Funding for Lending: A Big & Important Change
The Bank of England is amending the Funding for Lending Scheme from next year so banks will no longer be able to access cheap finance for mortgage borrowing. Instead the scheme will be entirely focused on SMEs.
This is both news and good news. As the Bank says today:
Although the growth in household loan volumes remains modest, activity in the housing market is picking up and house price inflation appears to be gaining momentum. As a result there is no longer a need for the FLS to provide further broad support to household lending.
That’s a close as the Bank can really come to say ‘we’re a bit concerned about the housing market’.
I have also worried that FLS took too much of a ‘scatter gun approach’ as I wrote last year I had three primary concerns:
firstly it might not actually boost net lending, secondly in the final analysis the success of otherwise of the scheme will depend on the behaviour of the big banks and finally it provided no control as to where the net lending actually goes…
The big question though is exactly what kind of lending is growing? The Bank data doesn’t distinguish between lending to business and lending to households. Other data suggests that lending to business is still falling. It may well be the case that lending for mortgages is growing at a weak pace whilst lending to firms continues to contract.
A year later it is clear that FLS succeeded in improving access to credit for households but did little for SMEs.
Consider the following numbers:
Over the last 12 months lending to private non-financial firms has fallen by 2.1%.
Lending to manufacturers has fallen by 3.9%.
Lending to construction firms has fallen by 6.7%.
Lending to SMEs has fallen by 3.2%.
Mortgage lending has risen by 0.6%.
Why this is really big news is that FLS appears to have been one of the larger factors behind our current recovery.
However, from mid-2012 onwards this trend has reversed. During the year to July, households increased their unsecured borrowing by almost £5.4bn.”
“The cause of this switch is unclear, but one factor is likely to be recent falls in the interest rates on personal loans. While the rates for personal loans of up to £10,000 have been on a broadly downward trend since late 2009, the rate for smaller loans fell quite sharply at the end of 2012. These may be indicative of the effects of the Funding for Lending Scheme which was announced in July 2012, although it is difficult to identify the impact of this scheme and that of a more general easing of credit conditions.
The change in household behaviour over the past year may be associated with the performance of the housing market. House prices have been rising since 2011, and this may in turn have influenced household confidence and expenditure.”
I.e. Funding for Lending both directly thoroughly lowering unsecured borrowing rates and indirectly through boosting housing market activity has been factor behind the falling household savings ratio, which is the key driver of consumption growth in recent quarters – which itself is the driver of the recovery.
Unless real wage growth picks up strongly there is a danger that consumption growth will weaken.
Of course two other factors might now come into play – the role of Help to Buy might provide a further fillip to the housing market essentially replacing FLS or banks might now feel confident to continue lending at lower rates even without the cheap finance.
The reason that I think changing FLS is a good thing is the increasingly evidence that a rising housing market is bad for business lending. As one paper found:
Policymakers have argued for the need to support important asset markets, such as housing, with the intent of increasing consumer wealth, consumer demand, and real economic activity… Such intervention may very well increase consumer wealth and consumer demand; however, if the banks are interested in reaping the returns in these supported markets at the expense of commercial lending, firms may be unable to increase investment and real activity in response to that demand.
Our recovery to date has been focused on rising consumption underpinned by rising household borrowing. Today’s action from the Bank may well cool it. The hope is that business investment will kick in as a more solid component of growth – although that has yet to really begin.
Despite today’s announcement being a joint one from the Bank and the Treasury, the cynic in me suspects the Bank is behind this move.
The Chancellor likes nothing better than to hail low mortgage borrowing rates and today’s announcement puts that at risk.
Fundamentally the problem is one of system design and the nature of growth. As I’ve long argued the current macroprudential framework in the UK (the FPC, new powers for the Bank, etc) was designed to sit alongside a ‘new economic model; of growth based on net exports and rising business investment.
After the economy stagnated from late 2010 until mid 2012, the Chancellor (at least in the short term) gave up on a serious attempt at rebalancing in favour of asset price, debt led consumer growth.
There are fundamental tensions between the nature of the recovery we have and the Bank’s new financial framework.
This looks like a sensible move from the Bank but one unlikely to be welcomed in Number Eleven.