Trouble brewing around council reserves

The local government finance settlement was published at the end of December and local authorities now have everything they need to put together their budgets for the 2013/14 financial year. This promises to be a critical period, the process will involve an extremely difficult balancing act between maintaining essential services and maintaining the financial health of the organisation.

With the easiest cuts already made, councils are running out of opportunities to make savings through efficiencies and back office reforms. Instead, cuts will increasingly fall on frontline services and budget setters have difficult decisions to make on which services to keep and which to lose.

Councils’ reserves are one of the more controversial components of this tricky equation. In recent weeks this issue has become something of a hot potato with the leaders of Sheffield, Newcastle and Liverpool Councils all saying that the cuts might even lead to civil unrest. For his part Eric Pickles, Communities Secretary, has said that it is unacceptable that some councils are maintaining such high levels of reserves while threatening to cut frontline services. In reality the argument is more complicated than simply choosing to either spend or save money.

In fact, reserves are held for a variety of different reasons. Some relate to known and relatively certain future costs such as a planned building project. Others concern possible, though less certain, liabilities such as the costs associated with extreme weather events. The recent floods are an excellent example of this, in 2007 the Government provided some supplementary funding to help communities hit by floods, but they made clear that this was not to be viewed as a common occurrence.

This is where we move into questions of judgement and prudence. If reserves are depleted, a severe winter or a period of exceptionally heavy rainfall has the potential to generate significant unbudgeted costs which the council will be unable to fund other than by cutting services. The event may never arise, but if it does, the consequences for the organisation's financial sustainability may be devastating.

More generally, reserves are a hedge against risk. In the current economic climate, for example, councils know that they are likely to find demand for some services increasing at the same time that income from sources such as planning application fees and parking charges are falling. Though predictable in general terms, these trends are difficult to quantify and forecast precisely. Reserves provide a fall-back solution if there is a painful gap between the assumptions made in the budget and the trends which actually emerge.

Similarly 2013/14 budgets will include a range of initial financial assumptions about new Government initiatives to allow local authorities to retain a proportion of business rates and to localise responsibility for council tax benefit schemes. Inevitably there is risk and uncertainty around these new arrangements as they become operational for the first time. Local councillors will sleep easier if they know that, in extremis, there are reserves to fill the gap short term in case any shortfall in income or increases in spending emerge.

Beyond this, it is important to remember that each local authority is unique and each authority will have a different judgement around its required level of reserves. CIPFA do not advise on minimum or maximum reserve levels. A well-managed authority, for example, with a prudent approach to budgeting should be able to operate with a level of general reserves appropriate for the risks to which it is exposed.

In fact, recent increases in the aggregate level of reserves can be seen to reflect councils’ good financial management to date. They have universally reduced their budgets in real terms and in many cases they have also managed their affairs to deliver underspends which bolster reserves.

For all of these reasons, reserves will undoubtedly loom large in budget debates across the country over the next few weeks. In some cases councils will decide to draw down an element of reserves to address a potential gap in funding. In doing so, however, they will need to exercise great care, including working through medium and long term consequences. The nature of most local services is that they require recurring funding to meet staff and running costs year after year. Reserves are a one-off, finite source of funding. They can cover a shortfall in recurring funding for a specific period but, after they have been exhausted, the underlying shortfall will still be there. Ultimately services will need to be reduced to a level which is affordable within the envelope of recurring funding available.

Rather like a household which is living beyond its means, savings (reserves) can help to put off the evil day when economies must be made, but they cannot prevent the inevitable.

Tim Windle is Press and Public Affairs Officer at the Chartered Institute of Public Finance and Accountancy (http://www.cipfa.org). CIPFA is the professional body for people in public finance with 14,000 members working throughout the public services, in national audit agencies, in major accountancy firms, and in other bodies where public money needs to be effectively and efficiently managed.

The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of The Information Daily, its parent company or any associated businesses.