A new mission-oriented bank for Scotland
By Laurie Macfarlane and Mariana Mazzucato
Today Scotland’s First Minister Nicola Sturgeon endorsed the plan for a new Scottish National Investment Bank (SNIB) at a press conference in Edinburgh.
For the past six months, IIPP has been part of a small advisory group supporting the creation of the SNIB, with Benny Higgins, CEO of Tesco Bank, chairing the group. We developed an evidence-based implementation plan for the new bank, which was announced in the Scottish Government’s Programme for Government in September 2017.
This work has seen the publication of two new IIPP working papers examining the activities of state investment banks from different countries and regions around the world, and the role they play in their respective economies. The lessons drawn from this research — along with IIPP’s wider research on patient finance and mission-oriented innovation policy — has been instrumental in shaping the design of the new bank.
In this blog, we discuss some of the key lessons from this research and outline how they are being applied in Scotland.
Mandate and mission
In examining different state investment banks, we found a notable contrast between state investment banks that are ‘mission driven’, with activities being driven by a desire to solve big societal problems, and those which are focused on more static outcomes such as ‘competitiveness’, or which focus on serving particular sectors. Banks that are mission-oriented, such as Germany’s KfW, make strategic investments across multiple sectors in order to shape the direction of growth, avoiding many of the pitfalls of a sectoral approach which can often get captured by business interests.
Reflecting this, the implementation plan for the new Scottish bank proposes a bold, mission-oriented vision for the new Bank:
“The Scottish National Investment Bank will provide finance and act to catalyse private investment to achieve a step change in growth for the Scottish economy by powering innovation and accelerating the move to a low carbon, high-tech, connected, globally competitive and inclusive economy.”
The Scottish Government will be responsible for setting missions for the bank on a periodic basis, which may initially be focused on:
- transitioning to a low carbon economy, including decarbonisation of the transport network;
- responding to emerging demographic pressures, including the twin challenges of an ageing population and wider population health; and
- promoting inclusive growth through place-making and local regeneration.
Our report published last week for the European Commission on Mission-Oriented Research and Innovation outlines key criteria, and different implementation issues, for mission setting. Making sure missions are cross-sectoral, enabling bottom up solutions, and knowing when to adapt and shift are all key lessons also for the SNIB if it is to be led by missions that address societal goals.
The plan also recommends that the Scottish Government establishes a stakeholder advisory group to advise the Scottish Government on setting the missions for the Bank, with membership drawn from a cross-section of civic society.
Investment activities
The investment activities of state investment banks vary between countries according to the bank’s mandate, socio-economic circumstances and the stage of development. Our research finds that state investment banks are most effective when they focus their activities on generating additionality i.e. catalysing activity that otherwise would not happen. As John Maynard Keynes famously remarked:
“The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all”.
The SNIB will aim to maximise additionality by providing access to the long-term patient finance necessary for ambitious firms to invest in the acceleration and scaling up of innovation, and for large scale projects that will help transform Scotland’s economy in line with the bank’s missions. It is proposed that the bank will be at the centre of Scotland’s investment ecosystem, nurturing new industrial landscapes and acting as investor of first resort — not just investor of last resort.
Some state investment banks have been criticised on the basis of ‘picking winners’, ‘crowding out’ or funding large incumbent companies. While there are instances where criticism is merited, another reason for this may lie in the absence of monitoring and evaluation frameworks which adequately capture the dynamic outcomes of mission-oriented investments and the additionality they generate. Such frameworks are required in order to assess the performance of the bank, which could include an array of new indicators aimed at assessing the extent to which it has been successful at catalysing activity that otherwise would not have happened. And since engaging in mission oriented projects requires organisations to invest and transform their strategies, a “picking winners” mentality should be replaced with “picking the willing”.
EU State Aid rules are often held up as a barrier to more active government industrial policy. However, the UK has a long history of spending less on State Aid expenditure relative to other Northern European economies, suggesting that it has been ideology rather than regulatory impediments that have blocked more active policy. Many of the world’s largest and most active state investment banks operate in the EU, including the German KfW, Italy’s Cassa Depositi e Prestiti, France’s Bpifrance — as well the European Investment Bank.
