Does the UK’s financial services sector only exist to drive profits for shareholders? Can we hard-wire deeper social and environmental purpose into our financial institutions? The burgeoning purpose-driven banking sector in the UK is key to securing a sustainable, democratic and resilient system for all, but how do we ensure it continues to grow in the face of one-size-fits-all regulation and lack of long-term capital? Driving awareness will be the first step.  

At Finance Innovation Lab’s virtual event, ‘Building Purpose-Driven Banking’, industry experts gathered to check the pulse of the UK’s purpose-driven banking sector, explore the key barriers to its growth, and brainstorm how they can be overcome.

In December 2020, Finance Innovation Lab published a discussion paper, written by senior fellow, Dr Gemma Bone Dodds, which defines purpose-driven banks as financial institutions that are led by a positive social or environmental mission, and have embedded this ethos in their ownership, governance, culture, and leadership practices – in other words, meeting environmental, social, and governance (ESG) criteria.

The paper points to five types of institutions in the UK that today meet the definition of purpose-driven banks, namely:

• credit unions,
• community development financial institutions (CDFIs),
• building societies,
• sustainable banks, and
• mutual banks.

Each of these types of institution were represented at Finance Innovation Lab’s event, during which experts discussed how to overcome some of the key challenges for the continued growth of the purpose-driven banking ecosystem in the UK – including one-size-fits-all regulation, lack of capital, and scaling up.

One-size-fits-all regulation

In a post-event interview with Finextra, Neil Sellers, Head of Credit risk, Triodos Bank UK, said that updating existing banking regulations is key to ensuring the UK’s nascent purpose-driven banking sector continues to grow.

“Regulation has adopted a one-size-fits-all approach”, said Sellers. “The same regulation that seeks to prevent further RBS-like crises – and is aimed at banks with massive, complex balance sheets, huge footprints and impact costs – applies to entities like Triodos Bank, with our billion-pound balance sheet and 800 borrowing customers. Regulations need to take a tiered approach and implement sandboxes for nascent purpose-driven financial institutions.”

Founded in 1980 in the Netherlands, Triodos Bank is a sustainable financial institution, whose approach to banking is informed by Rudolf Steiner’s philosophy of anthroposophy. In a practical sense, this means providing sustainable financial products that enable individuals and organisations to deploy capital in ways that benefit the environment and society-at-large. In 2020, for example, Triodos Bank financed green electricity from 561 energy projects for 700,000 households worldwide – contributing to the decarbonisation efforts of a number of economies.

There is, however, more that can be done in the UK to support entities like Triodos Bank with their work. Speakers at the event agreed that regulation must be updated to suit the needs of purpose-driven banks. This sentiment is reflected in Finance Innovation Lab’s 2018 report, “The Regulatory Compass: Towards a purpose-driven approach to financial regulation”, which argues that rather than being purpose-neutral, banking regulation is currently designed around the large, shareholder-focussed firms that dominate the UK market.

However, positive regulatory change may be on the horizon. The UK government has already discussed plans to create a new regulatory regime for small banks – acknowledging the need for different kinds of regulation for different kinds of financial institutions.

In addition, the purpose-driven banking sector has garnered support from within the House of Lords. On 22 February 2021, Lord Chris Holmes spoke in favour of improving rights for small and medium-sized enterprises (SMEs) at the Committee Stage for the Financial Services Bill – highlighting the power imbalance that is occurring between small businesses and large, mainstream financial institutions.

Another solution to support purpose-driven banks could be to reform competition law, suggested experts at a workshop held by Finance Innovation Lab on 19 March 2021: “Competition law is preventing networks of smaller purpose-driven institutions, such as mutual banks, from collaborating to achieve economies of scale.”

Clearly, banking regulations in the UK need to be re-examined and specialised.

Lack of long-term capital

Until then, Triodos Bank is able to support other purpose-driven financial institutions by providing capital for lending. One of its beneficiaries, a CDFI called Responsible Finance, was represented at the event by Eleanor Pughe, who argued that strong mainstream banking support, and securing long-term capital, will be key to ensuring the sector continues to grow.

