On 24 September, the Independent Commission on Banking set off on its year long odyssey. Its mandate is to consider ‘structural and related non-structural reforms to the UK banking sector to promote financial stability and competition’. It will report to the coalition government by September 2011, and to kick things off published an issues paper – that is, ‘a questions paper, not an answers paper’, according to the Commission’s chair, Sir John Vickers.

The potential separation of retail and investment banking has attracted the most headlines. But the Commission must look at the broader question of how the banking sector can contribute to a climate of more sustainable investment in the UK. This was a point made by both Ed Miliband and David Miliband in this year’s Labour leadership debates. As the latter put it, the banking sector ‘must ensure it serves its proper role in allocating capital to drive growth and jobs – not just seek the quickest, speculative gain’.

A publicly owned British Investment Bank would help do that, and it would mean taking a radical view of the way we look at banking in the UK. When asked about the mutualisation of Northern Rock – a Labour manifesto promise – Ed Miliband gave an ambitious take on the future of the British banking sector:

‘I think we can’t just go back to business as usual when it comes to the banking system. If we think we’re just going to end up back in a situation of the private sector banks with just a bit more regulation, then I don’t think that that’s the right way forward. We’ve got to look at all of these options, not just mutual ownership by the way, public ownership, because that’s what they do in other countries like Germany where they’ve succeeded in building a bigger industrial base.’

The legal mandates of Germany’s KfW, and the Nordic Investment Bank (originally a joint venture between Sweden, Denmark, Norway, Finland and Iceland), provide an illuminating perspective on what a publicly owned investment bank can do. The Independent Commission on Banking should take the opportunity to study them closely.

Germany’s KfW Bankengruppe – owned 80 per cent by the federal government and 20 per cent by the Länder (federal states) – was set up in 1948 and capitalised with Marshall Plan money. Today it raises EUR 60-70 billion in the capital markets every year, which makes it the fifth-largest capital markets issuer in Europe after the Italian, German, French and UK governments.

The Gesetz über die KfW (‘Law concerning KfW’) gives the Bank’s mission as ‘performing promotional tasks, in particular financings, pursuant to a state mandate in the following areas: (a) small and medium-sized enterprises; (b) risk capital; (c) housing; (d) environmental protection; (e) infrastructure; (f) technical progress and innovations; (g) internationally agreed promotional programmes; and (h) development cooperation.’

This is, on the face of it, an eclectic mix of investment targets. Three areas jump out as things any British Investment Bank should focus on: support for small and medium sized businesses (SMEs), which employ 60 per cent of our private sector workforce; investment in businesses and projects that which will help accelerate the UK’s progress towards a low-carbon economy; and investment in infrastructure.

Financial support for SMEs has fallen away sharply since 2008, in spite of the Labour government’s banking bailout and initiatives like the Enterprise Finance Guarantee (which made £1.3 billion available to support bank lending to UK businesses with a turnover of up to £25 million). The smallest businesses were hit particularly hard, and even sectors which have weathered the economic storm comparatively well (like biosciences and IT) have had a difficult time attracting funding. This is a strategic problem for our economy. If we are to diversify away from what has become an unsustainable reliance on finance we need investment in high-tech innovation and manufacturing. But the market is not meeting that demand: the National Endowment for Science, Technology and the Arts estimates that venture capital funding to high-tech firms across the UK has fallen by 40 per cent since 2008.

Many smaller high-tech firms are incubating the low-carbon technologies of the future, but there is no doubt that the UK needs a considerable push in low-carbon investment if we are to meet our obligations under the Climate Change Act 2008, which enshrines in law the commitment to cut our national greenhouse gas emissions by 80 per cent from their 1990 levels by 2050. The Labour government’s proposed loan to Sheffield Forgemasters illustrates the problem well. The firm needed finance to buy a 15,000 tonne press to produce ultra-heavy forgings for, amongst other things, the civil nuclear industry. In the absence of bank financing on reasonable commercial terms, the government stepped in with an £80 million loan, alongside a £40 million commitment from Westinghouse. The coalition’s subsequent cancellation of the loan has severely compromised the UK’s ability to grow its manufacturing capability in a developing low-carbon industrial field. The saga underlines why we need a banking capability in the UK which takes a more holistic, long-term view of investment opportunities and that looks for more than just the biggest return in the shortest time.

