The Bank of England announced last Friday that it will start its funding for lending scheme in August, with £80bn being offered to banks at very little cost. The goal of the initiative is to stimulate economic growth through increased bank lending, which has remained constricted for several recession-hit years.
The Funding for Lending scheme follows a previous plan with similar aims called Project Merlin (2011), which was a ‘gentleman’s agreement’ between the BoE and the UK’s biggest lenders, RBS, Lloyds, HSBC and Barclays, to lend more money to small businesses and individuals. With lending actually reducing over the past year, Project Merlin has been dismissed as a failure. The difference in this new scheme comes in the way it is structured. With concrete deal terms and the opportunity for banks to receive considerably cheaper money from the BoE if targets are met, banks should be adequately incentivized to step up lending.
The money under the Funding for Lending Scheme will be offered to all large banks, with the cost of the loans based on their ability to continue lending. The cost will be dependent on its net lending between June 30 and the end of 2013. Banks that increase or maintain their lending over that period will pay 0.25% in interest. However, for every 1.00% fall in net lending, the bank will be forced to pay an additional 0.25% interest up to a maximum of 1.50% (still less than the current market price).
It is a measure of the economic quagmire that the UK finds itself in that this new scheme is being delivered in tandem with the Monetary Policy Committee’s decision to expand its asset-purchase facility (quantitative easing) by another £50bn.
The Bank of England’s figures show that the stock of bank loans to the corporate sector peaked in August 2008 at £517bn, but have since fallen by £95bn, a staggering 18%. The theory is that the availability of cheap loans may encourage some firms to take on loans in order to expand their business, especially those that were previously unwilling due to the high price associated with borrowing.
Of course there is some skepticism towards the scheme, the most notable being that banks may not pass on the cheaper lending, instead pocketing the cheap money, despite the higher costs that this would incur. Moreover, we are right to question whether withering bank lending is indeed a major factor behind the current recession. Is there really demand for loans? Are UK businesses really targeting expansion in the current climate? Or are companies just content to cautiously weather the storm and wait for friendlier economic conditions before they take on debt and with it, risk. Indeed the key drivers of the UK recession lie outside lending; the debt crisis and low consumer confidence to name just two.
Sterling responded positively to the announcement of the Funding for Lending details, with GBP/EUR spiking from €1.2650 to €1.2700, continuing the uptrend this pair has seen this month. Investors were clearly encouraged by the scheme with many believing that this could have a positive impact on the UK economy. Clearly events on the continent are of greater importance, GBP/EUR’s rise has much more to do with euro-weakness than with sterling-strength. Only time will tell whether the BoE’s new scheme will help UK growth pick up in the second half of the year – if it doesn’t you can bank on yet more QE. You can't blame the BoE for trying though, it must be seen to do something to promote growth, particularly amid rising extermal threats from the eurozone.
Adam Highfield
Analyst – Caxton FX
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