The Bank of England said its new lending plan could boost credit to companies and households by at least 80 billion pounds ($124 billion) as it unveiled the details of its latest weapon against the euro crisis.
Banks will be able to borrow treasury bills from the central bank from Aug. 1 to fund lending into the economy, according to details of the Funding for Lending Scheme published in London today. Banks will have 18 months to use the facility and then up to four years to repay.
The program, designed with the U.K. Treasury, is the latest in a series of measures introduced to help the economy fend off contagion from the turmoil in the euro area and recover from a recession. The Bank of England activated a sterling liquidity facility in June to ease potential strains on banks and restarted quantitative easing last week.
“This joint action creates strong incentives for banks to expand their lending to the real economy,” Governor Mervyn King said in a statement. “That will encourage banks to make loans to families and businesses both cheaper and more easily available.”
HSBC Holdings Plc won’t participate in the new program, saying it will “continue to fund its planned lending growth through its own resources.” It added that it “would not hesitate to join” the scheme if circumstances change.
Under the collateral swap, a bank can borrow treasury bills worth an initial 5 percent of its existing stock of loans to the non-financial sector as of June 30, plus “any expansion of its lending during a reference period from that date to the end of 2013.” Banks will pay a minimum fee of 0.25 percent of the amount borrowed provided they maintain current lending levels or increase them.
The fee will climb by 0.25 percent for each 1 percent drop in lending, rising to a maximum 1.5 percent if their lending contracts by 5 percent or more. The Bank of England said this creates an additional incentive to boost lending.
“After accounting for the cost of using the T-bills to borrow money, the total cost of funding for an institution using the FLS will be lower than current term funding rates, even for the strongest institutions,” the Bank of England said. “So as banks increase lending, their overall funding costs will fall.”
The central bank said collateral currently accepted in its discount window facility will also be accepted for the FLS. It will also accept pools of loans to the real economy. As of March, lenders had pre-positioned 265 billion pounds of securities as collateral, and the Bank of England can lend about 160 billion pounds without the need for further checks.
The central bank will publish the amount banks draw down from the FLS and net lending figures on a quarterly basis. Banks that sign up to the facility must agree to details being published, it said. George Buckley, an economist at Deutsche Bank in London, said the effectiveness of the scheme “will of course depend on how much of the weakness in lending is a credit supply versus demand issue.”
The new program was announced by King and Chancellor of the Exchequer George Osborne last month. Since then, King has said the outlook for the economy has worsened. The central bank said today that U.K. bank lending “was more likely to decline than increase over the coming 18 months” without the FLS.
“The success of the scheme will depend on the extent to which it can prevent that projected outcome,” it said.
“Today’s announcement aims to make mortgages and loans cheaper and more easily available, providing welcome support to businesses that want to expand and families aspiring to own their own home,” Osborne said in a statement. “We are not powerless to act in the face of the euro-zone debt storm.”