Outside the banking sector and its critics, not everyone grasped the radicalism of Ed Miliband’s announcement a few weeks ago that the next Labour government will establish a network of regional banks. But this was policymaking at its best, signalling a commitment to radically reform the relationship between finance and the real economy and a determination to make Labour the party of small businesses across the nation.

The British banking system is astonishingly uncompetitive: 89 per cent of all our businesses are dependent on the five major clearing banks. Yet over the last 30 years these banks have become disconnected from the needs of these businesses, seeking quick profits in the City and in the property markets rather than long term investments in the industries and regions outside the southeast. Duncan Weldon has calculated that, in the decade before the crisis, 84% of the money lent to British residents by British banks went into property and financial services.

The crisis has exacerbated this problem, with net lending to businesses down by £4.5bn in the last quarter of 2012. Newsnight’s Paul Mason has set out this problem with regard to Barclays, one of the largest lenders to SMEs in Britain, showing that the bank has reduced the amount it lends to non-finance, non-property businesses by a quarter (from £52bn to £38bn) since the crisis hit in 2008. In the process, Mason says, ‘the bank – single-handedly – has taken £3bn of capital out of manufacturing, more than £3bn out of retail/wholesale, while ploughing an extra £10bn into home loans and £6bn into property.’

The upshot is that many small businesses and entrepreneurs across the country are struggling to access the finance they need to innovate and grow, hampering economic recovery. The lack of long-term finance also makes it harder for firms to make long-term investments in training, R&D or infrastructure. Research by the EEF found that more SME loan applications are unsuccessful in the UK than in our main competitor countries, leaving most firms that wish to expand dependent on credit cards and overdrafts with short term repayment conditions. This has contributed to deeply-entrenched regional inequalities in the UK, with business surveys finding regional disparities in both the provision of unsecured lending and refusal rates.

Research conducted as part of Labour’s policy review has also drawn attention to this problem. The final report of the Small Business Taskforce – a group of leading businessmen, entrepreneurs and academics commissioned by Labour to examine how to support small businesses to thrive – highlighted widespread dissatisfaction with the ability of the big banks to meet the financing needs of small businesses. Local banking staff have long been stripped of the local knowledge or skills required to make informed lending decisions, and many businesses complain that the power to lend now rests with centralised credit teams that have no direct contact with their customers and thus no understanding of their needs.

A key recommendation to emerge from the Taskforce was that Labour should set up a new network of local banks to address these long-standing issues, learning from the German Sparkassen system. The Sparkassen are restricted to only lend to businesses and entrepreneurs within a defined geographic area, and so are unable to pursue high risk investment strategies. They are commercially run civic institutions that seek to support growth and innovation in their local areas, not maximise profits for shareholders. And they are built on well-trained staff that know and understand their customers.

There are many ways in which regional banks could be set up and run in the UK context – but it is these principles that we should seek to embed in the British banking system. If we succeed, Ed Miliband’s commitment to a regional banking system, acting as the delivery arms to the British Investment Bank we have already called for, could represent a life-line to Britain’s small businesses, and the bedrock of a One Nation economy that is built by the many and not just a few at the top.

This article is part of the Democratic Wealth series, hosted by Politics in Spires in partnership with OurKingdom.

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