United Kingdom: Why The FLS Could Disappoint

In July, the Bank of England (BoE) announced, in conjunction with the Treasury, that it was to introduce an additional mediumterm refinancing scheme, called the Funding for Lending Scheme (FLS). At the end of September, the Financial Services Authority (FSA) also unveiled an easing of the regulatory vice on capital and liquidity to give banks some more room for manoeuvre in supporting the economy.

FLS: foundations and operating principles
In the wake of the financial crisis, the economic downturn led to a sharp deterioration in private economic agents’ confidence. This has caused a slowdown then a contraction in lending since 2009 (see Chart 1). For households, the erosion of their solvency and shortage of credit have been accompanied by a fall in the value of property assets, which has itself triggered a downward spiral in credit provision.

For non-financial companies, the deterioration in their financial health in the wake of the crisis has led them to introduce deleveraging strategies. These have in turn led to them reducing their investment rate (15.5% in 2010 vs. 19.4% in 2000). Private sector lending contracted particularly sharply at the end of December 2010 (-9.4%) and had not re-established real momentum in August 2012: the growth rate of private sector lending remained negative in August 2012 (-1.4%) and showed a more pronounced fall for non-financial companies (-4.3%) than for households (-0.3%).

The various previous liquidity support measures (see box below) have not been enough to revive credit growth. The FLS seeks to address this. This scheme aims to restart lending to households and corporations by offering banks additional central bank resources at rates that become lower as they increase their lending to the private sector.

The question now is what the effect of this scheme will be. At a time when the British credit market seems to be in a liquidity trap, meaning that credit demand is inelastic to interest rates, there are doubts about the effectiveness of this new scheme.

Initially, the BoE exchanges government debt (treasury bills) for assets eligible for the Discount Window Facility (DWF), which cover a broad range of collateral (residential mortgage-backed securities, securitised credit card receivables, student or consumer loans, securities backed by commercial loans and asset-backed commercial paper). Banks can then use these securities to obtain financing from the BoE at the base rate.

The total financing cost of the transaction equals the base rate plus the fee paid to the BoE. Institutions that wish to make use of this facility must first inform the BoE of their intentions, the amount requested and the collateral offered in exchange for the credit lines made available.

Institutions eligible for this scheme, namely banks and building societies participating in monetary policy operations, may for a maximum of four years borrow up to 5% of the amount already lent to the private sector at 30 June 2012, totalling £80bn, from 1 August 2012 until 31 January 2014, plus any increase in lending during a reference period running until end-2013. They must pay an annual fee, whose rate depends on the volume of loans advanced: for institutions which undertake to maintain or increase their lending volume, the annual fee is set at a floor rate of 0.25%.

By Aurent Nahmias

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