April 24 (Bloomberg) -- The Bank of England will extend by one year its plan to provide cheaper loans to companies and consumers and increase incentives to get funds to smaller firms, enhancing a nine-month-old program to aid the economy.
The Funding for Lending Scheme will now last until January 2015, make loans to small companies more attractive and be open to non-bank lenders, the BOE and the Treasury said in London today. While credit conditions have improved since the FLS started, “there remain risks of renewed stresses in bank funding markets” because of the euro-area crisis, they said.
Chancellor of the Exchequer George Osborne and BOE Governor Mervyn King are expanding the program on the eve of economic statistics that may show Britain’s economy was close to an unprecedented triple dip in the first quarter. The announcement also precedes an audit of the U.K. by the International Monetary Fund, whose delegation visits London next month after the fund said Osborne should ease his austerity plan to aid growth.
The FLS revamp will give banks “continued assurance against the risk that market funding rates increase, especially in the light of continued uncertainty in the euro area,” King said in a letter to Osborne. It will “help to maintain easier funding conditions for banks into 2015, and thereby help to support credit conditions and the recovery.”
The move comes as BOE policy makers split on whether to increase their quantitative-easing program. The Monetary Policy Committee kept its QE target at 375 billion pounds ($572 billion) on April 4 as a push by King and two other officials was defeated by a majority on the nine-member panel.
Royal Bank of Scotland Group Plc said today’s FLS extension may lower the probability of future bond purchases. U.K. government bonds opened little changed, leaving 10-year yields at 1.71 percent as of 8:04 a.m. London time. The yield on two-year notes was at 0.26 percent.
“Focusing the BOE easing bias towards targeted credit measures means the need for more gilt purchases is less pressing,” RBS analysts Simon Peck and Andrew Roberts said in an e-mailed note to clients. They also said the “immediate follow through on bank funding costs is likely to be less pronounced than the launch of the original FLS.”
Today’s FLS overhaul will allow banks to borrow 10 pounds next year for every 1 pound they lend to small companies in 2013, the Treasury said. If they wait to extend the loan until next year, the amount they can borrow under the plan is halved to 5 pounds for every pound loaned. Banks can borrow 1 pound for every pound loaned with the rest of the program.
The plan is also being expanded to allow access to some non-bank lenders such as financial leasing corporations, which are a source of credit for smaller companies.
The targeting of smaller firms follows evidence that they have only seen a limited benefit from the FLS. In a survey on April 3, the BOE said while credit availability for companies improved in the first quarter, this was confined to large firms.
“It is important that we continue to support the real economy,” Osborne said. “As the impact of the scheme on small-and medium- sized firms has taken longer to develop, I welcome the extension.”
Simon Hayes, an economist at Barclays Plc in London, said the enhancements increase the chances the FLS will be “effective,” while noting that weak credit demand is part of the problem. “The FLS is likely to provide a boost when confidence returns to the economy, but confidence is the elusive factor,” he said.
The credit program began operating in August and allows banks to borrow treasury bills from the central bank to fund lending. Under the original plan, they had 18 months to use the facility. That plan also only allowed banks with access to the BOE’s discount-window facility to use the program.
The government says the program has lowered borrowing costs by about 100 basis points and provided 13.8 billion pounds between its creation and December. Osborne, who has refused to ease his fiscal squeeze, said today’s announcement complements his strategy of “fiscal responsibility and monetary activism.”
BOE data this month showed that U.K. net lending to companies dropped by 2.8 billion pounds in February after a 300 million-pound decline in January. In the three months through February, the stock of lending to both small and medium-sized enterprises and large businesses also contracted.
The BOE said last month that while there are “indications of an improvement” in credit conditions because of the FLS, “it will take time for this to feed through to lending volumes, given the typical lags involved.”
“The impact of the FLS is likely to be more marked in coming months,” BOE policy maker Ian McCafferty said yesterday.
A report this week showed a factory index unexpectedly fell to the lowest in 2 1/2 years this month. The economy probably grew 0.1 percent in the first quarter, according to a Bloomberg News survey, barely escaping another recession after shrinking 0.3 percent in the previous three months. The Office for National Statistics will release the data tomorrow.