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Learning to weigh up the risks

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The collapse of Iceland’s three banks has certainly had a big effect on councils, their finance directors and elected members. And they have no intention of being caught out the same way again.

The Chartered Institute of Public Finance & Accountancy’s assistant director local government, Alison Scott, says that councils have made important changes in policy and practice since the crisis hit.

“There is greater member scrutiny than before,” she says. “Certainly we have now engaged with members much more in terms of treasury management.

“It has moved much higher up the agenda. There is a much better understanding of what treasury management can achieve, but also what the risks are,” she adds.

Councils are now looking to a wider range of information sources to help them make their investment decisions, including the pages of the Financial Times, and referring to credit default swap rates, Ms Scott says.

Becoming wary

Local authorities have become wary of exposure to particular countries. Many councils had investments in all three Iceland banks - now the lesson, for example, is not to have multiple exposure to Irish banks.

She adds that the initial “massive flight” to put money in the Debt Management Office has tailed off as councils realise the cost of taking this option.

One of the hidden realities exposed, not just by the Icelandic crisis but also by the collapse of Lehman Brothers, was that local authorities were often engaged in strings of transactions, and it was not always clear who all the counterparties were.

That risk of exposure to counterparties has been made much more transparent in recent months, says Ms Scott.

Change in policy

John Simmons, Kent CC’s cabinet member for finance (Con) - himself an ex-banker - reports significant change to investment policy and practice in his authority since the Iceland banking crisis put £50m of council taxpayers’ money at risk.

“We are a large authority and at most times we have £400m in funds available,” says Cllr Simmons.

Investment policy practice is, therefore, very important to the council. Yet in the immediate aftermath of the Iceland crisis the authority moved its balances to the Debt Management Office, where it received a mere 0.25% to 0.30% interest.

One of the messages absorbed by Kent was that the global failure was so systemic that potential investment losses could have been much greater.

“There but for the grace of God could have gone RBS and Halifax,” admits Cllr Simmons.

As Kent drew up its revised investment policy, the council considered CIPFA’s investment guidance, which was revised in September. The authority also carefully evaluated its counterparty exposure.

“One thing we have put in place that was not there before is country exposure,” says Cllr Simmons.

Perspectives on risk

Another is “group banking exposure - who owns what”. A further consideration is “reputational risk”, with the Financial Times and other sources read more carefully to obtain a variety of perspectives on market risks.

“Previously we had relied on the credit ratings agencies,” says Cllr Simmons. “When push came to shove, the ratings system was found not to be the flexible beast we would have wished it to be. The advice did not, perhaps, keep pace with what was happening in the market.”

Questions are now more likely to be asked about how much exposure a bank has to a particular asset class, such as property.

There is also a smaller list of institutions in which the council will place its money - these are limited to the Government’s Debt Management Office, Abbey National Treasury Management, Barclays, HSBC, Lloyds, RBS and, just added to the list, the Nationwide Building Society.

Stricter limits

As well as restricting the number of institutions in which funds are placed, there are stronger limits on the size of deposits - the cap is now a strictly observed £40m maximum per counterparty - and a maximum investment period of six months.

With a shorter investment time frame, Kent is now better placed to respond to any changes in the credit rating of institutions and governments.

And that, explains Cllr Simmons, includes the UK’s own rating. After recent experience, Kent is in no mood to take any chances.

Paul Gosling , ‘Financial Agony Uncle’, The Independent

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