A national membership body for responsible finance providers, Responsible Finance aims to create a fair financial system in the UK by helping to scale up the community development finance sector. As a not-for-profit organisation, with no shareholder to generate returns for, Responsible Finance bridges the financing gap for people, businesses and social enterprises that are unable to secure loans from mainstream lenders.

Some businesses, for instance, may be unable to borrow as a result of being new to the market; having recent trading losses; or lacking assets to act as loan security. Indeed, 90% of CDFI business loans go to those who have already been rejected by another lender, explained Pughe.

Social enterprises, meanwhile, can struggle to access finance due to being considered an unworthy investment by profit-driven lenders. Individuals, on the other hand, that have defaulted on a loan in the past, but are on a more stable financial footing and cannot get it reflected in their credit score, will also find it challenging to qualify for a loan from a mainstream bank.

CDFIs like Responsible Finance serve to support these kinds of customer, by looking in-depth at loan applications, and basing their lending decision on a number of factors – as opposed to simply a credit score, or recent trading history. In addition, shareholder return is not a priority for CDFIs, which means the potential positive impact of the loan is considered, instead of purely the profit that can be made from it.

This model has powerful implications. In 2020 alone, revealed Pughe, CDFIs helped protect 7,000 jobs in the UK via Coronavirus Business Interruption Loan Scheme lending.

Yet, despite this potential, many CDFIs require further investment to upscale their work. To address this lack of long-term capital supply, experts at the event agreed that the use of public finances to support the purpose-driven banking ecosystem in the UK is a viable option – as demonstrated successfully in countries such as Germany, where over 60% of its banking is purpose-driven.

Stimulating private capital to flow to the sector will be key, too – be it via tax breaks or guarantees, for example.

Scaling up

Growth, however, can bring with it a number of unique challenges. For instance, how should a purpose-driven bank – which is predicated on its close relationships with customers, clients and the local community – scale up, while also retaining the human angle that is so fundamental to its work?

This human centric ethos was a common theme at Finance Innovation Lab’s event. Sellers said it is key to achieving effective sustainable development: “Fintechs can be too focussed on technology, as opposed to valuing the human perspective. For instance, while satellite data can be effectively deployed to identify areas of land that are suitable for agriculture, it does not factor in the skill of the prospective farmer. This, arguably, is the most significant variable.”

Despite this, Sellers also acknowledged that partnering with select fintechs may be one means by which purpose-driven banks can meet the inevitable technological demands associated with growth, while also staying close to customers.  

Perhaps this idea can be put to the test by the small number of mutual banks that are starting to emerge in the UK.

Representing Northern Ireland-based mutual bank, Northern Mutual, at the event was its Co-Founder, Dr Bridget Meehan, who explained that all its investments go back into the region. As such, mutual banks focus on supporting small businesses, and local farmers, who are typically neglected by mainstream banks in the region.

This kind of banking produces a halo effect within financial institutions themselves. Indeed, it is much easier to create a motivated group of colleagues within a bank if they can see positive impacts occurring in communities as a result of the work they are doing, as opposed to, for instance, reporting strong top-line figures.

Valuing financial inclusion and reducing the focus on profit, mutual banks like Northern Mutual are rising steadily across the UK. However, as Sellers noted, the real challenge will be remaining close to the community, while at the same time developing new technologies to remain competitive, efficient, and support growth.

Driving awareness

It seems the overarching barrier to the continued growth of the UK’s purpose-driven banking ecosystem stems from a lack of understanding of its nature and aims – an issue that comes from the sector’s underdevelopment, and the dominance of mainstream banks. Whatever the cause, these factors have contributed to misaligned regulations, slow customer acquisition, and limitations regarding the extent to which purpose-driven financial institutions can work together.

Going forward, more educational initiatives will need to be introduced, perhaps even as early as at business school and university – where sustainable or purpose-driven business models are not yet widely taught. If this happens, we may be able to transform the UK’s banking sector, which, unlike many other European countries’, is predominantly constituted of shareholder banks.

In recent years, the UK has undergone some promising developments in the area of purpose-driven banking, but we still have a long way to go.