BofE Program Boosts Lending Incentives

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The Bank of England (BofE) on Friday launched  its Funding for Lending Scheme (FLS)  that will allow U.K. banks and building societies to borrow up to 5% of their stock of existing lending to the real economy, which is equal to roughly £80 billion ($125 billion) across all potentially eligible banks and building societies.

The plan is designed to boost new lending growth in the U.K. real economy.  From August 2012 to February 2014, banks and U.K. building societies will be able to borrow U.K. Treasury Bills from the BofE for up to four years against collateral, securitizations.

For banks or building societies maintaining or expanding their lending over that period, the fee will be 0.25% on the amount borrowed, according to a BofE press release. 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.

For banks or building societies whose lending declines, the fee will increase linearly, up to a maximum of 1.5% pa where lending decreases by 5% or more. Access to the scheme will be for those banks and building societies who sign up for the BofE's Discount Window Facility.  

“This joint action by the Bank and the Treasury creates strong incentives for banks to expand their lending to the real economy," said Mervyn King, the Governor of the BofE, in the press release. "The more banks expand lending, the more they can use the Scheme. That will encourage banks to make loans to families and businesses both cheaper and more easily available."

Barclays Capital analysts think that the scheme satisfies some key BofE goals. It would likely spur competition on the high street by incentivising new entrants to enter the market. It also assists the consumer by increasing lending at affordable prices. Offering a welcome potential side effect, the program can improve public sentiment by passing on the lending costs to the banks.

But, there will probably cause significantly less issuance volume from U.K. RMBS issuers. The shorter-term funding offered by last month’s announcement of the Extended Collateral Term Repo (ECTR) Facility already gave banks funding on the shorter end of the curve and thus analysts expect issuers to target longer duration. This new FLS facility now gives enough assistance for longer-term funding, with the maximum at four years from January 31, 2014. This will limit the need for other secured forms of term funding such as RMBS and covered bonds, Barclays analysts said.

While the scheme is in effect over the next few years, analysts also expect limited volumes from large issuers that would want to keep the RMBS avenue open. They added that smaller deals will be placed far less frequently than currently and mid-sized firms such as building societies might also find the scheme restrictive given the increase in the net lending requirement.

However, analysts also expect prepayments to rise for U.K. RMBS deals given the reduced mortgage lending rates. This would entice borrowers to re-mortgage once they come to the end of their teaser period. This can lead to a reversion to the pre-crisis scenario when borrower rate-hopping at the end of the teaser period became the norm, they said.


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