SMEs And The New Bank Of England Funding For Lending Scheme.

A new scheme to prompt banks and other lenders to make more money available to homeowners and businesses has come into operation.

Under the new Funding for Lending (FLS) initiative, the Bank of England will lend money at below-market rates to the financial institutions. The Bank will then monitor their progress in lending the cash out. If the banks fail to distribute funds as widely as the Bank of England would like, then financial institutions will be penalised with increased interest rates

Some mortgage lenders have already cut the cost of their long-term, fixed-rate deals on the strength of the scheme.

However, the lower borrowing costs being introduced by mortgage lenders are only being offered so far to people with large deposits. The introduction of the new lending scheme comes as the Nationwide building society claims that house prices had fallen in July for the fourth time in five months: the decline of 0.7% in July means prices are now 2.6% lower than they were a year ago, leaving the average cost of a home in England at £164,389.

According to the Bank of England, the Funding for Lending scheme (FLS) is ‘designed to incentivise banks and building societies to boost their lending to UK households and non-financial companies’.  The programme will supersede the current National Loan Guarantee Scheme. Under the initiative, the commercial banks will be able to exchange collateral, such as existing loans for pieces of paper known as Treasury bills, on which they will pay an interest rate of 0.25%. They will then be able to use these bills as backing with which to borrow cash cheaply on the wholesale markets, money they can then lend onto homes and SMEs. In the past couple of weeks several of the UK’s biggest lenders – NatWest, HSBC, Santander and now the Nationwide – have cut their mortgage rates to below 3% for new, four or five-year, fixed-rate deals.

However, the purpose of the Bank of England’s new scheme is not simply to inject a new lease of life into the flat-lining housing market: its aim is also to make cheaper loans available to small and medium-sized firms, outside the financial sector. These firms have complained for several years that the banks have been holding onto their cash reserves, rather than lending to those businesses wishing to expand. This reluctance to lend even applied to relatively-safe borrowers. The criticism have been backed up by the Bank of England which confirmed that official figures show that lending to non-financial firms has indeed been falling consistently. In the past four years the stock of outstanding loans to non-financial companies has shrunk by 17% from its peak, to £420 billion in June this year. The governor of the institution has stated clearly that he wants to see this trend reversed.

How will the new Funding for Lending scheme work?

  • Banks and building societies can initially borrow Treasury bills up to 5% of the amount they currently lend.
  • They will be charged just 0.25% interest, much lower than the going rate.
  • They can borrow more than 5%, only if they increase their overall lending.
  • If they decrease lending, the interest rate will increase up to 1.5%.
  • The banks use the Treasury bills as backing to buy money cheaply on the financial markets. It is this money that they then lend out.
  • The Bank of England and taxpayers will be protected from any losses made on the loans agreed by the banks with homes or firms, because the banks will have to provide collateral to the Bank of England of a higher value than the loans.
  • Lending levels are to be monitored closely by the Bank of England.

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