Troubled Waters and the Bank of England's Funding for Lending Scheme

By Humpage, Owen; Jacobson, Maggie | Economic Trends, August 2012 | Go to article overview

Troubled Waters and the Bank of England's Funding for Lending Scheme


Humpage, Owen, Jacobson, Maggie, Economic Trends


08.01.2012

by Owen Humpage and Maggie Jacobson

With economies drifting into the doldrums, central banks are looking for ways to hoist more sail. Recently, the Bank of England unfurled its Funding for Lending Scheme, an economic jib of sorts that hopes to spur household and business loans. The Scheme will begin on August 1, 2012, and continue through 2013. Central bankers around the globe are keenly interested.

The Bank of England tacked hard toward stimulus last year as economic conditions began deteriorating. In early July, when the Bank explained the Funding for Lending Scheme, its Monetary Policy Committee also indicated that it would maintain the current policy rate at 0.5 percent and expand its asset-purchase program by [pounds sterling]50 billion to [pounds sterling]375 billion. A sharp drop in real GDP during the second quarter of 2012 confirms that the United Kingdom has entered a recession, with unemployment already hovering around 8 percent of the labor force, roughly where it's been since 2009, and output still 4.5 percent below its 2008 business-cycle peak. Although inflation has been moderating, it remains above the Bank's 2 percent target rate.

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The Funding for Lending Scheme offers low-cost funding to banks that maintain their net lending to households and businesses despite the softening economy. The mechanics involve a collateral swap between a British commercial bank and the Bank of England's Discount Window Facility, in which the commercial bank receives U.K. Treasury bills in exchange for acceptable collateral. The overall value of the Treasury bills that a bank might draw from the facility depends on the amount of outstanding loans that the bank currently holds and the amount of any net new lending that the bank undertakes prior to the Scheme's expiration. The Bank of England will charge an annual fee for the Treasury bills, which will rise should the bank's net lending fall.

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At the outset, participating British banks can claim Treasury bills equal to 5 percent of their outstanding loans as of June 30, 2012. To do so, a bank must post preapproved collateral with the Bank of England's Discount Window Facility, which then applies a haircut reflecting the collateral's underlying risk and liquidity before discounting its value. In return, the bank receives nine-month U.K. Treasury bills.

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After August 1, 2012, and throughout 2013, British commercial banks can acquire Treasury bills through the Scheme, pound-for-pound against any net new lending to the household or private nonfinancial corporate sectors of the U.K. economy. A 0.25 percent annual fee applies and stays the same as long as the participating bank's net lending does not fall. The fee climbs to a maximum of 1.50 percent should the bank's net lending falls 5 percent or more. Although the draw-down period ends next year, banks can borrow the Treasury bills for as long as four years. A participating bank must roll over the bills when they mature. To avoid a fiscal impact, a bank must return the Treasury bill 10 to 20 days prior to its maturity and before the U.K. Treasury issues a new nine-month bill.

Ideally, banks that receive the Treasury bills can sell them in financial markets--either directly or through repurchase agreements--to finance additional loans. …

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