The Charity Commission is considering a request by Charity Bank to change its governing documents to allow it to distribute profits to its charitable shareholders, a decision that could have wider implications for all charitable companies.

Charity Bank – a registered charity – has been prompted to make the application by proposed new European banking regulations that are designed to prevent a repeat of the banking crisis at large commercial banks.

The bank’s chief executive, Malcolm Hayday (pictured), told civilsociety.co.uk that the new regulations as currently drafted contain some demands that are at odds with charity law, putting Charity Bank in a tricky position as it has to comply with both charity law and banking law.

He said the new EU rules could limit his bank’s ability to attract further capital investment and so meet the growing financial needs of the UK’s charity sector – unless the Charity Commission allows it to change its articles of association so that it can distribute profits to its charitable shareholders and so comply with the regulations.

The Commission is considering the request but points out that its decision will have wider implications for the way that charitable companies distribute profits to shareholders.

Characteristics of capital

In a nutshell, the new regulations state that the capital held by banks in Europe must have certain characteristics, designed to increase the quantity and quality of capital. One of these characteristics is that a bank’s shareholders must have the ability to share in any surpluses.

Currently, if a charity wishes to invest in Charity Bank, it is eligible for a dividend capped at 10 per cent and, should the bank be wound up, it cannot share in any surpluses because charity law states that any surplus on winding up must be passed on to a similar type of charity – even though the shareholder charity could be a recipient.

The new regulations remove the 10 per cent cap and make the surplus distribution more explicit in that it must go pro rata to the shareholders. The Financial Services Authority, as UK implementer of the EU rules, is demanding that Charity Bank make these changes in order to comply.

Consequently, Charity Bank has applied to the Charity Commission to change its Articles of Association so as to permit the distribution of profit by way of dividend, and surplus on a winding up, to its charity shareholders.

Ability to raise capital ‘constrained’

Hayday said: “If the regulations are passed as they are and if we can’t get flexibility from the Charity Commission then our ability to raise share capital in an investment sense, becomes constrained.”  He said the bank would be limited to raising capital from classic grantmakers rather than the social investment market.

Charity Bank has also contacted the European Parliament banking and economics committee to point out the unintended consequences of the proposals, but has not yet heard back.

Hayday said Charity Bank fully accepted the objectives behind the new regulations of increasing the quantities of capital held by banks and ensuring they can absorb any losses. “But it needs to be recognised that the behaviour of international banks, social banks, regional banks and co-operatives is actually quite different and there isn’t a one-size-fits-all solution.

“We have to make sure that the voice of social banking is heard and not just ignored as a niche, irrelevant activity, because actually this could be an alternative way for banking in Europe to go forward.”

The optimum result, Hayday said, would be if the Charity Commission agreed to relax the rules governing the distribution of profits to shareholders.  He said: “The best outcome is that the Charity Commission agrees to be a bit more flexible. We’ve put our proposals in and we know that they’re chewing on them and we’re hoping for the right result - because if we don’t get the right result then the chances of further charitable institutions being developed goes out the window.”

Hayday added that the Charity Bank model was proving attractive to a number of organisations in Europe and beyond who are interested in socially responsible banking, but “it’s in danger of not being allowed to flourish and develop because the rules were written for a classic banking system”.

“If we’re saying we want a better society, we want to do things differently, then we can’t keep creating rules that are based on the old models.”

Commission: ‘Wider implications for sector’

The Charity Commission told civilsociety.co.uk: “We are aware that the charity is under considerable time pressure to meet these requirements and we will endeavour to reach an early conclusion.

"However, it is important to note that the charity’s request raises a number of complex and wide-ranging issues of charity and EU legislation and our decision in this case would have wider implications for the way in which charitable companies might carry out their activities and distribute profit.

“It is therefore important that we consider this request carefully.”

Charity Bank’s biggest shareholder is Charities Aid Foundation but its 19 shareholders also include Esmée Fairbairn Nominees, Tudor Trust, NCVO and the Vodafone UK Foundation.