Funding for Lending: What's in Mervyn King's mind?

The Funding for Lending Scheme has got off to a disappointing start. If it continues to fail to deliver, what else could the Bank of England and ministers do to boost lending?

The Bank of England and the Treasury released a progress report on their Funding for Lending Scheme (FLS) yesterday. The results did not look good. Since the scheme was launched, to considerable fanfare, last summer the participating banks have drawn down £13.8bn in cheap funding from the central bank. But rather than using this money to increase the volume of lending to households and small businesses, as the scheme was designed to encourage, the banks have instead shrunk their lending books by £1.5bn. Royal Bank of Scotland drew down £750m, but reduced its stock of loans by £2.3bn. Lloyds tapped the FLS for £3bn, but cut the size of its loan book by £5.6bn. "Funding for not lending" was the acerbic assessment of the scheme by Citi analyst Michael Saunders. "It is pretty clear that the FLS is not living up to expectations" he said.

But the Treasury and the Bank insist it is far too early to call the FLS a failure. The Treasury points out that the scheme has already pushed down the average interest rate on mortgages, helping relieve the burden on household finances. And the Bank says it was always going to take time for institutions to process new loan applications and for the FLS impact to be felt. Officials at Threadneedle Street say they expect net lending under the scheme to turn positive later this year.

But what if that doesn't happen? What if the banks simply keep accepting the cheap funds and use them as a subsidy for further deleveraging? What other means do the authorities have at their disposal to increase the flow of lending to the economy? What else does the Bank of England have in its toolkit?

More and different quantitative easing?

The Bank's Monetary Policy Committee will meet this week to decide whether to increase the £375bn quantitative easing programme. There was a surprise last month when the Bank Governor, Sir Mervyn King, voted in favour of £25bn in additional asset purchases.

But there is also growing pressure for the Bank to buy up securities other than gilts. The incoming governor, Mark Carney, mooted this recently. Some have suggested that the Bank should buy bundles of small business loans to ensure that the stimulus reaches the real economy. Bank officials, however, remain highly nervous about this idea because they say the central bank would effectively be subsidising individual businesses by driving down their cost of borrowing. At a Treasury Select Committee hearing recently the deputy Governor, Paul Tucker, hinted at resurrecting a system whereby the central bank would accept companies' trade order invoices as collateral for lending.

Cut the base rate below 0.5 per cent?

The International Monetary Fund suggested last year that the Bank should consider taking its main borrowing rate down below 0.5 per cent, which is already the lowest level in the central bank's history. This would bring the Bank into line with the US Federal Reserve which has a base borrowing rate of zero to 0.25 per cent.

This should reduce interest rates slightly through the economy. But the Bank has rejected it in the past due to the impact on building societies. These small lenders would get less income from the rate tracker mortgages they have sold (which would automatically fall), but might be unable to reduce further the rock bottom rates they pay to depositors. The feeling within the Bank is that this would squeeze these vulnerable lenders' margins to intolerable levels and thus prevent them from lending – the precise opposite of what policymakers want.

Negative interest rates?

Paul Tucker also attracted headlines recently by talking about negative interest rates. The base rate is what the Bank of England charges commercial banks to borrow. But it also pays interest to commercial banks when they deposit funds at the central bank. One option – which the MPC has discussed – is to disincentivise the banks from keeping money on deposit at Threadneedle Street by charging them a fee rather than paying them interest. The hope would be that the banks would instead use the money to seek profitable lending opportunities. The downside is that the banks might simply pass the fee on to savers by cutting their own deposit rates, or introducing account charges.

Enhance Funding for Lending?

The FLS effectively allows banks to borrow at 0.25 per cent. One option is to make the scheme more effective by improving these terms – by dropping the Bank of England's fee to zero. Banks are also penalised by higher borrowing costs under the scheme if their stock of lending falls by more than 5 per cent over the period. The trouble is that making the FLS more generous to the banks in these ways could simply result in the sector deleveraging faster.

Some have argued that the FLS is too reliant on the major banks. One idea is to open the subsidised borrowing scheme to a wider range of lenders. The attraction is that smaller lenders are less burdened by bad legacy assets and should be more willing and able to pass on the cheap funding. It is striking that some of the smaller banks that have made use of the FLS have increased lending by more than the bigger institutions. The problem is one of scale, which only the big players can deliver. For example Aldermore, one of the crop of new banks, has increased lending by an impressive 30.6 per cent since last summer. But that translates into new lending of just £479m.

