Funding for Lending, the UK’s latest scheme to pump credit into the real economy, caused confusion when it was announced in mid-June.
Just three months earlier, the government had unveiled an apparently similar programme, the National Loan Guarantee Scheme. The initiatives were just the latest in a long lineage of UK crisis-fighting measures to support bank lending, including the Special Liquidity Scheme and Project Merlin.
But initiative fatigue is no reason to dismiss Funding for Lending as a fancy that is bound to be replaced, sooner or later, by yet another clever wheeze.
Funding for Lending has a couple of strong attributes. The first is the cost. Analysts reckon the programme will make funding cheaper for banks that sign up to it.
Second, a far broader range of lending is targeted in this scheme than, for example, in the National Loan Guarantee Scheme. While that was only for small business lending, the new programme covers any corporate or retail lending, including mortgages and credit cards.
Will it work? Observers agree that the scheme will, at least, do no harm. The idea is to give banks a new, cheaper funding source for up to 5% of their existing eligible UK loans. This has been estimated at about £80bn, though it will be less as HSBC is not participating.
More powerfully perhaps, they can also use this funding source for any increase in their eligible loan books in the next 18 months.
Cheap repos
The technique is to enable them to place commercial loans at the Bank of England in return for government bills, which they can then borrow against in the repo market more cheaply than their ordinary cost of funds.
Of course, the main problem facing Britain’s large banks is not obtaining funding, or even its cost. Lloyds last week felt it had so much money it could afford to buy back £4.9bn of its own senior debt.
But the government will use moral suasion to try and force the banks to pass on the funding cost to borrowers. In the present climate after the Libor scandal, there would seem little risk of banks trying to cheat and pocket the benefit.
That in itself means UK corporate and retail borrowers could get a free cash handout, in the form of lower borrowing costs.
Analysts have estimated that banks could finance the bills they received from the Bank of England with repos at about 0.5%, to which would be added a 0.25% fee to the Bank, for a combined 0.75% cost of funds.
Barclays has a January 2015 floater whose coupon for the current three month interest rate period is about 2.3%.
This very rough back-of-the-envelope calculation suggests banks might be able to reduce their cost of funds on part of their UK assets by perhaps 150bp, by replacing wholesale funding with the new Funding for Lending finance.
Sharing the spoils
The immediate question prompted, is how would the banks share out that saving among their customers? If it was given indiscriminately across the whole UK loan book, the benefit might be only 7.5bp off each customer’s loan — barely noticeable.
Instead, the banks may concentrate the funding benefit to specific classes of borrower, or to new loans. Banks have long offered low introductory rates to try and win new customers. If the benefit was transferred to borrowers pro rata, 150bp off a Barclays mortgage at, say, 4.5%, is worth having.
How much economic benefit this cash giveaway yields is likely to depend on how the banks allocate the savings among their customers.
Politicians would probably like it to go the neediest borrowers — those who face financing difficulties at present.
Whether Funding for Lending will bring loans to those who cannot get them already, or will not do so, is the big uncertainty.
It cannot be denied that huge hurdles stand in the way of a return to credit growth.
Demand for borrowing is one, as EuroWeek has argued in the past. Both companies and households are reluctant to borrow in the present uncertain economic environment. Making loans cheaper may not change their minds — and when the economy does take off again, may be a dangerous stimulus that needs to be withdrawn quickly.
Capital screw tightens
Higher capital regulations are another. As capital standards rise with the introduction of Basel III and Capital Requirements Directive IV/Capital Requirements Regulation I from the beginning of next year, the amount of equity banks have to hold against lending will go up further.
That may act as a powerful brake on banks wanting to lend more, especially to riskier borrowers.
But most important are banks’ own lending standards. Since the boom and bust, banks have tightened their criteria for credit — anecdotally, to corporate customers, but demonstrably to households.
The down payment required to obtain a typical UK mortgage, for example, has risen from 5%-10% of the purchase price before the crisis, to 20%-25% now.
With UK house prices still very high relative to incomes, that, rather than interest rates, is the huge barrier to young families obtaining mortgages.
Funding for Lending leaves credit risk with the banks, and hence does nothing to encourage them to lend to riskier borrowers.
If the banks use the scheme creatively, they could ease the funding pressure on the most stressed borrowers by giving them an interest rate subsidy.
But looser credit standards will be a function of cyclical factors — not a result of cheaper funding.
Funding for Lending may then run into the same problems as its predecessor schemes. Borrowers that can already obtain credit might find it gets a little easier, or a little cheaper. Those that cannot borrow may find little has changed.