LEGISLATIVE ANALYST REPORT

TO: HONORABLE MEMBERS OF THE BOARD OF SUPERVISORS
FROM: Jesse Martinez, Legislative Analyst
DATE: December 31, 2001
FILE: 011768
SUBJECT: Municipal Bank

SUMMARY OF REQUESTED ACTION

A motion (introduced by Supervisor Matt Gonzalez) requesting the Office of the Legislative Analyst (OLA) to provide information on what other cities in the United States and elsewhere have "municipal banks." Particularly, the motion requested information on what services those banks provide, and benefits or complications of municipal banks.

EXECUTIVE SUMMARY

Subsequent to the receipt of the request, the office met with the Supervisor’s representative in attempt to further clarify the request and the definition of a "municipal bank." At the time of this report, clarification remains questionable.

Based on the conversation with the sponsor’s office, the following assumptions were made:

1. That the request to examine "municipal banks" means a financial institution owned by the city or public entity. Research showed that no such entity in the United States or the State of California. Since there are no apparent United States municipal banks or retail lending firms that are city-owned, the office reviewed four international central banks: Berlin, Beijing, Jakarta, and, Moscow. The report also contains an exception. This is the State of Maine’s efforts on a city-owned municipal bond bank;
2. That the intent of this entity or "municipal bank" to be to improve financial service to San Franciscans in general and specifically, to the segments of the population traditionally neglected by the banking institutions, such as minorities and low-income individuals.

Based on these assumption there are four models and policy issues, which may be of interest in future exploration and reformulation a concept or interest in "municipal banking." These models include: 1) insured depository institutions like community development banks, and, 2) community development credit unions, to uninsured high impact, 3) community development loan funds and micro-enterprise funds, to, 4) community development venture capital.

Thus, the report explores the community development bank prototype or here referred to as, ‘community bank.’

BACKGROUND

The past decade has noted the conventional banking industry resort to an increased effort to serve the oft-neglected low-income segments of the City. According to most research in the area, this was largely due to the encouragement of the Community Reinvestment Act (CRA). The CRA, enacted by the Congress in 1977, is designed to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods. The consequence is that various practices and models of "community banking" have emerged to address the assumed prospective goal of this proposed public-owned bank or ‘municipal bank.’

Assuming that the intent is to pursue a city-owned bank or ‘municipal bank," in order to improve public service to those identified as "most in need of banking services," there are numerous applications or practices that readily exist to signal policy of being in a better position to serve the common good.

Community Development Banks—The CRA, which encouraged banking institutions to help meet the credit needs of all segments of their local communities, including those of small businesses, minority communities, and, low-income populations, community banking has emerged as a viable institution serving the traditionally economically disadvantaged. Available data indicate that most loans extended to small businesses by community banking institutions are to firms in their local community and about half of their lending is to small firms or businesses in lower-income areas. Further, survey results indicate that, in the area of small business lending, CRA does not appear to have been costly for banking institutions as most lenders report their CRA-related small business lending is at least as profitable as their other small business lending.

CURRENT LAW AND PRACTICE

Presently, according to the Federal Reserve Bank of San Francisco (FRBSF) and the California Department of Financial Institutions (DFI), no city-owned banks exist in California or elsewhere in the United States. The FRBSF and DFI are the supervising and regulatory agents required to oversee and license the nation or state’s financial institutions, respectively. Both agencies strive "to ensure their financial soundness and compliance with banking, consumer, and other applicable laws."

Indeed, according to the respective staff of these institutions, a public corporation or public entity must apply for a license to operate a bank under Federal and/or California law (see 12 CFR 201 et seq. and, California Financial Code 1-407). There are no public entities licensed (under these codes) to provide banking services at this time.

MUNICIPAL BANKS--JURISDICTIONS

As indicated earlier, the only American city-owned bank was the Maine Municipal Bond Bank and four foreign public owned banks akin to central banks. The non-American banks surveyed are: Berlin, Beijing (China), Jakarta, and, Russia.

Maine-The Maine Municipal Bond Bank was created by the legislature in 1972 to provide unique financing program allowing Maine towns, cities, counties, school systems, water districts, sewer districts or other governmental entities access to national money markets for their public purpose borrowing needs. It was established as an independent agency administered by a board of commissioners, including the Treasurer of State, Superintendent of Banking and three commissioners appointed by the Governor.

Berlin- Eberhard Diepgen, a Christian Democrat who had governed Berlin since just after reunification in1990 help found the Bankgesellschaft Berlin, a community development bank, which is 56% owned by the city. The city was able to support a mix of culture and services, with three opera houses, a world-class orchestra in the Berlin Philharmonic and three universities. Unfortunately, the recent economic downturn and mismanagement appears to be ending this public-owned episode.

Beijing Municipal Commercial Bank-In 1999 the Beijing Municipal Commercial Bank introduced a new loan program to enable consumers to buy consumption goods. The Beijing Bank joined a group of other banks in pioneering consumer credit. The Chinese government recently adopted a policy to stimulate consumption in order to reverse a decline in the economic growth. The new bank loans are available under restricted conditions. For example, consumers can only use the funds at 17 major shopping malls in Beijing. The approval must be approved by related establishments prior to signing contracts with the bank. Recipients must also deposit funds ranging between 20-40 percent of total loan. The loans will be extended for periods ranging from six months to five years. Loans will range from 3,000 yuan (360 US dollars) to 100,000 yuan ($12,000). The bank is also considering loans for home furnishings, automobiles, travel and education

Jakarta, Indonesia - Bank DKI, which was established in 1961, has 11 branches throughout the city. The city administration is the sole shareholder. The bank is obliged to contribute to city revenues by maintain and investing city funds. It also is expected to advance community city projects. However, the Jakarta administration will change the status of city-owned Bank DKI into a limited liability company starting early next year to enable it to be more competitive and flexible. After the status change, the bank"s policies will be in the hands of shareholders. Under its current status, if the bank changes or passes a certain policy its management must submit a proposal to several institutions/people: the governor, the Ministry of Home Affairs, Bank Indonesia and the Ministry of Finance, and head of City Council Commission. Officials stated the change was expected to shorten the lengthy and arduous bureaucratic system of the public sector currently adopted by the banks" management.