Sources of finance
Our research finds that sources of finance can have an impact on the ability of state investment banks to successfully meet their mandates: if a source of finance proves to be volatile or unstable, then it can impair the ability of the bank to fulfil its mandate.
The Scottish Government already set aside money for the initial capitalisation of the bank in its December Budget, and it is envisioned that this will be increased year-on-year up to a level of £2bn. This equates to around 1.3% of Scotland’s GDP, which is in line with other major state investment banks. Most other banks are able to leverage their initial capital base by issuing bonds or borrowing from other sources — thereby increasing the amount of funds available for investment in the economy. It is envisioned that over time the SNIB will also develop this capacity to provide it with the full range of financing powers and flexibility that is required to play a major role in the economy.
Funding instruments
In order to provide the flexibility required to fulfil a mission-oriented mandate, it is important to offer a range of instruments suited to different areas of the risk landscape. Having a range of funding instruments also ensures that the banks are able to capture some of the reward that is made possible by their risk-taking, which will help cover the inevitable losses when they occur.
The implementation plan proposes that the SNB will invest through a variety of instruments, including debt, equity and mezzanine finance, to suit the risk profile of different investments. Over time, the management team should be able to develop a portfolio that balances the risk of the various investments and the timeframes of expected returns.
Governance
Governance arrangements are vital to the success and legitimacy of state investment banks. It is the distinct governance structures of public banks that enable them to play a fundamentally different role in the economy compared to that of private financial institutions. Typically the arrangements do not create pressure to deliver short-term returns, meaning that they can provide patient financing over a longer time horizon and prioritise wider social and environmental objectives.
A key challenge is to achieve the right balance between political oversight and independent decision making. In Scotland, it is proposed that the Chair of the bank and Non-Executive Board members will be appointed by Scottish Ministers, while the Executive Management team will be appointed by the Board. The chair of the Stakeholder advisory group will also have a place on the Bank’s Board as a non-executive director member. The Bank will adopt a leadership role with regards to diversity and inclusiveness, with a gender balance across its board members. Ultimately the bank will be accountable to the Scottish Ministers for its performance, and through them to the Scottish Parliament, but will operate at arm’s length from government and make independent investment decisions.
Links to government policy
Close alignment between state investment banks and government policy can create a powerful synergy between policy, regulation and financing, which can be coordinated for maximum impact. Previous initiatives such as the existing Scottish Investment Bank and Scottish Growth Scheme have helped firms access finance, but without the scale, bold remit and policy alignment they have not been able to have a transformative effect on Scotland’s economy.
The missions of the new SNIB will be aligned with government policy and other public sector agencies, helping to ‘tilt’ the playing field in the direction of the desired goals. In turn, this will help increase business expectations about future growth areas and create confidence in the private sector to invest where previously it would not have done. An exciting area for future exploration relates to how the bank might optimally interact with other public agencies to drive innovation and contribute to the development of the kind of ‘networked entrepreneurial state’ that has been responsible for many great technological breakthroughs elsewhere.
What next?
Investment-led growth is not just about investing in infrastructure. Rather it means engaging with the challenge of setting a direction for the economy (with multiple missions) and providing the patient finance to help the ‘willing’ come together and ‘get there’. The new mission-oriented SNIB embraces both these challenges.
The implementation plan is only the first step towards establishing a fully functioning bank. It is expected that a shadow board and interim executive management team will be appointed this year, who will be tasked with developing the initial Investment Strategy and Business Plan for 2019–20.
But the signs are promising, and there is now a great opportunity for Scotland to demonstrate global leadership in mission-oriented banking — and in doing so play a leading role confronting the key challenges of the 21st century. It is not an easy task, and of course much can go wrong along the way. But as economists we have a duty to try and it’s been an honour to offer our ideas to the Scottish Government. Remaining flexible along the way and able to adapt to new challenges will be just as important as setting the mission itself.
The rest of the UK should take note. Innovation-led growth and patient finance go hand in hand, but the fact that BEIS’s work on industrial strategy and HM Treasury’s work on Patient Capital are not connected suggest there is a lot of catching up to do.
