15 Jun 2012

Bank of England offers £80bn loans

Plans for a multi-billion pound emergency bank funding scheme are the latest attempt to spark the UK’s economy – but will they work?

Bank governor Sir Mervyn King and Chancellor George Osborne announced they were working together on a “funding for lending” proposal to ward off a worrying new phase of the credit crunch.

Under the proposals, expected to be worth around £80bn, British banks – facing higher funding costs and under pressure to put more capital aside – will be offered vital support at low interest rates to provide loans at a cheaper rate than international markets as long as banks use the money to provide credit to households and businesses.

The scheme is expected to be in place within a few weeks and will last for four years.

But will they work? Economists believe fears over the eurozone will outweigh any desire by banks to increase lending, even with cheaper rates.

Vicky Redwood of Capital Economics said: “High bank funding costs are just one challenge facing the UK economy. Indeed, these moves on their own will do little to reduce the effect of the eurozone crisis on UK exports or reduce the uncertainty facing UK companies.”

Eurozone fears

Graeme Leach, chief economist at the Institute of Directors, said the schemes were “welcome, but limited”. He added: “The liquidity scheme will need to be massively expanded if break-ups spread across the eurozone.

“The funding for lending scheme helps the supply of money and the demand for it, by lowering the cost of borrowing. But the core problem remains. Companies alarmed by the euro crisis will not be eager to borrow, regardless of the cost.”

Ismail Erturk is a senior lecturer in banking at Manchester Business School.

He said: “The Bank of England has been doing this since 2008 and there is no evidence that it is working. What the UK needs is an intelligent comprehensive policy to reform banking and to allocate capital to the right industries that can generate growth and employment. Aimless fire power will not work.”

Figures for the first quarter of 2012 show lending is still in the doldrums.

Home loan approvals fell to 48,986, their lowest in eight months, in February. This was in line with analysts’ expectations and prompted warnings from mortgage brokers that conditions resembled the “dark days” of the banking crisis in 2008.

For small, medium and large companies, the total amount of credit available to them was unchanged in the three months to March â?? in contrast to the predictions of lenders, who had expected it to rise.

Businesses repaid £4bn more than was granted in new loans, according to the Bank of England’s latest lending data, which showed a three-month contraction of 7.9 per cent for February â?? the weakest figure since September 2009.

‘Devil in the detail’

The Federation of Small Business (FSB) has been sceptical of schemes aimed at helping the small business get credit from big banks.

The national loan guarantee scheme, unveiled in March, sees businesses with a turnover of less than £50m receive cheaper loans under a government programme which guarantees £20bn of loans from major high street banks.

As the Federation of Small Businesses makes clear, despite the launch of the NLGS, if you did not qualify for a loan before, you are unlikely to qualify for one now.

It said: “The FSB welcomes the ‘funding for lending’ scheme and hopes that this will be the kick-start for banks to lend that small businesses need.

“As with prior small business lending schemes the devil will be in the detail so we await to see exactly how this scheme will result in banks changing their view of credit risk and more small firms’ applications being accepted.

“The banks have long said that it is a lack of demand that has reduced lending, but the FSB’s own research shows of those firms applying for credit around 40 per cent are rejected.

“Coupled with that is the fact that of the 2,000 firms that took their banks’ decision not to lend to the independent appeals adjudicator, four in 10 were successful at getting the decision reversed.”

Shadow Chancellor Ed Balls was critical, saying the proposals “do not go far enough”.

“The governor is now recognising what the Chancellor still refuses to – that urgent action to stimulate the British economy is needed now that we are in a double-dip recession.

“The Bank of England’s new funding for lending scheme is a significant admission that the Government’s existing policies have failed.”