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25 July 2012
The new Funding for Lending scheme, due to be launched at the beginning of next month, aims to improve the availability of credit and ultimately to get growth going in the UK economy. The Bank of England has provided for a 5% increase in funds for lending – up to £80 billion – over the next 18 months, so the scheme has the potential eventually to deliver a substantial boost to the UK economy.
Assessing how the scheme will affect the mortgage market, particularly in the short term, is not easy. But in the last few weeks, a number of lenders - including some of the largest in the UK - have announced reductions in rates and some very attractively priced mortgages.
In publishing more details of the Funding for Lending scheme earlier this month, the authorities made a number of references to increased mortgage lending – even though the scheme is really about extending credit to businesses and individuals in a wide variety of forms. The chancellor, George Osborne, said, for example, that he hoped the scheme would make “mortgages and loans more easily available.” And the Bank referred to increased lending “to the UK real economy through, for example, business loans and residential mortgages.”
How the scheme will work
Over the next 18 months, the Bank will lend Treasury Bills to banks and building societies in exchange for collateral in the form of loans already advanced to businesses and households, and other assets.
Lenders qualifying for the scheme will be able to borrow up to 5% of their stock of existing loans to the UK non-financial sector at the end of June – what the Bank describes as “the real economy” – plus any increase in net lending between then and the end of next year. Under the scheme, firms will be able to borrow pound-for-pound to match any increase in lending.
The price of borrowing under the scheme will depend on net lending by participating firms. For those that maintain or expand their lending, the fee will be 0.25% annually on the amount borrowed. For those whose lending declines, the fee will rise by 0.25% for each 1% fall in net lending. The maximum fee will be 1.5% of the amount borrowed for firms whose net lending falls by 5% or more. The Bank believes that the scheme encourages firms that had been planning to expand lending to do so to an even greater extent.
The Bank says that lenders should be able to “fund new lending at a cost of roughly Bank rate plus 0.25%, much lower than current market term funding rates, even for the strongest banks.” The Bills will be loaned for up to four years and can be used “to borrow money at rates close to the expected path of Bank rate.” This rate, plus the fee paid to the Bank, gives the cost of funding under the scheme.
The Bank argues that the scheme is intended to reduce funding costs, with the potential to lower interest rates and increase the availability of credit. That, in turn, should boost spending, create jobs and raise incomes.
To protect the Bank's balance sheet – and the taxpayer – firms participating in the scheme will be required to put up a greater value of collateral than the quantity of Treasury Bills they receive in exchange. If any of the loans to households or firms posted as collateral are not repaid, the associated losses are borne by the bank or building society that originated them. Similarly, any firm participating in the scheme that fails to return Treasury Bills when they are due could see its collateral sold or retained by the Bank to make good any loss it could face.
Who can access the scheme?
Funding for Lending will provide access to cheaper funding in the months ahead for those banks and building societies that qualify for the scheme and choose to join it. Lenders with access to the Bank's discount window facility (DWF) will have immediate access to the scheme. Firms that are part of the Bank's sterling market framework can apply to join the DWF, and the Bank has said that it will endeavour to help firms with the application process.
But it is important to emphasis that not all mortgage lenders will have access to the scheme. The Bank has already confirmed that non-bank lenders, for example, will not qualify. Those that do not qualify may find themselves at a disadvantage, so we are likely to see mixed results in the volume of lending by individual firms.
Although the scheme is not open to all institutions, the Bank says it is "designed to encourage broad participation." It continues: "It is structured so as to incentivise all banks to lend more to households and firms than would otherwise be the case."
The Bank intends to publish quarterly data on the impact of Funding for Lending, including figures on the size of outstanding drawings under the scheme and net lending by participating firms. It plans to do this for “each participating institution.” The Bank says that the data it publishes will be at an aggregate level by firm and not split between residential and commercial lending. But politicians, journalists and commentators will scrutinise the data, perhaps seeking not only to assess the wider impact of Funding for Lending but to work out its effect on mortgage advances as well.
In explaining how the scheme will work, the Bank helpfully offers a balanced interpretation of how success might be judged. Under explanatory notes headed “How will we know if the scheme has worked?” the Bank acknowledges that, while it is intended to affect the quantity and price of lending “it will be difficult to quantify the exact impact because we cannot know what would have happened in its absence.”
This is a crucial point, and one that we made ourselves in reaction to the announcement of the basic details of the scheme in the Mansion House speeches back in June. We sought to emphasise that the real point about Funding for Lending is that it would make loans cheaper and more readily available than they might otherwise have been.
The Bank points out that some firms had been planning to shrink new lending to businesses and individuals over the next few years, as they sought to adjust their balance sheets to the post-financial crisis environment. Prior to the announcement of Funding for Lending, therefore, the Bank says that credit availability had been looking more likely to fall than rise over the next 18 months. Now, the Bank says that it expects “lending to UK households and companies to be higher than in the absence of the scheme” – a view that chimes with our own.
The Bank also argues that the UK banking system has been affected by increasing market uncertainty and the widespread risk aversion associated with problems in the euro area. As a result, funding costs have risen sharply, leading to higher borrowing rates and reduced availability of credit for individuals and businesses, including mortgages.
The Bank estimates that quoted rates on new mortgages have risen by around 50 basis points since last summer, and believes that conditions would continue to exert upward pressure on rates. Recently, however, a number of lenders have announced reductions in rates that have been widely welcomed by commentators.
Despite these recent developments, the Bank acknowledges that the launch of the scheme generally coincides with a period in which the cost of lending is expected to continue to rise. “To the extent that (lenders) are able to fund themselves more cheaply under the scheme,” the Bank says, “that rise should be prevented.”
Broadly, we welcome the scheme. It has potential to improve the cost and availability of credit. But, despite the prominent references to mortgages in the announcements earlier this month, the central message is that Funding for Lending is broadly targeted at encouraging all types of lending to non-financial businesses and individuals. It is far from being just about mortgages, and there are no specific targets for mortgage-directed lending.
Lenders will make their own careful assessment of the scheme. What it delivers for them will depend on how it matches lenders' individual funding requirements and lending aspirations – as well as the more fundamental question of whether they qualify or not.