Don’t Be Afraid of a Municipal Bank There’s so much to be gained.

Original Article: Philly Mag

Lately there has been much talk about the merits of a municipal bank here in Philadelphia. Mayoral candidate Anthony Hardy Williams has been touting it as a part of his mayoral platform; and Nelson Diaz thinks it’s a good idea too. Lynne Abraham, in classic Lynne Abraham fashion, shot the idea down saying, “That scares me.” Philly Magazine’s Patrick Kerkstra added, “City Hall often struggles to deliver basic municipal services as well as city residents would like. Now it’s supposed to act as a banker, too?”

Well actually, no. The city would not act as a banker. The reasons the concept “scares” people is because 1) they don’t understand banking or the banking industry generally, and 2) they don’t understand municipal banking specifically. The third most damning reason is that Philadelphia just doesn’t think big enough. We are quick to talk about what we CAN’T do, and hesitant to dream about the great things that we CAN do. So I decided to talk to someone who DOES know something about municipal banking: Mike Krauss, Chairman of the Pennsylvania Municipal Banking Project.

Krauss helped to dispel a few myths about municipal banking and showed me a successful model:

The City Will Not Operate a Bank

The City of Philadelphia will create the municipal bank. However, it will not run the bank. Because public banks partner with community banks in making loans that extend credit into their communities and do not compete as retail banks, public banks need no branches, tellers, ATMs or broad and expensive marketing. As the Pennsylvania Public Bank Project notes, “Public banks are chartered to serve the public not exploit it. Hence, there are no mega salaries, bonuses or commissions to provide incentives for imprudent risk taking. The business model of public banks means that its profits are returned annually to the municipal general fund and reinvested in growing the partnership loan portfolio. This helps balance the operating budget without raising taxes, cutting vital programs, taking on more debt, asking for givebacks from employees or raiding pension funds.”

A Municipal Bank Can Work and Can Grow Philadelphia’s Economy

A prime example of a successful public bank is the public Bank of North Dakota (BND). BND earned $94 million last year in profits for North Dakota’s 740,000 residents. BND deposits roughly half its profits into the State’s general budget and uses the other half to increase its capitalization in order to make more loans. In the past decade, BND has returned over $300 million to the general fund. In addition to lending based on a formula that includes both its public deposits and its capitalization, BND also has access to low-cost Federal Home Loan Bank capital. BND is not required to contribute to FDIC insurance because it is not a retail bank and it is backed instead by the full faith and credit of the State of North Dakota. This and its partnership arrangements with local banks lower its operating costs considerably. The BND has averaged more than 25 percent return on equity over the past 16 years. Since 2008, BND’s annual return on investment has been between 17 percent and 26 percent.

The Pennsylvania Public Bank Project estimates that the startup phase of a new public bank during which time it attains profitability is from two to three years; less than the three to five year range for commercial de novo banks. This is because of the regularity of its deposits and outflows combined with its unique partnership business model.

If Philadelphia replicates North Dakota’s model, we can create astonishing economic growth and a new non-tax revenue stream that can support our schools, fully fund our pension, etc.

A Municipal Bank Can Play a Huge Role in the City’s Economic Development

Not only do public banks return profits to the municipality as non-tax revenue, but by providing reliable and affordable credit, they facilitate economic development, create jobs, and grow the tax base. Further, public banks can reduce public debt and the debt service costs loaded onto annual municipal budgets. A public bank allows a municipality to direct local lending, offer below market-rate loans, and leverage other capital for specific public purposes such as affordable housing, neighborhood development, infrastructure, small business development, education, and job creation. Loans for qualifying entrepreneurs are offered at a 1% interest rate.

Like North Dakota, dedicated loan funds in Philadelphia can be set up in the bank’s charter and it can modify its loan portfolio priorities from year to year with input from board members, local government and the public. A process like the participatory budgeting already used in cities such as New York and Chicago would allow for public input to help set broad portfolio priorities, without designating specific investments, something done by professional bankers and lending officers. Credit becomes local and supports longer-term investments. Partner banks facilitate hiring local contractors rather than large out-of-state companies often favored by directors of major, private banks.

Because quarterly profits for stockholders are not paramount, the public bank and community bank working in partnership can invest for the longer term. Some profits, such as that from a highway improvement that brings in new business may not be measureable in quarterly increments. Because local banks in North Dakota are supported by a public bank, they are able to make a greater proportion of small business loans than banks in other states. Ellen Brown wrote:

Over the last ten years, the amount of lending per capita by small community banks (those under $1 billion in assets) in North Dakota has averaged about $12,000, compared to $9,000 in South Dakota and $3,000 nationally. The gap is even greater for small business lending. North Dakota community banks averaged 49 percent more lending for small businesses over the last decade than those in South Dakota and 434 percent more than the national average. In other states, increased regulatory compliance costs are putting small banks out of business. The number of small banks in the US has shrunk by 9.5 percent just since the Dodd-Frank Act was passed in 2010, and their share of US banking assets has shrunk by 18.6 percent. But that is not the case in North Dakota, which has 35 percent more banks per capita than its nearest neighbor South Dakota, and four times as many as the national average. The resilience of North Dakota’s local banks is largely due to their amicable partnership with the innovative state-owned Bank of North Dakota.

In 2010, the Center for State Innovation published a study analyzing the effects of moving Massachusetts State Funds from large banks (assets greater than $100 billion) to medium banks (assets of $1 billion to $10 billion) and small banks (assets less than $1 billion). This complex study included bank limits to absorb deposits and the willingness of different sized banks to lend. The study found that for each $10 million moved, small banks created between 4.50 and 7.23 jobs and medium banks created between 4.67 and 5.75 jobs. This was simply the result of moving deposits. With a partnership public bank, the entire lending system is refocused to create local jobs. Community banks tend to make loans to local businesses that create the bulk of new jobs. By contrast, large banks tend to rely on computerized FICO models that eliminate most businesses requiring less profitable loans of below $5 million. Apparently these banks not only exclude “relationship” criteria, they are eliminating loan officers.

Now there is much more to this municipal banking conversation. For the sake of brevity, I will end with these points to consider here in Philadelphia:

  • Municipal banks are a way to generate additional non-tax revenue.
  • By providing affordable and reliable credit, municipal banks facilitate economic development, create jobs, and grow the tax base.
  • Municipal banks reduce public debt and debt service costs.
  • Municipal banks reduce banking costs and maximize return on municipal deposits.
  • Municipal Banks are more secure than banking with large Wall Street banks.

My only question is “Why wouldn’t we want that?” Is our failure to think big the only thing that is holding us back?

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