gift in ways that would lead to a low-carbon economy — the money would be distributed in such a way that it could not be used directly for consumption spending.

Small, carefully controlled amounts of non-debt money could be injected into the eurozone economy at regular intervals until public and private debt levels had been brought into better balance with public and private incomes. The immediate effect of this quick-and-easy-to-implement approach would be to take pressure off the banks by reducing their lending, thus improving their capital-adequacy ratio. Their bad debts would be reduced and the additional economic activity the new money generated would make it easier for their customers to service their remaining debts. Asset values would cease to fall and may even begin to rise again, thus improving the banks’ security.

The public, which has been angered by the fact that the banks are being bailed out while ordinary families in negative equity have been ignored, would be enthusiastic about their debts being cut. They would regard the scheme as fair as everyone would be being given the same amount of new money. They would also welcome the fact that public services were not being reduced.

It is hard to say what effect injecting money in this way might have on the value of the euro. It might fall initially on inflation fears but recover later when it became clear that the eurozone economy was doing well and the banks and public finances had been stabilised. Any fall in the value of the euro would help with recovery, of course, as it would increase the zone’s competitiveness and mean more internal production for internal use.

2. An internal solution

The collective solution above should be promoted at EU level but, such is the level of monetary conservatism in Germany, it is most unlikely to be adopted and Ireland will almost certainly need to take an independent way out. Its attitude should be that if the ECB will not provide it with debt-free money, it must provide its own and that it is going to launch a currency to run in parallel with the euro. This could be done in the following way.

  • The new currency, the harp, would be announced as an emergency measure. It would be entirely electronic and used only to trade. It would not have any guaranteed exchange rate with the euro although, initially at least, the government would accept it at parity with the euro for the payment of taxes. The commercial banks would be instructed to open harp accounts for each of their customers. Individuals with accounts in more than one bank would be asked to nominate the bank at which they wished to hold their harp account. A quantity of harp would be deposited in each individual’s account to allow him or her to buy goods and services. They would transfer the harp they received to each other and to companies using their mobile phones for small amounts and from their computers or through their banks for larger sums. No harp notes and coins would be issued. This is essential if the currency is to be removed from circulation later on. Their absence also gets around Article 105a of the European Treaty which states that “The ECB shall have the exclusive right to authorise the issue of bank notes within the Community.”
  • Firms would open harp accounts but they would not be given an initial float; they would be expected to earn their harp by supplying the public. It would be up to each company to tell prospective customers which goods and services they were prepared to supply for payment entirely in harp and, if they wanted a mixed currency payment, the price in a combination of euros and harp. Similarly, it would be up to employers and employees to negotiate what proportion of wages could be paid in harp.
  • Harp accounts would not be confidential; the issuing body would have access to them, regardless of the bank that provided them, so that it could manage the system.
  • As the volume of business being done in harp increased, the issuing body would watch the velocity of circulation closely and, once it had crossed a previously announced threshold, it would give more harp into circulation by adding them to the accounts of those who had the highest velocity themselves. However, the harp given to accountholders initially or to enable them to trade more actively later on would not belong to them. Anyone whose velocity fell below a certain level would have a percentage of the harp they had been given removed. This would enable the supply of harp to be kept tight to maintain its value. So, for example, if the euro economy began to pick up and less trading was done in harp, unearned units could be removed from the slowest accounts.

A parallel currency on these lines would attract much less criticism from the European Commission, the ECB and the other member states than a decision to leave the eurozone to revert to a national currency. It would also be much simpler and less disruptive. The government would naturally point out to its partners that if the euro became abundant again and the harp ceased to be used so much, units would be withdrawn. Eventually, it would say, the harp system could wither away entirely because companies would not want to be bothered with keeping their books in two currencies and would stop accepting it. However, if the analysis in this book is correct, such a withering away would be unlikely to happen unless the euro, too, was issued on a non-debt basis.

The introduction of the harp would be very popular with the public. After months of what has been seen as the bailing out of the better-off, the state would be seen as doing something for ordinary people. Anyone with euro debts would immediately find that their problems were eased because, now that they had the harp for some of their expenditure, they could use their euros to keep up payments to their bank. This would immediately cut the banks’ bad debts and thus the risk of the state’s guarantees being called.

The government itself would be able to avoid public spending cuts cuts by paying a proportion of its social welfare and salary costs in harp. Moreover, the extra activity in the economy would increase its tax revenue, reducing the number of harp it had to issue to balance its income and expenditure.

STEP 2 – Restructure the financial system

All banks borrow short and lend long. This means that they are always technically insolvent and only the depositors’ confidence, supplemented where necessary by state guarantees, ensures that they — and the financial system — remain in business. This timing imbalance contributed to the credit crunch when some banks, Northern Rock and Anglo Irish among them, found that they could not replace their short-term borrowings with new ones when the former had to be repaid.

In future, banks should be required to match their periods for which they lend with the periods for which they have borrowed from their depositors. Moreover, bank lending should be limited in term. It should be purely to enable their customers to overcome temporary imbalances in their inflows and outflows. Long-term funding should be handled by new institutions on a different basis, such as equity partnerships.

