Green Investment Bank

Supplementary written evidence submitted by the Department for Business, Innovation and Skills

1. This note sets out the possible public and departmental finance impacts of different Green Investment Bank models   .

2. All references of borrowing in this note could be done through GIB-issued bonds

Relevant public accounting principles

3. The National Accounts, from which measures of deficit and debt are drawn, are compiled by the independent Office for National Statistics (ONS). National Accounts includes GDP statistics, and Public Sector Finance (PSF) statistics. The latter are economic statistics relating to the activity of the public sector including receipts, expenditures, borrowing and debt.

4. HMG chooses to define fiscal policy objectives by reference to PSFs statistics, most notably Public Sector Net Debt (PSND) and Public Sector Net Borrowing (PSNB – the deficit). In broad terms, PSNB is the difference between the Public Sector’s income and spending in a financial year. PSND is the difference between public sector financial liabilities and liquid public sector financial assets.

5. Alongside the fiscal mandate [1] , the Chancellor set out in Budget 2010 a supplementary debt target – to ensure that PSND as a percentage of GDP is falling by 2015-16. As part of meeting these targets, the Spending Review plans entail a reduction in total managed expenditure of over £80bn in 2014-15 [2] .

6. These are factors in considering the classification of the GIB and treatment of its functions. It is also important to note the need for transparency for the government’s fiscal credibility and also for the GIB’s credibility if it is to eventually attract investment.

Classification of the GIB as "public" or "private"

7. The ONS assesses whether bodies are classified to the public or private sector. The decision would be based on whether the Government was deemed to be in control of the general corporate policy of the body, with relevant considerations being whether Government:

· Had the right to appoint directors

· Owned the majority ownership of shares.

8. There are also a number of other secondary factors which could indicate control including:

· Right to limit financial flexibility (such as borrowing limits)

· Right to approve business plans

· Right to control Director’s pay.

Private sector classification

9. Private sector classification of the GIB would mean that any borrowing by the GIB would not impact on PSND; and the impact on PSND would be limited to any Government equity investment in the bank.

Public Sector classification

10. The activities of a public sector GIB would score against the fiscal aggregates when the GIB transferred money outside of the public sector, i.e. made investments in the private sector. GIB activities could also create contingent liabilities for the public sector which could materialise as an impact on the fiscal aggregates at a later date. The OBR is looking to improve reporting of contingent liabilities.

Liability side of bank: Impact on PSND/B of different sources of funding

Asset sales

11. Sales of government financial assets reduce PSND and are PSNB neutral. Since government taking an equity stake a private sector GIB would also be a financial asset, redirecting the funds from asset sales in this way would have no impact; other than to note a lost opportunity to pay down debt. Similarly, if the GIB was public sector, then the granting of loans or purchase of equity by the GIB would be financial transactions giving rise to financial assets, so would similarly net off.

Conventional Government funding

12. Government could fund the GIB as it does with other Government spending: through tax receipts or borrowing through either the Debt Management Office (DMO) issuing gilts, or to a lesser extent National Savings and Investments. The principle in determining the mix of borrowing is to minimise the costs of debt management.

13. But to control the overall need for borrowing, the Chancellor sets an overall envelope for Government spending which is then allocated to departmental budgets (Departmental Expenditure Limits – DEL) at the Spending Review. Transactions outside this envelope will increase PSND and PSNB, depending on the nature of the asset bought.

14. The £1bn that has been allocated to the GIB from departmental budgets in 2013-14 is funded within the planned spending envelope

Bonds and other borrowing by the GIB itself

15. If the GIB were classified by the ONS as being in the private sector, any borrowing by the GIB would not impact on PSND/B.

16. For a public sector GIB, funding additional activity through issuing its own bonds or otherwise borrowing would score against PSND and possibly PSNB (depending on how the cash was spent, see next section) [1] in the same way as if funding came directly from Government.

17. All borrowing could impact other fiscal measures, such as PSNB and General Government Gross Debt, in the event that the GIB could not pay its debts and the Government provided further funds to support it. The precise impact would depend on the form of support provided.

18. An important consideration is the efficiency of a GIB borrowing itself compared to its activities being funded from general government (e.g. extra DMO borrowing activity at the margin). GIB debt issuance would need to pay a premium on DMO debt issuance, even if the GIB debt had an explicit government guarantee, as institutional investors would demand a premium to reflect the fact that GIB debt would be significantly less liquid than gilts.

Asset side of bank: Impact on PSND/B of GIB products

Equity and Loans

19. Financial transactions with the private sector – the GIB making loans or equity investments in return for which it receives an asset – would increase PSND but not PSNB. A public sector GIB could make loans and equity investments up to the Spending Review allocation (including up to the level of additional asset sale proceeds that are allocated to it), without increasing PSND above the overall path set out in the Spending Review.

Guarantees

20. Any payouts made as the result of a guarantee would score as grants so, would score against PSNB and PSND and therefore need to be funded from within the GIB’s DEL allocation if the overall PSNB/PSND impact is to remain within the Government’s SR plans

21. Payouts from guarantees, however, are by their nature uncertain. The income from guarantees would score to offset PSNB/PSND (unless used to fund further departmental spending) but there would be a timing mismatch (as the income would reduce PSNB/D in earlier years but payouts would increase PSNB/ PSND later on); and a risk that payouts exceed the total sum of costs (if charged below market value or if payouts exceeded expectations). In addition, the payouts could be lumpy and uncertain.

Deficit reduction and the scale of the bank

22. A borrowing, public sector GIB would need to restrict its borrowing to stay inside the Government’s fiscal plans, and could particularly impact on the ability to meet the supplementary debt test set alongside the fiscal mandate. It could also create pressures on PSNB and the central test of the fiscal mandate as the contingent liabilities involved in GIB borrowing could materialise into calls for further government support.

23. Assuming that the GIB was successful in obtaining return on its investments these restrictions would become less of a burden as its balance sheet increased organically.

24. Unless excluded from Basel requirements, the GIB also would need to keep a capital reserve as a certain minimum percentage of equity capital, so could only borrow a limited amount for a fixed amount of equity.

Comparison with European models

25. An analysis of other European models, including KfW in Germany, CDC in France and CDP in Italy, shows a wide range of models, most of which are majority owned or wholly owned by the state. A summary table is at Annex 1.

Scope and role

26. European development banks have key differences to the GIB:

· They have broad scopes, well beyond green infrastructure

· Their customer base is different – most European state banks lend to the public sector and to other banks

· They have conservative investment policies, focused on asset quality

· Most provide low cost liquidity rather than risk-mitigation products.

Accounting treatment

27. While all European countries operate under the European System of Accounts ("ESA") 1995, European development banks operate under different national fiscal policies. In particular, the UK uses a wider (and truer) definition of "public sector" debt and borrowing (PSND/B) than other European Governments (which use "general government" net debt and borrowing). As a result, European state banks score differently on their countries’ balance sheets.

Should UK change its accounting treatment or treat GIB differently?

28. Excluding GIB borrowing from PSND, as was done for Lloyds and RBS, would remove the risk of the GIB breaching the fiscal mandate through borrowing. The treatment of Lloyds and RBS debt was, however, justified as a temporary and extraordinary (non-discretionary) situation.

Annex 1. European State Development Banks

17 February 2011