tony's blog

Thursday, April 25, 2013

Funding for Lending Scheme 2 – the Final Story?

As soon as the Bank of England said that the Funding for Lending Scheme (FLS) was temporary and would not be extended we should have known that change was on the cards. This has happened before with the predecessor scheme the Special Liquidity Scheme. Remember it?
When the FLS was first introduced, Sir Mervyn King said it could only be a temporary solution and must be used as a "window of opportunity" to "restore the capital position of the UK banking system". I guess it depends on your definition of temporary and perhaps underlies the problem we have with the banks and the economy not being in the state they need to be right now.
Much has been written about the FLS. Quite a lot of it negative in that it was a blunt instrument, wasn’t being used as intended and should have been made available to other lenders who might be more prepared to focus their lending efforts on the sectors that the government really wanted served: namely lending to SMEs.
I have written about the FLS as well. I have defended it when others have knocked it. I have recognised that it has done some good for all lenders whether directly or indirectly. The amount of liquidity it has provided has allowed Libor rates to fall to more acceptable levels without supply shortages pushing up rates. Yes it has been unfair in not providing support to non-banks although I think we have to recognise that the Bank is trying to provide solutions within existing frameworks (the Sterling Monetary Framework in this case) that have the biggest impact on the markets and economy possible without providing an unwieldy solution.
I have also argued that the FLS should cease when the Bank said it would because it is going to dampen the revival of the core funding markets – covered bonds and securitisation - that we really do need to see re-emerging in rude health. How will we know when to believe them when they really mean to withdraw it? Yesterday’s news won’t help on that score.
The other issue that the Bank has had to work around are the State aid rules. You can guarantee that any changes of the scheme to focus assistance to one sector or another will be scrutinised by hordes of apparatchiks sitting in Europe to determine whether this constitutes an unfair distortion to the markets.
But however they have done it, this FLS Mark 2, the “Super Improved” version has done just that: under the new deal, every pound of additional lending to small and medium-sized enterprises (SMEs) next year will allow the lender to access £5 of discounted funding from the Bank and in an effort to accelerate the flow of credit into the system, each pound lent to SMEs for the rest of this year will allow a draw-down of 10 times that in 2014. This shows how seriously they are taking it.
And what of the other announcement, that non-banks can have a look-in but not directly? Well I share some of the scepticism I have read online that this won’t work because trying to find a bank to act as a ‘conduit’ through to the FLS is going to be hard in practice. But better than nothing. At least there is a mechanism for access and the more imaginative among us can work with that. We have to remember, the Bank isn’t trying to be fair, it’s trying to find a solution that works in the way they need it to and quickly. Inevitably that means a tweak of the existing scheme rather than a wholesale re-write. That automatically rules out direct access for non-banks.
So having seen the original FLS, how will the sequel pan out? One to watch. I suspect we may not have heard the end of this one.

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