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Banking

Bank of England offers funding carrot to lending banks

Having failed to force banks to increase their lending through Project Merlin, the UK government is now offering a funding incentive. But the Funding for Lending scheme will achieve little if businesses do not want to borrow

The Bank of England and the UK chancellor’s latest plan to jumpstart the comatose UK economy looks like a classic case of shutting the door after the horse has bolted. After the woeful failure of the Project Merlin exercise – under which UK banks were given targets for lending to small and medium-sized enterprises, which they singularly failed to meet – the latest scheme, dubbed “Funding for Lending” (FLS) was perhaps inauspiciously announced on Friday 13th July. The scheme has been designed to lower borrowing costs for businesses and households by reducing UK banks’ term funding costs. This will involve the Bank of England lending Treasury bills to the banks in volumes up to 5% of their stock of existing loans to the UK non-financial sector as at June 2012 (around £80 billion). The T-bills will be lent for up to four years in return for a fee and against eligible collateral. If banks expand their lending volumes the fee will be 0.25%, if they do not or volumes decline the fee will increase up to 1.5%. If they increase lending UK banks should therefore be able to finance lending at around 0.6% (a six-month T-Bill rate of 0.35% plus 0.25% fee) versus 1.25% to 2.5% in the market. The government is hoping that this will spur an increase not only in corporate lending but in mortgage lending as well.

Announcing the scheme chancellor George Osborne stated that it would inject new confidence into the financial system. “It will support the flow of credit to where it is needed in the real economy – showing that we are not powerless to act in the face of the eurozone debt storm,” he claimed.

According to RBS net monthly lending to non-financial corporates in the UK fell in both 2010 and 2011, with average monthly reductions of £2.1 billion (down 7.7% year on year) and £0.8 billion (down 3.3% year on year) respectively.So far in 2012 net lending was down £3.4 billion in January and £4 billion in February.

Funding gap 
Change in bank funding and lending rates,31 July 2011 to 31 May 2012 
Source: BoE and UBS 

Whether or not the new scheme has the desired effect remains to be seen. At the onset of the financial crisis the unwillingness or inability of the banks to lend was inarguably a brake on activity among SMEs and access to credit in this sector of the economy has been a problem ever since. But economic confidence is now at such a low ebb that it is no longer a problem of banks not being willing to lend – it is more a problem of businesses hunkering down and not wanting to borrow for investment. “ONS data show that the UK corporate sector is sitting on £754 billion of cash and liquid assets – which could be used to fund an investment-led recovery,” say analysts at RBS. “Yet capex remains distinctly hesitant. The FLS could clearly function effectively against a backdrop where demand for funding from businesses is already picking up; it remains to be seen how effective it will be in kick-starting that investment.”

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