Where the Bank of England places its faith...

It is impossible to read the latest Inflation Report from the Bank of England, published yesterday, without encountering its optimism, or at least hope, in the Funding for Lending Scheme (FLS), launched last month.

The FLS was launched jointly by the government and the Bank.  The aim of the FLS is to "provide strong incentives for banks, building societies and related specialist lenders to expand lending to UK households and companies".  Banks place collateral with the Bank of England which lends them UK Treasury bills for up to four years for a fee.  These bills can then be used to borrow money from the market at close to the Bank rate.  Banks can borrow up to 5% of their current loans to households and companies as well as any net expansion of their lending to the UK real economy up to the end of 2013.  Five percent of the current UK banking loan stock is £80bn.  The fee charged depends on whether banks maintain/increase or decrease their net lending.

The FLS should reduce funding costs for banks, which should reduce borrowing costs to households and businesses and/or increase lending.  This makes a big assumption that banks don't just boost their own profits and capital ratios (which, by the way, regulators are encouraging them to do).

The Bank had estimated that UK bank lending "was more likely to decrease than increase over the coming 18 months".  However it now believes the FLS will prevent that outcome.  So even the downgraded GDP forecasts in the Inflation Report rely on this new and belated funding scheme being successful.

Stephen Beer, 09/08/2012

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