Banking as a Model: Strengths and Weaknesses

What are the Main Strengths of Banks?

The use of banks has many advantages over more prescriptive public policy approaches. Most of these advantages fall under the two categories of economic benefits and environmental benefits. 

The environmental benefits of mitigation banks include:

  • The possibility of large, ecologically significant, conservation areas that increase the probability that species, natural resources, or natural processes will thrive;

  • The possibility of protecting resources into perpetuity;

  • The opportunity to avoid the temporal loss of resources as destructive actions are exchanged for pre-existing reconstructive ones;

  • The high management standards demanded from regulators to create and maintain banks;

  • The potential for banks to have a restorative affect, if managed with that objective in mind.

The economic benefits of banks include:

  • The severance and consolidation of liability for preserving and enhancing natural resources in some programs;

  • The time and effort saved by pre-established banks to achieve compliance;

  • The reduction of risk for developers;

  • The ability to transform a liability (like endangered species) into a financial asset;

  • The management of land for multiple uses (grazing, recreation, and perhaps ecosystem services) and hence multiple revenue streams.

Banks may also promote strategic behavior through market mechanisms. For instance, some have suggested that a bank with a statewide service area could trade less critical wetland credits for more critical species credits. Or to put it bluntly, banks could trade apples for oranges. Doing this would demand that the banking system "balance the benefits of conserving the highest priority habitats (regardless of location and type impacted) with the benefits of replacing impacted habitat with the same habitat and in close proximity" (Hummon and Cochran 34). 

Overall, banking offers the government an opportunity to require a type of change that reduces the expenses associated with it to the absolute minimum. However, doing this requires no small amount of expertise and carries with it a number of weaknesses. 

What are the Main Weaknesses of Banks?

While there is some overlap between the categories, the weaknesses of banks as a policy model for the conservation of natural resources can be broken down into the categories of design limitations and implementation challenges. 

Design Limitations

One major design limitation of compensatory mitigation banks is that, while some sort of compliance is mandatory, participation in mitigation banking is optional. Because developers often have other options to banking to achieve compliance, a bank's strategic effectiveness is limited unless they are consistently viewed as the most attractive option for developers to use. For instance, research indicates that, "commercial wetlands banks provide only a relatively small fraction, perhaps 10-20% of all wetland credits" (Woodward 66). 

This is attributed in part to the fact that: "Only after regulators have determined that the on-site credit production is impractical or environmentally undesirable can credits from a third-party credit provider be used as wetland credits. Then, commercial banks must compete with [in-lieu of financing] and cash donations programs that don't have the same regulatory barriers and upfront investment costs" (Woodward 66). 

If the banking option is not prioritized as the most favorable one, and considered favorably by those who would use it, then banks will be a minor contributor to the management of natural resources. The design of this policy tool must then be continually evaluated to reflect changing market conditions. This being said, the U.S. Army Corps of Engineers and the Environmental Protection Agency recently proposed a rule change for wetland mitigation banking that, among other things, addresses the limitation above (the public comment period for the proposal ended June 30, 2006). It does this mainly through embracing a watershed approach when reviewing mitigation options, thereby taking into consideration the broader landscape when determining which mitigation option is best in any given situation (U.S. EPA).  This departs dramatically from existing rules that follow a more hierarchal set of options regardless of their potential efficacy. The final rule change will be published sometime in 2007.

A second design limitation often attributed to banks is their resource-intensive nature. The large amounts of expertise and money required to establish, manage, regulate, and promote banks makes them unattractive to the public and private sectors alike. The relative novelty of banking also means that expertise about their structure and operation is limited. And, when so much of their design requires an in-depth understanding and consideration of local phenomena, much of the expertise that exists is only transferable in a generalized way. The legal expertise alone required to finalize banking agreements is significant and grows quickly if the approval process drags on. 

A final design problem with banking as a model involves the necessity to balance competing definitions of success. The results of banking "can be measured in two contexts: biological, defined as success in maintaining or restoring endangered species on bank lands, and economic, defined as success in selling credits (at a profitable price) to developers" (Wilcove and Lee 643).  The danger is that only one of these measures will be emphasized in our evolving regulatory framework. Emphasizing the biological context, at the expense of the economic context, will lead to fewer and fewer participants in the market and limit its impact as a policy tool. Doing the opposite, and emphasizing the economic context, will promote participation in the market but not guarantee the outcomes mitigation banks intend to produce. The monetary value can therefore compete against the ecological value. 

Implementation Challenges

Regulations often lack transparency and consistent application. All those being regulated voice this complaint at some point. For banking, transparency may be lacking due to the inexperience of regulators and agencies in creating the banks. It may also be due to the ambiguity created by the multiple and conflicting mandates agencies operate under. Meanwhile, the inconsistent application of rules may result from both technical and political issues. Agencies may lack the means to process bank applications or they may be directed to prioritize other activities by the elected officials that oversee them.

Frustrations with redundant paperwork, unclear procedural steps, and inadequate staffing are all well documented when it comes to mitigation banking. Some time may be necessary to build the institutional knowledge necessary to use mitigation banking effectively, even after a political consensus emerges that it is a good approach to take.

A second implementation challenge highlights what can be described as market apathy. A buyer (or developer) may not care about the quality of the resource being used to achieve mitigation. He or she just wants their liability eradicated. A seller (or banker) may not care about investing anything more than the absolute minimum necessary to generate the credits they want. Therefore, the only party truly interesting in preserving the resource to the highest standard possible is the regulating body, and their track record of doing this is not stellar. Furthermore, when credits are traded, natural resource bankers seek to maximize the recognized ecological value of their land. Those required to mitigate seek to minimize the recognized ecological value of their land. If both of these parties successfully meet their objectives, then "when the mitigation seeker is matched to a credit seller there is likely to be a net loss of ecological value" (Fox and Nino-Murcia 1005).  What both of these points suggest is that the banking model does not fully align the private interests of it participants with the public interest and that the only party really interested in the quality of the banks is the government (Salzman and Ruhl 18). 

Finally, timing is one of the most common implementation complaints about banking. One study about conservation banks found that the "process to establish an agreement took an average of 2.18 years" (Salzman and Ruhl 1002).  During that window of time landowners have to mange the land and pay property taxes on it, creating a significant liability for them without an immediate source of income. This then leads to the more general implementation challenge of risk. What happens if the bank fails due to environmental conditions, financing issues, volatile or non-existent markets, or unforeseen costs? As a newer approach to conservation, banks have not had the opportunity to prove their durability over the long term. And, more so than other prescriptive regulations that offer the government a high degree of management control, mitigation banking divides this control creating a significantly higher level of complexity and greater chance for problems to arise. This, and all the other shortcomings can be addressed, to some extent, by better design and increased expertise.

Next. . .

Payments for Ecosystem Services
The development of markets through which ecosystem processes or services may be bought and sold represents another market-based policy approach to conservation.