The Funding for Lending Scheme (FLS) was launched by the Bank of England and the Government in July 2012. It is designed to encourage banks and building societies to expand their lending to households and private non-financial corporates, by providing funds at cheaper rates than those prevailing in current markets. Both the quantity and the price of these funds are linked to the amount of lending that banks do.a The lower cost of FLS funds should then be passed on to real economy customers in lower borrowing costs.
The scale of FLS funding and the lending behaviour of participating banks, as well as the wider economic context, will determine the size of its impact. If loan demand is strong all participants should be able to grow their loan books and take the lowest 25bpb fee rate. And even assuming a slightly higher average fee and a cost for additional collateral required under the scheme, FLS funds are likely to be considerably cheaper than other funding sources over the drawdown period.c For this reason, we expect the large majority of banks with FLS-qualifying assets to use their full allocation, although timing of drawdown is difficult to predict. Cheaper FLS funding should then feed through to real economy borrowers. However, the speed, scale and form of transmission is uncertain:
- Transmission of past fluctuations in funding costs to headline lending rates appears to have been weak. Banks may previously have used margins on new lending to boost depressed profits, or to fund rising deposit rates. But the stability of FLS funding terms – at an assured rate for a period of up to four years – could lead to a more full and rapid transmission to customers.
- Lower funding costs will affect different markets in different ways: the mortgage market is relatively competitive, with standardised products, and lower costs may feed fairly quickly into lower rates; but corporate lending is more relationship-based and less standardised, and rates may be less responsive.
- FLS could prompt relaxation of non-price, quantity constraints: recent announcements suggest lower loan-to-value (LTV) limits may be one direct consequence. However, given longer-term pressures on capital, banks may be wary of taking on more risk; under the FLS, credit risk stays with the banks. This may particularly constrain new lending to SMEs, compared to relatively low-risk residential mortgages, and we expect most additional, FLS-related lending to go households, primarily as mortgages.
Overall, we assume that the scheme is likely to have contributed to the general fall in banks’ credit spreads since June (Chart 3.12) by reducing participating banks’ funding needs, although the precise size of the FLS’s effect is difficult to isolate from other market developments. This, together with the direct benefit of cheaper FLS funds, affects our wider economic forecast primarily through lower servicing costs on new borrowing, although even a significant improvement in marginal funding costs will take time to feed through into the whole stock of real economy loans. We assume that the overall fall in funding costs persists and estimate that this will add up to around 0.3 per cent to the level of real GDP by the start of 2014, compared to the position if funding costs remained at their summer level.d This excludes other possible effects, such as the impact on asset prices (we expect more property transactions as a result, which could have a positive effect on house prices) and household balance sheets, and productivity gains from improved credit access for the corporate sector.