Nationalise RBS?

Some argue that the time for subtle incentive schemes designed to encourage bank lending is over and that the authorities need to be more radical.

Lord Oakeshott was the Liberal Democrats' Treasury spokesman until he resigned in 2011 over the Government's "pitiful" design of the predecessor of the FLS, known as Project Merlin. He now argues that the Coalition should nationalise RBS and direct it to ramp up lending.

"The excuses have run out" he said yesterday. "Now is the time to impose net lending targets on the state controlled banks, as envisaged in the Coalition agreement."

Critics of the idea claim that to put politicians in charge of lending decisions would inevitably result in a plethora of bad loans. And the Treasury is dead set against full nationalisation. Tory ministers say their objective is to return RBS to full private ownership as soon as possible.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA celebration of British elections
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant - Swiss Banking and Finance

£20000 - £25000 per annum + Uncapped commission: SThree: Can you speak German,...

Ashdown Group: Marketing Executive - 6 month FTC - Central London

£25000 - £30000 per annum + benefits: Ashdown Group: An exciting opportunity f...

Ashdown Group: Junior Project Manager (website, web application) - Agile

£215 per day: Ashdown Group: Junior Project Manager (website, web application ...

Guru Careers: Software Engineer / Software Developer

£40-50K: Guru Careers: We are seeking an experienced Software Engineer / Softw...

Day In a Page

Fishing for votes with Nigel Farage: The Ukip leader shows how he can work an audience as he casts his line to the disaffected of Grimsby

Fishing is on Nigel Farage's mind

Ukip leader casts a line to the disaffected
Who is bombing whom in the Middle East? It's amazing they don't all hit each other

Who is bombing whom in the Middle East?

Robert Fisk untangles the countries and factions
China's influence on fashion: At the top of the game both creatively and commercially

China's influence on fashion

At the top of the game both creatively and commercially
Lord O’Donnell: Former cabinet secretary on the election and life away from the levers of power

The man known as GOD has a reputation for getting the job done

Lord O'Donnell's three principles of rule
Rainbow shades: It's all bright on the night

Rainbow shades

It's all bright on the night
'It was first time I had ever tasted chocolate. I kept a piece, and when Amsterdam was liberated, I gave it to the first Allied soldier I saw'

Bread from heaven

Dutch survivors thank RAF for World War II drop that saved millions
Britain will be 'run for the wealthy and powerful' if Tories retain power - Labour

How 'the Axe' helped Labour

UK will be 'run for the wealthy and powerful' if Tories retain power
Rare and exclusive video shows the horrific price paid by activists for challenging the rule of jihadist extremists in Syria

The price to be paid for challenging the rule of extremists

A revolution now 'consuming its own children'
Welcome to the world of Megagames

Welcome to the world of Megagames

300 players take part in Watch the Skies! board game in London
'Nymphomaniac' actress reveals what it was really like to star in one of the most explicit films ever

Charlotte Gainsbourg on 'Nymphomaniac'

Starring in one of the most explicit films ever
Robert Fisk in Abu Dhabi: The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers

Robert Fisk in Abu Dhabi

The Emirates' out-of-sight migrant workers helping to build the dream projects of its rulers
Vince Cable interview: Charging fees for employment tribunals was 'a very bad move'

Vince Cable exclusive interview

Charging fees for employment tribunals was 'a very bad move'
Iwan Rheon interview: Game of Thrones star returns to his Welsh roots to record debut album

Iwan Rheon is returning to his Welsh roots

Rheon is best known for his role as the Bastard of Bolton. It's gruelling playing a sadistic torturer, he tells Craig McLean, but it hasn't stopped him recording an album of Welsh psychedelia
Morne Hardenberg interview: Cameraman for BBC's upcoming show Shark on filming the ocean's most dangerous predator

It's time for my close-up

Meet the man who films great whites for a living
Increasing numbers of homeless people in America keep their mobile phones on the streets

Homeless people keep mobile phones

A homeless person with a smartphone is a common sight in the US. And that's creating a network where the 'hobo' community can share information - and fight stigma - like never before