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
News
ebooksAn unforgettable anthology of contemporary reportage
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

Recruitment Genius: Digital Optimisation Executive - Marketing

£30000 - £35000 per annum: Recruitment Genius: The UK's fastest growing, multi...

Recruitment Genius: Financial Reporting Manager

£70000 - £90000 per annum: Recruitment Genius: A Financial Reporting Manager i...

Recruitment Genius: Payments Operations Assistant

£23000 - £25000 per annum: Recruitment Genius: They win lots of awards for the...

Recruitment Genius: Telephone Debt Negotiator

£13500 - £20000 per annum: Recruitment Genius: This nationwide enforcement com...

Day In a Page

On your feet! Spending at least two hours a day standing reduces the risk of heart attacks, cancer and diabetes, according to new research

On your feet!

Spending half the day standing 'reduces risk of heart attacks and cancer'
Liverpool close in on Milner signing

Liverpool close in on Milner signing

Reds baulk at Christian Benteke £32.5m release clause
With scores of surgeries closing, what hope is there for the David Cameron's promise of 5,000 more GPs and a 24/7 NHS?

The big NHS question

Why are there so few new GPs when so many want to study medicine?
Big knickers are back: Thongs ain't what they used to be

Thongs ain't what they used to be

Big knickers are back
Thurston Moore interview

Thurston Moore interview

On living in London, Sonic Youth and musical memoirs
In full bloom

In full bloom

Floral print womenswear
From leading man to Elephant Man, Bradley Cooper is terrific

From leading man to Elephant Man

Bradley Cooper is terrific
In this the person to restore our trust in the banks?

In this the person to restore our trust in the banks?

Dame Colette Bowe - interview
When do the creative juices dry up?

When do the creative juices dry up?

David Lodge thinks he knows
The 'Cher moment' happening across fashion just now

Fashion's Cher moment

Ageing beauty will always be more classy than all that booty
Thousands of teenage girls enduring debilitating illnesses after routine school cancer vaccination

Health fears over school cancer jab

Shock new Freedom of Information figures show how thousands of girls have suffered serious symptoms after routine HPV injection
Fifa President Sepp Blatter warns his opponents: 'I forgive everyone, but I don't forget'

'I forgive everyone, but I don't forget'

Fifa president Sepp Blatter issues defiant warning to opponents
Extreme summer temperatures will soon cause deaths of up to 1,700 more Britons a year, says government report

Weather warning

Extreme summer temperatures will soon cause deaths of up to 1,700 more Britons a year, says government report
LSD: Speaking to volunteer users of the drug as trials get underway to see if it cures depression and addiction

High hopes for LSD

Meet the volunteer users helping to see if it cures depression and addiction
German soldier who died fighting for UK in Battle of Waterloo should be removed from museum display and given dignified funeral, say historians

Saving Private Brandt

A Belgian museum's display of the skeleton of a soldier killed at Waterloo prompts calls for him to be given a dignified funeral