This note reports on information that has become available since the staff report (SM/12/168) and staff supplement were issued and does not alter the thrust of the staff appraisal.

The Bank of England and UK Treasury announced details of the Funding for Lending Scheme (FLS) on July 13, 2012.¹ The FLS is designed to reduce funding costs for banks and building societies so that they can make loans cheaper and more easily available. Access to the scheme will be directly linked to how much each bank and building society lends to the real economy. Those that increase lending will be able to borrow more in the scheme and do so at a much lower cost than those that scale back their loans.

Terms of the Scheme: Under the scheme, from August 1 (and for 18 months thereafter), UK banks will be able to swap up to 5 percent of their existing stock of loans to the non-financial sector as at end-June 2012 (amounting to around £80bn) for T-bills. In addition, banks will also be able to swap unlimited amounts for new lending.

• The funding will be provided against a wide range of collateral, with haircuts applied on the same terms as the BoE’s existing Sterling Monetary Framework. The swap will be for a fixed term of four years, and the fee will depend on banks’ lending behavior during a reference period of end-June 2012 through the end of 2013.

• For banks maintaining or expanding their lending over that period, the fee will be 0.25 percent per year on the amount borrowed. For banks whose lending declines, the fee will increase linearly up to a maximum fee of 1.5 percent of the amount borrowed. With banks being able to use T-bills to borrow money at rates close to the expected path of the policy rate (now at 0.5 percent), the total cost of obtaining cash under the scheme will vary between 0.75 and 2 percent.

• The BoE will publish participants’ outstanding drawings under the scheme on a quarterly basis.

The FLS could be more successful in boosting bank lending than previous measures. An important innovation of this scheme is that the pricing is designed to encourage an expansion of net lending, consistent with staff advice during the consultation discussions. Importantly, if banks maintain or expand their lending, the lower fee of 0.25 percent will apply to all of the funding they obtain through the scheme and not just on the incremental funding they receive to engage in new lending. Therefore, banks will have a strong incentive to maintain or increase market lending, or else suffer the penalty of an increase in their overall funding costs. Moreover, the FLS loans are for a period of four years, longer than the terms of the other facilities available, including the ECTR, which provides 6-month funding. Although it is unclear what final effect the FLS will have on demand and growth, it should help keep funding costs low for the target market.