In a move designed to incentivise banks and building societies to boost their lending to UK households and non-financial corporations, the Bank of England and HM Treasury announced the Funding for Lending Scheme on 13 July 2012.
The Funding for Lending Scheme (FLS) is designed to reduce the funding costs for banks and building societies which, it is hoped, will allow increased lending to the non-financial sector both by lowering interest rates and increasing credit availability.
Funding to banks and building societies will be at below current market rates with both the price and quantity of funding provided linked to their lending to the UK non-financial sector. Banks and building societies that increase their lending will be able to borrow more under the FLS and at a lower cost.
Eligibility and borrowing
Institutions eligible to participate in the FLS will be banks and building societies that are participants (Participants) in the Bank of England's (BoE) Sterling Monetary Framework and signed up to the Discount Window Facility (DWF).
The quantity and price of funding available will be based on the amount of sterling loans made available to the non-financial sector. Lending will be monitored during a reference period from 30 June 2012 to 31 December 2013.
The FLS is available for drawdown from 1 August 2012 until 31 January 2014 and each loan for a term of four years from the date of drawdown.
Participants will be able to borrow UK Treasury Bills (Bills) with a maturity of nine months in exchange for eligible collateral for four years by means of a 'collateral swap'. When the loans mature the collateral will be swapped back. This arrangement ensures that the risk from the collateral remains with the Participant and is not transferred to the BoE.
The collateral must be pre-positioned with the BoE in advance of drawdown. Bills must be returned to the BoE between 20 and 10 business days prior to their maturity, to be exchanged for further nine-month Bills.
The fee for Participants who maintain or increase their lending during the reference period will be 0.25% per annum on the amount borrowed. For Participants whose lending declines, the fee will increase on a sliding scale adding 0.25% per each 1% fall in borrowing, up to a maximum of 1.5%.
The initial response from the banking sector is positive with some banks committing new funds specifically to support local business or decreasing the cost of their long term fixed rate deals.
The government recognises that it will be difficult to quantify the impact of the scheme, its success depending on the extent to which it can prevent projected shrinking of new lending.
However, the scheme has received only a lukewarm reception in the national press, with the suggestion that the lack of strings attached means that there is no obligation for banks to increase lending to a particular market.