George Buckley is Chief UK Economist at Deutsche Bank.
Follow George on Twitter: @georgebuckley
In his Budget speech last month Chancellor George Osborne said that "We are now actively considering with the Bank of England whether there are potential extensions to the successful Funding for Lending Scheme". That extension was set out in Wednesday morning’s announcement from HM Treasury and the BoE.
The original scheme allows banks and building societies to borrow 9-month T-Bills from the BoE over a period of up to four years in exchange for eligible collateral (i.e. that used in the Bank’s Discount Window Facility, subject to, a haircut) with a drawdown period from the start of August 2012 until the end of January 2014. Under the scheme banks can borrow up to 5% of their end-Q2 2012 eligible (i.e. to the non-financial sector) loan stock plus an amount equal to any net new lending undertaken. The fee is 25bps for banks growing their loan stock between mid-2012 and end-2013, rising to 150bps if the loan stock falls more than 5%. The scheme is thus similar in many ways to the ECB's LTRO programme – but with strings attached to achieve the best rates.
Wednesday's announcement extends this scheme in three ways – lengthening the drawdown period by a year to the end of January 2015, widening the set of institutions that can use the scheme to non-bank financial firms, and increasing the focus on SME lending. The latter part of the extension is perhaps the most interesting. Wednesday's announcement allows banks to drawdown ten times (rather than just pound-for-pound) in 2014 whatever it lends to SMEs in the rest of this year, and five times for lending next year.
Whether this has much effect in stimulating additional lending will depend on how correct the government and Bank of England's judgment is that the problem with SME lending relates to supply rather than demand. The Bank's own Credit Conditions Survey raises some doubts here. While it is true that since the start of 2012 the cumulative credit availability balance to SMEs has been less than 6%, compared to nearly 26% for large firms, it is also the case that demand for loans by small business has contracted more sharply (-60% cumulative) than that for medium (-14%) and large (-28%) firms. Still, the expected demand balance for SME credit rose to a record high in the March survey, which does support the tweaking of the FLS in favour of SMEs.
It is understandable why the authorities wanted to expand the scheme given concerns about its effectiveness. In its February & November Inflation Reports the BoE outlined four stages of FLS – i.e. where and when the scheme should show up in the data. While there is some evidence to suggest the FLS has led to lower bank funding costs (Stage 1) and easier credit conditions/lower rates for households (Stage 2), there has thus far been little improvement in credit availability to SMEs and approvals/net lending (Stages 3 & 4). According to BoE drawings data, while £14 billion of FLS borrowing has been taken up so far, net lending in H2 last year was negative. Moreover, it is debatable how much of the improvement in Stages 1 & 2 has been due to the ECB’s OMT announcement last summer versus the FLS itself.
It is worth bearing in mind that the FLS may appear less successful as financial markets improve, since lower market funding costs would reduce the incentive for banks to use the scheme. This may be a reason for the relatively slow takeup of the scheme thus far. Still, it is early days and with bank deleveraging still ongoing the FLS may not have a sizable effect on lending for some time to come.
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