Moscow-In the early 1990s, the Moscow Committee on Science and Technology built a private, $1 billion financial-industrial conglomerate named Systema, which in Russian means "The System." In Moscow, Systema is everything the name implies. The companies are inextricably linked with the city government. Some of the companies draw loans and business from the city. The result is a near-complete mixture of politics and business, and a model of economic and political power that is at the heart of a vision for Russia.

In the Moscow network, it"s important to have two legs -- one in business, the other in the administration," said Alexei Ulyukaev, a member of the city council and deputy director of the Institute for the Economy in Transition, a reformist think tank. "There is no division of economic and political powers."

The complex links between the two companies and the city government benefit the Moscow Bank for Reconstruction and Development, by serving city accounts. One of its main activities was sponsoring the design of an anti-pollution device for trucks and buses in Moscow. Luzhkov has championed this approach of mixing city affairs and private interests. The bank has thrust the city into high-profile businesses, such as the failing Zil truck factory, and launched a chain of fast-food restaurants, Russkoye Bistro. The city owns all or part of 200 other companies and controls the Bank of Moscow, one of the biggest in Russia.

POLICY PROSPECTIVE- COMMUNITY INVESTMENT

Community Investment describes investing that supports development initiatives in low-income communities both in the United States and in developing countries. Community Investment provides affordable housing, creates jobs, and helps responsible businesses get started. If community investment is the goal of the proposed municipal bank in San Francisco, then there are at least four (4) delivery models to choose from: 1) Community Banks, 2) Community Credit Unions, 3) Community Loan Funds and 4) Microenterprise lenders (see below).

Community Development Banks operate similarly to regular banks, but their business is the permanent, long-term economic development of low-and moderate-income communities. They target loan resources to residents of their primary service area - the people living, working, and doing business in their marketplace. Deposits are FDIC insured like conventional banks. There are many Community Development Banks across the country where you can open a variety of accounts just as you would at a conventional bank.

Community Development Credit Unions operate just like commercial credit unions, but focus on economic development in specific areas. Similar to banks, credit unions provide a range of savings and investment options. The difference is that credit unions are membership-owned and controlled and they are nonprofit financial institutions. There are over 100 Community Credit Unions in America, serving people and communities with limited access to traditional financial institutions. Like commercial credit unions, Community Credit Unions are federally insured and regulated.

Both Community Development Banks and Community Development Credit Unions offers a wide variety of savings and investment products. Community Development Loan Funds and Microenterprise Lenders. Community loan funds are direct unsecured loans targeted toward high-impact community development. Loan funds use grant money and pre-funded loss reserve to help protect individual investors.

Loan funds typically accept investments at rates of 0-5 % for 1-10 years. Community loan funds generally operate in specific geographic areas. A subset of Loan Funds is the Microenterprise Loan Fund. Microenterprise lenders have lent more than $25 million to low-income individuals for home purchases and small business start-ups. These funds help people who may not be able to obtain financing through traditional lenders, which tend to favor more established enterprises. Community loan funds and microenterprise development loan funds are not federally insured.

COMMUNITY BANKS--PROTOTYPES

Community banks draw their main strength and advantage over larger competitors from their position in the community. Thriving communities need banks. And tight-knit communities, where residents can live, work, shop and eat, are likely to be receptive to a bank that is part of that community. In addition, the assumption is that since this bank is closer to the communities it serves, it is more familiar with the specific needs and, therefore, shapes and customizes its services accordingly.

The communities around South Shore Bank, Chicago, are about 97% African American. The median household income is just over $20,000 and unemployment hovers high above the national average. But South Shore Bank is still there, nurturing what community affairs manager Wendy Baird calls a "dual bottom line" of development output and financial performance. Now, in addition to a Bonds for Kids program, a free community internet

access center and a full college scholarship program for area kids, South Shore also sponsors Studio Air, an actual storefront business that trains teens in design, sales and business management.

Another prototype for community investment or community banks is in Danbury, CT, where 12 competing lenders have joined in the first program of its kind to encourage minority lending and community investment. The head of Danbury"s Minority Business Association, Alexander B. Williams Jr., called the plan "a breath of fresh air" in a city where, he said, almost no loans have been extended to minority businesses in recent years. Charles Frosch, president of Union Savings Bank, said the new program led to his bank"s creation of a business loan program aimed specifically at answering complaints from the minority community. He predicted the effort would prompt other lenders to reach out to the African-American and Hispanic communities.

CONCLUSION

An American based "municipal bank" defined as public-owned, does not exist with the exception of Maine’s municipal bond bank. However, there are four (4) international municipal banks. There are a number of "community-investment" models established to provide banking services to those undeserved by the traditional lending institutions. Research has proven community-investment banking to be effective in removing barriers to accessing financial resources. In summary, the data presented here concerning the various aspects or variation of a ‘municipal bank’ is intended to provide preliminary framework relevant to policy discourse.

Prepared by: Jesse Martinez, Legislative Analyst
Phone: (415) 554-7782