On 13th July 2012, the Bank of England and HM Treasury launched the Funding for Lending Scheme (FLS) to boost the incentive for banks and building societies to lend to UK households and non-financial companies, thus to spur economic growth.
Why is FLS being launched?
With the impact of the euro crisis, the UK’s trade volume has declined seriously; the market uncertainty caused funding costs for banks to rise sharply, leading to higher interest rates and lower credit availability for both household and corporate borrowers.
Before the launch of FLS, The Monetary Policy Committee has responded to the weakness of demand in the economy by putting the “Quantitative Easing” policy into action. This meant interest rates were maintained at a historically low level and the amount of money circulating in the economy got increased. However, it has not been able to deal directly with the problem of elevated bank funding costs.
How does FLS work?
According to FLS, over the eighteen months to the end of January 2014, the Bank of England will lend UK Treasury Bills to banks and building societies at a minimum interest rate approximately equal to the Treasury bill rate plus 25 basis points. As security against that lending, the banks will provide collateral – in the form of loans to businesses and households and other assets – to the Bank of England. When the loans from the Bank of England mature, the collateral will be swapped back again.
The amount that a bank can borrow depends on the amount it lends. FLS state, each participating bank will be able to borrow an amount up to 5% of its stock of existing loans to the UK non-financial sectors. The more that they lend, the more they can borrow from the Bank of England.
This way, banks are strongly motivated to boost lending to households and businesses. Easier access to cheaper bank borrowing would boost spending in the economy, for example by allowing more people to purchase homes, or by allowing firms to finance investments in new and productive enterprises. In turn, higher spending should create jobs and raise incomes.
As George Osborne (Chancellor of the Exchequer HM Treasury) said, this new scheme will balance the need to ensure as wide a participation in the scheme as possible with strong incentives for individual banks to improve their lending performance.