In Sweden, as in many other countries around the world, post-war changes in the financial markets had important effect on local authorities. The last of central government interference into municipal borrowing was removed in the end of the 1970s and this led to a change in the nature of the providers of municipal credit. Where state actors, like the pension funds, retreated the big commercial banks were allowed to come in and split the market between them.
In the early 1980s the money market developed quickly. The largest cities could draw some short-term advantages by finding access to cost-efficient short-term borrowing in this new market. For a majority of the Swedish municipal sector the reality was drastically different. They were forced to turn to the big banks, institutions that had few incentives to compete between themselves.
For the banks it was the beginning of a comfortable period in which they could at low risk and to great margins (of several percentage points) take care of municipal financial needs, undisturbed. The local and regional political leadership accepted this situation, in many cases in part as a consequence of that many of them were enrolled by the banks to serve on local boards.
A reason for the acceptance of the changes was the common fallacy that there was no alternative. There was a simple lack of knowledge concerning the possibility of another way, even though neighbouring Denmark had a municipal bank, Danish Kommunekredit, with 80 years to its name. Few voices pointed out the clear and significant imbalances between risk and margins in bank-loans to municipalities.
It is important to remember that even though Swedish municipalities are often larger than municipalities in other countries, they are still very small for the financial markets. Being too small has a number of important consequences. The cost of handling the credit becomes high in comparison to the size of the loan and the borrowing needs are limited. This is what justifies slightly higher margins. It is also the case that individual municipal borrowings very rarely reach the size that makes for efficient operations on the capital markets.
The world of international finance is complex. Small local authorities do not have their own financial experts or even people with experience of working with financial solutions. The obvious outcome of this is a situation where municipalities lack the knowledge and skills to handle external funding in an efficient way. This is also what characterised the Swedish case in the 1980s. In Sweden there was the added complication that most of the municipalities had a number of municipal companies that handled their own borrowing without much control from the owning municipality. Small might be beautiful, but in financial terms it is hardly effective.
The Beginnings of Kommuninvest
Örebro County is located in central south Sweden and has a population of a little less than 300 000 inhabitants. It was here that a group of civil servants and politicians came together in a discussion about municipal financing in the 1980s. The idea of creating a local government funding agency for the county entered the discussions in February 1986 and the agency Kommuninvest i Örebro län (Kommuninvest in Örebro County) was formed in November of the same year. It was a regional initiative, comprising of nine municipalities in the county as well as the Council of Örebro County coming together in cooperation.
The aim of Kommuninvest was simply to pool the borrowing needs of the owners and on their behalf negotiate for funding from the capital markets to be brought back to the owners. The agency was also to use any potential surplus liquidity among the owners for the financing purposes of another if consent for this was reached. Kommuninvest facilitated these types of transactions as a broker. Its honesty was guaranteed by the expressed aim of the agency not to maximise profit for itself.
An important early task for Kommuninvest was to “transport” the creditworthiness of its owners to the agency. This was first done through a REPO-agreement with the financier, where the municipal loan agreements were used. This worked, but the handling of these agreements was rather burdensome. In the end a system inspired by Kommunekredit in Denmark was used with a joint and several guarantee entered in by the participating municipalities.
From Local to National Project
Kommuninvest established borrowing operation in the international capital markets in the end of the 1980s and managed quickly to secure cost-effective funding for the municipalities that owned the agency. The news of this success spread to outside to Örebro County. It was something radically new in a situation where commercial banks constituted a virtual oligopoly on the market. Municipalities had also, by structure and tradition, stood with their backs turned to one another. Competition, rather than cooperation, had hitherto been a common approach.
As the success of Kommuninvest grew in the early 1990s the commercial banks played out every trick in the book to disturb the project; a development closely monitored by Swedish municipalities. In 1993 a banking crisis hit the nation leading and the banks suddenly found it difficult to supply the municipalities with both new funding and refinancing. The crisis did not hit Kommuninvest and the agency was approached by a number of municipalities outside Örebro County who wanted to join. After lengthy discussions Kommuninvest i Örebro län changed its name to Kommuninvest i Sverige (in Sweden). There was also another very important change: the municipalities were no longer direct shareholders in the joint-stock agency. Instead a cooperative society, Kommuninvest Cooperative Society, was formed that were the sole owner of the agency. In the cooperative society the municipalities were members with equal voting rights, irrespective of the size of the municipality. In the board of the cooperative society local politicians held the chairs, while the board of the agency consisted of professionals.
It was decided that membership in the cooperative society was to be granted to Swedish municipalities and county councils that had a good creditworthiness. Every applicant was, and is, thoroughly reviewed before granted membership. A member can be expelled from the society if the creditworthiness deteriorates. This system gives a clear incentive for all Swedish municipalities to keep in line and take measures to ensure that they do not fall behind. Kommuninvest was to be capitalised by the new members in the cooperative society paying a participation fee, based on the population of the municipality, to the society, which yearly (if not otherwise is decided by the yearly meeting) is transferred to the joint-stock agency as equity.
Kommuninvest as a national local government funding agency became a very successful operation. It owes it success in large part to the following factors:
- Swedish municipalities are creditworthy. Creditworthiness is, of course, mostly a relative question. The road to success lies in being more creditworthy than the majority of the other players in the market.
- Kommuninvest has been successful in explaining the Swedish municipal system and their creditworthiness to domestic and international capital markets. The agency has invested extensive time and work for investor presentations all over the world and in building contacts with media.
- Trust between the municipalities and in the investor- and banking community has been built. For this end it was important to have in Kommuninvest staff with prior experience of both municipalities and banking.
- Municipal creditworthiness could in the end of the day be “transported” to Kommuninvest through the joint and several guarantee. Among other thing this made any state guarantee unnecessary.
- Kommuninvest worked well in the current open market. It does not seek monopoly on extending credits to its members and works in free competition.
Kommuninvest has had a tremendous impact of the domestic municipal credit market and the whole area of financial management in municipalities.
Kommuninvest has lowered funding costs for all Swedish municipalities, since it brought an alternative to the market and hence tough competition to the banks.
Kommuninvest lowered the funding costs for the members. Growth of both balance sheet and members tells the story.
Kommuninvest has contributed to the development the creditworthiness of Swedish municipalities through the continuous monitoring of the members, setting the standard even for non-members.
Kommuninvest has helped to increase the financial expertise in municipalities, both in the way business is conducted (in close cooperation with the individual municipality) and by arranging training seminars for civil servants and politicians.
Kommuninvest has developed the domestic bond market, which was almost non-existing to others than the Kingdom and the mortgage institutes before Kommuninvest made its first bond issue.