Another common complaint of UK businesses is the lack of investment in infrastructure, particularly in financially straitened times. The German experience is instructive. In April 2009 KfW announced an ‘infrastructure investment offensive’ with a £3 billion commitment for 2009/10 targeting reduced-interest loans for municipal and social infrastructure for what it termed ‘structurally weak regions’. The Bank’s initiative was intended to support the federal government’s intervention to kick-start growth and jobs in vulnerable areas.

These three areas – support for SMEs, investment in low-carbon technologies and infrastructure projects – were the ones highlighted by David Miliband as being a focus for a British Investment Bank in a speech this summer, and he was surely right to do so. Yet KfW’s legal mandate is striking for its breadth and ambition. Take housing, for example: between 1990 and 1997, KfW’s Home Construction and Modernisation Programme financed the modernisation of 3.2 million apartments in the new Länder – nearly half the total number in the GDR at the fall of the Berlin wall. It is doubtful that such an ambitious makeover of housing stock could have been attempted without the backing of a bank legally mandated for the purpose.

Looking further north, the Nordic Investment Bank (NIB) provides more ideas about the direction a British Investment Bank might take. NIB was established in 1976 by Sweden, Denmark, Norway, Finland and Iceland, which were later joined by Estonia, Latvia and Lithuania. In April 2010 NIB had EUR 14 billion of loans on its balance sheet.

The Bank’s statutes enshrine its purpose: ‘to make loans and issue guarantees in accordance with sound banking principles and taking into account socioeconomic considerations, to carry into effect investment projects of interest to the Member countries and other countries which receive such loans and guarantees.’

NIB puts particular emphasis on infrastructure investments, projects aimed at improving the environment, and ‘small and medium-sized enterprises, targeted in cooperation with financial intermediaries.’

NIB’s policy of supporting SMEs through local intermediaries – generally commercial banks in the member countries – is particularly interesting. The intermediaries enable NIB to channel funds to SMEs through financial institutions with a knowledge of specific national and regional markets. Drilling money down to SMEs has been a problem in Britain, particularly (and perversely) since the onset of the recession. One of the perceived injustices of the Bank of England’s quantitative easing operations – which injected £200 billion of new money into the economy after the financial crash – is that the new credit remained out of reach to SMEs. As Faisal Islam has put it, ‘The [Bank of England’s] magic money was finding its way into corporate credit markets, but it wasn’t being passed on by commercial banks to businesses.’

As with the German experience, the scope and ambition of the operations of a publicly owned and mandated investment bank like NIB raises the eyebrows of those used to the Anglo-Saxon investment culture of the financial bottom line. Acting through its intermediaries, NIB has also financed things that accord with its socioeconomic purpose but which might struggle to attract funding on a purely commercial basis, like small-scale environmental projects and a loan facility to finance women’s entrepreneurial activities in Latvia, Lithuania and Estonia.

The coalition government’s first steps on UK banking reform do not suggest that it will take a bold look at the sector. The Treasury’s 2010 spending review committed to capitalise a Green Investment Bank (proposed by Labour) to finance green infrastructure projects, but to only half the amount promised by Alistair Darling. The Independent Commission on Banking should take the opportunity to think more radically about how we can change our banking sector for the better, and should look to European precedents like KfW and NIB to see how a publicly owned and mandated investment bank could contribute towards a more sustainable climate of investment in the UK. How to capitalise a British Investment Bank would be the next question to grapple with. On that point, it’s worth remembering that the UK already has – by accident rather than design – a large, state-owned bank. Time to look at its legal mandate perhaps?

Richard Stevens is a practising solicitor specialising in high technology SMEs and is deputy leader of the Labour group on Oxfordshire county council