One point that has been mentioned several times, but not examined, is the need for local businesses to have access to local sources of wealth, for both debt and equity1. In many cases, multi-national banks won’t lend to small businesses, so local financial institutions are the only way for local businesses to access the capital they need to grow. A community that shows broad-based support for its local financial institutions is one that will bootstrap the growth of the community’s wealth by ensuring existing wealth is reinvested locally, instead of globally.
For most communities, the financial system works something like this: people save and invest some part of their income. The savings are deposited in their account with Bank of America, Chase, or Wells Fargo; the investments are made through a mutual fund. The bank takes their deposits and lends that money to large borrowers around the world. The mutual fund manager purchases stocks from companies generally based in Delaware, with their headquarters in a major metropolitan area and operations globally. None of this money that the community saves is loaned or invested to the businesses in their neighborhoods.
The multi-national banks and the mutual funds have trillions of dollars to loan and invest. For them, it’s not profitable to disperse that amount of money in $10,000 increments, which is what small businesses need and can afford. For the multi-national banks and mutual funds, they must disperse the money millions of dollars at a time, which makes it very difficult for small businesses to qualify for loans from the biggest banks. In addition, this creates a competitive advantage for large firms and projects, while reducing returns for the average creditor.
The alternative to this is to save and invest locally. Local financial institutions, generally community credit unions, can create a three-fold benefit for a community:
- Community credit unions provide access to capital for members of the community, both individuals and businesses, who might not otherwise qualify for credit and can provide credit at a lower rate. Due to their small size, credit unions are able to look beyond the basic numbers of credit score, outstanding debt, and income, and make a determination of a persons credit risk based on the whole person. They are able to treat people like people, instead of as a collection of numbers.
- Community credit unions provide higher returns on savings by community members. They can do this due by having lower overhead than large banks, and by passing all of the profit of the bank through to account holders.
- Community credit unions focus investment and economic activity towards members of the community. The wealth of the community is used to reinvest in and grow that wealth.
Unfortunately, community credit unions can only replace the function of banks in society. They cannot serve as a means for equity investment in companies. However, the Jumpstart Our Business Startups Act (JOBS Act), which was signed into law in 2013, will provide a mechanism for a new type of local financial institution to match local businesses that need investment capital with local members of the community who have money to invest. The rules implementing the JOBS Act aren’t due until late 2015, so how exactly this could work remains uncertain, but it will be possible for businesses to take on investments from non-qualified investors in the not too distant future. Communities that take advantage of this change in the law and promote investment into local companies will go a long way towards creating a sustainable local economy.
Local financial institutions, so that wealth owned by the community is reinvested into the community, are critical for creating a vibrant local economy. Without local financial institutions that have a mandate to invest in the community, our wealth will continue to be used to benefit the world’s biggest companies to the detriment of our cities.
1. For those unfamiliar, debt is when you loan a company money with the expectation that you’re paid back over time with interest. Equity is when you give a company money in exchange for owning a portion of the company, with the expectation that as the company grows the value of your share of the company grows. ^