When is the reward worth the risk for councils?

Thursday, June 11, 2009

A committee of MPs has criticised councils for putting taxpayers' money at risk in high interest bank accounts. CIPFA's Alison Scott looks at the impact of the Icelandic bank collapse on local authorities

The collapse of the Icelandic banks in the autumn has put local authority treasury management under the spotlight. It should be seen as a strength that no local authority was placed in severe financial difficulty as a direct result of the money at risk in the country – all authorities had invested their cash across a number of institutions and all could meet immediate demands on spending.

At the time of writing it is still not clear how much of the money at risk will be eventually lost. The government has stepped in so that authorities will not need to write off any money at risk immediately. The eventual impact of any losses will depend on both the size of the losses and whether the government is willing to issue capitalisation directions to allow authorities to spread the cost over a number of years.

Of greater immediate impact to all local authorities as they set their budgets has been the reduction in interest income all are facing as a result of the credit crunch and falling base rates. Authorities have always put security of investments above return; the current climate is placing even more emphasis on ensuring that invested cash is safe.

Given bank collapses and takeovers, authorities have an ever decreasing number of institutions with whom they can invest, a situation which makes diversification problematic. An increasing number of local authorities are choosing to invest surplus cash with the government through its deposit taking facility with a resulting loss in interest income. The loss in investment income is being particularly hard felt by district councils as typically this represents a much greater proportion of their overall budgets. These are the same authorities that are suffering from reductions in fees and charges – such as planning fees and parking charges – due to the economic downturn.

There are a number of issues emerging from the review of local authority investments following the collapse of the Icelandic banks. Perhaps one of the key ones is how councillors are fully involved in treasury management decisions and how we equip them for the task.

We should first acknowledge that we are starting from a position very different from that which we were in when BCCI collapsed a number of years ago. The introduction of the CIPFA Treasury Management Code, the Government's Investment Guidance and the Prudential Code mean that the annual investment strategy and treasury management strategy are approved at the meeting of full council that agrees the budget for the next year. This means that all councillors should be aware of the organisations being invested in and the maximum amounts that can be put with each of them.

Whilst the decision is rightly taken by full council, there is a question as to whether the significance of the decisions being taken is properly recognised or understood. The best authorities will ensure that key figures are brought in within the main budget report and that the decision is subject to discussion either within the Executive Committee or Overview and Scrutiny.

Moving forward we need to ensure that we are equipping councillors with the skills they need, not to duplicate the work of the professionals on whom they should rely, but to be able to understand the potential investment risks the authority is taking and to ask the right questions. There would clearly seem to be a role for audit committees in reviewing treasury management strategies as this is a key focus for building financial understanding and knowledge with councillors. CIPFA will be looking at the support and tools it can provide for councillors to help develop this capacity.

Looking to the future, it is clear that the future investment environment for local authorities will be different from that before the credit crunch, and that stability in the banking sector is some way off. The challenge is to provide for local authorities the additional advice that will remain pragmatic and practical. To illustrate the point, there has been much discussion about the role and effectiveness of credit rating agencies in reacting to deterioration in a bank's standing but it would not be practical to suggest that local authorities could carry out this function for themselves; they clearly do not have the skills or resources. A more pragmatic reaction would be to reduce the reliance placed on any one rating through a lowest common denominator approach and to use other sources of information where available to temper their views.

CIPFA will continue to build the skills and knowledge of those involved in treasury management in the public sector. We already provide written guidance, conferences and the Treasury Management Forum and have included treasury management in our professional syllabus. Even before recent events, we had acknowledged a need for a further specialist qualification. CIPFA will shortly be launching a joint qualification with the Association of Corporate Treasurers to improve the treasury management skill level in public services yet further.

A revised Treasury Management Code and revised Guidance will emerge from the review following the collapse of the Icelandic banks but these will be very much about improving what is there rather than a revolution in the way authorities invest. It is clear that the underlying framework is sound with its emphasis on risk above reward and that the banking sector will eventually stabilise. We need to ensure that local authorities retain the ability and skills to continue to effectively manage their treasury management activities.