UK Funding for Lending Scheme fails to spur credit creation

George Osborne predicted the Funding for Lending Scheme would provide a "big boost" to small and medium-sized businesses when he announced an extension to the initiative in April.

Yet, the latest disappointing lending figures on Monday underlined why the government felt the need to strengthen its credit creation scheme.

Banks pulled back on lending to British businesses and households for the second consecutive quarter in the three months to March. The stock of loans made by the 40 banks participating in the Funding for Lending Scheme (FLS) fell slightly, by £300m, following a sharper contraction in the final quarter of last year.

Bank of England and Treasury officials pointed to lower borrowing costs as evidence that the FLS was having a positive impact on credit conditions. But the big picture is that banks are continuing to shrink their loan books; since last June the outstanding stock of loans granted by participating banks, which together make up 80 per cent of lending to businesses and households, has fallen by £1.7bn.

That the FLS has failed to boost net lending owes a lot to what has happened to the loan books of the UK's biggest banks.

All of the major high street lenders have taken part in the scheme except HSBC. But of the four big banks participating, only Barclays has expanded its loan book since the scheme was launched.

Lloyds Banking Group and the Royal Bank of Scotland, the two part-nationalised banks, and Santander are all lending less than they were at the end of June 2012.

The UK loan books of Lloyds and RBS, both institutions that were expected to shrink their balance sheets substantially in the aftermath of the financial crisis, are now 1.5 per cent and 1.8 per cent smaller than they were before the introduction of the government's scheme. Lloyds has drawn down £3bn of cheap loans through the facility, RBS £750m. Santander's UK loan book is more than 4 per cent smaller than at the end of last June.

Nationwide, the UK's biggest building society, has expanded its loan book since the scheme began and many of the UK's smaller lenders have also lent more over the past year.

The BoE refused to write off the FLS, calling for more time for the improvements in credit conditions to feed through to lending figures "given the typical lags involved in the loan application, approval and drawdown process".

The BoE added: "Prior to the launch of the FLS, bank staff judged that UK bank lending was more likely to decline than increase over the subsequent 18 months. Net lending is expected to pick up and become modestly positive over the remainder of the year."

The scheme was launched jointly by the BoE and the Treasury last summer and extended in April until the start of 2015. Incentives for banks to lend to small and midsized businesses were also increased and the scheme was extended to some non-bank credit providers such as financial leasing corporations.

However, even after these enhancements, economists and BoE officials do not expect the revamp to have a dramatic impact on lending volumes.

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