June 20, 2012 10:54 am

Banks to get cheap money to lift UK lending

A stash of UK pound coins and bills

The government’s new “funding for lending” programme, designed to boost credit for British business, will cut banks’ costs to as little as 1.2 per cent, according to people briefed on the scheme.

The supply of such cheap money to the banks is supposed to encourage them to lend to companies and stimulate the sluggish economy.

Under current plans, which are still being revised the rate at which banks could borrow government money would start at the baseline Libor rate plus 125 basis points and fall to a minimum possible surcharge of just 25 basis points, according to one senior banker.

At current Libor rates, that would suggest a minimum funding cost of less than 1.2 per cent, comparable with the 1 per cent charged by the European Central Bank’s for its €1tn longer-term refinancing operation early this year.

“This will end the scepticism surrounding the ‘funding for lending’ plan,” the banker said. “This will give everyone good reason to expand lending.”

The details of the funding for lending scheme emerged as minutes from the Bank of England’s Monetary Policy Committee meeting earlier this month signalled that it was prepared to step up monetary stimulus.

In the US, the Federal Reserve extended Operation Twist – a plan to sell short-term bonds while purchasing longer-term securities – to support a slowing economic recovery, but refrained from a more aggressive plan to ease monetary policy.

According to the Bank of England minutes, the nine-member MPC narrowly defeated a proposal, supported by Sir Mervyn King, the governor, to begin immediately a £50bn round of gilts purchases in an extension of the existing £325bn quantitative easing programme.

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Although a majority of five MPC members opposed the move in early June, most accepted that “further stimulus was likely to become warranted at some point” but preferred to wait for the outcome of events elsewhere in Europe that could have a bearing on the financial sector.

Many economists are forecasting that a gilts purchase programme of £50bn to £75bn will be unveiled with the MPC next meets on July 5.

The MPC minutes also spelt out several other options for monetary stimulus, including a cut in bank rate from its current historic low of half a percentage point, where it has been for three years.

Although this option was discarded for the moment out of concerns about its effects on bank profit margins and lending, the minutes made clear that the MPC might reconsider it in the future.

“The underlying message is that the MPC are deeply alarmed at the state of the economy,” said Michael Saunders, economist at Citi. “The situation is sufficiently bad to consider a whole range of options besides QE in their primary toolbox.”

Analysts said the mooted structure of the funding for lending programme represented a switch of government tactics, introducing a “carrot” mentality. This would replace the “stick” of public admonishment for failure to meet last year’s lending targets, which were set out under the Merlin programme.

When George Osborne, chancellor, announced the initiative last week, he suggested it would lead to a £100bn lending boost.

Bankers said £80bn – equivalent to 5 per cent of outstanding non-financial lending – would effectively replace existing borrowing backed by more expensive funding. Any lending growth beyond that would become steadily cheaper, with a 25 basis point reduction for each 1 percentage point increase in net lending the most likely scenario.

Separately, the Bank said on Wednesday that UK banks had taken up the full £5bn allotment of funds in its first auction under its extended collateral term Repo facility. The auctions offer UK banks access to funding in instalments of no less than £5bn each month at a minimum 25 basis points spread over the bank rate, which is currently set at 0.5 per cent.

The facility, activated last week, is designed to respond to actual or potential stress in the system triggered by the eurozone crisis.

The Bank gave no detail of how many banks had taken up the facility. But the funds were cleared at the minimum 25bp spread, suggesting that there are no bug stresses in the UK banking system at the moment.

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