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Croydon council's bankruptcy is a warning for the UK government 

Croydon’s bankruptcy shows the problems of delaying decisions on local government funding

Croydon’s bankruptcy shows the problems of delaying decisions on local government funding, says Graham Atkins, who warns that councils will be searching for savings when they should be focusing on responding to the pandemic

On Wednesday 11 November, Croydon council issued a Section 114 notice – effectively declaring itself bankrupt. This means that the council cannot spend money on things it is not legally required to provide – such as parks and community centres – and any new spending decisions need to be signed off by Croydon’s chief financial officer for three weeks.

Croydon’s circumstances were to some extent unusual. As the damning verdict from the council’s auditors, Grant Thornton, set out: “Collective corporate blindness to both the seriousness of the financial position and the urgency with which actions needed to be taken…the Council’s fragile financial position and weak underlying arrangements have been ruthlessly exposed by the impact of the Covid-19 pandemic”.

But some of the problems experienced by the council – sharp falls in revenue, heightened demand for services like social care, and substantial increases in the costs of providing those services – are also faced by many others in England. They may not get pushed into issuing Section 114 notice, but many face the prospect of cutting services during the pandemic. The UK government needs to provides clarity about how much it will cover councils’ lost revenues and higher spending needs

Croydon had weak and risky finances before the crisis

Croydon was badly positioned to weather the Covid crisis. Its earmarked and unallocated reserves – that is, money which the council could use to cover any unexpected increase in costs or decrease in revenues – were equivalent to just 8.1% of council spending, compared to a median of 37% across all councils responsible for social care in England. The council had one of the lowest levels of usable reserves as a percentage of annual spending of any council, and had been warned by its auditors for two years running that its reserves were too low.

Croydon also invested to buy commercial properties – ranging from a shopping centre to a hotel – in the hope of generating a steady stream of rental income to supplement locally-raised tax revenue and central government grants. While this strategy might have worked prior to coronavirus, closures during the pandemic sharply reduced the income they received from these investments. The Croydon Park hotel, acquired in September 2018, went into administration in June this year, and the Colonnades retail park, acquired in May 2019, closed in March 2020.

The council spent over £210m over the last five years to acquire properties for trading services – the closest measure we have for commercial property investment, and the third highest of any of the councils in England that have responsibility for social care. The percentage of Croydon’s income that these investments was expected to provide is not reported, but Croydon had the sixth highest level of interest and investment income as a percentage of spending of any London council. This left Croydon particularly exposed to any downturn, without much spare cash to cushion themselves should anything go wrong. 

Croydon is not the only council facing financial problems 

While Croydon’s unusually weak financial position left it susceptible to shocks, other councils in England face similar same pressures. Councils are legally obliged to run balanced budgets – so even if councils do not issue Section 114s many will still feel pressured to cut services, in the middle of a pandemic, to balance the books. Kent, Leeds, Manchester, and Nottingham councils have all warned that they will have to reduce staff numbers and cut service provision. Only one in five county councils are confident they can balance their budgets next year without dramatic cuts to services.

The UK government responded to these warnings by providing extra grants, covering up to 75% of lost income from sales, fees, and charges (excluding property investments), and extending the time which councils have to repay any council tax and business rates collection shortfalls from one year to three. This staved off a likely wave of Section 114s but didn’t lift the pressure on councils this year because the government has not covered all lost revenues or extra costs – even taking into account the £1bn announced at the end of October. The announcements at yesterday’s spending review, which provided £1.5bn for councils to cover Covid pressures next year, did not plug the shortfall councils face this financial year.

Councils need greater funding certainty during the pandemic

The government’s actions suggest that it is worried about moral hazard – that to compensate councils for lost revenue from commercial investments would set a precedent of bailing out councils which have made risky bets. In normal times, refusing to cover lost income from commercial property would be justifiable. But councils are playing a critical role in the response to the pandemic – delivering food to those self-isolating, running local test-and-trace systems and providing social care. The bigger risk now is that councils’ response to coronavirus is undermined by a lack of funding. To allow Croydon – whatever its poor management – to issue a Section 114 during the pandemic was a mistake. It diverted council officials’ attention away from tackling coronavirus and focussed minds instead on how to make savings.

To avoid more councils issuing Section 114s and allow them to focus on responding to Covid, the government must provide more certainty on local government funding. The government has provided £1.5bn of grants to cover Covid-19 pressures next year, but not said explicitly what pressures it will cover. While this kind of delay is not new, repeatedly topping up council budgets with emergency funding is not an effective way to fund local government – both in normal times, and especially so during a pandemic.

The government’s decision to hold only a one-year spending review was sensible in light of the considerable uncertainty that remains about the course of the pandemic and future demands on services. But nonetheless the government could and should have provided an explicit statement to councils about what coronavirus pressures it will cover. Until it does so, many councils will be fighting the virus while considering how to make large savings after a decade of austerity. 

Institute for Government

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