Step 2 therefore involves getting long-term lending off the banks’ books and onto those of the new funding organisations. This could be achieved if the banks put their property loans into equity partnerships in exchange for shares that they then sold on to private investors and pension funds. This would allow them to climb down from the grotesquely over-exposed property position they built up during the boom. Over 80% of the loans the banks made in 2006 were property related. As a result, 63% of the loans they had outstanding at the end of 2009 were to do with property whereas only 1.8% were to manufacturing industry. up and less trading was done in harp, unearned units could be removed from the slowest accounts.

As it is currently structured, three conditions have to be met simultaneously before the Irish property market can work properly. These are:

  1. potential buyers/lessees have to be confident that property prices and rents are not going to fall, leaving them either in negative equity or paying a fixed rent that makes their business uncompetitive
  2. potential buyers/lessees have to be sufficiently confident about their future incomes to be happy about taking on long-term commitments
  3. long-term finance needs to be available at affordable interest rates.

Conditions 1 and 2 can never be met in a shrinking economy so it is immaterial whether loans would be available or not. With equity partnerships, however, the situation is quite different as no-one gets locked into a long-term rental agreement and declining property prices do not matter because the assets acquired at current prices are never going to be re-sold. All that concerns investors in equity partnerships is the income they get from the rents, and those rents move up and down according to market circumstances. The widespread use of equity partnerships or something similar is therefore essential for a functioning economy in circumstances in which incomes are likely to decline.

STEP 3 – Invest in energy independence

Ireland’s third target should be to achieve energy independence. It should finance this by setting up an agency to sell energy bonds, each of which would entitle the owner to the value of a specific amount of energy at some specified date in the future when the facilities that were built with the capital raised by the bond sales had come onstream. The agency, which would also make a market in the bonds so that holders could sell them before maturity, would work on both community and national level.

Community level

The agency’s community energy division (CE) would be invited by communities to study their potential renewable energy sources and produce a report on how they might be developed and the cost of doing so. If the community decided to go ahead, it would set up a company and CE would act as a consultant to that company. Suppose, for example, the locality had wind, biomass, hydro and animal slurry. CE would work out a way of developing these in combination with each other so that the highest value local energy needs (lighting, vehicle fuel, cooking gas?) were met first and, as far as was possible, whenever there was an electricity flow out of the community, it happened at times of peak demand elsewhere. Equally, if the wind was not blowing and the community had to take in power, the amount taken at peak times would be minimised by putting the biomass-fired CHP plant on full load and running the hydro plant. Smart meters would also help by cutting out low-priority electricity uses temporarily.

An energy bond might be for 10,000 kWh for delivery in December 2015. When it matured, the holder would get whatever the inhabitants of the community were paying for 10,000 kWh at that time. No interest would be paid on the bonds. Instead, those with longer maturity dates would be sold at a lower price than those with shorter ones. potential buyers/lessees have to be confident that property prices and rents are not going to fall, leaving them either in negative equity or paying a fixed rent that makes their business uncompetitive potential buyers/lessees have to be sufficiently confident about their future incomes to be happy about taking on long-term commitments long-term finance needs to be available at affordable interest rates.

Each district would issue bonds to finance its projects but CE would provide a guarantee for them. Its relationship with the community company would therefore have to give it sufficient authority over the management of the projects to ensure that enough power was being produced to generate the income to pay off the bondholders as their bonds matured. CE might, for example, have a management contract. It would charge a fee for its guarantees and for making a market in the bonds. The bonds could be sold anywhere in the world — it would not be necessary for locals to buy them. Equally, it would not be necessary for all the projects which the bonds financed to be in a community’s own area. Some communities would have the potential to carry out big projects and other communities could share in these.

CE would make the arrangements for the electrical component of the community energy company’s output to be fed into the grid. Anyone in the local area who wished to do so could nominate the community company as their electricity supplier and the bill they got from ESB Networks, which would still, of course, read their meters, would be in two parts. One part would be the actual marginal cost to the community company of producing and delivering the units they used. This cost would include the maintenance costs of the wind turbine and the cost of the woodchip for the CHP plant. It would also include the payments for the agency’s services, the cost per unit of using the grid and the charge for top-up and spill, which the design of the system and the smart meters would minimise.

If a kWh cost 15 cents, the actual costs of production and delivery might amount to 5 cents. VAT would be paid on this part of the bill. The rest of bill would be to cover the cost of buying out the bondholders as their bonds matured. This would be a loan repayment and no VAT would be payable on it. Bills for heat or biogas direct from the community company would also be in the two parts.

Two-part bills make the system tax efficient but there is more to them than that. The non-VAT-able part of the bills would be a form of saving for the customer. Each payment a customer made would build up his or her investment in the community company. Once they reached a certain age, however, the savings element would stop and they would only pay the marginal cost for their power. They would also get their capital investment back month by month as a form of pension, paid for by younger customers taking over their stake in the community company.

This savings element would make the system very attractive and the price of electricity from other suppliers would have to be considerably lower than that from the community company for them to be able to compete.

National level

The agency would also stand ready to issue bonds on behalf of the promoters of major projects and to make a market in the bonds it had issued. These bonds would not carry its guarantee, however. Investors would have to rely on the management of the companies concerned, which could always take out performance insurance in the way that film-production companies purchase completion bonds to give comfort to their investors.

The agency’s activities would provide a safe home for Irish savings while at the same time increasing economic activity, much of which would benefit the construction sector. There would be to a rapid acceleration in the pace at which Ireland replaced its imported fossil energy with renewable energy from its own sources.